Banking in the Aftermath

Bank Director: Will the financial guidelines proposed by President Bush have any effect on banks’ bottom lines?

Nancy Bush: I don’t know at this point. But my assumption is that it is going to be ratcheted up a notch, and that is not a tremendously expensive process. So, no; I don’t think this is going to have an effect on the bottom line, except for those banks that would just as soon not know about their customers and, yes, I think there is going to be some pressure. But I think we are primarily talking about European banks.

Could this put a damper on some correspondent banking relationships?

Yes. They will have to be more careful about their correspondents.

But, in general, the effects would not be widespread?

No. Not the security aspects of what happened on Sept. 11, but if you are talking about the practical aspects, those will be quite widespread.

Do you think the security aspects will create any heightened liability for directors?

I have long been a believer that oversight of bank boards is pretty bad to start with, so I think there will be a heightened burden on directors to make sure their institutions know what they are doing; who they are dealing with.
What are the practical effects?

The whole industry now has not a clue what the next year is going to look like either from a credit quality or an earnings perspective. Nobody knows what originations are going to be. We knew it was going to be a slippery year to begin with in terms of consumer demand and possible recession. There is now an X factor that no one can really deal with.

What particular issues should directors focus on?

This is going to be a year, maybe the first year, when risk management is going to have to be the biggest focus of boards of directors everywhere, not just in the banking industry, but everywhere, but particularly in the banking industry.

Is that because we are in such an uncertain environment that you have to be ready for any unforeseen events?
Bank directors have always been loathe to look over management’s shoulder to the degree that they really should be. They have always been loathe to rock the boat. But you’ve got to rock the boat now, if you haven’t already.

Some boards of directors have already been tested, such as the New England banks. They got their wrists slapped pretty hard back in the late ’80s, early ’90s, and they tend to be more aware of these issues. But there are some that have just not been tested to the degree that the times require, and I think that’s coming up.

Do you think the financial guidelines and limitations that the Bush administration has imposed on banks, things like freezing assets, will have any effect on bank bottom lines?

Sean Ryan: No. I really don’t. We are talking about relatively modest sums in the overall scheme of things. I would be quite surprised to see any of them fall through to the bottom line.

Do they create heightened liabilities for bank directors?

I guess I wouldn’t be able to rule that out. In fact, intuitively, it wouldn’t surprise me if there were. But I just can’t give you a definitive answer.

Do you think the events of Sept. 11 will put us into a recession or heighten a recession?

In my opinion, the impact of the attack is not so much to dramatically change economic conditions as to bring perceptions in line with economic conditions, but this may be colored by my view prior to the 11th that we’ve been in a recession.

Certainly there is some economic deterioration that can be directly attributed to the attack, but I think it is relatively modest. Most of what we are seeing is people just ratcheting downward what had been unrealistic hopes of a second half turnaround.

That said, in the short run, you have banks coming out and acknowledging much more pervasive credit problems than they previously had. But I think a lot of those problems were there and were being swept under the rug or ignored in the hopes that a second half turnaround would bail them out. That not being the case, probably some of these guys were getting a little concerned and now, because of this exogenous factor, it’s an opportunity to cleanse your balance sheet, take a big hit and shift some of the blame for your mistakes onto Osama bin Laden.

Maybe that’s what FASB was worried about in their recent ruling? [Financial Accounting Standard Board, EITF issue 01-10: ruling on terrorist attack of Sept. 11, 2001, that those events were not an act of war and should not be itemized as a single, umbrella event.]

Right. At least as far as banks go, I think it is almost academic with regard to whether or not it is broken out explicitly as a nonrecurring item, because I think the natural tendency of most analysts is to take anything lumpy out of the numbers, even if it is properly regarded as an operating item. One example would be [the just announced] loan loss provisions at U.S. Bancorp.

Could this mean that people will take a harder look at the realities and that the excesses in the system could be wrung out more quickly?

I think that’s absolutely the case. In fact, two weeks ago, for the first time all year, we turned bullish on banks generally. And that’s really the reason. This now causes banks to clear the decks. We’ll have a quarter or two of more acute pain than anyone anticipated, but that will clear the decks for 2002. So banks will have a fairly clean slate just when nine months’ worth of rate cuts is working its way through the system. Then you will have this tsunami of liquidity that’s poised to start having an impact.

So you have that starting to hit in the first quarter, coupled with the other change: renewed vigor on the part of the Fed in cutting rates. I think perhaps the more significant thing is the shift in fiscal policy from being highly contractionary, as it has been for the past several of years, to nowu00e2u20ac”properly, given the economic circumstancesu00e2u20ac”being fairly expansionary. We haven’t seen that for quite some time. I think those things lend a lot of optimism for the economy in 2002 and, as a consequence, the banking system.

You put the buy out after Sept. 11?

Yes. It was on the Thursday following, so we missed the bottom by one day.

This was something you had been thinking about?

Actually, we had been pretty resolutely bearish all year long. It was in the week that the market was closed that we chewed on things and tried to figure out what the impact on the economy would be. Once we saw how sharply the market reacted, we felt like the market began to price in all the banks’ credit quality problems that it had been ignoring. This all happened at just the moment that changes in fiscal and monetary policy were bringing hope that things could be improving next year.

What is your timeframe for this?

I think we could see an actual economic rebound in the second or third quarter. And, with the market being a discounting mechanism, you would expect the banks to turn one or two quarters ahead of the overall economy. So we think there are some buys out there.

On a trading basis, we put out a note yesterday [Oct. 5] saying that we think that this bounce is a little bit overdone, so investors should hold off on putting on new positions or making new investments because they will probably find some more attractive entry points later in the fall. But even from these levelsu00e2u20ac”for the first time this yearu00e2u20ac”I think there are some pretty attractive values if you are looking out six or 12 or 18 months.

What are some of the top buys on your list?

In the credit card area, we are big fans of Capital One. In banks properly defined we are big fans
of Wells Fargo, BB&T [Corp.] and, actually, U.S. Bancorp.

What should bank directors do? Should they take the pain now?

Directors should be aggressive in taking the hit now, because you are not going to be singled out the way you normally would. You are going to be part of the group. You might as well take this opportunity. It is almost a free pass. Do whatever kind of clean-up you need and may have been putting off. You have the opportunity to lay the groundwork for very impressive earnings growth in 2002. By next year, if I am right generally about what will be happening in the economy, you will be very, very handsomely rewarded for posting clean, steady growth.

By the same token, you would not want to be late to take the hit, correct?

That’s right, because it goes to credibility. There is the old saw that every dog gets one bite. Just ball up all your problems into one big hit; take it, and move on with life.

But if you keep coming back … in fact, you can see it with Bank One. Few people enjoy as large a reservoir of goodwill as Jamie Dimon [chairman and CEO of Bank One]. He came in, took a big charge, wrote down 15% of Bank One’s equity, and people were glad to see him do it. The stock rallied. The last time he came to New York and announced a charge, there was a much more muted reaction to it and the beginning of some grumbling.

Even the most highly regarded manager doesn’t have unlimited capacity to keep coming back. At the same time, you can take a very mammoth one-time charge and have the market look past it, if it really is a nonrecurring thing.
So this is would be a time to recoup, regenerate and enjoy the rebound?

It’s been a lousy year and probably nothing you can do is going to make it a great year. So probably the best course of action is to spend the remainder of it healing and preparing for what could be a very strong 2002.

In this environment, are any changes in capital adequacy called for?

I think it is unlikely only because I think the problems are going to pass sooner than they did in the last cycle.

Last time we had a problem with real estate and, of course, that is a very sticky market and takes a long time to heal.

The problems now are on the consumer side, and historically the consumer has been much more quick to heal himself.

Is there any particular sector causing the problem or is this across the board?

Of course, telecom has been a long-standing bugaboo. Various segments of health care have caused banks problems. And now, of course, there is transportation.

I think the biggest single problem is the consumer, but even there, I think, there is nothing like the sort of concentration that banks had to deal with last time around.

The competitive environmentu00e2u20ac”as irrational as some of the things they are doing now areu00e2u20ac”has changed. You don’t have the hyper-irrational competitors, the thrifts that are going out of business, and the Japanese banks that were indifferent to return on capital, that were operating in the last cycle. These things just kind of poisoned the pricing and return environment for everyone. So, overall, it is healthier than we were last time around.

So there could be a silver lining, at least in the banking industry?

Yes. |BD|