When businesses began budgeting for 2017 a year ago,
few foresaw the dramatic economic effect of Donald Trump’s election to the White House.
Now that companies are seeing what the administration is doing, what are they planning? Will the economic expansion that began in 2009 and accelerated last year grow at a faster pace or slow?
Orange County bankers are often on the inside of business decisions, knowing which firms are growing revenue or retrenching. They make it their business to familiarize themselves with the hottest industries and therefore know where to extend or withhold credit.
The Business Journal’s Peter J. Brennan asked eight of Orange County’s top bankers for their views on the local and national economy next year; whether there’s a local real estate bubble; the hottest industries to lend into; industries struggling to get credit; and their favorite metrics. Edited excerpts of their responses follow:
Doug Bowers
CEO
Banc of California
Based on what we are seeing and hearing from clients and prospects, it appears the OC economy remains quite vibrant. Firms continue to hire, and capital investment is continuing, albeit a bit more selectively.
We see continued market demand across all of our real estate verticals, including multifamily, commercial and investor real estate, and jumbo residential lending. Financial services, broadly speaking, continue to experience strong demand.
The real question is the absolute level and direction of interest rates and the impact higher rates might have on continuing loan demand. Given slightly higher interest rates overall, the impact on real estate businesses is yet to be fully seen related to refinancing opportunities for existing projects.
On the residential side, demand remains strong for existing homes, with income levels largely there to support the affordability side, broadly speaking. On the multifamily side, owners continue to see support for increased rents, which helps to support valuations.
As any banker would, we look across a variety of economic metrics, some of which include employment levels, GDP, personal income growth, and of course internally, we monitor delinquencies and current payment status across all of our borrowers. We don’t see much out there today in OC that overly concerns us as far as the economic environment goes.
We still are in a rate environment that is near historic lows. Although we’ve seen a nominal increase to rates on the short end, largely the long end of the rate curve has over the last six months not moved outside of the range we anticipated. Rates generally only have one way to go, and that’s higher; it’s just a matter of time and magnitude.
For many borrowers, there is certainly availability of credit. We see it every day, with many competitors in the market, and banks with a balance sheet to lend out. The competition remains intense; however we have not forgotten the recent cycle. Where we may compete on rate for the best clients, you will not see us bend credit structure. Our hallmark to serving clients is much more centered on our responsiveness to efficient decision times and certainty of closing.
What you see at Banc of California is a refocused effort really centered on how to best serve the needs of business owners and entrepreneurs. We have the benefit of a $10 billion balance sheet and over $1 billion of equity, all of which puts us in a position to be able to serve nearly all businesses, regardless of size. Add to that the products and teams we have added over the past year, and there’s rarely a transaction or opportunity to which we can’t compete on and often win. Finally, I’d add that having the majority of our people based in Orange County gives us a step up on our focused efforts here.
Edward Carpenter
Chairman, CEO
Carpenter Community BancFunds,
Carpenter & Co.
We see Orange County continuing as a vibrant economy in 2018. Complementing our traditional local strengths in all sectors of real estate, financial services, hospitality and manufacturing is our emergence as a center of technology and innovation. From 2015 through October of this year, about $2.69 billion was raised in 177 deals in OC at an average size of $16.9 million and a median of $7 million. Investments ranged from fintech, hi-tech, gaming, healthcare and biopharma, to name just a few.
The county unemployment is well below national and state averages. The base of businesses is strong and well-diversified. In our banks, the hottest industries to lend into are technology, small entrepreneurial businesses and owner-occupied commercial real estate. There seems to be a cooling in retail-based business activities. The bubble appears to be big-box retail commercial real estate.
All components of demand indicate that real estate is currently fairly valued. However, the appreciation rates of real property are anticipated to increase very slowly over the next few years.
We use unemployment, county gross domestic product by Standard Industrial Codes, population and housing growth, and total banking asset and liability growth.
We are telling our customers that a few rate rises by the Federal Reserve will likely occur over the next two years.
There is no dramatic difference in the availability of business credit over the last three years. Regulatory compliance staff has been increased in the majority of OC-based banks. Of the 18 banks based in OC, total loan growth has been 21.3% since year-end 2015 to a present level of $24 billion.
Our bank balance sheets cumulatively reflect growth in total loans and noninterest-bearing deposits. Staffing is up slightly, and our technology available to business customers continues to improve. Portfolio makeup remains nearly the same.
Of note is the organization of a few startup banks in the county. These are the first since 2008.
Alan Epperson
Senior Vice President, Regional Manager
Wells Fargo Business Banking Group,
Orange County
The economy is primed for continued growth. Businesses in OC overall are doing well. Every week, I visit with several businesses, the overwhelming majority of them stable or growing.
Increased competition for loans is making it easier for businesses to find great deals, and this, coupled with continued low interest rates, is making expansion very favorable for businesses.
Even if the Federal Reserve were to show us four rate adjustments over the next 15 months, that would be somewhere around a prime rate of 5.25%, still relatively low compared to historical rates. Business optimism is keeping pace with what is happening in the market, and we are seeing lending increases across most sectors.
The hot local segments continue to be medical device manufacturers, technology, software, and the professional service companies that support these businesses.
OC will continue to grapple with high commercial real estate prices driven by low vacancy rates, inventory, and a lack of new construction. These factors will continue to push some growth to the Inland Empire and other outer areas. However, even with more scrutiny on residential lending, we are seeing that many can afford OC.
In recent years, businesses were holding back on purchasing new equipment and expanding, but this year the hesitation ended for many. Our customers are growing and buying equipment at an elevated rate. Looking to 2018, I think that as long as unemployment remains low and interest rates remain reasonable, OC businesses will continue to overcome obstacles and grow. There is positive momentum.
Mike Feldman
Head of Wealth Markets
Union Bank
The overall U.S. economy is on solid footing with low unemployment and steady growth at 2%, which we consider healthy at this stage of the economic cycle. There are positive signs of a globally sequenced recovery under way. If we translate those trends into the OC economy, we would expect it to continue growing steady but at a slower rate versus 2017. Unemployment trends indicate a slight increase in the prior quarter. However, personal income is forecasted to increase at current employment levels. We expect housing affordability to remain stable and supported by strong wage growth and continued low interest rates.
In OC, we have seen a rise in technology, medical device, pharmaceutical/nutraceutical, healthcare services and general services companies incorporating in this region. This is in addition to the basic manufacturing and distribution companies the region has seen throughout the last couple of years.
In the most desirable areas of the state, such as San Francisco, Los Angeles and OC, we have witnessed continued high levels of economic strength, especially in real estate. In terms of the housing market, we continue to monitor affordability levels, personal debt-to-income levels, and foreign investment trends. For example, we want to ensure that personal debt-to-income levels do not become too stretched relative to asset values.
For commercial properties, we expect growth to slow slightly next year because there is growing evidence that we will probably top the commercial real estate cycle this year due to general market softening. We are seeing declining net operating income growth, declining CRE sales activity across all sectors, and lower foreign investment.
On the housing front, prices have increased at an annualized rate of 5% to 8% in the past 12 months, with low inventory and turnover expected to support continued home price appreciation, albeit at a lower level, and with particular focus on lower priced homes. In addition, prices for condominiums have outpaced the home price appreciation of single-family residential housing.
The general economy is strong, and there is no indication of a sudden reversal, which will translate into a stable real estate market in OC, albeit with decreased growth when compared to 2017.
We monitor a range of economic data to get a sense of the health of the local economy, including: economic and job growth; household formation; unemployment rates; median household income adjusted for inflation; housing affordability segmented by historical home price appreciation; percentage of income spent on housing; and year-over-year comparison of home price trends.
Early this year, Union Bank surveyed small-business owners in OC, and 55% of respondents indicated they felt the local economy was headed in the right direction.
Our expectations are that rates will continue to rise in a deliberate, transparent and measured manner as telegraphed by the Federal Reserve. Our forecast is for one additional rate hike this year. We expect two to three additional increases next year.
The OC business environment continues to be robust and dynamic. Lending activity has not slowed down from the levels we saw a year or two ago. Good companies can access the lending market at competitive rates as access to credit remains strong.
Bob Iritani
EVP, OC Regional Executive
City National Bank
We see the OC economy stabilizing with modest growth. The majority of our economic growth and lower unemployment has been tied to construction over the past several years. I don’t feel we’ll see strong additional growth next year.
We’ve seen a tremendous increase in commercial real estate lending in 2017. This is driven by purchase money transactions, as well as maturing refinances. While prices have increased significantly since 2009, the low rate environment coupled with increasing rental rates in the county, has made it still affordable to most commercial business owners to now purchase their own buildings. The increase in rental rates has made purchasing a strong alternative, as monthly payments are equitable to rental rates.
To determine if real estate is over-valued, the three things to look at are interest rates, median days on market, and the supply on hand for residential real estate. The lower interest rates still make the home prices affordable. I believe we haven’t seen an uptick in the other two and do not believe we’ve seen an increase in new home construction permits, which would add to supply. So those would lead to the county not being seen as overvalued, and price would need to adjust to move the supply. I do believe the first-time home buyer here does have a challenge, which has led to all the rental construction.
Much of the success people and companies have had in OC has been tied to real estate. Professional services industries, such as legal, CPAs, and medical, also continue to be strong, as are manufacturing and wholesale/distribution.
All of the standard metrics, such as unemployment, tax revenue, consumer spending, provide a lot of color to the health of the economy, and all seem to be positive. OC is fairly insulated and actually came through the Great Recession unscathed. It doesn’t appear there are any signs on the horizon that would indicate the local economy will experience major problems.
There has been a slight tightening in real estate credit over the last six-plus months due to the perceived risk of some type of recessionary pressure, given the length of this cycle. The construction lending industry continues to have a regulatory governor on construction loans under Dodd-Frank.
It’s anticipated that the Fed will increase short-term rates one more time at a quarter point before the end of the year, but I’m less bullish about another increase. Conversely, we have not seen a material rise in long-term rates; therefore securing long-term financing, such as in purchasing or refinancing commercial real estate, is still an attractive proposition from a historical perspective.
Scott Kavanaugh
CEO
First Foundation Inc.
Overall, I see the economy in Orange County for 2018 in a place of strength. We are in a fairly tight labor market here, but I don’t really see anything at this point that is impeding continued growth for Orange County or Southern California.
Currently, one of the most competitive industries in Orange County is still commercial and industrial lending. For First Foundation, we want to continue to support small-business lending, and that’s been a constant focus for us.
I don’t see a bubble necessarily, but housing prices in certain areas of Orange County are starting to approach the high-water mark from a decade ago. There are pockets of Orange County that could arguably be said to still be undervalued.
We continue to gauge the health of the economy with metrics, including GDP, employment, manufacturing and inflation.
We are telling our clients to expect flat-to-rising interest rates.
There is always continued regulatory scrutiny over lending practices to make sure that banks aren’t getting ‘overheated.’ It is our belief that banks, for the most part, are sticking to the credit metrics. There are a few abnormalities in the industry, but most tend to have very low delinquency and default rates. I think credit standards are holding pretty well. There is probably more credit available today than even three years ago, because banks are more profitable, with more capital to lend.
We continue to invest in technological advances to serve our clients best, as well as continuing to support staffing in operations and compliance. We have more capital than we did a year ago, and a larger balance sheet. We are actively seeking to expand Orange County lending levels, and our portfolio makeup is comprised of single-family loans, as well as multifamily apartment lending, with a continued emphasis on expanding business lending.
Ash Patel
CEO, President
Commercial Bank of California
We will continue to see a strong OC economy in the manufacturing, services and housing industries. If you compare unemployment statistics to our local economic data, even during the economic crisis, OC has continued to perform higher than the state and the U.S. overall.
The hot industries for lending continue to be healthcare, technology and manufacturing. It is more difficult to receive capital in the areas of construction, housing and small startups in OC.
The OC housing market is in a bubble. Not necessarily for starter homes, but certainly for speculative real estate like we see in very high-end communities like Newport Coast and Crystal Cove.
Real estate in OC is overvalued because the average is significantly higher than the rest of the nation. Per capita income is much higher in our county, and as a result there are the affordability rating spikes that lead to everything being higher, the cost of land, labor, etc.
I have not seen any metrics that lead me to conclude the health of the OC economy is faltering. If you look at the Cal State University-Fullerton economic forecast and other reputable economic outlook surveys, unemployment is at an all-time low, and output from leading OC industries is increasing across the board.
Developers are building homes in OC at a rapid pace due to great demand. If the demand were to shift, that could lead to a decline. I do not anticipate that will happen anytime soon.
We are educating our clients about approaching higher interest rates based on a few factors: GDP output was over 3% in the second quarter; GDP of 3% is high and indicates threats of inflation; and interest rates will go up to curb inflation.
Capital is more available for businesses looking to borrow because their financial performance is better. There is an overall credit worthiness now that we did not see three years ago, so banks have become more aggressive in lending.
There are potential regulations on the horizon that would curb commercial real estate lending.
CBC recently took on a large equity stake in a financial technology company. We believe fintech is here to stay, and we are investing heavily in new technology and human capital to build the bank that doesn’t exist today.
DeAnne Steele
Managing Director,
U.S. Trust
Bank of America Private
Wealth Management
The synchronized global upturn that started last year continues, and OC is well-positioned to benefit. OC has been growing faster than the state and country, with an unemployment rate below the state and national average. It has also seen robust property growth.
As our CIO office indicates, those metrics serve as evidence that from an employer and workforce perspective, we are well-positioned. And their continued improvement creates an environment of continued business and consumer confidence that can help sustain economic growth.
Although we are in one of the longest economic cycles in our country’s history, cycles do not die of old age. Recessions occur when unemployment is rising, earnings are declining and inflation is increasing at a rate that requires greater Federal Reserve action. A yield curve inversion is a warning sign to which we pay particular attention. Those indicators all signal continued economic expansion, although we are in the later stages of the cycle, according to our CIO office. One interesting fact is that we have never had a recession when earnings growth was positive, as it is now.
Regarding the Federal Reserve raising rates, 11 of the last 14 interest rate tightening cycles were followed by a recession, so that is certainly something to watch. It is also important to watch the effect of the Fed’s quantitative easing roll-off policy taking effect this month. They will allow a combined $10 billion a month of Treasury and mortgage-backed securities to mature without replacement. This will increase over time. In combination, those moves should increase short- and long-term rates. According to our CIO office, our range of expectations for the Fed Funds rate by the end of 2018 is 1.87% to 2.37% from today’s 1.25%, and our expectation for the 10-year Treasury is 2.87% to 3.37%, so a continued, positively sloped yield curve. The rise in the yield curve will depend on wage growth and inflation, the strength of the dollar—which could also serve to reduce growth—and the demand from foreign investors for our bonds.
Our two favorite sectors are technology and healthcare. Given the life science and information technology employers in the county, we are well-positioned. In addition, we benefit from the growing middle-class, emerging market consumer who is drawn to our beautiful weather, beaches and attractions, such as theme parks and shopping destinations.
