July ’19

The BAN Report: Bank Earnings Roundup / DB Skids / Easing Small Biz 401ks / “Safe” Deposit Boxes? / Subway Mistreats Franchisees-7/25/19

Bank Earnings Roundup

Most banks have released their 2nd quarter earnings.     We decided to look at a few of the regionals.

M&T Bank Corporation

Tough quarter for M&T Bank Corporation, as the market was surprised by higher expenses and increased loan loss provisions.

M&T Bank Corporation delivered a negative earnings surprise of 9.7% in second-quarter 2019, on account of higher expenses and provisions. Net earnings of $3.34 per share lagged the Zacks Consensus Estimate of $3.70. The bottom line, however, improved 2% year over year.

The company’s results were affected by rise in expenses and deteriorating credit metrics. However, rise in net interest income and fee income was a driving factor. Further, strong capital position remains a tailwind.

For M&T Bank, credit metrics deteriorated during the April-June period. Provision for credit losses surged 57.1% year over year to $55 million. Also, net charge-offs of loans came in at $44 million, up 25.7%.

The economy is slowing, so increases in provisions and charge-offs are to be expected, but they are still at very low levels.      Non-accrual loans represent only 0.96% of total net loans.

Zions Bancorporation

Zions Bancorporation missed estimates, due to higher expenses and lower non-interest income.

Zions Bancorporation’s second-quarter 2019 earnings per share of 99 cents missed the Zacks Consensus Estimate of $1.09. Nevertheless, the figure compared favorably with the prior-year quarter’s earnings of 89 cents.

Results were adversely affected by an increase in expenses and lower non-interest income. Moreover, the company recorded higher provision for credit losses during the quarter, which was a negative factor. However, rise in net interest income (NII) was a tailwind. Also, the balance sheet position remained strong.

Zions missed on top-line revenue as well.     Despite a few rate cuts, net interest margin contracted 2 basis points from the prior year, which shows how the abrupt shift in rates has challenged banks.

Northern Trust

Northern Trust had a solid quarter, beating analyst estimates.

The $126.6 billion-asset custody bank reported net income of $379.7 million, compared with $379.5 million a year earlier. Its earnings per share of $1.75 were 8 cents higher than the mean estimate of analysts compiled by FactSet Research Systems.

Interest income rose 12% to $647.9 million as the bank shifted more of its holdings from lower-yielding investment securities to loans and other earning assets with higher short-term interest rates.

However, net interest income rose just 1% to $417.4 million as deposits costs soared. Interest expense increased 44% to $222.8 million. One reason was that cheaper non-interest-bearing deposits fell 17% to $22.1 billion, far outpacing a 2% decline in interest-bearing deposits to $78.1 billion.

As rates rose, customers began to shift money from non-interest-bearing deposits to interest-bearing deposits.   Lower rates do mean that banks will pay less on these interest-bearing deposits

Comerica Bank

Comerica missed on earnings estimates and revenues.

Comerica reported second-quarter 2019 earnings per share of $1.94 that lagged the Zacks Consensus Estimate of $2.01. However, the bottom line was up from the prior-year quarter adjusted figure of $1.87.

Higher revenues, rise in interest and non-interest income, and lower expenses were recorded. Moreover, rise in loans was another tailwind. However, lower deposits and rise in provisions were undermining factors.

Comerica guided loan growth of 3-4% with declines in deposits of about 2%, thus leading to slightly higher funding costs.

Overall, a few common themes emerge.    Banks are having a tough time meeting earnings expectations due to a weakening economy and a falling rate environment.    Many banks are facing higher funding costs due to a shift from non-interest bearing to interest-bearing deposits.    Credit costs generally have only one direction to move as well.

Deutsche Bank Skids

This week was tough week for Deutsche Bank, as they announced their largest loss since 2008.

Deutsche Bank on Wednesday morning announced a loss that was bigger than the bank previously indicated, sending the shares plunging. 

The German bank’s loss in the second quarter was €3.1 billion ($3.5 billion) after “strategic transformation charges” of €3.4 billion — the Financial Times said the loss was the worst quarterly result for Deutsche since the 2008 financial crash. 

Credit Suisse analysts said the loss was wider than the €2.8 billion loss the bank previously flagged to the market, and in a note to clients called the results “disappointing.” The analysts said adjusted pretax profit was a big miss — €588 million euros versus consensus of €806 million. 

On July 7, Deutsche Bank announced a radical overhaul of the business. It entailed a cut of 18,000 jobs by 2022 and dropping the stock sales and trading unit. At the time Deutsche said the cost of restructuring would be €6 billion. 

It is never a good idea to guide lower to the Street and underperform the revised expectations.    The bank would have been profitable without the restructuring costs.     Meanwhile, the New York Times reported that DB had done business with convicted felon Jeffrey Epstein as late as last year!

At least one bank dropped Mr. Epstein as a client in the years after his guilty plea. But it wasn’t until late last year, after The Miami Herald published an investigation into the earlier sexual abuse allegations, that Deutsche Bank decided to sever ties with him. The process proved more complicated and time-consuming than executives had initially anticipated because Deutsche Bank’s private-banking division had opened several dozen accounts for Mr. Epstein and his businesses.

Not a good look for DB.    Internal compliance officers warned the bank as early as 2016, but it took over two years to sever ties?

Easing Small Biz 401ks

The Labor Department is finalizing a rule that would make it easier for small business to create 401(k) retirement plans for their employees.

Small businesses would have an easier time banding together to create joint 401(k) retirement plans for workers under a rule the Labor Department is set to finish soon, according to a senior administration official.

The expected rule would broaden the ways companies could join together to offer retirement accounts. Under a proposal floated in October, different types of businesses, say landscaping companies and real-estate firms, could create a joint plan as long as they are located in the same state or metropolitan area. The proposal also would make it clear that similar companies located across the country could band together.

Such arrangements, often called multiple-employer plans, are currently limited to employers with an affiliation or connection, such as a common owner or being members of an industry trade group.

Small businesses lag larger businesses in providing retirement benefits, so this ruling will make it easier for them to offer 401(k) plans.

“Safe” Deposit Boxes?

It turns out that many customers are losing their valuables within safe deposit boxes at banks and have limited recourse to recoup their losses.

There are an estimated 25 million safe deposit boxes in America, and they operate in a legal gray zone within the highly regulated banking industry. There are no federal laws governing the boxes; no rules require banks to compensate customers if their property is stolen or destroyed.

Every year, a few hundred customers report to the authorities that valuable items — art, memorabilia, diamonds, jewelry, rare coins, stacks of cash — have disappeared from their safe deposit boxes. Sometimes the fault lies with the customer. People remove items and then forget having done so. Others allow children or spouses access to their boxes, and don’t realize that they have been removing things. But even when a bank is clearly at fault, customers rarely recover more than a small fraction of what they’ve lost — if they recover anything at all. The combination of lax regulations and customers not paying attention to the fine print of their box-leasing agreements allows many banks to deflect responsibility when valuables are damaged or go missing.

Many banks view them as a headache as well.   Capital One has stopped renting new ones since 2016, for example, and many new bank branches do not include them.    Banks typically limit the liability for the contents to a multiple of the yearly rent.

Subway Mistreats Franchisees

Despite its recent underperformance, Subway is still the largest-fast food company in the world by store count.     An investigation by the New York Times showed that the private company often uses conflicted development agents to shut franchisees down for minor violations.

Subway parcels its vast network of stores into more than 100 regional fiefs. Each is overseen by a development agent, who recruits new franchisees, approves buyers for existing stores and sends inspectors — known as field consultants — to conduct monthly reviews. But usually, development agents are also franchisees themselves. When that is the case, they are both in charge of and competing with other store operators, and their own locations are inspected by people they hire.

These feel like conflicts of interest to many Subway owners — giving development agents the means and motivation to shut down competing stores and take over profitable ones by manipulating inspections. Many franchisees who have lost their restaurants say that they have recouped little of their original investments. Intervention from Subway’s headquarters in Connecticut is rare.

In May, US Senator Catherine Cortez Masto wrote a letter to the SBA acting administrator, launching a probe into Subway’s practices.   Many prudent franchise lenders for years have avoided loans to Subway owners.  I asked a leading SBA 7(a) lender who commented: “They have ‘franchisor’ predatory behavior and put competition close to you.  They don’t protect their franchisees.”

The BAN Report: CECL Delayed / Lower Rates Haven’t Boosted Housing / 5G Growing Pains / Large Cities Lose Kids-7/19/19

CECL Delayed
FASB delayed the implementation of CECL until 2023 for most banks, giving a reprieve to banks.    The Current Expected Credit Loss (“CECL”) will fundamentally change how banks account for loan loss reserves.    Bankers don’t like change, but they have been especially cranky about CECL.   
The CECL standard is currently set to take effect in January 2020 for SEC filers, except for small reporting companies, which are supposed to begin implementing it in January 2023. The proposal would push back the dates for all other public business entities from January 2021 to January 2023, and for private companies and nonprofits from January 2022 to January 2023.
Small reporting companies are defined as those with a public float of less than $250 million; or annual revenue of less than $100 million and either no public float or a public float of less than $700 million.
One of our clients, a CFO of a large community bank, had an interesting comment on this debate, observing:
“Frankly, I’m tired of all the bloviating over the years about the ALLL methodology. Politicians may say they ‘hate CECL’ but could it be they’re approaching an election cycle and looking to raise contributions and so now they’re suddenly changing their tune?  Congress has no credibility to oppose CECL.  It was Congress pushing FASB to address what they believed to be too low levels of ALLL after the great recession.  As you know, this ALLL debate has been going on for 25+ years since the SEC cracked down on SunTrust and others managing earnings by padding the allowance.  Out of concern over inflated ALLL levels, the government forced the ‘incurred loss model’ to become the supposedly ‘enforced’ rule but we all know the regulators still expected banks to keep unwritten minimum levels of ALLL and justify it when necessary as ‘environmental factors’ under the accounting rules.  The recession was the impetus to force the next change in the debate.  CECL is an indirect overly complicated increase to capital requirements.  I am not saying I like CECL.  However, if they pull the plug on it now, what a fiasco by Congress, FASB and the regulators.  Congress pushed for more reserves and FASB reacted under the constant implied threat of the government assuming the authority for setting accounting standards.  Congress got what they asked for!
Don’t forget there’s the phase-in for the capital effect of CECL and bank balance sheets are as strong as they’ve been in years.  They need to quit wasting time and money and proceed with an ALLL rule and shut up.  CECL is probably all we’re going to get so let’s move on and leave the ALLL rules alone for a long time.  Neither the ‘incurred loss model’ or the ‘expected loss model’ will be the crystal ball that Congress was asking for nor that the theorists think it will be.  Under either model, banks would have not foreseen the level of losses in the recession and likely will not foresee the level in the next recession.  For most banks, CECL will effectively be a one-time increase to regulatory capital requirements at adoption and then it’s back to estimating ongoing losses whether ‘incurred’ or ‘expected.’”
FASB may be heading towards a confusing “two-tier” system for loan loss reserves: CECL for the larger banks and the old methodology for everyone else.    The banking industry is going to push to eliminate it completely, especially for the smaller banks.   
Lower Rates Haven’t Boosted Housing
A 100-basis point drop in the 30-year fixed rate has not shown much of an impact in the housing market, including everything from housing starts to new and existing home sales.
Thanks in large part to the Federal Reserve’s dovish turn this year, mortgages have rarely been so cheap. As of last week, the average rate on a 30-year fixed was 3.75%, according to Freddie Mac, down from 4.73% a year earlier. Throw in an unemployment rate at nearly a 50-year low and improving household balance sheets and it seems like the housing market should have plenty of fuel.
But housing doesn’t look so hot. The latest evidence of that came Wednesday as the Commerce Department reported that construction was started on an annualized 1.25 million new homes last month, fewer than the 1.27 million economists expected.
Single-family housing starts, which better capture the trend in construction than the volatile overall figure, came to an annualized 847,000, which was down 1% from a year earlier. Residential building permits, a measure of the pipeline for new construction, also came in below expectations. Recent home-sales figures also have been on the weak side. Late last month, shares of Lennar, the country’s second-largest home builder, fell sharply after it gave a disappointing outlook on new home orders.
There are a variety of forces that might be muting the effect of lower mortgage rates on the housing market. Would-be buyers have to qualify for a mortgage before they get one, for example, and lending standards remain far more stringent than they were before the financial crisis. Nor do Americans view homes as such a good investment as they used to.
Then there is the issue of affordability: Home-price gains have moderated, but as of May prices were still up 3.6% from a year earlier, according to CoreLogic, outpacing the 3.1% in average increase in hourly earnings over the same period. Moreover, the 2017 tax overhaul effectively raised the costs of homeownership for many buyers, particularly in high-tax states.
Perhaps it is just a matter of time before lower rates start to work their magic. But given the overall backdrop—low rates, strong hiring, soaring stock prices—it seems as if the housing market ought to be doing a whole lot better than it is already. One or two Fed rate cuts are unlikely to make a big difference. This might be about as good as it gets.
We suspect that the rate cuts have been so unexpected that it is taking time for the message to get out to home purchasers.    Keep in mind that the consensus was 1-2 rate cuts in 2019 late last year, and now the market expects rate cuts.   
5G Growing Pains
The Wall Street Journal did a recent test of 5G in a few cities, concluding that “it’s crazy fast and a hot mess.”
The fifth generation of cellular networking, 5G is designed to replace 4G (aka LTE) and pave the way for innovation ranging from augmented reality to self-driving cars. Name any tech buzzword: It’ll probably benefit from 5G’s faster speeds and reduced lag.
Leading U.S. carriers are already taking the first steps, launching 5G here and there around the U.S. In just the past few weeks, Sprint launched in Chicago, AT&T in Las Vegas, T-Mobile in New York City and Verizon in Denver and Providence, R.I. By the end of the year, there should be 5G in around 30 U.S. cities.
After nearly 120 tests, more than 12 city miles walked and a couple of big blisters, I can report that 5G is fasten-your-seat-belt fast…when you can find it. And you’re standing outdoors. And the temperature is just right.
I downloaded the whole new season of “Stranger Things” from Netflix —2.1 gigabytes of video—in 34 seconds. The same averaged more than an hour on my 4G connections. And I downloaded a huge, 10GB file full of video and images from Google Drive in 2.5 minutes.
Sounds promising, but it won’t change your life for a while.    Sprint seems furthest along in implementation, but every carrier is expanding their 5G service.   
Large Cities Lose Kids
New York is the poster child of this urban renaissance. But as the city has attracted more wealth, housing prices have soared alongside the skyscrapers, and young families have found staying put with school-age children more difficult. Since 2011, the number of babies born in New York has declined 9 percent in the five boroughs and 15 percent in Manhattan. (At this rate, Manhattan’s infant population will halve in 30 years.) In that same period, the net number of New York residents leaving the city has more than doubled. There are many reasons New York might be shrinking, but most of them come down to the same unavoidable fact: Raising a family in the city is just too hard. And the same could be said of pretty much every other dense and expensive urban area in the country.
In high-density cities like San Francisco, Seattle, and Washington, D.C., no group is growing faster than rich college-educated whites without children, according to Census analysis by the economist Jed Kolko. By contrast, families with children older than 6 are in outright decline in these places. In the biggest picture, it turns out that America’s urban rebirth is missing a key element: births.
Cities have effectively traded away their children, swapping capital for kids. College graduates descend into cities, inhale fast-casual meals, emit the fumes of overwork, get washed, and bounce to smaller cities or the suburbs by the time their kids are old enough to spell. It’s a coast-to-coast trend: In Washington, D.C., the overall population has grown more than 20 percent this century, but the number of children under the age of 18 has declined. Meanwhile, San Francisco has the lowest share of children of any of the largest 100 cities in the U.S.
A desire for home ownership and to raise children will continue to push city-dwellers to the suburbs, especially those with shorter commutes to downtowns.    

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