We surveyed commercial bankers in Q4 to get their thoughts about a potential economic downturn. In this episode, we look at the survey results and Dallas Wells interprets what bankers are REALLY saying.
How to Steer Your Bank's Portfolio Through an Economic Downturn (Webinar)
A Recession is the Time for Banks to Get Ahead
The State of Commercial Banking: Jan. 2020 Market Analysis (Webinar registration)
Maria Abbe: Hi, and welcome to The Purposeful Banker, the podcast brought to you by PrecisionLender, where we discuss the big topics on the minds of today's best bankers. I'm Maria Abbe, senior communications manager here at PrecisionLender.
Today's show features Dallas Wells, PrecisionLender's EVP of strategic initiatives, and Jim Young, our director of content. They're going to discuss the results of a survey that we did earlier this quarter in which we asked bankers about how prepared or unprepared their bank will be for an eventual economic downturn, whenever that day comes. We'll have links in the episode notes to relevant articles and information. Now, onto the show. Enjoy.
Okay, Dallas. Before we dive into these numbers ... and again, as Maria mentioned, these are the results of a survey that we sent out in advance of the webinar
and report that Dallas put out earlier this quarter that was about basically steering your portfolio through an economic downturn. So, we put out this survey ahead of time to get a feel for, "Hey, bankers, how do you feel about where your bank is in terms of its ability, should things eventually turn south economically... How are you feeling about your bank's ability to steer its way through that?" So, Dallas, I guess my first question on this is really more of a general feeling about the responses that you saw on this. Were they what you expected?
Dallas Wells: Yeah, I think they were mostly what I would have expected, which I think is a different question than, do I believe all the answers? Well, we'll get into that maybe one by one, but I think sometimes you send these out and you get back something and it's like, "Oh, wow. Holy crap, that's not what I expected there." There weren't really any of those that really stood out as a big surprise. I think mostly what we expected.
Jim Young: Okay. By we, you mean not me, because I was caught off guard.
Dallas Wells: Okay, so the royal we, then, but-
Jim Young: Exactly. I'm the naive person here that went, "Wait, really?" So, all right. Well, anyway, you'll see what we mean here, when we start going into some of these. We're going to go through these on this podcast, some of the answers here, and I want to get Dallas's ability to read between the lines on some of them, or give his interpretation of what bankers mean with some of the answers.
The first one here, 79% of bankers feel their bank's portfolio is ready to withstand a recession. More striking than that, really, was that 50% feel their bank is better positioned than their peers. I think what it is, Dallas, is I've always gotten the... to be honest, caught up a little bit in the stereotype of the banker as super-cautious, part Eeyore sort of thing, of feeling like things are going to turn bad at any moment, and this seems like not only, "Hey, are we all right," but, "We're better than everybody else around us." That confidence bordering on cockiness is what threw me off.
Dallas Wells: Yeah, and I guess that's the nature of cycles, right, is the bad stuff comes around right when everyone decides it's okay to look away. This one actually came out surprisingly well, in that I believe it was exactly... no rounding, even, but exactly 50% said that they felt like they were in a better position than their peers, which mathematically means right about where you'd expect that. But bankers are, I think, notoriously bad for making that judgment.
What we get a lot of times, conversationally, is, bankers will say, "Well, look, this is going to be a nightmare for the industry. We're okay, but I think everybody else is going to be in bad shape." I think generally everybody feels like... These numbers say the same thing. 79% say, "Hey, we're in good shape. I think for the most part, everybody else is, too." I think they're right, that for the most part standards have been better than they were, certainly better than they were leading up to the financial crisis, but there are pockets that have people concerned, meaning pockets of industries, pockets of the country. It feels like there's some places out there that are wobbly. But generally, people are in pretty good shape this time around.
Jim Young: Okay. All right. I would've thought that if I was going to point out that we didn't have 50% saying their bank is not in as good a position as their peers, so...
Dallas Wells: Fair enough.
Jim Young: We didn't have that part of it. But, yeah. I take your point on that, and there is a little bit of that... I guess you could spin that the other way around, is that maybe people are a little too negative on the industry, then, because if everybody feels pretty good about themselves but doesn't feel good about the industry, well, maybe they're just not quite viewing the industry through the right lens.
Dallas Wells: Yeah. That could be one option, and I think the other one is just that people generally feeling they're in better shape than others, and at least what the last several recessions have said is that everybody's not quite in as good a shape as they thought. There's always things that surprise you, and obviously you're the bankers that put those things on the books, so you feel good about them or they wouldn't be there, but some of them are going to go sideways on you.
Jim Young: All right, so, speaking of things you feel confident about putting on the books, the next question I want to look at was about credit standards over the past couple of years. This one's interesting to me because of the split in the responses. 29% said they're giving more favorable terms and pricing on deals. Now, also add a little bit of that, though, most of that 29% was, "We're doing it for customers we already have and know, but we are giving them more favorable terms." 44% said their standards haven't changed. 27% said their standards have tightened. So, this one's a variance across the board here. Does that reflect, maybe, the range of banks that took the survey? I mean, are you a bigger bank, you're going to perhaps be different in your standards than smaller ones, or vice versa?
Dallas Wells: Well, I think we are, at least... I have no idea how close we are to the actual next change in the cycle, but what I do know is that there are some banks that are starting to change their behavior. So, there are some that are saying... according to the survey we did, 27% saying, "We're actually tightening things up a little bit." If you look at... The Federal Reserve does a similar survey of tightening standards, and it has flipped positive, meaning more bankers than not are saying that they're starting to tighten standards.
But we were also getting at not just, "Would you say yes or no to a deal," but, "Are you being a little more forgiving on standards?" This is where... I actually thought that this, at least according to the data that we see on... and also anecdotally, what bankers are telling us, it's not necessarily that bankers are saying yes to credits that they used to say no to. It's that credits that have always gotten a yes are now getting a yes without the same sort of restrictions, without the same sort of covenants, with longer terms, longer amortization periods, less collateral requirements. Basically, that aspect of loosening is very much true, and also just more favorable pricing.
Credit spreads, especially when you account for risk, credit spreads just continue to get smaller and smaller, and so bankers are saying, "Hey, we're being cautious. We're tightening standards. We're not letting things through the gates that we didn't use to," but structure matters and especially when some of those deals do go sideways, the probability of default, I think, is what they're saying hasn't changed. The loss, given default, that piece of that expected loss equation is most definitely changing in the industry, and in a big way. I think that's where bankers are maybe not being honest with themselves about what this looks like.
Jim Young: I did have, also, the thought to myself that you could probably actually, depending on... You could probably take this survey to a bank and ask all of them in there, and probably get this spread within the same bank.
Dallas Wells: Oh, definitely. Most definitely.
Jim Young: ... in the sense that... and Gita Tholleson and I have talked about this in her research for her first-quarter piece that she's going to be doing again on the state of commercial banking, that if you talk to credit people, they'll say, "Oh, yeah, we're tightening," and then you talk to sales people and they'll say, "It's competitive, man. We're having to really be pretty forgiving on this sort of thing." So, yeah. I think that's probably a part of who's answering it.
Dallas Wells: I think you're exactly right on that, is it depends on who you ask, and the answers will be all over the place, and the reality of where and how deals are getting booked says that, along that spectrum are the credit people or are the sales people winning? The salespeople are winning right now. They're getting their way. The deals are competitive, and they're getting through at some pretty forgiving standards.
Jim Young: Yeah, absolutely. All right. Now, here's another one that, again, struck me as a confident stance, which is the, "How well can your bank quickly change course in the event of a downturn?" Again, I don't know. Maybe I talked to guys who are either more open or just more glass half empty. I probably attract glass-half-empty people.
Dallas Wells: I think you're drawn to pessimists, Jim. It's just the way it goes.
Jim Young: And in turn, they are drawn to me. Anyway, bankers on this one said ... 53% described their bank as nimble and capable of quickly changing strategies and tactics, and 40%, in addition to that, said that they could change, but it would take a while. So, literally only 7% of our people that responded to this felt that their bank struggles in this area. I don't know. This one I'm still having a hard time wrapping my head around. There's very few bankers I've talked to that really describe their bank as nimble. So, what do you think here? Again, is it just the people I hang out with, or is something missing here?
Dallas Wells: So, I think either there's some wishful thinking here, or we've got some bankers that are just plain liars. No, in fairness-
Jim Young: Wow. I wasn't going to go that harsh, but okay. Right.
Yeah. So, in fairness, the way we worded that question maybe says ... Maybe what they're saying is true, but I think there's a difference between being able to change strategy and just turning the faucet on and off, which is what the reaction has been. Again, if you go back to those same Federal Reserve surveys where they look at tightening and loosening standards and they chart those ... Maria Abbe included these in a blog post
she did a couple weeks ago. They're really good charts because they also have bands in there that show where the recessions are, and what you can see is that the numbers go negative. In other words, standards are loosening through the good times, and then right before, through, and right after a recession, bankers really tighten things up, to the tune of more than half of bankers start tightening standards.
So, what's actually happening, and you can see this in the amount of credit that was available, net credit created following recessions, is a banker's reaction, the way they change strategy, is they just say, "That's it. No more new credit. Just turn it off," which is not really a viable ongoing business strategy. It's hard to keep the lights on if you just turn off the credit.
So, what happens is, is things go bad. Bankers turn off the spigots, they lick their wounds, they recover, and then they slowly start turning them back on again. What we're looking for is banks that can truly be agile in that area and make the right sort of adjustments, where it's not just all or nothing, but you can actually change the flow. Stop it over there, turn it up over here where there's actually some positive things happening, and basically redirect credit flow away from areas where you have exposure and to areas where you have opportunity or where you're comfortable.
Now, are there 53% of banks that are capable of doing that? Absolutely not. So, that's, I think, where what we really mean by that probably isn't clear to those taking the survey, but that's what we're after, is banks that can actually be nimble and not just say, "Turn it off."
Jim Young: Yeah. Yeah. If given the choice of calling bankers liars or us not very good at writing survey questions, I'll go with the latter on that one as well.
Dallas Wells: That's fair.
Jim Young: Yeah, because I would also say that it's not just changing strategy but changing strategy and actually executing on that strategy. Right? Because you can sit there and say, "Oh, here's what we're doing. We're doing this now. That was nimble. That was quick." But it actually didn't... It may not change anything.
Dallas Wells: Yeah. Out in the field, nothing actually changed. Right.
Jim Young: Right. Exactly. All right. So, strategic focus was another question in this survey. Basically, we asked banks, "If there's a downturn, would you look to cut costs during that time period? Would you look to be aggressive, grab some market share, or would you stay the course and make no strategic changes?"
This is probably the most overwhelming one. 66% said, "We're staying the course." I guess, again, maybe I'm doing the whole fighting the last war thing, but like you described, I don't think banks in the last big economic downturn just kept chugging along with what they were doing. If anything, you'd usually say that they swung so violently back, they over-corrected on it. But again, maybe this time around, they already feel like, "Look, we know this is coming out there somewhere, so we're not gone off guard, so we already have"... Kind of in the way you price the stock market into something. I mean, is it possible they've already locked in that strategy, and they don't feel like it's going to need to change?
Dallas Wells: So, you're going with the efficient market hypothesis on this one, that it's already priced in, right?
Jim Young: If that's what you call it, sure.
Dallas Wells: So, the financial crisis, right? 2008 to 2010, there is no doubt that it was an extreme version of this, right? Basically, the worst credit markets and worst economic numbers since the Great Depression, but this isn't something that was just isolated to that extreme event. We saw the same thing in the 2001 recession, the same thing in the early '90s recession, same thing back in the early '80s. This is just what happens. So, bankers say they're just going to stay the course, and they don't.
Anecdotally, the bank I was at in 2008, when the you-know-what started to hit the fan, I remember sitting in our board room and we literally made a list of our biggest expenses that could be cut on a whiteboard. It was like, "All right, the bonus accrual. How much is that? How much do we spend on this certain kind of marketing?" All of what we were doing was looking for money that we could either cut to drop to the bottom line, or we were redirecting it to loan loss reserves. Just basically, how can we build a giant cushion and go into turtle mode, just hunker down and try to survive?
On the flip side, there was another community bank here in the great state of Missouri, First State Community Bank, which is based out of Farmington, Missouri. So, they, coming out of the recession, kept doing what they were doing, and actually, when Bank of America said, "Hey, we have to very quickly shrink into our new smaller capital base," they started looking to just sell big blocks of their branch footprint, and the folks down in First State down in Farmington, at First State Community Bank, bought, I think, 30-something Bank of America branches, and essentially, in a couple of years, doubled the size of their bank.
I just checked before we had this conversation. Their margins are better, their return on equity is better, their return on assets is better. They're, without a doubt, a stronger, more profitable bank because when there was blood in the streets and everyone else was running scared, they were brave enough to step up and not just keep doing what they were doing, but make some investments in taking market share. They've done that. They're new markets that are now growing and expanding, and it was the right long-term answer.
So, yeah. That 66% number, again, I think that's the genuine belief of banks, but that's not historically what has actually happened. That was the point of what we talked about in the webinar and what we talk about in the report is, how can you connect that longer-term thinking, the big strategic picture, to the actual day-to-day tactics when things get a little scary, because your salespeople, your line managers, the people that are actually making the day-to-day calls, what happens when things get bad is they get scared. So, if you want them to do something different, you have to have a mechanism in place to allow them to make those sorts of decisions.
Jim Young: Mm-hmm (affirmative). Gotcha. Okay. By the way, it was not lost on me that when you started listing out the superfluous expenses at your other bank, you put marketing in there, I think second on the list.
Dallas Wells: Right after bonus accruals? Yeah.
Jim Young: Duly noted. Duly noted.
Dallas Wells: On both counts, right? Yeah.
Jim Young: Yeah. I just wanted to know, at what point during the conversation did anyone write "Dallas Wells" up on the board?
Dallas Wells: Oh, it was on there. Yeah.
Jim Young: All right. One last question here on this. This one's good news. Actually, to be honest, after what you just told me, I think you're probably overstating issues, because according to this, we're good. This question was about how proactive... "How proactive is your bank at spotting potential problems with a customer and then acting on it?" None of our respondents said their bankers do this too late. Some of them said, "Hey, we're a little slow. Sometimes we wait until the problem has shown up before we do it." The vast majority of them said, "Oh, we're great at this." But literally nobody said, "By the time we spot a problem with a customer, it's too late." So, I think we're good.
Dallas Wells: Yeah. Problem solved.
Jim Young: I think we're done here. Podcast has achieved what it needs to do. We can wrap this thing up here.
Dallas Wells: Yeah. I only wish that were true, right? Again, it is... So, in my mind, if a loan is past due, I think the ship has sailed, right?
Jim Young: Yeah, I was going to say, maybe, again, this is a little bit of how you define too late, right?
Dallas Wells: Yeah. So, so does the bank automatically lose money when a loan goes past due? No. Most of the time they're able to cure it, to either work through the issue or go to those secondary sources of repayment and be made whole. That's why these deals are structured the way they are. But I would argue that once something gets wildly like that, your risk-adjusted return on it is already way out of whack. So, even if you get paid back, the time, the attention, the opportunity cost, where else those funds could have been, that is too late, even if you collect. So, what this is about is, again, looking at, are there ways that you can see problems coming before somebody misses a payment, before somebody's 45 days late and on their way to 90 days late?
So, there's lots of indicators. Banks have access to tons of these. I think this is what... There's a lot of tech companies, a lot of fintechs out there, that are starting to work on what I think are some pretty interesting ways of looking at not just the financial statements that a borrower brings you, which looks at... They bring it 45 days plus after the fact, and it looks backwards 90 days, so you are months removed from what that's telling you. When coming through your bank, plumbing through your systems... You've got credit card data, you've got their outbound ACH data, you've got deposit balances, you are seeing, through their lockbox receivables, you're seeing the constant flow through their business, and you should have a much firmer grasp on when things are changing.
That's not just to look for warning flags, but also to look for opportunities. So, the banks that are now starting to get really good at cross-selling, they're not doing it by just harassing salespeople into, "Hey, did you offer a new credit card? Did you offer new credit card?" It's not the old "aid is great" mantra from the bank that we've beat up too much for that, and they shan't be named here. But it's about looking for real opportunities and actually using that data for something useful besides just making pretty charts in Tableau.
So, that's where I think ... First bankers have to realize that that's there, that they do have a problem. What our survey results said here is that banks don't see this as a problem. It's not a problem to be solved. It's not something worth paying attention to and putting resources too. My fear is that the wake up call there is another round of losses, and then they look back and say, "You know what? We had indicators that said this was going to happen, and we had time to act, and we just didn't." So, unfortunately that's probably what it'll take, but there's a few banks out there figuring it out, and I think they're going to separate themselves from the pack when things do take a turn.
Jim Young: Yeah, and I will tell you, again, in the disclosure here, that we could probably do a podcast on, "If I had to reword the survey questions, here's how I would word it the second time," because I think people seized on the problem part of this and thought about it in terms of, "Hey that guy defaulted on the loan. What should we do? Well, we reacted very quickly to it. Okay, great." But maybe that... To be fair, I did put the word proactively on there, but maybe the thing is as much about spotting potential problems as much about spotting potential opportunities.
Dallas Wells: Yeah, I think that's right.
Jim Young: I would be curious. If we spun it that way, I think you might get a less, "Oh, yeah, we do that." If we'd said, "Hey, we can really spot opportunities and act quickly on them," I think you might got a more, "We're not that great on that."
Dallas Wells: Yeah, well, that's different.
Jim Young: Yeah. It's a different animal. As you mentioned, the mechanism shouldn't be, right? It's the data. The data is going to give you either a problem or an opportunity, and if you're set up that way, you should be able to act quickly in either direction, so...
Dallas Wells: That's right.
Jim Young: The data on this one is probably telling me that I should get a little more precise in survey questions next time around.
Dallas Wells: There you go. That's your change to make for next time.
Jim Young: Well, sure. In the event of an economic downturn, we've already determined that marketing is going to get cut, so I've got to-
Dallas Wells: You have plenty of time on your hands. Yeah.
Jim Young: Got to improve my game here a little bit. So, that'll do it for this... Actually, gosh, this year's episode, this last episode of 2019. So, thanks to everybody for listening, and we'll be back to grace you with more wit and hopefully a little bit of insight about commercial banking in 2020.
Maria Abbe: That'll do it for this week's show, and for this podcast for 2019. Thank you so much for listening this year, and we will meet you back here in 2020. Now, for a few friendly reminders, if you want to listen to more podcasts or check out more of our content, you can visit our resource page at precisionlender.com, or you can just head over to our homepage to learn more about the company behind this content. Finally, if you like what you've been hearing, make sure to subscribe to the feed in iTunes, Google Play, or Stitcher, and we would love to get ratings and feedback on any of those platforms. Until next time, this is Maria Abbe for Jim Young and Dallas Wells, and you've been listening to The Purposeful Banker.
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