Give heed to my sighing.
Listen to the sound of my cry
–Psalm 5
David’s lament is appropriate given the trials today’s Gonzo Bankers are going through. There is no shortage of significant concerns on the minds in the corner offices of today’s c-level banking executives. Every week more banks are failing. In spite of the market rally, the economy is stagnant at best, and there is talk that commercial real estate may be the other size 13 headed for the linoleum. If you’re feeling a bit more stressed than ever before, GonzoBankers, it’s for good reason. Let me take through a quick, random tour of the items causing the stomach to turn and the hair to gray.
To understand the magnitude of bank troubles, resources other than the mainstream media are required. In spite of the fact that there have been more bank failures than cases of swine flu, the pesky virus is getting all the press. The best source these days for what’s really going on in banking are the OCC and Federal Reserve Board’s email notifications of enforcement actions. These tiny documents generate more gossipy-scoop than TMZ on celebrity-overdose day.
Keeping the wolves at bayTo avoid one of these Written Agreements with your “regulatory partners,” it is important to stay below the FDIC’s radar. With the FDIC’s Troubled Bank list growing from 252 in February, 305 in May, to over 400 now, we fully expect these agreements to continue populating our inboxes at a steady rate. The reasons behind the increasing rate of bank failures are numerous but mostly related to insufficient capital and bleak earnings future as impacted by:
There are a few basic types of enforcement actions that are making the rounds lately. Let’s cover these first and then offer some advice on how to avoid being roadkill in this stressful banking environment.
“Arriba, arriba, ándale, ándale!” –Speedy GonzalesOne type of enforcement action is the Prompt Corrective Action. Once the asleep-at-the-wheel regulators awaken, their orders are to “raise capital or sell yourself.” Unfortunately, selling shares with a public PCA on the street is harder than Kanye West trying to sell a country song. Along with this type of action comes a heavy-handed approach to managing your bank.
Another common enforcement action is the Written Agreement. The main points of most written agreements are to:
In these types of agreements, the feds have complete control over your use of capital.
Sometimes within these written agreements are suggestions for:
All pretty standard blocking and tackling that for some reason came unwound during either the last round of management succession or as a by-product of letting the loan production guys run the bank.
Lastly, we are still seeing the old “You screwed up flood insurance tracking again and now we’re gonna fine ya’” flavor of enforcement action.
The good news is the fines peaked in 2007. The bad news is these are still occurring, and when the federalies catch their breath from a credit quality focus, they’ll be all over this again.
FREE ADVICE: Avoiding this type of flood insurance related enforcement action and associated fine is easy. If your operations can’t get this right, I suggest changing your real estate target market to only include locations in the Mojave Desert so you don’t have to worry about it. Alternatively, you could outsource this to an insurance tracking vendor. Depending on your loan portfolio size, geography and propensity for annihilation (Hurricane Alley Florida and Below-Sea-Level New Orleans are not good candidates), the insurance companies may track your loans for free if you move the associated premium business to them. Since you have to pay the premiums anyway, it’s almost like you get insurance tracking for free.
Steering clear of the other enforcement actions based on weak earnings and capital impairments requires a bit more work but we know you Gonzomongers are up to the task.
Possibly the only thing that is going to rise faster than interest rates is the national debt. Even if banks have been somewhat successful in converting to more adjustable rate loans, there is still a good slice of the portfolio that for the past three years has been priced when the fed funds rate has been below 4 percent.
As this chart muddily shows, that 50th percentile of net interest margin has dropped from just above a 4.06 margin in 2007 to 3.76 in 2009, a drop-off of 7 percent. On the fringes the reduction in NIM was almost 25%. This ship don’t turn real quick so that top line driver will be under pressure for a while.
Speaking of low interest rates, I thought I was technically savvy but even I did not know core systems could actually calculate and print a savings account rate of 0.00001%. Consumers won’t put up with this for long when Bernanke starts tapping the brakes and raising interest rates to slow down this runaway train of economic growth. My guess is you have a couple of weeks at best to worry about it. We’ll see who can survive at a 2.75 margin when the 20th percentile becomes the new norm.
While there is nothing you can do to control the interest environment, you do have influence over your spread. If you don’t have an ALCO in place you are already under an enforcement action so I won’t speak to that. Some improvements you can make are:
Speaking of compensating balances, if your core system or other covenant tracking system does not automatically monitor the relationship between loan pricing and relationship deposits, put somebody on this. Finding just two or three deals a quarter to clean up will pay for their efforts.
Loan portfolios of all kinds are dragging down earnings because those darn borrowers won’t pay us back. Of course it’s not their fault. How were they supposed to know the credit crunch was coming? Last they checked, the mailbox was still full of card offers and the ATM in the kitchen was still pumping out equity cash.
When we look at the percent of non-current loans and leases by loan type for the bottom 20% of banks with credit quality issues, the only place we didn’t see a triple digit percentage increase in non-accruals from June 2008 to June 2009 was Consumer Real Estate and Single and Multifamily Mortgages.
While it is clear that construction lending had a bad ’07 to ’08 comparison and it still looks bad in ’08 to ’09, we all know this. What is most concerning about this data is that the last two categories, non-farm non-real estate (a.k.a. C&I), have had some of the worst deterioration of any category. So forget about Commercial RE being the only cause of the double dip. It looks like operating lines are tanking, which makes sense in the big ecoNOmic cycle. Consumer NO spend, company NO cash, bank NO repayment.
These C&I loans are the types of deals that most community banks have been targeting in recent years to replace commercial real estate. It takes a different set of skills and monitoring to manage this portfolio. Given this deterioration spike, the main strategy that you want in place is known as the six F’s:
Frequent and Frank conversations with borrowers about their current Fiscal situation and their Forecast for Future Financial performance. These are the relationship deals the head of commercial sold you on. It’s hard to maintain a relationship without constant dialogue, or so my wife told me when we talked over Labor Day weekend.
We earn money the old-fashioned way … … snake oilWhile it’s no secret that bank earnings are in the tank, even the very large financial institutions are resorting to early Halloween trickery to artificially inflate 3Q earnings. On the last day of the quarter, BofA sold the Stock and Bond Mutual Fund business of its subsidiary, Columbia Management, for about a billion dollars, and Wells Fargo sold $1.2B of Campbell Soup Stock. This is the equivalent of me hocking my CD collection to cover this month’s rent and it begs the questions:
Most community banks don’t have such a portfolio of non-core businesses or large investments to offload in time of need, so the one-time adjustments are limited to accounting changes. And the Financial Accounting Standards Board is sitting tight after the fair-value, mark-to-market changes. So what is the future expectation on revenue?
After spitting in the punch bowl of credit cards, the too-big-to-fail-but-we-ought-to-let-them-anyway banks are on the verge of screwing up overdraft fees for everybody. Now that Senator Christopher Dodd (D-Conn.) has the Credit Card Act of 2009 under his belt, his sights are set on overdraft fees and interchange income. The large credit card issuers side-stepped a lot of the Card Act of 2009 negative impact by going ahead and jacking up rates before the law takes affect. But don’t worry, Reps. Barney Fife-Frank and Carolyn Phony-Baloney-Maloney are on it now with a bill to move the effective date up to December from February.
Many national and super-regional banks, in an effort to head off the aforementioned OD legislation, are “proactively” reducing the overdraft penalties to consumers. They are limiting the number of items charged per day, not charging at all for ODs under five bucks, and – shock of all shocks – moving away from high-to-low and towards chronological posting. I guess when you’ve got a multi-billion dollar red-white-and-blue lifeline, you can string it across the highway and clothesline the competition. This will kill the profitability of the courtesy pay program for community banks. Overdraft fee income has been one of the primary drivers of bank earnings for a decade now. That gravy train is on its last run. We should be preparing our systems now for two legislative actions.
Interchange income is going to get creamed from both sides. GovCo is looking to cap the fees merchants pay for card acceptance, and the card associations are trying to satisfy Wall Street. Unless the bank bought some Visa or MasterCard stock at the Initial Public Offering , don’t look for their recent increases in micro-fees associated with processing to do you any favors. Add to this the impact of the migration of transactions from credit to lower interchange-paying debit transactions, and further migration of signature debit to even lower interchange-paying PIN debit, and it really is a perfect storm. The only way to try to mitigate this storm is to take the following actions:
I once had an employee ask for a three month advance on his paycheck so he could catch up on his mortgage. When I ask him how he was going to eat in Months 2 and 3, that old Bambi in the grilled halogens look is what I got in return. The good Brother Hodge covered the FDIC’s equivalent position in his GonzoBanker article a few weeks ago so I won’t rehash that here. Suffice it to say that even though this round may not adversely affect earnings today, the door is still wide open for future impacts.
Executive CompensationBecause GovCo owns good chunks of banks, GovCo thinks it should have a say in how and how much bank execs should get paid. This not only will affect execs at TARP banks but the entire industry. I thought that’s what boards were for. And I thought shareholders elected boards. And I thought being a shareholder was voluntary. Maybe the silver-lining, glass-half-full perspective is that this will trim non-interest expense. Or maybe just run talent off to other, more lucrative industries. Like Senate-seat recruiting… In Illinois…
In closing, I apologize for the downbeat assessment, but looking on the bright-side, well… … …there is no bright side. Cheers.
-mc
I’m waitin’, waitin’ on a sunny day
Gonna chase the clouds away
Waitin’ on a sunny day
–Bruce Springsteen
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