BAN Reports

The BAN Report: 80K Retail Closings / Time to Ditch Distressed Credits / No Rush to Raise Deposit Rates: B of A / Beneficial Ownership Rule-4/19/18

UBS Predicts 80K Retail Closings

As consumers shift purchases from retail stores to online, UBS predicts a staggering number of retail store closings by 2025.

UBS analysts examined the supply of brick-and-mortar retail locations that would be necessary to align with the demand to shop in those physical locations. What they found paints a bleak picture for the future for retail stores.

“We [estimate] for each 100 bps increase in [e-commerce] penetration (currently 16%), an additional [9,000] stores would need to close,” the UBS analysts write. “To put this in perspective, it would be the equivalent of 7 Toys ‘R’ US chains.”

What’s more, UBS estimates that anywhere from 30,000 to 80,000 stores would need to close to maintain low-single digit sales/store growth should the e-commerce penetration reach 25% of retails sales by 2025. The 80,000 figure assumes that there’s 2% total retail sales growth, while the 30,000 figure assumes there’s 3% sales growth.

Already, we’ve seen a significant number of retail liquidations.

Since 2008, commercial real estate services firm CoStar Group has been tracking the amount of retail square footage slated to close annually. Already in April, more than 90 million square feet of space is expected to be vacated, including Bon-Ton’s stores, in 2018. That’s easily on track to surpass a record 105 million square feet of space shuttered last year, said Suzanne Mulvee, a senior real estate strategist at CoStar. All it will take is another handful of closures.

Sam’s Club, Sears, Bon-Ton, and Toys R Us are just some of the big names shuttering stores. We think it’s difficult to predict where e-commerce penetration ends up at, but I think most people would be surprised that it is still at 16%. For the first time, Amazon announced the size of its Prime membership, which exceeds 100 million people globally.

Time to Ditch Distressed Credits

According to the American banker, banks should be more proactive in disposing of troubled credits in today’s rising interest rate environment.

Now capital levels are higher so banks would be better able to absorb losses, and investors are still hungry to buy distressed assets for good prices. But banks have mostly been reluctant to complete loans sales.

That could be a mistake if credit quality were to take a turn for the worse, and there are a few indicators that new problems could be on the horizon.

“If you are selling assets today, you are probably being more tactical,” said Jeff Davis, a managing director in Mercer Capital’s financial institutions group. “You are thinking strategically as the economic cycle ages, and you are trying to take some chips off the table.”

“Banks still have a pretty elevated level of classified assets because many of them didn’t fully pull off the Band-Aid half a decade ago,” said Jon Winick, CEO Clark Street Capital. “You are starting with a decent sized workout universe to begin with. Now there are new credits coming in.”

There are signs that credit quality could weaken, though certainly no one is predicting an imminent financial collapse. For instance, the Federal Reserve Bank of New York said in a report on household debt earlier this year that credit card delinquencies increased “notably.” The percent of credit card balances that were at least 90 days late rose to 7.55% in the fourth quarter from 7.14% a year earlier, according to the report.

Recently, we have fielded several calls from proactive banks that are looking to get ahead of expected credit weaknesses.   For example, higher rates will push many loans from watch to substandard as many NOIs are flat, yet annual debt service levels are increasing.    A decade ago, many of the banks that sold early in the cycle did very well on those asset sales.

No Rush to Raise Deposit Rates: B of A

Despite multiple rate increases, Bank of America has not yet raised rates on deposit accounts, thus boosting margins.

Like all the major banks, Bank of America has profited from the Federal Reserve hiking its benchmark interest rates, which allows them to make money by charging more for loans, while paying depositors next to nothing for their money.

On Monday, analysts seemed skeptical how long the bank can continue to do that as online banks — and even Goldman Sachs’ consumer bank — have started to offer competitive rates.

“We deliver a lot of value to depositors,” Paul Donofrio, BofA’s CFO, said during the call, citing online banking apps and transparency as some of the perks that customers get instead of interest.

He added there was a “lack of market pressure so far” as one of the reasons why depositor rates have yet to rise in about 10 years.

Banks have been flush with liquidity for so long that they don’t need to do much to keep depositors from leaving for other banks. Of course, this is not going to last forever, and you’ll start to see some upward movement on deposit rates. Nonetheless, there does appear to be more banks that are offering far more than the national average for deposits. For example, the best savings rate on Bank-rate is 2% while the national average is 0.09%, and the best money market rate is 1.77% with a national overage of 0.17%. Bank of America is unique as it has been far less aggressive than its peers in loan growth.

Beneficial Ownership Rule

Effective May 11, banks will be required to comply with FinCEN’s new beneficial ownership rule, which requires financial institutions to identify the beneficial owners of all legal entity customers.   The intent is to combat money laundering, but one of our clients described it as “very onerous and invasive.”   FinCEN published guidance this month.

Covered financial institutions must verify the identity of each beneficial owner according to risk-based procedures that contain, at a minimum, the same elements financial institutions are required to use to verify the identity of individual customers under applicable Customer Identification Program (“CIP”) requirements. This includes the requirement to address situations in which the financial institution cannot form a reasonable belief that it knows the true identity of the legal entity customer’s beneficial owners.

A financial institution’s CIP must contain procedures for verifying customer identification, including describing when the institution will use documentary, non-documentary, or a combination of both methods for identity verification.

The Financial Crimes Enforcement Network set the threshold for identification of a beneficial owner at 25% equity.  To disclose control, a legal entity will need to provide a certification form to the bank with the details of individuals that have significant responsibility in the entity. Matt Howe, Vice President at Lakeside Bank, said “from a compliance standpoint, we are still determining the impact on our lending practices and putting our account officers through adequate beneficial ownership training.   The cost and inconvenience is uncertain at this time.” We are curious to hear from you as to the impact of this new rule on your institution.

The BAN Report: Surging Libor Boosts Bank Profits / America’s Richest Zip Codes / A $1 Billion Tax Bill / Court Rules on Equal Pay / Diverse Networks Increase Firm Value-4/12/18

Surging Libor Boosts Bank Profits
As Libor rates rise to their highest levels since 2008, banks stand to benefit as many variable rate loans are priced using Libor.   
The largest U.S. lenders could each make at least $1 billion in additional pretax profit in 2018 from a jump in the London interbank offered rate for dollars, based on data disclosed by the companies. That’s because customers who take out loans are forced to pay more as Libor rises while the banks’ own cost of credit has mostly held steady.
Since banks aren’t dependent on the short-term overseas markets the way they were 10 years ago, they’re funding much of their operations through deposits. The companies pay those customers interest rates that stayed low even after the Federal Reserve raised its benchmark rate three times in 2017, for a total of 0.75 percentage point. The average rate paid by the largest U.S. banks on their deposits climbed only about 0.1 percentage point last year, according to company filings.
Most banks don’t reveal how much of their lending is at variable rates, or if they do, how much of it is indexed to Libor. JPMorgan Chase & Co., the biggest U.S. bank, said in its 2017 annual report that $122 billion of wholesale loans were at variable rates. Assuming those were all indexed to Libor, the 1.19 percentage-point increase in the rate in the past year would mean $1.45 billion in additional income.
This story singles out Libor, yet all variable rate loans will benefit from higher rates.    The current WSJ Prime rate is 4.75%, which is the highest rate since April 2008.    But, Libor has increased faster from its record lows than Prime has, so it may be that Libor priced loans will benefit banks faster than Prime based loans.   Of course, banks should be shifting away from Libor anyway, as it is scheduled to be eliminated in 2021.  
Chris Marinac of Fig Partners, who has done some extensive research on which banks will benefit from higher rates, said, “The largest banks probably have the most repricing benefits since they tend to use LIBOR pricing much more.”  He added, “The banks are not great at clarifying their precise duration of Earning Assets vs. Duration of Liabilities.”
We tend to agree with Chris as many consumer loans (HELOCs, credit cards) are based on variable rates, and larger banks tend to do better in consumer lending.    
America’s Richest Zip Codes
Bloomberg analyzed IRS data to determine the wealthiest zip codes in the US.   Fisher Island, Florida led the back with an average income of $2.5MM in 2015 – one million higher than the next.
The richest zip code in America is just as exclusive and elite as the people who live there. Fisher Island, located just off the coast of Miami, is accessible only by ferry or water taxi and is a haven for the world’s richest.
The 216-acre island has diverse residents, representing over 50 nationalities and professions ranging from professional athletes and supermodels to executives and lawyers.
The average income in Fisher Island, zip code 33109, was $2.5 million in 2015, according to a Bloomberg analysis of 2015 Internal Revenue Service data. That’s $1 million more than the second-place spot, held by zip code 94027 in Silicon Valley, also known as the City of Atherton on the San Francisco Peninsula. The area’s neighbors include Stanford University and Menlo Park, home to Facebook and various tech companies. While the IRS data only provide the averages of tax returns, which can be skewed by outliers, Fisher Island is the only zip code in the Bloomberg analysis where more than half of all tax returns showed an income of over $200,000.
To no one’s surprise, neighborhoods in California and the New York tri-state area comprise a majority of the top 20 richest U.S. zip codes. States with favorable tax structures like Florida and Wyoming are drawing the wealthy, too.
A zip code in Palm Beach, Florida was third, and a Naples zip code stood at fifteen.     Northern California had 4 of the top-20.    Metro-New York had 4 as well.     We’ve never heard of Moose Wilson Road, Wyoming (near Jackson Hole), but it stood at 14!   
It will be interesting to see how tax reform impacts this list in the coming years.    Of course, measuring wealth solely on income tax returns is imperfect.   Moreover, we suspect many Fisher Island residents make the bulk of their income elsewhere but establish Florida residences for tax purposes.    Seven US states do not have income taxes, including Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.    New Hampshire and Tennessee tax investment income and dividends, but not wages.
A $1 Billion Tax Bill
The good news about a large tax bill is it means you made a lot of money!   John Paulson, a hedge fund manager who bet correctly against subprime mortgages a decade ago, must finally pay the IRS on some taxes that were deferred.  
John Paulson won fame after he made one of the greatest financial bets of all time. What comes next? One of the largest-ever personal tax bills.
By April 17, the hedge-fund manager must make federal and state tax payments of about $1 billion, on top of roughly $500 million in taxes he paid late last year, said people close to the firm. That sum is so big it dwarfs the maximum amount the Internal Revenue Service will allow any single taxpayer to pay with a single check. (That’s $99,999,999, in case you’re wondering.)
Mr. Paulson bet big against subprime mortgages ahead of last decade’s financial crisis, earning about $15 billion of profits for his funds and approximately $4 billion for himself. He deferred the bulk of the taxes on these profits, using a tax provision available at the time to hedge-fund managers, said the people close to the firm. Now the bill is due.
Paulson Partners has struggled the last few years, losing 20% last year and 27% the prior year.    Assets under management have fallen from $38 billion to $9 billion, which is predominantly Mr. Paulson’s personal assets.    Superstar hedge fund managers can fall out of favor fast.    But, we are confident that no tears need to be shed for Mr. Paulson, although a $1 billion tax bill must sting!
Court Rules on Equal Pay
The Ninth Circuit Court of Appeals decided in favor of the plaintiff in Rizo v. Fresno County Office of Education, ruling that wage disparity based on “prior salary alone or in combination with other factors” violated the Equal Pay Act.
The case was heard by the entire 11-judge panel, including the late Judge Stephen Reinhardt. He penned the majority opinion prior to his death last month.
“The Equal Pay Act stands for a principle as simple as it is just: men and women should receive equal pay for equal work regardless of sex,” Reinhardt wrote. “The question before us is also simple: can an employer justify a wage differential between male and female employees by relying on prior salary? Based on the text, history and purpose of the Equal Pay Act, the answer is clear: No.”
Stephanie Bornstein, an associate professor of law at the University of Florida Levin College of Law, told CNN that “this decision stands to make a major difference in the way all women’s pay is determined — and in closing the pay gap.”
“Many employers use prior salary alone or as one factor in setting pay. Because a woman’s pay may be unfairly low to begin with, it perpetuates pay discrimination into the future, from her first job throughout her entire career,” she said. “This ruling means that, even if an employer does not intend to discriminate, it cannot consider prior salary when setting an employee’s pay — it must focus only on job-related factors.”
This ruling is a big deal for employers and will lead to an exponential increase in litigation.   Companies should proactively review their salary levels by gender to avoid becoming defendants in a lawsuit.   
Diverse Networks Increase Firm Value
A study by the Harvard Business Review found that CEOs with diverse networks generate materially greater firm value.
Our study, published in the Journal of Corporate Finance, found that CEOs with strong connections to people of different demographic backgrounds and skill sets create higher firm value. We also found that this greater firm value comes from better corporate innovations and successful diversified M&As. Our work suggests that the diversity of leaders’ social networks is a key ingredient in how they grow their companies.
Our estimation results implied that a CEO who was diversely connected (at the 75th percentile of our diversity index) improved Tobin’s Q by 0.017, compared with an average CEO (at the 50th percentile). And a CEO who was less connected (at the 25th percentile) experienced 0.025 lower Tobin’s Q than an average CEO. To translate the economic magnitude of this: A 0.017 increase of firm value is equivalent to an $81 million increase in market capitalization for a median-size firm in our S&P 1500 sample. Given that the median level of CEO pay of S&P 1500 firms was about $5 million during the sample period, a diversely networked CEO generated an approximately sixteenfold firm market value increase relative to their compensation.
Diversity was measured in six factors, including gender, nationality, academic degrees, majors, professional expertise, and global work experience.    Perhaps, this is a good lesson for all employers, who are often taking few risks in hiring employees, often choosing the person that has done the same job for a competitor, versus someone with well-rounded experience.

 

The BAN Report: Trade War? / Jamie’s Letter / Speculators in Houston / Appraisal Rule Finalized-4/5/18

Trade War?
Over the past two weeks, the US and China have engaged in various proposed tariffs on products, initiated by President Trump.     While the markets have reacted negatively, many believe that a trade war is unlikely.
With its plans to levy 25 percent tariffs on $50 billion of U.S. products including soybeans, cars and aircraft, China looks to have stepped the simmering trans-Pacific economic battle up a gear.
The initial parries between Washington and Beijing resulted in little more than flesh wounds. There were a series of levies on steel and aluminum exports to the U.S., which largely excluded the countries that export steel and aluminum to the U.S.; an impost on China’s infinitesimal imports of U.S. pork, and on a scrap trade that Beijing is already trying to stamp out; and then Tuesday’s heftier $50 billion tariff list from Washington, which was nonetheless carefully crafted to be almost invisible to Joe Sixpack.
Pick apart Beijing’s latest list of countervailing duties and you’ll see that in many areas there’s once again less than meets the eye.
To be sure, the list deals a few headline-grabbing blows to select political constituencies. There’s a special levy on cranberries, which these days are mainly grown in Wisconsin, the home state of House of Representatives Speaker Paul Ryan. Another hits the whiskey industry associated with Senate Majority Leader Mitch McConnell’s base of Kentucky, borrowing a move from the European Union’s tit-for-tat trade war game plan. And let’s not forget those levies on fresh orange juice, calculated to hit growers in the electorally pivotal state of Florida.
Beneath that, though, many of the details suggest a more moderate approach. The duties on aircraft exclude all planes with an operating empty weight above 45 metric tons, a provision that looks to spare every aircraft that matters to Boeing Co. — and, in any case, aerospace companies can get around tariffs by deferring orders to China and bringing forward deliveries to lessors elsewhere in the world.
Of course, this is all predicated on all actors acting rationally.     The President is taking a substantial risk here, and his gambit could harshly impact global growth.   538 had its readers play a trade war simulation, and the results were not encouraging.
Because many readers played this game repeatedly, you gave us a little bit of insight into how trading strategies evolve over time. As reader-presidents learned how the game worked and what strategies tended to be successful, they began to favor unfriendliness and vindictiveness. In other words, you turned nasty as you aged.
The President has made the stock market too much of a referendum on his economic plan that he needs a deal on trade.    Moreover, China cannot match the US in a trade war because it is more reliant on exports than the US.     We believe that cooler heads will prevail, and this trade dispute will end with a whimper.
Jamie’s Letter
JP Morgan Chase released CEO Jamie Dimon’s Annual Letter to the Shareholders this week.   Mr. Dimon sounded an optimistic note.
“We see growth opportunities even in fixed income, currencies and commodities, where we already have the No. 1 market share,” Dimon wrote, pointing to an area where competitors have pulled back amid a slump in client transactions. Those operations will benefit as capital markets around the world expand, and JPMorgan can win more business “in various products and in certain regions where we have low share,” he said.
In other areas — such as investment banking, asset management and consumer and commercial banking — the bank plans to hire, add branches, enter new markets or roll out new technology, he said. In some cases, it already has announced specific targets.
Chase’s biggest geopolitical risks were all related to trade, citing Brexit and the increasing risk to the European Union, and De-globalization, Mexico and China.
We do not believe globalization will reverse course – we believe trade has been absolutely critical for growth around the world and has benefited billions of people. While there are some issues with our trade policies that need to be fixed, poorly conceived anti-trade policies could be quite disruptive, particularly with two of our key trading partners: Mexico and China.
He also had some optimistic views on the stability of the US banking system.
These changes taken together not only largely eliminate the chance of a major bank failing today but also prevent such failure from having a threatening domino effect on other banks and the economy as a whole. And if a major bank does fail, regulators have the necessary tools to manage it in an orderly way. Moreover, the banking industry itself has an inherent interest in the safety and soundness of the financial system because if there is a failure, the entire industry will be liable for that cost.
While it may come across sometimes as self-serving and defensive, Mr. Dimon has been a lone voice defending the US banking system.    The industry needs more spokespeople to defend its practices, as the public still has a negative perception of the industry.
Speculators in Houston
As Houston homeowners continue recovery efforts from Harvey, opportunistic speculators have been stepping in and buying distressed houses.
Mr. Pelletiere is one of the many speculators driving a new — and somewhat confounding — economy in neighborhoods across post-Harvey Houston, one that is especially notable in Canyon Gate, a subdivision built in the 1990s where rice fields once stretched to the horizon. Many parts of the city were hit hard by the hurricane, but Canyon Gate has the extraordinary distinction of being built within the confines of a reservoir specifically designed by the Army Corps of Engineers to protect central Houston from calamitous flooding. Nearly every one of the 721 homes there is destined to flood again, yet the local trade in storm-damaged real estate is flourishing.
Mr. Pelletiere, for his part, sees nothing wrong with buying flooded homes. He said he did not expect everyone to approve of what he was doing, but said that investing in such real estate depended on acquiring local knowledge and accurately measuring the value of a property. Even now, he said he refrained from informing buyers of his damaged homes of the flood risks, explaining that the law did not require him to do so.
“Yeah, people call me a vulture when they learn what I do,” said Mr. Pelletiere, his sturdy frame clad in home-office attire of jeans, T-shirt and socks on a typical work day in February. He was darting around his home, barking instructions to construction workers fixing the first floor.
“In reality I’m offering homeowners solutions,” Mr. Pelletiere said. “I was flooded, too, I get it, but this hurricane is a monstrous opportunity.”
While distasteful to some, opportunists like Mr. Pelletiere are an encouraging sign.   After all, you don’t see opportunists chasing quick books in places that are unlikely to recover.    No one is forcing a homeowner to sell cheaply, and many households don’t have the stomach to endure a lengthy rebuild.   
Appraisal Rule Finalized
The Banking Agencies released a final rule, which will no longer require appraisals for commercial real estate transactions of $500,000 or less.   The prior threshold was $250,000.    
The Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency issued a final rule that increases the threshold for commercial real estate transactions requiring an appraisal from $250,000 to $500,000.
The agencies originally proposed to raise the threshold, which has been in place since 1994, to $400,000, but determined that a $500,000 threshold will materially reduce regulatory burden and the number of transactions that require an appraisal. The agencies also determined that the increased threshold will not pose a threat to the safety and soundness of financial institutions.
The final rule allows a financial institution to use an evaluation rather than an appraisal for commercial real estate transactions exempted by the $500,000 threshold. Evaluations provide a market value estimate of the real estate pledged as collateral, but do not have to comply with the Uniform Standards of Professional Appraiser Practices and do not require completion by a state licensed or certified appraiser.
The final rule responds, in part, to concerns financial industry representatives raised that the current threshold level had not kept pace with price appreciation in the commercial real estate market in the 24 years since the threshold was established and about regulatory burden during the Economic Growth and Regulatory Paperwork Reduction Act review process completed in March 2017.
The new threshold will encourage many banks to use internal evaluations on smaller properties.   It excludes, though, all 1-4 properties, even if they are commercial purpose, although banks can still use evaluations for loans under $250,000.  Moreover, the “transaction value” is basically the UPB of the loan, not the value of the collateral.    For example, let’s suppose you have a $495,000 loan secured by a $2MM office building.   The Bank would not have to order an appraisal – it could do an internal evaluation.    The OCC referred us to these 2010 Guidelines.
An evaluation must be consistent with safe and sound banking practices and should support the institution’s decision to engage in the transaction. An institution should be able to demonstrate that an evaluation, whether prepared by an individual or supported by an analytical method or a technological tool, provides a reliable estimate of the collateral’s market value as of a stated effective date prior to the decision to enter into a transaction.
We recommend that banks develop robust and independent internal evaluation processes, as it could become a competitive advantage of the marketplace, saving a borrower from $2-5K of closing costs.

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