Local business leaders are beginning to express concerns—note the quarterly measures of optimism by Orange County think tanks, for instance—on the strength of the local economy. Bankers can be canaries in the OC coal mine, able to sense a good outlook by,
for instance, a rise in loan requests, or a faltering financial future via spikes in delinquent loan payments. Executive
Editor Peter J. Brennan asked OC’s leading bankers for their 2019 outlook. Edited responses are below.
JoAnn M. Anderson
Managing Director
U.S. Trust, Bank of America Private Wealth Management for Pacific Southwest
Newport Beach
A trend that affects our work is an exciting dynamic benefitting business owners, from an historic combination of federal tax cuts, the repatriation of capital, deregulation and a strong economy. For example, CEOs of family and privately owned businesses have been receiving unprecedented levels of unsolicited offers to buy their business. There’s a lot of interest from buyers and sellers.
While strategic buyers now have lower tax rates and are motivated to invest by acquiring companies, the seller’s tax rate has also decreased, so there is more incentive to sell one. But other tax laws also make it more attractive to hold onto a business for its cash flow, since LLC and S-corps are also benefiting from a 20% deduction.
Adding to this dynamic are shifting demographics: more than half of business owners in a recent survey want to sell but nearly seven in 10 have no formal plans in place to do so.
Planning will involve these new tax impacts and company valuation—minimizing the former while maximizing the latter—to best respond to those acquisition offers.
Richard Cabrera
Executive Vice President
Umpqua Bank
Newport Beach
We see plenty of opportunities to serve businesses in a still solid local economy.
The economic outlook remains strong but there’s a wait-and-see mentality in the market. Volatility, tax policy, tariffs and the 2018 spike in the 10-year Treasury note have contributed to a sense of economic uncertainty and caution. Higher interest rates and expectations that home values could decline cool the housing market.
Tax changes have also created an overlay locally. The $10,000 cap on SALT—state and local taxes—at the federal level produce a psychological impact on consumers. People with a lot of money are less likely to spend it on bigger household items and discretionary goods and services.
Other OC developments we’re watching are unemployment at historic lows and our evolution to a service economy.
The first is great news in many respects but it’s produced wage inflation, especially at lower pay levels. That poses a dilemma for manufacturing companies. Owners must decide whether to offer higher pay to harder-to-find workers or accelerate investments in automation—an increasingly viable alternative for long-term productivity.
The second issue involves storage and heavy manufacturing moving out as technology and “clean” manufacturing, often with smaller footprints, move in. This affects commercial real estate: industrial parks replaced by offices and more multifamily housing in work centers such as Anaheim, Orange, and around John Wayne Airport. So there’s a big redevelopment story taking place locally as well.
Michael Hahn
Regional President, Commercial Lending
HomeStreet Bank
Irvine
For executives seeking business loans in 2019, there are new considerations. You can largely thank the economy for these. The Southern California Leading Economic Indicator jumped by 3.5% in the third quarter of 2018, compared to 2.7% in the prior quarter. Job gains have also been steady.
Banks, though, have been more cautious and regulatory oversight has increased since the last recession. Executives should note this deeper analysis of new loan requests as they assess their companies’ credit needs; this isn’t bad—it reduces fraud potential and helps mitigate risk—but execs should anticipate more questions and less flexibility from banks on, for instance, credit policy exceptions.
Banks will maintain strong loan underwriting standards and want to know and understand your business to ensure the integration of financing need and regulatory compliance. They may require additional documentation.
Businesses may also see an increase in deposit and earnings credit rates. Most community banks need deposits as a way to maintain or improve loan margins and to meet regulatory loan-to-deposit ratios.
Expect increased competition among banks in real estate, where many lenders are active. Shop for rates and terms on asset-based credit facilities. Ask for a two-year term on your revolving credit instead of just one, for instance.
The area has a bright past and a robust future. With the right economic “intel” and a little flexibility the right option is out there.
Bob Iritani
Regional Executive, Orange County
City National
Irvine
A major issue for Orange County banks right now is people. This is certainly the case at City National. Our local business continues to grow and we’re working to identify and recruit talented people who can thrive and grow in 21st century banking—but banks are running into the same labor force headwinds confronting other employers.
OC unemployment at year-end 2018 was 2.8%, compared to 4.1% for California and 3.7% in the U.S. Underlying this is the housing crunch: as with other coastal California markets, the supply is too low and the prices are too high.
This makes recruiting and retention harder in the region—especially in the emerging workforce of young people growing up in Orange County who don’t see a future for themselves here.
Last fall, the California Association of Realtors warned of an increase in homebuyers leaving the state and said the outmigration will continue “as long as home prices are out of reach.”
Another factor, especially as it relates to banking: a dearth of candidates with solid backgrounds in math, science or technology. The industry continues to automate mundane jobs; these roles will become increasingly scarce; in fact, they’ll go away.
What isn’t going away are positions requiring a high order of analytic skills. Banking is all about numbers. Even at the entry level, candidates need to demonstrate strength in this, along with technology prowess.
Scott Kavanaugh
Chief Executive
First Foundation
Irvine
A year ago, the economy began dealing with rising interest rates for the first time in 10 years but more recently our Fed Chair has been more dovish, hinting “patience” is a virtue. An expectation of four rate hikes in 2019 becoming zero—in the space of 60 days—has a big impact.
There’s continued economic strength locally, including strong employment, and OC banking will be strong as well. Banks must be more competitive in key areas, such as how people save and invest. Consumers win and banks that can’t keep up will lose clients.
In lending, for example, borrowers with homes worth more than $1 million with a loan above $750,000 are leaning toward 5-, 7-, and 10-year fixed rates versus traditional 30-year loans. A second area: high demand for housing and lack of affordable supply means multifamily lending should continue to perform well.
A third ongoing trend is accelerated M&A. We, and several peers, last year successfully merged with and acquired other institutions. Established banks in this market continue to grow in size.
There’s been talk of a recession but frankly the data doesn’t yet support it. People are quick to say “12 to 24 months” and we think this is a knee-jerk reaction by those who missed that call in ’08. More must happen before a recession can take hold and only a few of those dominoes have fallen thus far.
Also, while a recession affects everyone, Orange County is highly diversified. We have tech, pharma, banking, and other industries; this will help us weather recessionary trends.
Finally, there’s tax reform. It created a bit of a reprieve, but California is still a high-tax state and at the federal level you can no longer deduct [all?] state or county taxes.
Tax reform also has unintended consequence for underwriting: we now have to assume what will occur regarding taxes in the next several years, but it won’t be until we actually see the returns to know how comfortable we are at evaluating those numbers correctly. It will take a few years to play out.
Orange County has matured as a financial center over the past decade and it’s still a desirable place to live and work so the population continues to grow. We feel very fortunate to be at the epicenter of it all.
Brian Mulvaney
Managing Director, Commercial Banking
Union Bank
Irvine
Local economic growth is in part being driven by the county’s strong and diverse middle-market economic base that serves virtually every industry sector from tourism and aerospace to healthcare and financial services, among others.
Growth results in steady demand for traditional financing for equipment, real estate, expansion and working capital, as well as recapitalizations and acquisitions.
Middle-market and large companies with active acquisition strategies increase M&A activity in Orange County. A third of our recent non-real estate loan commitments here have been acquisition-related. The increased activity has touched us directly as well: In January, Union Bank bought a middle-market investment banking firm in L.A., with experience in positioning companies to maximize value in capital transactions. The buy links M&A, capital markets advisory services and commercial banking.
Ash Patel
Chief Executive
Mike Helmuth
OC Market President
Commercial Bank of California
Irvine
Some say we’re experiencing the best economy in more than 30 years, including low unemployment and slowed but ongoing, job creation. California State University-Fullerton and Chapman University forecasts predict continued expansion, albeit at a slightly slower pace.
All sounds positive.
But local banking has what appears to be a 2020 storm on the horizon. Short-term interest rates are rising, the yield curve is flattening and many OC banks reported slowed year-over-year growth at the close of 2018.
We’re at a fork in the road.
Down one path, the next 18 months is a time of caution: banks will not reach for extra risk just to close another deal. We temper confidence with prudence.
Down the other, we remind ourselves we’re entrepreneurs and continue to develop new revenue streams with products to support our clients’ holistic business needs.
Orange County has blossomed into a technology powerhouse and it’s time we used that to help businesses reach their full potential. A key growth area for many OC banks is developing and deploying fintech products.
So far, this has typically taken the form of banks buying or partnering with payment processers—creating a void.
As organizations consolidate, innovation is temporarily stifled, even as demands by business owners for streamlined financial capabilities continue to rise. Banks that have completed their acquisitions or finalized partnerships have a great opportunity. Banks must maintain financial strength as they launch new fintech products and platforms.
The state EDD shows 98,000 OC businesses with less than 20 employees; many don’t have access to capital. Banks can offer solutions to lower the cost of managing financial operations while removing barriers to entry for lending via automated technology.
Tom Vertin
Chief Executive
Pacific Mercantile Bank
Costa Mesa
Banks of any size with an agile, effective digital transformation strategy will remain relevant and enjoy the opportunity to grow and prosper. Laggards will be disrupted, diminished and relegated to commodity status.
Big banks are getting bigger: In 1993, the 20 biggest banks held 30% of all deposits; by the end of last year, 60%.
There are two related reasons for this: Big banks made the biggest investment in technology to support digital transactions and new customers, looking for low-cost and ease of use, found these digitally enabled platforms appealing.
At U.S. Bancorp, nearly 75% of mortgage applications are completed and tracked by clients on its mobile app. At a recent lunch with colleagues, one reimbursed me with cash, and others used a person-to-person payment service like Venmo.
The future is digital.
Banks that lack a strategy will see client attrition and reduced pricing power and trends like these raise questions about the future of banking, especially the role and relevancy of community banks. Can they compete against the billion-dollar tech budgets of megabanks?
The four largest banks have technology budgets, expense and investment, in aggregate exceeding $30 billion and about 16% to 20% of expenses. A survey of 314 small and mid-sized community banks showed their tech spending was 8.5% of expenses.
Community banks digitize through collaboration. They’re joining together in various ways to combine resources and their knowledge of fintech to improve client experience, ease of use, increase efficiency, cut costs, drive growth and revenue via technology, and grow deposits and cross-selling.
Digital consumer banking is now also driving commercial banking expectations. Seventy-three percent of businesses, for instance, want banks to offer integrated payments, which automate incoming and outgoing payments in current accounting software. Big banks and forward-looking community banks offer this—often powered by fintech firms.
Community banks were late to realize digital transformation was relevant, but can level the playing field with agile strategies, fintech partners and embracing clients’ wants and needs.
Innovative community banks need not become the taxicabs of the financial industry.
Joe Yurosek
California Market President
Pete Fitzpatrick
Orange County Regional Manager
Fifth Third Bank
Newport Beach
Banking evolves—keeping what works and adopting what’s next.
We see technology propelling change, along with the tried-and-true indicators of job growth and global commerce, in five areas:
• The biggest banks investing big dollars in tech: Spending more than other industries and likely at a faster rate. This includes fintech and infrastructure: core computing, the cloud, artificial intelligence and blockchain.
• M&A to acquire technology: In addition to buying other financial institutions, banks will bring tech in-house to fill gaps in operations and marketing.
• Personalized banks: By integrating new technologies in areas like data mining and cybersecurity, banks can create unique experiences for each customer, including better targeting and identifying their needs to reduce cycle times in loans and account openings; scale and service here will enhance customer satisfaction and profitability.
• Tighter job market: California and OC expect stronger employment growth than the U.S. and L.A., respectively. A tighter market in, for instance, manufacturing and transportation, means more technology and automation.
• Local economy goes global: As tariffs and trade wars breed uncertainty, we expect the U.S. economy to grow more slowly than last year, but still above trend.
Add-in capital market trends, market liquidity and an ever-changing investment landscape more and more connected to local and global economies. Banks with a keen understanding of those local, national and global implications will be best positioned to understand customer needs, and provide relevant solutions and advice.
