Hurricane Harvey Risk Advisory – Investments

The US wakes up the first Monday after the catastrophic Houston flooding and the country is a bit poorer today.  Hurricane Harvey should have a negative impact on both the bond and equity markets, given the broad impact to business and consumers and the potential for increased government borrowing against a pending debt ceiling limit. I am writing because the usual media investment advice is following the usual albeit tired litany for hurricanes such as: watch out for insurance company losses; rising gas prices due to Gulf refinery shutdowns; buy any dips in the equity market, and specifically buy Home Depot and Lowe’s as they benefit from the rebuilding effort. Undoubtedly, our country’s priority must be to support and protect the people along the Gulf Coast, but I believe the risks are much broader than what is being discussed.

Let me focus on other companies that may be exposed to this event in the Gulf Coast. This analysis is purely based on my risk assessment, and my oversight role in managing money for my family foundation. I do have some equity positions in some of these companies as full disclosure. Please consult your financial adviser to review your risk tolerance and financial objectives before making any investment decisions.

What is so important in my mind in investing is what risk management details are provided in 10K’s and 10Q’s for investors. You will find that many companies do NOT break out regional or even state geographic concentrations, which are most helpful in assessing credit and operational risk from episodic events like Harvey. As a good risk management practice, large concentration risks should have an action plan framework so that management and the Board of Directors can make decisions quickly. Boards should proactively review event-based frameworks for any major concentration as part of annual risk management assessments. Here is my list of heightened risk exposures:

1)     JP Morgan (JPM) has the largest deposit base ($83B, 4.2% market share) and by that measure is one of the largest banks in the Houston area. JPM also has the United Credit Card program and Houston is the second largest hub for United Airlines. Risk managers use airport hubs as a credit card customer acquisition strategy. Collection of credit card debt from hurricane losses takes patience and thoughtful risk management decisions to minimize losses. The key is customer care that generates improved recoveries but the recoveries usually occur after a spike in delinquency rates that creates reserve volatility on the income statement.

2)     The next largest banks by customer and business deposits as a proxy for customer lending exposure in the Houston area are: Wells Fargo ($25B, 1.5% of deposits). Bank of America ($20.5B, 1.2% of deposits), BBVA’s Houston subsidiary (15% of subsidiary deposits), and Zion Bank (Subsidiary Amergy) (15% of Zion’s Deposits). These banks should expect higher delinquency rates and must manage regulatory expectations, which remain high especially regarding settlement and collection practices.

3)     This will be the first test of FinTech lenders’ collection strategies and there is no meaningful risk data by geography to assess true exposures.

4)     The largest home insurers by premium written in this region are: State Farm ($1.7B premiums, 22% market share); Allstate ($765MM premiums, 9.7% market share). Please remember homeowner’s insurance does not cover floods and usually requires separate flood insurance. Therefore, there will be higher mortgage delinquencies, increased demand for government support, and overall lower debt collection from all customers in the Gulf coast region. The largest auto insurers by premiums underwritten are: State Farm (16.2% market share); Progressive Auto (8.56% market share); Allstate (7.3% market share).

 

In my opinion, Hurricane Harvey losses could exceed expectations and ongoing monitoring is key to any risk management or investment decision. The stock market did not heed my risk assessment and it opened higher this morning on August 28, 2017 because of the positive interest rate and regulatory implications from Jackson Hole. Investors may not be risk-adjusting returns given the potential outcomes of hurricane Harvey, the debt ceiling vote, tax reform, and debt collection regulatory scrutiny. Perhaps I am a bit bearish, so take that into consideration with your cup of coffee.

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