BP: How has your institution’s strategic direction changed since the Great Recession, particularly following Dodd-Frank? Do you see more or less opportunity for growth in the market?
Michalak: Our core strategic direction remains unchanged, which confirms the validity of our forward strategy. We continually make tactical refinements in response to a wide variety of external developments, one of which is Dodd-Frank, but have kept fully intact our broader strategy of core relationship banking in markets and businesses we know and understand.
Finneran: Our core strategy has always remained a constant – to go where the market is going. The resilience of our core businesses through the Great Recession enabled us to further that vision. We completed three strategic acquisitions from 2009 through 2012, extending our retail and commercial banking footprint to Washington, D.C. and surrounding states, acquiring the leading national direct deposit business, and expanding our card franchise.
Tuuk: We have not changed our primary strategy, which is to provide traditional banking services to a broad range of consumers and businesses. Our strategy includes addressing important changes in the channel preferences of our customers in terms of how they want to do business, particularly the greater use of online service and newer channels including mobile banking, and addressing concerns in terms of cybersecurity.
Parker: U.S. Bank’s strategic direction has been consistent before, during, and since the recession, particularly related to our growth plans. We continue to see tremendous opportunity for growth in markets or in business areas where we already have a significant presence, rather than entering new markets. Recent examples are our Charter One branch acquisition in Chicago, as well as recent acquisitions in our payments, trust and fund services businesses.
Harris: We have taken a number of actions to better position the company going forward. We have refocused and realigned around core competencies, while also emphasizing our client focus and relationship-based strategy. We have also reduced our risk profile by exiting select businesses, refocusing lending efforts, increasing our liquidity profile, and aggressively addressing credit quality. We have invested for growth in several targeted businesses, such as payment products, digital channels and commercial mortgage servicing.
We believe we are doing the right things to position ourselves for the long term. We are focused on acquiring and expanding relationships with our distinctive business model and broad product offering, improving efficiency and productivity, and optimizing our strong capital position. While the slow-growth economy, low interest rate environment and other macroeconomic challenges are likely to persist in the near term for banks, our bank remains well positioned to grow.
BP: What are the biggest challenges facing regional banks?
Michalak: The greatest competitive challenge for the industry at present is an aggressive loan environment, which can cause terms, structure, and pricing to deteriorate. With this as a backdrop, the “shadow banking” system continues to play a significant competitive role with less stringent regulatory and capital demands, impacting segments across the lending spectrum. By driving the marketplace to accept more risk at continuingly lower pricing, the shadow banking system increases volatility and represents an unquantified risk to the financial stability of the marketplace. Further, the introduction of unregulated capital and liquidity to the system increasingly undermines the risk management principles that govern the financial services industry.
The most substantial regulatory challenge for the industry is clearly the liquidity coverage ratio. From almost every perspective, newly proposed liquidity standards – the LCR in particular – pose a bigger challenge to the industry than even the Basel III capital rules. Addressing LCR remediation will require adjustments at the corporate level, the line-of-business level, and even the product level, depending on the final terms of the rule. Basel III requirements affect all banks in some way, with varying severity depending on the type and size of bank, and challenges will be compounded as we presume that most banks will seek to make similar adjustments at the same time to ensure compliance. LCR constraints also will force banks to change, or at least reassess, their current business models as bank balance sheet size may now be limited by the ability to attract funding and not the ability to find assets.
Parker: We need to be mindful of any effort to remove all risk from banking. Risk-taking has always been part of banking, but that doesn’t mean banking is a risky business. Basic finance textbooks teach us that risk must be assumed in order to earn a return. We believe risk is necessary and essential to the system and we would like to be able to take risk and manage that risk intelligently and prudently.
BP: Mike mentioned the LCR as a significant challenge. Is this a universal concern for regional banks? What areas of the rule are most troubling?
Finneran: Though the Basel liquidity regime was designed principally for globally active banks, under the proposed LCR rule, regional banks would be subject to at least a modified version of the liquidity framework. Beyond the questions we have pertaining to the scope of the rule, we have been engaged with our regulators quite a bit on this issue, particularly in voicing our concerns with the requirement imposed on several of us to report our liquidity positions daily. Designing, building, validating, and operating a compliance apparatus to satisfy this requirement by January 2015 is extraordinarily challenging and it’s questionable whether the regional bank business model, which is devoid of meaningful trading book activity or wholesale funding reliance, presents the kind of liquidity risk that daily LCR reporting was intended to capture.
BP: What about your customers? What are the primary concerns you are hearing from those that you serve?
Parker: Economic uncertainty continues to be a concern among the businesses we serve. Our small and medium-size customers are still a bit cautious to borrow and expand their businesses. These businesses are preparing for growth once they sense the economic recovery is picking up its pace. While we are not quite at that point yet, there are glimmers of hope. Earlier this year, the U.S. Bank Annual Small Business Survey showed that for the first time in five years, a majority of small business owners are optimistic about the economy and future conditions. Survey respondents also said their three biggest issues of concern nationally are the federal budget/deficit, healthcare and taxes.
Michalak: Small business owners continue be cautious about significant capital outlays for expansion (people, equipment, larger facilities) due to lack of long-term confidence in the economic environment. The impact of healthcare reform and taxes is still uncertain, and many small business owners are unwilling to increase debt loads/leverage while such conditions exist.
Consumer borrowers, like their commercial counterparts, are generally cautious due to the uncertainty in the economy. While consumer attitudes and willingness to spend appear to be improving, the pace is uneven from month to month.
Despite moderate demand for new credit, there is intense competition for the very creditworthy borrowers who are looking to maximize loan structure and rate. Excess balance sheet capacity and intense competition for loan growth have resulted in a continued relaxation in pricing and structure.
Tuuk: Uncertainty makes it difficult for businesses to forecast demand and expenses, creating caution regarding expansion plans. While there has been improvement, many business customers still are unsure about the longer-term cost impact of healthcare reform and the overall growth of the U.S. economy. The concerns of most consumers are tied to their life stage. Retirees and older customers are concerned about the low level of interest rates and the outlook for their investments, and the cost of long-term care. Customers with children are concerned about the cost of higher education, the level of debt their children incur, and the employment outlook for graduates, not to mention their own retirement savings. Our youngest customers are concerned about their job outlook, but are generally more optimistic. Most of their feedback relates to the bank’s technology. They expect convenience, responsiveness, and transparency.
Harris: Our business clients are profitable with strong balance sheets, good order books, and high levels of liquidity. They remain cautiously optimistic, seeking evidence of clear direction for the economy. Clients are moving forward with fundamental business decisions but are deferring investments on the margin, with the lack of a demand-driven catalyst. Clients also have been increasing their focus on strategic growth through acquiring products, capabilities, and their own competitors. Consumers also remain cautious but have turned modestly more positive as the employment outlook has improved.
BP: Shifting gears back to the regulatory environment, it seemed that there had been quite a bit of concern with the original proposal of the Volcker Rule. With the release of the final Volcker regulations, are there still areas where regional banks are focusing before the end of the conformance period?
Finneran: We began considering the impact of the Volcker Rule long before final regulations were issued. Because our core activities are consumer and commercial lending and deposit taking, we have very few activities that are covered by the prohibition in the rule. However, the final regulations require, solely by virtue of our size, that we implement a so-called “enhanced” compliance program. As a result, since the release of the final regulations we have focused principally on building out an enterprise-wide compliance program, and we expect that other regional banks have been similarly focused.
Tuuk: The lack of clarity regarding the definition of “illiquid” for purposes of the final extension to hold “covered funds” is causing some concern and hopefully will be be crystallized in formal guidance from regulators. Additionally, the process to receive initial extensions should be clarified.
Harris: Banking institutions that own private equity funds or other “covered funds” are struggling to understand how the Federal Reserve will approach the process and decision making for granting extensions. We’ve made it clear that banks will suffer significant losses if forced to sell private equity funds, with benefits of fire sale pricing largely being transferred to hedge funds, vulture funds, or other third parties outside the banking system. The industry needs the assurance that the Fed will give banking institutions the full benefit of the extensions, including for illiquid funds, that Congress made available in the Volcker Rule.
BP: It seems that the regional banks banded together as a result of the Dodd-Frank Act’s establishment of $50 billion as the line for imposing enhanced regulatory requirements to reduce systemic risk. Do regional banks believe this threshold appropriately differentiates institutions that pose systemic risk in the banking system? Are there alternative metrics that the regional banks feel might more accurately capture systemically important institutions?
Michalak: Consistent with Federal Reserve Governor Tarullo’s comments on May 8, size, along with the type of business the bank conducts, should be part of the calculus used to determine systemic importance. Commercial banks that simply make loans and collect deposits from their customers, particularly on a regional basis, wouldn’t seem to pose systemic risk to the financial stability of the banking system.
While there may be some relative differentiation in regulatory requirements among the $50 billion and greater banks, evidence seems to suggest there is one set of rules. For instance, the Federal Reserve has established a single “range of practices” document to advise banks on where they have deemed appropriate practices. As there is only one set of practices, it suggests there isn’t any differentiation from the very largest banks to those that are simply at the $50 billion threshold.
Finneran: Though it is a useful metric in assembling a comprehensive risk profile, asset size in and of itself is not an indicator of systemic risk. Systemic risk is more a function of the kinds of activity in which a bank is involved, how interconnected that bank is with other institutions, how much exposure that bank has to economic events across the world, and how substitutable that bank’s products and services are in the markets it serves. As banks that are both much smaller than the largest institutions and also much more traditional in our business models with predominantly domestic footprints, regional banks feel strongly that the regulators should use a more comprehensive assessment beyond asset size as they implement the various new prudential standards intended to reduce systemic risk.
BP: Given this perspective, are there specific policy proposals being considered by the regulators for which the regional banks believe they should not be in scope?
Tuuk: It is our view that there are far too many regulatory policies based on arbitrary dollar thresholds. $10 billion, $50 billion, $250 billion – the list goes on and on. We believe a better policy would be to have two groups – systemic and non-systemic – and apply higher standards to those institutions that could actually damage the system in the event of their failure.
BP: Speaking of the regulators differentiating among different sized institutions, what refinements in the CCAR process do regional banks feel the Federal Reserve should make?
Michalak: Capital planning has been largely enhanced as a result of the CCAR process. Overall improvement connecting risk management with capital adequacy has favorably impacted regional banks. However, as noted earlier, the complexity of the rules and the lack of strong differentiation between the capital planning requirements of an “active trillion dollar, multi-diverse bank” versus a “$50 billion traditional commercial bank” is where far greater refinements are needed. So while the foundation of the exercise is good, the requirements surrounding the execution are challenging. At some point, the big picture of effective risk management and the capital supporting the risks is in danger of being lost on bank’s efforts to merely achieve compliance with the filing requirements.
Harris: CCAR has played a major role in changing how our bank manages capital. Incorporating stress testing and providing significantly more information to management and the Board are two of the large enhancements to our capital management process that have been driven by CCAR. While risk has always been an important consideration for capital, the stress testing has made that assessment much more explicit. This, of course, ensures that capital is maintained at sufficient levels to mitigate risk. Along with that has come a significant investment in models and model validation, forecasting, more reporting and analysis, and more meetings to plan, analyze, review, challenge, and govern the overall process.
BP: One last question: The banking agencies have increased focus on both enterprise-wide risk governance and risk governance at the bank level. How are regional banks tackling aligning their risk governance frameworks to satisfy the expectations of these potentially overlapping supervisory regimes?
Finneran: It’s true that the bank regulatory agencies have increased their focus on corporate governance, whether it’s the Federal Reserve through SR Letter 12-17 or the OCC through “Heightened Expectations”. As the agencies continue to refine their expectations, it’s important for their requirements to be clear, principles-based, and flexible to best address the risks presented by each individual bank’s business. I don’t think the agencies intend for regional bank management and directors to make choices and trade-offs based on a checklist of prescriptive regulatory requirements. Rather, I think our collective intent is for the governance framework to be tailored to the bank’s business model, strategy, culture and risk profile. So, I think the objectives of the agencies and interests of the banks to achieve strong risk governance are aligned. Each bank should continue to work with its regulators to make sure it understands how the bank’s governance framework not only satisfies their requirements but also reflects the bank’s specific risk profile and other relevant factors.
Parker: Banking is all about being a partner to our customers and taking managed risk so they have access to capital to succeed personally or in their business. It’s something we do very well. Corporate governance has been and remains an important priority. Managing risk through prudent credit and risk policies continues to be a significant focus for all banks. The goal is not to avoid risk altogether but to know your customer, know the industry, have a plan for the challenges they may face – all of these things continue to be important in making good quality lending decisions under the guidance of strong corporate risk governance, policies, and procedures.
BP: Thank you all for your time. •