With Utah’s economy finally showing signs of growth and recovery, banking officials and experts discuss the challenges of new federal regulations on the industry and give advice to business execs who are wondering if now is the right time to finance expansion. Capital is available, say the experts, and banks are eager to work with qualified borrowers.
We’d like to give a special thank you to Hal Heaton, professor of fianance at Brigham Young University, for moderating the discussion and to Holland & Hart for hosting the event.
George Sutton, Durham Jones;
Nicole Sherman, Far West Bank;
John Beckstead, Holland & Hart;
Jeff Thredgold, Zions Bank;
Hal Heaton, Brigham Young University;
George Hoffman, Zions Bank;
Greg Winegardner, Wells Fargo;
Scott Parkinson, Bank of Utah;
Rick Beard, Bank of American Fork;
Curtis Taylor, Heber Valley National Bank;
Frank Pignanelli, Utah Association of Financial Services;
Sheila Camarello, Key Bank;
Robert Carpenter, JP Morgan Chase;
Howard Headlee, Utah Banker’s Association;
Ed Leary, Utah Department of Financial Institutions
We are coming off of two very memorable, unforgettable years. By my count, five banks in Utah have been shut over the last 18-20 months. If I heard correctly, Zions just announced nine straight quarters of losses. How are we doing? How is your company doing? How is your capital adequacy?
LEARY: For Utah, it has been a very difficult last two years. Like the rest of the country, we’ve had stressed conditions in our economy, stressed conditions in our financial institutions. Unfortunately, it has resulted in a closing of a number of financial institutions in the state. Compared with our peers around the country, we’re probably somewhere on the lower third as far as numbers of institutions within the state. Some of the larger-growth states have closed more of a number of institutions than we have.
With regard to that stress, it’s safe to say it is centered predominantly in construc-tion development loans. Real estate based lending had been very solid for 50 years, 80 years, and suddenly the values went south very quickly. So it was demanded of the regulators, demanded of the financial institutions, to quickly adapt.
At the same time, you have the political action that has caused additional concern and heartache, at a time when we’re trying to repair our system. This has simply exacerbated what we currently have going on across the country. The magnitude of rules and regulations caused as a result of the Dodd-Frank Act is beyond belief for most people. For banking alone, in excess of 200 hundred rules have to be written within the next year.
So we’re getting into the home stretch, which will be a massive tidal wave of additional rules. That’s the uncertainty that I’m talking about at a time when we need certainty within the financial institutions and within the economy as a whole. The mortgage crisis, whether or not financial institutions appropriately are foreclosing, has simply been another factor in causing uncertainty at this time.
CAMARELLO: 2010 was a solid year for Key Bank. We had four straight quarters of profits, a solid year of profitability. The thing that we’re most pleased with is the reduction in nonperforming loans. Obviously, that’s impacted all of our profitability over the last couple of years. We’ve been acting prudently in terms of reserving properly for bad loans; and we’re now seeing those monies that have to be set aside in loan loss reserves coming down.
In short, you’re ready, willing and able to start making business loans?
CAMARELLO: Absolutely. We’ve been making them. We put out some numbers as far as fourth quarter: roughly $9 billion in lending. For the year, just under $30 billion on both consumer and commercial. Definitely doors were open for business and have been all throughout 2010. How we do business, who we’re lending to, that’s where some of the dynamics have changed.
HOFFMAN: A misnomer in banking is that banks haven’t been willing to lend. Banks have probably put out more effort to find qualified borrowers in the last two years than at any time in recent history. But because of the uncertainty in the economy, you find borrowers unwilling or entrepreneurs unwilling to take risk and increased leverage.
BEARD: Whenever I see that the banks aren’t lending, I just don’t understand that. In our case, we’ve been profitable through this mess, we’ve had some asset problems that we’ve had to deal with. Ours were also declining. We seem to be hopefully working through those. But our problem is we had a lot of liquidity, and we don’t have people who can repay the money who are wanting to take out loans.
Have you had to change your qualifying standard regarding what it takes to get a loan?
BEARD: We still are making construction loans to qualified borrowers. We want to make sure we’re getting repaid. What’s happened is a lot of the financial statements of developers deteriorated, and so in that sense it becomes harder for them to borrow. But there are still developers out there doing development work. And in cases where they’re solid, then we’re willing to make loans.
PIGNANELLI: Industry banks in Utah, in the West, are doing just fine. We are in good shape. As a matter of fact, we’re looking forward to the government GAO study that’s coming out that has been commissioned pursuant to the Dodd-Frank legislation. There is a moratorium that will be offered in 18 months, and we’re looking forward to what we think is an opportunity with this new Congress and with a new enlightened mentality in the administration.
We talked about the ability of industrial banks to buy credit to a lot of different niche markets, small business, big business, whatever. It’s morning in America for industry banks.
HEADLEE: I’ve been out visiting all the banks in the state, and I’m hearing very encouraging news in terms of the decline in the problem loans, signs of increased demands from qualified borrowers, and really the bankers just doing a fantastic job of managing their institutions
through clearly what has been the most difficult time in my lifetime.
It takes two to tango: bankers willing to lend and businesses wanting to borrow. What is your view of Utah’s economy, par-ticularly relative to the rest of the United States? Is the loan demand going to be there?
THREDGOLD: Utah in general is actually leading the West in terms of employment growth. What we now call The Great Recession took all 50 states into recession. We went into recession about a year later than the average state, so that’s one reason we’re near the top of some of the lists on foreclosures and bankruptcies.
But we’ve come out, we’ve added about 15 and a half thousand jobs the last 12 months, a growth rate of 1.3 percent. When compared to historic numbers, it’s fairly poor. But you can step back about 15 or 16 months ago, and in the prior 12-month period we lost 74,000 jobs. So we’ve made the transition from our most painful recession since the Great Depression back to growth. It’s modest growth. It’ll be better this year; it’ll be better next year.
Housing, we think, in terms of prices will probably in this market reach bottom, stabilize, about this summer, but we expect to see better performance in 2012, 2013.
The nightmare that happened last year in terms of the documentation on residential loans, particularly related to securitization of mortgages, delayed a lot of foreclosures, which may have sustained the recession for a longer period of time. Have those issues been resolved?
THREDGOLD: The whole foreclosure process is really stuck in the mud right now. Something like 2 million homes have come out of the market across the country in terms of foreclosures, the estimated shadow inventory is anywhere from 3 to 5 million more. So one of the things that limits the upside on housing in the next few years is just as prices stabilize, you get some improvement and inventory comes out of the market.
SUTTON: There’s a legal and an operational aspect to that. The legal issues, they may need to be worked out still. The operational stuff was just sloppy record keeping. I think Bank of America noted that Countrywide, which it acquired at some point, had simply stopped sending the original documents of securitization to trustees, which it was supposed to do. And some of those documents, they lost them. So that’s the core of the problem. I think the volume just blew up and they got sloppy in their recordkeeping. And I don’t think anybody’s being sloppy that way anymore.
But the old style of mortgage lending has gone on, and there’s probably going to need to be some change in the law to catch up with this new system. Before, when the S & L made the loan and kept the loan and all the documents were there and they served it—those days are gone.
Identifying who all those interest holders are that ultimately collect the payments is just beyond what a county recorder can do. We’re going to have to work through those issues.
HOFFMAN: With that said, probably none of the institutions locally have any of that going on, but the stigma of what happens on a national level impacts the public perception of what we’re doing.
So we’ve not had the documenta-tion problems in Utah?
BECKSTEAD: Not from these banks, but there’s a service that reports new lawsuits filed every day that we subscribe to, and almost every single day there are anywhere from two or three to five or six cases filed by homeowners against their lenders, trying to stop the mortgage foreclosure. The courts are clogging with those, the law firms are very busy defending those, and we’re not getting traction because there’s so many unresolved issues on a national level.
HEADLEE: In many cases banks inherited problems through acquisitions during the crisis. So to some degree, they came to the rescue of some of these more aggressive players, and now they’re dealing with the implications of the sloppy record keeping that they inherited. In fairness to them, I know the volume has been huge.
What’s happened behind the scenes is that to the consumer, you go out and get a 30-year mortgage or a 20-year mortgage. You had a lot of different options—the options grew in the last 10 years. But what was happening behind the scenes changed dramatically, and now when the problems are popping up and people can’t make payments and you go into foreclosure, that process, on the face it’s the same, but when you try to find out who owns the note and who can you talk to, you may find that there’s a lot of different people who own pieces of that note.
The idea that you would stop making payments becomes much more problematic because you have a lot of different people relying on a lot of different aspects of your mortgage payment. And in many cases, foreclosure is really the only answer to wipe that slate clean. It’s very complex. And a lot of people who you would think understood what was going on are just starting to come to an awareness of how complex that secondary market for those securities is and how those loans were sliced and diced and sold to different investment groups, different pieces of the same loan.
Now, you can say it’s bad and we miss the old days of the banker down the street making the loan and holding it and you can go talk to them, but that’s just not reality, it’s not possible. And the benefits of the system we had are pretty substantial, so we just have to work through this new reality, these new details, and find solu-tions. But we can’t go back. As much as people would like to go back, I don’t think anybody in this room is going to make a 30-year loan at a fixed rate of 5 percent in this environment. It just is not going to happen. That would be disastrous.
CARPENTER: Ultimately the way out of this mess is going to be great-paying jobs. People need to have jobs that enable payments on houses. And in Utah, we’re very fortunate not only to have a government that’s fiscally responsible, certainly by comparison to a lot of other states in the country, but also an economy with the industries and jobs of the future. We’re not dealing with rust belt industries—their jobs are going to China. We’re dealing with a great place to live, great people, great industries that will lead us out of this probably before the rest of the country.
The Dodd-Frank Act passed 2,300 pages of initial legislation. As I understand it, there are 1,400 officials drafting what will be tens of thousands of pages of interpretation of what those rules mean. The CARD Act, we’re behind it about a year and a half, so you may have some sense of what’s happening there. Elizabeth Warren is putting together this new consumer protection agency discussion about systemic risk. How is all of that impacting your organizations?
TAYLOR: It has a huge effect. Our footing in 2010 and this year is so much better than it was in 2008 and the first half of 2009. But our progress forward is being limited by the uncertainty that many have already spoken of.
The American consumer and the American employer are hesitating because they’re trying to absorb, “What does health reform really mean to me and maybe I better not hire until I figure that out,” and, “What does financial reform mean and maybe I better hesitate a little bit and hold steady until we can absorb what this all means.”
Those changes have been a drastic impediment to recovery, and it’s going to take some time to sort through them and realize what the effect really is before employers and consumers are ready to move forward on the bottom line.
SHERMAN: The other concern, at least for those of us around the table, is what impact the Dodd-Frank Act and all of these others are going to have on our bottom line. We don’t know that yet because we’re just beginning the implementation process.
Banks, specifically community banks, are just like businesses. As the businesses out there in Utah grow and do well, so does the banking industry. The concern with all of that legislation and regulation is that there’s a cost to it. And the unfortunate cost is banks are no different than any other business. When your expenses go up, then the amount that you’re charging goes up. And I think this could have a huge backfire.
BEARD: If you step back, we’re seeing a huge philosophical issue. What we’ve got is essentially the idea of the free market economy versus a planned economy. So if you come in on an interchange fee and say it’s $0.12 by law, that’s a planned economy that effectively is being imposed on business as opposed to saying you compete and it’s going to find its price level wherever it ought to be. And we’re seeing that all the way through the system.
It’s really, in my view, a pivotal time in terms of government and how we’re going to view the banking area. The banking area has always been heavily regulated, but it’s becoming extremely heavily regulated when you get down to capping interchange fees and some of these things. Then you get the political shift to it, where it’s treated as if it’s a consumer issue, when it’s really an economic issue between big box retailers and banks.
SUTTON: I’ve been doing this for 28 years full time. When I started, Reg Z was roughly a 40-page booklet that was folded in half, and you could learn it fairly quickly. And people could call with questions, and I could generally answer them. Reg Z today is a 2,000-page monster. You get into one rule, which takes you over here, which takes you over here, which then takes you over here.
And the compliance costs—the APA estimates something like 10 pages of regulations for every page of the Act. That’s over 10,000 pages of new regs. There’s actually talk that the compliance burden is becoming so great on the banks that you have to be a certain size to carry that burden or you won’t be able to survive. And there’s a lot of concern about if the smallest community banks can weather this kind of environment.
The bigger question is, when all of this is finally hashed out, how much of a constraint is there going to be on credit? Credit is what drives the economy. The concern really is that it’s going to be narrowed down to a plain vanilla credit card, a plain vanilla auto loan, a plain vanilla mortgage. And that’s all the regulators will permit. A lot of credit could go away, and the economic impact of that could be very significant.
Speak to the readers of Utah Business magazine. Give them the regulatory uncertainty. What do they do? Do they line up their credit now or should they wait for a year and a half until the uncertainty gets resolved?
HEADLEE: We’re all in it together. We’re only as strong as our customers and as successful as our customers, and they rely on us for credit. The worst thing that’s happened in the last two years is the finger-pointing and the vilification and the misuse of the word “bank.” Everyone in this room has been misrepresented. There’s a lot of people who have gone through a lot of pain in the last couple years, and so they’ve jumped on the bandwagon of pointing the finger and blaming the banks.
But in reality, what’s been adopted is just going to make it more difficult for all of us to recover, and so we’re going to need support from the whole community to go and unwind some of the really negative things that were done in this last year by Congress in a misguided reaction to what just happened, or things will change for all of us and it will be more difficult.
CARPENTER: Our industry has been very resilient through good times and bad, and our ability to adapt is probably one of the better—of all the industries in the country, we’re adding jobs, we’re expanding our products and services. When I started banking, our slate of products could probably fit on a single sheet of paper, and now we’re all over the world doing all kinds of sophisticated things.
We’ll get through this regulation, but it does come with unintended consequences. It’s going to take consumers longer to get credit, it’s going to take businesses longer to get a loan. There’s going to be more paperwork, more hoops to go through.
BECKSTEAD: We represent a number of non-bank lenders, asset-based lenders, specialty lenders, factory and companies. The scenario you’re describing creates great opportunity for them because they don’t have these regulatory costs and restrictions that you’re seeing on the types of products. If they’re going to be innovative and creative, it’s a great opportunity for them. But the number one problem those types of lenders have right now is no access to capital. You can’t do a public offering in this market. Very, very few banks will lend to that type of company.
Are you as banks going to see an opportunity there to finance other lenders rather than their customers and avoid some of the constraints that are on you? Historically, in my experience, you don’t like that type of lending; you can’t control it well, it has a lot of risks that are disadvantageous. That’s one example of what might come out of this in the process going forward. Those that are creative and can see opportunities like that that can figure out a way to make them work will be able to profit rather than being hamstrung by the new regulations and other problems.
WINEGARDNER: But that’s only going to happen in the larger institutions that can specialize in that. A community bank can’t take the risk that’s associated with that type of credit.
THREDGOLD: It’s important also that the banking industry needs to speak with one voice. If the community bankers are saying this and the regional banks are saying that, they’re all conflicting with each other, then the chance of minimizing the pain is pretty limited. But if the banks speak as one, that these specific items within the legislation are hurting credit—that we’re just not going to make these kind of loans anymore—then I think there’s some chance that that momentum from lessening the pain of Obamacare can carry over into Dodd-Frank and some of the other legislation that took place.
BEARD: I want to challenge what’s going on here and come back to the basic philosophy. If regulation is good, assuming that it is, and you’re going to say in financial matters, “We want it regulated and we’re going to impose all these different regulations on what we call the banks,” but then we say, “We’re not going to allow those to be imposed on certain institutions,” you’ve created a distortion that is totally political in nature that creates an advantage for one party. And, in my own opinion, a lot of the mess we’ve just been going through, the mortgage meltdown, if you look at the regulation on the banks that we have through that mess—and it was heavy—what about the independent mortgage bankers, guys that were doing it in the basements?
There wasn’t any regulation, but they were by fiat sort of exempted from the basic regulatory scheme. So you have this huge distortion that’s taking place and that’s exacerbated by what you’re talking about, John. If that’s not imposed on that group—you know, people don’t care, they’re after the money.
BECKSTEAD: Those groups understand that issue very well and they’re well organized and they’re lobbying hard not to have those kind of regulations imposed on them. It’s a real tension there as to where that will go.
BEARD: And it’s a real issue in terms of the distortion in the financial markets if we don’t recognize that, and I’m concerned we don’t.
LEARY: Commenting specifically on John’s comment, largely over the last few years in Utah we’ve had commercial entities trying to wrestle with the decision in order to obtain deposit-taking funding, “Do I want to enter that banking regulated world?” A number of them stepped forward and said yes, but a significant number, after they looked at it said, “No, we will stay with our funding coming out of private equity, out of private capital, out of the commercial paper markets.”
What happened in this downturn of the last three years is those markets dried up. So a number of those entities had serious problems in obtaining funding. A number of them changed the mechanism and the philosophy of what they see themselves as going forward. A number of the investment banks said, “We want to become more bank-like,” and, therefore, they accepted all the rules and regulations.
But clearly there’s a distinct difference between money lenders that are predominantly lending to commercial enterprises versus those institutions that are known as banks that carry federal deposit insurance and fund through those deposit-taking activities. And I think that’s entirely appropriate. Ironically, one of the stated purposes of the new Consumer Protection Bureau going forward is those entities that are lending to consumers that aren’t regulated by banks need to be done so. So one of the objectives will be to replace consumer protections on industries that historically have not had it.
Is that likely to happen?
LEARY: If it’s a consumer transaction, I think everybody is understanding and sympathetic. If they’re lending to consumers, they should have the same consumer protections that they inherit under the banking regulated system.
The interesting aspect of that is largely it may be business entities lending to other business entities. And do you want consumer protections extended into that arena? That’s a philosophical question that’s very, very different, because suddenly now you’re asking government and/or deposit insurance to get involved in the business-to-business world where they have historically not been before.
BECKSTEAD: Right now you can escape much of the regulatory burden by lending to a business who’s not regulated and then lends to the consumer or other businesses. It’s an attractive situation right now. How long will it stay that way is anyone’s guess.
What I’m seeing even in the consumer area, companies that are not bank-owned are moving more to consumer areas. The check cashing stores recognize that they have a limited future, that they’re going to get regulated. They’re looking for other opportunities, setting up new ventures and things to fund those consumers in a less onerous way.
HOFFMAN: But you’ve been talking that we’re facing this massive amount of regulation. What has been ignored here largely is the fact that the amount of regulation we have on us particularly with the Patriot Act and rampant money laundering has absorbed enormous time, money and FTE increases in the banking industry. And if consumers knew what banks were required to do looking over their shoulder and reporting to the government, I think they’d step back and run.
The national trend seems to be that lenders are laying off workers. Overall, are your banks hiring or are you laying off? Is this growth environment in Utah making a difference?
CARPENTER: It depends a lot on the lines of businesses, but in our case, we’ve expanded dramatically in the West. Over the last two years, we’ve opened up commercial lending operations in Irvine, Portland, Seattle, getting ready to open one in San Diego, and we’ve added hundreds of jobs in our commercial banking side and across the board in terms of retail branches.
It’s kind of an individual story more than an industry story. Every bank has a different situation in different markets. Different parts of the country have felt this differently.
HOFFMAN: I think it’s an Eastern/Western story. Look at the Western part of the U.S. and it’s growth; you look at the Eastern and it’s retrenched with not a lot of opportunity.
Many are predicting that interest rates are going to start rising and have advised businesses to get credit now while rates are low and before the uncertainty makes the credit environment more difficult. Do you agree with that? If you’re a small business, if you’re a consumer, should you move now?
BEARD: It takes an act of faith on a businessman’s part to do that, but there’s no question if you look at the dynamics that the rates are about as low as they’re going to get. If you have the view that we’re not going to go in the tank and that we can move forward as a society, it’s a great time to be investing. But the psychology is still, in the nation, one that’s a beat-up psychology. There are signs that we’re coming through it. If every business in Utah would hire one person, we’d have a significant drop in the jobless rate in Utah. But it takes a lit bit of an act of faith to do that.
HOFFMAN: Well, if you talk about positioning of the banks, we’ve never been in a stronger capital position and a stronger loan loss reserve position in the history of banking. So banks are totally safe, sound and positioned to go forward and lend as the economy comes out of the doldrums.
TAYLOR: You just touched on what could be the next crisis or semi-crisis, and that is interest risk or the result of interest rate risk. Bankers have got to be smart about that, and we’re all really sensitive to it and our regulators are making sure we’re sensitive to it. But the small business owner has to think about it, too. The small business owner doesn’t get a 30-year fixed rate loan, he gets a loan that’s either variable daily, yearly, sometimes every three years, and he has adequate debt service coverage at the historically low rates.
Well, we don’t know when they’re going up, but they will go up. And when they do, is he going to have the business strength to have adequate cash flow and debt service coverage? Both the banker and the business person need to think about that and allow for that.
CARPENTER: From a commercial side, our clients have a lot of advantages they didn’t have in previous cycles: access to tools to manage things like interest rate risk, to diversify your customer base going abroad. Those things weren’t accessible to small businesses 10, 15 years ago. But all of our banks in town are out talking to small businesses, mid-sized businesses, and giving them those tools which, hopefully, should help them if interest rates rise or commodity inflation come into place.
PARKINSON: We tell our bankers to think like business people and we ask our business owners to think like bankers.
CAMARELLO: In the past we have just seen, “OK, recession over, full speed ahead.” This has been just a whole new dynamic and, because of the education that we’ve done, the conversations we’ve had with our clients, in particular, small business owners, they are taking it slower, they are being more cautious.
What do you see on the commercial lending, residential lending and consumer lending lines?
HOFFMAN: There’s a lot of opportunity in commercial real estate right now with the resizing that’s going on of valuations. There’s lenders coming in and loaning on an office building now—or loaning on a product that’s probably 30 percent devalued from where it’s been and properly margined with good tenants. It’s a great opportunity to move forward and build some balance sheet.
On the commercial side, companies still have so much liquidity sitting on the sideline that their need to borrow is many quarters into the future because they’re going to eat up their liquidity. Their line usage is as low as I think it’s ever been. They’ve got enormous availability on capital.
CARPENTER: From a commercial side, the story probably changes by institution and institution. There’s a real advantage that’s been developed for large institutions like JP Morgan Chase. You know, we don’t have to have a client relationship just based solely on lending to have a great client relationship for the bank. So those companies may have a lot of liquidity, maybe not be in the borrowing market, but may need help in going to China or going to Europe with the products. We can get involved in that aspect of the business.
Just as a barometer of health, the terms and conditions a commercial client can get right now for borrowing money, it’s as attractive as it was prior to the recession. So businesses need to be optimistic. They have access to capital. They have access to lending; but, again, it’s about client selection, it’s about a good business with good leadership, good management, good products, kind of those basic things.
CAMARELLO: I don’t care if you’re a small business or big business; there’s still a lot of risk in companies that are still in that one- to three-year timeframe. It’s still a hard time. It was hard five years ago, even harder today. But I’m really optimistic. We’re ready to lend, and I think that there will be businesses that will demonstrate that they’re able to borrow. The appetite, that’s still kind of an unknown. And I give them credit for being cautious.
HOFFMAN: The thing that validates what you’re saying is the level of problem loans in all the financial institutions are falling dramatically, which is a sign of health in the borrowing community.
Describe the overall health of banks in Utah.
LEARY: Those institutions that need additional capital have been very aggressive about going out and getting it and, in many cases, being very innovative in going out and getting that capital. Profitability in the banks is slowly coming. Naturally, as a regulator, I’d love to see more and I’d love to see it faster. But for those institutions that have taken prudent steps, there’s going to be profitability and, therefore, the regulatory hand that’s been on them—more like anvil on them—is being removed slowly.
Any final messages to readers and small business consumers? Anything that they ought to know going forward in 2011?
HEADLEE: One of the other things that a lot of people don’t realize when you look state to state is the diversity of our banking industry. None of the Western states right around us have the diversity that we have and the number of small banks to the number of regional banks and the larger national banks or industrial banks.
SHERMAN: If I could ask two things of the readership, of our customers, on behalf of all the banks, number one, it would be to stay in relationship with your banker. If your bank is not already calling you, stay in touch with them, ask them what the facts are.
The second thing I would say is it’s OK to hit Google and Wikipedia, but all of us and our employees are right here living in the same economy, in the same environment, as our customers are, and we know what we’re talking about when they come in and share with us the issues that are going on in their business, and we can coach and assist them through that.