If you listen to the news pundits, there is lots of talk about asset bubbles. To figure out if banks are lending into inflated asset prices we turn to the data for answers. Since valuation is a function of future cash flow, having a more accurate vision of the future is helpful when lending. Once predictive factor to alert commercial real estate lenders is when supply outstrips demand by more than a 2-to-1 ratio. When this occurs there is better than a 60% chance that cash flow remains flat or even goes down, thereby hurting property values.
Banker To Banker
Last week, the Securities and Exchange Commission announced changes to money market fund (MMF) regulation in an attempt to lower the risk to investors. During the financial crisis, the combination of credit and liquidity shocks caused several money market funds to “break the buck” or trade below their par value due to losses. One notable one close to home, The Reserve Fund, caused many community banks problems.
There is an opening scene in Sharknado where an Eastern European fisherman and an Asian businessman are on a boat negotiating the classic cliché-filled shady business transaction. Negotiations are over in about 10 seconds, which is good because it is right before a shark washes up on the deck and starts eating people. Other than how fast these negotiations concluded, the rest of the movie was pretty realistic.
If you were a financial institution on the frontier during the late 1700’s you had an exchange rate for beaver pelts. Sometimes you didn’t trade any beaver pelts, or some problem customer brought in some deer skins to trade for cash and you had to either make up a beaver pelt rate or do some esoteric conversion in order to have an accurate index rate to base some of your deposit and lending activities on. Well, the beaver pelt problem isn’t all that different than our modern rate structure with LIBOR, Fed Funds and Prime, which is why it is changing.
In bank sales training, one of the most talked about concepts today is the “trigger event.” A trigger event is a notable event that has occurred in a customer’s or potential customer’s world that has them more open to a change or to using a product. For example, a customer’s competitor announced a major acquisition. This causes your customer to think about why they aren’t looking for an acquisition.
All bankers agree that the more equity an owner has in a property or business, the better the credit. While statestically true, the real question is how much does equity matter? Or, a similar question, what is that equity worth? The answer is that it depends on how much you are talking about and what type of loan you are talking about. In the companion graph, we have charted the pobability of default with the ownership equity percentage. The solid line in black represents all commercial bank loans, while the dashed line are just commercial real estate loans.
As of the end of June, commercial real estate is the second largest credit risk on community bank’s balance sheets, composing almost 29% of the loan portfolio - just slightly behind residential real estate exposure. On a dollar basis, we are now approaching some of the highest levels in history and are on track to break the record in the next year, a record set back in Dec, of 2008.
During 2Q bank earnings calls and comments, JP Morgan, Citigroup and Wells had some interesting comments that may impact your bank. The Fed is winding down their Quantitative Easing liquidity that will remove balances from the banking system and from corporate balance sheets (that are also largely on bank’s balance sheets).
When it comes to corporate culture, many banks know that building a true and sustainable culture is like baptizing cats. It’s tough work fraught with many scratches and a lot of moving around. However, when it comes to corporate culture, Netflix is in the pantheon and can give banks insight. In 2011, their CEO, Reed Hastings, their Chief Talent Officer and others produced a “Culture Doc” (below) that was leaked and spread like wildfire among the Silicon Valley’s elite.
If you have spent some time in men’s locker rooms, then you likely know about the unspoken “naked man right away.” This regulation in the man-code stipulates that the least dressed man goes first should your paths cross simultaneously in a locker room. If you have a towel on, for example, you yield to the guy with only hair gel. This regulation permits safe passage and prevents getting hit with random body parts which is awkward at best.