Industry Outlook: Banking
Our panel of bankers say they are optimistic about the future, but many are still waiting for the regulatory changes they hoped the election of Pres. Donald Trump would bring. The panel also discusses the financial health of Utah’s commercial real estate industry and their efforts to embrace fintech within their organizations.
Rick Anderson, Bank of American Fork
Kay Hall, Zions Bank
Scott Irwin, Holland & Hart, LLC
Edward Leary, Utah Department of Financial Institutions
Kent Nelson, Brighton Bank
Clint Okerlund, Bank of America Merrill Lynch
Frank Pignanelli, Utah Association of Financial Services
Edward Sanches, Central Bank
Roger Shumway, Bank of Utah
Drew Yergensen, KeyBank
Mark Zupon, First Utah Bank
A special thank you to Juliette Tennert, director of economics and public policy at the Kem C. Gardner Policy Institute at the University of Utah, for moderating the discussion.
Let’s start by talking about what’s changed in your industry since the election last year.
PIGNANELLI: A year ago today I went before my board of industrial bankers and said it’s like Moses leading the slaves out of Egypt, because the world changed. I may not have voted for the guy, but God bless the results because the world has changed from us playing defense to us playing offense. And it has made a big difference in terms of how Washington, D.C., is reinterpreting Dodd Frank, the great leprosy that is on America.
But the biggest thing for us is the FDIC. Because Marty Greenberg was likely to get reappointed and we were going to have to play strategy to prevent that. And it’s gone from that to where we have a new chairman and possibly new board members. Because of that, we now have had applications for IOC charters.
LEARY: Right after the election, there were great expectations from the financial services industry that you’d get significant regulatory changes. Federal agency heads changing. Those kinds of things. And I just don’t think they have happened as fast as everybody expected them to. That’s been very, very slow on both fronts.
PIGNANELLI: It’s been slow. That’s been frustrating, especially with the Republicans controlling all branches of government. And part of it is I think there’s this fear of the backlash publicity wise, and they need to get over that and put on their Big Boy pants and say, “We are going to change the regulations.”
SHUMWAY: The good part is the stock market has gone very well in the positive position. And that makes people somewhat happy. But there are a lot of openings in every regulatory body that haven’t been filled. People are optimistic, but so far bankers have to pick their battles of what we want changed, because change just isn’t coming yet.
YERGENSEN: One thing we have been starting to see this year is softening in loan demand. Over the last few quarters, bigger bank stocks have slowed their growth, given the softer loan demand. And you start wondering what is driving that. There is some regulatory commentary. But the last couple of years, large companies have taken advantage of loading up debt, building up cash. I think companies that have been wanting to sell have sold. There’s a few more with higher multiples, so that activities happen. There’s a real concern that maybe there’s some softer loan demand and there’s going to be heightened competition in our industry as a result.
SANCHES: We are just Utah County based, but we are actually the opposite. Our loan demand has never been stronger. But we are more concentrated on construction lending. And that’s just been a huge boom over this last year, and I feel it will continue. The growth of Vineyard and everything happening in north county with Silicon Slopes and all the jobs coming in there, the demand for housing is absolutely at the peak. There’s some concern there as far as availability of land, affordability of lots. But as far as the demand, it’s never been stronger. Usually in early winter we see a softening of demand, just naturally. And last year it didn’t slow down at all. And this year it’s not slowing down, either.
HALL: Utah County, Washington County, that’s where the growth is. If you go into some of these other communities, it’s really slowed down.
On a national basis, some of your bigger, larger corporate customers, away from the consumer housing market, it has slowed down significantly. And the companies are full of cash. They have got a lot of liquidity. The value of deposits still is pretty nonexistent. And so they are paying down debt. It’s very interesting to see companies just come in and say, “You know I’ve got $15, $20 million worth of debt on my facilities and I’m just going to pay it off because I have $30 million sitting in cash. And you are paying me this on my deposit, and I’m paying this on the loan.” A lot of big companies are doing that.
The big corporate customers are struggling right now because it has been so slow. Even with the new presidency, we haven’t seen any significant changes in our economy as it relates to corporate America. There’s just not that opportunity.
TENNERT: From the economist standpoint, it feels like we are getting toward the end of some sort of cycle. It’s been long and drawn out. We are in the third largest expansion on record. But mixed in is the uncertainty about policy and what do we do there.
NELSON: At Brighton Bank, we were expecting a slowdown in this coming year and it didn’t happen for us, either. Especially in the construction and commercial real estate arenas. Demand has been very brisk. The interesting thing to me is that our builders are building all presold homes. Very few spec. And not only are they presold homes, but they don’t fall out. Of all the dozens and dozens of construction loans we have made during the past year, only one or two of the contracts fell through.
We don’t see a slowdown. We look to 2018 as being similar to 2017. So we have seen brisk demand and it continues
SHUMWAY: It used to be if we could get two presolds to one spec, that used to be a nice standard. We are at five presolds to one spec. The difficulty is it used to be that the $300,000 homes were $600,000 or $700,000. Now we are starting to see the $600,000 or $700,000 homes weakening in price and a little bit jittery.
Does multi-family lending look like it’s accelerating, decelerating? Do we feel like we are over supplied?
SHUMWAY: I don’t know about the oversupply. We have to be able to look out three years, and that’s very, very difficult. But I have seen, in the last six months, a change in that people are now doing it as a hobby, trying to get loans. It used to be people who were actually in the business and had management companies and had feasibility studies. But now we are seeing people kind of like last time: An excavator who thinks he can build something, or someone whose neighbor all the sudden has apartment buildings so he wants to do them. And I call those hobbies, because they are really not skilled in either the building or the leasing or the management. And I foresee that could be a problem if they were able to flood the market and hurt other people.
HALL: If you are starting to build large multi-family, you’re way too late, because that’s gone. That opportunity was two or three years ago. There’s some of the littler ones, but bottom line is if you look at the vacancy rates in some of those things, we have a lot on the market right now, even in our market in Utah. You are going to see a big slowdown in big multifamily construction.
NELSON: All of the recent commercial real estate market reports show that the multifamily market is still alive and well. The only thing that is happening right now is the cost of building a lot of those projects is getting to a point where the returns aren’t what a lot of the investors are wanting. So there are several projects that are now being cancelled because of cost.
But vacancies in multifamily are only supposed to get to 5.7 percent in Salt Lake County within the next three years. And it’s a percent higher in Salt Lake City: 6.7 percent. So that’s not bad. I think cost of projects will keep it in tow. But there’s a ready demand and a lot of capital out there driving some of these projects.
One thing we have seen is there’s more out-of-state investors coming into the state. I’m dealing with more out-of-state borrowers as a community bank than I ever have. There’s a recent report showing Salt Lake City is the third best commercial real estate community in the country. And as a small community like ours, third is amazing. So that’s a market we have dealt in. We are still delving in it, but we are also being cautious to make sure of location, our debt coverage, and obviously our borrower and their experience are critical.
HALL: It’s not just out-of-market customers that are coming in. It’s out of the country. For example, we’ve got a situation where a company is being acquired by a Chinese company that will pay us off about $20 million in loans.
ZUPON: As a bank we stayed away from multifamily. I think it’s high risk, especially where the market is today. It’s pretty mature in the Salt Lake area. And with the cost to build and the required rents that the investors have to get, there’s a lot more downside than upside. If you look at it, you do the formula and you look at what a 10 percent vacancy rate would do to the value of your collateral and to the debt service coverage. It’s quite risky.
YERGENSEN: We hear things about construction costs being as high as they have ever been, real estate values starting to be as high as they have been since 2007 levels. In my world it is a little different. In the corporate space where we track multiples and enterprise value, you are seeing people transact because multiples are so rich right now it motivates them to actually do something. And I don’t think that’s really a fault line. I think that could be sustainable. But when you start thinking about mixing in debt and leverage, for example, if there’s a company that five years ago would sell six times their EBIDA, today maybe they sell 12 times. And if they want 50 percent debt and 50 percent equity on the transaction, that’s a pretty big difference on how much debt you are loading up on that company.
So we are seeing a lot more in our space with a lower loan demand; banks pushing to compete a lot more on how much leverage we can actually provide. What kind of friendly terms can we provide? And that always makes us, as banks, nervous. Did we not learn our lesson last time? Are we going to compete on those kinds of instruments with values being as high as they are right now? If they move a little bit down, what kind of shock wave does that send through the system?
SHUMWAY: The community banks do a lot in what I’d call the acquisition, development and construction area. The regulators call it ADC. Dodd Frank came out with something known as HVCRE, Highly Volatile Commercial Real Estate, and we all swallowed hard on that and we continued our own underwriting independent. But the regulators, which is sound, wanted us to prove that at least 15 percent in any ACD loan was cash. Which is very prudent. And if you didn’t put that in, you were penalized like it was a substandard credit. So instead of 100 percent of capital you had to put 150 percent of capital aside for these.
They tried to define what HVCRE was, but it wasn’t very clear. The attorneys made it so vague that it was open. And all of us interpreted it a little bit different. But recently they have come out with Highly Volatile Acquisition Development and Construction. And the definition is very easy to understand. Now everything that falls in acquisition, development or construction, you’ll have to set aside 130 percent of capital. It doesn’t matter if it has 15 percent cash.
Now there’s a move by the American Bankers Association to move that definition back into HVCRE and make it simple. But if it were to go through as it is presently, that would cause us, in a risk-based capital, to put every commercial loan that’s acquisition, development or construction, we would have to set aside 130 percent of capital.
Well, for this area, that could hurt community banks. For the ones on the East Coast, they wouldn’t even know about it, or the larger banks. But at a time when that is vibrant in this area, that’s a concern that could come out. At first the regulators came out and said the big losses in the last downturn were in acquisition, development and construction. But most of it was on the residential side.
ZUPON: We are not as heavy in construction as maybe Brighton Bank, Bank of Utah or Central Bank, but it impacts the deals we will do. We try to structure around HVCRE. Regulators will do things such as there’s kind of a line in the sand which is that you can’t exceed 100 percent of your capital in construction lending. And it used to be kind of a soft line. Now it seems to be more of a hard line. And that impacts growth, where banks aren’t doing as much construction lending as they were doing.
And the other issue is the amount of capital banks have to hold. If you had 10 percent risk-based capital in the old days, you were considered extremely strong and the banks and regulators would leave you alone. We are seeing in our peer group it’s 15 percent. So as far as regulators are concerned, more capital is better. It gives a larger cushion for the downturn, which makes their life easier because if we have a recession fewer banks are going to get into trouble. But it also impacts on the other side what banks can do to help stimulate the economy and growth. They do fewer loans and they limit the type of construction loans that are being done.
LEARY: From my viewpoint as the state regulator, it seems that in the last downturn Utah was heavily concentrated in CRE. When the value of the real estate collapsed underneath it, then Utah banks, particularly the community banks, suffered a lot from that. So this time as we are going into a very long growth period, we are tracking concentrations in ADC loans very closely. This time, though, Utah is not extremely high. In fact, we are fairly in the middle of the road right now. Other states in the West are all higher than Utah right now as far as those concentrations.
Let’s talk about fintech. Where is that headed, and how does it interact with millennial preferences for online banking and loan processes?
PIGNANELLI: The FDIC and others in DC have been so reluctant to adapt to 21st century dynamics—I mean, the FDIC has approved, what, four banks in the last nine years? Four in a $20 trillion economy. So a majority of the financial transactions in this country are now done outside of the regulated sector.
People around this table are visionary, but unfortunately, we have some bankers in other parts of the country that are nervous about fintech getting into the banking sector. We are saying why? They want to come in and compete in the same rules and regulations that you live under, and that evens the table.
LEARY: Fintech has gotten a head start because it works on the customer experience to make it quick, easy and efficient. Bankers will say because of the regulators they have a difficult time creating a really good customer experience when they are trying to engage in a transaction. But the fact that they can go to a local branch, still there’s a significant part of the population that wants to do that.
ANDERSON: People want the convenience of online banking, but they also want to know something is close if they need to. They may never go in there, but they want to know it’s close. You are not doing vaults and safety deposit boxes and those type things, but you almost have to have something in a geographical region or else you are not deemed as credible. So that’s kind of the Catch 22 you’re in.
PIGNANELLI: With fintech, they want that ability to say they have a banking operation here to help the customer. And it will also take deposits, which is a big deal, too. But they want to be able to say, “We are a bank. We are providing customer services.” That’s why you are feeling this pressure, not just in Utah, but across the country, for fintech. That’s why the OCC opened up their charter, also.
SANCHES: There’s always going to be a need for people to come in and receive some kind of expert advice, consultation. They are not coming in necessarily to cash a check. While that is still happening, the offices are going to be primarily there for consultative purposes. You are seeing teller lines move away to more of a concierge desk, where you have one employee that can really do pretty much anything the customer needs at the time. That will continue to evolve and change. And it will be interesting to see what happens in the next 10 years as fintech forces banks to think different than they have certainly in the past.
OKERLUND: It’s interesting to hear the way we talk about fintech as an alternative to banks. But, at least from the standpoint of Bank of America, which has its own fintech that it is investing in, it gives us another level of resources to tap into. The amount of financial, technological investment that is happening with the larger nationwide banks is obviously a direct result of the pressure that we are seeing from Venmo, Square, SoFi and others. But regulations notwithstanding, we are finding ways to meet the needs of our customers, right?
LEARY: As a regulator, that’s the biggest challenge. How do regulators maintain their role of overseeing the institutions and ensuring their safety and soundness, and yet allow innovation in there somewhere? Because the expectation is that the regulators will stop innovation. And unfortunately, I probably have to agree with that. They slow it down. And that’s not always good.
But on the other hand, banking has always had this stable, consistent expectation and history. And suddenly if you have banks going off the rail in the fintech area, then it’s more of an industry-wide concern for the regulators. So the dynamics going forward will be technology versus stability.
YERGENSEN: Think about how greatly fintech changes every couple of years. And think about that over the last 20 years. While we have been focused on regulatory changes and battling low rates and demand, the tech landscape has changed 30 times.
A lot of us around the table are not going to be able to have those resources to plow into that kind of change. So it becomes much more of a function of who do we collaborate with? Who can we invest with in fintech? Who can we co-brand, co-own? Because they will be able to change, bring that kind of capital, bring that kind of expertise to solutions that still touch our clients, like payments and delivery and access.
ZUPON: The challenge we have with our regulators is in their mind they think that a bank should have a very defined local market where people walk in and make deposits and that kind of thing. Their ideal bank is a bank from the 1950s, and that’s not what the market is today. So how do we get our regulators on board to say it’s OK to have deposits out of our market area? They view them as a brokered deposit, or hot money. And there’s a lot of studies that show they are pretty much as stable as local deposits. But people don’t walk into a bank. They may shop and go on to Bankrate or other online services to look for the best rate. And they are comfortable dealing with a bank in another state.
SHUMWAY: The Office of the Comptroller of Currency really gave us a hint three years ago when they encouraged banks to collaborate, if you will. The big money banks have big money, and the small community banks have small community money. And the opportunities to invest are far different. But the credit unions have a model for collaborative service organizations, CUSOs, where they get together and share services such as compliance or the technology side or whatever. And I think community banks are going to have to do a CUSO-type arrangement because we haven’t got the money to develop our own fintech. And if we try to buy some of these fintechs, the multiple is a lot more than our capital. So I see that as an interesting opportunity.
OKERLUND: I think there really does have to be some way that money differentiates itself, otherwise you don’t care whether your account is in Illinois or Indiana. So in the commercial bank we have to differentiate ourselves by the advisory capacity that our bankers provide to the CFOs and CEOs of the companies they work with. And if we don’t do that, then people are shopping by basically going to Bankrate and saying, “This is the bank that I’m going to choose.”
For the companies that also operate outside of the state, what’s unique about the Utah market?
ZUPON: Credit union competition on the consumer side. That’s what’s so unique about Utah is credit unions own the consumer market. More so than any other market.
HALL: Aside from the ILCs, the third and fourth largest institutions are credit unions. They are significant players in our market. They have taken the automobile market right away from us. And I understand that 80 percent of all automobile loans are done through the dealer and indirect paper. But you go to the dealership and they ask, “Do you want financing? What credit union do you want?” That’s what comes out of their mouth.
Now they are really taking over, in my opinion, the second mortgage, the equity credit lines where they have really, really expanded and they are growing very fast in that area.
LEARY: I was just in a meeting with bankers and regulators and the potential for issues within auto lending came up regarding going down the credit scale into subprime auto lending. The bankers in the room said, “We are not worried about that. That’s a credit union issue.” Yes, certain areas, particularly in Utah, have been taken over by that industry. I don’t have current numbers but I know at one point, Utah had the second-highest people in the nation that are members of credit unions.
SANCHES: In Utah County we have experienced competition from credit unions. We do a great job of garnering the construction credits on the commercial and residential side. But on the commercial side, we have seen an increase in competition from credit unions once the risky part of doing the construction on a commercial building, once it is leased up and occupied, credit unions are just flocking and offering just amazingly low rates that are hard for taxed entities like banks to compete with.
So now they are starting to deal in that arena. Luckily, they still really don’t know what they are doing and don’t have the expertise. But the scary part is if they do start acquiring that, then it is going to be interesting.
What is the biggest challenge and biggest opportunity for 2018?
HALL: Cyber crime. It is alive, it is dangerous. And it can happen to any one of us around this table immediately. We have to educate consumers about cyber security, about how to protect themselves from this kind of stuff. Because it is just rampant. And I know some in the smaller community banks are going to say, “I’m not too worried about this,” but it’s coming. Trust me. And this is something that could really hurt small community banks immediately. And that gets out in the media and press, and guess what? Confidence is gone.
ZUPON: Cyber security is a huge risk and I think the banks are handling it well. But the weak link is our customers. The criminals are figuring out how to get to the bank through the back door. We are doing a lot to educate our customers on that. And the opportunity there is the value add that the banks can do.
YERGENSEN: Talent is the biggest challenge. The opportunity is really to become much more collaborative. We have to work together a little bit better. We have to partner with fintech companies. We have to start asking questions to our businesses that are not just about a loan or a deposit. It’s tell me about how you collect on a receivable and how you pay a payable; tell me about the next generation. It’s collaborating with other people in the community that help provide those services. That’s where I think we have to go.
SANCHES: Rapidly shifting technology is both a challenge and really going to be the opportunity for banks to set themselves apart. Banks that can evolve over the next 10 years to meet the client needs are going to be the ones that are going to be successful and be able to separate themselves.
NELSON: Managing our risk, making sure we are keeping our underwriting standards constant, and being cautious and careful, because we have seen a lot of institutions aggressively wanting to get their money out. That’s a real risk. Opportunity for us is just supporting a market that’s here as a business bank, and making sure we have our niches, we are a boutique bank. But that we go after those niches and be careful.
HALL: Talent, cyber security are significant challenges. But probably the bigger challenge is the lack of change with regulation. Now, there are some great things that are happening back East. But we have to have some change and some regulatory relief.
LEARY: The number one concern in the state remains the cyber security issues. The secondary challenge is getting good folks into our bank examinations, having experienced, well-trained individuals involved there.