Market Overview

The 2017 Forecast On Financials: A Conversation With Community Bank Analyst Chris Marinac, Part Two

The 2017 Forecast On Financials: A Conversation With Community Bank Analyst Chris Marinac, Part Two

Marketfy Maven Tim Melvin recently had the opportunity to speak with Chris Marinac, co-Founder and Director of Research with FIG Partners—a community bank specialist research and investment firm—to get his thoughts on the future of financial institutions, big and small, and what part fintech and regulation reform will play in the next 12 months.

Below is part two of their conversation, slightly edited for length and clarity. Click here to read part one.

Melvin: How likely is it that the whole fintech scenario plays out and the banks end up acquiring a lot of these technologies outright. Is that a realistic view?

Marinac: I think so. If you think about it, the banks have more currency now. So the fact that they have stocks that they can use to do small equity deals, absolutely. In many respects, the marketplace would embrace that. 

I think you’re also going to see alliances come. I encourage investors to take a look at what Fifth Third Bancorp (NASDAQ: FITB) is doing. They announced an alliance in September with a company out of Atlanta called GreenSky that does home improvement lending. Not only are they buying loans from GreenSky, but they’re also licensing their technology, and the technology is very sharp. It’s very regulatory friendly, but it allows Fifth Third to kind of rethink their own internal processes. That’s going to help them not only save money, but also create more revenue over time. So that’s a real good example of where fintech and the banking industry overlap and I think can actually be very helpful for each other.

Melvin: I think that the fintech lenders in particular have to look to sell or license to the banks because the technology may be wonderful, but at heart they’re a non depository lender and the first time there is a liquidity crisis, they’re in trouble.

Marinac: Absolutely. I think you and I have talked about this before. The deposits are the lifeblood of the banking industry.  The banking industry does extend into the fintech and those lenders, but most of those lenders do not have a good cost of funds, and that’s when the banks win. I think at the end of the day banks and their low cost of funds is really what’s going to win out, and that’s where I think the partnership with online lenders is going. I just think that some of them have admitted and some have not.

Melvin: Let’s move to loan classifications and categories. Regulators earlier this year expressed some concerns about commercial real estate concentrations, and there is a fear that it will go from a gentle suggestion to a regulation, talking the 100/300 rule. Can you comment a little bit on that?

Marinac: I think that it’s a fair expectation. Like a lot of things, the regulators can only hint at things so long and there comes a point where they have to make it more of an official rule. While we may not necessarily get an official ruling, I think it’s going to become more direct. 

The interesting thing to me is that the technical rule takes all four categories in real estate—construction, multifamily, owner occupied, and non owner occupied—and lump them together for the concentration ratio. For the most part, the owner occupied real estate has been excluded from the conversation, but in the Fed and FDIC guidelines they really include it, so they have the ability to create a letter of the law expectation for you to abide by it. If you’re above that level, we want to know why. 

I think that there is going to be more and there already have been changes made as banks diversify away from commercial real estate. It’s both good and bad. I mean, it’s bad because there are some really good lenders in real estate who know how to make very good money despite their concentration, and they have had really good credit scores, but I think they are going to naturally back down. But it’s also positive in that it forces banks to find a way to be not only creative, but I think also focused on other categories. C&I lending is something that some banks are good at and other banks are not. But we can see that purchase. I think more banks are purchasing loans from each other to try to get themselves some diversity. I think you’re going to see banks focus on the consumer area, and not necessarily trying to match car loans or match the online lenders, but really trying to find where they can have niches.

A lot of it is focus, but I do think your general point is accurate that we are going to see more banks having to limit their commercial real estate.  There are a lot of companies that I think have to improve their internal processes in terms of how they track real estate, and that’s really what the regulators want. They want to see banks getting deeper on their own book of business so they know where the issues are and they can respond when there are problems because that was a big lesson learned from the financial crisis is that banks have too much real estate and too much construction and they didn’t know how to respond and what to do. We are definitely educating a better financial system and a better financial institutions industry as a result of this sort regulatory guidence that continues to be talked about louder.

Melvin: Are there any loan categories that you’re a little concerned about at this point where you see total value being a problem down the road.

Marinac:  Multifamily has grown a lot. It has been the biggest growth category. I think that multifamily is something to watch.  At the end of day, multifamily is a function of supply and demand. If the supply and demand are in balance, multifamily will be fine.

We think that there has been a lot of attention paid to multifamily in the past 6 months and that banks have already made changes and pulled back and changed behavior. I think that is very positive already. It gets back to the job growth and the economic activity. If the economic activity is positive, it’s going to sop up the supply.

Melvin: It doesn’t really look like going back to the commercial side of it. It may not appreciate as much as it had over the last 5 years, but it doesn’t look like it’s going to go down a bunch, which basically means it’s an okay time to be a lender in that sector, doesn’t it?

Marinac:  I think it does. To me the attitude is that companies have to build reserves. One of the things that could happen if the corporate tax rate gets cut is that you can see companies actually investing those dollars back into reserves and that would be a really healthy thing. 

The reserve argument for years has always been that the SEC and the accounting firms do not want to see bank using the reserves as a cookie jar where they kind of set them aside without any rationality and they kind of pull them out when they need it, but the reality is reserves in equity go hand in hand and it’s a really healthy thing. I think the regulators are mistaken sometimes for not having more reserves. 

I think banks are going to get better at putting reserves aside and really documenting it.  What we’re hearing companies do is getting more creative about how they document putting those loan loss reserves up.  The challenge for the industry is that loan loss rates are very low. You have a lot of companies who have charge up rates below 20 basis points, so if they have a 1 percent reserve they effectively have five years of coverage. Five years of coverage is pretty doggone strong, but 20 basis points can easily become 40, and that’s the point that I think banks are going to hang their hat on, that we may have a low loss rate in 2017 but we can’t guarantee that in the future.

Forecasting higher losses, there is nothing wrong with being conservative. We do have a new accounting standard that is going to place in 2020 called CECL which is going to be kind of expecting losses instead of going historical in forecasting. I think you’re going to see banks getting creative to be pretty cautious and pretty conservative about expecting the future. It’s a way for them to justify higher reserves.

Melvin: When we talked last December, doing a little year ahead look, you suggested that bank book values you thought in 2016 would grow probably right around 7 percent. I think you came in pretty close to the actual number. How does that look for 2017?

Marinac:  Fourth quarter is going to be a reset because fourth quarter is going to have the mark to market on having interest rates go up as much as they have. We’ve seen 70 basis points approximately the 10 year increase from the end of September to where we are here at late December. That unfortunately is going to create a negative mark to market for the available for sale securities. But I think most banks will probably only see book value go down about net 1 percent, maybe less. That’s because earnings can still be very good for the quarter. 

For example, banks may take a 2 percent hit on the book value from the mark to market, but they may make 1.5 percent or so back in terms of their profits for the quarter, so that’s going to really mean the net change is less than a percent. So I feel like we will see a little bit of that noise quarter to quarter in 2017, but I think a 6 percent growth rate is still a pretty good number to have because the industry will have a good year.

Melvin: Any final thoughts on the community bank space for investors as we go into 2017?

Marinac:  So we’ve seen a lot of stocks go from 90 percent of book to now 120 percent or 130 percent at book, and some that have gone from 120 percent to 150 percent. The challenge is we’ve seen 25 plus percent returns in banks in the last 2 months, and that always is lovely while it lasts, but we have to be realistic that this is an industry that, if we can get a 9 to 10 percent or 10 to 12 percent return each year, that is pretty solid and that would be my expectation for this year after the big move we’ve had. 

Posted in: Analyst Color Fintech M&A Entrepreneurship Asset Sales Management Markets Tech


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