Banking and Finance Round Table October 2013
North Carolina financial institutions are rethinking everything from branches
to loans while addressing regulations and a new generation of customers.
What’s the current climate of banking and finance in the state?
Willingham: It’s getting better, but it is not robust. Most banks are focused on the same clients, so competition is as stiff as ever. That narrows margins and spawns compromises on credit standards and terms. First Citizens acquired six failed institutions from the Federal Deposit Insurance Corp., and in almost every case lenders were chasing inflated real-estate prices. When the housing bubble burst, those banks didn’t have any collateral. North Carolina didn’t have the volatility in real estate the same way Florida, Georgia and California did.
Cherry: The industry here, as it has across much of the country, has moved from an asset-quality crisis to a net-interest-margin crisis, which will probably continue even if rates increase.
Hutchens: A large part of our practice is representing creditors from across the country. Over the last five or six years, it seems banks in North Carolina have fared better than those elsewhere.
Woodard: The industry is changing. Looking back is just wishful thinking. It is scary to look ahead because it is an untraveled road. The way we did business is going to change dramatically. That gives a new generation the opportunity to cope with new challenges.
What put financial institutions in this situation?
Martin: There are many reasons including the Great Recession, but it’s like when a plane falls out of the sky: It’s not just one problem but a series of them. Incentives were misaligned, so banks are dealing with the fallout. Then the Dodd-Frank Wall Street Reform and Consumer Protection Act, which aims to prevent another financial crisis, was passed. Then you throw in other things such as technology. It’s a lot to cope with in a little bit of time.
Willingham: North Carolina probably had fewer bank failures per capita than many other states, especially in the Southeast. The regulatory environment here has always been good, especially for branching, and that’s how banks build a strong footprint. Georgia, until 30 years ago, didn’t allow branches outside a bank’s home county. That encouraged failure because those banks had limited markets.
Fox: There have always been good banks — both large and small — here. Much of that goodness carried the state through this last down business cycle. Many of the bankers, even in the small banks, started at big banks.
Woodard: There is a lot of David versus Goliath in North Carolina banking history. The small banks found opportunity in disenchanted customers of large banks. But the thing that scares me is the dearth of that activity now. There are no de novo banks — state-member banks open less than five years — and there is not an attitude among the regulators or the administration to let them come forward. Those new banks will be very different if they ever do. And with the litigious nature of things today, there are not many folks interested in a board-of-directors position.
Dodd-Frank reform contains regulations on mortgage servicing and lending. What’s the impact on financial institutions?
Cherry: Large banks will shrink to become more cost efficient, and small banks will grow in order to compete. Smaller banks will need more expertise and greater corporate governance to ensure good oversight along with geographic and product diversity. Regional banks between $5 billion and $20 billion of assets are absent from the state. Three years ago, First Citizens of South Carolina was the only one between those goal posts. Before that, that space was filled with First Union, North Carolina National Bank, BB&T, Southern National and others. All of them grew up. Banks that size aren’t lacking in other regions of the U.S. They were large enough to have a diverse geography and array of services yet small enough to build relationships with customers. Long term, there will be a different formula for starting a bank. You won’t be able to start a bank with only $20 million of capital and have the needed infrastructure.
Fox: Banks are used to working in a regulated environment and will continue to do so. The bigger impact will be on the historically unregulated shadow-banking system, made up of financial institutions such as finance companies and credit-hedge funds that act like banks but are not supervised the same way and which, at its peak, was as large as the entire U.S. banking system. More regulation means more compliance but more spent on training and technology.
Who or what will Dodd-Frank affect the most?
Martin: Most of Dodd-Frank is geared toward large banks, but there are parts — the Federal Trade Commission’s Bureau of Consumer Protection, for example, because it regulates product markets — that could impact community banks. It would be a travesty if the bureau limits innovation or offerings either directly or indirectly. Its attempt to solve one problem could force banks to withdraw products elsewhere, which could slow economic growth. Right now the state’s economy is a two-cylinder engine: the Triangle and Charlotte.
Hutchens: One of the mandates of the consumer bureau is to encourage lenders to go into rural communities.
Fox: In some rural areas there are structural issues such as unemployment. Many of the textile jobs have left the state and are not coming back. While it is great to announce that 250 or 300 jobs are being created, it takes a lot of those to make up for 300,000 lost jobs, many of which were in rural communities.
Cherry: Consumers and small businesses will be impacted the most because of compliance and other restrictions. The customers in the center will probably find themselves well served, but the ones on the fringe, where most growth originates, won’t. Anyone with any kind of nuance that requires some level of discretion will find it more difficult. There is uncertainty ahead. The Federal Reserve Act, for example, is 31 pages, but Dodd-Frank is more than 2,300 pages. I don’t know anyone who has read it all, and that probably includes anyone who voted on it. It will take years in the promulgation of rules and criteria to follow. I can’t tell you if it’s bad or good. I can tell you it’s going to be expensive. If you look at foreclosures, 90% involved loans that originated through mortgage brokers outside of the banking industry. So a significant portion of the problem is outside the industry that is receiving the brunt of the regulations. It seems the same regulators who believe a practice is best at one level think it is best at every level. So regardless of where you are today, you’ll have to reach for a higher bar.
Willingham: The qualified mortgage rules address subprime credit, where people were given mortgages they didn’t qualify for. If lenders follow the rules they supposedly can avoid litigation. My interpretation is if a loan is made on potential and that potential is not realized, the borrower can claim that the loan should not have been made. That’s new risk, because past lending has not drawn litigation. We have done 100% mortgage lending to health-care professionals for decades. That might not disappear, but it will draw more caution. There are retirees who are balance-sheet wealthy, but their income streams are marginal. Underwriting a mortgage for them — unless they liquidate assets and pay that money down — is riskier under the new rules. How this risk is dealt with might impact construction and first-time homebuyers.
Do financial institutions have a role in educating customers?
Fox: We’ve always had a role, and disclosure is already an important part of it. There will be more efforts to simplify disclosures. At some point, everyone may be using an identical document. First Tennessee has added wording to make it easier for consumers to understand. On the commercial side, bankers first ensure that the client is getting good advice. Who provides that solution is irrelevant as long as the client is getting it. If a client does well, the bank does well.
Cherry: The amount of disclosure today only complicates the process. The documents needed to close a residential mortgage are inches thick. I don’t believe anyone is reading them, just like Dodd-Frank. They are becoming more complex rather than simply saying, “Here are the key elements you need to understand about this transaction.”
Rank: Many consumers get their financial education while finding out why their application for credit was denied. Educating them beforehand is difficult. Most of us are a lot like me: A packet comes in the mail, and it isn’t read.
Martin: From the Fed’s perspective, if consumers get the big financial decisions — such as borrowing for education or a home — largely right, they will be largely OK. That also builds protection from economic instability. I’ve had the chance to speak with borrowers who said point blank: “I thought the broker was acting in my best interest.” They didn’t understand that the broker was paid more to put them in a particular product regardless of the borrower’s costs.
Woodard: Industry members have been strong supporters of the association’s Camp Challenge, which has taught 8,300 sixth-, seventh- and eighth-graders from low-resource homes financial skills in a summer-camp setting over the past 20 years. It’s drawn the attention of retired Gen. and former Secretary of State Colin Powell and other leaders. More of this type of education is needed because society needs responsible people.
How will financial institutions serve the next generation of customers?
Cherry: Through other channels, such as smartphones. The emerging changes are neither good nor bad. They only mean that it’s going to be different. However you reach them, you’ll still need a variety of them. Historically, about 60% of deposits have come from consumers, and about 60% of assets or loans have come from commercial. If you’re just a commercial bank, you’re bound to have a funding problem. If you’re just a consumer bank, you’ll have an asset-generation problem. There are examples of that in our own state: communities where the opportunity to grow assets begins to dry up but ample consumer deposits remain, so banks reach into other communities. They did not go this route to try to grow assets.
Rank: Most of us in this room are comforted by brick-and-mortar locations, but tablets and smartphones comfort the younger generation.
Fox: You won’t need as many brick-and-mortar locations, and the ones banks will have will be smaller — 1,200 square feet compared with 3,500 to 4,500 square feet. They might not have a traditional teller line, but they will facilitate services that benefit clients most, particularly consultation. First Tennessee’s Mid-Atlantic region has a few offices with a high premium on quality bankers, service and delivery. We might want a few more branches but not the saturation we once had.
Willingham: First Citizens bought Bank of Bladenboro about 20 years ago, when its namesake was a booming textile town. It’s about a 7,500-square-foot building, which probably makes us the county’s biggest taxpayer. I went there about a month ago, and maybe three people were working in the building, which the bank is stuck with. Branches are part of branding and advertising. Customers may not need one for transactions, but they want one as validation the institution is real. The bank’s de novo experience over the last 15 years in Georgia, Florida, Texas and Oregon included putting a couple of loan-production offices and business banks in each market. We’re building some retail, but that is not the target. It’s possible to create viable banks with few buildings and many online opportunities.
What effect will changes to the state’s mortgage-interest deduction and the corporate-income tax have?
Cherry: Anything that increases cash flow helps business development and job creation. The reduction is basically a new tax. It might affect high-end purchase decisions, but anything that reduces the economics of buying a home is going to reduce sales. There was a time that incentives such as the deduction made buying more advantageous than renting. Lately renting an apartment has been better, and we’re about to see the benefits of each become equal.
Martin: Rents are coming up, and the homeownership rate is back to its longtime resting point around 64%. Baby boomers are downsizing, so the high-end market was going to struggle anyway.
Willingham: The mortgage-interest deduction will sort itself out. Its impact is probably fairly nominal for most homeowners.
Fox: Generational changes — whether it is banking, the way you live or where you work — bring a different way of thinking. Many of these rules will be rewritten.
What needs to happen on the federal level to help state banking?
Martin: There is a good relationship between bankers and the Fed. It certainly gets regular input on what they’d like to see happen, and that’s taken into consideration.
Willingham: Congress pushes Federal Reserve Chairman Ben Bernanke on why the Fed is not doing more to improve the economy. The Fed has done what it can. Bernanke tries to say, without turning the spotlight around, that lawmakers need to provide certainty in taxes, spending and policy and develop a better understanding of regulations. Leadership is needed in all parties to find solutions that will move the economy forward.
Cherry: The challenge is finding a way to work across party lines. What you would like to have is a nimble and cooperative legislature that works with the executive branch to solve issues as they arise. The sense is that whatever is in place cannot be changed except if there is a crisis. You don’t want everything going to a crisis before being resolved.
Fox: Today’s consumer and commercial borrowers have less debt, more liquidity and healthy debt-coverage ratios. They are some of the best credit conditions I’ve seen. Those people are not going to change that profile until they see more certainty. They’ve lived through the Great Recession and don’t want to again. Many of them are comfortable where they are and only more certainty will justify more investment.
Woodard: Everybody was culpable for the Great Recession. The government was supposed to take care of us. Lenders were supposed to fulfill their responsibilities. Nobody was supposed to mislead the public, but they did because people got greedy. It’s a natural reaction to revamp the system. The pendulum has swung, but it’s swinging to its other extreme. It needs to come back to the center, where practicality reigns. We will get back to the center, but there will be fewer of us after it does.