Wells Fargo & Co. continues to grapple with the aftershocks of a sales-fraud fiasco. But during the company’s annual investor day May 11, executives touted improvements and vowed to bolster an efficiency ratio recently headed in the wrong direction.
Driven in part by higher regulatory and legal costs tied to the fallout from a sales scandal that erupted last September, when regulators fined Wells and said it had opened millions of phony accounts to meet overly aggressive sales goals, the San Francisco-based bank’s expense base expanded in 2016.
The trend continued during the first quarter of this year, when expenses rose 6% from a year earlier. That increase, combined with a roughly 1% decline in revenue generation that was hindered by customer apprehension tied to the sales matter, pushed up the company’s efficiency ratio. Wells’ first-quarter efficiency ratio, which measures noninterest expense as a share of revenue, increased to 62.7% from 58.7% a year earlier.
“Operating at this level is completely unacceptable,” President and CEO Timothy Sloan told investors and analysts. First-quarter earnings were flat, again hindered by the sales issue and lower levels of lending and new customer generation tied to it. Wells said new consumer checking account openings in March declined 35% from a year earlier, while new credit card applications fell 42%, continuing a trend that took hold early in the fourth quarter of 2016. Total average loans declined during the first quarter.
In previous years, Wells targeted a sub-60% efficiency ratio, and during the investor day presentations, executives said they will build on a sweeping branch reduction effort already in motion to squeeze out billions of dollars in costs and bring the efficiency ratio down into a range of 55-59% in coming years. “We’ve undertaken a rigorous review across the company,” CFO John Shrewsberry said. Wells executives previously said they planned to close about 200 branches in 2017 and 200 more in 2018, among other steps to reduce expenses by $2 billion annually. Mary Mack, head of Wells’ community bank division, told investors May 11 that the bank is on pace to meet the 200 goal for this year and that executives now envision
closing some 250 in 2018. Savings from those efforts are slated to be reinvested in new technology and other innovation endeavors, among various business needs, with the goal of both operating more efficiently and driving revenue growth.
Wells joins a broader industry movement toward fewer branches amid a yearslong trend of customers visiting branches less and increasingly doing routine banking online and via mobile devices.
“Branch visits have been free-falling for years,” Jon Winick, president of bank adviser Clark Street Capital, said in an interview. “In my opinion, the banks in
this country can’t close branches fast enough.”
In addition to the branch consolidation, Wells executives say they now aim to ring out another $2 billion in annual expenses by the end of 2019. These savings would flow directly to the bottom line, executives said.
Mack and other Wells leaders spoke mostly in generalities about how the additional savings would be produced. But they emphasized Wells is capitalizing on advancing technology to improve efficiency in everything from call centers to the delivery of products, including plans for the second half of this year to begin allowing customers to submit one credit application for multiple product approvals.
Executives also noted efforts to increase the use of data to more quickly identify and meet customer needs, as well as ongoing facility reductions, among other efforts. Wells also is reportedly considering business line divestitures. Bloomberg News reported this week that Wells is exploring the potential sale of an insurance brokerage unit that employs about 3,500 people.
In the near term, Mack said that while Wells continues to endure the effects of the sales scandal, its consumer account openings have begun to improve on a month-over-month basis, and customer satisfaction surveys also are now trending favorably. “We are emerging stronger than before,” Mack said. Winick, however, said that at least in the near term, with the cloud of scandal still hovering over it, Wells likely will struggle to grow lending and revenue. That makes the cost-cutting paramount, he said.
Longer term, it could prove difficult for big banks such as Wells that are reliant on loan growth to boost revenue meaningfully, said Ken Mayland, president of ClearView Economics and a bank adviser. He said the strong credit quality environment that banks have enjoyed for years has begun to deteriorate and recent indications from the likes of Wells suggest a trend could be forming.
Wells’ first-quarter credit card charge-off rate of 3.54% was up from 3.09% at the end of last year and up from 2.82% at the end of the third quarter of 2016. Its first-quarter auto loan charge-off rate, at 1.10% of average loans, was up from 1.05% at the end of the 2016 fourth quarter and up from 0.87% atthe close of the 2016 third quarter.
After Wells reported those figures, Mayland said in an interview that the bank may need to pull back on lending in key areas. “I think risk aversion only grows from here,” he said. During the investor day, Wells executives said they had already eased up some in auto lending and are more broadly willing to give up some market share to guard against risks to the strength of the company’s balance sheet.
Lending by the largest U.S. banks was flat in the first quarter, held in check by a seasonal pullback in demand and uncertainty in the nation’s capital.
Total first-quarter loans and leases among the 10 biggest commercial banks by assets inched down 0.1% from the previous quarter on an aggregate basis,
according to an S&P Global Market Intelligence analysis of regulatory filings.
Commercial-and-industrial lending rose 2.2% during the quarter among the big banks, a decent advance but mild relative to expectations heading into the
quarter. Commercial real estate and multifamily lending advanced more modestly, by less than 1% in both categories.
Lending in other key categories fell notably during the first three months of the year, including a 3% dip in consumer lending, offsetting moderate gains
Analysts say that loan demand among consumers often slows during the first quarter, as Americans ease up on borrowing after holiday spending sprees
and shop less amid winter weather. Demand for credit also often stagnates some among commercial clients, who tend to tap credit lines late in a given year
in order to shore up business plans for the following year, leaving them with fewer borrowing needs early in a new year.
But analysts noted throughout first-quarter earnings season that investors had expected more for the start of this year, largely because of lofty optimism fueled by promises in Washington for healthcare reform, deregulation and, perhaps most significantly, corporate tax cuts.
Republican President Donald Trump, who took control of the White House in January, has vowed to work with a GOP-controlled Congress to get legislative
wins on each of those fronts — wins that would lower costs for many businesses and provide them more resources for expansion, the thinking goes.
Banks could finance such expansion, lenders say.
Trump also has touted plans for new international trade policies and domestic infrastructure spending that could benefit American businesses.
But Trump and allies in Congress have made little progress to date on the legislative front, and the likelihood and timing of major reforms remain uncertain,
analysts say. “There is a lot of waiting to see what happens,” among business owners, “a lot of questions and not a lot of answers yet,” FIG Partners bank
analyst Christopher Marinac said in a post-earnings interview.
“So with the slow first quarter loan growth, right now, it’s hard to tell how much of what we saw is seasonal and how much of it has to do with people
waiting to see what Trump can accomplish,” Jon Winick, president of bank adviser Clark Street Capital, said in an interview.
Minneapolis-based U.S. Bancorp, whose first-quarter commercial lending was essentially flat from the previous quarter, attests to the uncertainty.
“Our large corporate customers tell us that they are optimistic about the future but are awaiting more clarity regarding potential changes in tax and regulatory
reform, infrastructure spend and trade policies,” U.S. Bancorp President and CEO Andrew Cecere said during the company’s first-quarter earnings call.
The $10MM Lone Star Multi-Family Portfolio
Clark Street Capital’s Bank Asset Network (“BAN”) proudly presents: “The $10MM Lone Star Multi-Family 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.
There is something for everyone looking for lending pitfalls in the coming months.
Mortgages, subprime auto lending, commercial-and-industrial loans and student lending are ripe for setbacks and, in some cases, crises.
Here is a breakdown of each of those risk factors, the reasons behind them and the possible upsides or alternative strategies.
The refinance market has largely carried the mortgage industry over the past few years because consumers took advantage of historically low rates. Now that the Federal Open Market Committee has raised rates twice in the past year, and the benchmark 10-year Treasury has spiked upward since the presidential election, many expect the refinancing market to nosedive.
“We’ll see refinancing all but dry up, and the mortgage business is going to really suffer” in 2017, said Donald Musso, CEO of FinPro Capital Advisors, a bank consulting firm in Gladstone, N.J.
The question becomes whether an improvement in the overall health of the housing market can take up the slack.
“It’s going to be sales that drive your mortgage lending now,” said Jay Pelham, president of the $3 billion-asset TotalBank in Miami.
That may be easier said than done. The incoming Trump administration and the Republican-led Congress have signaled they may reduce the mortgage interest deduction, a move that the National Association of Realtors and other housing industry groups have warned will wallop the housing market.
Banks’ mortgage fortunes could vary among geographic markets, too. The South Florida market, especially downtown Miami, appears to be set for a high level of purchase activity, Pelham said.
“If you look at our downtown market, it’s full of restaurants, jobs and apartments that both professionals and young people want,” he said. “When I look at prices per square foot here, we are still cheap compared to New York, London and Chicago.”
For months, regulators have forcefully warned about soaring balances of subprime auto loans and the risks associated with them. The data seemed to back them up.
In March, Fitch Ratings reported that more than 5% of securitized subprime auto loans were at least 60 days late, the highest delinquency rate in 20 years.
And the 90-day delinquency rate for subprime auto loans was 2% in the third quarter, versus 1.9% a year earlier and 1.4% in the third quarter of 2012, according to a Federal Reserve Bank of New York report. Over the same period, delinquency rates for borrowers with higher credit scores were relatively flat. Meanwhile, about 3.6% of overall auto loan balances were 90 days behind in payments.
Lenders have downplayed those concerns, saying that they have applied strict underwriting standards.
Yet some banks have begun to take precautions. The $143 billion-asset Fifth Third Bancorp in Cincinnati and the $147 billion-asset Citizens Financial Group in Providence, R.I., this fall announced plans to scale back indirect auto lending.
At the same time, some community banks have shown greater interest in auto lending as consumer demand for car loans continues to soar. The $4 billion-asset Fidelity Southern in Atlanta and the $9 billion-asset First Interstate BancSystem in Billings, Mont., each posted double-digit increases in auto loans in the third quarter.
Lenders have recently made improvements in how they underwrite subprime auto loans, and that may prevent a big meltdown, said Jon Winick, CEO of Clark Street Capital, a bank consulting firm in Chicago.
“There have been real innovations in the subprime auto space that are unique to that asset class,” he said. “You can prevent someone from using their own car if they’re 30 days delinquent and you don’t have that level of control with a real estate deal.”
Tough competition for commercial-and-industrial loans has created one of the riskiest situations as many banks are said to have cut pricing to win business.
Banks have crowded into the C&I space for plenty of reasons. One is that regulators have placed a great deal of emphasis on commercial real estate loan concentrations, and banks have responded by improving risk management and bolstering capital levels. Those steps may help limit CRE losses, but they have encouraged more banks to risk expansion in C&I loans as they hunt for places to deploy their capital.
There is so much competition in the C&I market that many players have caved to borrowers’ demands for lower rates and better terms, Winick said.
“Underwriting standards have collapsed the most in C&I,” he said.
At the same time, C&I loans present significant challenges when they default as they are typically not collateralized by tangible assets.
“If a C&I project defaults, you don’t have an automobile you can repossess or a house you can foreclose on,” Winick said.
But there are some potential bright spots for C&I. One is that the presidential election is over, which should remove the anxiety that had led many businesses to hold back on capital spending for months because of political uncertainties, Musso said. Talk of tax cuts and regulatory relief has played well in commercial sectors.
“I actually think we may see a modest uptick there because the business community believes we’ll see some relief from the Trump administration,” Musso said.
Another is that banks may have already suffered through the worst part in two subcategories of C&I lending, energy and taxi medallion loans. A rebound in oil prices dampened the losses at energy lenders, while some banks like the $72 billion-asset Comerica in Dallas reduced their exposure to the sector. And executives at the $38 billion-asset Signature Bank in New York recently said that they have restructured troubled taxi loans.
“I think the new normal has come out in taxi loans,” said Dave Etter, managing director of loan review services at Sheshunoff Consulting. “To try to sell taxi loans now is just impossible. You’re just looking to generate some cash flow.”
Finally, some banks have attempted to carve out specialties within the C&I category to diversify loan portfolios and improve yields. The $28 billion-asset First Horizon National in Memphis, Tenn., for example, has expanded in franchise finance and health care finance to help dilute its C&I exposure.
The massive pile of student loan debt threatens to send scores of consumers into financial ruin. The Congress and the incoming Trump administration may try to address the situation by getting the U.S. government out of the student loan business. That could create an opportunity for banks to re-enter the private student loan market.
Investors are betting that will happen. Shares of SLM Corp., the Newark, Del., company known as Sallie Mae, rose 54% from Nov. 8 to Dec. 28, to $10.95. Sallie Mae is the largest private student lender.
Only a few banks remain active in student loans, including Citizens Financial. Those banks stand to benefit from the new political environment, KBW analysts wrote in a December report, and other banks may want a piece of the action.
What most analysts agree on is that the amount of student-loan debt that consumers are carrying is unsustainable.
“It’s my biggest concern in the consumer space, hands down,” Winick said. “We know the losses will be terrible.”
Bankers are entering a new year feeling a sense of déjà vu about regulatory warnings over commercial real estate concentrations.
A decade earlier, regulators were warning that CRE exposure could lead to earnings and capital volatility. While many bankers said those concerns were overblown – arguing that few institutions were in trouble – hundreds of banks ended up failing.
Fast forward to today and regulators are expressing similar reservations, warning that areas such as multifamily could become problematic. Bankers, however, say they believe the industry is better equipped to handle an economic shock, pointing to a system with more capital, backstops from borrowers and improved risk management processes.
Only time will tell if those views are correct and whether bankers will remain relatively cautious.
“You see comments about taking a foot off the gas,” said Peter Cherpack, principal of credit technology at Ardmore Banking Advisors. “The enthusiasm for real estate for many bankers is now somewhat tempered.”
Still, the industry struggles “with bankers who have short memories,” Cherpack said.
Several banks exceed recommended CRE levels, as a percentage of total risk-based capital, prompting regulators late last year to remind banks of their guidance on concentrations. Regulators prefer that CRE remain below 300% of a bank’s total risk-based capital and for construction and land development loans to stay under 100%.
Regulators said in a joint statement that “many CRE asset and lending markets are experiencing substantial growth, and that increased competitive pressures are contributing significantly to historically low capitalization rates and rising property values.”
There is no prohibition for going over those levels, and the numbers aren’t considered limits. Banks may still be targeted for more supervisory analysis and, as a result, should implement enhanced risk controls, such as stress testing for CRE portfolios.
New York Community Bancorp and Astoria Financial earlier this week terminated a $2 billion merger after facing regulatory delays that some industry observers believe could be linked to CRE concentrations.
It seems unlikely that a focus on CRE will let up next year. Fitch Ratings warned last month that CRE lending at U.S. banks had reached record levels that are unsustainable.
“I don’t think commercial real estate will be dropping off the radar,” said Patrick Ryan, president and CEO of First Bank in Hamilton, N.J. “Other areas like cybersecurity might also become an area of focus … but it may not replace CRE.”
A review of the financial crisis provides some rationale for regulators’ diligence. A 2013 report from the Office of the Comptroller of the Currency and the Federal Reserve found that 23% of banks that exceeded guided levels for both CRE and C&D loans failed during the three-year economic downturn, compared with less than 1% of banks that stayed below those levels.
The Federal Deposit Insurance Corp. did not provide a comment for this story. The OCC and the Fed did not comment on the record.
“There’s the sense that the industry got a little ahead of itself and loaned too much on deals that were not tangible,” said James Kaplan, a lawyer at Quarles & Brady. “It was unclear that these buildings would have tenants, and banks got left holding … something that didn’t have too much value.”
Some industry observers believe those numbers don’t tell the full story, pointing out that not all types of CRE perform the same. Many of the defaulted loans were tied to residential projects that failed when people stopped buying homes.
“I think the way regulators classify CRE – at least from a numbers standpoint – is suboptimal,” said Jon Winick, CEO at Clark Street Capital. “Many of those losses weren’t really CRE projects. They were … classified as CRE but they were really residential.”
Banks largely pulled out of funding speculative construction and development loans after the crisis. Roughly 320 banks at mid-2016 exceeded the 100% guidance on C&D loans as a percentage of total risk-based capital, versus nearly 2,400 in 2007, based on regulatory data.
“Banks understand that construction is more of a risky market … and the first one to collapse,” said Tim Scholten, founder of Visible Progress, a consulting firm. “A project that is half done isn’t good collateral.”
The $4.8 billion-asset Peapack-Gladstone Financial is among the banks that pulled back from C&D loans, which accounted for most of its losses during the last downturn, said Vincent Spero, the Bedminster, N.J., company’s head of commercial real estate.
“We just don’t have the stomach and the appetite for those loans,” Spero said. “You need the infrastructure in place to complete those loans, so we have pursued a different strategy.”
Peapack-Gladstone is focusing on the rent-regulated space for multifamily loans, an area that has historically had lower chargeoff rates and better credit analytics, Spero said. The bank has a CRE to total risk-based capital ratio of almost 590%, according to BankRegData.com.
Peapack-Gladstone has spent close to $1 million on processes, data analytics and third-party vendors to “ensure from a risk management perspective that we’re on top of it,” said Chief Credit Officer Lisa Chalkan. The company earlier this year hired a real estate expert to provide granular data on asset classes that management uses to evaluate limits on different types of loans.
“With the reissuance of the guidance, it was abundantly clear that the regulators were focused on real estate,” Chalkan said. “It just seemed like a prudent time to make changes.”
Industry experts also believe that banks are better capitalized today and would be in a better position to withstand a significant economic downturn. Total risk-based capital at banks with less than $10 billion of assets averaged 15.5% at Sept. 30, up from 14.4% a decade earlier, according to the FDIC.
Banks have also been more careful about underwriting, risk management and deals outside of their comfort zone, said Mitch Razook, president of RLR Management Consulting. Stress testing is also helping a number of banks.
“Lenders are better educated now and underwriters are more conservative,” Razook said. “Banks have a lot more controls in place.”
Though the $1 billion-asset First Bank has a CRE focus – CRE to total risk-based capital was roughly 390%, according to BankRegData.com – it has resisted the urge to diversify by branching out into areas where it lacks expertise, Ryan said. Rather, the company works to have varied assets, such as retail, industrial and mixed use, within its CRE book.
While there is talk that banks are loosening standards, Ryan said he believes many institutions are normalizing their stance after years of having tight criteria.
“If you compare what banks and borrowers are doing today, it is much more controlled, rational and logical compared with what was happening from 2005 to 2007,” Ryan said. “It is probably a better, happy medium.”
“These two transactions demonstrate the broad range of Clark Street’s expertise, as we are the best firm for highly unique and customized transactions. I am confident that no other firm could have delivered as capably as we did on these two deals, and we received broad accolades from our clients.”
In one offering, Clark Street helped a regional bank divest out of a legacy portfolio of largely performing, but classified commercial real estate loans within the Louisville, KY metro area. In selling a complicated portfolio to two different private equity firms, Clark Street solicited bids from over two dozen parties, including several local and regional banks. Final pricing exceeded Clark Street’s initial estimates by approximately 100 basis points.
In another sale that closed in late September, Clark Street helped a bank operating in more than a dozen states divest out of fixed rate residential mortgages acquired for CRA purposes. It was a unique transaction, as the seller of the loans was not the servicer, which presented significant operational challenges. Ultimately, four different parties had to be comfortable with a highly complicated transaction featuring over 400 small-balance residential mortgages. The loans were sold at a premium to par and exceeded the reserve price by over 50 basis points.
Jon Winick, CEO of Clark Street Capital, said, “These two transactions demonstrate the broad range of Clark Street’s expertise, as we are the best firm for highly unique and customized transactions. I am confident that no other firm could have delivered as capably as we did on these two deals, and we received broad accolades from our clients.”
Clark Street has the largest database in the industry, with over 40,000 contacts in its collective databases. Over 21,000 professionals receive the BAN Report, our weekly banking industry blog.
Clark Street Capital is a full-service bank advisory firm specializing in loan sales, loan due diligence and valuation, and wholesale lending.