In the past six weeks, the banking landscape has radically changed. Spreads, volume forecasts and the economics of banking have shifted. The outlook for loans credit, deposits, and fee lines are now all different than they were prior to the Trump Administration and banks that are not thinking through the next four years will find themselves being reactive. Most importantly, the mindset and catalysts within public psychology have changed which has caused new thinking within bank marketing. We have been discussing these trends within our bank and with other leading banks throughout the nation in order to brainstorm and codify these trends and what they mean. In this article, we cover the four major changes that all banks should be positioning for, plus we discuss the impact and the best strategies and tactics to execute to get ahead of the competition.
Here are the four national trends.
We will assume some form of tax relief occurs for companies that have overseas revenues that desire to bring cash balances on shore. Apple, Microsoft, Oracle, Alphabet and Qualcomm alone compose almost $500 billion of cash, and our forecasts put this number more than $3 trillion. All this cash will come back and be used for capital investments and dividends.
What this means for banks: As money comes back onshore, there will be less need for debt and more cash balances available. Credit spreads will tighten as demand is lowered for debt, supply contracts and the probability of default decreases. The funds that come back to the US that is invested in infrastructure will serve to further inflate asset prices and raise future loss given defaults. We also look for more capital spending to be inflationary and increase the prices across the board thereby pushing interest rates higher.
How Banks Should Play It: Identify mid-market commercial customers with overseas operations now and see if they maintain offshore accounts. If so, these are prime targets for foreign exchange fee income and deposit marketing. Banks will make a big deposit marketing push targeted at wealthy individuals and family offices as a large portion of this overseas cash will ultimately end up being dividended out or used to repurchase equity.
Tax Law Changes
The Trump and Paul Ryan plan have the top marginal tax bracket going from 35% to 15% and 20% respectively. Conservative bank economists are using 25% for their forecasts. This is a high probability event and if it does it will most likely include provisions that will exclude corporate interest expense from being deducted and may allow for 100% of capital expenditures to be expensed in the year spent. Banks are watching for signs to see if the interest expense exclusion will be retroactive or if it will be on new debt going forward presumably at least after January of 2018.
What This Means For Banks: The increase in the net present value of cash flow at firms and projects will increase the entities value and cash flow coverage thereby reducing credit risk and tightening credit spreads. Excluding interest expense will also decrease demand for credit further tightening credit spreads. Higher earnings mean more capital available for infrastructure investment and more dividends, both of which will support inflation and higher rates.
How Banks Should Play It: First, banks should identify all commercial customers with loans that could be interest expense sensitive as should existing loans not be grandfathered, then companies may have the incentive to repay these loans and finance with equity. We doubt this will have a large impact on banks, but it could so it will pay to have the conversation now instead of being surprised.
Banks want to crank up production now as credit risk will be at the lowest early in this new cycle. Credit spreads will continue to tighten; we predict by another 40 basis points, as demand for loans decreases causing dislocations late in the cycle between pricing and credit risk ala 2006. In addition, inflation-fueled rates will also credit more demand for longer-term fixed rate loans. Tax changes will create a massive void for information and interpretation so every bank should train its staff on how to take thought leadership positions for businesses and households as many will be looking for answers, and we don’t want large banks and non-banks to fill that void.
This trend is the most critical and hardest to quantify but will serve to reduce friction for many businesses particularly those in key industries such as energy, pharmaceuticals, real estate and financial services. Reducing the regulatory burden will open new revenue opportunities and further reduce expenses at companies. The net result should be greater profit, higher asset prices and a greater chance for inflation. We don’t see this as a 2017 item and look for the real impact to take place in 2019.
What This Means For Banks: More of the same themes as above, but this benefit, should it occur, will accrue mainly to a small subset of industries.
How Banks Should Play It: It is unclear, but early identification of those customers and those industries that will be impacted by less regulation will be key so banks can assist with capital expenditure financing and treasury management. Unlike all the other trends, deregulation gets technical quick, so it will be harder for banks to take a thought leadership position in their marketing. However, as we get closer, preparing key marketing campaigns around certain aspects of deregulation will prove very fruitful for some banks. For instance, identifying key land use projects that could become available with less environmental concern and positioning financing accordingly could be a positive, proactive move for banks to market to certain real estate developers.
Like deregulation, municipal spending at the Federal level will not likely be tangible for banks until mid-2018. Most infrastructure spending is at the State and local level which will take even longer if this trend does, in fact, trickle down. However, unlike deregulation, greater infrastructure spend (and the companion higher deficits issue) has greater bipartisan support that most all the other initiatives. As such, this trend has a high degree of variability and banks should plan accordingly.
What This Means For Banks: This trend will have little impact for your average community bank other than putting more wages in customer’s pockets.
How Banks Should Play It: Most of this benefit will be to banks that finance or provide credit support for municipal debt. Banks that are active in tax-exempt financing should get ready for more requests for proposals and more negotiated transactions. Banks that finance the trades that can handle larger projects will be the biggest bank beneficiaries, so it will pay for banks to increase staff and increase marketing to those companies that handle road construction, transportation projects, and general infrastructure.
Putting This Into Action
There is a common set of themes to each of these four macro trends - tighter spreads, lower credit risk, and higher interest rates. Banks should prepare for all three themes and get aggressive on loan production early in the cycle. Our progress since the downturn has been slow, but steady and should the above changes occur, economic growth will be turbocharged. The downside is that turbocharged growth is harder to control and we will likely overshoot even more so than in past cycles. Banks would do well to come out fast build assets and liabilities and then sharply curtail credit as asset prices move up from already lofty levels.
Getting out early affords banks to book loans before credit spreads hit their lows while also affording a couple of years of appreciation of the financed business or real estate.
Bank risk managers would do well to also closely monitor housing and retail spending, two major leading indicators of the general economy. When these bellwether indicators turn consistently down, that should signal the peak. While too early to tell, this feels like the start of a four to six-year cycle that banks can profit from if they are proactive in their positioning.
Submitted by Chris Nichols on December 19, 2016