What a difference a couple of months makes.
Since President Donald Trump signed the tax reform bill,
business-sector optimism has shot up.
The Business Journal’s Peter J. Brennan asked some of Orange County’s
top bankers about their plans for this year.
What will they do with the savings from the lowered tax rate?
Will they issue more loans? Banc of California, Opus Bank and Pacific Premier
Bancorp have all said they plan to boost lending this year.
What are the OC economy’s hot sectors?
Has local real estate appreciated too much?
Are banks seeing fewer regulations like other sectors are?
How many interest rate hikes do they predict by the Federal Reserve?
What do they think about concerns of a flattening yield
curve and potential for a slowdown?
Here are edited excerpts of their answers:
Carson Lappetito
President
Sunwest Bank
The Tax Cuts and Jobs Act will have positive and negative impacts on the California banking industry over the coming years.
The initial impact will be very positive, as banking is one of the most highly taxed industries in the country, because, unlike many large corporations with offshore entities that shelter income, banking operations are domestic and receive the full tax burden. As a result, most institutions are receiving a significant corporate tax reduction and corresponding increase in net income. This is why the equity values of small and midsize banks increased nearly 8% over the past three months and rose nearly 15% before this month’s sell-off.
Another benefit for banks is that their growth is heavily tied to their economy. The tax change, which removes incentives to offshore the production of goods, will increase domestic spending and growth.
Additionally, small and midsize businesses are receiving significant benefit from the corporate tax reduction, and these companies are choosing to use this tax savings in different ways. Some organizations are choosing to pass the entire savings to investors, which is leading to higher earnings, corporate valuations and equity values. Others are choosing to use the tax savings to invest in their businesses by purchasing additional equipment, facilities or launching expansions. Lastly, businesses are deciding to invest savings in employees through increased compensation, benefits and professional development.
At Sunwest, we decided to reinvest a portion of the tax savings in our people. In banking, the biggest asset is talent, and we are focused on acquiring, retaining and grooming the best talent. To support that effort, we doubled our 401(k) contribution to a 75% match up to 8%. We provided across-the-board wage increases up to 5% based on tenure to reward employees over the long term, and we provided a $500 one-time bonus to all employees to put additional cash into their Sunwest accounts. We truly believe that great talent builds great organizations, and it’s important to reward employees when we all succeed.
With all tax reform, there are winners and losers. The negative from this tax reform is the impact on high-tax and high property-value states like California through the elimination of the state, local and property tax deduction, as well as limiting the mortgage interest deduction. As a result, we are seeing more and more clients discussing the relocation of their businesses from California to lower tax states, such as Utah, Arizona, Nevada and Idaho.
At Sunwest, we have already expanded into Utah, Idaho and Arizona to establish a presence in the growing states, both through building local relationships and providing continuity for California clients that are expanding or relocating to those states.
All in all, tax reform is overwhelmingly positive for corporations, their employees and equity values. However, California will experience drawbacks due to its high state and local taxes.
Rick Nogueira
Managing Director, Region Manager
JPMorgan Chase Middle Market Banking in Orange County
We’re seeing increased optimism about the global, national and local economy, given tax reforms and the relaxed regulatory environment.
According to our recently released Business Leaders Outlook report, which surveyed nearly 1,700 middle market C-suite executives, optimism about the local economy has increased this year from 68% to 75%. Even more drastic was that the outlook for the global economy doubled from the year prior, reaching 69%.
The majority of midsize companies shared that they expect to see some benefit from tax reform and that they plan to use their tax savings to pay down debt, make capital expenditures and increase wages. At our own firm, more than 270 of our 1,700 Orange County employees saw wages increase this week to $16.50 to $18 an hour in response to some of the changes.
Hiring is also on the rise. Most companies say they plan to hire full-time employees this year—64% compared to 57% in last year’s survey. The primary driver is anticipated sales growth. As JPMorgan Chase’s presence grows in Orange County, we are hiring, as well, across our business.
One of the top business challenges midsize companies are seeing is a limited supply of talent. As the economy improves, more people are changing jobs. There’s also a shift of people leaving the workforce as baby boomers reach retirement age.
Two-thirds of midsize companies we surveyed have made changes to their work environment or culture to attract and retain a younger workforce. Solutions include providing more flexible hours, improving benefits, allowing employees to work from home, and increasing paid time off and compensation.
Orange County is well-positioned for growth this year.
DeAnne Steele
Managing Director, Head of National
Portfolio Management
US Trust, Bank of America Private
Wealth Management
With the United States and global growth accelerating, many industries should benefit. Continued strong consumer and business confidence, along with benefits of the tax law changes, should help companies increase capital spending to expand and to increase productivity, and we look forward to supporting their growth.
We are specifically focused on lending to Orange County’s professional services industries, including medical practices, aerospace and defense, manufacturing, building products companies and wholesale distribution companies in particular.
We expect the Fed to raise rates three times as strong employment leads to higher wages, and inflation normalizes. The U.S. 10-year yield should rise moderately, ending 2018 in a range of 2 ⅞% to 3 ⅛%.
The longer portion of the yield curve hasn’t risen as quickly as the front-end and the belly. While we anticipated this, the flattening in two- to 10-year and five- to 10-year portions of the curve has caused some consternation in the market.
We believe these concerns are unwarranted; the curve is at a normal level for the latter third of an economic cycle. Moreover, the curve is not a static result of monetary policy, but rather a dynamic factor in setting that policy.
If the curve inverted, the Fed could, if it desired, adjust policy by slowing the pace of rate hikes or decreasing the pace of balance sheet roll-off. Therefore, while the curve remains a key metric to watch, it’s not yet ringing any alarm bells.
Henry Walker
President
Farmers & Merchants Bank
The new tax law doesn’t change enormously how we go about our day-to-day work. However, it does allow us to continue to grow our company, build our capital and treat our employees correctly. Some of our employees have been here more than 30 years, and the tenure of our employee base is among the highest in the industry. This allows us to build strong customer relationships, some of which have endured for decades through multiple generations. We are enormously proud of that.
The new law also helps our banking margin. Net interest margins have been on a continuous slide for 10 years.
We’re sitting at 3.43% today. We look forward to getting it normalized, such as the days when it was 7% to 8%.
My great-grandfather, CJ Walker, started F&M Bank in 1907, and in the days when I working with my father and grandfather, they would make between 2% to 3% ROA. Today, it’s down to 1.05%. We’ll see what we go back to in the new economy. There’s a lot of competition, but we’re always looking for an opportunity to increase lending to the best borrowers. We probably will make close to $1 billion in new loans this year. None of that is attributable to the new tax law.
The best areas we feel to issue new loans are to qualified borrowers who appreciate our corporate values of honesty, integrity, the home, the church, and service above self. We get long-term relations out of that. That is the hallmark of our 110-year-old bank.
Also, Farmers & Merchants does a lot of commercial real estate. I believe we have seen an enormous amount of appreciation in real estate. It’s driven by very low interest rates and by 1031 Exchange moneys chasing products. Both have pushed valuations high in commercial real estate. If you see a significant bump in interest rates, not only will you see the stock market adjust, you’ll also see the valuations of commercial real estate go down. If we do have a downturn, my chief concern is that this will affect construction, as it did in the last downturn.
Still, it’s a very interesting time. Although we haven’t seen a reduction in regulations, we do closely follow a multitude of data points, especially jobs, unemployment, and wage growth. I think we’ll see the Fed raise interest rates three times this year, but banks need to be careful about what they’re willing to pay in deposits. You have to know your borrowers, and you have to be cautious in how you extend credit in this environment, because you don’t know when things will change.
Tom Vertin
CEO
Pacific Mercantile Bank
The recently signed tax bill has no impact on our willingness or ability to serve our community. The bill also has no impact on our strategic plan or our targeted business client. We don’t make business decisions based on tax implications. Furthermore, the tax bill neither helps nor hinders our lending efforts. We are an OC-based bank continuing to invest in our community. Our mission is to help companies succeed.
In Orange County, we see an abundance of opportunity to bank the operating companies we seek to serve: e.g., light manufacturers, distributors/wholesalers, service companies and, given recent events, former business clients of Wells Fargo.
In regards to real estate, other than the owner-occupied real estate of our clients, investor real estate isn’t our emphasis. We are a full-service business bank helping operating companies succeed.
We have yet to experience a reduction in regulation. However, President Trump has stopped the government from making additional regulations. This is a good thing for U.S. banks, in that the Dodd Frank bill is still 50% unwritten.
Our bank is committed to meeting the credit needs of the community. The Community Re-investment Act was passed in 1977, and its regulations have yet to be updated. For example: The regulations haven’t changed the definition of small business. Small business is still defined as companies with annual sales of less than $1 million. The definition should be updated by increasing the limit from $1 million to $5 million to $10 million.
The economists who we listen to advance the opinion that there will be two interest rate increases this year. I don’t anticipate that precipitating a slowdown.
An economic slowdown in 2018 caused by multiple interest rate hikes is unlikely, as I don’t anticipate unhealthy inflation. Our labor participation rate is around 62%, meaning we still have considerable labor on the sidelines. Historical rates approximate 68% to 69%. We have a ways to go before high employment drives up the cost of labor, which would contribute to an unfavorable rate of inflation.
