NorthWesternFinancialReview.com Blog

The biggest news story of 2008 was the deteriorating economy. It is a story we covered thoroughly in the pages of NorthWestern Financial Review magazine. Bank earnings were collectively off, even though they reached record levels at some institutions, particularly institutions in rural areas.

The decline in earnings actually started in 2007, with aggregate industry-wide earnings for that year coming in 27 percent lower than in 2006. Final year-end numbers of 2008 won’t be available until February, but we know the decline throughout the year was steep. In the third quarter, the industry collectively earned $1.7 billion, a 94 percent drop compared to third quarter 2007. One in four banks across the country reported losses for the third quarter, while 58 percent said third quarter earnings in 2008 were lower than they were in 2007.

In the Upper Midwest, 17.5 percent of the banks (611 out of 3,480) reported losses for the third quarter. That’s unusually high. Some states are suffering more than others; in Michigan, 38.3 percent of the banks reported third quarter losses; 25.6 percent reported losses in Colorado; and 24.0 percent reported losses in Missouri.

Earnings trouble put bank failures back in the news. Twenty-five banks closed this year, compared to three in 2007. The IndyMac Bank failure on July 11 captured a lot of headlines. With $32 billion in assets, it was the second-largest bank failure in history. The bank was somewhat emblematic of the mortgage finance troubles plaguing the economy; IndyMac specialized in Alt-A mortgages, the ones with reduced documentation.

First Integrity Bank, N.A., of Staples, Minn., was the nation’s fourth bank failure in 2008; it was closed by the OCC on May 30. This was a $57 million bank that reached beyond its home lending area by making loans in Florida, where the real estate bubble made business look promising a year or more earlier.

The housing bubble burst also caused trouble at Fannie Mae and Freddie Mac. When stock prices at the GSEs plummeted by 45 percent in early July, the U.S. Treasury Department stepped in to “help.” It made arrangements to shore up capital, but ultimately placed the two agencies in conservatorship on Sept. 7. The capital markets responded, all but freezing up. The Treasury Secretary begged Congress for money to restore faith in the markets. By Oct. 1, President Bush signed a $700 billion package.

In the meantime, Lehman Brothers filed for bankruptcy, while Morgan Stanley and Goldman Sachs applied for bank holding company status. Also, Wells Fargo struck a deal to acquire Wachovia, edging out a Citigroup, which thought it already had inked a deal to buy Wachovia.

Treasury Secretary Paulson used half the money from congress to create a new program called the Troubled Asset Recovery Program. In a dramatic move on Oct. 14, Treasury said it would buy $125 billion in preferred stock in nine of the largest banks in the country. Another $125 billion was to be used to buy stock in other banks. Treasury wanted the banks to lend the money, but as the economy has suffered, loan demand has fallen off. Paulson originally had said some of the TARP money would be used to buy troubled assets from banks, but on Nov. 12, he rescinded that idea, saying instead he would use the money to encourage rejuvenation of the asset-backed securities market.

The FDIC also helped out to lubricate the lending markets by guaranteeing loans between banks and by upping the level of insurance protection on deposits at banks. It is something the banks have wanted for a long time anyway. But it comes at a price. Insurance rates charged by the FDIC are going up, on average, seven cents for every $100 in deposits, a doubling of the rate for most banks.

The Federal Reserve aggressively lowered interest rates throughout the year in an effort to stimulate the economy. The Fed Funds rate currently stands at a historic low in a range from 0 to 0.25 percent; on Dec. 11, 2007, the rate was 4.25 percent.

As investors lost confidence in the economy, money migrated away from the commodities markets into U.S. Treasury bonds. That brought prices for farm commodities down out of the stratosphere. Equations for determining profits related to farm operations look entirely different today than they did a year ago. With the dollar strengthening, export opportunities are down, but the price of fuel is also down, making it easier to plant. Lower commodities prices are depressing farm land prices, which anecdotally had reached as high as $10,000 per acre in some parts of Iowa. Also, enthusiasm for ethanol seems to have waned, as lower gas prices and higher food prices reduce the incentive to convert corn into fuel.

Weather across much of the Upper Midwest allowed farmers to produce record yields, although in eastern Iowa, spring flooding and tornadoes had a significant negative impact on farmers and rural communities.

Other major stories for bankers in the Upper Midwest this year included the merger discussion that took place between the Federal Home Loan Banks for Chicago and Dallas, the rewrite of the banking code in South Dakota, and the attempt to beef up the laws governing mortgage transactions in Minnesota. The Chicago and Dallas home loan banks decided not to merge and the Chicago bank took steps throughout the year to improve its earnings. In South Dakota it became a little easier for a bank to set up a new branch; and in Minnesota, the bankers were able to persuade Gov. Tim Pawlenty to veto an onerous mortgage foreclosure bill.

Several well-known bankers in the Upper Midwest changed jobs in 2008. Suku Radia became the new president of Bankers Trust in Des Moines, replacing the retiring J. Michael Earley (a former NorthWestern Financial Review Banker of the Year). Jim Ghiglieri left his bank in Toluca, Ill., to join the Shazam ATM/EFT network. Phil Koepke, a correspondent banker for 30 years, retired from M&I Bank in Milwaukee in February. Wells Fargo correspondent bankers Bill Meyer, Mike Bodeen, Troy Rosenbrook and Cathy Morrissey all took new jobs; Meyer and Bodeen went to National Exchange Bank & Trust in Fond du Lac, Wis.; Rosenbrook went to American Bank in St. Paul, and Morrissey became the new president of NetWorks, the EFT network in Nebraska. Robert English, working in Chicago, now heads Wells Fargo’s correspondent banking department.

Kirby Davidson was promoted at the Graduate School of Banking in Madison, Wis., to president. Dorothy Bridges left Franklin Bank in Minneapolis to join a bank in the Washington, D.C. area. And Shari Weber, who had been president and CEO of the Community Bankers of Kansas for five years, left in order to run for a state senate seat. (She lost that election.) Also worth noting, former Iowa Gov. Tom Vilsak, who gave a speech on the unexpected topic of global warming at last May’s annual gathering hosted by the Iowa Superintendent of Banking, was appointed U.S. Secretary of Agriculture by president-elect Barak Obama.

It was a big year in financial services. We look forward to covering the industry’s events and developments throughout the coming year.

I hope you got a chance to read this article, which ran on the front page of the Wall Street Journal on December 24. It is probably the best article on community banking I have ever seen in the WSJ, which I consider to be the nation’s best newspaper.

San Francisco-based writer Phred Dvorak flew to Kalamazoo, Mich., and spent three days with James MacPhee, chief executive officer of the Kalamazoo County State Bank in Schoolcraft, a community of 1,600 people. MacPhee explained to me that the WSJ wanted to do a story on community banking in the current economic climate. They called the Independent Community Bankers of America, and they put them in touch with MacPhee, who is the association’s vice chairman. MacPhee said he initially was reluctant to set aside the time to do the story, given the demands on his time posed by end-of-year obligations. But Dvorak persisted and MacPhee agreed.

Here are a few excerpts from the article which I think capture the essence of community banking:

Bankers “walk a fine line. Holding lending standards that are too strict can worsen the local economic toll. Being too lenient can run afoul of newly nervous bank directors and regulators, or endanger the bank’s own survival. Add to that the tension of making hard decisions about customers who are also neighbors.”

…

“Some small town bankers say there just aren’t all that many creditworthy customers who wish to borrow now.”

…

Banks with fewer than $1 billion in assets hold 13 percent of the industry’s assets, but more than one-third of the loans worth less than $1 million.

“Banking at this level can be intensely personal and flavored with civic pride.”

I love that last one, because the implication is that banking at the Wall Street level is not personal nor does it have anything to do with civic pride.

Watch for the Jan. 15 edition of NorthWestern Financial Review for more from my interview with MacPhee.

Don’t you wonder what the point of this Associated Press story is? It certainly is not news that the presidents and senior managers of large banks in this country make a lot of money.

I have a theory that these kinds of stories are designed to make people angry. Maybe angry people buy more newspapers; I am not sure.

The reporters in this case, who surely know better, have not bothered to explain the differences between investment banks and commercial banks. Nor have they bothered to explain that the U.S. Treasury Department basically forced the largest bank holding companies in the country, including Wells Fargo, to take money in exchange for preferred stock. Since TARP was announced, Treasury has said it would buy preferred stock at an attractive price from any bank that’s interested. What’s being called a bailout, of course, is really a federal government program to buy bank stock. Dividends will be paid along the way, and eventually the banks will have to buy the stock back. No mention of any of this in the AP story.

 Certainly the relationship between the commercial banking industry and the newspaper industry is strained right now. The commercial banking industry doesn’t need any help from the government but is getting it, while the newspaper industry is rapidly deteriorating and really could use a bailout, but it will never get it. It has to be even more maddening to newspaper people that the President is willing to use TARP money to fund loans for the auto industry. Meanwhile, newspapers in major cities are up for sale and others are on the verge of bankruptcy. No wonder the newspaper people are so jealous of the bankers.

If you understand the relationship between a reporter and what he or she is covering, you can sometimes understand the story a little better.

ICBA supports the Federal Reserve Board’s disclosure modifications and bans on double-cycle billing and high-fee subprime credit cards. However, the association expresses ‘deep disappointment’ with risk-based repricing restrictions.

ABA’s statement is here.

A day after economists from the Federal Reserve Bank of Minneapolis released a gloomy economic forecast, economists from Wells Fargo & Co., hosted a meeting with reporters to communicate a similarly gloomy forecast. Near-term signs seem bleak, they said, although a limited number of hopeful signs are signalling potential improvement by second half of next year.

“I think it is really lousy now and next quarter, a flat second quarter in 2009 and I think probably better than expected third and fourth quarters,” said Jim Paulsen, chief investment strategist for Wells Capital Management. He had the most optimistic forecast of the three Wells Fargo economists at the meeting.

“As we head into 2009, the U.S. economy continues to plunge with little sign of a near-term lift,” said Scott Anderson, senior economist for Wells Fargo. “There is very little in the economic tea leaves to give me hope that an economic recovery is near. I expect the 2008-2009 recession will end up being the worst recession in the post-war period in terms of both depth and duration… Certainly, this will be a prolonged downturn. I think the recession will last 19 months to at least June. That will exceed the length of the recessions in 1981 or 1973.”

“The U.S. economy is in trouble and no one seems to know what needs to be done,” commented Eugenio Aleman, senior economist at Wells Fargo.

Each economist articulated many of the economy’s woes, including declines in consumer spending, declines in business spending, increases in unemployment (to as high as 8.8 percent by fourth quarter 2009), and increases in the federal budget deficit.

“There is no such thing as a free lunch in economics,” Anderson reminded. “The fiscal deficit will be pretty stunning. We think it will be $1.3 trillion in fiscal 2009, over a trillion dollars in 2010. That’s enough to move our deficit from 3 percent of GDP to 9 percent of GDP. Anything over 6 percent gets me nervous about a possible collapse of the currency or other nasty effects such as inflation and rising bond yields. We will have to service that debt and pay it down; that will mean higher taxes, and slower economic trend growth in the future.”

The economists, however, were not completely negative.

“Sometimes you lose track of how much policy stimulus we’ve dumped on this sucker. It’s amazing,” said Paulsen. “By the time Obama takes office, we will have spent a trillion dollars in the previous 12 months already. So it will actually be a $2 trillion package over the haul.

“This cycle seems to me like you are trying to get your charcoal briquettes lighted at the barbeque and you can’t get it going so you keep squirting the lighter fluid on it,” Paulsen explained. “And you keep squirting lighter fluid, and all of a sudden, next spring or summer, it goes poof and it really takes off.”

Paulsen asserted signs are already visible which point to economic improvement. “It seems like we have a little better handle on this thing than we ever have had,” he said. “We have brought Libor down. We have the short commercial paper markets functioning and growing again. We’ve dropped mortgage-backed security yields and we’re dropping the current mortgage rate for the first time. We’ve got investment grade corporate yields coming down after spiking. We’ve got emerging market stocks and even emerging market bonds doing a little better. We’ve got the panic trade coming out of the dollar. There is some descent stuff that is going on. It seems to me that since the Fed started using its balance sheet to buy short paper and to buy long paper that this thing is working out a little better.”

Anderson said he expects housing to be one of the first sectors to see improvement. 

“I think the housing market is about to turn a corner and start adding, at least modestly, to economic growth in 2009, perhaps as early as this summer,” Anderson said. “Homebuilding has seen more than three years of contraction. It’s the worst decline in terms of homebuilding since the Great Depression. I expect only one more decline in housing starts in the first quarter, but I think we will start recovery in the second quarter.”

Aleman said a recovery is dependent upon action by the federal government. He said capital has fled private sectors and poured into the U.S. Treasury. He said that while this has reduced the cost of borrowing for the U.S. government, it has made it “almost impossible for the private sector to borrow. This means the U.S. government is the only alternative to get us out of this crisis,” Aleman said. “The U.S. government has plenty of cheap financing available to help the economy forward.  Of course, this is going to be very, very expensive and is going to require taxes in the future to increase, but the alternative is letting the economy continue to collapse.”

The Federal Reserve Bank of Minneapolis hosted an economic forecast meeting this morning at their offices on the banks of the Mississippi. Economists Toby Madden and Rob Grunewald told a room full of reporters that conditions likely will worsen throughout 2009. Unemployment is expected to increase to as high as 7 percent in the Upper Midwest. This is a summary of their forecast.

There has been some debate about the extent to which banks have tightened up lending in the last few months. In this paper published in October, Fed economists argue that reports of credit drying up are exaggerated. Madden, however, said that the Minneapolis Fed Bank wanted to get a better handle on the answer.

“We decided to do some additional surveys and ask additional questions on our current surveys,” he said in an interview this morning. “Based on those survey results, we found credit conditions have tightened. Banks are requiring more documentation and more collateral and have tighter standards in general, even charging higher interest rates.

“Meanwhile, the banks are saying they have enough cash on hand to lend,” Madden continued.

Comments from business owners, Madden said, suggest a reduced demand for credit. For example, most business owners and managers in the Upper Midwest say they are cutting back on employment, capital investment and acquisitions. “So they need to borrow less money,” Madden said.

With conditions in the business world tougher, Madden said, “banks are looking to make sure that they get paid back. Possibly in the previous cycle they might have lent too freely and now they are seeing higher write-offs. So they are tightening their credit standards. Peoples’ financial conditions have deteriorated slightly because of the downturn in the economy, so they are less credit worthy to borrow money.”

I asked to what extent he thought regulators are driving the tightening of lending standards. “I don’t get the sense this is regulatory driven,” Madden said. The Fed got “comments from hundreds of bankers surveyed and I think we got one or two comments regarding regulation, whereas most of it is just saying, ‘hey, that’s business.’”

Interest rates are down, deposit insurance rates are going up. The FDIC almost doubled its budget for 2009. Just another day in the U.S. economy.

Curtis Hage, chairman and CEO of Home Federal Bank in Sioux Falls, S.D., participated in a panel discussion at the National Housing Forum last week in Washington, D.C. I talked to Hage after the conference; he said everyone was talking about ways to reduce the number of home mortgage foreclosures. Various industry observers offered ideas about what should be done. See the Jan. 1 NorthWestern Financial Review for a report.

Hage commented, however, that many of the steps designed to mitigate foreclosures that have already been taken are causing problems. For example, he said that efforts to reduce fraud in loan applications are likely to substantially slow the mortgage approval process.

He said new rules have been implemented which require a borrower to present a Social Security card. “Most people don’t carry their Social Security card with them, and many don’t know where their card is,” Hage said. In those cases, the lender gets a waiver from the borrower allowing the lender to get a copy directly from the Social Security Administration.

“My concern is, I don’t know if anyone bothered to call Social Security,” Hage said. “I don’t know if they have people to support that, or is it going to take us months to get turn-around from the Social Security Administration?”

Hage said he has similar concerns about a new requirement to match an applicant’s tax return with returns actually filed with the IRS. Mortgage lenders are now required to obtain copies of tax returns from the IRS in order to verify information presented by borrowers seeking stated-income loans.

“I don’t know if anyone called IRS to tell them they may be getting thousands of calls asking for copies of tax returns. Are you staffed up and ready to do that? Our other experiences with the Social Security Administration and the IRS is they respond in their own sweet time. Sometimes that is months — if not years — apart from the time you start asking for stuff and the time you get it,” Hage said.

“You could have people standing in line at a title company for 6, 8 12 months to get information from Social Security and/or the IRS.”

As in, Crumbling Automaker Relief Program. Via Bloomberg, a snippet from a statement from Dana Perino, White House press secretary:

“Given the current weakend state of the U.S. economy, we will consider other options if necessary–including use of the TARP program–to prevent a collapse of troubled automakers.”

At least according to this seasonal send-up from Mike Steelman, chairman and CEO of Farmers & Merchants State Bank, Bushnell, Ill. And who could blame the jolly old elf, what with the high cost of reindeer feed, overdue toy payables and mounting expense for his elfin workforce?

If you scroll to the last page on the link you’ll find a fun and timely rendition of the holiday tune “Let it Snow” from bank employee Connie Morrow. Sample:

“Oh it dosen’t show signs of stopping,/With the dollar’s value flopping./We’re aware of your status quo./Yes we know, feeling low, let it go.”

Good fun.