June ’17

The BANReport: Oil Prices in Bear Market Again While Banks Step Up Lending / Banks Curb Provisioning:SNL / Cred Report Black Marks Vanish / Uber CEO Out-6/21/17

Oil Prices in Bear Market Again While Banks Step Up Lending
Steps by OPEC members to limit oil production have not worked, as US producers have stepped up production, sending oil prices back into a bear market as with a 20% decline since February.    
Oil prices are back in bear-market territory, frustrating OPEC members that cut production in an attempt to boost prices and renewing fears that falling prices could spill into stocks and other markets.
A persistent glut has weighed on prices for most of the past three years, a blow to investors who believed that the Organization of the Petroleum Exporting Countries’ move this year to limit production would provide relief.
Instead, U.S. producers ramped up production when the world was already swimming in oil as OPEC members, Russia and other producing nations curtailed output.
U.S. oil production is up 7.3% to 9.3 million barrels a day since OPEC announced plans in November to cut output, and the number of active rigs in the U.S. is at a two-year high.
Prices are down 20.6% since Feb. 23, marking the sixth bear market for crude in four years and the first since August. Crude prices have lost 62% since settling at $115.06 a barrel three years ago. A bear market is typically defined as a decline of 20% or more from a recent peak, while a bull market is a gain of 20% or more from a recent trough.
Obviously, this is good news for consumers, the airline industry, and hotels, but could cause problems in regions dependent on energy.    Meanwhile, many US banks are increasing lending in the energy sector, after paring back in prior years.   Comerica, Zions, and BOK Financial are growing their energy portfolios again. 
The current price range in the $40s is more economically feasible for lenders that specialize in exploration-and-production loans — essentially mortgages secured by the mineral rights, said Jared Shaw, an analyst at Wells Fargo Securities.
“Oil … seems to have stabilized in the high-$40s, low-$50s kind of range,” Harris Simmons, chairman and CEO of the $64 billion-asset Zions, in Salt Lake City, said at a May 31 investor conference. “At that level, there is enough activity going to … continue [loan] demand.”
Cheaper oil has also created a credit environment that is more appealing for some banks, such as the $33 billion-asset BOK Financial in Tulsa, Okla., which has added $1 billion of energy loan commitments in the past 12 months, said Stacy Kymes, executive vice president of corporate banking. Key segments of the industry “are exhibiting growth characteristics that are positive for loan demand,” Kymes said.
About three-quarters of BOK’s energy loans are to oil and gas producers, which means the loans are secured by oil and gas reserves. That provides BOK with some insulation from the sector’s volatility, Shaw said. “They’re seeing better pricing and better structure, and it’s less competitive than it was before,” he said.
A recovery after a correction is often a good time for banks to increase lending, as they can see which energy producers are viable when the price of oil is in the 40s.     Moreover, many banks moved so quickly to shed energy loans that some very strong companies saw their access to credit curtailed.   
Banks Curb Provisioning: SNL
Smaller banks, on the other hand, have elevated provisioning, providing community banks with a larger buffer against loan losses if delinquencies rise. A key measure of provisioning looks at the amount set aside for losses relative to the bank’s net charge-offs for the quarter. If the amount exceeds 100%, it means banks have provisioned more than their loans lost, typically resulting in an increase of aggregate reserves. But if the ratio is below 100%, banks have likely released reserves, providing a boost to profits but shrinking the bank’s buffer against a credit downturn.
After years of releasing a mountain of reserves built up from the 2008 credit crisis, banks with more than $250 billion in assets increased the ratio of provisioning to charge-offs to above 100% in the first and second quarters of 2016. But since then, the ratio has fallen below the key threshold and declined again in the 2017 first quarter, reaching 85%. Meanwhile, banks with less than $10 billion in assets have continued to build reserves, posting a ratio of provisioning to charge-offs of 147% in the first quarter of 2017.
Banks have enjoyed exceptionally strong credit quality in recent years, but some analysts warn that could be coming to an end. In a June 15 report, analysts at Sandler O’Neill wrote that credit had reached a Jack Nicholson moment: “Credit is ‘As Good As It Gets’ right now.” Analysts from Credit Suisse offered a similar assessment in a June 9 note on large-cap banks, writing that “credit costs have passed their cyclical trough and that the predominant trend is now upwards.” At the same time, the analysts did not express concern at the current low level of provisioning of the largest banks as there are not many signs of credit quality deterioration.
It’s very hard for outsiders to determine whether a bank is skimping on reserves, as it would require a better understanding of the bank’s credit quality.    A bank could be increasing reserve levels, but they may still be woefully inadequate.   Or, they could be reducing them and still have excess provisions.    And, there are differences between the risk profile of a bank’s loans.   For example, Capital One reserves 2.89% of all gross loans, but they are a large player in credit cards, especially sub-prime borrowers.     Nevertheless, these banks are all heavily scrutinized by multiple banking agencies, the investment community, and their auditors.    
Credit Report Black Marks Vanish Next Month
Starting July 1, many Americans will see substantial increases to their credit scores, as many liens and judgement will be removed from consumer credit files.   
On July 1, about half of tax liens and almost all civil judgments — both big negatives — will be expunged from consumer credit files, thanks to an agreement the big three credit bureaus made under pressure from regulators and state attorneys general to improve the accuracy of credit reporting.
In September, the three bureaus — Experian, Equifax and TransUnion — will also make consumer-friendly changes in the way medical debts are reported.
Studies suggest that people with liens and judgments could see their credit scores rise after these items are expunged, generally by less than 20 points but in some cases by 40 points or more. In some cases, scores could decrease. How it actually plays out depends on how lenders and credit-scoring companies respond to the changes.
Lenders who want the missing data could simply ask borrowers on a loan application if they have outstanding liens or judgments. Or they could obtain the information from the public record.
Starting on that date, the bureaus will no longer display tax liens and civil judgments on a credit report unless they include the person’s name, address and either Social Security number or date of birth. About half of tax liens and virtually all judgments do not have a Social Security number or birth date, which can cause mix-ups, especially for people with common names or large families.
This creates some big problems from lenders, as they will have to work harder to identify outstanding liens and civil judgments.   Lending based solely on credit bureau scores that does not take these items into account could be significantly mispricing credit.   Naturally, there will be products available to supplement the credit file, but lenders will have to rethink “FICO-only” underwriting.     
Uber CEO Out
Despite a board of directors controlled by loyal allies and significant ownership of the company (estimated at about 10%), investors in Uber forced CEO Travis Kalanick out, making a temporary leave of absence a permanent one.
Pressure from investors, who’ve poured more than $15 billion into a company that has burned through billions, ultimately did what the board could, or would, not: It convinced the 40-year-old chief executive to step aside. Five of Uber’s major investors, including Fidelity and Benchmark, asked Kalanick to step aside in a letter to him entitled “Moving Uber Forward,” according to people familiar with the matter.
Kalanick began an indefinite leave of absence on June 13 and left the day-to-day management of the company to a committee of 14 top executives. Regional operations heads continue to oversee much of the company’s business.
Uber’s been searching for a chief operating officer. With Kalanick’s departure, the company is now also looking for a chief executive officer–a far more desirable position for a business leader. Whoever takes the helm will have to plug a leadership vacuum. Uber needs to hire a COO, an independent board chair, a chief marketing officer, and a general counsel. Many of the company’s top executives were promoted internally after their bosses left, including heads of business, policy and communications, and product.
What’s interesting and noteworthy here is that Uber, like many other tech companies, was set up to ensure that the founder maintained control of the company.    But, Uber is burning cash and reliant on continued funding from outside investors.   If those investors are not on board with the current CEO, they can make continued funding difficult.     Mr. Kalnick’s missteps were plentiful:
He called the company “Boob-er.” He argued with a driver about pay in a video published by Bloomberg. He’s said to have questioned whether a female passenger had been raped by a driver who was convicted of the crime in India. Kalanick co-authored corporate values that included “Let Builders Build, Always Be Hustlin’, Meritocracy and Toe-Stepping, and Principled Confrontation.” Uber now plans to scrap many of those tenets on the advice of former U.S. Attorney General Eric Holder, who just concluded an investigation into the cultural failings of a company built in Kalanick’s image.
Since he owns 10% of the company, his continued involvement was hurting his investment.   Uber had hired Eric Holder, former attorney general, to make recommendations in improving the work culture, and all the findings were adopted by the Board.    Here’s a timeline of the downfall, which came in just a few months.      Even if you are not in a heavily regulated industry, investors and boards are just not going to tolerate a cowboy CEO and culture for too long!

The BAN Report: Fed Raises Rates and Begins the Great Unwind / Treasury Weighs in on Regulatory Reform / Hedge Funds in Crisis / Property Tax Inequality-6/15/17

Fed Raises Rates and Begins the Great Unwind
Plans revealed by the Fed on Wednesday would start reducing the central bank’s holdings gradually by allowing a small amount of net maturities every month. It would start by allowing up to $6 billion in Treasury securities and $4 billion in mortgage bonds to roll off without reinvestment, and let those amounts rise each quarter, essentially setting a speed limit for the wind-down.
The limits would ultimately rise to a maximum of $30 billion a month for Treasurys and $20 billion a month for mortgage-backed securities.
Ms. Yellen said if the economy performed in line with the central bank’s forecasts, the Fed could set those plans into motion “relatively soon,” which market strategists believe could mean September or October.
Officials have taken pains to communicate their strategy in advance to avoid a rerun of the 2013 “taper tantrum,” when investor concerns over the Fed’s decision to slow down asset purchases triggered market turmoil, including a sharp increase in Treasury yields and capital outflows from emerging markets.
The big question is what impact this will have on asset prices, as the Fed will be running off a massive portfolio in a short period.    There will likely be one more hike in interest rates as well.  
Treasury Weighs in on Regulatory Reform
The Treasury Department outlined its views on regulatory reform with the publication of “Summary of Recommendations for Regulatory Reform.”  
Treasury’s recommendations to the President are focused on identifying laws, regulations, and other government policies that inhibit regulation of the financial system according to the Core Principles. In developing the recommendations, several common themes have emerged. First, there is a need for enhanced policy coordination among federal financial regulatory agencies. Second, supervisory and enforcement policies and practices should be better coordinated for purposes of promoting both safety and soundness and financial stability. Increased coordination on the part of the regulators will identify problem areas and help financial regulators prioritize enforcement actions. Third, financial laws, regulations, and supervisory practices must be harmonized and modernized for consistency.
Some specific recommendations included reducing regulations for mid-sized and community banks so they can better compete with the larger banks; reducing the stress testing burden for the regional banks; making sure that the foreign banks don’t have lower capital ratios than the US banks during the Basel process; increased regulatory transparency, encouraging De Novo activity; subjecting regulation to cost/benefit analysis; a total review of CRA including updating assessment areas; limit the applicability of the Volker rule to smaller institutions and those who do very little trading; reform and limit the CFPB, and simplify some of the new mortgage rules.
Overall, the Treasury Department is not diverting materially from the House bill that was passed last week.    Many of their recommendations do not require legislation, so expect at least some of these policies to filter down to the examiners in the next several months.
Hedge Funds in Crisis
With just over $3 trillion in assets under management globally, hedge fund magnates are anxiously awaiting a recovery from last year’s feeble industry returns of 5.5 percent, compared with 10 percent for the S&P 500-stock index. 
Investors already withdrew $111.6 billion from hedge funds last year, according to eVestment, as some 1,100 funds — the largest total since the 2008 financial crisis — closed, and thousands of pros were axed.
About 9,700 hedge funds remain. “These funds have very good marketing,” said Ng. “But you can also lose 50 or 100 percent of your money.”
While some individual funds certainly had market-beating returns and this year had early glimmers of hope, the year-to-date performance of the HFRI Fund Weighted Composite Index stands at a paltry 3.5 percent.
That’s easily eclipsed by the more than 9 percent return for the S&P 500, meaning the hedge fund industry overall is way behind. 
Sensing that funds were trailing the market indexes, investors in April pulled $930 million, according to eVestment data. 
This isn’t exactly shocking.   Because of the high fees of hedge funds (typically 2% for management and 20% for profits), they must produce above-average risk-adjusted returns to justify their existence.    While there are some that outperform the market, the vast majority cannot justify their fees.  
Property Tax Inequality
In some great journalism, the Chicago Tribune investigated the property tax system in Chicago and Cook County, concluding that the poorer residents pay a disproportionate share of the tax burden.
In unprecedented analysis by the Tribune reveals that for years the county’s property tax system created an unequal burden on residents, handing huge financial breaks to homeowners who are well-off while punishing those who have the least, particularly people living in minority communities.
The problem lies with the fundamentally flawed way the county assessor’s office values property.
The valuations are a crucial factor when it comes to calculating property tax bills, a burden that for many determines whether they can afford to stay in their homes. Done well, these estimates should be fair, transparent and stand up to scrutiny.
But that’s not how it works in Cook County, where Assessor Joseph Berrios has resisted reforms and ignored industry standards while his office churned out inaccurate values. The result is a staggering pattern of inequality.
From North Lawndale and Little Village to Calumet City and Melrose Park, residents in working-class neighborhoods were more likely to receive property tax bills that assumed their homes were worth more than their true market value, the Tribune found.
Meanwhile, many living in the county’s wealthier and mostly white communities — including Winnetka, Glencoe, Lakeview and the Gold Coast — caught a break because property taxes weren’t based on the full value of their homes.
As a result, people living in poorer areas tended to pay more in taxes as a percentage of their home’s value than residents in more affluent communities. Known as the effective tax rate, the percentage should be roughly the same for everyone living in a single taxing district.
Most likely, this is not unique to Chicago, as wealthier households are more likely to protest property tax increases.    But, the disparity in Cook County is depressing to say the least.   

The BAN Report: Credit Suisse Makes Dire Call on Malls / House Moving on Regulatory Reform / Credit Unions to Discuss CECL with FASB / Overhaul at Mayo-6/8/17

Credit Suisse Makes Dire Call on Malls
In a report earlier this month, Credit Suisse predicted a surge in store closings and a loss of up to ¼ of all shopping malls within five years.
According to the Swiss bank’s calculations, on a unit basis approximately 2,880 store closings were announced as of the end of April, more than twice as many closings as the 1,153 announced during the same period last year. Historically, roughly 60% of store closure announcements occur in the first five months of the year. By extrapolating the year-to-date announcements, CS estimated that there could be more than 8,640 store closings this year, which will be higher than the historical 2008 peak of approximately 6,200 store closings, which suggests that for brick-and-mortar stores stores the current transition period is far worse than the depth of the credit crisis depression.
Which brings us to the latest report from Credit Suisse, according to which a staggering 20-25% of the 1,100 US shopping malls – between 220 and 275 shopping centers – will shut down within the next five year, resulting in a shockwave within the US retail and mall REIT sector, and slamming everything from equities to CMBS.
The Swiss bank cited mass store closings, the rise of e-commerce, and the growing popularity of off-price chains, which tend to be located outside shopping malls, among the reasons for the potential mall closings.
While we do see challenging times ahead for retail, many shopping centers have successfully reinvented themselves to become more relevant.   Clearly, there are too many clothing stores, for example.    And, we’ve seen malls rent spaces to office tenants, for example.    But, the trend is certainly not good and few large retailers are adding stores today.
House Moving on Regulatory Reform
The House of Representative is taking up regulatory reform, and the Financial Choice Act is expected to be passed by the chamber soon.
The House’s Financial Choice Act would unwind major parts of Dodd-Frank by relieving healthy banks of some regulatory requirements and forcing failing firms through bankruptcy rather than a liquidation process spearheaded by the regulators. It would also repeal the Volcker rule restricting banks from speculative trading. Supporters of the Choice Act say scrapping what they view as onerous regulatory requirements will ultimately help smaller businesses, allowing them to grow and create jobs.
“Dodd-Frank represents the greatest regulatory burden on our economy,” Rep. Jeb Hensarling (R., Texas), the author of the Choice Act, told reporters Wednesday.
To garner sufficient votes to pass the measure, Mr. Hensarling agreed last month to remove a controversial provision that capped the fees banks charge merchants for debit-card transactions. The provision pitted retailers and banks against one another and had divided GOP lawmakers.
The main trade-off embedded in the Choice Act: Banks can win significant regulatory relief if they maintain a so-called leverage ratio of 10%, meaning they must fund every $100 of loans or investments with at least $10 of equity raised from investors, as opposed to borrowed money like deposits.
While there are some good aspects of this effort, we can’t quite comprehend why anyone would support removing the FDIC’s ability to liquidate non-depository institutions.    If we learned anything from Lehman Brothers, the federal bankruptcy courts are an expensive and inefficient way of winding down a non-bank lender.    The FDIC can do the job far cheaper and with less contagion to the financial system.
Credit Unions to Discuss CECL with FASB
Next week, the National Association of Federally-Insured Credit Unions will meet again with FASB, in order to delay the implementation of CECL.
CECL will replace the financial services industry’s current incurred-loss standard with an expected-loss model that requires institutions to project losses when a loan is booked. Regulators, meanwhile, have sought to convince bankers and credit unions that they will not force institutions to invest in expensive software to make calculations.
While NAFCU may hold high hopes for an eleventh-hour action, suspending CECL implementation, which is set to occur in stages from 2019 to 2021, remains a long shot. The FASB spokeswoman said the transition resource group that will meet on Monday lacks the authority to approve a delay. Rather, the group will tackle questions tied to a limited number of issues such as credit card receivables and troubled-debt restructurings.
Most likely, the credit unions will be merely banging their heads against the wall, as CECL is coming and there is almost nothing anyone can do to stop it.     But, we suppose it doesn’t hurt to try.
Overhaul at Mayo
It’s always difficult to overhaul an organization like the Mayo which is extremely well-regarded.    But, Mayo is going through the most dramatic reorganization in its history.
Each year, some 1.3 million patients from all 50 states and 140 countries come to Mayo. Scores of doctors, hospital administrators, politicians and health researchers visit each month in hopes of emulating it.
To maintain its approach, it must adapt to new payment policies from Medicare, high-deductible health plans and insurers’ restrictions on out-of-network care that are putting pressure on hospital revenue across the U.S. And while the Medicaid expansion under the Affordable Care Act extended coverage in many states, efforts by President Donald Trump and his Republican Party to repeal it could change that.
Mayo, long insulated from many such forces, is no longer immune, says Dr. Noseworthy. “We’re going to be paid a lot less for the work we do.”
The overhaul, called the Mayo Clinic 2020 Initiative, is well past the halfway point, and officials are seeing results of more than 400 projects aimed at squeezing costs and improving quality in services ranging from heart surgery to emergency-room waiting time. Dr. Noseworthy says dozens of major re-engineering projects have helped cut an accumulated $900 million in costs in the past five years.
For great organizations to stay great, they can’t lose sight of the need to often reinvent themselves to changing business environments.    If you’re going to be paid less for the work you do, you better get on with rethinking your entire business model.

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