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Banking

Introduction | Spotlight: Banking Outlook Conference | Spotlight: Net Interest Margin Performance, Part II | State of the District | National Banking Trends


Spotlight: Banking Outlook Conference

Cyberthreats, Reputational Risk Highlight Conference

The Federal Reserve Bank of Atlanta's annual Banking Outlook Conference on February 28 brought more than 200 bankers and regulators to the Reserve Bank's headquarters to discuss an array of issues affecting depository institutions and the nation's financial system. Panels and presentations covered a range of topics under the conference's title, "Navigating the New Banking Landscape." A few predominant themes emerged, including:

  • Reputational risks and the growing threat of cyber-attacks;
  • The impact of new regulation, including the costs of compliance;
  • Operational challenges and regulators' concerns;
  • And gradual improvements in underlying economic and residential real estate conditions.

This summary of the conference will explore each of those themes.

Reputational risk, cyberthreats
In the keynote speech, Fed Governor Sarah Bloom Raskin addressed the importance of reputational risk for individual banks and the nation's financial system. She said that much of the public mistrusts financial institutions, particularly the largest ones. This mistrust results in part from the widespread perception that big banks were rescued by taxpayers, and yet have not been held to account for putting the nation's financial system in danger, Raskin explained.

"Even as the economy comes back to life, our memory of these events is still sharp and the reputational damage suffered by U.S. financial institutions during the crisis endures," Raskin said.

To better safeguard reputations, she said that bank supervisors, managers and directors should pay closer attention to existing and potential risks to banks' reputations. A loss of credibility is not just bad PR; it can hurt business. Raskin noted that banks could lose deposits or have trouble launching fee-generating products if customers and prospective customers hold banks in low regard.

Others at the conference also called reputational risk an important concern. Reputational problems have held down some banks' share prices, said Christopher Marinac, a veteran bank stock analyst and managing principal and director of research at FIG Partners LLC. His fellow panelist, Nancy Bush, managing member of NAB Research, LLC, declared it "extremely important" that the industry restore its reputation. Noted as a candid commentator, Bush said that the financial services industry is undergoing a structural transformation in the wake of recession and a global financial crisis. Instilling institutional cultures that prize frugality is critical to success, and so is reputation, according to Bush.

"That is a major factor getting into revenues itself, that people just don't want to deal with banks right now," Bush said. "It's not all the banking industry's fault."

Some bad actors are, in fact, eager to damage the reputations of banks. During a panel discussion on Southeast banking conditions, Regions Financial Corporation President and CEO Grayson Hall said cyber-attacks endanger a bank's brand and reputation. Online threats are not new, but the nature of the threats has changed, Hall observed. Rather than simply trying to steal money, well-organized cyber intruders today often aim to disrupt a bank's capacity to operate.

"It literally is a daily race to stay in front of these folks," said Hall. "It threatens our reputation."

Today's cyberattackers are also growing increasingly sophisticated, panelists said. "I wish we could get some of that intelligence and bring it in-house," Carl Chaney, president of Hancock Bank, said of the acumen of today's cyberattackers.

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Regulatory matters, compliance costs
The conference featured much discussion of both uncertainty surrounding the final form of proposed rules, and of the rising costs of regulatory compliance. For example, new qualified mortgage rules from the Consumer Financial Protection Bureau are likely to increase costs and drive lenders out of the home mortgage finance business, said Jay Brinkmann, chief economist and senior vice president of the Mortgage Bankers Association. That exodus from mortgage lending will make home loans harder to get, Brinkmann opined, and more lending will be done through government programs such as the Federal Housing Administration.

In general, greater regulation slows everything banks try to do, and increases costs, said Paul Willson, chairman and CEO of Citizens National Bank, a community bank in Athens, Tennessee. The unintended consequences of certain rules meant to protect consumers could end up pushing certain consumers toward nonbank lenders such as title loan operations and pawn shops, Chaney said. He argued that legislators and rule writers had become overzealous in their consumer advocacy. Regulatory compliance costs are climbing so much, he said, that even well-run banks will seek buyers just to escape the burdens.

Right now, Willson observed, the most difficult aspect of regulation is uncertainty about the ultimate form of rules contained in the Dodd-Frank Wall Street Reform and Consumer Protection Act. Bush, the analyst, sounded a similar note about uncertainty when she said regulators need to clearly signal their intentions. In particular, she said investors fear that regulators will continue to essentially dictate, based on stress test results, whether banking companies can pay stock dividends or repurchase their own shares.

Complaints notwithstanding, most speakers acknowledged that some revamped regulation was necessary after the financial crisis. The key is to strike a balance so that the regulatory weight is thoughtful, effective and not overly burdensome, Atlanta Fed President and CEO Dennis Lockhart noted in remarks opening the conference.

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Regulators' concerns, operational challenges
A panel of bank supervisory officials from the Atlanta Fed, the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) noted several promising trends in banking conditions. Broad measures of capital, earnings and asset quality are generally moving in the right direction, the panelists noted. Overall, the industry has passed the discovery phase of problems and is in a "maintenance phase," said Gil Barker, deputy controller, southern district for the OCC.

Banks in some areas in the Southeast, notably Florida and Georgia, continue to lag institutions elsewhere. But on the whole the regulators said that their examiners and analysts have begun looking ahead to the strategic and operational risks facing banks now and in coming months and years.

Institutions that weathered the recession well generally stuck to fundamentally sound business plans, said Thomas Dujenski, regional director, Division of Risk Management Supervision for the FDIC. Healthier institutions as a group did not pursue rapid-growth agendas that included high concentrations of loans in particular categories or unstable sources of deposits. Going forward, the FDIC will be watchful to ensure that institutions conduct proper due diligence of third parties that they engage to help generate fee incomes, Dujenski said.

Meanwhile, the Atlanta Fed's senior vice president, supervision and regulation, Michael Johnson, said his present concerns include a refrain similar to one he often heard leading up to the financial crisis. Johnson said he has begun hearing from bankers that their competitors are offering unusual pricing or terms to secure commercial and industrial lending business. In pre-crisis days, those deals involved real estate lending.

"I'm not saying there's a bubble or anything like that, but it's just a little worrisome," Johnson said.

What's worrisome for the bankers at the conference includes navigating through what one called an "unnatural" interest rate environment. Hall of Regions Financial said his customers typically do not understand the intricacies of monetary policy. They just know their bank is paying them a low rate on deposits. As a result, he said he is concerned about keeping savers, especially retired people, loyal to his company. And a related concern is structuring the company's balance sheet to withstand an eventual rise in interest rates.

The analysts, Bush and Marinac, said it is critical that banks formulate thoughtful strategies to navigate the ongoing low interest rate environment, and an eventual rise in rates. Marinac sees some bankers beginning to move deposits into demand deposit accounts and away from money market accounts, whose holders typically demand higher returns the instant broader market rates start to climb. Holders of demand deposit accounts are less likely to move their money around, Marinac noted.

Also, Bush said she thinks middle-sized banks—with assets of $10 billion to $50 billion—should strengthen their wealth management businesses. Those institutions could benefit from a couple of forces, she believes. The first is lingering mistrust of the largest financial institutions, which harkens back to the reputation issues. As some customers turn away from large institutions, they could consider taking their money management business to a mid-sized institution. Second, an aging population will likely generate more demand for wealth management and trust services.

Willson of Citizens National, meanwhile, said he worries about where demand for quality credits will come from. He said if his bank can maintain steady loan volume in 2013, he will be "tickled to death." Chaney said his institution, Hancock Bank, benefits from operating mostly in south Louisiana and the Gulf South region, from Houston to Tampa. Those markets continue to provide loan growth. "It's all about where you are and how you execute," he said.

Bush and Marinac also stressed the importance of cost control.

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Economic conditions gradually improving
During 2013, the private sector of the U.S. economy will be put to the test. Federal government spending has been a key engine of recent economic growth. But spending cuts this year will force a "handoff" of economic momentum to the private sector, said Michelle Meyer, senior economist at Bank of America Merrill Lynch.

The good news: we have seen stronger underlying economic growth stemming mainly from positive signs in the housing market, strong auto production, signs of improved credit flows, and healing in state and local government finances. On the other hand, federal fiscal cuts, along with the payroll tax hike, are likely to restrain economic growth in the next few months, Meyer predicted. Her team forecasts growth in gross domestic product of 1.4 percent this year, including 2 percent in the first quarter and just 1 percent in the second quarter. And she expects unemployment to remain high. It was 7.9 percent in January.

In the Southeast, Meyer pointed to Atlanta and Florida as interesting studies in residential real estate. In recent months, home prices in metropolitan Atlanta have finally begun climbing after a long decline. A large reason for that reversal is that distressed inventory is being removed from the market, much of it bought in bulk by investors including private equity funds. To the south in Florida, Miami's residential prices are rising quickly because of an influx of foreign money. However, many Florida markets retain large inventories of distressed properties.

Broadly, Meyer cited factors that she said suggest the housing market recovery could be sustainable. She pointed to declining inventory of unsold homes and rising demand. Plus, housing starts should climb again this year and continue to rise, she forecasts. What's more, she foresees a surge in household formation, which for the past five years has been at about half the historical level.

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