How Has Banking Changed

8/14/2019 How Has Banking Changed

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changes." Ely predicts that 2009, whenCongress is expected to consider the finan-cial regulatory system, will turn out to bethe most significant legislative year forbanking since the 1930s.What bankers have been watching inrecent weeks "is shaping up to be worsethan the S&L crisis," says Nicholas J.Ketcha, Jr., principal now at consultancyFinPro, Inc., Liberty Corner, N.J., andpreviously director of the N.J. Divisionof Banks, and FD IC Director of Supervi-sion. "This is going to be the biggestdownturn in the economy in a while,"continues Ketcha, and comes down to aliquidity-eroding crisis of confidence.How'd we get here?The blame game is something that Con-gress will spend much time on, in themonths and years ahead. It could beargued that we all own a piece of some-thing that became mevitable; an economythat was 70% driven by consumer spend-ing coupled with a fair amount of irre-sponsible borrowing and lending, withpeople often living beyond their means,was headed for trouble.

"This is a matter of people goingwhere they thought they would findmoney," for what have you, says a long-time observer of the credit scene.Hom eow nership is one example:"We've got the notion in the U.S. thateveryone needs to own a home," saysthe veteran, preferring not to be quotedby name. While such societal attitudesplay a part, so do some structural issues.The panorama of companies that lendmoney in modern America is wide, butone factor used to be fairly commonamong the players: the lending officerwho found a loan evaluated the loan, and,after other officers or committees passedon it, lived with the loan.Increasingly, those roles have beenbusted apart, both internally and exter-nally. Think of internal "silos." Think ofsecuritization. Think of loan brokers ver-sus loan officers."That was a waters hed event,"observes Edward T. O'Leary, bankingconsultant and former banker, and ABABanking]oHYnal\ "Talking Credit" blog-master. "The guys who are making thedeals today are not the guys who fully

understand the deals."This evolution occurred for all kindof reasons, including the metamorphosof many banks into sales-oriented orgaizations. O'Lear)''s point is that once throles of hunter and analyst break aparthere is a tendency in good times not tlisten too closely to the analyst.The flip side has been that witmcreasing specialization, lending organzations lost internal cross-pollination."The best loan review guys," foinstance, says O'Leary, with over 4years in credit experience, "are the guywho have actually loaned money."In many organizations the front-enlender isn't performing credit judgmensays Barksdale, but is simply gatherinitems on a checklist that will be bundlefor backshop troops to make sense of.

What's your lender up to?Another factor is Kick of experiencWhile most community banks, evethose with significant exposure to commercial real estate lending, don't appeato be in serious trouble at this poinbanking has seen a shrinkage in its activ

SnapshotThe few, the proudy the banks that can raise capitalA lthough capital adequacy remained the central focus ofthe banking industry, the pace of underwritten publiciifterings nearly fell off a cliff in the third quarter.Banks and thrifts faced a hostile environment in which tobrmg an issue to market. With the trust-preferred securitiesmarket closed to all but a few large institutions and the debtmarkets in deep turmoil, most banks and thrifts issued pre-

ferred and common stock to raise capital.Thomas Killian, a principal at Sandier O'Neill & PartnersLP, said that three different types of banks and thrifts can tapthe markets in this environment. The firsttype IS a company with relatively strongcredit quality that looks to raise oppor-tunistic capital, which Killian said wouldenjoy the best reception in the market.Companies with credit quality chal-lenges arising from their geographic loca-tion or particular types of ending arc thesecond possible issuer in this market, Kil-lian said.Killian said the othe r companies raisingcapital arc small banks that might have

such as notable losses arising from construction and devel-opment loans, that need to fill a small capital hole, oftenachieved through private placements. He said those compa-nies can no longer access the trust-preferred market, andtheir capital raises are not large enough to attract maji>r pri-vate equity firms."I think that's where you might see smaller common equi-ty deals being done. And we're seeing more of those everyday," Killian told SNL. Nathan Stovall. senior industry editor nstovallC'snl.comCapital raised by banks and thrifts, by quarter

Comnwn stock B Preferred stodt H Tnnt-preferred stock

Q2 2008 Q4 2008


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experience base in credit."In my 40-year eareer in banking, howyou analyze credits, structure loans, thathasn't changed," says Thomas A. Brack-en, regional president at TriState CapitalBank, a $750 million-assets de novo serv-ing muhiple states from Pittsburgh, Pa.,and satellite offices. Many of the tech-niquesobtaining guaranties, and such-remain cons tan t , l ike bas ic indus t r ia lprocesses. The only significant change inthose building blocks has been that moreIS done using technology, he notes.

"T h e b a s i c s a r e t h e b a s i c s , " s a y sBracken. "So if you stuck to that , youprobably have a limited amount of pain."However, something that has changedis the age and sophistication of front-linelenders. "Unfortunately," says Bracken,"tbere aren't a lot of veterans left."

This can lead to some significant laps-New on ababj.comUnderstanding the"Digital Native"

"Digital natives," also referred to asthe Millennials, Generation-Ts, or LateGen Ys, comprise the segment of thepopulation born after 1985. The dif-ference between the digital native and"digita l immigrants"those born priorto 1985is that the digita l native hasgrown (or is growing) up immersed intechnology, while digita l immigrantsdid not grow up with it. Digitalnatives do not refer to a "digital cam-e r a , " they simply call it a "camera."(What's "film"?). Text messaging istheir preferred communication.

Author Dan Fisher, head of consult-ing firm The Copper River Group,explores the unique characteristics ofthis emerging segment both from theperspective of bank customers andbank employees on www.ababj.com(under "Exclus ives"). As he writes,they are accustomed to speed, graph-i c s , flat panels, and games, and arenot inclined to sit in a training roomand endure hours of PowerPoints.

Fisher suggest bankers attend theConsumer Electronics Show in LasVegas (usually in January) to get abetter understanding of digital natives.

"There's a real turn off on securitization.for a wh ile. The se lf-correctingmechanisms d idn 't seem to kick in asquickly as they should have."Securitization allowed lenders to"pass the buck" on credit problems Be rt Ely, Ely & Co.

e s . One example i s the r eve la t ion , tosome younger front liners, that collateralvalues not only rise, but fall. Another, hecontinues, is why covenants are part ofcommercial loan contracts to begin with.

"Veteran bankers know that covenantsare one of the m ost im portan t factors in aloan contract," says Bracken. Covenantsserve as an early warning system; as theyare brok en , a savvy lender kno ws i t 'stime to talkor act.Younger players "are getting a master 'sdegree in a matter of mo nths ," he says.E d O ' L e a r y w o r r i e s a b o u t t h a tprocess, because of its impact on thesebankers' future efforts. Loan officers in

their 30s are in their "formative years,"according to O'Leary. Those who makeit through the current periodespeciallyi f commerc ia l r ea l e s ta te lending andother asset types follow the curve takenby residential lendingwill be formingvery conservative attitudes. O'Leary sayssuch attitudes have a way of hanging oneven after things turn around.For now, that is a remoter r isk thanothers. Indeed, consultant Nick Ketchanotes that one message his f irm keepsstressing to community banks is not tob e t e m p te d i n b a d d i r e c t i o n s b y t h egrowth of small business borrowers whowant to shift to their institutions."We've cautioned them not to grab atbus iness , " says Ke tcha . "This i s no t at i m e to b e c o m p l a c e n t , o r t h i n k i n g ,'We're isolated, ' or, 'We're removed fromw h a t ' s g o in g o n . ' W e e x p e c t t o s e espillovers of trouble in all parts of thebanking business."Securitization, hero turned villainSecuritization accomplished financial mir-acles for a good part of its history. Butthen it became a big part of the problem.

risk off to anybody, and even if they dithe risk came back," says David D. Gib o n s , s p e c i a l a d v i s e r t o P r o mo n to rFinancial Group, LLC, Washington, anformer Deputy Comptroller of the Curency for Credit Risk. Regulators and thindus t ry s t ruggled for yea r s wi th thissue of recourse, and some of that effobecame moot in the event.

"The separation of an actor from thconsequences of his action is a recipe fpathology in every other human endeaor," says Randal Quarles, "so there's nreason to think credit organizations aany different." Quarles is managing diretor. The Carlylc Grou p, Washington, D.CAs the securit ization engines repacaged debt and risk, leverage was piled oleverage."It was bad," says Quarles. The riswere spread, and broadly. "But it was lika manure spreader, if you will."T h e g o v e r n me n t c o n s e r v a to r s h ip oFannie Mac and Freddie Mac cast a paover the granddaddy of securitization, thsecondary residentia l mortgage markeEly doesn't see "normality" returning securitization markets for several years."There's a real turnoff on securitizt ion, for a while ," says Ely. "The selcor rec t ing mechanisms d idn ' t seem kick in as quickly as they should haveSecurit ization allowed lenders to "pathe buck on credit problems," says ElH e s u g g e s t s t h a t c o v e r e d b o n dexplained in detail in last month's Brieing (p. 12), have the potential for displacing much of the need for securitizatioHe observes that covered bonds are moefficient than securitization.Other observers point out that som

means of providing liquidity to the morgage markets must be found. As homebegin to move again, there will be a nee


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BANKING 2.0: CREDIT contnuedfrom page 10for capital to fund them, without tyingup lender balance sheets."Simply going back to only portfoliolending will not be good for the homebuyer," says Jo Ann S. Barefoot, principalat Jo Ann Barefoot & Co., Defiance, Oh io.Securitization changed the dynamic ofbig portions of the credit granting business,says Quarles. Securitization increased thepools of capital available for many activitiesand provided more robust support for eco-nomic activity, he says. "Those were realbenefits that are worth preserving, as we goforward." But it is essential some form ofaccountability be considered.Changes in the wo rksObservers think that some areas of lend-ing will change more, in the months andyears to come, than others. The contro-versy over the degree to which the Com-munity Reinvestment Act played a partin current conditions, to be treated in a

subsequent part of the "Banking 2.0"series, will have its own resolution.Credit consultant Ed O 'Leary suggeststhere will be both temporary shifts inattitude and practice, and more structuralshifts. It may be some time before itbecomes clear which is which.To a degree, at least in the short term,lenders are going to retreat to the triedand proven techniques that they wereweaned on ."This is truly a back-to-basics timeand that's good," says Ed O'Leary. "Buta lot of people are going to get squeezedout." To a degree, he argues, back tobasics means hewing more to the strictview of things, with somewhat less flexi-bility for the out of the ordinary, the bor-derline, the not-quite-there credit."This is a time for careful analysis anda close review of the bank's risk toler-ances," says FinPro's Nick Ketcha. "I canguarantee you that that's the marchmgorders that examiners are getting."

O'Leary sees this return to consevatism affecting both commercial anconsumer credit types. To a degrethough, he says, "the consumer markwill tend to wag the dog."In extreme cases, some banks may finthat their best short-term strategy is shrink the bank, says O'Leary. This wpreserve capital, and help bring capitratios in line with regulatory requirments. The jury is still out on whethsmaller banks will make use of any of tfederal efforts to inject capital into tbanking system.As Congress examines the ongoicontroversies in banking next year, ilikely that regulators will come in ftheir share of bashing. When made inscapegoats, says O'Leary, they will reaby coming down harder on the instittions that they regulate.Regulatory at t i tudeGoing forward, there's a matter of ho

Both the product prospectus and under ly ing fund prospectuses ca n b e o b t a i n e d b y w r i t i n g t o N a t i o n w i dI n s u r a n c e C o m p a n y , P .O. Bo x 1 8 2 0 2 1 , C o l u m b u s , OH 4 3 2 1 6 - 20 2 1 . Linccostis0 75% in New York, ihebenetlts ano cost may varconiinu ation is an additional cost. AvailaDie w ith certain N ationw ide variable annuities. When evaluating the purchase ot a variable annuity, your clients saware that variable annuities ere long-term investment vehicles designed tor retirem ent purposes and w ill fluctuate in value, annuities have lim itations; and


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m u c h r o o m o r r o p e , d e p e n d i n g onone's starting pointthe banking regula-tors will grant the organization. A rela-tively permissive period has just come toan end, with a jerk.

Promontory's David Gibbons notes thatin the period before the crisis, some regula-tors clearly believed that something b.ulw a s c o m i n g , if t r e nds t he y saw w e n tunchecked and unlimited. But it t ook along, long time, he points out, for any for-mal action to come out, in interagencyform. In the meantime, top regulators jaw-boned in this or that forum, hoping to puttheir point across through oratory. Thiswas seen in the areas of nontraditional andexotic mortgage mstruments, home equitylines, and co mmercial real estate, notably.

A n d w h e n i n t e r a g e n c y d o c u m e n t swere i ssued , wha t came out w e r e notrules and regulations, but "guidance."

F o r G ibbons pa r t , he w o n d e r s howthings might have turned out if regulatorshad shut some forms of lending down

Ripple effects from current loanissues are a concern."We are actually not out of thewoods on this"

David Gibbons,Promontory FinancialGroup LLCtw o or three years ago.Going forward. Gibbons expects thatregulators will tend to be more countercyclical with credit than ever. They willhave to be, if, playing off a 1980s regula-tor 's statement, they are to be able to takea w a y the punc hbow l be f o r e som e onedrowns themselves in it.

"You need to have regulations withsome supervisory teeth," says Gibbons.This is not something he feels the system

currently has.Analyst Bert Ely sees the regula tor s '

task becoming wider anddeeper, with theo u t c o m e ot congress iona l inqui ry andtheir own revisiting of their role resultingin major regulatory restructur ing. Thiswill not only affect who regulates whom,but wha t is regulated. Such unregulatedc r e a t u r e s as h e d g e f u n d s and c r e d i tdefault swaps, won't remain so for much

BANKING 2 ,0 : CREDIT continues on page

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briefngBANKING 2.0: CREDIT continued from page 19longer, he predicts.Regulators' challenge going forwardwill be to rein in risk, enabling the indus-try to heal, without going overboard. Thehardest days will be now."We've got a wound that's bleeding,"says Nick Ketcha, former regulator. "Youcan put a pressure bandage on it and youmay stop the bleeding. Or you can put atourniquet on it." While the tourniquetstops the bleeding, it stops all circulation."My biggest fear," says Ketcha, "isknowing when to loosen the tourn iquet."As banks and regulators try to find thepath back to moderation, there will becasualties. "I think people with goodcredit will continue to be able to bor-row," says Bill Barksdale, the ex-Wachovian. "But people with marginalcredit, they won't be able to get financ-ing." Glimmers of this have already beenseen, such AS GMAC'S ratcheting up ofacceptable credit bureau scores.Over the horizonSome observers are worried that what wehave seen thus far is not the end of trouble.What concerns Promontory's DavidGibbons is that the extent of the rippleeffects from subprime and related devel-opments isn't clear. He sees coming trou-bles from construction loans made forretail projects going bad. And he suspectsthat there will be trouble in hotels andmotels catering toboth business and per-sonal travelers, as the recession bitesharder.

"We are actually not out of the woodson this," says Gibbons.There is simply an enormous amountof debt out there, points out Quarles ofCariyle Group. Hecites these figures asone example: In 1980, all public and pri-vate debt represented 160% of GrossDomestic Product; in 2007, the figurecame to346%and the public debt piecehadn't changed, by share, all that much.In the same period, household debt dou-bled as a percentage of GDP.

Indeed, O'Leary likes to quote Machi-avelli on this po int, from The Prince:"In the beginning of the malady it iseasy to cure but difficult to detect, but inthe course of time, not having been eitherdetected or treated in the beginning, itbecomes easy to detect but difficult to

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How Has Banking Changed