Red-Hot Nashville Presents Risks, Rewards for Banks

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Business is booming in the Music City and banks are eager to capitalize on it.

The Nashville, Tenn., area and its banks largely avoided the hard knock suffered in other Southeastern markets during the financial crisis. Millions of dollars have flowed into local banks, and fueling accelerated growth tied to the tourist, music and health care industries.

With rapid growth come concerns about credit exposure, especially in areas such as multifamily and hospitality. Still, low vacancy rates indicate to some industry observers that a downturn isn’t imminent.

"There have been some real estate ups and downs, but Nashville has always been a place with a strong, diversified economy, a strong, business-friendly environment and steady growth," said Andrew May, president and chief financial officer at Truxton Trust, a $398 million-asset bank based in the city.

Strong performance is reflected in Nashville's metrics. The area's unemployment rate in October was 3.8%, almost a full percentage point below the U.S. rate at that time, according to the Bureau of Labor Statistics. The city's population has grown by nearly 9% since 2010, based on Census Bureau data.

While many immediately associate Nashville with the country music industry, health care has been among the city's fastest-growing sectors, industry experts said. In addition to hospital management, areas such and medical equipment manufacturing have also flourished. The health care industry also helped create a need for specialty IT services, which in turn spurred more expansion in the technology sector.

Music and tourism have also played a role. The construction of a new convention center in 2013 has brought more people to the city and there has been a concerted effort to have more live music downtown.

Even the television show "Nashville," which ran for four seasons on ABC before being picked up by a cable channel, has "created a bit of a vibe," May said. "It helped the visitor and tourist economy. It's an exciting time to be in Nashville."

Banks and investors are looking to take advantage. More than $450 million in capital has poured into area banks such as CapStar Financial Holdings, Franklin Financial and FB Financial in the last two years. Tennessee Bank & Trust, which has been a division of Farmers Bank & Trust in Blytheville, Ark., for more than a decade, has filed an application for a bank charter.

Institutional investors generally look at the size and growth of a bank's market, said Terry Turner, president and CEO of Pinnacle Financial Partners in Nashville. As a result, the city's banks have benefitted from the area's economic prosperity.

"Banks obviously do best in growth environments," Turner said. "A bank will generally reflect the market it serves. When you get into a high-growth market, banks do well because their clients do well."

In July, Pinnacle bought Avenue Financial, another Nashville bank that had gone public a year earlier.

Franklin Financial Network in Franklin, Tenn., was able to complete its initial public offering in March 2015 largely because of its location, said Richard Herrington, the $2.7 billion-asset company's chairman and CEO. Franklin is about 20 miles south of Nashville.

"To be candid, a lot of people who have invested in us and others that have gone public [do so] because it was a way for them to invest in Nashville," Herrington said.

Nashville, where Franklin has a loan production office, will likely become a more important part of the company's strategy. The company, which wants to target the health care sector, last year hired a lending team specializing in the field.

Smaller banks have been able to grow at a faster rate than some bigger institutions. Deposit market share for Nashville's five biggest banks in 2005 has fallen significantly, from 66% to 52%, over the past decade. In comparison, market share at Pinnacle, including deposits from Avenue, jumped from eighth place in 2005 to third at June 30.

As bigger institutions dealt with the fallout from the financial crisis and new regulatory requirements, smaller banks "were in a position to mine customers" by focusing on specialized business lines and an emphasis on customer service, said Peyton Green, an analyst at Piper Jaffray.

Banks must be mindful of potential risks that often correlate with rapid growth. Concerns are growing about overly enthusiastic development, which has happened before in Nashville and other markets, industry observers said.

"I'm not sure how much longer we can keep the foot on the gas without reaching that point," said Frank McCreary, a retired banker and bank lawyer who lives in the Nashville area. "I'm not saying I predict a recession, but the wise lenders will start watching for that and slow their growth as best they can."

At least one area bank was recently flagged for a concentration of commercial real estate loans, an asset that has been drawing extra scrutiny from regulators.

Franklin Financial disclosed last month that it had reached a memorandum of understanding with regulators tied to its underwriting, internal controls, risk management policies and portfolio stress testing, largely as a result of its CRE exposure. About 55% of the company's loans at Sept. 30 consisted of CRE.

The company subsequently raised $72 million of new capital.

"The loans we make are a lot less risky than if we were in other markets because of the vibrancy here," Herrington said. He said he understands the regulators' perspective, "but you have to look beyond" to "the big picture."

While the city has benefited from low vacancy rates, one area that could overheat is multifamily housing, said Tom Hooper, executive vice president at JLL, a financial and professional services firm that specializes in commercial real estate services. Banks have been pulling back in that sector as developments are completed and absorbed into the market.

Lenders have also been requiring developers to lease a certain percentage of office space before making a loan, Hopper added.

Tennessee's bank examiners are monitoring CRE exposure, though they aim to avoid a "one size fits all" approach to supervision, said Greg Gonzales, the state's banking commissioner. Instead, the agency tailors oversight based on "how banks are understanding their risk and managing that risk," he said.

Nashville is expected to add more than 4,200 multifamily units this year, an amount expected to surpass cities such as Orlando, Fla., and Miami, Green said. The "activity level is elevated, which makes the concern elevated," Green said, though he said factors including income levels, job growth and vacancy rates should be taken into account before hitting the panic button.

Nashville "was underinvested in hotels and multifamily – and now supply it just catching up," Green said. "These things are cyclical. Sometimes the supply overshoots the demand on a temporary basis, so people are being more cautious than they were a year ago."

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