Area Banks Find Their Way Through the Uncertainty

On a clear day in early January, a score of the area’s leading banking executives met high atop the Downtown Kansas City headquarters of Stinson Morrison Hecker, the sponsor of this year’s Banking Industry Outlook, the 12th in our annual series.

As would become clear, the past year was a profitable one for most banks, but it was a troubling one in ways that Main Street bankers had no reason to anticipate—namely, media attempts to scapegoat banks and bankers for the nation’s economic woes.

“I think our industry is sort of under attack,” said Bruce Easterly, chief lending officer of Bank of Blue Valley, “if you look at what the media think of us, and Obama calling us fat cats.” Bob Monroe, chairman of Stinson’s Financial Services Division, led those assembled in a lively discussion of this issue and other of the more pressing issues facing the banking community.

As an initial question, participants were asked to cite the most pressing threat or the most promising opportunity facing their respective banks.
For Tom Metzger, president of Bank Midwest, the uncertainty of the legislative rule-making process loomed large. “If it’s bad news, as long as you know what the bad news is, you can at least begin to deal with it and plan around it,” said Metzger. “But when you don’t know what the news is, the unknown is sometimes worse than the bad news.”

“There’s a triple threat of political, regulatory and economic uncertainty that’s facing the industry, facing our country generally,” said Paul Holewinski, CEO of Dickinson Financial Corp. “It’s one thing to manage around one or two of those, but really all three at the same time makes it very threatening for the industry.”

“There is a lot of uncertainty,” agreed Jim Sangster, president of UMB Bank, “but the certainty that’s out there is that [these new laws] are costing us a lot of money, a lot of full-time employees that aren’t being used in a very useful manner.” Sangster estimates that the laws passed last year are costing his bank upwards of $10 million a year and keeping at least 10 employees busy doing nothing else but monitoring the new regulations.

Adding specifics, Mark Jorgenson, the president and CEO for US Bank in the KC region, noted that more than 250 regulations still need to be codified: “That’s a daunting number, and one that makes long-term planning that much more difficult.”

“It is easy to put [new regulations] in legislation,” conceded Chuck Morris, vice president and economist of the Federal Reserve Bank in Kansas City, “but it is very hard to implement them in actual practice.” He added that the Fed tries hard to find the right balance between enforcing rules it has been asked to enforce, as well as creating the rules it has been tasked to create.

Greg Bynum, president of First Community Bank, observed that regulation comes at a cost, and a community bank needs the capital to comply. Regulation almost inevitably favors the larger banks.

Hoping to make lemonade out of lemons, Jeff Carson, vice president for Commercial Banking at INTRUST, expects that his bank will be able to provide consulting service to smaller banks that are struggling with the new regulations.

“I’m a little bit afraid that the smaller business person will be crowded out,” said Paul Thompson, president and CEO of Country Club Bank. As he explained, 80 to 85 percent of new jobs created derive from small businesses that historically rely on community banks. If the cost of doing business goes up for the banks,
it means less capital for small business and eventually fewer banks.

“The biggest threat among our banking clients is really a lack of earnings power,” said Kevin Cook, partner in charge of the financial services practice for the accounting and consulting firm  BKD LLP in Kansas City. “Their access to capital is pretty limited, and if it is accessible, then it’s very expensive.”

Despite the down economy, local banks have found ways to generate earnings—and in some cases, record earnings.

“Regulation is a part of our business. It keeps changing. It has been changing forever, and we’ve just got to deal with rules as they come along,” said Marc Maun, CEO of Bank of Kansas City. His parent company, Bank of Oklahoma, is among those with record years. An optimist, Maun expects his bank to find new lines of business to replace revenues diverted to regulatory costs.

Economist Ernie Goss of Creighton University has been surveying rural banks in the central Midwest for years. He sees some “really great opportunities” for the sale of agricultural commodities to South Korea as a result of a recent trade bill with that country. Rural banks are doing well, he observed, but loans are not that strong because “farmers are cash-rich and don’t need to borrow a lot.”

Henry Heimsoth, managing director for Commercial Lending at Great Southern Bank, likes “where we are in the world and with our bank.” Others also affirmed the virtues of a stable Kansas City marketplace and a prudent business community.

Paul Thompson sees the silver lining for Country Club Bank in the consolidation going on in the industry. “It’s an opportunity for us to grow our market share,” he noted.

UMB has a similar perspective. “I tell our folks that we can’t control the economy. We can’t control what our customers are doing as far as their borrowing or what have you,” said Jim Sangster. “But we can try to take market share, and I think we’ve done that.”

“I think banks are in a better spot now than they were last year” said Paul Holewinski. “You’ve got balance sheets that are healing. You’ve got acquisition opportunities that many are taking advantage of, and we’re one year closer to being out of the slog.”

Lending Availability
Bob Monroe shared a common perception, one circulated by the media, that banks are not making loans in any appreciable number. He wondered whether that perception was accurate and whether there was active competition for borrowers.

Mark Jorgenson thought the media perception is misguided. “It’s a bit silly to say that banks don’t want to make loans,” he said, “because that’s how we make money.”
UMB has increased its commitments, but line utilization is down. Good borrowers “have hunkered down,” said Jim Sangster.

“They have cut their inventories. They have cut their expenses. They have a lot of cash on hand. So the need to borrow is not there.”

“The good news is we have good borrowers in our portfolio,” said Thompson. As at UMB, however, these borrowers are holding their positions and preparing for the future. They don’t want to see a repeat of the liquidity issues that troubled some a few years ago.

“They are asking for those lines,” said Thompson, “but because they’re so strong from an economic standpoint, they don’t need [loans] right now.”  
“There is a lot of competition for quality loans,” said Henry Heimsoth.  The problem he saw is that with asset valuations down as far as they are, de-leveraging is difficult and slow. “There’s a lot fewer opportunities to do new business,” he added.

The Bank of Kansas City has seen an increase in commercial and industrial loans. Said CEO Marc Maun, “Maybe not the demand we saw a few years ago, but we’re seeing some signs of life.”

Ernie Goss has asked this question of the rural banks he surveys four times a year. As they tell him that the small businesses in their market areas don’t
see enough demand to justify expansion.

According to Bruce Easterly, customers are starting to think about investing in new machinery, but, he added, “I think the same uncertainty that’s affecting banks is affecting borrowers out there.”

As Jim Sangster noted, there is obviously money available for borrowing, and yet Kansas City had a net gain of only 300 jobs in 2011. Why the slow growth? Said Sangster, “It’s because there’s uncertainty about taxes, uncertainty about health care costs, uncertainty about lots of things.” He argued that employers resist hiring until there is clarity.

Paul Holewinski believes that clarity must come from the top. “Really, it starts politically, that’s where the uncertainty is: Leadership at the top.” He is hoping that the election of 2012 will resolve the uncertainty. “I think a lot of us are banking that it will.”

Negative Images
Bob Monroe observed that banks seem to go through phases when they are favorite targets of the media. He cited the misinformation about loans as an example and asked how banks combat the negative and often inaccurate stereotyping.

Greg Bynum observed that many of the bankers at the table represented relationship banks. “We know our customers,” said Bynum. “They don’t look at us as the bad guys.”

“I think business people don’t really pay attention to that,” Marc Maun said of the media portrayals. He agreed with Bynum that their business customers were relationship-oriented. “They want to work with their bank.”

Ernie Goss offered the caution that the negative imagery could create the political environment that causes problem for banks. He cited the attorney general of Massachusetts, who is attempting to slow down or stop the home foreclosure process there. Economists, Goss said, generally respond with, “Let the market work, please.”

One point on which the anti-bank forces have coalesced is the notion that people should not have to pay a fee to use another bank’s ATM. This struck a nerve with Paul Thompson. He explained how much easier ATMs had made life for those who remember a time before them. People will happily pay $2.50 for a cup of coffee, he said, but gripe at having to pay the same amount for a hugely more complex and valuable transaction. “I don’t think there’s a better value out there than an ATM
card,” said Thompson.

Bob Monroe questioned his colleagues on the accuracy of appraisals and how that affects their business. “This is a huge issue, at least for the Bank of Blue Valley,” said Bruce Easterly.

Easterly cited a recent example of an appraiser who priced a fairly complex piece of office real estate $1 million higher than did a second appraiser. When alerted to the discrepancy, the original appraiser acknowledged his oversight, and lowered his own figure. “That’s tough to deal with,” said Easterly, “but does anybody really know what the right answer is when there’s no demand?”

“There are no comps. That’s the issue,” agreed Tom Metzger. “Since there are no comps, we’ll just write it down at least by a third, maybe half.”

“From an underwriting standpoint right now,” said Greg Bynum, “banks and regulators are both looking for the cash flow.”

“What do you all think about the experts out there,” asked Bob Monroe, “saying we’ve come from 25,000 to 13,000 to 7,000 [banks] and there may be only 3,500 banks in the 5- to 10-year future?”

Mark Jorgenson conceded that there were more troubled banks than is the norm, something like 800, according to the FDIC. “There will be some blow-off,” said Jorgenson, “but to say it’s going to decline by 50 percent is ridiculous, in my opinion.”

Paul Thompson expressed his concern for rural banks. The regulatory burden, when coupled with the cost of modern technology, is pushing the price of doing business up. “I don’t know that they’re going to be of the size to continue,” said Thompson. Another problem for the rural banks is the legion of quasi-government entities that are competing against them.

“There is a concern,” Ernie Goss confirmed, “at least among the CEOs we survey, about being bought by a techno-bigger bank, and the customers are even more concerned than the bankers.”

Given the regulatory burden and its attendant costs, said Jim Sangster, “It’s not as much fun as it used to be for a lot of these guys out there, particularly in rural areas.” He expects to see some consolidation.

In 2013, when TARP dividends go up and the government begins to demand its money back, Marc Maun estimates that it might push as many as 10 percent of all banks into consolidation or worse.

Tom Metzger explained the historic forces leading to consolidation, including more competitive interest on deposits, shrinking margins, and swelling regulatory costs. “You’ve got more burden, less earnings power,” said Metzger. “You can’t raise the capital, so you start to see consolidation.”

But, even with institutions consolidating, Paul Thompson noted that the growth in number of branches and the advent of mobile banking technologies eased many of the concerns over access to banking services.

An Italian, a Spaniard, and a Greek go into a London bar for the evening. Who pays the tab? The American. So goes the joke circulating in Europe, said Ernie Goss: “There is a belief out there that somehow, some way, the American taxpayer is going to pay for any failure in Europe.”

Speaking for most of those in the room, Mark Jorgenson said that US Bank did not have much exposure in Europe. “If the economy is sidetracked because of what happens in Europe,” Jorgenson added, “that’s going to affect all of us. But outside of that, I see the effect as negligible.”

Residential Lending
An exception to the trends in lending, Tom Metzger pointed out, was real estate construction, particularly speculative construction. To the real estate developer who might complain that the loans aren’t forthcoming, Metzger would be inclined to say, “Yes, that’s true. You’ve got to have a little more skin in the game. For the good borrower that can substantiate it, we’ll all take a look at making the loan.”

Residential lending, however, is a growth business, at least for the Bank of Kansas City. “We’re seeing good opportunities,” said Marc Maun, “and really not having a whole lot of problems selling off the mortgages.”

Tom Metzger agreed with Maun’s assessment, but the appraisal issues raised earlier play havoc with market certainties: “If the appraised value isn’t there, it’s pretty hard to get it done.”

Bruce Easterly of the Bank of Blue Valley worried that recent government regulations suggest that the federal government did not learn any lessons from the subprime meltdown.

Ernie Goss more or less agreed. As Goss noted, Fannie Mae and Freddie Mac resist letting investors buy foreclosed properties and reserve them strictly for homeowners. The net result is “a lot of foreclosed properties are still in the pipeline.”

As Bruce Easterly observed, in New York state, it now takes two years to foreclose a house. “It’s ludicrous,” he added. “You can manipulate the system over
and over and over. It never cleanses. It never heals itself.”

Kansas City
By way of concluding the session, assembly chairman Bob Monroe praised “the solid nature of the businesses here and the people” in the Kansas City market. He wondered where the region might go from here.

“I think you’ll see entrepreneurship really thriving in this area,” said Mark Jorgenson. “Being in the center of the country with logistics, we need to focus on those strengths and then I think that will help drive us out of this recessionary period.”

“I think, historically, Kansas City is very well-positioned,” Jim Sangster affirmed. “We’re blessed that most of our companies here in this region are very well-managed. There are a lot of smart people running them. Kansas City is a great place to do business. I can’t think of a better market I’d want to be in.”