The BAN Report: Bye, Bye LIBOR / The GSE Profit Sweep / Margin Loans Spike / The Downside of High Rents-7/27/17
The BAN Report: What’s Eating the Examiners? / Banks Stay Stingy on Deposits / CFPB Curbs Arbitration / Fed to Slow Rate Increases? / After Walmart Leaves-7/13/17
What’s Eating the Examiners?
The Office of the Comptroller of the Currency, the primary regulator for most of the US banks by assets, published its “Semiannual Risk Perspective for Spring 2017” last week. This important publication tells industry participants what issues are most at the forefront of bank examiners concerns today. A few concerns of note:
- Strategic risk remains elevated as banks make decisions to expand into new products or services or consider new delivery channels and continue merger and acquisition (M&A) activity. Banks face competition from nonfinancial firms, including financial technology (fintech) companies entering the traditional banking industry. This competition is causing changes in the way customers and financial institutions approach banking.
- Credit underwriting standards and practices across commercial and retail portfolios remain an area of OCC emphasis. Over the past two years, commercial and retail credit underwriting has loosened, showing a transition from a conservative to an increasing risk appetite as banks strive to achieve loan growth and maintain or grow market share.
- Strong CRE loan growth has resulted in increasing credit concentrations. Results from recent supervisory activities raise concern over the quality of CRE risk management, particularly as it relates to managing concentration risk.
- Operational risk continues to challenge banks because of increasing cyber threats, reliance on concentrations in significant third-party service providers, and the need for sound governance over product service and delivery.
- Some banks continue to face challenges complying with Bank Secrecy Act (BSA) requirements as money laundering and terrorism financing methods evolve.
- Multiple new or amended regulations are posing challenges to change management processes and increasing operational, compliance, and other risks.
These concerns are basically unchanged from the last report in Fall of 2016. However, a few larger macro risks were added:
- Heavy reliance on third-party service providers for critical activities and the increasing changes driven by new products offered by emerging fintech companies create increased risk relating to third-party risk management.
- Credit risk in banks with high concentrations in agricultural lending is increasing. Commodity prices for grain crops have declined over the past three years and livestock, and dairy prices have declined over the last two years, resulting in lower income and cash flow for agriculture industry borrowers.
- Changes in interest rates and the yield curve are raising interest rate risk. This increased risk is evident in changes in unrealized gains and losses in bank investment portfolios with long duration assets
Sometimes, one gets the impression that the OCC does not know what to do with fintech. They are very worried about banks relying on third-party service providers to offer additional products to their customers, while they are still considering a fintech charter.
The concern about agricultural lending is a new concern, as lower commodity prices could cause problems through agricultural portfolios. Fortunately, a large portion of agricultural lending involves government support. The worry about interest rate risk has been elevated as well.
Banks Stay Stingy on Deposits
Still flush with deposits, banks have not budged on increasing deposit yields despite four rate increases. So far, consumers have stood pat, perhaps conditioned for low yields for nearly a decade.
Banks have been dealing with interest-rate cycles and depositors for decades, but a number of factors, both psychological and technological, make this time of rising rates different. A decade of near-zero rates, more competition from online firms, less loyalty from customers and new capital rules, among other factors, are making preparations more difficult.
Of course, banks don’t want to raise deposit rates until they have to. Though they tend to raise certain loan rates as soon as the Fed makes a move, they prefer to let deposit rates lag, bolstering profits.
And when they do raise rates, it is often because competition has forced them. “Nobody wants to be first,” said Greg Carmichael, chief executive of Fifth Third Bancorp. “But nobody wants to lose deposits.”
Bank of America is a case in point. Its cost for U.S. interest-bearing deposits in the first quarter was just 0.09%—unchanged from the prior quarter and the lowest among its peers.
Talking with analysts recently, finance chief Paul Donofrio said it seemed unlikely that customers would leave the bank to chase rates because many had their primary checking accounts there.
Or at least they used to care. A complicating factor is that depositors haven’t thought of bank accounts as income-producing instruments in nearly a decade, thanks to the Fed’s near-zero interest-rate policies.
Given that, many customers have come to view banks in terms of the services they offer, such as mobile banking, rather than the rates they pay.
How long will this continue? With lagging loan growth this year, banks are not lacking in funding, so it makes little sense to pay up for more deposits. We suspect that someone will eventually go first and other banks will have to follow. But, in the meantime, this is great for bank earnings as banks can continue to increase loan yields while funding costs are flat, thus boosting net interest margins.
CFPB Curbs Arbitration
This week, the Consumer Financial Protection Bureau adopted a rule that would make it easier for consumers to sue financial firms by breaking up mandatory arbitration clauses common in consumer loans.
The nation’s consumer watchdog adopted a rule on Monday that would pry open the courtroom doors for millions of Americans, by prohibiting financial firms from forcing them into arbitration in disputes over their bank and credit card accounts.
The action, by the Consumer Financial Protection Bureau, would deal a serious blow to banks and other financial firms, freeing consumers to band together in class-action lawsuits that could cost the institutions billions of dollars.
“A cherished tenet of our justice system is that no one, no matter how big or how powerful, should escape accountability if they break the law,” Richard Cordray, the director of the consumer agency, said in a statement.
The new rule, which could take effect next year, is almost certain to set off a political firestorm in Washington. Both the Trump administration and House Republicans have pushed to rein in the consumer finance agency as part of a broader effort to lighten regulation on the financial industry.
Lawmakers have 60 legislative days to overturn this rule, and there will undoubtedly be lots of pressure from the banking industry, which had worked for a decade to move consumer disputes from the courts to arbitration.
Rob Nicholas, ABA President and CEO, said “We’re disappointed that the CFPB has chosen to put class action lawyers – rather than consumers – first with today’s final rule. Banks resolve the overwhelming majority of disputes quickly and amicably, long before they get to court or arbitration. The Bureau’s own study found that arbitration has significant benefits over litigation in general and class actions in particular. Arbitration is a convenient, efficient and fair method of resolving disputes at a fraction of the cost of expensive litigation, which helps keep costs down for all consumers.”
From a practical standpoint, this rule would dramatically increase the number of class action lawsuits, as the arbitration clauses have made class action suits very difficult. Consumer lending has already been viewed as toxic by many banks, and this ruling, if it stands, will not make it any easier.
Fed to Slow Rate Increases?
Traders often hear what they want to hear to support their market view, and yesterday’s hearing by Janet Yellen was no exception.
Ms. Yellen added, however, that the Fed was paying close attention to the recent weakness of inflation. While emphasizing that she expected prices to start rising more quickly, she said persistent weakness could lead the Fed to raise interest rates more slowly.
“It’s premature to reach the judgment that we’re not on the path to 2 percent inflation over the next couple of years,” she said. “We’re watching this very closely and stand ready to adjust our policy if it appears the inflation undershoot will be persistent.”
Ms. Yellen’s testimony before the House Financial Services Committee lifted stock prices and lowered bond yields on Wednesday. Investors tend to celebrate any sign that the Fed might slow the pace of its interest-rate increases.
So, rates will probably continue to go up, unless inflation is not as bad as we thought.
After Walmart Leaves
While there are better sources for one’s sympathy, Walmart, the nation’s largest retailer, gets blamed for destroying communities when it opens a store, and then destroying them when they leave.
Much has been written about what happens when the corporate giant opens up in an area,with numerous studies recording how it sucks the energy out of a locality, overpowering the competition through sheer scale and forcing the closure of mom-and-pop stores for up to 20 miles around. A more pressing, and much less-well-understood, question is what are the consequences when Walmart screeches into reverse: when it ups and quits, leaving behind a trail of lost jobs and broken promises.
The subject is gathering increasing urgency as the megacorporation rethinks its business strategy. Rural areas like McDowell County, where Walmart focused its expansion plans in the 1990s, are experiencing accelerating depopulation that is putting a strain on the firm’s boundless ambitions.
When you combine the county’s economic malaise with Walmart’s increasingly ferocious battle against Amazon for dominance over online retailing, you can see why outsized physical presences could seem surplus to requirements. “There has been a wave of closings across the US, most acutely in small towns and rural communities that have had heavy population loss,” said Michael Hicks, an economics professor at Ball State University who is an authority on Walmart’s local impact.
On 15 January 2016, those winds of change swept across the country with a fury. Walmart announced that it was closing 269 stores worldwide, 154 of them in the US. Of those, 14 were supercenters, the gargantuan “big boxes” that have become the familiar face of the company since the first opened in Missouri in 1988.
While these stories are unfortunate, towns with shrinking populations in a tough retail environment are going to continue to see loss of large retailers.