January ’17

The BAN Report: The $9MM Badger C&I Relationship / Energy Woes Wane / Small Businesses Struggle to Hire / No Children in San Fran / Loss of Anchors Crushes Small Town Malls-1/26/17

The $9MM Badger Relationship

Clark Street Capital’s Bank Asset Network (“BAN”) proudly presents: “The $9MM Badger C&I Relationship.”  This exclusively-offered loan relationship is offered for sale by one institution (“Seller”).   Highlights include:

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.   



Sale Announcement

Friday, January 27, 2017

Due Diligence Materials Available Online

Tuesday, January 31, 2017

Indicative Bid Date

Tuesday, February 14, 2017

Closing Date

Thursday, March 2, 2017

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.  

Energy Woes Wane

Last year, US banks were building up loan loss reserves as the price of oil plummeted, sending billions of energy loans into workout departments.    Some banks like Green Bank in Houston got out of energy completely.   But, recent earnings and comments from three Texas and Oklahoma banks suggest that the energy sector is recovering, and no longer a drag on bank earnings.

Texas’ energy sector may not yet have fully recovered from last year’s plunge in oil and gas prices, but the rest of the state’s economy appears to be doing just fine.

That message that came through loud and clear Wednesday on the earnings calls of Cullen/Frost Bankers in San Antonio, Prosperity Bancshares in Houston and BOK Financial in Tulsa, Okla.  All reported healthy loan growth in the state in 2016 and all predicted even stronger demand for commercial, consumer and residential and commercial real estate loans this year. Even with some energy firms still struggling, bankers seemed confident that the Texas economy would remain one of the nation’s strongest in 2017.

BOK Financial is beginning to make new loans in the sector, while Cullen/Frost is in run-off mode, and Prosperity never had much exposure to the sector.   What’s noteworthy and refreshing here is that US banks moved fast to classify, downgrade, and reserve for potential losses in energy loans, setting themselves up for future earnings surprises if provisions exceed actual losses.    One wonders if the problem with expected loss has been corrected without any need for the 2020 change to the Current Expected Credit Loss Standard for ALLL (CECL).   Market and regulatory pressure have essentially forced banks to take earlier losses on problem credits, thus solving the problem with bank being too slow to build up reserves.    

Small Businesses Struggle to Hire

The JP Morgan Chase Institute released its latest report on the financial condition of small businesses, specifically the struggle for small businesses to increase employment.   

“The Ups and Downs of Small Business Employment” reports that most small businesses experience substantial volatility in payroll expenses. Moreover, more than two-thirds (68 percent) of small employer businesses either reduced their number of employees or added less than the equivalent of one full-time employee in a calendar year.

The typical small business saw payroll expenses grow by 8.5 percent per year. These payroll expenses were significant for small employer businesses, with the typical owner paying $18,700 in payroll expenses a month, or 18 percent of all outflows for their business. Making their financial situation even more difficult to manage, small businesses with employees had only 18 cash buffer days, compared to 27 cash buffer days for small businesses overall.

The full report is available here.    The struggle to manage payroll and minimize layoffs makes it hard for small businesses to hire workers.   While small businesses are a key component in job creation, its actually new small businesses that create net new jobs, while existing small businesses do not.       

New small businesses create new net job; existing small businesses do not. While policy makers have historically focused on the contributions of small businesses to job creation (Birch, 1981), recent research has emphasized the impact of young firms on net job creation (Haltiwanger, et al., 2013; Decker, et al., 2014). In fact, after their first year of employment, existing small businesses lose more jobs than they create, principally through firm failure. For every 100 small business jobs that existed in 2013, new small businesses created 5.6 new jobs, while existing small businesses lost 3.9 jobs—mostly due to losses from the exit of these small businesses. Policy makers, advocates, and private-sector partners should focus on the incentives and sustainability of the new small businesses that create these jobs. This is especially concerning in light of the overall decline in startup rates, which have fallen from 17.1 percent in 1977 to 10 percent in 2014.

This research suggests that more needs to be done to encourage the creation of start-ups and small businesses.   Unfortunately, most banks do not lend money to small businesses unless they’ve been in business for three years.   

No Children in San Fran

The city of San Francisco is becoming a tough place to raise children, as families move out to the suburbs, leaving a city with as many dogs as children.   This has obvious public policy and economic considerations, and could become a trend for other highly expensive cities.

There is one statistic that the city’s natives have heard too many times. San Francisco, population 865,000, has roughly the same number of dogs as children: 120,000. In many areas of the city, pet grooming shops seem more common than schools.

In an interview last year, Peter Thiel, the billionaire Silicon Valley investor and a co-founder of PayPal, described San Francisco as “structurally hostile to families.”

Prohibitive housing costs are not the only reason there are relatively few children. A public school system of uneven quality, the attractiveness of the less-foggy suburbs to families, and the large number of gay men and women, many of them childless, have all played roles in the decline in the number of children, which began with white flight from the city in the 1970s. The tech boom now reinforces the notion that San Francisco is a place for the young, single and rich.

“If you get to the age that you’re going to have kids in San Francisco and you haven’t made your million — or more — you probably begin to think you have to leave,” said Richard Florida, an expert in urban demographics and author of “The Rise of the Creative Class.”

Mr. Florida sees a larger national trend. Jobs in America have become more specialized and the country’s demography has become more segmented, he says. Technology workers who move to San Francisco and Silicon Valley anticipate long hours and know they may have to put off having families.

“It’s a statement on our age that in order to make it in our more advanced, best and most-skilled industries you really have to sacrifice,” Mr. Florida said. “And the sacrifice may be your family.”

We think the cost of housing is the culprit, caused largely by the indifference the city has towards satisfying the housing demand.   Many of the new housing developments are low-density on sites that could support five times as many units.   For all the talk about downtown revivals in our largest cities, their growth is going to be constrained by their inabilities to support families.  

Loss of Anchors Crushes Small Town Malls

Most enclosed malls are anchored by large department stores, the loss of which can be devastating to a retail property.   Consider the example of the Fort Steuben Mall in Steubenville, Ohio, birthplace of Dean Martin.    The mall recently lost two of its four anchors, as Macy’s and Sears closed shop.  

The Fort Steuben Mall in this former steel town on the edge of the Ohio River is battling a double whammy of store closures that have thrust it into a fight for survival.

On one side of the mall is an empty space that housed a Sears department store and automotive center until the struggling retailer closed the location last June.  On the opposite side sits a Macy’s set to close in early spring, the retail chain said early this month, as part of 100 closures announced last summer. Together, the two anchor locations make up 37% of the property’s leasable space.

Fort Steuben Mall is being swept up in a wave of store closings that is buffeting landlords across the U.S. Specialty retailers such as the Limited and department stores such as Sears and Macy’s in recent months have announced plans to close hundreds of stores nationwide and slash jobs as online shopping takes a growing share of revenue.

DLC purchased the mall for $43 million in 2006, just before the recession. Since then, the mall has suffered from store closures including apparel retailer Steve & Barry’s, Waldenbooks and Toys “R” Us.

Kroll now values the mall at just $7.4 million, taking into account the coming loss of Macy’s. It projects creditors face a loss of $31.3 million.

Unfortunately, there are just not enough large retailers to fill large anchor spaces.   Once they are gone, it can cause a snowballing effect, as many tenant leases have “co-tenancy clauses,” which allow them to vacate the space if certain anchor tenants vacate.    Patrick Forkin of Baum Realty Group said, “Landlords are scrambling to figure out what to do with their soon-to-be vacant mall-anchor spaces.  Many landlords are getting creative to back-fill these spaces by considering experiential and destination-oriented users to the retail mix such as fitness clubs, outdoor outfitters, arcades, and storage.  Some of the active tenant in these areas include Planet Fitness, Cabela’s, Dave and Busters, and Life Storage.”

Bank Earnings Review
The BAN Report: Bank Earnings Review / Wells Tweaks Pay Plan While Former Exec Slams / Will New Falcons’ Stadium Revitalize Neighborhood?-1/19/17

The Big 4 Banks have all released earnings for ‘Q4 2016, wrapping up an overall strong 2016 earnings picture.   Last week, we discussed Wells Fargo, so let’s see how JP Morgan Chase, Citigroup, and Bank of America performed.   

JP Morgan Chase

JP Morgan Chase had a great fourth quarter as earnings were 30% greater than the prior quarter, although revenue was only up 2%.    Earnings of $6.7 billion (1.71 / share) beat expectations of $1.43.   For the year, revenue of $99 billion just missed the coveted 12-figure club, which JP Morgan Chase last reached in 2010.

The best news perhaps is that the gains J.P. Morgan saw in the fourth quarter seem to be coming from the so-called real economy, and not the financial one. Its investment banking revenue was decent in the fourth quarter, but profits improved in part because compensation declined. The firm’s trading revenue fell in the fourth quarter compared with the prior three months.

One of the bank’s biggest boosts, in fact, came from having fewer bad loans, and that trend is expected to continue. The bank’s provision for bad loans dropped nearly $400 million in the fourth quarter from a year ago. That’s another sign that the bank thinks the real economy is still strong.

The market reaction was flat, but after the Trump rally in bank stocks, this was too be expected.


Citigroup slightly exceeded expectations on earnings as they beat by 2 cents, but missed the revenue number by $300MM.    

“We had a strong finish to 2016, bringing momentum into this year. We drove revenue growth in our businesses and demonstrated strong expense discipline across the firm,” Citi CEO Michael Corbat said in a release.

The bank reported a 36-percent rise in fixed income markets revenue to $3 billion, and a 15-percent rise in equity markets revenue.   Full-year 2016 net income of $14.9 billion on revenue of $69.9 billion marked 13 percent and 8.5 percent declines from the prior year, respectively. 

A bright spot was Citi Holdings.

The quarter marks the last time the financial institution will report the results of Citi Holdings separately. That business segment now represents only 3 percent of Citigroup’s balance sheet, with $54 billion in assets but was profitable for the tenth quarter in a row. 

At its peak, Holdings had more than $800 billion in assets and sometimes posted multi-billion dollar losses in a quarter.

The decline of Citi Holdings is a microcosm for the broad recovery in the banking system as a whole, as it shows how much bad assets banks have shed over the last few years.   For Citi, it was over $700 billion.

Bank of America

Bank of America was the most optimistic of the large banks in reporting 4th quarter earnings and bragged about a boost in net interest income expected in the first quarter.

Bank of America reported fourth quarter earnings Friday that topped expectations and said it expects a “significant increase” in net interest income for the current quarter. Revenue came in a touch below expectations.

The firm reported earnings per share of 40 cents on revenue $19.99 billion. Analysts polled by Reuters expected Bank of America to report a profit of 38 cents a share on revenue of $20.85 billion.

“Strong client activity and good expense discipline created solid operating leverage again this quarter,” Chief Financial Officer Paul M. Donofrio said in a release. “While the recent rise in interest rates came too late to impact fourth-quarter results, we expect to see a significant increase in net interest income in the first quarter of 2017.”

The bank said it expects to earn an additional $600 million in additional net interest income in the current quarter. 

The story is fairly simply – higher interest rates mean more net interest income for consumer-oriented banks like Bank of America.    A 25 basis point increase in the Prime lending rate means higher rates on credit cards and other short term loans, yet Bank of America has to do little to attract deposits.   For example, Bank of America’s Interest Checking Account pays a whopping 0.01% APY for accounts under $50,000.    

Overall, the large banks have a lot to be optimistic about the prospects of a friendlier regulatory environment and higher interest rates.

Wells Tweaks Pay Plan While Former Exec Slams

The banking industry has been eagerly awaiting for the revised Wells Fargo new pay plan, a change resulting from the phony account scandal.     Early indications from the American Banker is the new plan is not a radical departure.

Banks large and small have been waiting anxiously to see how much regulators’ expectations are going to change in the wake of the Wells scandal. The fear was that the San Francisco bank, on a short leash with its regulators, would eliminate performance-based pay, putting pressure on other banks to follow suit.

Wells Fargo is keeping many details under wraps, but the revised scheme appears to bring the $1.9 trillion-asset company into closer alignment with the rest of the sector, consultants said. Notably, the new plan does not get rid of incentive pay, which has long been a staple of compensation plans throughout the retail banking industry.

“I think the construct was not that radical, and I’m happy that it wasn’t,” said Darryl Demos, an executive vice president at Novantas. “They could have easily overreacted.”

We sincerely hope that the Wells scandal doesn’t sink performance-based pay for everyone, as there is nothing wrong with rewarding good performance, providing that there are appropriate internal controls in place.  

A former senior executive at Wells has disagreed with our defense of Wells Fargo last week, when we said: “We think the bashing of Wells Fargo has gone too far, and they have paid far more in penalties than the estimated $5 million in damages caused to their customers by unauthorized accounts.”   Here was his response:

“I respectfully disagree. The Wells Fargo managers who implemented the unforgivable strategic plan created by Carrie Tolstedt, brutally harassed, insulted, pressured, and also fired hundreds and thousands of employees (for doing what the managers themselves forced down their throats). What management did was calculated and with intent. They micromanaged, cross sold to death, and forced employees into unsafe positions of fear to keep their families clothed, fed, and sheltered. This was a coordinated effort which translates to organized crime and thus RICO Act investigation worthy. In addition, there may be numerous cases of EEOC violations from this scenario. Paying a fine from the shareholders pockets and permitting the same managers to run free is not solving the problem. The government is aware of this and the fire is still smoldering awaiting a possible inquiry and then the house of cards could come tumbling and it is all the senior management’s fault. In the meantime, depositors and borrowers are clearly voting with their pocketbooks by pulling funds out of anything Wells and choosing more ethically responsible alternative banks. I survived Wells and let me tell you, they deserve what they are getting and it was only a slap on the wrist so far.”

Strong words, and we appreciate spirited discussions in this publication!

Will New Falcolns’ Stadium Revitalize Neighborhood?

There is a mixture of optimism and disappointment from the community as the finishing touches are completed on the Mercedes-Benz Stadium, a $1.5 billion facility located in the west side of Atlanta.

There the team owner and home improvement magnate Arthur Blank is building the Falcons’ new home, Mercedes-Benz Stadium, a $1.5 billion palace with eye-popping features: a 30-story-high retractable roof shaped like petals, the N.F.L.’s largest video board and enormous windows that face the Atlanta skyline.

The view through the windows at the other end of the building tells a very different story, one that many fans go out of their way to avoid: English Avenue and Vine City, two of the poorest neighborhoods in the Southeastern United States.   Home to drug dealers, swaths of empty plots and abandoned houses, they are part of the Westside, where 42 percent of the households are in poverty and the unemployment rate is twice that of the rest of Fulton County.   

The stadium’s place in that chasm between the rich and poor is an uncomfortable reminder of the disconnect between the vast wealth of the N.F.L. and the cities to which they extend open palms.   Immensely wealthy team owners, back by a $13 billion-a-year league, routinely push local lawmakers to provide hundreds of millions of dollars in subsidies that, they claim, will pay for themselves through the creation of new jobs, new tax revenue and the intangible prestige of professional sports (the new stadium will host the Super Bowl in 2019.)

Public financing for sports stadiums cannot be justified under almost any circumstances, although the article dumps on Arthur Blank, who is in good faith trying to revitalize this section of Atlanta.   

Blank’s plans are ambitious not only because of the neighborhood’s history and decay, but also because he said he hopes to effect real change in the lives of his neighbors – though critics say it will be on his terms.

It’s his money!   Not only is he placing a $1.5 billion investment in the community, but he has also donated $20 million via his foundation for job training, and new parks.    We agree that the public investment is a lousy deal for the taxpayers of Atlanta, but that’s the fault of the elected officials and the citizens – you can’t blame the owners for looking for public subsidies.   Blank got over $200MM for constructions and potentially hundreds of millions more for its upkeep.

We applaud San Diego voters for rejecting the Chargers stadium plan, and allowing them to leave for Los Angeles.   According to an analysis, the public has spent $7 billion since 1996 to finance NFL stadiums.    

Meanwhile, Los Angeles has not exactly rolled out the red carpet for the Los Angeles Chargers.  The LA Times had this to say:

Every relationship is built on honesty, so the San Diego Chargers should hear this as their moving vans are chugging up the 5 Freeway on their noble mission of greed.

We. Don’t. Want. You.

Hopefully, voters and politicians elsewhere come to their senses and stop subsidizing sports stadiums.   Whether the NFL owners are wealthy or not is irrelevant – these are just bad deals for the public.    

The BAN Report: Mnuchin Under Fire for OneWest / De Novos Open for Business / CMBS Delinquencies Spike / US Auto Industry Sets Record in 2016 / Can’t Give It Away-1/5/17

Mnuchin Under Fire for OneWest

Proposed Treasury Secretary Steven Mnuchin is under fire due to how OneWest Bank, which he ran from 2009 – 2015, handled foreclosures in California.   Elizabeth Warren called Mnuchin “the Forrest Gump of financial crisis.”    Earlier this week, a confidential memo was released by The Intercept, in which attorneys at the state attorney general recommended a civil enforcement action.

The memo obtained by The Intercept alleges that OneWest rushed delinquent homeowners out of their homes by violating notice and waiting period statutes, illegally backdated key documents, and effectively gamed foreclosure auctions.

In the memo, the leaders of the state attorney general’s Consumer Law Section said they had “uncovered evidence suggestive of widespread misconduct” in a yearlong investigation. In a detailed 22-page request, they identified over a thousand legal violations in the small subsection of OneWest loans they were able to examine, and they recommended that Attorney General Kamala Harris file a civil enforcement action against the Pasadena-based bank. They even wrote up a sample legal complaint, seeking injunctive relief and millions of dollars in penalties.

Senate Democrats have even set up a website to submit foreclosure complaints about Steve Mnuchin.    As a vigorous proponent of the rights of lenders to take action when borrowers break their contract to repay their loans (it’s called a promissory note, after all), it is exceedingly rare that a lender successfully forecloses on a property without clear evidence that there is an unpaid secured debt.    Sure, lenders sometimes act improperly and cut corners, but does that mean they shouldn’t be able to enforce their rights?   Moreover, OneWest did not make any of these loans – they merely paid the highest possible price to acquire IndyMac Bank from the FDIC, which indirectly reduced the potential cost to the taxpayer.   

De Novos Open for Business

The FDIC late last month sought comment on a new handbook for De Novo bank organizers, in an effort to reignite the stale market for De Novo banks.   

The Federal Deposit Insurance Corporation (FDIC) is seeking comment on a handbook developed to facilitate the process of establishing new banks. Applying for Deposit Insurance – A Handbook for Organizers of De Novo Institutions provides an overview of the business considerations and statutory requirements that de novo organizers will face as they work to establish a new depository institution and apply for deposit insurance. It offers guidance for navigating three phases of establishing an insured institution: pre-filing activities, the application process, and pre-opening activities.

“De novo institutions add vitality to our local banking markets, providing credit and services to communities that may be overlooked by larger institutions,” FDIC Chairman Martin J. Gruenberg said. “This handbook is the latest in a series of steps we have taken to support the establishment of de novo institutions. Our goal is to increase transparency about the application approval process and resources available to assist potential organizers. The FDIC has developed this handbook as a practical and plain language guide to help organizers navigate the application review process.”

Last year, the FDIC reduced the enhanced supervisory monitoring period of De Novos from 7 to 3 years, and started a series of outreach events which will continue in 2017.  

CMBS Delinquencies Spike

In December CMBS delinquencies spiked, and the new rate is at the highest level in over a year, according to Trepp, who predicts further increases in delinquencies as rates continue to rise.

The Trepp CMBS Delinquency Rate moved sharply higher in December, with the new rate hitting its highest level in 14 months. The delinquency rate for US commercial real estate loans in CMBS is now 5.23%, an increase of 20 basis points from November. The delinquency rate has now moved higher in nine of the last 10 months, and all of the gains from early 2016 have been reversed. The rate is now at its highest level since October 2015.

With a cascade of loans from the 2007 vintage coming due in 2017, it is hard to see the rate going down any time in the near future. Many of the stronger performing loans from 2006 and 2007 were either defeased prior to maturity or paid off during their open period. Those that make it to their maturity date tend to be loans with more middling debt service coverage or uncertainty in their rent rolls.

Many have been sounding the alarm about the maturity wall for years, but we don’t expect major problems.   For the most part, these are cash-flowing properties that may need some more equity to be refinanced, but only a few will become REO.    Higher rates though can tilt some loans from performing to non-performing status.   Even though 100 basis points does not sound like a lot, increasing the rate from say 4 to 5%, is a 25% increase in interest expense.   

US Auto Industry Sets Record in 2016

A strong fourth quarter propelled US light-vehicle sales to a second consecutive annual high, albeit with some heavy discounting.

U.S. light-vehicle sales hit a second consecutive annual high, aided by a fourth-quarter surge in demand that exceeded expectations and bolstered the outlook for an industry that has been a key engine for economic growth.

Such gains, however, are coming with a steep price tag. December’s sales pace, one of the strongest monthly performances in the industry’s history, was fueled by discounts of $3,542 per vehicle on average, according to J.D. Power, an independent research firm.

Auto makers sold 1.69 million vehicles in December, 3.1% more than the same period in 2015 despite one fewer sales day. The seasonally adjusted selling pace of 18.43 million was the highest since July 2005, when General Motors Co. and other auto makers stoked demand with a new campaign that offered employee pricing to all customers. A total of 17.55 million vehicles were sold in 2016, roughly 60% of which were classified as light trucks.

That compares with 17.48 sales million a year earlier and a mix of 56% light trucks. Growth in demand for pricier pickups, sport-utility vehicles and crossover wagons has helped pad auto maker profits as executives invest to speed development of autonomous cars and spend heavily to meet stricter emissions standards.

At the peak of the recession, US auto sales were barely above 10MM in sales, so this represents a dramatic recovery.     In December, GM and Nissan saw 10% increases from the prior year, while Fiat Chrysler was down 10%.  

Can’t Give It Away

Is there a better example of the difficulty in building new projects in America’s largest cities than George Lucas’s inability to find a city willing to take a $1.5 billion museum?    After being turned down by San Francisco and then Chicago, Mr. Lucas is trying once more in California with potential sites in San Francisco and Los Angeles.

He wants to construct a Lucas museum to house and display his art collection—much of it proudly lowbrow, such as works by the sentimentalist Norman Rockwell; original Flash Gordon comic book art; Mad magazine covers; and memorabilia from his own Star Wars films.  According to an early plan for the museum, his trove of Star Wars material includes 500,000 artifacts from the prequels alone. Lucas refers to such works as “narrative art,” the kind that “tells a story.” He believes they’ve been unfairly ignored by snooty critics and curators, and he wants his museum to rectify that.

Lucas has offered to build his museum in a major American city for free. Including construction costs, an endowment, and the value of the artwork, his organization says the total value of his gift is $1.5 billion. “It’s an epic act of generosity and altruism,” says Don Bacigalupi, the museum effort’s president. “George Lucas, as with any person of great resources and great success, could choose to do whatever he wants to do with his resources, and he has chosen to give an extraordinary gift to the people of a city and the world.”

But so far, Lucas hasn’t found a permanent home for his museum. Lucas tried to build in San Francisco’s Presidio, which is a national park, and then on Chicago’s downtown waterfront, only to abandon both sites after being assailed by local forces. Some people derided his architecture. Others knocked the artwork. Lucas seemed to find most irritating those who said they didn’t mind his proposal but thought he needed to be more flexible about where he put his building. He had long suffered highfalutin critics as a nuisance when he was selling tickets to movies. Now they were thwarting his will when he was trying to give something away.

In Chicago, groups like “Friends of the Parks” stopped the construction of the museum on Chicago’s waterfront, filing a federal lawsuit and unleashing a local PR campaign against the project.   Lucas bailed and turned back to California.  

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