THE INDUSTRY MAGAZINE FOR FINANCIAL EXECUTIVES & PROFESSIONALS • SUMMER 2011 • VOLUME 18
Inside
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MERS Under Court Scrutiny How American Consumers View Debt A Battle Plan for CRE
State’s Banks Report Beginning of Rebound
Light
at the End of the First-Quarter Tunnel
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As banks ease into the second quarter, there are signs that the recovery is progressing. Business loan demand is rising, real estate troubles are easing, and jobs have been added. But is it sustainable?
THE INDUSTRY MAGAZINE FOR FINANCIAL EXECUTIVES & PROFESSIONALS • SUMMER 2011 • VOLUME 18
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InsIde
MERS Under Court Scrutiny How American Consumers View Debt A Battle Plan for CRE
Cover Feature
Light at the End of
State’S BankS RepoRt Beginning of ReBound
the First-Quarter Tunnel
ligHt
At tHE EnD of
tHE fiRSt-QUARtER tUnnEl
Volume 18 Summer 2011
State’s Banks Report Beginning of Rebound
Vincent Michael Valvo Group Publisher & Editor in Chief Timothy M. Warren Chairman Timothy M. Warren Jr. CEO & Publisher David B. Lovins President Jeffrey E. Lewis Controller Dir. of Operations George Chateauneuf Publishing Group Sales Manager
12
Guarding the Gate
4
Locking the Back Door
current affairs
6 6
MERS Under Court Scrutiny
in New York State
Finally, a Critical Mass of Doubters
STUDY
10
How American Consumers View Debt
Sarah Cunningham Director of Events Emily Torres Advertising, Marketing & Events Coordinator Cara Inocencio Advertising Account Manager Richard Ofsthun Advertising Account Manager Christina P. O’Neill Custom Publications Editor Cassidy Norton Murphy Associate Editor John Bottini Creative Director Scott Ellison Senior Graphic Designer Ellie Aliabadi Graphic Designer
Management 10
18
Stress Testing
Drafting a ‘Battle Plan’ for CRE
20
22
Small Change
©2011 The Warren Group Inc. All rights reserved. The Warren Group is a trademark of The Warren Group Inc. No part of this publication may be reproduced in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without written permission from the publisher. Advertising, editorial and production inquiries should be directed to: The Warren Group, 280 Summer Street, Boston, MA 02210. Call 800-356-8805.
Guarding the Gate
By Kevin Hamel
Locking the Back Door You know it’s bad when the Simpsons cartoon series can instruct us on security. But here we are, considering the example of Montgomery Burns, the Simpson’s maniacal owner of a nuclear power plant, as he runs a gauntlet of body scans and password challenges required to enter his palatial office. Once inside, Burns notices a rickety screen door open to an unprotected field behind the plant.
I
mention this in the context of our most recent hacker headline – “Google Mail Hack is Blamed on China,” from the The Wall Street Journal. After reading through the ominous description of a brewing international incident, I saw that the victims had merely been tricked into sharing their Gmail passwords through a phishing attack. The irony really struck a nerve. Security mongers have built careers out of characterizing cyber criminals as super smart 24/7 monsters intent on one thing – gaining access to your online credentials to steal everything precious in your life. But in reality, the criminals are merely exploiting our inattentiveness. How many times has your bank said it will never ask for your user name, password, Social Security Number, date of birth or other personal information in an email? How many times have you supplied that information anyway? In a mock phishing experiment, the New York Office of Cyber Security & Critical Infrastructure Coordination sent fake phishing emails to nearly 10,000 state employees with the goal of tricking them into surrendering their passwords. More than 75 percent of the recipients opened the email, 17 percent followed the link, and 15 percent attempted to enter their passwords. How can any anti-phishing software and detection service compete with a user’s willingness to open bogus emails, follow bogus links, and enter our online credentials?
4 | Banking New York
It is the literal equivalent of Montgomery Burns’ rickety screen door behind his supersecure nuclear power plant. Given our tendency to overlook the most basic red flags, how can a bank or credit union help protect consumers from cybercrime? One answer may be training. Just as banks and IT companies regularly engage in security training for employees, you might consider training your customers as well. Clever online games have been designed to educate consumers about links to fake websites and other security risks. Training products, such as Wombat Security (www. wombatsecurity.com) have been shown to reduce the likelihood of users falling for a phishing attack by approximately 50 percent. Rather than jump on the security training bandwagon as today’s cure-all, banks and credit unions should think of Wombat Security and other training providers, such as Terranova (www. terranova.com), as ways to freshen their approach to security awareness in order to keep customers engaged. After all, the public tires easily, and eventually, even the most creative solutions will become wallpaper – increasingly easy to ignore. You might consider including information from “OUCH!,” the monthly SANS Institute newsletter (www. securingthehuman.org), to help your customers through practical issues, such as securing passwords, staying secure while
traveling and using your smart phone securely. You might also consider holding a security contest and awarding the winner an eye-popping prize – something to grab everyone’s attention. The point is to make security a central focus of your institution’s service delivery. Frankly, it has to be. The prevalence of portable devices and the spread of social media have created more systems and platforms to secure than ever before. The days of securing a customer’s technology with simple antivirus software are long gone. If you succeed in enlisting your customers in your security efforts, your bank or credit union will become more of a beacon of safety and soundness for your customers’ assets. That’s a great position to be in, because you will hold their trust for generations. Unfortunately, the alternative is an unsustainable, Simpsons-style irony – the hyper-secure front entrance sabotaged by a rickety back door to unprotected cyberspace. Kevin Hamel manages security for Avon, Conn.-based COCC, Inc., (www.cocc.com), a 44-year-old firm specializing in outsourced information technology and support.
TO OUR READERS We wish to thank outgoing Superintendent of Banks Richard Neiman for his years of support of Banking New York through his Superintendent’s Spotlight column. — Christina P. O’Neill, Editor, Banking New York — Cassidy Murphy, Associate Editor, Banking New York
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current affairs
MERS Under Court Scrutiny in New York State By Robert Brannum
Finally, a Critical Mass of Doubters The already-battered mortgage industry now faces a crisis that has been hidden in plain view for 14 years.
M
ortgage Electronic Registration System (MERS), an electronic document recording service with all of 50 employees (at present), has managed to displace an entire segment of the nation’s local government, taking $2.4 billion away from county coffers by bypassing the typical $30 county recording fee. It’s being taken to court in 17 states, including New York state, not for depriving the counties of revenue, but for its de facto role in obscuring the line of provenance that establishes title to property. MERS, corporately named Merscorp Inc.
and based in Reston, Virginia, was established in 1997 by the nation’s largest mortgage companies and Fannie Mae and Freddie, at a time when the federal government was pushing expansion of homeownership. To date, according to a recent Associated Press report, it has registered 65 million loans, or 60 percent of all outstanding mortgages.
“Shut Up!” They Exclaimed Public outcry has pushed 17 states to file lawsuits against MERS, which is listed as the mortgagee of record in legal notices,
although it is neither lender nor loan servicer. Instead, it’s a repository of records, a digital warehouse, assigned “agent status” by the lenders. Knowing the lender is a vital piece of information that establishes a clear property provenance and lineage of ownership. Or it did, until mortgages started being packaged into mortgage-backed securities (MBS) and sold in bundles to investors. This obscured the lineage of ownership, but nobody cared, because the housing market could only go up, and homeowners were told that they could always refinance before their adjustable-rate mortgages reset. It worked for a few years. Then we found out how many borrowers hadn’t done the math. Their mortgage brokers had, but only to figure out which loan product yielded the highest commission. As the number of foreclosures grew into tens of thousands, industry observers finally began to make a connection – MERS, and not the lender of record, was frequently the mortgagee in legal notices of mortgagee’s sale of real estate. For that, the role of MERS has come – finally – under legal scrutiny. The suits argue two important points: that MERS does not have the authority to circumvent established county-based recordkeeping practices, nor does it possess the legal authority to act as an agent for the lender, and so therefore cannot start foreclosure actions. County clerks’ early complaints about MERS lacked a collective voice. Their objections were dismissed by many in a position of governmental influence as another example of public sector turf-wars continued on page 8
6 | Banking New York
Current Affairs continued from page 6
versus private sector ingenuity. If MERS, in fact, does not have the legal ability to initiate foreclosure procedures, what do we make of the thousands of loans currently in the foreclosure process? Perhaps worse: what of the loans already foreclosed upon, with their related properties having changed hands? And does MERS owe those registration fees to the county offices they bypassed? A recent article in The New York Times reported that industry lawyers had researched the MERS-proposition at its inception, and found no restrictions that would prevent it from operating on a national level. The issue, critics of MERS claim, is that real estate is regulated on a local-level, not on a nationallevel, and that each state carries its own jurisdiction. In November, Karmela Lejarde, a spokesperson for MERS, continued its claim that MERS is an acceptable substitute for the county-based registrations by telling
8 | Banking New York
the Associated Press, “These are local fees for service; if no service [by the county] is needed or requested, no fee is appropriate.”
The Gordian Knot That’s Too Big to Untangle Fixing the problem may actually be worse than the problem itself. Courts in different states (and different judges within those states) have rendered different opinions on MERS’s authority, further clouding the issues. In January, a California appeals court ruled in favor of MERS, while a New York bankruptcy court ruled against MERS’s authority. Judge Robert E. Grossman, a federal bankruptcy judge for the Eastern District of New York, ruled that MERS may not serve as an agent for the lender, and therefore cannot itself pursue foreclosures. Realizing his ruling would likely contribute to the anxiety about how to untie the knot, Grossman responded to The New York Times, “This court does not accept the argument that because MERS may be involved with
50 percent of all residential mortgages in this country, that is reason enough for this court to turn a blind eye to the fact that this process does not comply with the law.” The state, along with the rest of the country, is clearly in the early innings of what might be a drawn-out legal baseball game. What is known is that the uncertainty of MERS will cause increasing disruption in the mortgage market. As MERS tries to sidestep some of the recent issues with new operating procedures and a new CEO, the level of scrutiny continues to rise. Around the country, title companies have started canceling closings of bank-owned homes due to concerns around MERS’s authority to represent the lender and to provide clarity around provenance. When will this growing issue be resolved, and by whom? In New York, several organizations are beginning to immerse themselves in the quagmire. Richard Neiman, the state’s outgoing superintendent of banks, after saying the issue of MERS was “not on our
priority list” offered that it was likely that regulators would have to get involved in final interpretations. He commented in April, “The issues that have been raised are real and will require guidance in light of diverse judicial opinions.” The Federal Reserve Bank of New York is also weighing in. In a recent statement, the Federal Reserve said that the Uniform Law Commission and the American Law Institute, “have joined forces with various stakeholders, including the Federal Reserve Bank of New York, to deal with the legal complexity and the fact that much of the applicable law no longer adequately reflects modern financial practice and technological developments.” Said Thomas Baxter, general counsel at the New York Fed, “The New York Fed is committed to addressing these issues and will continue to work on identifying potential changes to the legal framework which will better serve the needs of those who are subject to it.” Since the flush economic days of the Reagan era, the initiative to privatize
formerly public services has taken root, but without a robust economy to support it, the egregious abuses of privatization have emerged, warts and all. In a new book, Beyond Privatopia, author Evan McKenzie revisits the evolution of private housing developments and their governance, about which he first wrote in 1994. He makes a case somewhat parallel to the MERS crisis. Private communities took off when real estate values and demand for new building were on the rise. Private communities won acceptance from municipalities as a better way to finance growth, because their developers provided infrastructure that municipalities would otherwise have to raise taxes to build. The developers displaced public service (and were welcomed to do so at the time), and the towns got new property taxes without some of the cost. But now that the housing market is fraying, so is the fabric that holds private communities together. When a development encounters financial difficulty, the maintenance of its privatelyfinanced infrastructure may become a
problem for the municipality – i.e., the local taxpayers. MERS, designed as a private entity replacement for the public service function of deed recording, not only won acceptance from, it was created by the industry it serves, at a time when that industry was on the rise due to the housing boom. In the interest of getting the mortgage industry’s ticket punched, vital steps in the operations of property transfer were bypassed. As the legal battle progresses, this crisis could become a constitutional issue. Should private entities have the right to create other private entities that serve them, but in the process, displace a public service without fully replacing what that public service did? Will the entities thus created be required to come under the same regulations as public services they displaced, and if they are, is that restraint of trade? And are federal bailouts of private entities the same as taxation without representation? Just asking. Robert Brannum is a freelance writer.
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Summer 2011 | 9
study
How American Consumers View Debt A new study published in April that throws light on consumers’ credit habits shows a need for increased financial literacy, even in America’s white middle class. However, one of the study’s authors says the need is not as much for more information as it is a need for consumers to take the time to make informed, rational decisions about their spending habits.
“M
ost of what they need to know is not where to put the decimal point,” says Professor Michelle Barnhart of Oregon State University, one of the study’s co-authors. Instead, it’s to scrutinize the key points in one’s life to determine what’s really valuable – and how our belief systems influence the choices we make in how to handle credit. The study, titled “Living U.S. Capitalism: The Normalization of Credit/Debt,” will be published this December in the Journal of Consumer Research. The research subjects were 27 white, middle-class Americans, all from a major Midwestern city, who were interviewed in 2005 and 2006. Barnhart and Lisa Peñaloza of Ecole des Hautes Etudes Commerciales du Nord, a premier French business school, wanted to explore some of the attitudes, perceptions and cultural meanings behind how Americans view and use debt and credit, and how those attitudes and actions may have contributed to the economic recession. This case study, while a small sample, was able to ask detailed questions to probe into deeper issues within American society. Interviews conducted before the financial crisis show inherent weaknesses in decision processes that would not serve people well when hard times hit. Researchers found that even though consumers espouse that they should limit their debt, they take on significant debt because doing so has become normal. As one participant put it, taking on debt is “the American way.” In 2008 alone, Americans spent 9.3 percent 10 | Banking New York
of their income servicing debt, according to an article written that year by Michael Wood, which noted that credit card debt was rising as other funding sources dried up. And in 2010, more than 24 percent of homes in the United States had an upside-down mortgage – owing more than the homes were worth – according to a U.S. Federal Reserve report published in March of that year. Barnhart and Peñaloza’s research yielded a few key findings, including: • Americans suffer from a lack of financial literacy. Every participant said they had learned about credit card use and debt primarily through personal experience. Very few had received any training in school or at home, and most participants said they didn’t discuss family finances with their children. • About half of the 27 participants had debt they were unable to pay and one-third of them were dealing with collection agencies. • Participants often talked about credit as a measure of worth, noting that if they were approved for a certain loan they were “good enough for that car.” Statements often indicated that approval for big-ticket items such as cars and homes were directly related to a value of the person. “You know, your credit card is what you think you are worth, but it is really not,” said a 27-year-old study participant. • Those who had credit cards and paid them off each month tended to be older, and had higher incomes.
Several of the younger participants in the study noted that they did not want to use credit, but felt they had to in order to finance cars and homes in the future. Most of the younger participants also were encouraged by their parents to have credit cards, and started using credit at a much younger age than those older than 50. Barnhart, who is an assistant professor of marketing at OSU, said much of the research done on cultural behavior and attitudes leading up to the economic downturn has focused on ethnic minorities and low-income minorities. However, she said it has been some of the most educated and privileged of Americans who have engaged in risky financial behavior. An example of unintended consequences is parents’ frequent advice to their children that a credit card should only be used in an emergency. “The parent’s intention was good,” she said, “but when you have a credit card for an emergency, you don’t need to have a savings account for an emergency.”
The result: debt that’s incurred quickly, and which gets repaid slowly. “Over time, credit card use and heavy debt has become normalized in our culture,” she said. “Even though we say as a society, ‘don’t get in debt,’ the overwhelming messages being sent out – from the way credit is used to approve or disapprove us for services to political leaders telling us to spend after a big disaster to prove our patriotism – all of this has created a culture of debt.” That debt culture isn’t kind to those who try to avoid it. One of the few young participants to not carry any debt said she felt punished for her refusal to have a credit card. She was refused a cell phone, and had encountered embarrassing situations during business travel because she did not have a credit card. Barnhart said this system of penalizing consumers for not using credit is one of the problems. Barnhart would like to next do a study about how norms, values and habits have changed since the economic crisis. However, she said financial literacy is still the missing link in American society. She and Peñaloza believe that financial literacy classes should be required in schools, and that these classes should not only address credit card fees and compound interest, but also critique debt as a cultural value. The concept of “good debt” – the kind that supports an investment in one’s future, such as paying for an education or buying a house – can obscure fundamental weaknesses in reasoning. Those in the middle class are apt to think that they must go to college, or must own a house, to be part of the segment of society to which they desire inclusion. But what if the degree financed with loans doesn’t lead to a well-paying job (or any job, for that matter)? What if a person’s economic situation is too unstable to support living in a purchased home long enough to make back the closing costs, let alone build equity? Consumers need to get a better understanding of how the credit system
works, and where its vested interests are, Barnhart said, in order to work within that system to advance their own interests. And
they also need to ask the hard questions about which of their life decisions will generate actual value for them.
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12 | Banking New York
Light at the End of the First-Quarter Tunnel
State’s Banks Report
Beginning of Rebound BY Scott Van Voorhis
A
s the economic recovery picks up, Empire State banks are touting a return to healthy earnings as business loan demand rises and real estate woes level off. While favorable interest rate spreads are certainly helping, midsized and community banks across the state say they are also seeing encouraging growth in core business areas. Another positive trend: the bad-debt picture is easing, and with it, the level of capital requirements to cover potential losses. “I think all the banks are seeing less provision requirements to cover bad debt,” says John Millman, CEO of Sterling National Bank, based in New York City. “They are half of what they were a year ago. It translates into higher earnings.” Geography plays a crucial role as well, helping different banks in different ways. While banks in Upstate New York are still dealing with job losses at major area companies, the region for the most part escaped the escalation and later crash in housing prices. Their cousins in the state’s southern tier around New York City would have a hard time making such a claim, with the metro area still digging out after the implosion of the housing bubble. Yet the rebound on Wall Street has gone a long way towards reviving the New York metro economy, bringing back job growth and demand for business lending. After initial concern earlier this year that the recovery might be stalling locally, William Dudley, president of the Federal Reserve Bank of New York, recently gave a more encouraging pronouncement.
“The recovery of activity in New York state and New York City continues at a steady and sustained pace,’’ Dudley noted. Overall, New York, New Jersey and Connecticut’s Fairfield County have regained 100,000 private sector jobs over the past year, he said. For banks across the Empire State, the reviving job market has helped fuel a rise in commercial lending, even as the number of residential mortgages has dropped off amid the ongoing funk in the housing markets, a recent Beige Book report by the New York Fed found. “Bankers report decreased demand for consumer loans and residential mortgages, increased demand for commercial mortgages, and no change in demand for commercial and industrial loans. The decrease was most prevalent for residential mortgages,” the report found. Here’s a sample survey by Banking New York of bank performance across New York state, broken down by region: New York City and Long Island For two major community banks in the New York metro area, the first quarter saw profits soar amid a revival in commercial lending and a jump in deposits. Long Island-based Community National Bank saw first quarter net income hit $623,000, up nearly fourfold from the first three months of 2010. continued on page 14
Summer 2011 | 13
Banks Report Rebound continued from page 13
Sterling National Bank, based in New York, reported net income of $3.3 million in the first quarter, a 71 percent jump. John Millman, Sterling’s chief executive, is projecting double digit loan growth for the bank in 2011. Driving the demand is the professional staffing industry, which has seen a surge in activity with the comeback in the economy. “The staffing industry is an economic indicator,” he said. “It turns down first and it turns up first.” “We are seeing very substantial opportunities,” he said. Business lending also jumped at both banks. Community National posted a 22 percent increase, or $37.5 million, in its commercial lending, to $202.5 million for the quarter, while Sterling saw earnings from fee-generating products aimed at commercial customers rise to $11.4 million for the quarter. These included services such accounts receivable management, factoring, trade finance and mortgage banking.
Community National has also pumped up its small business lending. The Small Business Administration recently honored the bank as its top lender on Long Island after Community National more than doubled its SBA portfolio to $17.9 million. (The bank earned $1.3 million during the quarter from the sale of SBA loans.) Stuart Lubow, chairman, president and chief executive of Community National, noted his bank is ranked as the fourth highest SBA lender for the whole New York region. Branch employees are given incentives to bring in commercial loan business, he said. “It is just our philosophy,” Lubow told Banking New York. “We are focused on business relationships, on total relationships. Clearly, you grow your operating accounts, and depository relationships [grow] along with that.” The two banks also recorded significant increases in overall loan volume, total assets and deposits. Community Bank grew overall deposits by 12 percent in the first quarter, compared
to the same period in 2010, to $369 million. Sterling saw total deposits expand by 7 percent in the quarter, to $1.7 billion. Sterling also saw total loans in its portfolio post a 7.8 percent year-over-year increase during the quarter, to $1.3 billion. Total assets at Community National jumped to $475 million at the end of the first quarter, up from $432 million the year before. “We have been bucking the trends,” Lubow said. “We have kept a pretty consistent growth rate through this period. A lot of it is taking business from larger institutions that lost focus during this period,” he said, adding his bank has been focusing on forging “good, solid portfolio banking relationships.” The banks are also pointing to other significant milestones that would seem to suggest the economy recovery is gaining traction in the New York metro region. Community National will open its ninth branch later this year in Melville, having just opened its eighth in Queens. Sterling National saw provision for loan losses drop by half in the first quarter, to $3 million. The ratio of nonaccrual loans to
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14 | Banking New York
total loans improved to .53 percent at the end of March, compared to 1.42 percent in the first quarter of 2010, according to Sterling. But the growth on the commercial lending side was balanced somewhat by a contraction in residential lending. Interest income from residential loans dropped to $1.5 million at the end of the first quarter at Community National, from $1.7 million from the year before. By contrast, interest earned on commercial loans jumped to $2.9 million from $2.4 million during the same period, the bank reported.
the first three months of 2010. In another milestone, the bank repaid the federal government, wrapping up its participation in the Troubled Asset Relief Program with the repurchase of $2.5 billion in stock owned by the U.S. Treasury Department. Key Bank also has seen a big boost in asset quality. The bank reduced nonperforming assets by $249 million, while nonperforming loans dropped to $885 million, a fall of $183 million. Net charge offs dropped to $193 million in the quarter, down from $329 million during the first three months of 2010. “Our aggressive actions to exit riskier lending categories, which began over four years ago, have led to significant credit quality improvement again this quarter, placing our credit statistics at or near the top of our peer group,” said Henry L. Meyer III, Key Bank’s chief executive, in a statement. With the arrival of better times, the bank is also expanding its branch network, with a big boost planned for its presence in Western New York. The bank opened four branches in
Western/Central New York Cleveland-based Key Bank has a substantial and growing presence across Central and Western New York. While the bank does not break out its New York state numbers, the bank’s operations in the Empire State were a significant contributor to a strong first quarter, bank executives said. Key Bank reported net income of $184 million in the first quarter, a dramatic turnaround from a $98 million loss during
Buffalo last year and plans to add three more this year, said Hugh Donlon, president of Key’s Northeast region. The bank also recently opened a branch in the Capital Region and has expanded its presence in the Hudson Valley region through the acquisition of a local bank. In terms of commercial loan demand, the health care sector and small businesses have been two big drivers, Donlon noted. “Obviously, loan demand has been the big question mark,” Donlon noted. “Our [loan] pipeline levels are up. I would say this has been pretty consistent across all of our markets across New York state.” Another big player in the Western New York market, M&T Bank, also reported a significant improvement to its bottom line during the first quarter. Buffalo-based M&T’s earnings jumped 37 percent, to $206.3 million for the first quarter, beating Wall Street earnings estimates. Favorable interest rate trends played a big role, with the bank able to widen the spread between what it paid out to bring continued on page 17
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Banks Report Rebound
continued economic headwinds, noted Jack Webb, president and chief executive, in a statement. “Current economic conditions continue to suppress loan demand; however, we continue to see positive results from the execution of our commercial lending strategy,” Webb said. Overall, Upstate New York has its share of challenges for local banks, notes Michael Pollock, president of Fulton Savings Bank. With the region for the most part having missed the housing bubble, Fulton and other local banks have escaped big balance sheet hits related to residential real estate, he noted. But the economy upstate remains sluggish, with companies continuing to cut jobs and downsize operations, said Pollock, rattling off companies that have closed or cut their operations. While health care has grown, manufacturing, long a staple for the region, continues to decline. “It is going to be very difficult to replace the jobs that have left,” Pollock said.
continued from page 15
in deposits compared to what it is now able to earn on interest charged on loans. M&T was also able to boost first quarter earnings through the sale of residential mortgage-based securities backed by Fannie Mae, which contributed $24 million to the increase in net income. The bank also made progress in reducing losses from nonperforming loans and other assets. Provision for credit losses dropped to $75 million in the first quarter, down from $105 million a year earlier. Net charge-offs of bad loans fell to $74 million, down from $95 million. The ratio of nonperforming assets to total loans dropped to 2.73 percent in the quarter, down from 2.78 in the first quarter of 2010, according to M&T. In another encouraging sign, noninterest income hit $291 million, up from $284 million in the first quarter of 2010 amid higher commercial mortgage banking revenues, trading account and foreign exchange gains, and letter of credit and other credit related fees, the bank noted in its earnings statement. Still, loans past due 90 days or more actually expanded during the quarter, to $264 million, up from $203 million the year before. “We are also encouraged by continuing improved credit quality, which resulted in lower credit costs in the recent quarter,” said Rene Jones, executive vice president and chief financial officer at M&T, in a statement. “Although nonperforming assets remain at historically high levels, we have seen some encouraging signs of improving economic conditions within M&T’s footprint.” In Central New York, Alliance Financial Corp. also enjoyed a solid first quarter. While net interest income remained unchanged in the first quarter from a year earlier, the Syracuse-based bank saw a big improvement in losses from bad loans. The provision for credit losses dropped fivefold, to $200,000 in the first quarter, down from $1.1 million a year earlier. That is the lowest level since 2005, the bank reported. Alliance also doubled its commercial loan originations, to $16.5 million, in the first quarter, though the bank also faces
Capital Region – Albany By comparison, conditions in the relatively thriving Capital Region have prompted one major local bank to significantly expand its footprint. Chemung Financial reported a drop in first quarter net income as it comes off a major acquisition. Chemung’s acquisition of Albanybased Fort Orange Financial Corp. and its subsidiary bank, Capital Bank & Trust Company, gives it four new Capital District branches, including one in Albany. The now $1.2 billion bank also reported a $250,000 decrease during the quarter in its provision for bad loans. “We are very excited about the opportunity that this expansion into one of the most attractive markets in New York state provides, and we expect it to be accretive to earnings in 2011, excluding one-time transaction costs,” said Ronald M. Bentley, Chemung’s president and chief executive, in a statement. Scott Van Voorhis is a freelance writer.
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Summer 2011 | 17
Management
Stress Testing By James Adams
Drafting a ‘Battle Plan’ for CRE Portfolio Addressing the National Defense Executive Reserve Conference in Washington, D.C. in 1957, President Dwight D. Eisenhower said, “In preparing for battle, I have always found that plans are useless, but planning is indispensable.” Delivered by the man who had orchestrated the largest seaborne military invasion in world history 13 years earlier, the remarks came with an undeniable gravitas.
I
n finance, as in warfare, some potential impediments can be assessed months or years beforehand; others become manifest only on short notice. For James Adams banks interested in formulating either short- or long-term “battle plans,” stress testing is a good place to start. Stress testing received considerable attention in early 2009 as Treasury, Federal Reserve, FDIC, and OCC officials implemented a mandatory Supervisory Capital Assessment Program (SCAP) amongst the nation’s 19 largest bank holding companies in response to the global financial crisis. The exercise was designed to identify the potential losses, resources available to absorb losses, and resulting capital buffer needed to ensure that each bank could meet minimum capital requirements (Tier 1 and Tier 1 Common risk-based ratios of 6 percent and 4 percent, respectively) under specified adverse macroeconomic scenarios. In formulating the SCAP, regulators mandated that the banks evaluate the prospective losses of loan and securities portfolios given designated changes in GDP, housing prices and unemployment rates. Ostensibly, by applying “a consistent
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Banking New York
and systematic approach across the group,” each bank would furnish an objective appraisal of its situation. The SCAP may have achieved its objective in assuaging severe concerns about capital adequacy during the depths of the financial crisis, but the “one-size-fits-all” approach is not an ideal stress testing methodology. Currently, banks with fewer than $10 billion in assets have no regulatory requirement to run regular stress tests. Nevertheless, regulators have stipulated that risk management practices and capital levels should be commensurate with portfolio risks, particularly with regards to commercial real estate (CRE). Concerned that some institutions’ risk management practices were “not evolving with their increasing [CRE] concentrations,” the OCC, Federal Reserve and FDIC distributed an interagency memo addressing the issue in December 2006. The memo was largely focused on “CRE loans for which the cash flow from the real estate is the primary source of repayment,” i.e., investor-owned income producing properties, whose debt is mostly serviced by tenant rents, rather than owneroccupied properties whose debt service is principally serviced by cash flows from regular business operations. “An institution with CRE concentrations should perform portfolio-level stress tests or sensitivity analysis to quantify the impact of changing economic conditions on asset quality, earnings, and capital,” the memo said. The regulators’ concerns were not
unfounded. An FDIC study noted that “in all years between 1980 and 1993, the concentrations of commercial real estate loans relative to total assets were higher for banks that subsequently failed than for nonfailed banks.” Examining the ratio of commercial real estate loans relative to total real estate loans for failed and nonfailed banks told a similar story. Prior to the 2007-2009, meltdown in residential housing, commercial real estate had been the most nettlesome asset class for commercial banks. Historically, CRE had drawn more speculation– and consequently, more volatility– than residential markets. Long gestation periods meant that the financial viability of a given construction project could change markedly before its completion. In particular, the lengthy production process for office buildings exacerbated price collapses when regional markets turned downward in the late 1980s and early 1990s. Collateral value declines in excess of 50 percent were commonplace in energy-producing states like Texas, where falling oil prices exacerbated the problems caused by overbuilding and poorlyunderwritten loans. The interagency memo states that “a strong management information system (MIS) is key to effective portfolio management,” explaining that “MIS should provide management with sufficient information to identify, measure, monitor, and manage CRE concentration risk.” Indeed, the ability to readily access contemporary data from a bank’s core system and its most recent call report is integral to running a robust stress test. Just as they would group their loan portfolios into pools with similar risk characteristics for FAS 5 impairment tests, banks should likewise stratify their CRE portfolios for stress tests. Property type, geographic market, tenant concentrations, tenant industries, developer concentrations,
and risk rating are all legitimate stratification criteria. After the portfolio has been segmented, appropriate stress parameters should be applied to each segment. Debt service coverage adequacy may be tested by stressing property operating income and interest rates downward and upward, respectively. Operating income may be stressed directly by applying an appropriate discount to current NOI, or indirectly by raising vacancy rates. Similarly, collateral values can be directly stressed by discounting current appraisals, or indirectly by reducing NOI and/or raising capitalization rates. Stress effects should be considered for each segment in isolation; segment results should also be aggregated to examine the combined effects on capital, asset quality, and earnings. After re-segmenting the portfolio by different criteria, the exercise should be repeated– i.e., segment and test by geographic exposure, then by collateral type, then by risk rating, etc. Beyond examining impairment effects, managers may want to employ software which also shows rating migration trends under various scenarios. The more scenarios that management evaluates, the more effectively it can draft appropriate action plans and prepare for contingencies. If concentration levels are deemed modestly excessive, exposure might be sufficiently managed by changing underwriting criteria or limiting origination of various loan classes. If concentrations are heavily skewed, however, management might consider selling or securitizing loans to reduce exposures. In either case, ensuring capital adequacy is the paramount concern. Perhaps the greatest testament to the necessity of stress testing can be found by comparing a claim made by the interagency memo against contemporary data. The memo states that “consideration should be given to the lower risk profiles and
“Neither a wise man or a brave man lies down on the tracks of history to wait for the train of the future to run over him. ” historically superior performance of certain types of CRE, such as well-structured multifamily housing finance.” As of March 31, delinquency rates on securitized commercial mortgages are averaging 9.4 percent. In a noteworthy irony, the worstperforming sector is multifamily housing,
with 16.2 percent of securitized loans currently delinquent. Things never go exactly according to plan; studying history does not provide generals, bankers, or regulators with perfect clairvoyance. As Ike asserted during his first presidential campaign, “Neither a wise man or a brave man lies down on the tracks of history to wait for the train of the future to run over him.” Incidentally, he won by a landslide. James Adams is a senior analyst at Sageworks, a leading provider of credit risk management, loan loss reserve, and stress testing software to financial institutions.
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Summer 2011 | 19
Small Change
Signature Bank Appoints New Private Client Banking Team Signature Bank has appointed a new private client banking team. To date this year, five private client banking teams have joined the bank. Kevin W. Macpherson was appointed group director and senior vice president, along with colleagues Tracey Capobianco and Marion L. Ege, both of whom were named associate group director and vice president. The team will be based out of Signature Bank’s Woodmere, Long Island, private client banking office. Macpherson and his team join from HSBC’s Rockville Centre, Long Island branch. Macpherson most recently served as vice president and branch manager there, focused on serving professional services clients. He spent 34 years at JP Morgan Chase as vice president and branch manager at various locations throughout Long Island and Queens. Capobianco was previously a premier relationship manager at her former institution, working also at Massapequa, Long Island branch in addition to Rockville Centre. In this role, she managed portfolios of high-net-worth clients across both locations. Prior to that, Capobianco spent 16 years as vice president and branch manager at JP Morgan Chase in Long Beach. Ege spent five years at the same HSBC branch, where she served as vice president and business relationship manager, catering to a commercial clientele. She had spent four years as a small business relationship manager at JP Morgan Chase, also in Rockville Centre.
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Capital Business Credit Appoints COO, CFO Capital Business Credit LLC (CBC), a global integrated financial products and services company, announced the appointment of Robert Grbic as chief operating officer and Michael Fortino as chief financial officer. Grbic will continue to serve as CBC’s chief credit officer. This announcement comes on the heels of the addition of Marc Adelson as the company’s president and chief executive officer and the appointment of Andrew Tananbaum to executive chairman. The new management team will work together to expand CBC’s offerings, with an initial focus on growing its three core businesses – factoring, asset-based lending and trade finance. Robert Grbic has more than 30 years of commercial lending experience, and has been with CBC since 2005. During his tenure as CBC’s chief credit officer, he was involved in creating a hands-on, best-practices credit culture, as well as helping the company expand its client portfolio. Prior to joining CBC, Grbic was managing director at Morris Anderson & Associates LTD, a turnaround consulting firm. He also co-founded MetSource Capital, LLC, a restructuring and corporate finance firm specializing in working with small- and medium-sized companies. In addition, he served as an executive vice president at GMAC Commercial Credit, LLC and BNY Financial Corp. He began his career at Bankers Trust. Michael Fortino has served as general manager of CBC since 2006. In his new role as the Company’s chief financial officer, he will be responsible for overseeing the Company’s finance and IT departments. Prior to joining CBC, Fortino was chief financial officer at Levenger Co., a multi-channel retailer of high-end writing instruments and organizational products. continued on page 22
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Banking New York
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To submit your bank’s news, email Cassidy Murphy at cnortonmurphy@ thewarrengroup.com.
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Victory State Bank Donates $8K to Further Financial Literacy Initiative Victory State Bank has underscored its devotion to financial literacy with an $8,000 donation to the Coalition for Debtor Education (CDE), a non-profit organization with a mission to help vulnerable consumers improve their financial-management skills. The organization was presented with the contribution in March.
“Education about money matters is invaluable in bringing a positive resolution to those in financial difficulty,” said Ralph M. Branca, president and CEO of Victory State Bank. “The curriculum developed by the Coalition for Debtor Education should prove highly beneficial for our community.” Victory State Bank and CDE anticipate providing joint seminars on Staten Island. Carol O’Rourke, CDE’s executive director, said the organization plans to meet with the
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Banking New York
bank’s Community Development group to design a financial literacy program for the communities Victory State Bank serves on Staten Island. Victory State Bank is eager to work with the Coalition for Debtor Education in areas of Staten Island that are in greatest need, said Joseph J. LiBassi, chairman of VSB Bancorp Inc., the one-bank holding company for Victory State Bank. Customers Bank Appoints SVP, Regional Executive Customers Bank, based in Wyomissing, Penn., has appointed Sal Cortorillo to its retail banking team. He will serve as senior vice president and regional executive for the New York metropolitan markets (New York, Connecticut and New Jersey) and will work from the bank’s Port Chester, New York, office. Before coming to Customers Bank, Cortorillo was director for Lake Street Capital Group. His responsibilities included originating and closing commercial loans. Prior to that, he was senior vice president and senior lending officer for Hudson Valley Bank, NA, where he concentrated on middle market banking customers, primarily commercial loans and related banking services. Cortorillo will seek to expand the Customers Bank franchise in the New York metropolitan markets by developing and maintaining key business relationships. He graduated from William Patterson University with a bachelor’s degree. He obtained his MBA from Fairleigh Dickinson University. He is a member of the New York Bankers Association, Westchester County Bankers Association, NJ League of Community Bankers, and other professional organizations.
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