Aug. 4, 2012: Banks & lending, or the lack thereof, its impact on rates & inflation; banking M&A news
Rob Chrisman
The
mortgage and real estate doesn't always solely bear the brunt
of Congress's actions, or lack of actions. When Congress left
for a five week August recess it left many bills unfinished
and agencies in limbo. At midnight on Wednesday, for example,
for the first time in its history the U.S. Postal Service
defaulted on $5.5 billion in payments for future retiree
health care benefits. A 2006 law that requires the
agency to prefund health care benefits for future retirees
forces the Postal Service to pay a 75-year liability in a
10-year period at a cost of about $5.5 billion a year. This
onerous mandate accounts for 85 percent of the Postal
Service’s financial crisis. The U.S. Postal Service will lose
$25 million today, another $25 million tomorrow and $25
million more every day after that until Congress acts - and
unless Congress acts quickly, the service will likely default
on another $5.6 billion payment due on Sept. 30.
Returning to lending, and to banks, I am not a bank regulator,
nor will I ever be - too many tawdry jokes over the years to
be qualify for a job. But if I was, I'd be concerned
about core bank earnings, given low interest rates and weak
loan demand. Basically, banks have too much cash and
tight, but not unreasonable, underwriting guidelines under
which to loan the money out. While commercial, industrial, and
multifamily have seen some growth, outside of those sectors,
banks are struggling to find strong borrowers. Weak lending,
combined with persistently low interest rates, are hurting
margins. Those same factors are also driving banks to compete
aggressively, so underwriting practices are definitely one
area getting focus. But no one wants buybacks down the road,
and QM is looming.
In a recent speech, Treasury Secretary Geithner said the
housing sector will need two to three more years of “creative”
financing in order to recover. Huh? Funding is a concern
despite the piles of cash. Low interest rates have driven huge
growth in non-maturity business deposits, which is a good
thing. Regulators are concerned, however, that these deposits
are vulnerable to run-off and significant upward re-pricing
once businesses start redeploying funds or if interest rates
rise. That could strain funding costs and limit upside growth
in margin despite stronger economic growth. While this is a
lower risk right now, I am seeing banks have a plan to keep
both borrowers and depositors locked in for the longest terms
possible whenever they can do so.
Focus is also heightened on reduced loss provisions. Doing so
has helped industry ROA recover over the past 18 months, but
the trend cannot continue for much longer. Expect scrutiny
here, so have well-documented justification and be sure ALLL
levels are directionally consistent with asset quality trends.
The Pacific Coast Bankers Bank noted that examiners
are also looking at the bank’s risk appetite and loan growth.
Home equity lending has surfaced as a significant risk.
Over the next few years, large volumes of these loans will
reach the end of their draw periods. In fact, about 58% of all
HELOC balances will start amortizing between 2014 and 2017. As
these loans move from interest only to fully amortizing, and
given such a risk profile, regulatory scrutiny here is high.
Income producing CRE portfolios also remain an area of focus
for regulators. Concentrations, high vacancy rates and concern
over current and future operating income and borrower
performance mean this will remain an area of focus. Massive
industry changes have many rethinking their business models.
It is critical to evaluate your bank’s current situation and
have a strong strategic plan given the evolving environment.
And in the last month, a group of banks released public
disclosures on how the proposed Basel III capital
weightings might impact their Tier 1 capital ratios. SunTrust,
First Horizon, Huntington, and TCF get hit the hardest
of those banks that released the calculations driven by their
holdings of home equity loans, interest only/balloon mortgages
and non-performing assets. BofA, Citi, BONY and others
would see their ratios increase. Many banks are indeed caught
between a rock and a hard place. Why should some banks
originate more mortgages and add to servicing if Basel III is
going to limit MSR's and also impact required capital?
Over
the past four years, the U.S. monetary base has grown from
roughly $850 billion to more than $2.6 trillion, the primary
driver of which has been the implementation of quantitative
easing as the FOMC attempted to revive the U.S. economy.
And the markets fully expect another round: QE3. Once
in a while I am asked if all this extra money in the system
diminishes the value of the U.S. dollar and ultimately leads
to higher inflation. There is a legitimate basis to this
question as prices are a function of the money supply – there
is a relationship between money and prices. (Just try bidding
against Elton John for an art piece that you want.)
But
if prices were exclusively a function of the money supply, the
near tripling of the monetary base between late 2008 and 2011
should have given way to runaway inflation. That didn’t happen.
Price growth has been averaging nearly 2.5 percent on a
year-over-year basis for the past two years, in check with the
Consumer Price Index (CPI). When it comes to the impact of
the growth of the money supply and the impact on prices, one
major consideration is the money multiplier. When banks make
loans, the net effect is essentially an increase in the money
supply. Banks create money through lending, using that
money to purchase say a piece of new equipment. The seller of
the equipment now has cash that she might invest in another
bank. That new deposit provides the second bank the reserves
necessary to make another loan, which creates more money and
the cycle continues. This is the money multiplier. This
cycle continues, but is limited at some point by the amount
a bank is required by the Federal Reserve to keep on hand.
But bank lending has a tendency to slow in the immediate
wake of a recession, due to tightening in lending standards
and a growing reticence to engage in lending. With
lending growth essentially stagnant, there was little impact
on the money supply from the banking sector.
In
addition to the monetary base and the reserve-deposit ratio,
there is one additional factor to consider when thinking about
the money supply: the cash-deposit ratio: the cash in your
wallet, or cash that is squirreled away under a mattress. This
deprives the bank from the reserves that might otherwise be
used to make loans and expand the money supply. So the
reason why growth in the monetary base did not result in
runaway inflation over the past two years is that banks, in
aggregate, have not been lending. But that dynamic may
be changing. With the recovery now entering its fourth year,
the U.S. economy continues to slowly heal. Job growth, while
anemic compared to prior recoveries, continues to expand and
has slowly contributed the improving household financial
picture. Businesses have also restructured their balance
sheets to better position themselves for a feast or famine
type scenario–either a credit market tightening due to the
negative ramifications of the Euro Crisis or conversely to
take advantage of a potential opportunities to expand in their
market space. While a European credit shock would certainly
have the potential to derail the recovery, it appears that
unless a shock of that magnitude were to unfold, business
lending is on a sustainable improving pace that is consistent
with rising demand and improving credit conditions. Also, bank
consumer loans, which include credit cards, automobiles,
student loans and other personal loans, have increased in the
last several months. So there continue to be “green shoots.” And
obviously mortgage rates have been helped by the Federal
Reserve’s actions.
Moving
from some global theory and thinking into some practical,
down-to-earth banking and M&A news. As always, it
is best to read the actual releases, but these recent changes
will give you a flavor for the trends in the banking industry.
Heartland
Financial
USA ($4.4B, IA) will acquire The First
National Bank of Platteville ($135mm, WI) for about $11
million in cash and stock. And in Illinois Waukegan Savings
Bank of Waukegan was closed yesterday and is now part of the
First Midwest Bank over in Itasca.
In
New York Community Bank System has reported it will
close five branches.
City
Holding
Company has announced that it will be
acquiring Community Financial Corporation and its
wholly owned subsidiary, Community Bank. City will take ownership of
Community’s branches along western Virginia’s 1-81 corridor
along with its two Virginia Beach branches.The transaction is part
of City’s initiative to expand its presence in Virginia;
earlier this year, it acquired the Front Royal-based Virginia
Savings Bank.Assuming
that the transaction is approved by the relevant regulatory
bodies and Community shareholders, the deal should be
completed by the first quarter of 2013.
Urban
Partnership
Bank has entered an agreement with Northern
Trust whereby it will acquire the latter’s full-service
office on Chicago’s South Side (Northern Trust is actually an
investor in Urban Partnership Bank).The office will serve as
Urban Partnership Bank’s tenth branch in Chicago, extending
its reach to the Chatham, Auburn-Gresham, and Greater Grand
Crossing areas.Regulators’
approval of the transaction is anticipated for late 2012,
according to financial advisor Keefe, Bruyette & Woods.
Four brothers left home for college, and they became
successful doctors and lawyers.
One evening, they chatted after having dinner together. They
discussed the 95th birthday gifts they were able to give their
elderly mother who moved to Florida.
The first said, "You know I had a big house built for Mama."
The second said, "And I had a large theatre built in the
house."
The third said, "And I had my Mercedes dealer deliver an SL600
to her."
The fourth said, "You know how Mama loved reading the Bible
and you know she can't read anymore because she can't see very
well. I met this preacher who told me about a parrot who could
recite the entire Bible. It took ten preachers almost 8 years
to teach him. I had to pledge to contribute $50,000 a year for
five years to the church, but it was worth it Mama only has to
name the chapter and verse, and the parrot will recite it."
The other brothers were impressed. After the celebration Mama
sent out her "Thank You" notes.
She wrote: Milton, the house you built is so huge that I live
in only one room, but I have to clean the whole house. Thanks
anyway."
"Marvin, I am too old to travel. I stay home; I have my
groceries delivered, so I never use the Mercedes. The thought
was good. Thanks."
"Michael, you gave me an expensive theatre with Dolby sound
and it can hold 50 people, but all of my friends are dead,
I've lost my hearing, and I'm nearly blind. I'll never use it.
Thank you for the gesture just the same."
"Dearest Melvin, you were the only son to have the good sense
to give a little thought to your gift. The chicken was
delicious Thank you so much."
Love, Mama
If
you're interested, visit my twice-a-month blog at the STRATMOR
Group web site located at www.stratmorgroup.com.
The current blog discusses the FinCen, SAR’s, and the impact
on mortgage lenders. If you have both the time and
inclination, make a comment on what I have written, or on
other comments so that folks can learn what's going on out
there from the other readers.
