January ’19

The BAN Report: Fed Chills Out / SNC Credit Quality Improves / Wells Rebuilds Trust / Brady Defies Age-1/31/19

Fed Chills Out

Markets cheered the Federal Reserve suspending its plans to increase interest rates this week.

In suspending its previous plans to continue raising rates this year, the Federal Reserve signaled that its march toward higher interest rates may be ending sooner than expected.

The Fed’s chairman, Jerome H. Powell, said economic growth remained “solid” and the central bank expected growth to continue. But in a sharp reversal of the Fed’s stance just six week ago, Mr. Powell said the Fed had “the luxury of patience” in deciding whether to raise rates again.

“The case for raising rates has weakened somewhat,” Mr. Powell said, pointing to sluggish inflation, slowing growth in Europe and China, and the possibility of another federal government shutdown.

“My colleagues and I have one overarching goal,” Mr. Powell said at a news conference on Wednesday after a two-day meeting of the Fed’s policymaking committee, “to sustain the economic expansion.”

Its goal “to sustain the economic expansion” is a beautiful phrase to investors.    Moreover, the Fed also said it was reevaluating “quantitative tightening.”

Reinforcing this more cautious tone, the Fed also announced in a separate statement that it was prepared to slow or even reverse the steady slimming of its bond portfolio. This, too, was a striking shift. The Fed said in December that it was committed to steadily reducing its holdings of Treasuries and mortgage bonds, which it amassed during the financial crisis to help bolster the economy.

The Fed, recognizing that since US and global growth are slowing, there is no need to keep raising rates, especially since inflation is under control.

SNC Credit Quality Improves

The banking Agencies released their annual review of the Shared National Credit Program (“SNC”), a program in which the banking Agencies collectively review loans in excess of $100MM that are shared by at least two regulated financial institutions.     Since this report was last published a year prior, credit quality improved.

Reviewed loan commitments were stratified by the severity of their risk–special mention, substandard, doubtful, or loss, the last three of which are known as “classified.” Overall, the level of loans rated below “pass,” as a percentage of the total SNC portfolio, decreased year-over-year from 9.7 percent to 6.7 percent.  Leveraged lending was the primary contributor to the overall “special mention” and “classified” rates, comprising 73 percent of “special mention” and 86 percent of “classified” commitments. Investors outside the banking industry held the greatest volume of “special mention” and “classified” commitments, followed by U.S. banks and foreign banking organizations.

The level of loans in the SNC portfolio with the lowest supervisory ratings (special mention and classified) declined, largely because of improving economic conditions in the oil and gas sectors. Despite the improvement, special mention and classified commitment levels remain elevated compared to prior economic cycles. A significant portion of the special mention and classified commitments are concentrated in transactions that agent banks identified as leveraged loans.

Of the entire portfolio of $4.4 trillion in commitments, only $182.5 billion is classified, and $35.8 billion is in non-accrual.     In our view, this strong performance shows that the regulatory regime has done a very effective job in identifying risks in oil and gas and using its supervisory powers to restrain lending in the space, thus keeping a problem form turning into a disaster.

Wells Rebuilds Trust

This week, Wells Fargo released its “Business Standards Report,” in which it reviewed all aspects of its operations in order to rebuild trust with its stakeholders.

Wells Fargo & Co. on Wednesday detailed steps it has taken to address problems following a series of scandals that have resulted in more than $4 billion in fines and settlements since 2016 and tougher scrutiny from regulators.

The company again apologized for the problems that emerged in nearly all of its business lines, some of which resulted in improper customer charges and are still under government investigation.

“While we have made strong progress in our efforts to rebuild trust, our work to improve Wells Fargo will never be done,” the bank said in a roughly 100-page report. Wells Fargo said it continues to review areas across the bank “to identify and remedy problems.”

The report was in response to shareholder requests about 18 months ago. It addressed problems and resulting changes to the bank’s culture, employee structure, risk management and board oversight.

Wells Fargo said it is taking steps to improve inconsistencies in how it has handled customer complaints and refunds, which have added up to about $1 billion since the sales scandal. The Wall Street Journal previously reported problems with auto-loan customer refunds.

The bank said it would roll out a new system in the fourth quarter of 2019 to better handle customer complaints. It said it also has strengthened its platform for employees to anonymously report problems. Employees have said they have been retaliated against for reporting problems through that system over the years.

18 months to release this 104-page report?    We have been critical at the massive overreaction against the offenses of Wells, but we have also been very critical at how the management of Wells handled this PR crisis, responding slowly and tentatively when swift and decision action was needed.     Perhaps, Wells can finally put this bad chapter behind them, but we really wish they had moved a lot faster.

Brady Defies Age

At the age of 41, Tom Brady of the New England Patriots is still competing at an elite level, leading his team again to another Super Bowl.     So how is he doing it?

There are plenty of theories that attempt to explain Brady’s unprecedented combination of longevity and success. Brady frequently credits his health regimen. Others note his tireless work ethic and preparation. Maybe he’s a well-disguised robot.

But there’s a more convincing explanation that has nothing to do with his affinity for avocado ice cream. Brady has adjusted his game to compensate for all the things that a quarterback loses as he ages. He makes up for decreased mobility and diminishing arm strength by throwing the ball quickly and short. He avoids injury the same way, and as a result is rarely hit.

Brady, in practice, is the middle-aged guy at the YMCA who can no longer dunk or get up and down the court but somehow outscores all the people half his age anyway.

“You either evolve and get better, or you go home,” said Tom House, a former baseball pitcher who works with quarterbacks including Brady.

The quarterback Brady evolved from was once a dangerous downfield passer. His most prolific season came throwing bombs to the electric wide receiver Randy Moss. At a time when quarterbacks were less protected by the game’s rulebook, he fearlessly waited in the pocket to launch big passes deep down the field.

Brady’s changing targets are a product of his changing game. This season he has taken 2.61 seconds on average to get rid of his passes—one of the fastest releases in the league. It’s no coincidence that Drew Brees, Philip Rivers and other aging quarterbacks are also among the quickest.

Most of the country will be rooting against the New England Patriots on Sunday, but we all should have the greatest respect for how Tom Brady has defied father time!

The BAN Report: The Limping Chinese Consumer / Shutdown Persists / Fed Takes a Chill Pill / City Dwellers Try the Country-1/4/19

The Limping Chinese Consumer

This week, Apple stunned markets by downwardly revising its Q1 guidance from the $89-93 billion range to $84 billion, sending its stock price down 10% in the following trading session.     In Tim Cook’s note to investors, he blamed China.

While we anticipated some challenges in key emerging markets, we did not foresee the magnitude of the economic deceleration, particularly in Greater China. In fact, most of our revenue shortfall to our guidance, and over 100 percent of our year-over-year worldwide revenue decline, occurred in Greater China across iPhone, Mac and iPad.

The underlying macro-economic issue is that the Chinese consumer is running out of gas and cutting discretionary spending.

Retail sales eased during most of last year, with growth decelerating to 8.1% in November—the lowest level in more than 15 years. Consumption accounted for more than three-quarters of China’s economic growth last year, but is likely to fall to just under two-thirds this year, said Wang Bin, a Commerce Ministry official.

Chinese consumers, especially in cities, feel stretched, dimming the prospects for a quick boost. Last year’s gasoline prices through November were up 14% from a year earlier. Health-care costs rose 4.5% in the period, more than twice the rate of consumer inflation, while prices of eggs and other groceries rose as much as 13%.

As the costs of daily life rise, housing—whether for rent or purchase— has taken a bigger bite. Nationwide, about 20% of total household spending goes to housing, with the rate topping 30% in Beijing and Shanghai, according to official figures. November housing prices in 70 cities were up more than 10% on average compared with a year earlier, official data showed, with smaller cities seeing the biggest boost.

At the Shanghai Lao Miao Jewelry outlet in the eastern city of Zhenjiang, saleswoman Yang Ling said business is slow and customers are pickier about prices. “In the past, few customers would bargain, but now bargaining is commonplace,” said the 29-year-old, who was a sales leader.

At her outlet, Ms. Ling said revenue on Singles Day—the country’s heavily promoted Nov. 11 shopping day—was about half of the 2017 level, even with discounts.

The trade dispute between China and the US are raising costs on US goods while Chinese consumers are feeling pinched.     In addition to Apple, Ford Motor, General Motors, and Alibaba have all cut revenue forecasts as well.    While China has a lot of tools at its disposal, such as increasing government infrastructure spending, it will not change the limping Chinese consumer.

Shutdown Persists

The current government shutdown (14 days and counting) continues to persist and is well on its way to becoming the longest government shutdown in history.     Moreover, there doesn’t seem to be any possible end in sight.

Just yesterday, House Speaker Nancy Pelosi called the proposed wall “an immorality between countries,” stating simply, “We’re not doing a wall.”   President Trump has said he will not re-open the government unless he gets funding for the wall.    Where is the face-saving compromise here?

As the shut-down continues, it has some significant negative impacts on the economy.  The White House estimated that a shutdown reduces US GDP by about 0.1% per quarter every two weeks.    And the shutdown impacts the private economy as well.

While the broader U.S. economy has yet to feel sharp effects from the scaled-down federal government, economist Mark Zandi of Moody’s Analytics said that the impact could be significant if the shutdown drags on.

“If it extends into the spring, it’ll start to do real damage and have real impact, because it probably signifies other things are going off the rails — the acrimony in Washington is run amok,” Zandi said.

It’s difficult to know how that disruption might play out, he added.

“Take the housing market, for example. The fact that the IRS isn’t open and verifying tax returns and W-2 statements may mean that we might not get home closings,” he said. “The housing market could be severely disrupted, particularly during the spring selling season.”

We urge Washington to gets its act together and figure out a compromise to re-open the government, but we are not optimistic it will be solved anytime soon.   We expect it to persist well into the month of January.

Fed Takes a Chill Pill

Federal Reserve Chairman Jerome Powell spoke today to the American Economic Association, signaling more flexibility towards the policy of raising rates.

“As always, there is no preset path for policy,” Powell said. “And particularly with muted inflation readings that we’ve seen coming in, we will be waiting as we watch to see how the economy evolves.”

The policymaking Federal Open Market Committee raised its benchmark interest rate four time in 2018 and has indicated that two more increases this year are likely. However, markets believe differently, and in fact are pricing in about a 28 percent chance of a rate cut by the end of 2019.

Powell said the Fed has a history of adjusting policy according to condition, citing 2016 as a recent example. In that year, the FOMC had indicated four rate hikes were likely but ended up only approving one as financial conditions tightened particularly amid geopolitical concerns.

“No one knows whether this year will be like 2016. But what I do know is that we will be prepared to adjust policy quickly and flexibly and to use all of our tools to support the economy should that be appropriate to keep the expansion on track, to keep the labor market strong and to keep inflation near 2 percent.”

Markets cheered Powell’s remarks.    Late last month, markets were rattled by President Trump’s frustration with Powell and chatter that he has looked at whether he could fire Powell.     Powell today said he would not resign if asked by the President.

City Dwellers Try the Country

At least in the New York metro area, some people are escaping New York City not for the near suburbs but moving further out into the country.

When Casey Scieszka, a freelance writer, and her husband, Steven Weinberg, a children’s book writer and illustrator, decided to leave Park Slope, Brooklyn, they didn’t consider the New York suburbs, where the yards were too small and the property too pricey. Instead, they moved to a house five miles down a dirt road — in the Catskills.

“Ninety percent of my clients up here are from Brooklyn,” said Megan Brenn-White, a real estate agent in Kingston, N.Y., who left a 750-square-foot apartment in Clinton Hill, Brooklyn, that she shared with her husband for an A-frame style house surrounded by woods in Ulster County that they bought for $255,000 in 2016. Ms. Brenn-White markets listings and interesting local businesses on an Instagram account with 6,500 followers, many of them potential or recent transplants from the city.

“Everyone wants the same things: to be within two and a half hours from the city, to have a cute town with a coffee shop less than 10 minutes away,” she said. “Sometimes they’re looking for a weekend house and sometimes — about 20 percent of the time — they’re looking for the reverse: a ‘full-time’ move where they’ll still go a few times a month to the city for work.”

City dwellers are being drawn north, in part, because of affordability. You may live in an apartment in Hudson, N.Y., within walking distance of Basilica Hudson, a former glue factory that now has a busy lineup of concerts, readings and food-related events. Or you may buy a rural farmhouse a quick drive from Beacon, N.Y., with its galleries, restaurants and shops. Either way, you could buy or rent a house for a fraction of what a one-bedroom apartment in the city would cost. Freeing up a chunk of income enables some people to chase their dreams, allowing them to open a business or live the kind of life they might not have been able to in the city.

We suspect this phenomenon will spread to other large expensive cities as well, such as San Francisco, and Washington.    Moving from Manhattan to Westchester county, for example, may save you a $1,000 per month in rent, but you get more dramatic savings moving further out.

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