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BirdsEye View

a time of oppotunity

Another great idea regarding workouts came from Scott Trager of Republic Bank in KY. The bank's website offers virtual tours of the few REOs the bank has to offer. It stimulates interest and makes sales of distressed properties easier. This, coupled with a quick decision making process to approve short sales, certainly helps eliminating the backlog of non-performing assets.

In honor of Father's Day, I'd like to quote my husband, Dick, and his note to our son Paul. I hope it will both resonate with you and make you laugh as it did me.

Dick, my brilliant husband, decided to approach our son Paul with a clear explanation of how we want him to manage his expenses next year. His description is not only hilarious, but also oh so accurate for any self-respecting corporate budget process. Read, enjoy and weep!

"Paul, since you are a business student and obviously understand how businesses work, you need to give us a budget for June 2008 thru June of 2009. That way we can figure out your needs and see at what level we can fund them. Ignore tuition and fees that we pay directly to IU [do we pay them directly?], ignore auto insurance and health insurance[we will keep you on our policies as long as you are in school and as long as the insurance company permits it]; leave off personal expenses and gas and vacations etc. with friends and frat and entertainment [those come out of your pocket]; there may be other expenses that you have to shoulder in full or in part. By doing a budget we can all plan ahead and not have to review expenses on an ad hoc after the fact basis.

This is actually the way we did budgets at Colonial Penn; the operating department [that's you, lets call it the IU Division]submits a budget to corporate headquarters [that's Mom and me]; after corporate headquarters has a good laugh at the proposed budget they sharpen their pencils and come up with a realistic budget which they send to the operating division [in this case the IU Division]; after the IU Division regains consciousness from fainting from the sparseness of the budget, they submit a new proposed budget with explanations as to how they cannot possible live on the budget proposed by corporate headquarters; after one or 2 iterations a budget that neither party likes is agreed upon. During the year the operating division submits extraordinary "budget variances" for unanticipated expenses [which they knew all along that they would have but kept out of the budget process because they knew corporate would not approve them in advance].

And so it goes, but seriously, it would be an immense help to figure this out in advance. So, please submit a proposed budget by Friday [just kidding, did I mention that budget deadlines are always unrealistically short; that is because corporate headquarters knows that whatever the deadline the operating division will miss it by a few days]. However, since the IU Division is one of our top performers, corporate headquarters will give you some leeway on the budget deadline [playing favorites is another invariable aspect of modern American businesses no matter what your ethics professor says]. Get us something whenever you can but soon; pencil it out on the plane [but the final presentation must be to the full budget committee in Power Point format with numerous boring and irrelevant charts and graphs, the primary purpose of which is to put every one to sleep (although I am just kidding again, this is the precise way it works in the corporate world; I have been ready to slit my throat at many a budget presentation before)] ".

To all fathers who read this, have a fabulous Father's Day, and to all their children reading this, I hope you'll help make it so!

Article synopsis: there is a silver lining in every cloud.

Our industry has gone topsy-turvy in an extremely short period of time. Within months robust capital markets dried up or even evaporated, and a period of phenomenal credit quality turned into huge write-offs; acquisitions that appeared cheap at 3 times book are being written down as good will impairment to the point of threatening the capital position of some banks, and "safe" securities are losing value rapidly (even FHLMC and FNMA issues, those that were considered solid gold). What was off balance sheet is coming back home the roost, and the overall sentiment is negative bordering on incredulous. Times are eerily reminiscent of the early '90s.... plus we now have three ways to lose money: bad credit; bad securities (even if they have FNMA stamps on them); and overpriced acquisitions.

Here's where I see things stand:

ON THE HOUSING MARKET

  • Housing issues are very regional. Some markets still enjoy housing expansion and solid markets, although slow-down has been prevalent. Absorption rates are growing, as is inventory, while the number of QUALIFIED buyers is shrinking. Industry bailouts and Fed help might mitigate this trend, but it is indeed felt everywhere to some degree. Some markets have been hit very hard ( Stockton, CA is a prime example), while others are holding their own (Texas). Loan demand across the board is stable, sometimes robust, and solid credit quality still exist in many markets.

  • Housing issues depend on the product. In many markets high-end custom homes are still doing well, while starter homes and existing homes are languishing. Again, painting the entire industry with a broad brush does not provide an accurate picture of the situation. It makes a huge difference if your loan is on a custom home or a Miami high rise condo, and whether the buyer is an investor or a resident home owner.

  • Local builders are doing better than national builders as a general statement. Not all builders are hurting, but the pain national builders are feeling, which results in 30%+ discounts, plasma TVs and fully furnished houses and $100K price break as lures for qualified buyers, is impacting the entire market, including the smaller builders who have little market power.

  • Many loans are "dead man walking". Many builders have pulled away from projects, leaving the land unimproved and staying on the sidelines. They continue to service their debt, but the real question is, how long can they pull this off? A performing loan does not indicate an untroubled loan...

  • If it grows like a weed it probably IS a weed (Bill Perotti). In Bill's immortal words, if it's too good to be true, it probably is. We've seen it time and time again, but the lessons are hard to learn.

THE FRAUDSTERS

  • Fraud is rampant. ANY kind of fraud - consumer, employee, business, and those global phishing experts - everyone is working hard on finding ways to steal money from trusting bank depositors and lenders. The old fashioned kiting and financial statement falsification methods have given way to extremely sophisticated, highly quantitative, often continuous-learning schemes. Both frequency and magnitude of fraud is increasing, and the amounts at stake are often in the millions. Amidst rapidly rising credit costs, we also witness growing fraud losses in all categories. The current economic downturn, whether real or Psychosomatic, will spawn more fraudsters looking to make a quick couple of million dollars.

THE OPPORTUNITY

  • Be a contrarian. This is the time to realize that the country isn't monolithic, nor are segments within specific geographies. Ten states account for 65% of job growth in the US: Florida, California, Texas, New York, Georgia, North Carolina, Virginia, Washington, Utah and Colorado. Where there is job growth there is loan growth, prosperity and opportunity. True, Miami condos are a disaster, but this doesn't mean that the entire Miami economy is in the dumps, or that every builder is poor credit. It's time to take the offensive and court prospective customers that are being dropped by banks that operate by non-negotiable rules, banks who lack the flexibility to pick and choose the right customers even within a sector that is suffering. This is one of the main advantages of SuperCommunity banking; capitalize upon it.

  • Opportunity to cut costs without cutting muscle. At times like this cost cutting consultants start wielding their magic wands across the industry, cutting to reach a number, regardless to the ultimate cost to the bank and its shareholders. Banks will be brought to their knees with great cost efficiencies and the resultant elimination of most revenue growth power. Resist the temptation to optimize to cost reduction, and, instead, work on shifting the culture toward greater cost discipline and vigilance without compromising growth prospects and important strategic investments.

  • Opportunity to affect change. It's much harder to bring about change when things are going great. It's easier when things are tough. Times are certainly tough these days, and are likely to remain so for at least two more quarters, and, some say, two more years. This is a great time for bank leadership to bring about needed change, reinvigorate its troops and clarify strategic direction.

  • Enjoy the somewhat expanded margins that appeared after the sub-prime scare since lenders finally realized they were not being paid for the risk they've been taking. While deposit pricing has not rationalized, credit pricing has improved in many markets , as did, equally importantly, terms and covenants .

THE RISKS

  • Use experienced lenders. I know they are few and far in between, but finding the right lenders and testing them repeatedly on your credit philosophy is essential during these times.

  • Make sure workouts don't pour good money after bad. Some lenders continue "working out" loans when the borrower is beyond salvation. Ensuring this doesn't happen is critical.

  • Don't become too inward focused as you work problems out and anticipate more down the pike. Focus on the marketplace; many of your competitors will not remember to do so.

FUTURE OPPORTUNITIES

The news for the entire country, and especially for the financial sector, has not been encouraging lately. Things seem to be moving from bad to worse, and gloom is settling over industry participants and observers alike.

I have been accused of seeing a silver lining in every cloud, and I remain true to myself. These are indeed tough times, scary and uncertain times, yet it is precisely during such times that opportunity presents itself to the unorthodox thinkers who are not faint of heart.

The resurgence of the relationship lender. Non-depository institutions that have been eating our lunch for years are out of the market right now. Many are capital-depleted, others just gun-shy. Customers are realizing that lenders on whom they relied for funding are fair-weather friends. This also applies to some banks, typically the largest ones, who pull out entirely out of markets, only to return some time later, when borrowers are less distressed. This is a prime opportunity for the community banks to snag market share among credit-worthy borrowers who might have fallen on hard times. Often, these are solid borrowers, but the bank has pulled out of their sector in a wholesale fashion, and they were victims of that move.

Overall, banks are expecting to be more fairly compensated for the risk they are taking, which results in both better structures and, often, better pricing, for loans. Customers are also more willing to accept prepayment penalties and rate floors.

Community banks are well known for their relationship orientation and willingness to work with borrowers even when the going gets tough. This is a great time to remind your target prospects of this difference between you, the SuperCommunity Bank RM, and the "big guys" or the conduits.

Capital is king. Capital-rich banks have great opportunities to lend money profitably where capital-poor banks can't. The securitization markets died on a dime, leaving many borrowers (and lenders) high and dry. Loan yields have been expanding, with loan pricing rationalizing even if LIBOR-based. While the markets are still fiercely competitive, loan pricing and terms better reflects the risk embedded in various credits. C&I loan demand is as robust as it's been for years. Capital-rich banks, particularly risk-based capital, can capitalize upon their relative advantage and slightly widening margins by lending to credit-worthy borrowers and sweeping their operating accounts as well.

The willingness to hold loans on portfolio and the availability of risk-based capital to do so is a great advantage these days that should not be squandered.

Relationship Managers are more available and less expensive than 6-12 months ago. RMs were a pricy and scarce commodity only a couple of quarters ago. They expected large signing bonuses and could write their own ticket, flitting from one bank to another with promises of books of business to come. Now that many banks are pulling in their horns, especially the mega-banks, RMs are much more willing to move to a stable environment for a more reasonable price in many markets. It's a great time to hire talent, sometimes from banks that in the past did not lose a single banker. More people are open to conversations about job switching, and many large banks are releasing whole departments into the labor market. This is a great opportunity to scoop outstanding performers who were not available on the market for years.

Viable deposit gathering strategies exist. Merchant card can be a surprisingly a solid differentiator against small community banks, and a great way to gather deposits. In addition, it helps anchor commercial customers, including small business, to the bank, and, if you joint-call with a third party sales force, your RMs will learn a lot about effective sales too. Other deposit gathering strategies include specific industry segment focus. Among the most effective segments are property management firms, which are even better than HOAs, since they are the ones who often direct where the money the HOA gets should be invested.

Last, please don't forget core deposits when rates decline even further and wholesale funding becomes more attractive relative to core both in terms of cost as well as ease of access.

Acquisitions. Today acquisitions are for the brave banks who also have well equipped due diligent team. The risks are high, but so are the rewards. These times smack of the early '90s, the RTC and Southwest plan era, except that the bargains aren't as clear and the risks are higher. At the same time, banks with strong deposit bases are trading well below book, and distressed loans are selling at bargain basement prices. Opportunities (and duds) are abound.

Better controls. This is the time to improve internal controls, since receptivity to lower losses is at an all time high. Controls should not choke the sales forces and production teams, but can be used to continue prudent, credit-worthy loan growth. Many banks are finding C&I lending with double digit growth, which is exciting. With it, one might take the opportunity to implement measures such as:

  • Centralize appraisal review;

  • Limit the number of approved appraisers;

  • Refresh all appraisals more frequently (the regulators like that one a lot);

  • Add universal cash flow calculations to repayment schedules to reflect borrower cash flow from other sources.

Mortgages. Being a contrarian has often proved to be a winning strategy, and mortgage origination, a "dog" business with many dead bodies in its wake, might be among the opportunities that make you cringe yet can also make you much profit. As always, it all depends on effective execution and strategic scope. Mortgage originations within one's footprint might prove to be a good relationship-building strategy, especially when the number of lenders is dwindling, and even more so if your sales force is equipped with a valuable product bundle around the core mortgage.

In sum, 1Q08 earnings season has proven to be a depressing time, with 70% of the banking universe reporting earnings below expectations (which were downscaled in the first place). I hope the opportunities listed above might cheer you up a bit; we all know this, too, shall pass. What we don't know is how soon, and how many victims the storm will overtake. No one knows where the year will end up, but one thing is certain: opportunities present themselves under any economic scenario.