December ’18

The BAN Report: Leases Move to Balance Sheet in 2019 / Leveraged Loan Market Sinks / CFPB Report on College Student Banking / Madoff Update-12/13/18

Leases Move to Balance Sheet in 2019

Beginning next year, new leasing accounting rules go into effect, thus creating headaches for anyone with operating leases.     Despite a last-minute attempt to delay the implementation, FASB announced this week that it is moving forward as planned, impacting public companies in 2019 and most other entities in 2020.    The impact on banks will be modest but could have some slight negative impact on capital ratios.

Under the new rule, which takes effect for public firms on Jan. 1 and for private firms a year later, the Financial Accounting Standards Board will require companies to record operating leases as both liabilities and assets on their balance sheets. As it stands, these costs are kept off the balance sheet, leaving investors with an incomplete picture of a company’s financial obligations, according to FASB.

First, they will need to take into account all these new leases on corporate balance sheets when assessing clients’ financial positions and ability to repay loans, said Matt Shoemaker, an accountant at Porter Keadle Moore in Atlanta.

“It’s really going to affect how clients classify leases and it could affect their cash flows,” Shoemaker said. “Hopefully it’s going to give banks a better understanding of what’s going on” with their clients’ revenue streams and fixed expenses.

Additionally, banks themselves will see their own balance sheets swell with the new recognition of operating leases — a change that is expected to reduce capital ratios at most banks.

While this will increase transparency, it will change how banks underwrite loans, as it will have modest changes on the debt service coverage and impact balance sheet ratios.   We asked Matt Hunt, Chief Credit Officer at Avana Capital, and he added: “Banks have not historically taken the operating lease into account on either the cash flow or the debt service of a debt service coverage ratio.    A deal that was at 1.2X may be below that if you are both adding and subtracting the leases to the cash flow.”

Leveraged Loan Market Sinks

Investors have been pulling money from leveraged loans, thus reducing secondary market pricing.

Investors have pulled $5.4 billion from loan-focused mutual funds since mid-October, including $4.1 billion in the past three weeks alone, according to data from Lipper.

That’s quite the turnaround: Investors had poured nearly $12 billion into loan-focused mutual funds in the year up to mid-October, even as they withdrew more than $22 billion from high-yield bond funds, according to Lipper.

The recent downturn in loan prices is already contributing to a slowdown in borrowing, causing businesses to postpone fundraising deals or pay investors higher rates. Continued weakness in speculative-grade debt markets could eventually drag on the U.S. economy by making it harder for businesses with low credit ratings to fund investments or refinance coming bond and loan maturities.

Cleveland-based auto parts distributor Dealer Tire last week sold a $975 million loan backing its acquisition by private-equity firm Bain Capital at a 9.4% yield. That was well above its initial proposal of around 7.2% to 7.5%, according to LCD. Bain declined to comment. Dealer Tire didn’t respond to a request for comment.

Most of these loans are floating rate loans, so higher interest rates are not to blame.    This is another example of how markets are not perfectly efficient, as it makes little sense that bond prices would fall months before leveraged loan pricing adjusted accordingly.

CFPB Report on College Student Banking

This week, the CFPB released a previously unpublished report on how banks have benefited from alliances with colleges to pitch products to students.

Colleges and banks have long worked together to sell financial products to students, and in some cases the practice has exposed this potentially lucrative — but vulnerable — group of consumers to credit cards, bank accounts and debit cards with high fees.

Regulators, empowered by new laws, have tried to clamp down on this behavior in recent years. Those efforts have helped, but students are still paying tens of millions in fees to financial institutions, many of whom are paying their colleges for the opportunity to sell to them, according to a roughly year-old report from the Consumer Financial Protection Bureau released publicly for the first time last week.

“Anyone that looks at this data and the extent to which large banks continue to team up with colleges and universities to gouge the student body with overdraft fees should be outraged,” said Seth Frotman, the former student loan ombudsman at the CFPB and the executive director of the Student Borrower Protection Center, an advocacy group.

Mr. Frotman had resigned from the CFPB and this report only came to light because of a FOIA request.    Account providers who paid colleges for these alliances charged fees at 3X the rate versus those who weren’t paid.     Nevertheless, the dollars seem pretty low.     For example, PNC Bank paid the most and the average fee per active account was $15.84.    Attached is the complete report.

Madoff Update

Ten years ago, Bernie Madoff was arrested as the $65 billion Ponzi scheme was finally uncovered due to the withdrawals caused by the financial crisis.

As this scandal hit close to home, few at the time believed any recovery beyond the SIPC claim of $500,000 was possible.   Madoff’s trustee has now recovered 70% of the approved claims – an amazing job by any standard.

While no one will ever collect the phantom profits Madoff pretended he was earning, the cash deposits by his clients have been the primary objective for Irving Picard, a New York lawyer overseeing liquidation of Madoff’s firm in bankruptcy court. So far he’s recovered $13.3 billion—about 70 percent of approved claims—by suing those who profited from the scheme, knowingly or not. And Picard has billions more in his sights.

“That kind of recovery is extraordinary and atypical,” said Kathy Bazoian Phelps, a bankruptcy lawyer at Diamond McCarthy LLP in Los Angeles who isn’t involved in the case. Recoveries in Ponzi schemes range from 5 percent to 30 percent, and many victims don’t get anything, Phelps said.

If Picard wins the appeal and succeeds in all of those cases—an outcome he called “aspirational”—he’d boost recovery for victims to 91 percent of the lost principal, which could change depending on investor claims accepted or adjusted by the trustee.

Investors who weren’t direct Madoff customers—those who invested through feeder funds or money managers—weren’t allowed to file claims with Picard to recover their share of the cash principal. For them, the Department of Justice set up a separate $4 billion fund to compensate for some losses.

Pretty impressive stuff from the Trustee.   It helped that, early on, they received a $5 billion settlement from the estate of Jeffrey Picower, who was perhaps the richest man in American hardly anyone knew, profiting more from the Madoff scheme than Madoff himself.    Attached is the latest report from the Trustee.

The BAN Report: Tariff Talk Spooks Markets / Walgreens Launches Next-Day Home Delivery / FDIC Touts De Novos / SBA and Chicken Farmers / The LA Industrial Portfolio-12/6/18

Tariff Talk Spooks Markets

The US markets have been extremely volatile this week due to a number of fits and starts with respect to China and trade.    A tentative agreement over the weekend between the US and China sent the stock market up on Monday, before retreating heavily through today.

The Dow Jones Industrial Average rose nearly 300 points on Monday after President Donald Trump and Chinese President Xi Jinping announced a 90-day cease-fire in the trade war. The truce meant the U.S. and China would hold off on adding more tariffs on each other’s goods at the beginning of 2019.

But then things got bad.

Trump declared “I am a Tariff Man” in a tweet, threatening to put more tariffs on China if the trade negotiations fail.

“Equities plunged on” Trump’s tweet on Tuesday, “highlighting a tough stance on tariffs,” Citi equity analysts said in a note to investors titled “sing us a song, you’re the tariff man.” His statements gave investors little hope that progress had been made on trade negotiations.

Early this morning there was a mysterious plunge in the S&P futures and the S&P was down 2.5% this morning.    It’s our view that markets will remain highly volatile while the tariff issues are still outstanding.    Moreover, these types of negotiations are best done in secret, so that the market doesn’t whipsaw based on every twist and turn in the process.

Walgreens Launches Next-Day Home Delivery

This week Walgreens announced that it is launching a nationwide next-day prescription home-delivery service with FedEx.

Walgreens Boots Alliance Inc.  has teamed up with FedEx Corp.  to launch a nationwide next-day prescription home-delivery service as the drugstore chain works to stave off competition from Amazon.com Inc. and other rivals.

Under the delivery service called Walgreens Express, patients enrolled in text alerts will receive text notification when qualifying prescriptions are ready, Walgreens said Thursday. For a $4.99 fee, patients can have their prescriptions delivered by FedEx to their home as early as the next day. Same-day delivery is currently available in Dallas, Chicago, New York City, and Florida cities Miami, Gainesville, Tampa, and Fort Lauderdale. The company said it will expand the option to additional locations in 2019.

Walgreens’s move comes after CVS Health Corp. enlisted the U.S. Postal Service for a new home-delivery service in June. CVS struck a deal with the Postal Service to pick up prescriptions at CVS stores and bring them to customers’ homes in one or two days. CVS customers will be charged $4.99 per delivery, which could include over-the-counter products such as aspirin or face wash.

Later in June, The Wall Street Journal reported Amazon was buying online pharmacy PillPack Inc. for roughly $1 billion in cash, giving the e-commerce giant the ability to ship prescriptions around the country, and overnight, which made it a direct threat to the more than $400 billion pharmacy business.

It seems that every action in retail today is in response to Amazon.    Just the entry of Amazon into the prescription drug market led to Walgreens and CVS striking deals for home-delivery service.    Soon, the new standard will be same-day delivery in major markets.

FDIC Touts De Novos

New FDIC Chair Jelena McWilliams is aggressively pushing for new banks (de novos).   In an op-ed in the American Banker, she pointed out that many communities are losing locally-owned banks.

Small banks like these are slowly disappearing from America’s landscape. Today, 627 counties are only served by community banking offices, 122 counties have only one banking office, and 33 counties have no banking offices at all.

The banking landscape in the United States has changed dramatically in the last few decades. After remaining fairly steady for more than three decades, the total number of banking and thrift charters declined from around 15,160 in 1990 to 5,670 at the end of 2017. The share of industry assets held by the top 10 banking organizations rose from 19% in 1990 to 51% at the end of 2017.

I do not profess to know what the right number of banks in the U.S. is, but I recognize that, like many competitive industries, a dynamic banking sector needs new startups entering the marketplace. De novo banks are a key source of new capital, talent, ideas, and ways to serve customers. Most de novos are traditional banks that offer services and products to underserved communities and fill gaps in overlooked markets.

Over the past decade, de novo activity has screeched to a historic halt. As FDIC Chairman, one of my key priorities is to encourage new bank formation. The FDIC needs to do its part to make that happen.

Its our view that the banking Agencies need to do far more than advocate for de novos.    Perhaps, instead of being more heavily monitored, new banks should be given more relief.    But, it’s still hard to make the case that de novos make sense.   I asked Jim McAlpin of Bryan Cave, and he said “They’re looking for a significant amount of capital to start a bank.   You need to make it attractive to form a De Novo.   There are still opportunities to purchase charters of small banks at significantly less than the cost of a de novo.”

SBA and Chicken Farmers

After proposing to restrict loans to chicken farm businesses, the US Small Business Administration was flooded with comments decrying the plan.

The SBA, as of Tuesday, had received nearly 200 comment letters from poultry producers, farm appraisers and lenders, all decrying a plan to amend affiliation standards in a way that opponents claim would render the vast majority of chicken farmers ineligible for financing through the agency’s 7(a) loan program.

Arkansas Sens. John Boozman and Tom Cotton, as well as Mississippi Sens. Cindy Hyde-Smith and Roger Wicker, submitted comment letters last month opposing the rule change. On Tuesday, 34 members of the House of Representatives also raised objections.

“We are deeply concerned that this proposed rule would drive rural American out of SBA’s loan programs,” the congressional group wrote in their letter. Instead of acting as subsidiaries of larger chicken companies, most producers “operate diversified farming operations with poultry growing representing only one income stream.”

The SBA’s proposal was the result of an explosive report by its Office of Inspector General earlier this year.

We found that 7(a) loans made to growers did not meet regulatory and SBA requirements for eligibility.   The large chicken companies (integrators) in our sample exercised such comprehensive control over the growers that the SBA Office of Inspector General believes the concerns appear affiliative under SBA regulations.  Therefore, SBA and lenders approved 7(a) loans that were apparently ineligible under SBA size standard regulations and requirements.   

It’s hard to look at this issue without considering the political implications.   The ranking Democrat on the House Committee on Small Business is Nydia Velazquez, who has been very critical of these loans.   It’s unlikely there are many chicken farms in her district in New York City.    Meanwhile, the Congressional delegations from Arkansas and Mississippi are on the opposite side.  This is a good example in which politics pollute a debate.

BAN Report Sign-up