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.
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