Today we turn to looking at the banking scenarios facing CFO's and Treasurers. As 2009 ends we see the Obama Administration preparing to gear up its job restoration strategy. President Obama and his team, along with pretty much every other financial expert, correctly surmises the importance of bringing US unemployment down and restarting the Main Street economy as critical to maneuvering the economy away from the vortex created by the collapse of the leveraged finance house of cards.
I must say that I personally find the thought of a grassroots approach based on emphasizing small business recovery to be refreshing. The concept that "many hands make light work" makes good sense to me. The best of breed from the old ways will do well regardless. Encouraging and supporting smaller more maneuverable business to fill the needs voids will almost surely result in a revitalized and globally competitive United States of America. It's the kind of thing this country, encompassing all our political and cultural persuasions, is good at. It's certainly a more persuasive use of precious national wealth than continuing to prop up obsolescent "sucking sound" infrastructures. The question is of the new year will be can the Administration steer a course to the correct balance. I wish the President and his team the best in this effort.
The Flight to Quality, A Never Ending Journey
The impact on banks and businesses by what is about to unfold are many but ultimately it boils down to quality. The quality of the commercial and industrial entities that will seek and use business financing in 2010 and the quality of the banking institutions that will serve the new landscape. The banks will need to contend with two things to clear the way serving Main Street again.
First is completing the transition into a new reality that the country has moved into a post real estate boom phase. Shedding exposure is a tactical necessity. This means banks need to tend to their own health particularly with respect to the lingering cancer of losses from distressed real estate still in their bloodstreams. Projected real estate loan losses still to come are massive. The bulk of Option-ARM reset dates are in the still to come in 2010 and 2011 bucket. The reality is that these loans were never meant to survive the reset. Unless an alternative is created, the human pain and loss will be massive. The current loan modification program has an applicant failure rate of over 60% and the actuarial probability is that the remainder might just be a delaying tactic slowing the inevitable. Here's the truth. We have a lot of U.S. homeowners who can only afford to be U.S. renters. Until their relationship with finance and banking is morphed to reflect that truth the cancer will remain in the national bloodstream. Statutory loss reserves and FDIC insurance premiums will continue to suck discretionary capital away from new lending and a credit availability crisis will hamper the President's recovery agenda. Still, looking at the various piecemeal components of proposed solutions to this that have crossed my desk in the last year, I have a degree of belief there is a way to do this. It needs someone to architect it into a cohesive strategy then sell it to what is clearly still a weakened and hesitant hospital patient.
The second challenge to banks is to make the transition back to becoming a competitive marketplace for quality lending. Specifically, for the supporting the President's agenda, quality commercial and industrial lending. C&I loans and lines of credit are the fuel that grows economies. Targeted C&I for small firms may be forthcoming if the Administration follows through turning policy into substance. We should not be surprised if keen competition for the highest quality C&I customers will become all the rage next year. Indeed CFO's and Treasurers of well positioned firms should be insulted if they don't have several bankers knocking on your door courting their business accounts. There's some evidence of that happening already. Expect to see all kinds of spin about why your current bank is a pile of poop and you should become a client of bank X. It'll be all to the good because a competitive Main Street financing market is a sign of an improving economy. Don't believe bank advertising material on it's face though.
CFO's of commercial and industrial companies are well advised to exercise some "Trust No One Agent Mulder" prudence. We've seen a fair few "we're better than your old bank" pitches that turn out to have higher risk and stress ratings than a company's existing banking relationships. When asked we tell companies it's worth the peace of mind to obtain even the basic IRA report on one's bank and any bank pitching you for business. CFO's need an independent eye. Think of it as getting a "CarFax" before signing the papers. Making banks compete in the bright light of day could even sweeten the pot for a CFO particularly when being approached by equally good and competitively motivated banking alternatives. Finally, in these days of SOX compliance, it's also important to prove to the finance committee and to satisfy potential adequacy of internal controls challenges that one did use at least one independent criteria to base one's decision on.
In parallel, Treasurers need to look at their deposits placements and cash management strategies with a keen eye on bank quality. There are 8,500 or so active banks in the U.S. Not all of them are healthy. Some of them are "hazardous" and that's not a term I made up, it's a category they fall into based on business conditions exceeding regulatory criteria thresholds. And just relying on ladders and brokered deposit spreading isn't enough. Treasurers still need to pick one or more primary banking relationships where sizable balances may have to sit as part of enabling the smooth operations of the CFO and COO of the firm. The same reality that hit the Wall Street finance universe applies to industrials. Shifting risk is no substitute for reducing risk.