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Positioning Your Bank for the Future


Rising Bank Failures. States and Local Governments are in ... Bank of America $ 44 $ 45. JPMorgan 38 25. GE Capital 37 0. Goldman Sachs 29 10. Citigroup 27 50 ... – PowerPoint PPT presentation

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Title: Positioning Your Bank for the Future

Positioning Your Bank for the Future
  • Timothy Koch, Ph.D.
  • President, Graduate School
  • of Banking at Colorado
  • Professor of Finance, University
  • of South Carolina

Current Banking Environment
  • Day With The Superintendent
  • Timothy W. Koch
  • University of South Carolina
  • Graduate School of Banking at Colorado

Current Competitive Environment
  • Federal Reserve is committed to keeping interest
    rates low
  • The Treasury Yield curve will remain upsloping
  • Competition for deposits will be fierce
  • Loans will be better priced for credit risk and
    interest rate risk
  • Floors on loan rates will be increasingly common
  • Loan loss provisions will increase
  • Non-interest income will continue to contribute a
    relatively small fraction of income

Factors Affecting Confidence and the Economic
  • Deep Recession Falling Output and Rising
  • Weak Consumer Confidence
  • Real estate prices have not hit bottom
  • Large institutions remain undercapitalized
    (except for a few)
  • Loan losses will increase Mortgages Spillover
    Effects on HELs, Commercial Real Estate, Credit
    Card Receivables and other Asset-Backed
  • Rising Bank Failures
  • States and Local Governments are in Trouble
  • Declining Value of the Dollar

What Are the Impacts?
  • In the aggregate, credit is less available.
  • The Shadow Banking system has closed down (The
    Originate-to-Distribute Model is broken such that
    securitizations have fallen sharply)
  • Most banks are cautious about lending due to
    uncertainty about asset quality, viability of
    commercial and real estate business, regulatory
    sanctions, and limited access to capital
  • Everyone is de-leveraging (saving more, reducing
  • The recession will persist and GDP growth will
  • PPIP will not work as planned federal government
    will mandate asset sales by banks then
    recapitalize the banks
  • Mortgage cramdowns will be officially sanctioned

What Does the Future Hold?
  • Banks will experience a fundamental shift in
    their balance sheets and income statements
  • Balance Sheet
  • - Deposits will be available, but
    competition will increase the cost
  • - Wholesale funding will be punished by the
  • - Loan concentrations will shift
  • - Quality investments will offer lower
    relative yields
  • Income Statement
  • - Loan loss provisions will remain high
  • - Efficiency ratios will rise

Strategies For Positioning Your Bank
  • Review and Upgrade Your Banks Capital Plan
  • Take Advantage of Deposit Insurance and Federal
    Government Liquidity Facilities
  • Re-examine Your Banks Investment Portfolio for
    Credit Risk and Interest Rate Risk

Change in House Prices Recent Month Past Year
Through February 2009
Jan. 09 Feb. 09
1-Year Atlanta -
2.2 -15.3 Boston - 0.9
- 7.2 Charlotte - 1.2 -
9.3 Chicago - 3.0 -17.6 Cleveland -
4.3 - 8.4 Dallas - 0.1 - 4.5
Denver - 1.1 - 5.6 Detroit - 3.4
Change in House Prices Recent Month Past Year
Through February 2009
  • Jan. 09 - Feb. 09
  • Las Vegas - 3.3 -31.7
  • Los Angeles - 1.7 -24.0
  • Miami - 3.1 -29.5
  • Minneapolis - 2.3 -20.2
  • New York - 1.4 -10.2
  • Phoenix - 3.7 -35.2
  • San Diego - 0.9 -22.9
  • San Francisco - 2.9 -31.0
  • Washington, D.C. - 2.1 -19.2
  • Mar. 1, 2008 Feb. 28, 2009 Case-Shiller
    Housing Indexes

(No Transcript)
Where Are We Now?
Denning, Liam, A New Way to Bet Against (or for)
the House, WSJ, April 6, 2009
Homeowners with Negative Equity
Phillips Simon, WSJ, March 5, 2009

Horowitz, Andrew, Commercial Real Estate Time
Bomb Ticking, Seeking Alpha, April 17, 2009
Are Credit Cards the Next Problem?
Reddy, Sudeep, Policy Makers Target Credit Card
Issuers, WSJ, April 21, 2009
WSJ, March 3, 2009
Dedmon, Bill, U.S. Banks Suffer 149 Percent Rise
in Bad Loans, msnbc.com, March 17, 2009
As a result of the size and magnitude of the
recent failures, the FDIC Reserve Ratio fell
below the mandated percentage in 2008 . . .
1.15 Limit
The FDIC is proposing a combination of increasing
insurance premiums and access to a LOC from the
U.S. Treasury to replenish the fund over a period
of 5-7 years.
The FDIC is required by law to replenish the fund
when the reserve ratio, falls below 1.15 percent.
  • Economic Positives
  • Everyone (individuals, businesses, markets)
    assume the worst will happen
  • Problems in housing are concentrated in specific
    markets sales of existing homes rose 5.1 in
  • Central banks have unleashed their weapons to
  • - lower interest rates
  • - provide liquidity
  • - ensure capital adequacy for large
  • - unfreeze credit markets
  • Oil prices are reasonable
  • Businesses have reduced inventories
  • There are great buys out there.

(No Transcript)
April 14, 2009
B of A, Citigroup, JPMorgan Chase Wells
  • Hold almost 50 of all consumer and business
  • Hold 3.6 trillion in credit card, HELs,
    mortgage, commercial real estate, and other
    consumer business loans
  • Hold almost 2 trillion in securities such as
    CDOs, CLOs, CMBSs and residential MBSs
  • - Have marked down many of these securities
    to 0.70
  • on the dollar
  • - What happens when loan losses increase?

Current Economic Environment
  • GDP fell 6.2 in 4th Quarter of 2008
  • Unemployment rate
  • - 8.50 for the U.S. in March 2009
  • - 12.6 for Michigan in March 2009
  • - 11.4 for South Carolina in March 2009
  • - 5.2 for Iowa in March 2009
  • 2008 Federal Budget Deficit 454.8 billion
    projected 1.75 trillion - 2 trillion in 2009
  • Banks lost 26.2 billion in 4th Quarter 2008

Why is GDP Growth Slowing?
Dougherty Evans, Economy in Worst Fall Since
82, WSJ, Feb. 28, 2009
Retail Sales Plummet
WSJ, November 15, 2008
The Paradox of Thrift
  • Thrift Dont buy things you dont need. Dont
    spend more than you make.
  • Strategy Save More ….. Spend Less
  • Paradox If everyone reduces spending, total
    saving will decrease because less spending lowers
  • Implication All of you should increase spending.
    Go out and shop more!

Evans, Consumers New Frugality Hurts Business,
WSJ, March 3, 2009
Fitch, Stephane, The Savings Bugbear, Forbes,
April 27, 2009
The Periodot Capitalist, April 7, 2009
  • 2.5 million jobs were lost in 2008
  • National unemployment rate in March was 8.5

What Do We Know About Recessions?
Hilsenrath Reddy, WSJ, Dec. 2, 2008
How Does This Recession Compare?
WSJ Editorial, March 6, 2009
Wessel, David, Obama Falls Short of Dealing with
Deficit, WSJ, April 9, 2009
Most State Budgets are in Deficit
McNichol and Lay, State Budget Troubles Worsen,
Center on Budget Policy Priorities, Jan. 29,
State Tax Revenues are Falling
Dougherty, Conor, Sales-Tax Revenue Falls at the
Fastest Pace in Years, WSJ, April 15, 2009
How Much Has the U.S. Government
Committed to Rescue Large Firms?
  • 600 Billion Purchase of GSE mortgage-backed
  • 200 Billion Term Asset-Backed Securities
    Lending Facility (for private sector purchases of
  • 250 Billion Term Securities Lending allows
    firms to borrow Treasury Bonds and substitute
    other collateral
  • 540 Billion Money Market Investment Facility
    (buy commercial paper, CDs, etc. )
  • 1.8 Trillion Fund Commercial Paper purchases
    (GE, GMAC and Ford has used this)
  • 700 Billion Troubled Asset Relief Program
    (TARP) (buy equity in firms and problem assets)
  • 350 Billion Temporary Liquidity Guarantee
    Program (firms issue FDIC insured debt)
  • 800 Billion Buy problem mortgages and
    securities to help mortgage lenders, credit card
    lenders, student loans, and car loans
  • 900 Billion Term Auction Facility (negotiated
    bank borrowing from the Federal Reserve)
  • 2.0 Trillion Public Private Partnership
    Investment Program (PPIP) in which the government
    with the private sector buys toxic assets

What Must be Done to Get Banks Lending as in
Normal Times?
  • Large institutions must clean-up their balance
  • Must find a floor for housing prices and
    commercial real estate
  • Reintroduce securitization

Securitizations are Disappearing Business Week
April 20, 2009
CMO issuance is just 2.00 of 2006 levels. The
appetite for asset-backed securities has all but
vanished from investors
The market for CMOs has collapsed, decreasing by
719 billion from 2007 levels.
Source Bloomberg
March 4, 2009
Data are for Dec. 31, 2008 estimates from banks
New York Times, April 27, 2009
Quick Critique of TARP Capital
  • Can obtain up to 3 of risk-weighted assets
  • Preferred stock pays 5 dividend for 5 years
    thereafter it increases to 9 (non-voting stock)
  • Treasury gets warrants up to 15 of funds
    committed as preferred stock
  • Negatives
  • - Government ownership can change rules
  • - warrants represent common stock
  • Positives
  • - Use capital to make loans or expand
  • - Be a buyer not a seller of branches and

The total estimated committed TARP funds by the
U.S. Government as of March 2009
AIG has received 80 billion from TARP and the
other 90 billion in LOC and borrowings from the
Federal Reserve.
Source SNL Financial, Bloomberg
The TARP program generates significant income for
the U.S. Government
  • The first tranche of the TARP program issued 327
    billion of preferred shares with dividend yields
    of 5 . The government can expect the following
    annual net dividend income from its TARP

Note Cost of funds was calculated by spreading
expense equally across the Treasury Curve for the
week ending 10/17/2008.
Source SNL Financial, Federal Reserve
  • If all of the governments shares of Citigroup
    are converted from preferred to common shares and
    A.I.G. defers or does not pay its TARP preferred,
    net interest income falls drastically but is
    still positive

Government Subsidies Not Well Known
Debt TARP Bank of America
44 45 JPMorgan
25 GE Capital
37 0 Goldman Sachs
10 Citigroup
27 50 Morgan Stanley
24 10 Wells
Fargo 0
Bary, Andrew, How Do You Spell Sweet Deal? For
Banks, Its TLGP, Barrons, April 20, 2009
Do TARP Recipients Buy Failed Banks?
Data include 38 Failed Banks from Oct. 2008
April 24, 2009 5 banks w/o acquirer excluded.
PPIP With Private Sector Participation
Solomon Hilsenrath, WSJ, March 3, 2009
Treasury Toxic Asset Plan
Lattman, et al, WSJ, March 24, 2009
Important Issues with PPIP
  • Positives
  • - Will establish market values for problem
  • - Allows Selling Bank to make loans
  • Negatives
  • - If Private Bidder pays too much, selling
    firms get a direct subsidy and taxpayers lose
  • - If Private Bidder offers too little,
    institutions will not sell problem assets with a
    cramdown at low prices, some institutions will
  • - With high losses on problem assets, the
    government may have to contribute more equity

How Do We Get a Floor on Housing Prices?
  • Reduce foreclosures
  • - loan modifications are encouraged
  • Mortgage cramdowns
  • Increase demand for new housing via tax credits

Mortgage Delinquency Rates
Simon, Ruth, Banks Ramp Up Foreclosures, WSJ,
April 15, 2009
There is a High Probability That Congress Will
Authorize Mortgage Cramdowns
  • Bankruptcy judges can determine the new terms
    to allow a borrower to remain in the home
  • - lower rates
  • - principal reduction
  • - longer maturity
  • What do mortgage servicing agreements say about
  • Implications?
  • - lower pass-through yields
  • - faster prepays or slower prepays?
  • - collapse of demand leading to falling prices

Mollenkamp, WSJ, April 8, 2009
How Are Loan Modifications Working?
Simon, Ruth, Study Buoys Mortgage Modification,
WSJ, April 3, 2009
  • Review and Upgrade Your Capital Plan
  • Increased focus on Tangible Common Equity
  • Market for trust preferred stock in gone
  • Identify reasonable growth objectives
  • - organic growth and contribution of
    retained earnings
  • - acquisition opportunities
  • What sources of external tier 1 capital can be
  • How much external capital is available?
  • - rights offerings will increase
  • - common stock offerings
  • - private equity
  • Should you shrink the bank?

Which of These Firms are Bank
Holding Companies?
  • Goldman Sachs
  • Morgan Stanley
  • American Express
  • GMAC
  • CIT
  • Raymond James

Take Advantage of Deposit Insurance
  • Everyone wants to be a bank to access low-cost,
    stable core deposits.
  • The largest institutions will price up deposits
    in every market they enter (witness GMAC Bank)
  • Community banks must compete with relationships
    and service as it is difficult to match pricing
  • Focus obtain more deposit (operating) accounts
    from customers with loan relationships incent
    your lenders on retained core deposit growth
  • Focus offer new signature savings accounts
    that migrate rate-sensitive customers from retail

Take Advantage of Govt. Liquidity Facilities
  • If you have sufficient collateral (requirements
    recently increased), consider borrowing under the
    Term Auction Facility (TAF)
  • Auctions every 2 weeks with 150 billion
    available recently
  • If undersubscribed, all borrowers pay the
    lowest rate bid
  • At recent auctions (all of 2009) the stop-out
    rate has been 0.25

Wholesale Borrowings Should be Used Primarily to
Fund Shortfalls in Deposit Growth and/or to
Mitigate Interest Rate Risk
  • Will long-term funding be available from the
    Federal Home Loan Bank?
  • Wholesale funding will be increasingly
    difficult to obtain its use will be punished by
    the FDIC
  • Rates are at historic lows lock-in longer-term
    rates where available

Re-examine Your Investment Portfolio for Credit
Risk and Interest Rate Risk
  • Quality investments will be increasingly
    difficult to find yields will fall focus on
    plain vanilla securities
  • Limit the amount of long-term, fixed-rate
    securities that you hold they will soon be
  • Short duration and adjustable rate investments
    will work best as rates inevitably rise
  • Prepayment speeds will be highly volatile
  • - GNMA prepays have risen sharply
  • - Mortgage cramdowns will accelerate prepays
  • Sell longer-term securities to limit premium
    write-downs creates gains that can be used to
    offset losses

Be Careful With Municipal Investments
  • Municipal yields seem to be very attractive
  • Municipalities are being downgraded
  • Bond insurers have seen their ratings drop
  • Conduct a detailed credit analysis of all
    municipal holdings and purchases
  • Following information is from Ed Krei with The
    Baker Group

Municipal Bond Defaults Are Extremely Rare
Municipal Credit Is Far Superior To
Corporate Credit
Municipal Credit Analysis
  • General Obligations
  • Debt to Assessed Ratio
  • Percentage of an Issuers total outstanding
    bonded debt relative to the current tax assessed
  • Per Capita Debt
  •   Issuers Net Debt divided by to the total
    population of the taxable public for a particular
  • Revenues
  • Debt Coverage Ratio 1.25
  • A measure of an Issuers ability to meet a
    certain type of expense. A high coverage ratio
    indicates a better ability to meet the expense in

Source The Baker Group
MAC Texas G.O. TMR
31,019,374 60,296,505

51.44 Debt to Assessed
MAC Texas Revenue TMR
Municipal Ratings Report
How Do We Get Credit Flowing Again?
Rappaport Hilsenrath, Fed Moves to Free Up
Credit for Consumers, WSJ, March 4, 2009
In addition to fixing the economy, regulatory
reform is necessary
  • Financial Regulatory Reform
  • Eliminate too big to fail doctrine
  • Financial Institution Regulatory reform
    systemic regulator
  • Temporarily decrease capital requirements for
    CAMELS 1 and 2 institutions
  • Make permanent insurance of all noninterest
    bearing deposits
  • Clarify the roles of FHLB and Federal Reserve
  • Do Not Allow Bankruptcy Judge Cramdowns

Timothy Koch Moore School of Business University
of South Carolina Columbia, SC 29208 803-777-6748
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