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Banking & Financial Services

CECL Could Create Large Capital Shortfall For Community Banks

Energy

Power Forecast Briefing: Fleet Transformation, Under-Powered Markets, and Green Energy in 2018

Nexstar Buys WGN For A Song; Divestiture Of WGN, Stakes In Food Channels Likely

Ondeck Now Open To Exploring Deals, CEO Says

2018 US Insurtech Report


CECL Could Create Large Capital Shortfall For Community Banks

Feb. 02 2018 — The implementation of a new accounting standard that changes the way banks reserve for loan losses could have a far more punitive impact on community banks than their larger counterparts.

The accounting standard, known as the current expected credit loss model, or CECL, becomes effective for many institutions in 2020 and will require banks to set aside reserves for lifetime expected losses on the day of origination.

The new standard will mark a considerable shift in how banks currently reserve for losses. Today, banks record losses when it becomes probable that a loan will be impaired. That means reserves are dispersed over time, but CECL will cause banks to significantly build their allowance for loan losses on the date of adoption, according to Josh Siegel and Ethan Heisler.

The two bank observers said in the latest Street Talk podcast that the increase will be even larger for institutions with higher concentrations of longer-term loans since reserves for those credits are currently spread out over longer periods.

"The same credit, the same view, the same company, if you have a two-year loan or a 20-year loan, the reserve you're going to have to put it against it is dramatically different," Siegel, managing partner and CEO of StoneCastle Partners LLC, an investor and adviser to community banks, said in the episode.

He said a reserve for a loan with a two-year term under CECL might not be dramatically different than the current methodology since it requires banks to look ahead 12 to 18 months for losses. Loans with far longer terms such as real estate credits, however, could require multiples of currently required reserves. The burden of the new accounting standard could prove far greater for community banks since those institutions are much more heavily concentrated in real estate.

Siegel and Heisler — president of the Bank Treasury Newsletter, which highlights industry trends impacting bank treasurers — co-authored a white paper analyzing CECL's impact on banks with less than $50 billion in assets. The analysis found that hundreds of banks could be at risk of falling below well-capitalized status after adopting CECL, at least when it comes to meeting total risk-based capital requirements. Any reserve build required through CECL will be deducted from capital and could have the greatest impact on total risk-based capital ratios because the Basel III rules cap the inclusion of reserves at 1.25% of risk-weighted assets.

The required build under CECL could push reserves well above that level, according to Siegel and Heisler's analysis. They examined the banking industry's results since 2004 and assumed institutions adopted CECL beginning in 2005. The analysis further assumed that all loan portfolios had five-year terms, loans were originated at year-end and bankers were fully aware of the losses that would come between 2005 and 2016. The analysis assumed provisions equaled cumulative net charge-offs in the five years after adoption and considered a number of scenarios, with CECL implementation beginning in different years.

In the most severe scenario, where banks would have adopted CECL beginning in 2007, the analysis found that banks in aggregate would need as much as $70 billion to repair the capital shortfall. In the least severe scenario, with CECL adoption beginning in 2011, banks would need to raise close to $10 billion.

"It's not just a small change. You could today be very well-capitalized and wake up and not even be adequately capitalized," Siegel said. "You could be deemed undercapitalized and immediately be put under a cease and desist order."

Siegel said banks should begin calculating CECL's impact, even in a rough approximation, to see if they have a capital shortfall. For an institution falling short, they recommended that banks should consider issuing subordinated debt to bolster their balance sheets.

Siegel has encouraged community banks to utilize sub debt in the past, given that it allows banks with holding companies to raise funds, downstream them to their banking subsidiaries and count them as equity capital in far more cost-effective manner. He and Heisler noted that issuing sub debt today remains relatively cheap while interest rates continue to be low.

"Sub debt is a natural offset, a way to prepare for CECL," Heisler said in the episode. "Think of Tier 2 sub debt almost as a CECL buffer."

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Watch: Power Forecast Briefing: Fleet Transformation, Under-Powered Markets, and Green Energy in 2018

Steve Piper shares Power Forecast insights and a recap of recent events in the US power markets in Q4 of 2017. Watch our video for power generation trends and forecasts for utilities in 2018.

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Technology, Media & Telecom
Nexstar Buys WGN For A Song; Divestiture Of WGN, Stakes In Food Channels Likely

Dec. 10 2018 — Walt Disney Co.'s pending acquisition of much of 21st Century Fox Inc. certainly raised the bar for cable network valuations — at 15.4x cash flow — and the divestiture of the regional sports networks may see another double-digit-multiple transaction with Amazon.com Inc. in the mix of buyers. Another deal, Nexstar Media Group Inc.'s pending acquisition of Tribune Media Co., sees stakes in three cable nets going to the buyer for single-digit multiples (6.9x).

The deal follows the collapse of Sinclair Broadcast Group Inc.'s deal to buy the company, which is now being litigated. We think that Nexstar is getting quite a deal on the cable network assets and will likely flip them for a quick profit.

When Discovery Inc. agreed to buy Scripps Networks Interactive Inc. in July 2017, the domestic cable networks were valued at $10.14 billion, or 10.5x cash flow, with Food Network (US) valued at $4.5 billion (Scripps owned 68.7%) and Cooking Channel (US) (also at 68.7%) valued at $525 million.

In the current transaction, the valuations come to $3.47 billion and $323 million, respectively. Thus, if Nexstar can get Discovery Communications to pay at least what it paid in the Scripps transaction, Nexstar may make a quick profit. Granted, minority interests typically trade at a discount. Scripps Networks Interactive, however, has tried for years to cut a deal to buy out the minority stake and it may be willing to strike a deal at a higher price to put this issue behind it.

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Ondeck Now Open To Exploring Deals, CEO Says

Highlights

OnDeck has never done an acquisition, but M&A is a possibility now that the company is generating cash, Chairman and CEO Noah Breslow said.

Breslow expects there to be consolidation across online lending companies in the near future.

OnDeck plans to launch a new product line, such as a business credit card or an equipment financing product, by year-end.

Nov. 30 2018 — Noah Breslow has been at the helm of On Deck Capital Inc. since June 2012, overseeing the company's initial public offering and several profitable quarters. The online lender has originated more than $10 billion in small-business loans and is one of the largest players in the industry.

In addition to originating its own loans, OnDeck recently launched ODX, a new subsidiary focused on a platform-as-a-service product for banks. OnDeck has operated that sort of white-label partnership with JPMorgan Chase & Co. for several years and will launchoperations with PNC Financial Services Group Inc. in 2019.

Now, the lender is open to doing deals, Breslow said. He sat down with S&P Global Market Intelligence in Las Vegas to talk about his company's future product plans and the broader online lending marketplace.

The following is an edited transcript of that conversation.

OnDeck CEO Noah Breslow
Source: OnDeck

S&P Global Market Intelligence: How do you view the current state of the online lending marketplace?

Noah Breslow: What you're seeing in that market is a bit of survival of the fittest. Many smaller companies are probably going to be sold in the next couple of years.

The advantages in the business go to those with scale: You can raise capital on the best terms, you collect the most data, so you can make the best decisions when you build your models, and you can reach more small-business owners more efficiently.

That being said, do you foresee being an acquirer?

We're open to it. We haven't acquired a company in 11 years of doing business. One of the advantages of now being profitable and generating cash is we can look around the market.

But we're designing our core business model so we don't need to acquire to hit our targets. Anything we do in the M&A sphere will be additive, and it will not be aggressive M&A. It's going to be reasonable bets to have a nice return or nice synergies, if we do it.

Is OnDeck considering starting other products outside of small business lending?

Not at this time. We focus on trying to be the best small-business lender in the world, but that can mean a lot of different products over time.

Today we have a term loan and a line of credit product. We've talked about four other products that our customers use: equipment financing, invoice factoring, Small Business Administration lending and small-business credit cards. Those are all fair game for us over the next couple of years.

We're on track to announce our third major product by the end of the year. One of those four will probably be picked.

Why is OnDeck focusing on small business lending rather than other offerings?

It's where underwriting is not commoditized. Student lending and personal lending are based on FICO. You can go to 10 different websites and get identical products.

In small business lending, the intellectual property around the OnDeck score is unique.

I like being able to differentiate in that way. It creates a sustainable advantage for our business, whereas if we were just using FICO to underwrite, anyone can buy that and get into the market.

OnDeck's white-label product lets banks use its technology to streamline their own lending process. In those partnerships, do you face regulatory restrictions with the use of alternative data in underwriting models?

When we're partnering with banks, it's critical that the bank has a lot of control over the credit model and the data being used for decisioning.

The model we use with JPMorgan Chase was jointly developed between OnDeck and Chase, so obviously Chase was very comfortable data. The model we're using with PNC is more of PNC's design, and we're advising on its creation. In both cases, we're using data that's right down the middle of the fairway — business credit, business cash flow and evaluating the business owner — but nothing too esoteric.

In our own business at OnDeck, we can use more alternate data because we don't have the same modeled governance that a bank might have.

Are you using machine learning to synthesize data sources and create new models based on alternative data?

Some players out there have tried to go purely digital and almost let the computer decide how to make the decision. We don't believe in that.

We have a hybrid model, where people with a lot of commercial underwriting experience are working in concert with advanced modeling techniques to get the result.

OnDeck's charge-off rates have declined year over year in 2018. Is there correlation between these lower rates and your updated models using more alternative data?

Our credit models have improved over the last year, and alternative data definitely contributes.

Many of our improvements in the last year have been structural or operational. I view the modeling improvements as even more upside potential from here.

We noticed after we loaned our first billion dollars that our credit models got a step-function better. Now, with $10 billion under our belts, it's again happening. We can do a lot of data-driven decision-making about who we approve and who we decline on many years of history now.

It starts to become more powerful. That's why you see these scaled-up companies like American Express or Discover Financial or Capital One. They're reaping the benefits of decades of lending, and hopefully we'll be in the same place.

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Insurance
2018 US Insurtech Report

Highlights

S&P Global Market Intelligence’s 2018 US Insurtech Market Report projects that U.S. private auto insurance premiums written via the direct-to-consumer channel will exceed $90 billion by 2022. The report also examines startup funding trends and identifies other business lines that could be ripe for insurtech disruption.

Nov. 30 2018 — U.S. insurance technology startups are numerous and still very much in their early years. As is common with an emerging fintech segment, investor and public interest in the space is high despite the risky nature of startup investing. The insurtech space had a recent gauge of public investor interest with the IPO of lead aggregator EverQuote. While the IPO priced above its expected range, the stock’s performance since then has been lackluster, a disappointing sign for others looking to go public. But many startups are still many years away from that goal, and there might be more investor appetite for different business models. Unlike Netflix and other companies that have caused wholesale disruption in various industries, many insurtech startups are working with incumbents rather than trying to replace them. Incumbents are avid investors in insurtech companies, and the digital agency model relies heavily, for now at least, on partnerships with established underwriters. Of the different insurtech business models, digital agencies and underwriters continue to attract the most funding and therefore form the focus of our report. Though many facets of their business model are not revolutionary, they have added meaningful innovation in some key areas. Certain business lines appear more ripe for innovation than others. In private auto, for instance, the direct distribution model already has a firm foothold and therefore seems less vulnerable to disruption by startups. S&P Global Market Intelligence projects that premiums written in the direct response channel will exceed $90 billion by 2022 and that they will account for more than 30% of overall U.S. auto premiums. But if the direct model can be applied to other lines, such as small business insurance or life insurance, that might produce a more dramatic challenger to the incumbent writers of those lines.

Early days

Interest in the U.S. insurtech space has spiked in recent years, fed by a large crop of startup companies. It is too early to assess how successful most insurtech startups and their investors will be as many companies are only a few years old at this point. In S&P Global Market Intelligence’s coverage universe, the median age of U.S. insurtech companies — based on the year they were founded — is seven years. But the recent spate of startups is even younger than that. The years 2015 and 2016 were a particularly bountiful time; companies founded in those two years alone account for roughly 22% of the coverage universe.

Appetite for disruption

One of the textbook examples of industry disruption is Netflix, which drastically reshaped the distribution of entertainment, first through its DVD mail service and again through its on-demand streaming service. These changes brought about the demise of in-store video rental giant Blockbuster, which reportedly had the chance to buy Netflix for only $50 million in 2000.

We do not foresee the same kind of seismic changes coming for much of the U.S. insurance industry, since the fundamental distribution model is not changing. The startups covered in this report — both digital agents and fullstack companies — are proponents of the direct distribution model, selling policies directly to consumers via their websites and/or mobile apps. But this is far from a novel concept. Areas of the insurance industry have embraced online, direct-to-consumer distribution for some time.

S&P Global Market Intelligence client? Click here to login and read the full 2018 US Insurtech Market Report

The projections reflect various assumptions regarding premiums, losses and expenses. They are a product of a sum-of-the-parts analysis of individual business lines that is informed by third-party macroeconomic forecasts, historical trends and recent market observations that include first-quarter 2017 statutory results and anecdotal commentary about market conditions. Projected results are displayed on a total-filed basis and are not intended for application to individual states, regions or companies. S&P Global Market Intelligence reserves the right to update the projections at any time for any reason.

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