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US credit cycle in late stages but could be heading into extra innings

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US credit cycle in late stages but could be heading into extra innings

While some investors are sounding the alarm about the current economic expansion, others believe the streak will run longer.

The current expansion stands as the third longest on record and has come after the Federal Reserve responded to the Great Recession with highly accommodative monetary policy. While some market observers have sounded alarms, arguing that the Fed inflated asset prices, others note that leverage among U.S. non-financial corporate borrowers recently reached a record high. Both arguments are balanced against the thinking that the U.S. economy is due for a turn in the credit cycle because a recession has occurred every six years on average since World War II.

Still, some well-respected bankers, including BankUnited Inc. Chairman John Kanas, say they do not see a turn in the cycle coming soon. The veteran banker said he wakes up every morning looking for opportunities to take advantage of dislocation in the markets.

"I'm so disappointed that I can't see any bad news," Kanas said last week at the Big Decisions in Banking Conference, hosted by S&P Global Market Intelligence.

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Kanas has called cycles in the past, agreeing to sell North Fork to Capital One Financial Corp. at the top of the market for nearly 5.0x tangible book value. He then led an investor group that acquired BankUnited FSB from the FDIC near the bottom of the cycle and eventually wound down their positions through a series of offerings that allowed them to exit at 2.7x their original investment. Kanas maintained a large position in BankUnited through 2016 but engaged in a series of stock sales this year after retiring as the company's president and CEO that netted close to $50 million.

Kanas said it is hard to see any asset class heading for trouble right now. He said residential real estate is unlikely to create a problem and noted that regulators are heavily scrutinizing banks' exposures to commercial real estate, prompting some institutions to leave the business. Kanas noted that some banks have stopped CRE lending and turned their attention to unsecured, senior lending, a shift that he believes could lead to trouble but will take time for such pain to be felt.

"Other than that, things look pretty good," Kanas said at the conference.

We asked attendees at the S&P Global Market Intelligence event to give their view of the current credit cycle. The consensus at the event suggested that banks were operating in the seventh inning. The next closest answer chosen by attendees was the ninth inning but some presenters at the event expressed hope that a downturn did not lie around the corner.

'Extra innings'

Sally Pope Davis, portfolio manager at Goldman Sachs Asset Management, for instance, said that the credit cycle might be in the late innings, but she believes "we're heading for extra innings."

Stan Ivie, chief risk officer at PacWest Bancorp, offered support for that thinking. He was not convinced that the credit cycle was too late in the game and noted that the current recovery has not been going on all that long.

While the Business Cycle Dating Committee suggests that the Great Recession ended in June 2009, Ivie and others suggest the actual recovery did not occur until much later. Banks actually saw their loan portfolios decline in 2009 and loan growth remained quite weak between 2010 and 2014, falling well below the long-term average reported by the banking industry over the last 25 years. It was not until 2014 that loan growth resumed in force, exceeding 5% for the first time since the crisis.

Banks' credit quality has continued to improve since then, far exceeding many of the expectations on the Street. Interest rates are beginning to rise from historical lows, though, causing some to fear that the higher borrowing costs will spur higher delinquencies.

Bill Parker, vice chair and chief risk officer at U.S. Bancorp, noted at the event that higher rates could put pressure on some real estate credits and expects multifamily loans to be the first to experience issues. He said problems in a massive debt market like the home loan market would cause greater problems but noted that mortgages have been underwritten to pristine standards, particularly when compared to the practices seen before the credit crisis. The executive said that even though home values have risen considerably, borrowers have verified incomes.

"People will get nervous about the credit losses going up but I don't think it will be anything bad," Parker said.