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The Beef Is in the Breakouts

By: Bill Poquette

Capital and CRE stress testing were among myriad focal points at the American Bankers Association’s National Conference for Community Bankers last month at the JW Marriott Desert Springs in sunny Southern California, and coping with change was a broad theme. As has been the custom with this conference, the real meat of this 32nd annual revival was in more than a dozen breakout and roundtable sessions over three days, Feb. 20–22.

The community banking sector will require about $90 billion of new capital over the next several years, according to Matthew Dyckman of SNR Denton during a session on capital raising for community banks. The new equity will be needed to cover charge offs, build reserves, organic growth and acquisitions. “Both under the Dodd-Frank Act and Basel III there is a clear legislative and regulatory bias in favor of common equity for financial institutions over other types of capital,” Dykman said. Due to Dodd-Frank, new regulatory capital regulations are expected to be proposed this year, he added.

He suggested that financial institutions should begin now taking into consideration Basel III’s increased minimum requirements, including its greater emphasis on common equity. While Basel III is not legally binding in the United States yet, key elements will likely be applied to banks of all sizes, Dykman believes.

“Even institutions that will not be directly subject to Basel III should expect that the regulations implemented under the Dodd-Frank Act will reflect, to some extent, the Basel III thinking,” he said.

Among options for raising capital are shrinking the balance sheet and selling fixed assets, Dykman pointed out. Inability to access capital will drive mergers and acquisitions, he believes. In addition, “The uncertainty surrounding regulatory capital requirements specifically and the regulatory environment in general has a significant impact on how investors view the banking industry,” he said.

It has been harder to raise capital because banks have underperformed until very recently, Allen Laufenberg of Stifel Nicolaus Weisel, another member of the panel, pointed out. And investors’ perspectives have been influenced by the political environment, re-regulation, European issues, domestic economic momentum, housing market weakness and the yield curve and low rates.

Investors will go where there is money to be made, Laufenberg explained. In good times, they look to future earnings but now they are focused on asset quality. “Some interest is showing,” he said, “and the second half of 2012 should be better for raising capital.”

Click here to view photos from this conference.

Laufenberg suggested that “biding time” may be a good strategy for banks under $1 billion in assets. “Ask yourself where you want to be in three to five years and how you are going to create shareholder value,” he said. Even “vulture investors” can be a means to an end such as a sale in a few years, for instance.  And the value of communicating with existing shareholders should not be underestimated. “The further you get away from the people who know you and how you operate, the harder it is to raise capital.” 

Much of the presentation by Michelle Lucci of Banker’s Toolbox in a session on CRE stress testing was drawn from the regulatory guidance of December 2006 and appraisal and evaluation guidelines published in December 2010. The Office of the Comptroller of the Currency issued a new version of its Concentrations of Credit handbook in December 2011, she pointed out.

Lucci defined stress testing as when “a bank alters assumptions about one or more financial, structural or economic variables to determine the potential effect on portfolio performance.” Unfortunately, in her experience, bankers don’t know what to do and what is expected. Furthermore, she added, they don’t believe they can do what is expected because of data quality issues and believe that their loans are underwritten conservatively and this exercise doesn’t apply to them. “These reasons are no longer valid,” she cautioned.

Three methods of stress testing are currently available to bankers, according to Lucci: Excel spreadsheet, Report Writer and automated solutions. An OCC Excel template is available at For many software models, including Report Writer, a one-time extract of loan data is performed and loaded into the program, she explained. This information is then supplemented by the required manual entry of many additional fields, among them collateral value, date and address; loan to value; debt service coverage ratio; and net operating income.

Drawbacks to this process, Lucci explained, include the loan extract takes time to obtain and load into the software model, and the required additional data (NOI, DSCR, LTV) usually results in an intense manual effort to obtain the loan files and enter the information into the software. However, with the automated method, there are software models that use standard industry output files, she said, and these files are core system neutral and eliminate integration risk.

Whatever method bankers use, Lucci advised, they should keep in mind this conclusion from the OCC’s December 2011 handbook: “Identifying, measuring and appropriately mitigating concentration risk is ultimately dependent on the accurate and timely receipt and analysis of data.”

Solutions for dealing with change stemming from Dodd-Frank and the economic slowdown were the subject of another session with speakers from Abound Resources, a consulting firm based in Austin, Texas, specializing in the community financial services industry, along with a Texas community banker.

Brad Smith, Abound’s president and CEO, suggested that community banks have fallen short in addressing small businesses. They have a “lead with lending” mentality, no product differentiation, wait for walk-in traffic and give away too many services for free, he told the ABA members. “Commercial lenders want to hunt elephants, not quail, and branch managers are too busy with branch administration,” he said.

The goal, according to Smith, should be to double business fee income and business balances. Customers should be encouraged to buy multiple deposit, payments and loan products. Average balances can be increased with an enterprise loyalty/miles program, which also improves retention, he added. Promotion of heavy credit card, debit card and other payments products, along with strong Internet banking and bill pay usage were recommended by Smith to increase fee income.

The theme for the conference, “Open the Door to the Future, Forward Focused Strategies for Your Community Bank,” drew the largest registration in several years, according to ABA officials. The association’s 2013 National Conference for Community Bankers will be Feb. 17–20 at the JW Marriott Orlando Grande Lakes.

Bill Poquette is editor-in-chief of BankNews.

Copyright (c) March 2012 by BankNews Media