January ’18

The BAN Report: New Apartment Deliveries Surge / Discover CEO Trashes Online Lenders / Corrupt Banks Fuel Iran Protests / Swiss Banker Faces Music and Gets Acquitted-1/26/18

New Apartment Deliveries Surge

2018 is shaping up to be a record year for new apartments with 360,000 new units entering the market in 2018, at the very time that home ownership is on the upswing.

Following a slowdown last year, multifamily deliveries are expected to hit a peak in 2018. An estimated 360,000 new units are slated for delivery over the next 12 months, which is a 20% increase over 2017, according to a new Yardi Matrix report.

As of the fourth quarter, approximately 600,000 units were under construction across the U.S., but in the last three quarters of 2017, only 220,000 units were delivered nationally. This disconnect between construction and delivery has been attributed to the construction labor shortage, which caused the average project completion time to increase to 22 months during the same period, up from 16.5 months in the third quarter of 2013.

This year is expected to bring a rise in completions as units under construction reach the finish line, but new supply is predicted to level off in 2019 as an increase in vacancy rates coupled with construction lending regulations are causing some developers and lenders to exhibit caution moving forward.

Based on the total amount of new units, Dallas, Manhattan, and Denver are the top 3.    Denver, though, is seeing the highest growth in forecasted inventory, growing its total apartment inventory by 6.4%.   In fact, the supply in Denver is such an issue, that the city is providing housing subsidies in high-end buildings, an novel solution to its excess supply.

Real estate investors rely on financing, and an unintended consequence of the last recession is that financing single family homes and condos is very difficult, while financing apartments has been relatively easy.    In major cities, it’s even more pronounced as there are often virtually not large condominium buildings under construction, even though there is significant demand and limited supply.    This imbalance may hurt cities as first-time homebuyers are forced to leave downtowns to become homeowners.

Discover CEO Trashes Online Lenders

In an interview with American Banker, Discover Financial Services CEO David Nelms criticized the emerging online lenders, basically saying that they don’t know what they are doing.

Discover Financial Services CEO David Nelms said this week that many of the online lenders that have emerged in recent years do not understand how to underwrite the loans properly over the long run. He also jabbed at the technology-focused firms for their failure to achieve profitability.

“It really takes a decade of experience going through cycles to understand how to use credit bureau information to have good predictions,” Nelms said in an interview. “The funny thing is they’re not making money, even in a great cycle.”

Those barbs drew a sharp response from Nathaniel Hoopes, the executive director of the Marketplace Lending Association, a digital lending trade group whose members include LendingClub, Prosper Marketplace, Avant, Upstart and Affirm.

“The solid growth story in marketplace lending over the past few years must be starting to bite into the profitability of the credit card issuers and other traditional lenders,” Hoopes said in an email.

“Well over a million marketplace loans were issued last year, and after more than a decade of underwriting performance at some of the longest-operating platforms, marketplace platforms continue to attract investment from the most sophisticated credit investors. That simply speaks for itself,” Hoopes added.

The rising tensions come at a time when both banks and digital lenders are seeing losses in their personal loan portfolios increase. The unsecured installment loans typically feature lower interest rates than credit cards, so they can be an attractive way to consolidate existing card balances, though they can also enable consumers to add to their debt burdens.

Skepticism on how these lenders will survive a down cycle is certainly warranted.    Some online lenders we’ve observed have virtually no senior executives with real-world credit experience, relying mostly on models that certainly proved to be limited in the last cycle.    The growth of these online lenders is a direct result of a banking regulatory environment that has often made consumer lending seem toxic to many banks.   They fill a very important gap in the marketplace.   Moreover, nonbank lenders have done a better job at loan origination over the past decade.    Time will tell if some of these lenders will survive a downturn.

Corrupt Banks Fuel Iran Protests

Iran’s banking system is a disaster, and depositors have lost money, fueling the protests against the Iranian regime.

Bijan Khajehpour, an Iranian economist based in Vienna, estimated that as many as hundreds of thousands of people lost money because of the collapsing financial institutions. Iranians have a term for the growing class of victims: “property losers,” or “mal-baakhtegan” in Persian.

Many of the failing institutions sank the money into speculative investments during a real estate bubble, lent to well-connected friends or charged usurious interest rates to desperate borrowers. Now, regulators have quietly steered many of the companies into mergers with larger banks to try to absorb their losses, but that has created a worsening problem of bad loans and overvalued assets throughout the banking system.

Economists say that as many as 40 percent of the loans carried on the books of Iranian banks may be delinquent.

“The whole financial system in Iran is in a very fragile state,” said Borghan N. Narajabad, an economist in Washington who has studied the system.

The International Monetary Fund warned last month that Iran’s banks and lenders “need urgent restructuring and recapitalization,” calling for write-downs of overvalued assets and a crackdown on loans to insiders. The problem has grown so big, the fund warned, that the money required to prop up the banks will “cause government debt and interest outlays to rise substantially.”

These are lessons that US banks learned decades ago.    Problems with banks don’t generally get people to take to the streets, so this is a fascinating result.

Swiss Banker Faces Music and Gets Acquitted

A decade ago, the US authorities cracked down on the Swiss banks, essentially forcing them to turn over the names of their US clients who were presumably hiding income.    One small bank, Bank Frey, stepped in when no other Swiss banks would take US depositors money, grew to over $2 billion in assets, and then predictably closed in 2013.   In 2015, Bank Frey executive Stefan Buck was indicted, and decided to face the music in 2016 by voluntarily surrendering to US authorities, even though he could have avoided extradition.

The crux of the defense was that the responsibility to pay taxes and declare income did not rest with Mr. Buck. It was his clients who had decided not to pay taxes. He was under no obligation to tattle; in fact, he was prohibited from doing so by Swiss bank-secrecy laws.

Prosecutors said all the secrecy — the nameless debit cards, the scissored bank paperwork, the shadowy phone calls — showed Mr. Buck knew what he was doing was wrong. “These are techniques used by a person who is trying to keep from getting caught, not by a person who thinks he’s operating legally,” said Sarah E. Paul, an assistant United States attorney, near the end of the trial.

Mr. Buck’s acquittal reverberated through the legal community. The Justice Department had now lost the three cases it had tried against foreign bankers who helped Americans avoid taxes.

Dozens more cases are pending. Those who represent accused Swiss bankers say they expect Mr. Buck’s verdict to embolden defendants and to cause prosecutors to think twice before bringing new charges.

“It should change their calculus,” said Marc S. Harris, a lawyer at Scheper Kim & Harris, who successfully defended the Israeli banker in 2014. He said the cases represented a “misguided effort” by the Justice Department to respond to political pressure to prosecute bankers.

This excellent story in the New York Times is a fascinating overview of the unholy alliance between Swiss banks and their American customers, and one man’s decision to fight back.

The BAN Report: GE & Goldman Stumble / The Apple Repatriation / Amazon Narrows HQ2 Candidates / The Thundering Herd Portfolio-1/18/18

GE & Goldman Stumble

In 2007, General Electric was America’s most admired company, while Goldman Sachs stood at 11th.      A decade later, GE stood at 7 and Goldman at 27.    GE’s market cap in 2007 was $261.93 billion, while it’s $157.92 billion today.    Goldman’s year-end market cap was $102 billion in 2007, and stands at $97.49 billion today.   This week brought fresh evidence on how hard it is for great companies to maintain their elite status in today’s dynamic global economy.

GE announced this week a staggering charge in a legacy business that was abandoned over a decade ago.

General Electric Co. shares extended their losses Wednesday, a day after the company announced a fourth quarter after-tax charge of $6.2 billion and a $3 billion cash capital contribution to its insurance subsidiary that will grow to $15 billion by 2024.

On a call with analysts, GE Chief Executive John L. Flannery said he was “deeply disappointed at the magnitude of the charge” in the company’s legacy reinsurance portfolio.

GE’s North America Life & Health is the reinsurance portfolio that the company retained after mostly exiting the business between 2004 and 2006. A reinsurer buys the right to receive premiums from the primary insurers that deal directly with consumers in exchange for eventually shouldering any potential losses. Those primary insurers underwrite and administer the policies and process claims when they come in.

The decision to retain the current insurance-related business, 60% of which is related to long-term care insurance, was based on the view that a gradual runoff of existing claims would be more profitable than selling the business, Flannery told analysts. GE has not taken on any new claims in the area since 2006, according to GE Capital Chief Risk Officer, Ryan Zanin, who was also on the call.

Flannery’s understated conclusion: In hindsight, GE “underappreciated the risk in this book.”

This surprise comes after a thorough review of the company by new CEO John Flannery, who had conducted a thorough review of the company’s operations late last year, resulting in a cut of the dividend, and a company focusing on three core markets – power, aviation, and health care.   Now, the company is openly discussing a break-up.

Goldman Sachs announced its worst quarter since 2008 this week, caused by tax reform and a decline in trading revenue.

Debt traders at Goldman Sachs Group Inc. stumbled badly in the last quarter of 2017, generating just $1 billion of revenue. Back in 2009, they brought in that much every 10 days.

Reporting its fourth-quarter results Wednesday, Goldman said debt-trading revenue fell 50%—the worst three-month showing since 2008 and the latest in a nearly unbroken chain of quarterly declines in the business.

The numbers reflect problems not unique to Goldman, whose struggles have been acute, but also a wider malaise that has settled over Wall Street’s securities operations, once the source of fat profits.

The trouble isn’t rogue traders or big bets gone bad, but shrinking demand from investors who, with little conviction about how to play the markets, simply sit it out or opt for cheap, off-the-shelf investment products, such as index funds.

Meanwhile, new regulations have cast banks as mere toll-takers, and more transparent and accessible data have eroded the informational edge that once gave them pricing power over their clients.

The biggest quakes have hit banks’ fixed-income divisions, diverse operations that trade everything from sovereign debt to precious metals to products tied to global interest rates.

Fixed-income revenue last year at the four biggest U.S. trading banks—Goldman, JPMorgan Chase & Co., Citigroup and Bank of America Corp. —fell between 6% and 30% from 2016, and remains orders of magnitude below the peak years of the pre-financial-crisis boom.

In fairness, Goldman’s problems are industry-wide, while GE’s prior management team drove the company into a ditch.     While both companies are still leaders in their field and have tremendous potential to regain their former elite status, this week provided fresh evidence of how difficult it is to stay on top.    Perhaps, in ten years, we will be wondering how Apple and Amazon (#1 and #2 in 2017’s Fortune survey) lost their way.

The Apple Repatriation

This week, Apple announced that it would bring back most of its $252 billion in overseas cash.

Apple, which had long deferred paying taxes on its foreign earnings and had become synonymous with hoarding money overseas, unveiled plans on Wednesday that would bring back the vast majority of the $252 billion in cash that it held abroad and said it would make a sizable investment in the United States.

With the moves, Apple took advantage of the new tax code that President Trump signed into law last month. A provision allows for a one-time repatriation of corporate cash held abroad at a lower tax rate than what would have been paid under the previous tax plan. Apple, which has 94 percent of its total cash of $269 billion outside the United States, said it would make a one-time tax payment of $38 billion on the repatriated cash.

For years, Apple had said it would not bring its foreign earnings back to the United States until the corporate tax code changed, because such a move would be too costly. Now Apple’s bet to hold back on paying such taxes is reaping rewards under the Trump administration.

In return, Mr. Trump and other Republicans can point to Apple as having come around because of their legislative action. The $38 billion tax payment from the Silicon Valley giant is set to be among the biggest payouts from the tax bill, and Apple said it would put some of the money it brought back toward 20,000 new jobs, a new domestic campus and other spending.

To put this in perspective, JP Morgan Chase’s balance sheet from December 31, 2017, showed $25.8 billion in cash – about one tenth of Apple’s total cash position of $269 billion.    It remains to be seen what the next plan will do with respect to the economy and the deficit, but Apple’s actions should be stimulative.

Amazon Narrows HQ2 Candidates

Amazon announced that it is reducing its candidates for its second headquarters from 238 to 20.    Candidate metropolitan areas are as follows: Atlanta, Austin, Boston, Chicago, Columbus, Dallas, Denver, Indianapolis, Los Angeles, Miami, Montgomery County, Nashville, Newark, New York City, Northern Virginia, Philadelphia, Pittsburgh, Raleigh, Toronto, and Washington, DC.

“Thank you to all 238 communities that submitted proposals. Getting from 238 to 20 was very tough – all the proposals showed tremendous enthusiasm and creativity,” said Holly Sullivan, Amazon Public Policy. “Through this process we learned about many new communities across North America that we will consider as locations for future infrastructure investment and job creation.”

Amazon evaluated each of the proposals based on the criteria outlined in the RFP to create the list of 20 HQ2 candidates that will continue in the selection process. In the coming months, Amazon will work with each of the candidate locations to dive deeper into their proposals, request additional information, and evaluate the feasibility of a future partnership that can accommodate the company’s hiring plans as well as benefit its employees and the local community. Amazon expects to make a decision in 2018.

Amazon HQ2 will be a complete headquarters for Amazon, not a satellite office. The company plans to invest over $5 billion and grow this second headquarters to accommodate as many as 50,000 high-paying jobs. In addition to Amazon’s direct hiring and investment, construction and ongoing operation of Amazon HQ2 is expected to create tens of thousands of additional jobs and tens of billions of dollars in additional investment in the surrounding community.

At quick glance, three finalists from the Washington, DC area (Washington, Montgomery County, and Northern Virginia) are noteworthy, given CEO Jeff Bezos’ acquisition of the Washington Post.   He has five homes, one of which is in the DC area.   He also has homes in New York City, West Texas, and Beverly Hills – all of which are near finalist sites.      With a decision to be made in 2018, expect fierce jockeying among the final contenders.

The $20MM Thundering Herd Portfolio

Clark Street Capital’s Bank Asset Network (“BAN”) proudly presents: “The $20MM Thundering Herd Portfolio.”  This exclusively-offered portfolio 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.

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.    If you are only interested in the commercial loans, a commercial-only CA is available upon request.

The BAN Report: The $20MM Thundering Herd Portfolio / 4% GDP Growth? / California Skirts Cap / CRA Tweak?-1/11/18

The $20MM Thundering Herd Portfolio

Clark Street Capital’s Bank Asset Network (“BAN”) proudly presents: “The $20MM Thundering Herd Portfolio.”  This exclusively-offered portfolio is offered for sale by one institution (“Seller”).   Highlights include:

  • A total unpaid principal balance of $19,617,684
  • Two distinct pools (residential totals $12MM and commercial $8MM) offered on a servicing-retained or released basis
  • Residential pool is comprised of 86 loans with a weighted average coupon of 5.49% and a weighted average LTV of 76.17%
  • Residential loans are in the following MSAs: Huntington-Ashland (76%), Charleston (10%), Lexington-Fayette (5%), and Cincinnati-Middletown (3%)
  • All residential loans are fully-documented performing loans with a weighted average remaining maturity of 188 months and a weighted average seasoning of 44 months
  • Commercial pool is comprised of 9 relationships secured predominantly by single-family rental and small multi-family properties located in the Huntington-Ashland, WV-KY-OH MSA
  • Nearly all commercial loans are performing (94%) with a weighted average coupon of 7.32%, a weighted average remaining maturity of 71 months, and a weighted average seasoning of 80 months
  • Community Reinvestment Act (“CRA) eligible
  • All loans are whole loans
  • Bids on residential loans must be par or better

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.

Event Date
Sale Announcement Thursday, January 11, 2018
Due Diligence Materials Available Online Monday, January 15, 2018
Indicative Bid Date Thursday, February 1, 2018
Closing Date Thursday, February 22, 2018

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.    If you are only interested in the commercial loans, a commercial-only CA is available upon request.

4% GDP Growth?

Jamie Dimon this week argued that 4% GDP growth is a real possibility, dismissing his own bank’s economist.

‘If we have a couple of years of good growth, that could justify the markets where they are. Four percent economic growth this year is possible’

Those were the thoughts of JPMorgan Chase & Co. CEO Jamie Dimon, who offered a forecast for U.S. economic growth that outstrips even some of the more bullish economists.

Speaking during an interview with Fox Business’s Maria Bartiromo on Tuesday, Dimon said the recently signed tax legislation, which cuts the corporate tax rate to 21% from 35%, is likely to support higher levels for the Dow Jones Industrial Average, the S&P 500 Index, and the Nasdaq Composite Index, which have already rung up all-time highs in first several sessions of 2018, after a record-setting rally for the equity benchmarks last year.

Dimon said he expects the “competitive tax rate” to encourage deal-making on Wall Street, pointing to Europe which he said is on pace to grow at a 3% rate. A reading of gross domestic product is slated for Jan. 26.

In the U.S., the economy grew at a 3.1% annual pace in the second quarter and a 3.2% annual rate in the third, according to the Commerce Department, exceeding the postrecession pace of near 2% A fresh estimate of gross domestic product is slated for Jan. 26.

Mr. Dimon may be right, as passage of tax reform has already shown some positive impacts, although it may cause problems in the high-end residential real estate markets.    Nevertheless, there are good reasons to be optimistic in 2018.

California Skirts $10,000 Cap

Last week, California legislators introduced legislation that could help taxpayers avoid the new tax bill’s $10,000 limitation on state and local tax deductions.

California Senate leader on Thursday introduced legislation aimed at circumventing a central plank in the new Republican tax law, introducing a model that – if successful – could be replicated all over the country.

California Senate President Pro Tempore Kevin de León, D, introduced a bill that would allow taxpayers to make a charitable donation to the California Excellence Fund instead of paying certain state taxes. They could then deduct that contribution from their federal taxable income.

The bill is meant to completely upend part of the tax law congressional Republicans pushed into law last year. That law contains a provision that sets a new cap of $10,000 on the amount of state and local property and income taxes that can be deducted from federal taxable income. De Leon’s office said that one-third of all taxpayers, roughly 6 million people, itemized deductions on their tax returns and claimed an average of $18,438 for state and local taxes.

De Leon’s bill, if it became law, would essentially allow Americans to deduct much more than the $10,000 limit by redirecting state tax payments into a type of charitable contribution that eventually was later redirected to the state. The new federal tax law, which was only supported by Republicans, went into effect in January and does not include any caps on charitable deductions.

Other states and municipalities are looking at similar plans.   In the event that these work-arounds are successful, the $600 billion raised from capping deduction will go by the wayside.   Except a coming showdown between Washington and states and municipalities on this very topic, as high-tax areas can’t afford to lose their upper-income taxpayers without a fight.

CRA Tweak?

The Trump Administration is planning a major revision of the regulations surrounding compliance with the Community Reinvestment Act (“CRA”).

While both sides generally agree that CRA helps lower-income communities, debate has intensified about how it can be improved. Community groups say the law should be expanded in order to bring opportunity to more low-income areas, while banks say they would do a better job of helping these people if the law became more flexible and less bureaucratic.

“Community groups don’t like the way CRA is today, the banks don’t like the way CRA is today, and regulators don’t like it,” said Comptroller of the Currency Joseph Otting, whose agency is also planning changes to the way it regulates banks’ compliance with the law. “I have a very strong viewpoint of how to fix this.”

Mr. Otting has floated the idea of expanding the types of activities that fall under this category by allowing small-business loans to count as well.

The American Bankers Association has asked to expand the “community development” definition even further to include infrastructure lending and activities that don’t solely benefit the poor. They say this will free banks up to do more to help communities, such as revitalizing struggling rural areas.

The fair-lending advocacy group the National Community Reinvestment Coalition argues that expanding the definition of “community development” would diminish the services available to the poor and inflate banks’ CRA ratings. “If you begin to move away from the focus on income and class of the borrower and begin to expand it, you’re really changing the law,” said John Taylor, president of the group.

So far details are scarce, but most of the regulations have not changed for decades.   For example, the current assessment system hasn’t been changed since the law was passed in 1977, and are based on locations of physical branches, and do not consider the impact of mobile banking.    While there is a bipartisan consensus that CRA should be modernized, previous Administrations have not been successful.

BAN Report Sign-up