Reflections Of A Steel City Banker

James Rohr, who in April retired as CEO of PNC Financial Services Group, has always seemed a little more folksy and unpretentious than his big-bank peers. Colleagues like to tell the story about the time he belly-rolled into the back seat of a rented bright-red minivan when the seatback failed to fold down.

“On Wall Street, no one would have even gotten into that car,” let alone do gymnastics in it, recalled William Demchak, 49, Rohr’s right-hand man for more than a decade and his replacement as CEO, in a 2008 interview. “Here’s the chairman. He’s not making anyone else do it; he’s doing it himself.”

What might have been lacking in flash has been compensated for by performance and growth. Pittsburgh-based PNC grew fourfold during Rohr’s 13 years at the helm, becoming the sixth-largest commercial bank in the country, with more than $300 billion in assets. It also avoided the worst of the financial crisis by steering clear of mortgages and fancy derivatives during the boom times.

Rohr’s landmark achievement, the $5.6-billion purchase of $145-billion asset National City Corp. at the height of the crisis, doubled PNC’s size and put an exclamation point on a tenure marked by seeming contradictions. Rohr was known for running a conservative lending shop, yet wasn’t afraid to ruffle feathers or take strategic risks that other bankers dared not consider.

In 2002, PNC received a cease-and-desist order from the Securities and Exchange Commission, which charged the company with accounting irregularities and misleading statements in connection with some off-balance-sheet entities. Rohr, believing PNC had done nothing wrong, pushed back- which only made things worse. “We argued with the regulators,” he said in 2008. “That was a mistake.”

Rohr somehow managed to turn lemons into lemonade, using that regulatory crackdown as a hammer for a complete cultural makeover. He recruited top-flight managers from outside of PNC-including Demchak, who came in as vice chairman in 2002 from JPMorgan Chase & Co.-introduced a stronger sales focus and solicited employee ideas to improve the place.

Emboldened by their successes, Rohr and his team bought Riggs National Corp. in 2005, confident they could clean up a money-laundering regulatory mess at the Washington, D.C.-based bank. A handful of smaller, but strategically important, troubled institutions were acquired in ensuing years. In 2008, Rohr was the only bidder left willing to take on Cleveland-based National City, which was teetering on the brink of failure with some $20 billion in bad mortgage loans.

PNC has proven adept at fixing what it buys. Nonperformers dropped from 2.85 percent of assets in 2009 to 1.68 percent in 2012, according to SNL Financial. PNC was profitable every year of the crisis, and is on pace to report record earnings this year.

Rohr, who is staying on as PNC’s executive chairman for one year to ease the transition, recently shared his thoughts with Bank Director magazine on everything from the National City deal and Dodd-Frank to the roles of government-sponsored giants Fannie Mae and Freddie Mac in the housing collapse and the future of banking.

You’ve been non-executive chairman for a couple months now. What’s changed since you relinquished the CEO role?
The office. They politely moved me from the 30th floor to the second floor. Bill [Demchak] actually asked me to stay on the executive floor, which was nice of him, but he’s the CEO now and I don’t want to interfere with his ability to do the job.

The National City acquisition was transformational for PNC and important to the industry. What do you remember most about it now?
(Former PNC director) Steve Thieke was in charge of risk for both the Federal Reserve and JPMorgan Chase & Co. before he joined our board. He’s a very conservative, risk-oriented fellow, as you might guess. When we were close to buying National City, he said, ‘You know, we’re in the middle of the worst recession since the Great Depression. We’ve had a housing collapse, a political uprising with a lot of regulatory change. And you’re proposing to buy a troubled bank larger than we are?’ And I said, ‘Yes.’ And he said, ‘Well, I just wanted to make sure you knew what you were doing. I’m with you.’

I recall you set up shop in the Cleveland hotel where National City’s board was meeting. Was it tense?
Actually, it was funny. They stuck our team in this private dining room in the restaurant. We presented a bid to Peter Raskind (National City’s CEO) and his team. They went upstairs to their board meeting. Hours went by and we didn’t know what had happened. We just sat there.

Finally, my cell phone rings, and Peter says, ‘Where are you?’ And I said, ‘We’re sitting in the same room that you left us in.’ And he said, ‘We were down there, and the restaurant is closed. There’s a grate down in front of the door.’ (He laughs.) It was 11 o’clock at night. We went outside, and sure enough the whole place was shut down. They had to get a guard to open things up.

What advice do you give to new directors?
You’re going to have to spend a lot of time reading. Boards have so many more inputs, both internal and external, to consider today. The press is far more influential than it was 15 years ago. Analysts are doing deep dives into your company all the time, comparing you to other banks. The regulatory presentations are entirely different and [examiners] actually sit in on committee meetings. And the external audit folks are more aggressive than they used to be. They don’t want to be held accountable for what goes wrong. It’s a lot more work being on a board than it was 15 years ago.

You were both chairman and CEO. What are your thoughts about separating the roles?
I just don’t think it’s necessary. At PNC, we have a very strong lead director (Thomas Usher, 70, former CEO of U.S. Steel Corp.) and a very independent board. If the lead independent director thought I needed to resign and the board agreed with him, I’d have been gone in a nanosecond.

Directors have an executive session after every board and committee meeting, so there is plenty of opportunity for them to talk about things among themselves.

Some people say a separate chairman affords better oversight.
If the board wants to learn more about a subject then the lead director has a responsibility to go to the chairman and CEO and say, ‘Make sure that happens.’ That’s what happens here. So there isn’t much difference. The alternative would be for the chairman to bypass the CEO and schedule his own meetings with managers. That would be dysfunctional. You’d have employees looking at two masters.

You hire the CEO to run the business. If you aren’t getting the kind of information or transparency you want from the CEO, then you need a new CEO.

How do you think history will judge the past decade?
The full review can’t be written yet, but a few things are obvious in hindsight. Fannie and Freddie went from $600 billion in assets during the 1990s to $7 trillion by the early 2000s. They were as big as the eight largest banks combined, and they were levered at 40-to-1. They took all of the profitability out of the basic mortgage business for banks. In response, many banks embraced a different risk profile, subprime, to try to compete. And from there we had subprime securitizations and all that.

At PNC, we couldn’t make any money in the basic mortgage business, and we didn’t want to go into subprime. So we sold our mortgage company in 2002 to Washington Mutual. We were fortunate. We could afford to do that because the mortgage company wasn’t a large percentage of the company. If you were Countryside or Washington Mutual, that wasn’t an option.

You must have felt shrewd as the crisis evolved.
In hindsight, having sold the mortgage business positioned us very well for the National City purchase. But at the time it was tough. We were criticized heavily in 2005 and 2006, because we weren’t growing loans as fast as everyone else. You have to look at the risk/reward in everything you do because that’s the business we’re in, and we weren’t comfortable with the risks.

Looking at the legislative and regulatory response to the crisis, what has worked and what hasn’t?
There are a lot of good parts to the Dodd-Frank Act. Everybody believed before the crisis that U.S. housing prices would continue to rise. Nobody was looking at the whole system and saying, ‘Look at this bet that everyone is making!’ So the fact that the Fed was named the systemic risk regulator was a great thing. It’s obvious we needed that.

If you look at AIG or Goldman Sachs, there was huge counterparty risk that could have caused a devastating ripple effect. So the idea that Dodd-Frank addresses that is very good. And back in those days the whole industry was wandering around with 4 percent capital. That clearly wasn’t enough for a downturn like we experienced. So we’ve doubled the capital ratios of the banks, which is a good thing from a safety and soundness point of view.

So many bankers hate Dodd-Frank. It sounds like you’re a fan.
Well, I haven’t finished yet. There are a lot of good things, and then there’s the overkill. Dodd-Frank requires almost 300 rulings and 100 studies, and carries an enormous amount of red tape. Whether it’s the Durbin amendment, or limitations on trading, or the multiple agencies that are working on what the mortgage business should look like, it’s an enormous amount of rulings. I hope at some time there is a reconciliation bill. We see it with legislation in other industries. Congress needs to sit down and say, clearly there are some things that could be streamlined.

The Troubled Asset Relief Program comes in for a lot of criticism. Your thoughts?
TARP is the most misunderstood thing in America. You had a major liquidity crisis, a lack of confidence in the marketplace, and the government came up with the idea for a capital investment in banks’ preferred stock. From that day forward the market was stable and improved. It worked very well, beyond belief.

Then people began calling it bailout money when the reality is that almost all of the banks have paid the money back, and the government has made tens of billions of dollars. At PNC they gave us $7.5 billion of TARP money. That money never left our checking account at the Federal Reserve, and we paid $460 million in dividends on it. Then we paid another $400 or $500 million for the warrants.

If you get away from the emotion of the word bailout, the Fed did a great thing. It stabilized the economy and made some money for the federal government in the process.

What about the Consumer Financial Protection Bureau?
Our relationship with the CFPB has been good so far, and there are definitely abuses in the system to be addressed. The problem is we have all these regulations for the banks, but no regulations for the nonbanks.

Cleveland, for example, was the most-foreclosed-upon city in the United States, and 80 percent of those foreclosed loans never touched a bank. They went straight from a broker to Fannie and Freddie. I think the CFPB has a responsibility to bring the nonbanks into regulatory compliance.

What about the government’s stress testing regime?
I think it’s terrific, because it forces people to think about risk. We were stress testing before it was required. The one thing I’m a little concerned about is that all of the banks want their models to be as close to the Fed’s as possible, so they don’t have to explain the large gap to shareholders when the results are published. But it’s important to model your own company. We shouldn’t have everyone only modeling the way the Fed models.

But isn’t the incentive to match the Fed’s model?
Yes, and you certainly have to understand the way the Fed is looking at capital so you can be compliant. When the results are published in the newspaper, you don’t want a big gap between yourself and the Fed that you have to spend the next three months explaining. But you also need stress tests that are different from the Fed’s, more company-specific. We don’t want everyone married to one model. At some point in the time, the model will be wrong and you don’t want everybody in the same bubble.

So a bank should conduct two stress tests-one for the Fed and another for itself?
Yes. I think so.

How about the Fed’s quantitative easing policy? What does the medium-term future hold?
There was a lot of concern about commercial real estate prices crashing following the residential real estate crash. That didn’t happen. Commercial real estate cash flows went down because of the recession, but most of those property owners were able to survive because their interest costs had fallen so much. The Fed’s reducing of the rates in QE1 basically kept Libor low. So QE1 was very beneficial.

QE2 was still beneficial, but it wasn’t as required because the cash flows had come back for commercial properties. I question QE3’s effectiveness, except for the people who are on their fifth round of mortgage refinancing.

Is there some big comeuppance waiting when interest rates rise? How do banks prepare?
We’re staying very short, because rates will go up some day. If you’re the owner of a 1 percent or 1.5 percent long bond, you’re not going to be happy with the holding. People say there’s a lot of risk in buying high-yielding bonds for prepayment, but there’s also a lot of risk in buying long-term low-yielding bonds where, if interest rates move up, you could find yourself in a bad place. So it’s important to understand the interest rate risk you take going out on that yield curve.

What keeps you awake at night?
The business is changing very rapidly, especially on the retail side. You’ve got more customers taking advantage of electronic products, and those products are evolving every day.

A number of the competitors are nonbanks, and they’re not regulated. The idea that a significant amount of the payments system is now being facilitated outside of the banking system makes it ripe for risk.

And cyber security is extremely important. We saw the president mention it in his State of the Union address, which is highly unusual. It shows how important the administration thinks it is.

I know PNC has been dealing with a lot of denial of service attacks. How does a smart bank board try to stay ahead of cyber risk?
Our people work very hard at it. We haven’t been shut down, but our server has been delayed a lot from time to time. The attacks are regular now. They’re not once a week or once a month. They’re regular, if not constant. They change. Different people do them.

One of the big concerns discussed at our board meetings is, what if one of these cyber attackers was able to take over a smaller bank and then enter a larger bank under that identity? We need to make sure we’re safe from that, too. The odd thing is, all of a sudden you’re not having a discussion about too-big-to-fail anymore. Instead, you start talking about ‘too-small-to-defend- yourself,’ because it requires resources to protect yourself.

Big picture, what will the industry look like in five years?
There will be a lot more electronic banking and fewer branches. We have this product where you can make a deposit by taking a picture of the check with your cell phone. We’ve got 15,000 items a day coming in, and it’s growing rapidly.

Branch transactions are declining, but 87 percent of our customers still want a multichannel distribution system. There are certain things, like a mortgage or private banking, where people want to sit down in a branch and talk to someone. But those things don’t happen every day, so they’re not coming in as often.

How does that impact PNC’s strategy?
We’re going to close 200 branches this year. We’ll build some in some new areas, so the density will go down and our footprint will expand a little. And we’ll continue to improve our ability to use technology to understand our customers.

Are we talking about employing CRM systems and the like?
Yes. You’re trying to use technology to duplicate the personalized relationship that a platform banker 50 years ago might have had with a customer. Back then, the small business guy used to come into the bank every day, and if he was a dry cleaner and had a lot of cash, he showed up three times a day. The tellers were his best friends; he would buy them Cokes and ice cream. The relationship was very unique.

Now, we have remote deposit machines in customers’ offices, and they come into the branch once a week instead of three times a day. That doesn’t mean it isn’t still important for us to know his or her business so that we can make suggestions about financing or different treasury management products. But we’re going to have to do it more electronically than face-to-face.

If you scroll forward five years, the segmentation and relationship-building that took place in a branch is going to happen electronically. We’ll have a relationship with the customer that’s just as warm and close as the teller used to have.

It’s a very exciting time to be in the financial services business, because there’s going to be a lot of change. If you’re participating in that change, it can be a lot of fun.