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Friday, May 27, 2022

Midsize Banks Pressured by Non-Bank Lenders

Several local bankers say middle market business banks in the San Fernando Valley will face pressure in 2020 from fluctuating interest rates and a highly competitive landscape marked by a robust nonbank market. Tamara Gurney, chief executive of Mission Valley Bancorp. in Sun Valley, told the Business Journal that she’s preparing for an upcoming year of volatility. “Budgeting a year ago for 2019, we were (anticipating) rate hikes,” she said. “We ended up having rate cuts. There’s a lot of discussion of whether there’ll be a recession … or potentially somewhat of a correction (in 2020).” Gurney said Mission Valley is now stress testing to see how a correction would shake out for its portfolio. A top banker at a commercial bank in Encino who requested to remain anonymous said last year’s unexpectedly low rates are a hangover effect from the Federal Reserve Bank’s cash injections during the recession of 2007 and 2008. In addition to stagnant rates, that liquidity, the executive said, contributed heavily to the rise of non-bank lenders like online fintech players, retail companies like Costco Wholesale Corp., and even automakers, all of which have emerged as competitors for traditional banks. “Conduit lenders or people outside the banking system (are) becoming more aggressive in wanting a return on their money because they’ve got millions of dollars of cash laying around,” the person said. “There’s more alternative lenders out there. You’ve got to be a step ahead of the curve.” “Competition now is diverse,” added Gurney. Mid-market crunch According to the Encino banker, the defining narrative of the industry in recent years is the consolidation of middle market players, most of which get snatched up by global banks such as Wells Fargo, Chase or Bank of America. The Federal Deposit Insurance Corp. pegs the number of FDIC-insured commercial banks in the U.S. at 4,708 at the end of 2018, a decline from 7,870 banks in 2002 – a drop of more than 40 percent in 16 years. “Small and mid-size banks just don’t have the capital,” the banker said. “At $3 billion to $5 billion, they can be OK. Once they hit $5 billion, it’s really hard to get to $10 billion organically. That’s when you see them getting acquired.” The banker added that a large percentage of the consolidation is likely a result of the rise of online banking and apps like Venmo and Zelle, which further threaten the traditional model. While consumer demand for online banking is sky high, especially among young customers, so is the cost for banks to invest in such systems. The banker recalled Bank of America’s first attempt to develop a national online platform after being acquired by Nations Bank in 1998 — the corporation spent $1 billion on a system that failed so miserably upon its public rollout that Bank of America scrapped it and started over. “How many banks can afford to throw away a billion dollars? That’s the cost these things take,” the person said. “Smaller to mid-size banks can’t keep up. They just don’t have the equity base to pour $1 billion into a development.” The rise of online banking has rippled into banks’ staffing strategies too. Gurney said Mission Valley, which does have an online platform and mobile app, has expanded its back office and tech support staff but downsized on tellers. Of course, banking on the internet also gives rise to online theft — cybersecurity will remain a buzzword for banks next year, the banker said, but even more so for clients, who are typically slower to understand the need to adopt preventative technology. Kenn Phillips, president of the Valley Economic Alliance in Sherman Oaks, was a dissenting voice in that he predicted 2020 will be a strong year for business banks due to the deluge of both private and public sector infrastructure projects that will pump money – and jobs – into the Valley economy. He referred to the upcoming buildout of the East San Fernando Valley corridor, the 25-acre mixed-use NoHo West development on the former Laurel Plaza lot in North Hollywood, projects at Los Angeles Mission College in Sylmar and Los Angeles Pierce College in Woodland Hills, plus the developments of several hotels across the Valley. Phillips said the lending scene next year will be “highly competitive.” Legislation 2020 is, of course, a presidential election year, which often means more volatility as the market reacts to polls, Gurney said. And who ends up in the White House in November will have huge regulatory implications for 2021 and beyond. But Gurney said the wave of regulations that banks will feel in 2020 has already crashed — the industry has dealt with them for the past year or longer. She referred to “beneficial ownership” or “know your customer” regulations that require banks to collect identification documents for any owners of a 20-percent-or-greater stake in a business the bank loans money to as a preventative measure against money laundering. “They’re confusing for the borrowers,” Gurney said. “It’s a challenge for banks to capture and report the amount of information the government wants.” The Encino banker said that small and mid-size banks have to hire 15 to 30 anti-money laundering analysts to go through all the information. “It becomes very expensive for a bank to do that,” the banker added. Also, the whole process of providing documentation makes borrowers less prone to change banks. That makes it harder for banks to attract new clients organically and incentivizes them to do so through acquisitions. The banker also said federal regulations on cannabis have left that market completely untapped by traditional banks. “On the federal side, it’s still a prohibited industry, so how do you bank them? We don’t,” he said. If a bank has a loan on a strip mall and a cannabis dispensary opens there, the banker said the bank will scrap the whole loan — a troubling scenario for a middle-market institution fighting to attract new customers. Microlending void The Valley’s microlending market was thrown into flux in July when the Valley Economic Development Center entered Chapter 11, reportedly due to a liquidity crisis. The organization’s temporary leave of absence has left a significant gap in the loan market for small, disadvantaged and minority-owned businesses. “They were the only provider for microlending in the Valley,” said Phillips at the Valley Economic Alliance. “There still isn’t one.” He said the Alliance is trying to step up in VEDC’s absence but can’t come close to filling its shoes. Gurney said she hopes small businesses who would’ve been serviced by VEDC can find their way to Mission Valley and small, community-based banks like it. She said Mission Valley is considering the buildout of a digital bank platform to make small loans of less than $500,000 to businesses who don’t qualify for core bank loans. Even so, she conceded small-market banks can’t possibly accept all the loans VEDC would’ve and are no replacement for it. “That’s a void now for the Valley that needs to be addressed,” she said.

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