August ’17

The BAN Report: The $8MM Eastern SBA 504 Portfolio / Fed Waffling Over Rate Increases? / Family-Owned Banks Near Endgame / Loosen De Novo Capital Requirements? / Total Solar Eclipse Monday-8/16/17

The $8MM Eastern SBA 504 Portfolio

Clark Street Capital’s Bank Asset Network (“BAN”) proudly presents: “The $8MM Eastern SBA 504 Portfolio.”  This exclusively-offered portfolio is offered for sale by two institutions (“Seller”).   Highlights include:

  • A total unpaid principal balance of $8,123,034, comprised of 4 loans
  • All loans are performing SBA 504 1st mortgages
  • Portfolio has a weighted average coupon of 6.32%
  • All loans are secured by first mortgages on limited service hospitality properties
  • Assets are located in Florida, New York, Ohio, and Indiana
  • All loans have personal guarantees
  • All loans have prepayment penalties
  • Opportunity to acquire depository relationships
  • Community Reinvestment Act (“CRA”) eligible
  • All loans will trade for a premium to par and any bids below par will not be entertained

Loan files are scanned and available in a secure deal room for review.    Based on the information presented, a buyer should be able to complete the vast majority of their due diligence remotely.

Please read the executive summary for more information on the portfolio.  You will be able to execute the confidentiality agreement electronically by clicking on the upper left hand corner of the link to the executive summary.

Fed Waffling over Rate Increases?

The Federal Reserve is split on the timing of the next rate increase, according to the minutes from the meeting last month.

Minutes from the July 25-26 meeting released Wednesday reveal growing concern among some officials that recent soft inflation numbers could be a sign that something has fundamentally changed in the economy, leading them to suggest holding off on raising rates again for the time being.

But officials also agreed to soon begin the yearslong process of shrinking the central bank’s securities holdings, perhaps as early as September, according to the minutes released following the customary three-week lag.

The Fed has raised its benchmark short-term rate twice this year and in June penciled in one more for 2017, without indicating when that might occur. But some officials at the July meeting argued against another increase until the data “confirmed that the recent low readings on inflation were not likely to persist and that inflation was more clearly on a path toward” their 2% target.

The Fed “could afford to be patient under current circumstances,” they said.

Others, however, worried that the strong labor market could produce a spurt of inflation above 2% that could be difficult to control. This group cautioned that waiting too long to raise rates “could result in an overshooting of the [Fed’s] inflation objective that would likely be costly to reverse,” the minutes said.

Yields on the 10-year Treasury note fell following the release of the minutes, and the dollar weakened.

Conflicting economic data is the culprit and markets are no longer sure there will be another rate increase this year, as investor surveys show only 50% believe there will be one.     We think another rate increase is highly probable, and the question is when, not if.    But, after the next rate increase, it might be awhile before the Fed acts again.

Family-Owned Banks Near Endgame

While family-owned banks are not going anywhere, many are approaching a critical juncture, as the next generation has different attitudes during the industry, according to a great story in the American Banker.

Many face the same hurdles as other banks, including regulatory costs, heightened competition and revenue challenges. A large number of family owned banks are small and closely held, creating concerns about scale and raising capital.

Other wrinkles include family succession and tax and estate planning. Many members of the current generation were responsible for navigating their banks through the financial crisis and its aftermath.

To be sure, there are advantages to being family owned. Owners have more skin in the game than many other institutions. And being closely held often allows management to be nimble and make long-term decisions without having to sell their strategy to a large investor base.

All of these factors weigh on family-owned banks, particularly when one generation is looking to step aside. In that moment, the family is left with three options: promote a new leader from within, hire an outsider or hire an investment bank to sell the bank.

We have worked with several family-owned banks and we have noticed a lack of interest from the next generation in the bank.   Perhaps, continuous regulation isn’t as fun as managing an office building portfolio or an operating business.

The trigger point will be either the death or retirement of the primary family owner.    Death brings a fat estate tax bill that needs to be paid.   Many self-made owners don’t want to see their asset mismanaged by outsiders, so retirement often means a sale or recapitalization.

There are several large family-owned banks, including First Citizens, BOK Financial, and Arvest Bank, all of which are over $10 billion.

Loosen De Novo Capital Requirements?

Federal Financial Analytics released a paper this week, advocating lowering the capital requirements of De Novo Banks, in order to encourage more formations.   It’s a provocative idea that is worth discussion, although mostly from an economic development standpoint.

The post-crisis capital requirement for start-ups regardless of business plan and actual risk profile is essentially a sin tax levied against new charters for the sins of old ones before the crisis and, perhaps, those of the FDIC and other regulators that chartered them. As with so much in post-crisis regulation, regulatory-capital requirements lie at the heart of each new bank’s strategic dilemma.

When we looked at a new bank, the FDIC required that it hold an eight percent leverage ratio (LR) – more than double the LR otherwise required of small banks and even well above the six percent enhanced supplementary LR required of the nation’s largest and, the FDIC believes, riskiest banks. The FDIC has belatedly recognized the cost of its sin tax on new charters. As a result, it has shortened the time a new bank has to be in the penalty box. In its most recent handbook on new-bank charters, the FDIC has relented somewhat – now, the eight percent LR is required only for three years, not the initial seven-year span that deterred virtually all possible new entrants.

A necessary change, but far from sufficient to spur new charters. Shortening the time investors lose money doesn’t mean they still won’t lose it in amounts and for longer than likely in other investment opportunities – and there are many of them.

Is the three-year sin tax an insuperable barrier to new charters? Rising interest rates may boost profitability along with improved economic growth, but three years of punitive capital standards and uncertain relief in subsequent years make the twenty percent ROI conservative investors demand difficult, if not impossible. In short, few new charters are to be had since new, traditional charters take investors and the investors we know whom the FDIC might approve have taken a hike.

There’s no question that investor interest in de novo banks has been slim, so yes, lowering regulatory standards for de novos would prompt more interest.    But, a lot of de novos did poorly in the last decade, so the risks from a safety and soundness protective are high.     Moreover, there are still many existing charters that are seeking capital, so why work too hard to create new ones while there is still excess supply?   Nevertheless, the total lack of charter formations is a problem and should be addressed.

Total Solar Eclipse Monday

Lunch breaks on Monday may be longer than usual, as millions observe the first total eclipse of the sun in decades.    If you miss it, the next one won’t be until 2024.   The best places to view the eclipse are in the middle part of the country from Charleston, SC west towards Nashville, St. Louis, and west through southern Oregon.   NASA listed hundreds of events by location on their website.

On Monday, August 21, 2017, all of North America will be treated to an eclipse of the sun. Anyone within the path of totality can see one of nature’s most awe inspiring sights – a total solar eclipse. This path, where the moon will completely cover the sun and the sun’s tenuous atmosphere – the corona – can be seen, will stretch from Salem, Oregon to Charleston, South Carolina. Observers outside this path will still see a partial solar eclipse where the moon covers part of the sun’s disk. NASA created this website to provide a guide to this amazing event. Here you will find activities, events, broadcasts, and resources from NASA and our partners across the nation.

Mashable had a great video on what is exactly going to happen on Monday.    Be sure to check it out!

The BAN Report: SNC Portfolio Risk Declines / New GE CEO Takes Reins / The Benefits of Tax Reform / US Auto Sales Slump-8/3/17

SNC Portfolio Risk Declines

The Agencies released their semi-annual review of the Shared National Credit Program (SNC).    The findings suggest that, while still elevated, risk in the portfolio is declining.

Risk in the portfolio of large syndicated bank loans declined slightly but remains elevated, according to the Shared National Credit (SNC) Program Review released today by the Federal Reserve Board (Federal Reserve), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC).

The high level of credit risk in the SNC portfolio stems primarily from distressed borrowers in the oil and gas (O&G) sector and other industry sector borrowers exhibiting excessive leverage. The review also found that credit risk management practices at most large agent banks continued to improve, consistent with the 2013 Interagency Guidance on Leveraged Lending.

The percentage of non-pass commitments decreased year-over-year from 10.3 percent to 9.7 percent of the SNC portfolio. Commitments rated special mention and classified decreased from $421.4 billion in 2016 to $417.6 billion in 2017.

A shared national credit is any loan or formal loan commitment, and any asset such as real estate, stocks, notes, bonds, and debentures taken as debts previously contracted, extended to borrowers by a federally supervised institution, its subsidiaries, and affiliates, that aggregates to $20 million or more and is shared by three or more unaffiliated federally supervised institutions, or a portion of which is sold to two or more unaffiliated federally supervised institutions.

Credit must be given to the Agencies for their foresight in attacking leveraged lending in 2013, which is responsible for much of the risk in this portfolio.     Problems in the oil and gas sector appear to have peaked as well.

New GE CEO Takes Reins

John Flannery started work this week as CEO of General Electric, replacing Jeff Immelt, who served for 16 years.    On his first day, he sent a letter to his employees.

“I have a relentless focus on three things: customers, team, and execution/accountability,” the letter said. “When we bring those three things together we will create ‘our GE’.”

Flannery is encouraging employees in every role and function to always have customers as the “guiding principle.” He is also outlining expectations for a great team, including transparency, candor and an ability to debate real issues, adding that when those aren’t discussed, “we are an accident waiting to happen.”

But it’s the third topic — execution and accountability — Wall Street is sure to key in on.

The new CEO said that over the past month he met with 100 investors face-to-face to get their views on the company as he begins a deep dive into GE’s different businesses, a review expected to culminate in updated guidance come November.

“Investors want us to win — they know that GE has world class businesses and technology with unprecedented global reach and scale. They understand the importance of GE in the world but they think we are underperforming. They are expecting better execution on cash, margins and there is a focus on taking cost out,” he wrote.

“They understand how massive the portfolio transformation has been since 2001, but now we need an intense focus on running the company well. They also expect more accountability internally and externally and asked that we find a way to simplify our metrics.”

“I heard them loud and clear,” he said.

GE’s stock price languished under prior CEO Jeff Immelt, dropping nearly 30% during his tenure.   While he did reorganize the company, shed some lagging businesses and trimmed GE Capital, Mr. Immelt didn’t have Jack Welch’s toughness and single-minded focus on results.    Flannery is calling for some of the candor that Mr. Welch was famous for.    We especially like his three tenets.

“Let’s be amazing for our customers. Let’s be the best team players in the world. Let’s execute and produce results we can be proud of. Let’s win.”

SNC Portfolio Risk Declines

The Agencies released their semi-annual review of the Shared National Credit Program (SNC).    The findings suggest that, while still elevated, risk in the portfolio is declining.

Risk in the portfolio of large syndicated bank loans declined slightly but remains elevated, according to the Shared National Credit (SNC) Program Review released today by the Federal Reserve Board (Federal Reserve), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC).

The high level of credit risk in the SNC portfolio stems primarily from distressed borrowers in the oil and gas (O&G) sector and other industry sector borrowers exhibiting excessive leverage. The review also found that credit risk management practices at most large agent banks continued to improve, consistent with the 2013 Interagency Guidance on Leveraged Lending.

The percentage of non-pass commitments decreased year-over-year from 10.3 percent to 9.7 percent of the SNC portfolio. Commitments rated special mention and classified decreased from $421.4 billion in 2016 to $417.6 billion in 2017.

A shared national credit is any loan or formal loan commitment, and any asset such as real estate, stocks, notes, bonds, and debentures taken as debts previously contracted, extended to borrowers by a federally supervised institution, its subsidiaries, and affiliates, that aggregates to $20 million or more and is shared by three or more unaffiliated federally supervised institutions, or a portion of which is sold to two or more unaffiliated federally supervised institutions.

Credit must be given to the Agencies for their foresight in attacking leveraged lending in 2013, which is responsible for much of the risk in this portfolio.     Problems in the oil and gas sector appear to have peaked as well.

New GE CEO Takes Reins

John Flannery started work this week as CEO of General Electric, replacing Jeff Immelt, who served for 16 years.    On his first day, he sent a letter to his employees.

“I have a relentless focus on three things: customers, team, and execution/accountability,” the letter said. “When we bring those three things together we will create ‘our GE’.”

Flannery is encouraging employees in every role and function to always have customers as the “guiding principle.” He is also outlining expectations for a great team, including transparency, candor and an ability to debate real issues, adding that when those aren’t discussed, “we are an accident waiting to happen.”

But it’s the third topic — execution and accountability — Wall Street is sure to key in on.

The new CEO said that over the past month he met with 100 investors face-to-face to get their views on the company as he begins a deep dive into GE’s different businesses, a review expected to culminate in updated guidance come November.

“Investors want us to win — they know that GE has world class businesses and technology with unprecedented global reach and scale. They understand the importance of GE in the world but they think we are underperforming. They are expecting better execution on cash, margins and there is a focus on taking cost out,” he wrote.

“They understand how massive the portfolio transformation has been since 2001, but now we need an intense focus on running the company well. They also expect more accountability internally and externally and asked that we find a way to simplify our metrics.”

“I heard them loud and clear,” he said.

GE’s stock price languished under prior CEO Jeff Immelt, dropping nearly 30% during his tenure.   While he did reorganize the company, shed some lagging businesses and trimmed GE Capital, Mr. Immelt didn’t have Jack Welch’s toughness and single-minded focus on results.    Flannery is calling for some of the candor that Mr. Welch was famous for.    We especially like his three tenets.

“Let’s be amazing for our customers. Let’s be the best team players in the world. Let’s execute and produce results we can be proud of. Let’s win.”

The Benefits of Tax Reform

Writing in the New York Times, Eduardo Porter made a convincing case for the benefits of tax reform, beginning with a reduction in the US corporate tax rate.

As multinational corporations have hopscotched around the globe to find the most profitable base from which to run their affairs, they have set off furious competition among governments hoping to lure investment by slashing tax rates to the bone.

Smaller countries like Ireland or Hungary have been the most aggressive in this race. But big industrial powers have followed, too. Among the 35 members of the Organization for Economic Cooperation and Development, the policy think tank of the world’s industrialized countries, almost every one has reduced its corporate tax rate over the last 17 years.

There are two exceptions: Chile and, alone among the world’s wealthy nations, the United States.

In the United States, the federal tax rate on corporate profits is stuck at 35 percent— the same as 17 years ago, and more. This inability to adapt to economic reality is a signal of the impossibility, in the United States, of pragmatic, sensible tax reform.

Once one of the lowest among economically advanced countries, the American tax rate on corporate profits is by now the highest. And still, corporate tax revenues amount to only 2.2 percent of the nation’s gross domestic product, half a percentage point less than the O.E.C.D. average. Even Ireland collects more as a share of its economy.

A produced reduction of the corporate tax rate from 35 to 20 percent will cost $1.5 trillion over ten years, so the tough part is where to find the savings.    Lowering deductions sounds great, but the largest ones are so popular.    According to Pew, the largest tax deductions could make up the cost fairly easily, but which ones to cut?     Eliminating deductions for home mortgage interest, and state and local taxes would make up the difference, but these tax breaks are extremely popular.

While there is bipartisan support for tax reform, it is going to be very difficult to achieve.    For example, the last major tax reform effort (The Tax Reform Act of 1986) took two brutal years to accomplish, and led to some unforeseen consequences, such as a real estate recession and SNL crisis.    The author though makes a convincing argument that our current tax code is counterproductive and loaded with distortions.

US Auto Sales Slump

July saw the biggest decline in US vehicle sales this year, dropping 7% from the prior year.

U.S. sales of new cars and trucks fell 7 percent to 1.4 million in July, according to Autodata Corp. It was the seventh straight month of lower sales, and the biggest percentage drop so far this year.

July is often a slower month as buyers vacation and wait for dealers to offer model year clearance events in August and September. This year, big cuts in sales to rental car fleets and commercial customers were also a factor. Hyundai, for example, cut its fleet sales by 77 percent in July.

General Motors said its sales fell 15 percent in July, while Hyundai’s dropped 28 percent. Ford’s sales were down 7.5 percent. Fiat Chrysler’s sales declined 10 percent. Volkswagen’s sales fell 5.8 percent, while Nissan’s sales fell 3 percent. Honda’s sales were down 1.2 percent.

Two major automakers bucked the trend. Toyota’s sales rose 3.6 percent while Subaru’s were up 7 percent.

Analysts have been predicting lower U.S. sales this year as demand levels out after an unprecedented seven straight years of growth. U.S. new vehicle sales hit a record 17.55 million last year.

July’s pace would put annual sales at 16.7 million. That was lower than expected for Alec Gutierrez, a senior market analyst with the car shopping site Kelley Blue Book. Still, he’s maintaining his full-year forecast of 17.1 million sales.

The auto industry is responding with increased incentives.    Nevertheless, this year’s decline is not alarming after such a strong run for the industry, culminating in last year’s record year.    Weaknesses in auto lending may be playing a factor as used car prices have fallen due to an uptick in defaults.

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