The mortgage and real estate industry 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."