From federal budget challenges and Dodd-Frank to the housing market, borrowers’ shaky confidence and the state of the national economy, Nevada’s banking industry has its work cut out for it in 2013.
While top executives remain cautiously optimistic, they are under no illusions about the challenges facing growth over the next 12 months.
“I think we’re on the road to recovery,” suggests Bruce Hendricks, CEO of Bank of Nevada, “and things are getting better. But it’s going to take a while. We just need to continue to see improving trends in our local economy, which will ultimately lead to the creation of jobs, and that’s what will get us out of this.”
Another factor affecting the banking industry is the uncertainty surrounding the recent fiscal cliff crisis. “A lot of people out there aren’t comfortable about making long-term fiscal decisions for their companies, and so that in and of itself needs to get solved,” says Larry Charlton, Nevada Regional Executive for City National Bank. Interest rates have also proven a challenge, he adds. “Interest rates are critical as far as how a bank or financial institution makes money. Financial institutions make more money in a rising interest rate environment, not a static, very low interest rate. What we do as an industry is buy money. We buy it low and sell it high. Right now we’re buying it super low and having to sell it super low.”
“Overall, the major issue is having qualified customers to lend to,” Bill Uffelman, President and CEO of the Nevada Bankers Association, points out. “Qualified loan demand is very slim. That’s the biggest difficulty. Banks want to make money, and the interest rates are such that you can’t make money on the interest rate spread. You can make money on fees, but banks aren’t in business to make money from fees. So it’s a bad environment for the banks to be operating in.”
“We’re all coping with Dodd-Frank,” says Hendricks, “and then the phase-in of the new capital requirements with Basel III (a global regulatory standard on bank capital adequacy, stress testing and market liquidity risk agreed upon by the members of the Basel Committee on Banking Supervision in 2010 and 2011 and scheduled to be introduced between 2013 and 2018.). Those are two real critical issues facing the industry, and both regulatory driven. Obviously, our cost of compliance is going up.”
“Overall, the local banking industry fared well in 2012 relative to the preceding four years,” reflects Dallas Haun, President and CEO of Nevada State Bank. “We saw very few bank failures, with growth in deposits and greater efficiencies as our industry adapts to the new economic environment.” The Fed continues to promote a low-rate environment, he adds, and intends to keep rates low into 2014.
“This will continue to challenge banks’ net interest margins, but on the other hand, this presents a clear opportunity to consumers and businesses alike to reduce their cost of borrowing.”
“Nevada’s banking industry is in a recovery, much like the economic cycle,” says Kirk Clausen, Wells Fargo’s Nevada Region President. “We are seeing strong demand for business lending, in particular small business lending, which should continue this slow growth recovery into the next year. Even with a historically low interest rate environment, the prospects definitely look better than last year.”
Slow and Steady
“Generally there is slow and steady improvement, as evidenced by lower levels of non-performing loans that show up as past due and non-accrual items in the banks’ call reports,” explains John G. Sullivan, President of First Security Bank of Nevada. The surge of credit losses has slowed and, except in isolated cases, loans being charged off have slowed.
“The regulatory agencies have shifted their position on building reserves for loan losses from a measurement based on identified losses as of the measurement date to something closer to expected losses over the life of the loan,” Sullivan notes. “What this means in practical terms is that a bank will record some amounts of loss reserves when the loan is booked. Thus, a loan that closed in December 2012 would have caused the bank to add about $10,000 to the loan loss reserves in the same quarter.” This approach is a departure of the strict accounting rules, but those rules are being re-evaluated now by a joint group composed of the Financial Accounting Standards Board (FASB) and the regulatory agencies. It is expected that clearer guidance will come out in 2013.”
Many community banks continue to be saddled with problem loans from 2008 to 2010, Sullivan points out. In 2012, significant amounts of those loans have been charged off as banks have tried to “clean up” their balance sheets. As a result of charge offs and building reserves, many smaller community banks were operating at a loss in 2012. “This weakens capital levels, which puts additional pressure on the banks to raise capital. Raising capital is very difficult all across the country, especially in areas that were hard hit by the recession, such as Las Vegas.”
“Lending is certainly up,” notes George W. Smith, Nevada Market President, Bank of America, “driven by significantly increased demand from small and mid-size companies.” In 2012, Bank of America had a 40 percent increase in new lending just to small businesses; Smith and his colleagues see this same pace, if not better, for 2013 as commercial real estate values remain stable and refinancing is attractive due to low interest rates. “Also, now that the elections are behind us, many companies will get off the sidelines knowing what growth strategies are best for them based on who’s in office now.”
Stan Wilmoth, President and CEO of Heritage Bank of Nevada, sees the amount of liquidity in banks today as their biggest issue. “There is just so much cash out there that needs to be lent out, and not a whole lot of loan demand. Demand for loans in a small community bank, in the C&I (Commercial and industrial) program or real estate, is just not there. A qualified borrower doesn’t want to borrow because he wants to de-leverage; his fear is caused by the uncertainty in Washington, DC. It’s got him paralyzed.”
Once lawmakers in Washington have restored some certainty, Wilmoth says, “there’ll be a lot of upside. When we get some strong direction from Washington, small businesses will start to expand. I’m really hopeful for what California could send our way with some of the tax issues they have over there, with Proposition 30 (a sales and income tax increase initiative approved by voters in November).”
The most immediate issue, in Smith’s mind, is the ramifications of the so-called fiscal cliff. “If the issue lingers too long we may be looking at an economic impact that would go the entire year and into 2014. For example, we are seeing some mid-sized companies who are our clients pause activity and use debt to issue special dividends ahead of possible tax increases.”
Host of Challenges
A number of factors will contribute to making 2013 an interesting one in Nevada’s banking circles. Among them are:
Regs and Laws: “In Nevada, we are working together with several different industries led by Attorney General Cortez Masto to make positive changes to AB 284,” Smith explains. “Nationally, I think the industry is waiting to see what President Obama’s second-term cabinet looks like to gauge the tenor coming out of Washington DC.”
AB 284, a Nevada law that went into effect in October of 2011, was enacted to provide more protection to homeowners and regulate foreclosures. The Bill, among other things, prevents loan officers from “robo-signing” and requires they have personal knowledge of whomever owns the note.
Two significant changes are on the immediate horizon, says Sullivan. The Transaction Account Guaranty (TAG) program expired as of December 31, 2012. The program was adopted several years ago as a means to provide for full FDIC coverage on transaction accounts (i.e., non-interest-bearing checking accounts). “This significantly helped smaller banks to keep business accounts and customers that kept over $250,000 in the bank. Without this extended FDIC coverage, large balance customers would have likely moved their funds from smaller banks to very large too-big-to-fail banks. That would have had disastrous results for America’s banking system as the smaller banks would not have had the money to loan to small businesses or households.” The program ultimately failed and is in the process of being reconsidered.
With the expiration of TAG, says Sullivan, “the impact to community banks could be quite severe in 2013 if large balance customers start moving their funds to the larger banks. This will not help anyone. The larger banks generally pay lower interest rates on deposits, so the customers --typically small businesses -- will have less income and the loss of large deposits in smaller community banks will impede their efforts to loan to small businesses. In a worst case scenario, the loss of large deposit balances could cause a smaller bank to fail.”
Indeed, adds Haun, until the balance of the Dodd-Frank bill is actually written “we are in a holding pattern.”
Foreclosures: Will foreclosures remain a major banking issue in 2013?
“I think they could be,” says Wilmoth. “There is that overhang that we can’t measure right now, which I think could be a problem.” Foreclosures are a much smaller problem today than a year ago, he adds, “because we’ve had the HARP 2.0 (the Home Affordable Refinance Program, an initiative from the Federal Housing Finance Agency (FHFA) to assist homeowners whose homes are now worth less than what they owe) coupled with the short sales. Those two things together eliminated some of the overhang.”
Until the economic cycle fully recovers, Clausen predicts, foreclosures will continue to be an issue. “However, our strength and stability have enabled us to take a leadership role in Southern Nevada towards addressing the concern.” Wells Fargo held a home preservation workshop in Las Vegas to help people find solutions to stay in their homes. The bank has also partnered with the City of Las Vegas and Neighborhood Housing Services of Southern Nevada to address the issue of available home inventory. “Our forgivable grants of up to $15,000 for homebuyers enabled many people to purchase a home in the City of Las Vegas.”
Bank of America has several efforts underway in Nevada to help financially-distressed homeowners, such as reducing their principal balance on properties that are underwater. Through these programs, says Smith, the bank has offered $208 million in consumer relief to more than 1,800 Nevada homeowners. “We also have three customer assistance centers in Nevada to provide customers help with their mortgages, and have completed 25,000 modifications since the housing crisis began.”
Even with a strong arsenal of programs and generous principal forgiveness, however, re-default rates, while better, are still high. Smith says it’s because “at this point in the cycle it isn’t a lack of programs that is the issue. It’s that many customers remain unemployed, are still feeling the impacts of the recession and lack the cash flow to sustain a payment, even a modified one.”
The Year Ahead: Customers will have more complex financial needs in the year ahead, says Smith. “They’re telling us they want to bank and invest wherever they choose, want advice and solutions to fit their needs, rewards for doing business with us, and for us to know who they are and take care of them.” Thus, banks need to provide more resources for these needs.
“I think we’ll see continued consolidation within the industry,” says Haun, “particularly in the community banking sector. Low interest rates and lack of loan demand, combined with the new regulatory environment, make it harder for small banks to grow, and some will opt to sell to larger competitors.”
Haun says he and his colleagues remain optimistic that 2013 will be a good year for the community and for his bank. “The housing market continues to show signs of life and most other economic metrics are trending in a positive direction as we approach the new year.” His bank’s consumer loan balances are at an all-time high, he notes, and it continues to originate tens of millions of dollars in mortgages and other consumer loans. “In fact, this is where we are generally seeing the most activity.”
“I believe that the local economy will continue to recover in a slow and steady pace,” says Sullivan. “The improvement won’t affect all businesses equally, but it will tend to help all businesses as money will circulate a little faster provided that the banks will continue to provide capital resources to businesses emerging from the recession. It is those small businesses that are the backbone of the economy and it is their recovery that will heal the economy and not the large Wall Street traded companies that are still in a retraction mode in an effort to improve earnings efficiencies.”
Clausen believes it is too early to tell what is going to happen on the state and national political fronts. There are, he notes, a number of issues that need to be resolved to help the economy and the banking industry recover. “From a state perspective, we need to watch banking legislation affecting foreclosures very closely during this upcoming session. Meanwhile, on a Federal government front, the nation re-elected a status-quo government. It should be fascinating to see what effect that has on the banking industry.”
“While one cannot ignore the fact that our state’s economy can be heavily influenced by national politics,” Haun says, “our focus is on the economic health of the state of Nevada. We hope that President Obama and Congress can work together on policies that promote economic growth. This means freeing our small businesses to do what they do best: grow and create jobs. If this happens, the banking industry will be just fine.”