A more relaxed regulatory environment for banks, rising interest rates, a flattening debt yield curve and a fluctuating stock market are the buzz of the financial services industry halfway into 2018. While experts in the field and economists agree that a strong economy translates to a solid outlook through year’s end, some factors are creating future uncertainty.
The big news for banks this year occurred in May when Congress passed Senate Bill (SB) 2155, which rolled back some provisions instituted by the Dodd-Frank Act. “It’s going to exempt many of our community banks from some of the onerous provisions that Dodd-Frank had put in place,” Simone Lagomarsino, CEO of the California Bankers Association, commented. “It simplifies the capital requirements for community banks. It provides for longer exam cycles, so rather than [being examined] every year, it extends out the frequency of the exam cycles, which helps,” she said.
The bill raised the threshold for compliance with certain Dodd-Frank and Community Reinvestment Act rules from banks with assets of $50 billion to banks with $250 billion in assets. These banks are no longer subjected to ongoing stress tests, per the new law.
SB 2155 also makes mortgage lending a less onerous process for community-sized banks with $10 billion in assets or less. “For financial institutions that are $10 billion or less in assets, they can now portfolio mortgage loans. . . whereas before they had to make all of the qualified mortgage loans cash in order to be considered qualified mortgage loans,” Lagomarsino said. Under the law, banks or credit unions with assets of $10 billion or less are exempted from certain escrow requirements.
The Federal Reserve raised the federal funds rate to 2% recently, and has announced that it will likely raise the rate twice more this year. The rate dictates interest rates for loans. According to Lagomarsino, higher interest rates means banks will achieve higher revenues.
However, Lagomarsino pointed to the flattening of the yield curve, which measures the gap between short and long-term U.S. Treasury rates, as point of concern for the outlook for the financial services industry. “Many of our banks are what would be considered asset sensitive, meaning as rates go up they would make more money,” she said. “But the problem with a flattening of the yield curve is your deposit costs go up and at the same time you’re not raising your loan rates, [so] you end up having a compressed net interest margin.” She added, “Absent that, I think with the rest of the indicators in the economy, if the economy does well, we would expect the banks to do well.”
While the stock market has been somewhat volatile this year, Robert Kleinhenz, economist and executive director of research for Beacon Economics, noted that this is not necessarily a negative indicator for the economy. “We don’t want to equate turbulence in the stock market with a possible recession in the broader economy,” he said. He attributed swings in the stock market to political news. “The ups and downs that we have seen recently have been in reaction to in part pronouncements with respect to trade policy, and then also with respect to immigration policy and other things,” he said.
Kleinhenz continued, “It’s not like the stock market is way out of balance. And it certainly is not the case that the household sector is in danger the way it was leading up to the Great Recession. One of the issues with the Great Recession was the household sector was over leveraged. And right now that is anything but the case.”
Kris Allen
Vice President, Senior Bank Manager – First Bank, Bixby Knolls
It’s been a very long time since we have had an economy this strong.
The Fed increased rates 25 basis points last week, and there is a strong probability that we will get 2 more rate increases this year. But even if that happens, rates remain much lower than their 25 and 50 year historical averages. We have approximately 2 years of future rate increases before we have to worry.
So why is the Dow up 2% YTD, the S&P up 4% YTD and an investor with a 60/40 equity bond portfolio basically flat for the year?
I believe it’s because of the 2 Ts: Tariffs and Trade. Markets don’t like uncertainty, and the threat of a trade war is causing a lot of uncertainty. Now to be clear, total volume of trade in the U.S. is up and is increasing. However, the uncertainty around what’s to come is causing nervousness.
A trade war would have negative implication on corporate earnings, on GDP and on consumer spending. While this uncertainty is real, conventional wisdom is that all of this will get resolved and that we will avoid a trade war. A trade war is NOT priced into the market. But conventional wisdom can be wrong. In fact, it is often wrong! Make no mistake, we have an unconventional administration which does not focus on Canada, Mexico, Europe, Japan and China as long-term allies.
We remain sanguine that these tensions will get resolved and we in fact avoid any trade wars.
Blake Christian
Partner, Holthouse Carlin & Van Trigt LLP
We are seeing continued growth in the public accounting arena. The combination of very healthy local, regional and national economies is resulting in strong CPA firm hiring and continuing consolidation nationally. We will be opening our 12th office, in Phoenix, this year.
Revenue trends are also strong as a result of more demand for tax planning services generated by President Trump’s expansive personal and business tax policies passed in late 2017. We are also seeing very strong merger and acquisition activities within our client base, resulting in strong results for both our tax and audit practices.
Of course with unemployment dropping to decade lows, the industry and our clients are experiencing challenges in hiring new and experienced employees, and paying more for those positions. These and other inflationary pressures, interest rate increases, as well as the effects of the tariff wars will likely put some margin pressures on our many of our clients this year.
Clients are fairly optimistic from a domestic standpoint and are very pleased as they discover more about the advantageous 2018 business tax changes. However, the aforementioned inflationary pressures, political and international uncertainties, and state and local regulatory challenges are still a concern and may slow down some projects and expansions.
While many of the personal tax changes, namely limited state and local tax deductions and the elimination of many other itemized deductions, have a negative impact on California taxpayers, business owners (vs. W-2 employees) will generally gain a significant net overall advantage from the new tax bill.
Risks remain in areas such as: stock market corrections, trade wars, terrorism and hiring shortages.
Mark Vitner
Managing Director and Senior Economist, Wells Fargo
We are seeing good growth in parts of the financial services industry – very solid growth in demand for small business loans, for example. A lot of small businesses are looking to lease equipment. We are seeing fairly strong demand on most types of consumer lending. Mortgage demand is growing at a rate of 5-6% per year, and that’s all on the purchasing side. There is very little growth in refinancing volumes or home equity loans.
We are expecting two more quarter point interest rate hikes this year, one in September and one in December. Most of the impacts will be at the short end of the yield curve. We are not expecting long term rates to go up that much, so mortgage rates are probably only going to go up another quarter of a percentage point.
Banks are seeing fairly strong growth. The industry has gotten leaner. It is well capitalized. Most banks are remaining very cautious in terms of taking on credit risk, which is another reason that lending is growing as modestly as it is. But banks are looking to expand at the same time they are keeping a tight rate on expenses, which means that job growth in the banking industry is pretty modest.
W. Henry Walker
President, Farmers & Merchants Bank
For financial services, the outlook is strong through 2018 and into 2019. The rise in interest rates is going to bode well for banking and financial services, and will help margins that are now improving for the first time in 10 years. We see margins improving pretty much across the board. We look forward to a successful 2018 and a good 2019 as we sit here today. Credit quality continues at an all-time high. In other words, people are able to meet their obligations.
As banks are able to lend out money at higher interest rates, the majority of banking companies are keeping their cost of funds in control. The net interest margin is expanding because we are able to process deposits and money and loans at higher interest rates than we were before.
Today F&M just touched $7.3 billion in total assets, up $300 million since the start of the year. This again shows good growth in core deposits and that the marketplace is favoring our company over others. So for Farmers & Merchants, we still maintain our standing in the top 150 largest banks in the country and top 20 that are headquartered in California. We have had significant movement in the marketplace, and we’re continuing to see new customers on a regular basis who want authenticity, true relationships and someone to talk to. And that is what we excel at.