May ’18

The BAN Report: Regulatory Reform Becomes Law / FDIC Quarterly Banking Profile / MB Sells to Fifth Third / Trouble on the Home Front?-5/31/18

Regulatory Reform Becomes Law

In the most significant legislative victory for banks in over a decade, the Economic Growth, Regulatory Relief, and Consumer Protection Act became law last week, benefiting a broad spectrum of banks.   Both the ABA and ICBA hailed its passage.   ICBA CEO Rebeca Rainey said, “This landmark law signed by the president today unravels many of the suffocating regulatory burdens our nation’s community banks face and puts community banks in a much better position to unleash their full economic potential to the benefit of their customers and communities.    The National Law review had a great summary of the key changes in the legislation.

Higher SIFI Threshold – The controversial $50 billion asset threshold under Dodd-Frank is now $250 billion, affecting about two dozen bank holding companies. Under Section 165 of Dodd-Frank, bank holding companies with at least $50 billion in total consolidated assets were subjected to enhanced prudential standards.  Under the Act, the enhanced prudential standards under Section 165 no longer apply to bank holding companies below $100 billion, effective immediately.  Bank holding companies with total consolidated assets of between $100 billion and $250 billion will be exempted from such standards starting in November 2019

Volcker Rule – The Volcker Rule is amended so that it no longer applies to an insured depository institution that has, and is not controlled by a company that has, (i) less than $10 billion in total consolidated assets and (ii) total trading assets and trading liabilities that are not more than 5% of total consolidated assets. All other banking entities, however, remain subject to the Volcker Rule.  

“Off-Ramp” Relief for Qualifying Community Banks – A depository institution or depository institution holding company with less than $10 billion in total consolidated assets will constitute a “qualifying community bank” under the Act. The benefit of such a designation is that the institution will be exempt from generally applicable capital and leverage requirements, provided the institution complies with a leverage ratio of between 8% and 10%.

There are a few other changes, including relief from stress testing for banks under $250 billion, a more liberal interpretation of “high-volatility commercial real estate” loans, HMDA relief for small mortgage originators, and a more generous interpretation of the liquidity coverage ratio.   Over the next few weeks and as the new regulations are published, we will discuss them in greater detail.   Yesterday, the new revised Volker rule was rolled out by the Agencies for comment.

Overall, this is a significant victory for banks of all sizes without a dismantling of the Dodd / Frank regulatory framework.

FDIC Quarterly Banking Profile

Last week, the FDIC released its quarterly banking profile, the most comprehensive survey of the health of the banking industry.    A few highlights of note:

Overall, the industry is enjoying higher interest rates, increased trading revenue, positive tax reform changes with expected regulatory relief around the corner.   The biggest concern among investors is whether these developments are all already well-priced into bank stocks.

MB Sells to 5/3

MB Financial, a Chicago-based institution that grew from a small bank into a $20 billion regional bank through a series of acquisitions, announced it was selling to 5/3 Bank last week.   Many are hailing this purchase (2.8X Book) as a new era of increased bank M & A, as the super-regional banks, who have been quiet over the past decade, become acquires again.

Even more important, the deal marks a new era for US banks.   We see four main reasons why M&A activity in the sector will pick up markedly in the second half of the year.

First, since the 2008-2009 global financial crisis, capital ratios of US banks have risen significantly. Solid capital positions bode very well for M&A activity. As a reminder, the Fed will announce the results of the 2018 CCAR (Comprehensive Capital Analysis and Review) by June 30. We expect the 2018 CCAR to confirm that US banks have strong and well-capitalized balance sheets.

Second, the ongoing deregulation will free up additional capital. In March, Mike Crapo, the Chairman of the Senate Banking Committee, officially published The Economic Growth, Regulatory Relief, and Consumer Protection Act (the S.2155 bill). This is a complex document, but its key goal is to provide regulatory relief for regional banks and smaller community banks. For instance, the bill would increase the $50 billion threshold for the SIFI (systemically important financial institutions) status. We believe excess capital would be a major catalyst for M&A activity.

Third, despite a recent pickup, organic loan growth in the sector remains subdued. The sector’s total credit book grew by just 2% since the beginning of the year. As a result, US banks are increasingly looking at M&A deals as a way to boost credit growth inorganically.

Finally, deposit rates in the US have finally started rising.

We don’t disagree as the shackles places on the large banks post-Dodd/Frank appear to be coming off.    Our concern though is the loss of competition in certain markets.   We think it’s important that the Agencies support new charters.

Trouble on the Home Front?

This week saw a few concerns about the housing market.    The chief economist of the National Association of Realtors, hardly an independent body, was bearish on the run-up in home prices.

Home values have been rising for six straight years, and the gains have been accelerating for the past two years. Unlike the last housing boom, the gains are not driven by fast and easy mortgage money, but instead by solid buyer demand and very low supply. Still, like the last housing boom, some are starting to warn these price gains cannot continue.

“The continuing run-up in home prices above the pace of income growth is simply not sustainable,” wrote Lawrence Yun, chief economist for the National Association of Realtors, in response to the latest price reading from the much-watched S&P CoreLogic Case Shiller Home Price Indices. “From the cyclical low point in home prices six years ago, a typical home price has increased by 48 percent while the average wage rate has grown by only 14 percent.”

Yun also pointed to rising mortgage interest rates as a factor that would weaken affordability. The average rate on the 30-year fixed mortgage is nearly a full percentage point higher today than it was at its most recent low in September 2017.

We concur that supply constraints have boosted home prices, made homes less affordable for first-time buyers, and constrained economic growth.     Nevertheless, despite a nationwide run-up in home prices, there are still many homeowners that are underwater.

A staggering number of American homeowners remain under water on their mortgages a decade after the housing bubble burst.   Almost 4.5 million households — or 9.1 percent — owed more than their homes are worth in the fourth quarter of 2017, according to data firm Zillow, with an estimated 713,000 owing at least twice as much as their property’s value.

While the percentage is declining, families in communities with stagnant property values are “trapped in their homes with no easy options to regain equity other than waiting,” said Aaron Terrazas, a senior economist at Zillow.

That in turn could weigh on local economic growth.    Virginia Beach, Virginia; Baltimore and Chicago are the hardest hit metropolitan areas, based on effective negative interest rates.  

When you look at the data further, its often a neighborhood by neighborhood comparison, as even markets with high levels of underwater homeowners have seen enormous price appreciation in most neighborhoods.

The BAN Report: C & I Lending Grows / Supreme Court OKs Sports Betting / Firms Rethink Client Entertainment / Einhorn Skids / Births Plummet-5/17/18

C & I Lending Grows

Commercial and industrial loan growth has been stagnant the last year so for a variety of reasons, but recently showed a spike in growth.

The reasons ranged from policy uncertainty under the new Trump administration to companies reacting to rising interest rates by paying down variable-rate loans or tapping the bond market. The initial impact of this year’s corporate tax cuts further reduced borrowing, as many companies repatriated foreign funds, giving them more cash on hand. Weekly data from the Fed showed C&I loans posting their worst January performance since 2010, according to analysts at Keefe, Bruyette and Woods.

But lending has since accelerated. The latest Fed data, for the week ended May 2, shows total C&I loans outstanding up 3.1% from a year earlier, compared with 0.9% at the end of January.

SunTrust Banks Chief Financial Officer Allison Dukes said at an investor conference Tuesday that companies had slowed their pace of paying down debt. “So it’s early, it’s only been a couple of months, but we’re bullish on what that means for aggregate C&I loan growth for us,” she said.

Executives from other large regional banks, speaking at the same event, echoed that sentiment. Citizens Financial Group CFO John Woods said loan pipelines for the bank in April were “up meaningfully” compared with January. BB&T CFO Daryl Bible said the bank expects to hit the high end of its earlier guidance of 1% to 3% annualized loan growth in the second quarter.

In a rising interest rate environment, C & I loans are great assets for banks as they are more likely to be floating rate loans than CRE loans, for example.

Supreme Court OKs Sports Betting

This week the United States Supreme Court overturned a federal ban on sports gambling, thus opening the door for states to legalize sports betting.

“The legalization of sports gambling requires an important policy choice, but the choice is not ours to make,” Justice Samuel Alito, a New Jersey native, said in the opinion of the court. “Congress can regulate sports gambling directly, but if it elects not to do so, each State is free to act on its own.” 

Gov. Phil Murphy, who replaced Gov. Chris Christie as the lead plaintiff when he became governor in January, welcomed the ruling.

“I am thrilled to see the Supreme Court finally side with New Jersey and strike down the arbitrary ban on sports betting imposed by Congress decades ago,” Murphy said. “I look forward to working with the Legislature to enact a law authorizing and regulating sports betting in the very near future.”

State Senate President Stephen Sweeney said the state Legislature would move to enact the laws necessary to quickly bring sports betting to fruition. Sweeney told NJ Advance Media the hope is to have regulations in place by the end of June.

“We can now seize the opportunity with a new sector of gaming that will help create jobs, generate economic growth and be an important boost to the casino industry and horse racing,” Sweeney, D-Gloucester, said.

In Nevada, sports betting is only 2.5% of total gaming revenue, so it’s unlikely that sports betting will explode elsewhere.   States are simply free now to legalize it.   New Jersey and West Virginia are likely to legalize it, but it will most likely require gamblers to visit a casino or a racetrack in person.   Online betting would be limited to gamblers in the state that legalized it, as the Wire Act of 1961 makes interstate betting a federal crime.

Firms Rethink Client Entertainment

Due to tax reform, firms can no longer deduct client entertainment, and limited business meals with customers or business associates.   Consequently, many are canceling sporting tickets and expensive meals with clients.

A wholesale distributor plans to replace some expense-account lunches with open houses for customers. A marketing firm has stopped reimbursing employees’ commuting expenses and giving them raises instead. A tax-audit defense firm is giving up its season tickets to Sacramento Kings basketball games.

These are some of the ways small-business owners are responding to changes in the tax law that reduce or eliminate some popular deductions for meals, entertainment and transportation, though many of the fine points are unclear.

For instance, the changes eliminate the deduction for sports tickets, concerts and other client entertainment, and set new limits on deductions for certain employee meals. Among the uncertainties is whether companies will still be able to claim a 50% deduction for business meals with customers or business associates, or whether those expenses will be considered entertainment, which is no longer deductible. “That’s the one that has got everyone jumping up and down,” said Marianna Dyson, of counsel to Covington & Burling LLP.

The tighter limits, which take effect this year, will generate more than $41 billion in tax revenue between 2018 and 2027, according to Joint Committee on Taxation estimates. The changes were designed in part to offset corporate tax cuts and to simplify an area that some members of Congress felt was difficult for the Internal Revenue Service to enforce.

These changes are going to hurt restaurants, the catering industry, and sporting events.    Moreover, businesses can no longer deduct reimbursements for employee parking and transportation, so many are eliminating those perks and increasing salaries instead.

Einhorn Skids

Famed hedge fund manager David Einhorn has been in a slump, losing 25% to his investors since 2014.

So far this year, his Greenlight Capital has handed its investors a 15 percent loss, bringing the total decline since the end of 2014 to a staggering 25 percent — one of the worst showings among his peers. Investors have bolted, pulling almost $3 billion out of the firm in the last two years.

Yet the baby-faced billionaire is unperturbed, no matter that he has been wrong about nearly every one of the top 40 positions in his $5.5 billion portfolio this year. He’s as cocksure as ever — some might say cocky — publicly and in conversations with colleagues. “We believe our investment theses remain intact,” he wrote in an April investor letter. “Despite recent results, our portfolio should perform well over time.”

Einhorn’s this-too-shall-pass attitude puts him in an interesting spot in a $3.2 trillion industry invented back in the day on strategies that don’t work so well now — after a decade of historically low interest rates and the rise of passive investing and quant trading. The Einhorn modus operandi of buying the beaten-down stocks of companies he expects to grow and selling those that are overvalued has fallen out of favor.

Not surprisingly, many in Einhorn’s circuit have switched up approaches, at least on the margins. Lee Ainslie and Steve Cohen have added machine learning or other quant models to help in stock picking. Dan Loeb owns Facebook Inc. and Netflix Inc., even though in his early days as a value investor he would have never bought shares with such high prices relative to earnings.

Value investing just hasn’t been that profitable the last few years, and Mr. Einhorn has stuck to his guns.   Time will tell if he is brave or just unable to adapt to a different environment.

Births Plummet

In 2017, the number of babies born in the US dropped to a 30-year low.

Some 3.85 million babies were born last year, down 2% from 2016 and the lowest number since 1987, according to the Centers for Disease Control and Prevention’s National Center for Health Statistics. The general fertility rate for women age 15 to 44 was 60.2 births per 1,000 women—the lowest rate since the government began tracking it more than a century ago, said Brady Hamilton, a statistician at the center.

The figures suggest that a number of women who put off having babies after the 2007-09 recession are forgoing them altogether. Kenneth M. Johnson, senior demographer at the University of New Hampshire, estimates 4.8 million fewer babies were born after the recession than would have been born had fertility rates stayed at prerecession levels.

“Every year I expect the number of births to go up and they don’t,” said Prof. Johnson.

This dearth of births could exacerbate the problems of America’s aging population. Many baby boomers are in or are near retirement, leaving a smaller share of young workers to pay into Social Security and Medicare. That is creating a funding imbalance that strains the social safety net that supports the elderly.

In a strong economy, the birthrate should be increasing, not decreasing.    Is it millennials putting off child-bearing or simply having fewer children?    Perhaps, policy makers need to do more to encourage reproduction.

The BAN Report: The $16MM Illiana Portfolio / Modernizing CRA / House Flippers Destroying Neighborhoods? / Ford Abandons Sedans-5/2/18

The $16MM Illiana Portfolio

Clark Street Capital’s Bank Asset Network (“BAN”) proudly presents: “The $16MM Illiana Portfolio.” This exclusively-offered portfolio is offered for sale by two banks (“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.    If you are only interested in the commercial loans, a commercial-only CA is available upon request.

Modernizing CRA

Last month, the US Treasury Department released a long-anticipated memo proposing to modernize the 1977 Community Reinvestment Act (CRA).    Most notably, they have proposed changing how assessment areas are calculated.

Treasury recommends revisiting the approach of determining assessment areas. CRA’s concept of community should account for the current range of alternative channels that exist for accepting deposits and providing services arising from the ongoing evolution of digital banking.

The current definition of assessment areas includes the geographies surrounding the bank’s main office, branches, deposit-taking ATMs, and the surrounding geographies in which that bank has originated or purchased a substantial portion of its loans. In discussions with stakeholders, Treasury has determined that this method of directing CRA loans, investments, and services may exclude a substantial portion of the communities that the banks are effectively serving. Treasury advocates for a framework that not only includes areas where the bank is physically located, but also LMI communities outside of where the bank has its physical footprint, and in areas where the bank accepts deposits and does substantial business. Treasury believes that an approach that would allow banks to address needs that overlap with their entire customer base would improve the effectiveness of the CRA statute.

Ideally, this framework would allow banks to receive credit for CRA activity within their branch and deposit-taking footprint, and would also enable them to receive credit for investments in other LMI communities and identified areas as well.

Treasury believes that such an approach could be applied effectively to traditional banking organizations using alternative delivery channels, wholesale and limited purpose banks, and emerging “branchless” banks.

The Treasury also recommended changing the examination process and making it easier for a bank to be upgraded from an unsatisfactory CRA rating.    Overall, modernizing CRA is a challenging process and fraught with political minefields.     Community groups are concerned that modernization will entail weakening CRA, so the Treasury’s proposal is the first salvo in a complicated process.

House Flippers Destroying Neighborhoods?

According to the Center for NYC Neighborhoods, house flippers are making home ownership more difficult for residents, as the supply of affordable homes are reduced.   Their three main findings were as follows:

1. In 2017, investors purchased over one-third (38%) of the homes that sold at prices within reach of middle- and working-class families in New York City, dramatically diminishing the supply of homes affordable to those households.

2. Flipping is fueled by foreclosures: Twelve percent of all homes sold in 2017 had been in foreclosure at the time of sale while the same is true of 34% of the homes flipped in 2017. That means that a flipped home was almost three times more likely to have been in foreclosure than a home that sold without being flipped.

3. Flipping makes it more difficult for prospective buyers to find affordable homes by inflating prices beyond similar properties in the neighborhood. For example, flipped homes in Jamaica, Queens, sell for 33% more than similar properties not purchased by investors.

It’s hard to argue that house flipping does reduce the supply of affordable homes.   However, restricting or taxing speculative sales will create additional losses for mortgage lenders, thus raising mortgage rates potentially.   Rather than these steps, perhaps large mortgage lenders should work harder to get their foreclosed properties into the hands of owner-occupants, rather than investors.

Ford Abandons Sedans

Last week, the company founded by Henry Ford announced that it was dramatically reducing its lineup of traditional cars, focusing on SUVs and trucks.

After more than a century-long run, giant automakers like Ford can no longer escape the obvious: The demand for traditional cars is beginning to dry up, thanks to the evolving tastes of millennials and baby boomers, experts said.

Ford announced plans late Wednesday to eliminate some of the company’s most well-known cars in North America, including the Fiesta subcompact, Fusion midsize sedan, Taurus large sedan and the C-Max van, according to Ford’s quarterly earnings statement. The decision followed years of declining car sales.

Ford said eliminating most of the company’s cars except for two models will allow the company to focus on their “winning portfolio” in the United States, Canada and Mexico. The Detroit automaker plans to keep the Ford Mustang sports car and a new Focus crossover that the company plans to release next year.

Unlike a decade ago — when a combination of rising gas prices and economic anxiety led consumers to opt for smaller vehicles — a new generation of efficient engines have made SUV purchases a sound choice financially. The reason that many consumers resisted buying SUV’s — bad gas mileage — has been eliminated by “tremendous engineering improvements,” according to Michelle Krebs, an executive analyst at

Sedans have had a tough run, as Ford Fusion sales dropped 21% last year, while Nissan’s Altima dropped by 17%.    Ford’s new CEO Jim Hackett is taking a significant risk.   Bill George at Harvard Business School slammed the decision.

Bowing to short-term shareholder pressures that felled predecessor Mark Fields, Hackett is undoing 115 years of Ford’s automobile legacy. Unlike General Motors CEO Mary Barra, labelled a “car gal” for her 38 years in the business, Hackett has no experience in automobiles. He comes from thirty years of making furniture and most recently as interim athletic director at the University of Michigan.

In fairness, Ford is not abandoning cars, just re-tooling its portfolio to focus on two sedans.    Not too many people are going to miss the Fiesta, Fusion, and Taurus.   But, it is a bold and risky move that could be a home run or a disaster.

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