Phone Survey: Fiscal Cliff Will Impact Banks and Their Customers


fiscal-cliff.jpgAfter endless amounts of media coverage on the fiscal cliff, I felt it was time to hear from community bank chief executive officers.  Unlike the pundits on TV, community bankers work with small and medium-sized businesses that are driving economic growth and I thought it would be interesting to get a quick take on the fiscal cliff from the point of a view of community bankers. For instance, which will hurt bank customers the most: cuts in spending or tax increases? What are the chances that Congress and the president will reach a deal to avert the fiscal cliff before Jan. 1? How will the drastic cuts in spending and tax increases impact lending? What are the prospects for economic growth if a deal is reached?

The fiscal cliff refers to the series of automatic spending cuts and tax increases that will reduce the federal deficit by $503 billion in fiscal year 2012 to 2013, unless Congress comes up with a compromise to avoid the automatic cuts and tax increases, according to Council on Foreign Relations, a Washington, D.C.-based think tank. Half of the scheduled cuts would come from the defense budget. Some of the automatic tax increases include a reversal of the George W. Bush tax cuts, which would mean an increase in the top tax rate and higher capital gains and dividend taxes. Payroll taxes would also go back to prior year levels. The Congressional Budget Office has projected the automatic “cliff” could reduce the nation’s gross domestic product by 2.9 percent in the first six months, meaning unemployment would rise and the economy would likely fall into a double-dip recession, according to the nonpartisan Economic Policy Institute.

We conducted a phone poll Dec. 7 to Dec. 13 and got responses from 58 bank CEOs.

In our phone poll, CEOs expressed pessimism on the prospect of reaching a compromise before the deadline for automatic tax increases and spending cuts. Fifty-five percent of CEOs said they did not believe that Congress and the president would get a deal in place before the deadline.

Unsurprisingly, 66 percent of all CEOs thought the tax increases would be more detrimental to their customers than the spending cuts. Eighteen percent thought cuts would affect their customers more than tax increases.

On a happier note, if the fiscal cliff is averted and a compromise deal is reached with some tax increases and spending cuts, 57 percent of bank CEOs expected to see some economic growth while only 29 percent thought the economy would be stagnant with little growth.

While 67 percent of all bankers surveyed said they did not believe that “going off” the fiscal cliff would affect their lending activity, 31 percent said they thought the failure to reach a compromise would cause their bank to be less likely to lend.

Hopefully before the ball drops in Times Square, the folks in Washington won’t let the ball drop on the economy. 

The Mixed Blessing of Bank Deposits


mixed-blessing.jpgThe U.S. banking industry is drowning in deposits and that’s not necessarily a good thing. As of June 30, deposits in U.S. banks (but excluding credit unions) totaled $8.9 trillion, up nearly 8.5 percent from June 30, 2011, according to the Federal Deposit Insurance Corp. Total bank deposits have actually increased every year since 2003, although the increase from 2011 to 2012 was the sharpest jump over that time.

There’s no great mystery why this is happening. The U.S. economy’s uncertain outlook and a volatile stock market has led many consumers and businesses to park their investment funds in insured deposit accounts rather than risk losing a big chunk in another market meltdown. Normally banks would be quite happy to have a surfeit of low-cost deposit funding, but it’s actually something of a mixed blessing nowadays. Slack loan demand and low rates of return on investment securities like U.S. Treasuries, the latter a direct result of the Federal Reserve’s easy money policy in recent years that has kept interest rates low, are making it very difficult for banks to earn a decent return on all those deposits.

What makes this multi-year increase in deposits so interesting is that it has occurred at the same time banks have been closing branches and pruning their networks. As of June 30, according to the FDIC, there were 97,337 bank branches nationwide, down from a high of 99,550 in 2009, and there has been a consistent year-over-year decline since then. There’s no mystery why this is happening either. Two seminal events since 2010—new restrictions on overdraft charges and a cap on debit card fees—have taken a big bite out of the profitability of most retail banking operations and banks have responded by cutting costs, partly through layoffs but more so through branch closings. That deposit levels have continued to rise, even as the number of branches has declined, has no doubt made it easier for banks to trim their brick-and-mortar networks.

But here’s the rub. What happens if in a few years the U.S. economy makes a strong comeback and retail investors are once again confident enough to put their money into the stock market? Banks don’t have to compete with the stock market now for consumer funds, but they would in that scenario. Most banks have developed multi-channel distribution systems with the traditional branch as the hub and alternatives like automated teller machines, in-store branches, the Internet and more recently the mobile phone as spokes. And while remote channels like online and mobile have steadily grown in popularity in recent years, how effective will they be as deposit gathering tools if banks must once again compete for funds?

Here’s my best guess at what the future holds: Don’t be surprised if, say, five years from now the trend has reversed itself and banks are once again opening new branches.  It might be like a relic of days gone by, but a deposit war between Main Street and Wall Street would be just the thing to give the hoary old bank branch a new lease on life.

European Crisis: Should US Banks Be Concerned?


As Europe continues to experience a financial breakdown, there is no doubt that U.S. banks are and should be worried. All banks will be affected, although some more than others, depending on their relationship abroad. Business will be impacted in a number of ways, but according to the attorneys we polled, it’s not all bad.

Should boards at U.S. banks be concerned about the ongoing problems in Europe?

Sara-Lenet.jpgThe boards of U.S. banks that may be affected the most (such as banks that hold a significant amount of European debt, deal in Euros or otherwise engage in business in Europe or with European banks) should be particularly mindful of the situation. On the flipside, in some cases, the problems in Europe may actually open up new opportunities for U.S. banks, which are opportunities that boards of U.S. banks may want to consider. For instance, European banks may begin to lend less in the U.S. and focus on preserving capital and lending in their home countries, which would present increased lending opportunities to U.S. banks (including through loan syndications).

– Doug McClintock & Sara Lenet, Alston & Bird

dwight-smith.pngYes. On an immediate basis, the problems with the calculation of LIBOR will result in a different rate, although how that may be calculated is unclear. Since the rates on many commercial and consumer loans are based on LIBOR, any replacement will at a minimum complicate the lives of both borrowers and lenders. For lending going forward, a bank probably should not use a LIBOR-based rate and may want to consider whether to base lending on any standard rate. More broadly, on a macro basis, problems in Europe inevitably spill over into the United States.

Even though the spill-over seems unlikely to cause a second recession here, any resulting slow down necessarily will have an adverse effect on the U.S. banking industry—a phenomenon we are already experiencing. The macro consequences of the European problems are beyond the control of any bank, but on an individual basis, a U.S. bank should have a deep understanding of its European exposure. This would include not only any direct exposures, for example in the form of bonds, but also exposures to commercial borrowers that may depend to a material extent on their European businesses. A bank should re-visit the use of any foreign instruments that it may use for hedging purposes. The use of foreign exchange also may require more careful monitoring.

– Dwight Smith, Morrison Foerster

Chip-MacDonald.jpgOngoing problems in Europe affect U.S. monetary and fiscal policies, especially in a presidential election year. Concerns over Europe have led to an influx in foreign investment in U.S. Treasury securities as a safe haven investment. This has reduced yields upon Treasury instruments, and TIPs (Treasury Inflation Protected Securities) have even sold at negative rates. Lower Treasury rates adversely affect the yields on bank investment portfolios and compress margins on loans and other credit assets. This makes it more difficult for banks to generate returns on equity and funds available for dividends and repurchases of common stock. Current low interest policies may have created new systemic risks by encouraging investors to “reach” for higher yields in longer maturity securities with riskier credit quality.  

All directors should be concerned about current levels of interest rates, potential future inflation, and interest rate risks resulting from these policies driven by European and domestic U.S. concerns. The regulators are especially concerned about interest rate risks and their future effects on bank balance sheets and earnings.

– Chip MacDonald, Jones Day

john-bowman.pngYes. Boards of banks, regardless of asset size, must understand generally the business of their bank and the environment in which their bank operates. For example, it was not long ago that many bank directors had never heard of or made a subprime real estate loan. They quickly came to appreciate the many challenges to their banks that that loan product presented. The European Union is the largest trading partner of the U.S. Threats and the challenges presented by the second largest economy in the world (the combined economies of the euro zone) cannot and should not be ignored. Problems in Europe could have very real consequences for financial stability in the U.S. in areas such as employment and credit availability.

– John Bowman, Venable

Peter-Weinstock.jpgFortunately or unfortunately, the world in which we live is interconnected. What once appeared to be vast oceans now seem like small ponds (unless one is flying internationally in coach). With the current global economy, it is hard to avoid thinking of the Woody Allen quote, “More than any other time in history, mankind faces a crossroads. One path leads to despair and utter hopelessness; the other, to total extinction. Let us pray we have the wisdom to choose correctly.” Unfortunately, there are not many ways to inoculate our economy, and thus, the life blood of community banks from the contagion taking hold in Europe. Only if we as a country can get our own financial house in order will we be in a position not only to withstand, but to help the European economy to grow out of its problems.

– Peter Weinstock, Hunton & Williams

Nonaka_Michael.jpgObviously, boards at U.S. banks with European operations should pay close attention to country developments. However, boards at U.S. banks without European operations also should monitor Europe’s problems, because they have the potential for a major ripple effect if country initiatives are unsuccessful. A board should consider whether its bank has particular exposure to Europe and determine whether special contingency planning is necessary.

 —Jean Veta and Michael Nonaka, Covington & Burling

Is It Time For Bank Directors to Get A Raise?


Bank Director asked speakers at its upcoming Bank Executive & Board Compensation Conference November 5-6 in Chicago to answer a question lots of bank directors want to know: Is it time for a raise? Even if the industry’s financial performance is still lackluster, do bank directors deserve a raise?

Ed-Balderston.jpgYes, if performance is good.

Bank Directors deserve a raise if the bank performs benchmarked against industry peers. Performance should be an obvious consideration. The regulatory burden and expectations of serving as a director has exponentially increased. Regulators expect directors to be capable, competent, knowledgeable, engaged and responsible and they are increasingly held to those standards. Our performance is directly related to the economy which is a complex challenge for our industry. This demands more of our directors. Finally, regulation has diminished our revenue and increased our costs. All these things require directors who need to be compensated appropriately so banks can acquire and retain capable talent to represent shareholder interests and provide advice and counsel to management.

– Ed Balderston, former executive vice president and chief administrative officer, Susquehanna Bancshares, Inc., Lititz, PA


Yes.jim-bean.jpg

Director work load and risk has increased significantly as has the need for continuing education. 

– James C. Bean, Principal, McLagan, An Aon Hewitt Company


mike-blanchard.jpgIt depends.

I think the answer could be yes or no, depending on how current director compensation is positioned in the marketplace.  If a bank has a median market compensation (not too high or too low), I would recommend that the board should increase pay as the common philosophy is “pay for time” rather than pay for performance and many directors are working harder than ever in these tough times.  Of note, if the bank has frozen salaries for all employees or executive officers, I wouldn’t recommend the pay raise for the board, as it wouldn’t look good for the organization.

– Mike Blanchard, CEO, Blanchard Consulting Group


Daniel-Bockhorst.jpgIt depends.

Each compensation situation for bank directors is unique.  In general the expectations, involvement and liability of being a bank director has increased substantially over the last several years.  In order to attract high quality directors, the overall compensation package for a bank director needs to be commensurate with those responsibilities and expectations.  Bank directors need to be held accountable for a high level of engagement and should be compensated for that engagement.  

– Daniel E. Bockhorst, executive vice president and chief risk officer, CenterState Banks


Matt-Brei.jpg

It depends.

This question does not have a simple yes or no answer.  I certainly believe directors have seen their workload and responsibility increase in recent years and this may very well warrant a raise.  Market data trends in recent years have not shown an increase in director compensation, but I do believe we will see that change in the near future.  So, if the bank is performing at an adequate level and the directors have been working harder than in the past, I think it certainly might be time to give the directors a raise.

– Matt Brei, senior vice president and partner, Blanchard Consulting Group


Michael-Brittian.jpgIt depends.

While all corporate directors are facing increased responsibilities, the demands on bank directors have particularly escalated.  In light of the expanding requirements, the need for more diverse skills and expertise on boards has never been greater.  Meanwhile, surveys show director compensation at banks continues to lag other industries.  While financial performance and affordability are both important for banks to consider when evaluating director compensation, the following factors should also be assessed:

  • competitive positioning of director compensation against industry peers;
  • changes in board structure, such as the creation of a lead director position;
  • historical frequency of changes in director compensation at the company (many companies  consider changes to director compensation every 2-3 years); and
  • consistency with employee pay decisions (e.g., have employee salaries been frozen?)

– Michael W. Brittian, partner and senior consultant and Daniel Rodda, senior consultant, Meridian Compensation Partners LLC


Frank-Farnesi.jpgNo.

I hate to look at shareholders who have entrusted their ownership stakes to me and tell them I should be paid more as they see the value of their bank diminish.  Directors should feel the pain as shareholders. Perhaps rather than cash, perks or restricted stock (which is real economic value today), the best way to compensate directors for the added time is through option grants. At least through this, directors will make more only if the shareholders make more. It’s called alignment.

– Frank Farnesi, compensation committee chairman, Beneficial Mutual Bancorp Inc., Malvern, PA


Doug-Faucette.jpgIt depends.

Bank directors’ fees like everyone else’s compensation are driven by a number of factors. The first is performance of the director. If the director performs in a manner that enhances the operation of the bank and its profitability, then an increase may be in order. The second is performance of the bank. If the bank is performing favorably against its peers in meaningful ways, an increase is not unreasonable. However, if stock prices are at disappointing levels, it is not always effective to point to the bank’s or director’s above average performance. Stockholders in most cases will have the ability to vote against directors at least every three years.

– Douglas P. Faucette, partner, Locke Lorde LLP


It depends.

The answer is not an easy one.  Responsibilities for directors dealing with compliance requirements, time commitments and personal liability have significantly increased.  Recent studies suggest non-executive directors are not compensated adequately relative for their role. What is also clear is the expectations of directors have increased significantly and include a greater time commitment, exposure to legal liability and scrutiny by the public. Director pay is not simply an honorarium; it’s one the most difficult issues to assess.  For a director to deserve a raise, they should be able to answer “yes” to these questions:

  • Has the board performed a self-assessment as recommended by regulatory agencies?
  • Are all directors performing at a satisfactory level?
  • Is shareholder value increasing?
  • Have peer evaluations been conducted?

Finally, pay should be commensurate with the time and expertise required.  Shareholders should recognize that without qualified individuals, it is the company and eventually the other shareholders who will suffer.

– Flynt Gallagher, president, Meyer-Chatfield Compensation Advisors


Scott-Gallaway.jpgYes, with conditions.

There is certainly no question that bank directors are spending increasing amounts of time in the performance of their duties.  Most bank directors have a “day job” from which they take time to perform bank business, which creates an additional expense relative to lost time.  In addition to the time requirement is the potential risk of personal assets.  The short answer to the question is “yes,” but the reality is “not really.” The current environment makes it difficult to justify raises when the full-time employees are asked to sacrifice raises or additional benefits.  The bottom line is to improve performance, which will result in better financial footings, improved stockholder relations and conceivably more satisfied employees.

– W. Scott Gallaway, compensation committee chairman, Millington Savings Bank, Millington, NJ


Barbara-Jeremiah.jpgYes.

Directors’ compensation at any bank can only be evaluated against the specific performance of that bank.  The compensation committee needs to weigh both the performance of the bank for all of its stakeholders (shareholders, customers, employees and communities) and compensation for directors against market.  In difficult times like these, banks need to seek out the best talent when searching for a new director and can’t afford to be less competitive than other industries when searching for talented and experienced directors. While raises are probably not on the table this year, each committee needs to thoughtfully evaluate its package for directors each year.

– Barbara Jeremiah, compensation committee chairman, First Niagara Financial Group, Inc., Allison Park, PA


Dallas-Kayser.jpgYes, more challenges should mean more pay.

The overall financial performance of the industry is not the only determining factor when considering whether bank directors deserve raises.  Directors must work harder than ever to fulfill their duties in these times of shrinking margins, deteriorating asset quality, lackluster growth and increased government regulations.  Because of these challenges, assessing risks and creating policies responsive to those risks is increasingly difficult and now requires extra diligence and continual education.  Our shareholders deserve directors who commit the additional time, energy and effort to fulfill their fiduciary obligations.  Likewise, bank directors fully engaged to these tasks deserve to be fairly and adequately compensation for their effort and experience.

– Dallas Kayser, compensation committee chairman, City Holding Company, Point Pleasant, WV


Vincent-Manahan.jpgNo, pay should match the bank’s performance.

Industry performance good or bad should not be a major factor in setting director pay. Far more relevant is the performance of the director’s bank. The current climate for pay raises is negative because of generally lackluster industry performance. In a back drop of significantly increased regulatory burdens, director workload and responsibility, there is some justification for adjusting director pay to compensate for these factors. In the current industry situation however, it is my opinion that director pay increases should be undertaken with great reluctance and only after careful study. The optics of increased director pay in the current environment can be negative from an investor’s point of view.

– Vincent Manahan, compensation committee chairman, Investors Bancorp, Inc., Millburn, NJ


Yes – but don’t reward everyone equally.

Obviously, an involved director of any board will spend more time, energy and will be subject to more stress during times of adversity. However it is rare that all members share equally in the process of problem resolution. Therefore it is difficult to recommend blanket increases for all board members. How to financially recognize the ones heavily involved and critical to success would be a good topic of discussion.

– E. Lyle Miller, compensation committee chairman, Ouachita Independent Bank, Monroe, LA


John-Mitchell.jpgYes.

That would depend on the circumstances of the individual bank.  First, if the bank’s performance exceeded peers and met or exceeded expectations for return on equity, return on assets, adequate capital ratios, etc., a raise for directors might be in order if the directors’ compensation remained within its peer group.  Secondly, if the bank was having difficulty attracting qualified directors, a raise would most likely be in order unless the compensation was deemed unreasonable by best practices of the industry.  Thirdly, for individual directors who had certain expertise (i.e. financial experts) who carried additional responsibilities, an increase in compensation would be justified and prudent.  To base directors’ compensation solely on the industry’s overall performance would be counterproductive. 

– John Mitchell, compensation committee chairman, NBT Bancorp Inc., Ithaca, NY


Cathy-Nash.jpgYes.

Since the financial crisis, the role of a bank director has become increasingly demanding as the industry faces economic uncertainty and an expanded regulatory environment.  Bank directors must practice a delicate balance of executing their duties, while allowing bank management the latitude to do their jobs as experts in a complex, heavily regulated industry.  The progress an institution makes against its strategic objectives, combined with a strong link to long-term incentives, should also be factored into the decision.

– Cathy Nash, president and CEO, Citizens Republic Bancorp, Troy, MI


Susan-ODonnell.jpgIt depends.

Whether compensation should be “raised” depends on each bank’s current pay levels, program structure and unique requirements.  While the financial crisis brought several years of flat /modest increases, many banks recognized additional [board responsibilities] through increased retainers for board and committee chairs as well as meeting fees for key committees.  Public banks tended to make increases in the form of equity, to reinforce shareholder alignment.  With further regulations and a spotlight on the banking industry governance, we expect board pay will continue to evolve and increase to meet demands.

– Susan O’Donnell, managing partner, Pearl Meyer & Partners


Dave-Payne.jpgIt depends.

There is no one answer to the question of whether or not bank directors as a group deserve a raise in the present environment.  Treating all directors as a class would be manifestly unfair; each bank has faced different challenges and boards have reacted to these challenges in significantly different ways.

Pay raises need to be reviewed for boards while concentrating on the individual circumstances of each bank.  Pay raises need to be reviewed on a case-by-case situation to determine if the appropriate strategies and tactics were put into place.

– Dave Payne, senior vice president, Meyer Chatfield


Kent-Roberts.jpgMaybe.

I think bank directors are deserving of consideration for raises, even despite lackluster industry performance, based upon the increased workload and accountability board members are facing. Whether members of any particular bank board are deserving [of a raise] depends on the each bank’s unique circumstances, such as the bank’s long term shareholder return performance relative to peers, the bank’s status with regard to regulatory compliance issues and, of course, the current board member compensation relative to peers. So, the direct answer to your question is “maybe.”

– Kent L. Roberts, executive vice president and human resources director, Columbia Bank, Tacoma, WA


charles-schallioi.pngYes.

According to a recent survey performed by a well known executive search firm which used National Association of Corporate Directors data, bank directors in smaller publicly traded banks (market capitalization under $1 billion) are currently paid less on average than directors in other similarly sized public companies.  Given the greater responsibilities and regulatory requirements imposed on banks and bank directors, if we are to continue to attract the quality of directors we need, I do believe bank directors should be paid competitively with those in other public companies. Do we “deserve” it?  That’s more subject to personal opinion and a good topic for cocktail discussion!

– Charles Schalliol, compensation committee chairman, First Merchants Corporation, Indianapolis, IN


Tell us what you think in the comments section below.

What a Difference a Year Makes: Bank Executives’ Optimism Fades on the Economy


Bank executives are often in the unique position to get a first-hand view of their local economies, and if the most recent Bank Director and Grant Thornton LLP Bank Executive Survey is any indicator, they do not like what they see.  Only 28 percent of respondents expect an improvement in the local economy in the next six months compared to 44 percent at this time last year, and around twice as many respondents this year expect their local economy to get worse—13 percent compared to 6 percent last year.  The same trend holds true for the national economy with only 13 percent of respondents expecting an improvement compared to 39 percent last year.

The annual survey was emailed in June and July to CEOs, CFOs, and audit committee members from U.S. banks with more than $250 million in assets.  More than 170 bank executives completed the survey, which polled respondents on both the current state and future direction of the banking industry.

With the two year anniversary of the Dodd-Frank Act recently passed, the survey reveals that a slight majority of U.S. bank executives feel they are currently equipped to handle the increased compliance demands brought on by the historic legislation. Still, regulatory compliance burden is the number one concern among survey respondents for the second year in a row—94 percent this year compared to 91 percent last year.  Dorsey Baskin, a partner at Grant Thornton LLP, says that the 54 percent of respondents reporting they are equipped to handle the legislation to date are likely more concerned with the myriad of rules yet to be written.

Fortunately, bank executives as a whole appear to be preparing for whatever is to come.  Sixty-eight percent of respondents have strengthened their loan review procedures in the past 24 months, 59 percent have adopted an enterprise risk management structure, and 21 percent have hired a chief risk officer.  A full 78 percent of respondents are conducting stress testing on an ongoing basis, with 8 percent more expected to start this year.  Additionally, 33 percent of respondents are planning to hire additional staff and 21 percent are planning to hire an advisory firm to meet increased compliance demands. Only five percent of respondents have not begun planning for increased compliance demands.

In what might be attributed to hiring additional staff for compliance, 90 percent of executives expect the number of people they employ at their bank to increase or remain the same in the next six months compared to 85 percent last year. 

The increasingly pessimistic outlook on the economy might explain another chief concern of respondents this year, organic loan demand. Over 90 percent of respondents expect to find growth in organic loan origination in the future, but 67 percent list organic loan demand as a concern for their institution. Baskin says that even though bankers are currently seeing a demand for loans, they are rightly concerned with how long it will last and how far the economy will grow.  “A point might be made that contrary to all of the political discussions of loan growth and lending by the banking industry, the bankers don’t feel like they have enough loan growth opportunity,” says Baskin. “The bankers who are accused of not making loans are sitting here worried about not having loans to make, and that’s how they hope to grow.”  

While bank executives cannot be certain where the economy is headed, they do seem to agree on their presidential pick. When we asked respondents who they are supporting in the upcoming election, they chose Mitt Romney over Barack Obama by a wide margin—79 percent to 8 percent, with 13 percent undecided.   

For access to the full survey results, click here.

Bank stocks: “It’s really been a lost decade.”


audit12-hovde.jpgBank stocks rallied earlier this year but then faltered mid-year in the throng of worries about the European debt crisis.

“It’s really been a lost decade,’’ said Steve Hovde, the president and chief executive officer of The Hovde Group, an investment bank that focuses on  the financial services sector. He was speaking at Bank Director’s Bank Audit Committee Conference this month in Chicago.

Looking at bank stocks going back to 2007, when valuations reached their peak, the U.S. SNL Bank and Thrift index was down about 60 percent through May.

The current global outlook has put a good deal of pressure on bank stocks lately, as well. Even banks that don’t have exposure to European debt are feeling the heat, as the crisis will put a drag on the U.S. economy, Hovde said.  And a weak U.S. economy will do nothing for U.S. banks.

“Until we see a healthy economy, we’re not going to have a healthy banking sector,’’ he said. “Until we get employment back, the banking sector is going to have pressure.”

Housing

Housing still is a drag on the economy. Moody’s Analytics has predicted that home values, while improving in some markets, won’t return to pre-crisis levels until 2017. Home prices have lost about one-third of their value since hitting a peak in 2006, according to the Fiserv Case-Shiller composite index.

hovde-chart29.png

Profits

On the other hand, banks have been getting rid of bad loans and improving their balance sheets. On the credit side, net-charge offs of bad loans are declining, and tangible capital ratios are slowly being rebuilt, Hovde said.

Profitability has improved, as well, as banks reduced their loan loss provisions year-over-year in each of the past four quarters.

Return on average assets has risen to an average of 1 percent in the first quarter of 2012, up from .76 percent in the fourth quarter of last year, according to the Federal Deposit Insurance Corp.

M&A

A strengthening bank sector has led to slightly better deal pricing in mergers and acquisitions, but deal volume is still very low.

hovde-chart38.png

Uncertainty about commercial real estate and housing values still is hindering deals, as well as the fact that the stock of many buyers and sellers’ is trading below book value, Hovde said.

The glut of failed banks could also be putting a crimp on deals in some markets, and Hovde predicted that the Chicago area alone will probably have another 10 to 15 bank failures.  Nationwide, there were 403 banks with a Texas ratio greater than 100 percent as of March 31, according to SNL Financial LC. A Texas ratio greater than 100 is an indicator of potential failure. There were 59 banks with a Texas ratio greater than 300 percent, and 36 of them are in the Southeast.

Still, the pace of bank failures has slowed and many buyers are beginning to turn their focus to non-FDIC assisted deals, he said.

“With M&A I think we’ve probably hit the bottom and will probably see it pick up absent another global financial crisis,’’ Hovde said.

Lessons Learned from FDIC Lawsuits


As bank failures went on the rise after the crisis of 2008, so did lawsuits from the Federal Deposit Insurance Corp. The target of many of these lawsuits has been both the management of banks, but also independent directors, which can be a scary thought for anyone serving on a bank board today. So what can we learn from this moving forward? Based on the responses Bank Director received from lawyers across the country, the “best practices” today can still be summarized by the same timeless instructions: make sure your board is engaged, get a good directors and officers (D&O) insurance policy, and document, document, document!  

What is the most important lesson that bank boards should learn from the surge in FDIC lawsuits, and how should this be institutionalized in the form of a best practice?

William-Stern.jpgSome things never change, and it’s never too late to re-learn old lessons. Directors must remain independent, informed and involved in their institution’s affairs. It’s not enough to simply attend board meetings. Directors need to read materials provided by management, ask questions and actively participate in board discussions. And they should make sure their participation is accurately reflected in the minutes. Special care should be taken when considering transactions with insiders and affiliates, and directors should always require detailed presentations from management regarding steps to address regulatory criticisms raised in examinations or otherwise. In addition, professional advice and expertise should be sought when addressing complex issues or other out of the ordinary course matters, and fully documented when appropriate. 

—William Stern, Goodwin Procter

Gregory-Lyons.jpgGiven that the FDIC  has authorized lawsuits in a significant number of failed bank cases, directors are appropriately concerned about liability.  I continue to believe that ensuring fulfillment of the two underpinnings of the business judgment rule—the duty of loyalty and the duty of care—remain a director’s best defense against such actions.  The bank can help institutionalize that as a best practice by providing full board packages in a timely manner, strongly encouraging attendance at meetings, and making internal and external experts and counsel available to board members.

—Gregory Lyons, Debevoise & Plimpton

John-Gorman.jpgThere has been a surge in FDIC lawsuits because there has been a surge in bank failures and FDIC losses due to the financial market meltdown and the great recession. Perhaps the most important lessons for bank boards are that 1) capital is KING and 2) process is KING. Moreover, a board has to be diligent and honest in terms of assessing management performance and replacing management as needed. Finally, and as discussed above, a board’s fiduciary obligations require that adequate systems be in place to monitor compliance with laws, regulations and policies and that boards be informed and engaged and take action as necessary when red flags indicate issues or problems in certain areas. A cardinal sin in banking, which mirrors this fiduciary obligation, is to have regulatory violations repeated, i.e., uncorrected. Uncorrected violations are probably the single most cause of civil money penalties against banks and their boards.

—John Gorman, Luse Gorman

Douglas-McClintock.jpgFrom a legal standpoint, a best practice is threefold. First, maintain capital levels substantially higher than the minimum levels necessary to qualify as well-capitalized, even if it causes the bank’s return on equity (ROE) to suffer. Second, make sure that the bank’s charter and by-laws provide the maximum legal indemnification protection permitted under the applicable law, including providing for advancement of funds during litigation to defend the directors. And third, be sure to maintain an adequate directors and officers liability policy with no regulatory exclusion, so the insurance company has an obligation to defend FDIC claims. The only good protection from a storm surge such as this is a good wall of defenses and a plan of retreat!

—Doug McClintock, Alston + Bird

Victor-Cangelosi.jpgExcessive concentration of credit risk is a recurring theme in FDIC lawsuits.  Boards need to monitor on an ongoing basis significant credit risk concentrations, whether it be in type of loan, type of borrower, geographical concentration, etc.  Management reports to the board should address these and other concentration risks inherent in the institution’s loan portfolio.

—Victor Cangelosi, Kilpatrick Townsend

Mark-Nuccio.jpgDirectors should pay attention to their D&O insurance. All policies are not equal and the insurance markets are constantly evolving. Banks and their boards should consider involving experts in the negotiation of the policy terms and cost. Independent directors may want special counsel to be involved. Beyond paying attention to D&O insurance, directors need to pay more attention—pure and simple. The recent case brought by the FDIC against directors of Chicago-based defunct Broadway Bank criticizes the directors for not digging into lending policies or the details of lending relationships and deferring entirely to management. Documenting involvement is almost as important as the involvement itself.

—Mark Nuccio, Ropes & Gray

Twist This


america-money.jpgYour country needs you. Your country needs you to go into debt, that is.

Hoping to jumpstart a lackluster lending environment, the Federal Reserve recently announced “Operation Twist” to drive down long-term interest rates such as the 30-year fixed-rate mortgage while increasing short-term interest rates.

The idea, a much bigger replay of a 50-year economic program of the Federal Reserve during the Kennedy administration, is that the move will make long-term borrowing more attractive, which could encourage home buyers to buy homes and businesses to invest in job creation.  But will it?

Scott Brown, the chief economist and senior vice president for Raymond James & Associates, says the Federal Reserve’s $400 billion program of buying and selling U.S. Treasury securities is trying to get banks to lend more, possibly by squeezing the interest margins that banks depend on. This interest margin is the difference between the interest banks charge on loans and the interest they pay out for deposits. As their profits get squeezed, the banks could increase lending to make more money.

But will they?

“With banks in a much better position than they were three years ago, the Fed is betting that a flatter curve, and margin compression, will not cause undo strain, but instead lead them to make up the difference in loan volumes,’’ Brown writes in his weekly commentary. “We’ll see.”

The problem with such an approach is that there are few high-quality borrowers out there wanting to get loans, and the banks have worked hard to improve the credit quality of the assets on their books. The idea that they would stretch their underwriting guidelines to offer more loans is doubtful, and whether their regulators would even allow it is also doubtful.

What could really spur lending is for more high-quality borrowers to somehow come out of the woodwork looking for loans at record low interest rates. But many potential homebuyers can’t sell the homes they do have or take advantage of low rates to refinance as home values continue to decline. Freddie Mac announced this week that the average 30-year fixed-rate mortgage fell to a record low of 4.01 percent as of Sept. 29.

In contrast, the short-term, five-year adjustable -rate mortgage rate ticked up after the Sept. 21 announcement by the Federal Reserve from 2.99 percent to 3.01 percent. It has remained flat since then, according to Freddie Mac.

Whether all this will spur lending is another matter.

“We question whether this program can be successful because we believe the lack of borrowing and lending activity has more to do with other fundamental economic and regulatory conditions than it does with interest rates,’’ writes G. David MacEwen, chief investment officer of fixed income for American Century Investments.

He goes on to describe the Federal Reserve’s toolbox as “nearly empty.”

It may be that the Federal Reserve is in the same boat as the Obama administration: there’s not that much more it can do to incentivize a reluctant and hobbled private sector. The government would like you to borrow, but will you?

 

Why bank stocks are performing so badly


You can almost hear the wind come out of the recovery.

John Duffy, the chairman and CEO of investment bank Keefe, Bruyette & Woods gave his update on the state of the banking industry at Bank Director’s Bank Audit Committee conference in Chicago June 14, and it wasn’t a pretty picture.

As of early June, the recovery in bank stocks has stalled. This, despite the fact that 63 percent of bank stocks tracked by KBW beat analyst expectations in the first quarter.

kbw-recovery.png

That’s quite a change from the depths of the recession, when 73 percent of banks missed analyst expectations, back in the fourth quarter of 2008.

“I think there is some credibility being established between analysts and bank management, but unfortunately, the economic news is not always good,’’ Duffy said.

Credit quality has improved but non-performing assets still are high. Deposit growth has slowed dramatically. And even the biggest banks, which were more aggressive than the regional banks in terms of provisioning for bad loans, don’t have much room for growth.

“As you shrink the balance sheet, it’s hard to replace those assets,’’ Duffy said. “I think a lot of the optimists have now gone to the sidelines and are less convinced that the economic recovery is going to continue and that obviously has implications for loan volume in the banking industry as well as credit quality.”

Duffy said bank stock analysts are probably going to be focused on the fact that net new non-accruing loans (non-performing loans whose repayment is doubtful) rose in the first quarter for the first time in six quarters.

With all the loan problems and regulatory pressure, investment bankers such as John Duffy, who depend on M&A as their bread and butter, having been predicting a coming wave of consolidation.  It hasn’t happened yet.

With just 60 traditional, non-FDIC-assisted acquisitions this year through June 3, valued at about $3 billion in total, Duffy said he thinks it’s been difficult to raise capital, especially for banks below $1 billion in assets. Plus, there’s a lack of potentially healthy buyers in regions with a lot of hard-hit banks.

“We should think there are at least a couple hundred banks that are not going to make it,’’ he said. “For the banks that are healthy, we continue to think this remains a real opportunity.”