Though the recession was officially declared over in June, of 2009, Nevada’s recovery continues to lag behind that of the rest of the nation. There were more national banks than state-chartered banks involved in the residential mortgage and commercial real estates loan problems, but state-chartered banks in Nevada felt the impact through trickle down.
“The pressure on banks is the same as we’ve had for the last three years,” said Bill Uffelman, president and CEO of Nevada Bankers’ Association. “In general, Nevada community banks did not do mortgages, that was the larger banks, but residential mortgage issues trickle down to the small businesses that community banks catered to.”
This remains a challenging time for banks. It’s hard to find qualified borrowers, since most businesses that would qualify aren’t looking for loans, they’re making money. Businesses looking to borrow money to survive generally aren’t the qualified customers banks want to loan to. And this trend continues.
“I’m told it’s getting a little better,” Uffelman said. “Time will tell. The real issue is it’s not getting any worse.”
Banking on Nevada
“I think most banks continue, to varying degrees, to deal with troubled real estate loans,” said Dallas Haun, president and CEO of Nevada State Bank. “Banks that are well capitalized are going to survive.”
Haun calls the last three years a resetting of values, expectations and expected returns. During the period of 2003 to 2007, before the housing bubble burst, expectations were high for both borrowers and banks. It’s been during the last three years as real estate values and rents dropped and inventory grew that expectations have been reset. “We have an over-abundance of inventory, a multi-year supply of office space, condominiums, retail and commercial space. For those of us dealing with the overhanging inventory issue, it’s going to take a number of years of all of us working together to work through this inventory,” said Haun.
That said, Nevada State Bank has seen loan defaults slow dramatically in the last few quarters and now investors are showing renewed interest in Nevada. “We’ve talked to investors from all over the world; from London, Israel and Hong Kong. They’re all interested in making investments in Nevada real estate, as well as investors from around the country. That’s probably the most reassuring message; that people in the United States and around the world believe Nevada is a good place to invest,” Haun explained.
In Southern Nevada, Bruce Hendricks, CEO, Bank of Nevada, is watching four key indicators that show a slight improvement in the market, signs that the banking industry and economy may be stabilizing. The first, visitor volume, has shown a steady though slight increase since its lowest point in November 2009 (though what $4 a gallon for gas will do that increase remains a question, Hendricks notes).
The second indicator is convention bookings, which continue to pick up from the low in August 2009 and are expected to be stronger in the second half of 2011.
The third and fourth indicators are gaming revenue, which isn’t significantly stronger but appears to have stabilized, and visitor traffic through McCarran International Airport, which has stabilized since its low in November 2008.
“Overall what’s important to us with those indicators is it bodes well that we’ve seen the worst of it and trends are starting to improve,” said Hendricks. “It will take a period of time for banking and our community to recover. I don’t see a V type recovery but an elongated, Nike swoosh type recovery.”
Larry Charlton, Nevada regional executive, City National Bank, refers to the swoosh as a U-shaped recovery rather than the more dramatic V most of us would like to see. While we’re still at the bottom of the U, Charlton says there’s starting to be some green shoots coming up. “Visitor volume is up on the strip and I’ve seen the latest figures on gaming revenue, I believe it’s up a little bit. Some positive things are happening locally and even more positive things are happening nationally, so that helps banking. Low interest rates don’t, because they compress our spread. We would rather see interest rates rise and that widens our spread out so we can become a little bit more profitable for ourselves and our owners. A lot of banks have lost a lot of money over the last couple years.”
In Nevada we’re lagging behind the rest of the country in terms of recovery. “While the rest of the U.S. continues with a somewhat jobless recovery, it’s significantly better than in Nevada simply because of our main industry base which is tourism. That’s the big economic driver we have here, so everything is tending to lag behind,” said George Burns, commissioner of the Nevada Financial Institutions Division. “If we were to look at indicators we track, we’re still seeing significant job losses and housing price declines. As far as home price indexes go, we’re down an average of 40 to 60 percent in Southern Nevada; statewide it’s about 30 to 40 percent. Those percentages are hugely greater than in the rest of the country. The only states close to us are Arizona, Georgia and Florida, the other bubble real estate economies.”
Foreclosures and Defaults
One of the factors that continues to plague banks in Nevada during the recovery is the devaluation of real estate. Banks continue to try and restructure loans for customers having difficulty paying. Stepping away from the question of real estate, going forward banks are focused on matching the right product or service to the true needs of the customer, according to Reed Radosevich, president of Northern Trust. It’s business as usual with a focus on healthy practices for banks and consumers.
Radosevich sees defaults slowing, but suspects part of that may be simply due to the slow, tedious nature of the foreclosure process. That said, “I hope that banks are exploring every option to keep borrowers on properties as long as they’re willing to make payments,” said Radosevich. “We’re starting to see bright spots in the local economy which are going to bode well for both the banks and the borrowers, and certainly the biggest hindrance is unemployment and the drop in real estate values. If we reach stabilization and find the bottom in real estate and see some job creation, that’s going to help everybody involved.”
Other reasons defaults may be slowing are that there just aren’t that many outstanding. In addition, any business that’s survived this long in this environment is probably going to survive, Uffelman indicated. “That’s a very broad statement, but they’ve probably accommodated changes, they’re conserving cash, they’ve reduced staff and they’re holding on.”
Community banks were heavily involved in Nevada’s real estate and construction during the boom. “That’s what community banks do, which makes them very beneficial for businesses and local communities but, by their very nature, they loaned into the types and structures of industries that got hit the hardest,” said Charlton. “So that’s why you see more of the smaller banks having the problems. Are we seeing more defaults? No. Overall in the industry they have slowed and we’re getting a handle on them.”
Along with the stability of banks, there’s the question of the residential market in Nevada. While banks don’t want to become landlords and definitely don’t want to hold foreclosed and defaulted properties on their balance sheets, bankers are also aware that releasing a bank’s inventory of residential properties onto the market in a rush would cause housing prices to plummet even further, devastating the slowly recovering economy.
“Everybody is finally or slowly or deliberately releasing ‘X’ percent at a time,” said Charlton. “If everybody dumped everything back on the market at the same time it would drive prices down on everybody’s homes even further and it’s an asset to the banks so they want to be careful with it.”
If banks were to release their inventory of foreclosed and defaulted properties at once and drive housing prices even farther down, investors, who are already starting to look, would come in and buy up the houses. “With real estate prices down so low, people with money who are sitting on the sidelines see it again as a good time to buy. Another good reason not to release everything is because it could cause another bubble, five to 10 years out,” said Charlton. “I think they’re being very judicious with it and careful with how they handle that inventory.”
Residential defaults and foreclosures have changed. “The crazy loans that everybody got in trouble with in 2007 and 2008, those are done and gone,” said Uffelman. “Now we’re dealing with people who, because of job loss or salary reduction, don’t have the money to pay the normal mortgage. We have individuals that, because value of property is so far below what they’re paying, are asking, ‘Why am I [paying] $2,000 a month for something I can rent for $1,000?’ They’re defaulting on those mortgages. Almost 25 percent of defaults are from that.”
Commercial Real Estate
and Bank Stability
Retail follows rooftops, or, commercial real estate follows residential, providing the centers for services residents need. Because of that, commercial real estate foreclosures and defaults have lagged behind residential as real estate values plummeted and the economy hit the downturn.
“I think there are still some very huge challenges for financial institutions in the state with the languishing economy here and the unemployment rates, which we’re seeing some marginal improvements on. The problem is we still have the highest mortgage foreclosure rate in the nation which doesn’t have a direct effect on banks, per se, because they’re not big residential real estate lenders, but it is having a big effect on our credit unions that hold residential real estate for their members,” said Burns.
The indirect impact for banks is that because commercial real estate equates with strip malls and office buildings, which are supported by residential, state-chartered community banks with a portfolio of commercial real estate are feeling the devaluation of that real estate. “Devaluation is causing a lot of challenges as far as delinquencies and charge offs for our state-chartered institutions,” said Burns.
Hendricks has seen commercial real estate foreclosures going on for a while. “That’s probably the last shoe to drop,” he said. “There were residential problems, land issues, retail and now we’re seeing commercial but, we might be through the worst of that, too. Certainly there could be some issues, but we see that maybe starting to turn later this year.”
Commercial foreclosures aren’t as bad as originally predicted, Charlton said, but he’s definitely seeing buildings, shopping centers and retail stores, due to a drop in revenue, impacting owners’ ability to hang on to the asset. Many loans that had three to five year maturities are maturing on buildings that suddenly aren’t worth what the original loan was for. Owners, faced with the need to make additional payments to bring loan collateral – the property – back into line can’t, often because so many tenants have left the property. So, the bank, following regulatory rules, is forced to put more capital into their reserves because of the non-performing loans, which hurts the bank’s capital and can lead to the bank failing.
There are lists of shuttered banks online that have failed during the downturn. While there’s the possibility of more bank closings in Nevada, one positive indicator, according to Radosevich, is that most banks have managed to raise new capital and most have written off the bulk of non-performing loans. “I think that certainly, while not every bank is out of the woods, the future is vastly improved from where it was 12 to 24 months ago.”
Are we going to see more shuttered banks in Nevada? “We’re working diligently to avoid it, but I think we are going to see some,” said Burns.
The Business of Banking
Banks, like all businesses, need to make money. They need to build business, earn capital and increase market share in order to continue making loans. Interest-bearing loans are one of the biggest sources of capital for banks.
“Earnings in Nevada institutions are slightly improving but still remain quite negative,” said Burns. “In Nevada at the end of the year, most earnings were still at negative point 5 percent compared to the rest of the nation’s banks, which average around one percent. Most of that is driven by high delinquencies, which means people aren’t paying on their loans, and charge off costs. Non-accruals and charge-offs continue to rise in Nevada, right now non-accruals are up by almost 50 percent and charge-offs are up about 30 percent. Right now in loan growth, which is how banks make their money, one year growth in outstanding loans for Nevada is a negative 10 percent. For the nation, which wasn’t doing a whole lot better at year end, it was holding steady at a little above zero which means they were staying even instead of having loan runoff. That means for every hundred loans they could possibly make they’re losing instead so that’s really weakening their ability to generate income which is the number one thing that supplements capital which is what is needed in order to absorb loan losses. Although things have leveled off a bit, it’s not in a total nosedive, the trends are still downward.”
In our present economy, Nevada banks are finding new ways to increase market share, build business and raise capital. Nevada State Bank has focused on developing a small business platform and opening eight small business banking centers statewide. It also launched an educational self-help library for entrepreneurs that offers a series of webinars and online tools.
“I think our job in this economy and at this time is educating our clients and giving them tools to deal with the new economy, new reality,” Haun said. The education components, business centers, website and best practices have led some businesses to move their accounts to Nevada State Bank. “It’s never easy to move market share in a contracting economy, and the banks that are able to execute the best and focus on client experience and client service will be the most successful,” Haun said.
The Dodd-Frank Act
For Larry Charlton, what’s new in banking is the Dodd-Frank Wall Street Reform and Consumer Protection Act. “It’s coming out with over 2,000 pages of regulations we’re going to have to contend with and that alone is causing a number of potential issues and problems and expense for the financial industry. One part of that is the government moving into pricing our products and that’s putting a cap on the interchange fee. This adds new regulatory stuff on top of banks at a time when frankly we don’t need the extra expense.”
Among other things, the Act is expected to force banks and other financial institutions to create exit plans – charmingly called “funeral plans” – in order to assure failing banks find soft landings that don’t cost taxpayers or FDIC insurance funds. The interchange cap limits what banks can charge retailers for debit card transactions so that rather than taking a percentage of each sale, banks will only be able to collect 11 cents per transaction.
The Dodd-Frank Act is scheduled to go into effect on July 1, making sweeping changes to banking and financial institutions, proposed consumer protection regulations and probably a trickle down effect that will cause higher consumer prices for products at banks.
“There’s a lot of new information and news coming out of DC that this bill may get delayed or changed, so right now there are some unknown elements,” said Haun. “In general, directionally it will impact what banks can charge consumers and how they’re charged, but until this thing is final there’s a lot of unknown about what the final bill will look like.”
Hendricks commented, “Because our focus is on business and the professional community, we’re not going to be impacted by a lot of the retail issues contained in the Dodd-Frank Act, like a bank that’s retail-oriented. But overall for all of us our cost to comply is going to increase.”
That’s a concern for the whole industry, because it may lead to higher operating costs banks need to recoup and for consumers, it may mean higher costs for bank products.
“The sum total of the Dodd-Frank Act as it affects commercial banks of all sizes is the element of making banking more costly,” Uffelman said. “It adds a whole other layer of rules to deal with. In small community banks the reality is, they have to comply with just as many rules as the big bank does and have fewer people to spread the cost over, so it is not an inexpensive act.”
One of the largest impacts the Dodd-Frank Act is apt to have on Nevada involves out-of-state-chartered banks. According to Burns, legislation enacted at the state level (NRS 666.410) prohibits out-of-state-chartered banks from entering any Nevada county with a population of more than 100,000 (meaning Washoe and Clark), a move that protected small, community banks. Section 613 of the new legislation effectively preempts this state law.
“I think this is of some concern simply because it opens the door to anybody who wants to come into the market,” said Burns. “It’s especially a concern when our chartered institutions are in a weakened condition. Competition is good, but at a point where most institutions are weak from the crisis it’s a concern as to what it will do to the overall industry – will it edge out Nevada state-chartered institutions?”
Despite Dodd-Frank and continued unemployment rates, because of the improving indicators in visitors to Nevada and the slowing in defaulted loans, the banking industry is looking forward to a brighter future.
“I remain optimistic and the company remains optimistic about the future of Nevada,” said Haun. “This community, this state, will emerge from this downturn and when unemployment starts dropping, people are going to return to Nevada. If you look at job growth over the last 10 years, we’re still number one or two in job creation in the nation, but that’s hard to appreciate in the last three years we’ve been through. If you look at the tax structure, the business environment, the housing costs today, the long-term future of Nevada remains very bright,” he concluded.
