The BAN Report: Fed Pivots / Mod Relief Lapses / Credit Bureaus Lead Complaints / Ships Keep Cruising / Sprawl Crawls Back

Fed Pivots

After spending over a year propagating that inflation is transitory, the Fed is pivoting to rate increases beginning as soon as March, with the market expecting 3 or so rate increases in 2022.   

Minutes of their Dec. 14-15 meeting, released Wednesday, showed officials believed that rising inflation and a very tight labor market could call for lifting short-term rates “sooner or at a faster pace than participants had earlier anticipated.”

Some officials also thought the Fed should start shrinking its $8.76 trillion portfolio of bonds and other assets relatively soon after beginning to raise rates, the minutes said. Investors would see the move as another way for the Fed to tighten financial conditions to cool the economy.

Julia Coronado, founder of economic-advisory firm MacroPolicy Perspectives, said that the minutes prompted her to move up her forecast for rate increases to begin in March, instead of June.

“The Fed is on a glide path to hiking in March,” said Neil Dutta, an economist at research firm Renaissance Macro. “It is hard to see what is going to hold them back.”

Most central bank officials, in projections released after last month’s meeting, penciled in at least three quarter-percentage-point rate increases this year. In September, around half of the group thought rate increases could wait until 2023.

Before raising rates, the Fed wants to taper its bond-purchasing program.

The Fed wants to end the bond-buying program, a form of economic stimulus, before it lifts short-term rates to curb inflation. “The whole point of accelerating the tapering was…so the March meeting could be a live meeting” to raise rates, said Fed governor Christopher Waller in remarks on Dec. 17. “That was the intent.”

While rate cuts can be fast and dramatic, rate increases tend to be deliberate and predictable, in order to give the market time to digest higher rates. It’s encouraging that the Fed is changing course after the data suggested that inflation was more persistent then believed.

We are now moving away from a highly stimulative environment featuring record-low rates and unprecedented government spending. While we expect additional credit problems as rates increase, this is great news for US banks, who will finally see some improvement in their margins.   In early December, the 10-Year Treasury stood at 1.357% - now it’s at 1.739%.   

Mod Relief Lapses

The CARES Act in 2020 gave banks relief from TDR status for loans modified due to COVID-19, providing the borrower was current as of 12/31/2019. This encouraged banks to do COVID interest and/or principal deferrals to borrowers, as they could essentially do them without any penalty. This relief expired on January 1 and could have implications for commercial real estate, according to Globe St.

“In talking to bankers and lawyers, there has been a whole lot of kicking the can down the road,” Scott Williams, a partner at law firm RumbergerKirk and specialist in bankruptcy and restructuring, tells “They didn’t have to report it. Kick the can down the road and keep the credit. Banks are going to have to start reporting it and being more active about their bad loans.”

Being more active includes accounting requirements for handling impaired values of assets, which would include writing down the impaired part and then making arrangements, such as potentially calling in loans, demanding additional capital payment to keep the loan to value percentages where the bank wants them, or selling the loans at some loss to another institution.

“I think real estate is someplace where you’re going to see some of this,” says Williams. “There are two things that have taken place. Number one, there is a lot of money sloshing around the system. If I’ve got a bad loan, maybe I can refinance with a different lender.” A bank might be “willing to take a small haircut because they have a TDR at the beginning of the year, and they want to get it off their books and onto someone else.”

CRE borrowers who have properties with impaired values should look into their options now, because come January, they may find their lenders in a sudden hurry to catch up on compliance.

So, if a loan is modified today, it would now be subject to ASC 310-40, and could be considered a TDR and/or subject to a potential downgrade. However, for banks that have adopting CECL, ASC 310-40 is scheduled to go away.   

Stakeholders said that once an entity begins applying ASC 326, the required accounting and disclosures for a loan modified in a TDR no longer provide decision-useful information. That’s because ASC 326 requires the recognition of lifetime expected credit losses when a loan is originated or acquired, so the effect of many credit losses that occur in loans modified in TDRs are already included in the allowance for credit losses.

The proposal would also require enhanced disclosures for modifications made to borrowers experiencing financial difficulty. The disclosures would focus on the types and magnitude of modifications provided, along with their success in mitigating potential losses. For modifications that result only from an insignificant delay in payment, entities can choose whether to include those modifications in their disclosures.

The proposal would eliminate the “once a TDR, always a TDR” requirement for loan disclosures but require entities to make disclosures about the performance of modified loans to borrowers experiencing financial difficulty in the 12 months before the date of the financial statements. Entities will need to make sure they have appropriate processes and controls in place to support these enhanced disclosure requirement. 

The comment period on the proposed FASB rule ended last month. Since ASC 326 already requires banks to estimate credit losses at origination, a continued TDR designation seemed unnecessary. However, they will still need to make disclosures regarding modified loans, and bank analysts we’ve talked to said this would change very little, as they would still consider modifications as part of the troubled loan bucket. Moreover, if a loan is modified, its likely to be either substandard or special mention anyway.  

Credit Bureaus Lead Complaints

According to a report from the CFPB, more than half of all complaints are directed at the 3 major credit bureaus.

A new report from the Consumer Financial Protection Bureau reveals that more than half of the complaints the agency has received from the public from January 2020 to September 2021 were directed at Equifax, Experian or TransUnion, the three largest credit reporting firms.

The CFPB said consumers focused their frustration on automated systems that made it difficult to correct faulty information in their reports; an exasperating dispute process; and surprise debts such as medical bills reported to the companies without their knowledge. And the agency found the credit bureaus provided significantly less help last year when consumers protested, offering relief in 2 percent of cases, down from 25 percent in 2019.

“America’s credit reporting oligopoly has little incentive to treat consumers fairly when their credit reports have errors,” CFPB Director Rohit Chopra said in a statement. “Today’s report is further evidence of the serious harms stemming from their faulty financial surveillance business model.”

The Consumer Data Industry Association, which represents the credit bureaus, said it is reviewing the report and agrees with the federal consumer watchdog that “responding to legitimate consumer complaints and getting credit reports right are paramount.”

“The CFPB report highlights trends including increased activity by certain credit repair companies, which can inflate complaint numbers and undermine the process of addressing legitimate requests,” the industry group said in a statement. “We are committed to continuing to work with the FTC and CFPB to protect consumers against these harmful and abusive tactics.”

Improving the credit bureau reporting process seems to be a good role for the CFPB, as errors in credit reports can be devastating to borrowers. Rather than fix the problems, the credit bureaus seem more interested in blaming credit repair companies.   

Ships Keep Cruising

Despite record-levels of COVID cases with the Omicron variant, Americans seem to be largely shrugging it off. Flights are being canceled largely due to issues with crews, not due to falling demand.A good example is the cruise industry, which has seen strong demand despite CDC warnings to stay away.

Two days later, the Centers for Disease Control and Prevention told Americans to avoid travel on cruise ships, regardless of their vaccination status. The advisory, the agency’s highest coronavirus warning, came in response to a surge in cases in recent weeks, caused by the spread of the contagious Omicron variant.

But even as case numbers rise, and criticism mounts about the safety of cruising and over cruise line protocols in reporting cases to passengers, ships keep sailing and guests keep embarking, adamant that the onboard environment is safe because of stringent health and safety requirements, including pre-departure testing and vaccine mandates.

Consider the New Year’s Eve festivities held on ships around the world. One day after the C.D.C. announcement, as dozens of crew members and other passengers were confined to small cabins, infected and quarantined, thousands of revelers packed into ship bars, casinos and deck venues, partying like it was 2019.

Harvey Freid, 56, recently returned from a 17-day sailing to Antarctica, during which one positive case was reported. But Mr. Freid, an avid cruiser, is undeterred and is scheduled to go on a Caribbean cruise in late January.

“The cruise ships do a very good job of handling Covid, and I think it’s safer than my building in Miami and most places that I go on land, because people are vaccinated and cases are quickly identified and isolated,” he said.

The cruise industry’s trade group, Cruise Lines International Association, called the C.D.C.’s warning “perplexing,” and said that cases identified on ships “consistently make up a slim minority of the total population on board — far fewer than on land.”

“No setting can be immune from this virus — however, it is also the case that cruises provide one of the highest levels of demonstrated mitigation against the virus,” the group said in a statement.

I am attending the CREFC Miami conference early next week and I was told that as many people are signing up to attend in person, as those that are canceling or switching to remote. A few attendees are attending as individuals, since many of the banks pulled their participation. Business travelers remain skittish, but the consumer seems determined to travel.  

Sprawl Crawls Back

The pandemic has accelerated development in suburbs further from the core city, after a period in infill development dominated the conversation. Builders want to build where it’s cheaper and easier.

Home builders worked at a near-record post-Great Recession rate in 2021, with 1.7 million starts in November alone. Keeping that pace means building where it’s easiest and quickest — greenfield sites at the suburban fringes, not pricey urban infill with longer permitting processes. Across the South, exurban counties have grown 15%, twice the U.S. rate, including Lancaster County, South Carolina, a magnet for commuters from Charlotte, and Nassau County near Jacksonville, which grew by 23% in the last decade. 

According to Chuck Fowke, chairman of the National Association of Home Builders (NAHB), the shift in construction from high-density metro areas to more affordable regions, which accelerated at the start of the pandemic, ramped up in 2021. NAHB stats show so-called outlying areas of small and major metros accounted for 18% of homes built in the third quarter of 2021. 

“The outskirts of yesterday are the mainstream of today,” said Jacque Petroulakis, executive vice president of marketing for NexMetro Communities, a national builder of single-family rental home communities in suburban and exurban areas. “Ten years ago, people said I can’t believe you’re building in that market. Now, that same market is considered close in.”

While the pandemic may have helped, Petroulakis argues the overall trend was already well underway, thanks to a “perfect storm” of high rental costs and home prices. A December study of the top 100 metros by Markerr found that single-family home prices were up 18% year-to-date, with Austin, Boise and Phoenix surging 34%. Despite the sticker shock, the desire for a homeowner lifestyle isn’t going away. Covid’s much-discussed “urban exodus” was a more of a suburban shuffle, with city dwellers in places like Washington, D.C., and Columbus, Ohio, migrating to outlying areas. Falling immigration has also stymied population growth in many larger U.S. cities, especially relative to suburbs. 

The continued shift outward is “clearly going to continue,” said Adam Ducker, chief executive officer of RCLCO, a real estate consulting firm. “What happened to the voice and forces working against this kind of growth?” he said. “Seemed like smart growth and regionalism had become part of the religion of the development community. How did the discussion turn so quickly?”

Given an obvious need for more housing, banks need to lend more aggressively to homebuilders, but they seem to be afraid of repeating the mistakes of the mid-2000s. I recently pitched a publicly traded bank about the opportunity, and it was a short conversation. Perhaps, banks struggling with loan growth should take a closer look.