Full Faith and Credit

The following article appeared in the May 15, 2009 issue of American Banker. It was my eulogy to Bill Seidman, a great American.

As with any public figure, there were two (or more) sides to Bil Seidman. He was your basic consummate professional / belt-way insider / banker / lawyer / Regulator / Inflation-fighting / C-suite turned TV personality curmudgeon.

‘Losing him is bad for me, its bad for anyone who came to know and love him, and its bad for America. He kept us anchored to what banking really was and is and should always be; a bank 'takes deposits and makes loans' said the Chairman to me one night at dinner.’

And he was a cowboy.

Not a cowboy in the sense of an out-of-control, balance-sheet-wielding wall street transaction-driven loose cannon - I mean he was a Cowboy. A deyed-in-the-wool, horseback riding man on a horse; he loved horses. Bill wore boots, and Bill knew exactly how to wear boots; (real boots, worn under saddle and put up wet).

Once he arrived in Washington, as part of the "Whip Inflation Now" (WIN) team in the Nixon Whitehouse, he gave up horses but kept riding; a bicycle. Seeing him getting ready to leave his P-Street office on the way to CNBC back in the early-'90's became a tourist attraction around Georgetown. He was clockwork (even at the risk of being late, no car necessary); when it was time to get in front of the camera and talk about - well, no one ever really knew WHAT was going to come out his mouth in those early days (... or any days really) - but when his public called, he showed up and he delivered. He said it like it was and it turns out people were actually watching,; who would have known.

As a young banker, just out of FDIC/RTC "experience" (when the word "resolution" came to mean "best don't be at work" at an S&L on a Friday afternoon) - getting to meet, then getting to be around and then getting to work with "The Chairman" was a privilege beyond words. Every encounter was an experience in why America works; good old fashioned mid-west common sense (he was a Romney-ite, and I don't mean Mitt). He spoke, we listened, we learned. He was tough with us; tough as nails; there was a "no BS" zone around him the size of Michigan.

Losing him is bad for me, its bad for anyone who came to know and love him, and its bad for America. He kept us anchored to what banking really was and is and should always be; a bank "takes deposits and makes loans" said the Chairman to me one night at dinner.

Before you go back to work tomorrow, think about that for a moment.

Bill didnt' like the idea of little banks growing in to big ones fast, but nonetheless had a penchant for the under dog, the little guy. One look at the "portfolio" of relationships he cultivated shows where his heart was. He was an entrepreneur at heart who admired a can do attitude and a dream to match.

I know this, because I had one of those dreams, as President (at the age of 34 when I did not understand why a deposit was a liability) of a small insured institution outside of Philadelphia back in 1995. The Chairman agreed to serve as our Advisory Board Chairman. We had three things going for us; an insurance certificate, $9 million of assets (and i mean, total assets), and a branch the size of a closet. We were successor to a century-old Quaker savings bank charter, which by some freak of provenance had become an FDIC insured institution.

So why would the former Chairman of the one of the world's most powerful regulatory bodies affiliate with - this ? ... when he could have chosen ANY major multinational financial services conglomerate for his satisfaction ?

L. William Seidman believed in main street (and, as it turns out, I was lucky to be a better horseman than he and able to captivate his competitive spirit; he was actually quite a Polo player in his youth and I had a few pair of boots in the closet too).

At any rate, I will miss the Chairman. He lectured me on the evil of derivitives, the lure of yield ("Ken, sometimes there just IS NO interest rate HIGH enough to reflect the REAL RISK in a loan !") and admonished me for putting ice in a glass of single-malt scotch (I stayed away from the ice after that, but I can't say the same for some loans that would have been better left undone). The people close to him, he kept in his heart for life - (Birge Watkins, Jackie Pace, David Cooke, Bill Roelle, Patrick Hanraty, Amy Krallman - so many other good friends and co-workers) - and a trip to Nantucket for the weekend could easily turn out a political and corporate entourage fit to rival Congress in session). He loved and admired the political machine, and after a few early steps toward office, taught me that a "successful day" in the White House was any day the President did not notice you were there (a useful skill-set).

He was a true, red white and blue banker; he was a friend, he was a savior to a generation of lost banks and bankers - he was a great American. He gave the Japanese Fleet the better part of his grit, he gave S&L asset-junkies the better part of his mind and he gave his country the better part of his life. The Chairman may be gone but Full Faith and Credit (yes, a book plug, what he would have wanted) is here for good.

Is Bank Competition Really a Good Thing?

Truthfully, I’ve had to question everything. No stone on the surface of modern capitalism has been left unturned.

That got me to this question: Is bank competition really a good thing – or would fewer banks equate to more realistic pricing and therefore more reserves (and less net loss) every time an economic Armageddon comes around?

“If loan officers at my hometown bank won’t prostrate themselves to a 3% spread, there’s a lender somewhere else that will.”

I mean, who ever said a car loan should be anything under 20%? What ever happened to waiting to buy the car until you actually had earned (and saved) the cash to do it with?

Does the “reward” of a 6% car loan really have any relationship to the risk anymore of not getting paid back? How safe a financial industry model you can really build on a three (or under) point spread? Apparently, not one that’s safe enough.

But why is spread three points to begin with? Largely because if loan officers at my hometown bank won’t prostrate themselves to rate, there’s a lender somewhere else that will (probably around the corner at this point, or at least back when there was any credit to lend in the first place). And so the cycle begins; a good loan, set at a rate supposedly commensurate with real risk, turns into a time bomb.

That will – and I fear unfortunately has – gone off.

Will market competition ever allow real risk assessment in lending? And who ends up paying for the “under-market” rates in the end? We do in the form of TARP, TALF (and who knows what other four letter combinations are down the road waiting).

The metrics don’t quite add up. That’s because a spread of 3% (or under) leads to a return on assets of 1% (or under), which in turn means that banks can’t grow their capital base in a way that is consistent with the risk they are piling onto balance sheets. This leads me to the seemingly preposterous conclusion that banks ought to be lending money at something like 27% interest. Of course a number like that extracts an outrageous toll on borrowers, who pass the high cost of financing onto their customers, making the pain go even further and wider.

But then - it’s not like these same customers aren’t already getting a wallop in the form of perhaps another trillion (or more) on the national debt and the associated interest and taxes.

It gets down to the old “pay me now or pay me later” scenario. Frankly, I would have rather paid the up front costs associated with 27% (or whatever turns out to be “real”) interest rates from companies I’m doing business with in some form or another. As it stands now, it looks like I’ll be paying for all the lenders across the fruited plains who didn’t charge enough interest on their loans, which de facto, means every single one of them.

So if we want access to credit, make sure there is credit to access. Making it cheap may feel good for a few decades, but sooner or later, it gets expensive – apparently, very expensive and very fast. Maybe instead of caps on deposits (remember the 70’s? Take a look at the chart for “disintermediation and deposit rate ceilings” below) we need to set floors on loans.

Maybe the one metric the government needs to set is the “base rate of risk”. Anything above the base rate stays a private sector decision. Nationalize risk or nationalize banking; either way, someone has to start writing checks because the system is out of balance and out of control. The days of giving away cheap money without concern for what’s coming after are officially over.

Kelly Ripa’s Mona Lisa Look

When I look at the new TD Bank ads that Kelly Ripa does with Regis Philbin, there’s something inscrutable about her expression. It’s got a Mona Lisa quality to it.

Sometimes I think I see a little fear in her eyes while at other times she seems to be expressing mild uncertainty. Truthfully, it could be either.

“It’s not unreasonable to speculate that Kelly is wondering whether or not simply throwing away all of the brand awareness and brand equity created by Commerce Bank is really a good idea or not.”

Let examine the fear. Kelly’s a smart girl. She’s not one to endorse something without asking at least a few questions, like “Who are these people and what does TD stand for anyway?” When she found out she would be representing a Canadian bank, aka Toronto Dominion, she may have gotten just a tad uncomfortable.

Remember, Kelly is one of us. American yes, but also a Delaware Valley gal, born right here in the Philadelphia metropolitan region, where incidentally, I am from, and where her former benefactor, Commerce Bank, was founded. This is to say she was bred to root for the hometown team. If you’ve ever been a professional sporting event in Philadelphia, you’ll know what I mean. Or simply ask any hapless fan who had pluck to show up at a Phillies game wearing a Toronto Blue Jays jersey. You just don’t plug the visiting team without some kind of unpleasant consequence.

As for uncertainly, it’s not unreasonable to speculate that Kelly is wondering whether or not simply throwing away all of the brand awareness and brand equity created by Commerce Bank is really a good idea or not.

And on this score, she really is a smart gal. I’m sure she doesn’t spend her days thinking about intangible assets, but she is nonetheless onto something here.

After all, contained with the $8.5 billion TD paid for Commerce, there were millions and millions in goodwill. Enough that you would question the phalanx cranes that were deployed after the deal to take down the Commerce Bank signs and replace them with them emerald TD logo. One of these replacements happened in my neighborhood and I stopped to watch. In the few moments when the Commerce sign was hanging there at the end of the wire rope, I couldn’t but help see the whole thing for what I thought it was: a bit of a lynching for brand, and perhaps to some degree, shareholder value.

A little too passionate? Perhaps. But I’m passionate about banking. One reason for this is because it’s a simple business, that nonetheless can deliver truly remarkable returns to investors. But the way I see things, banking is a storefront business that has its roots – not it’s fiber mind you, but it’s roots – in customer service and consumer marketing. This is an idea that I think Commerce’s founder, Vernon Hill fully appreciated, and used to drive shareholder value for more than 20 years at Commerce.

So to watch all that brand equity disappear in one fell swoop, is a bit much for me. That’s why I may feel a little bit like Kelly, unsure if I should be a little uncertain or a little bit afraid.

We Should Have Bailed Out Santa Too

I have it on good authority that Santa applied for TARP funding but was denied. Because Santa is a mythical figure not covered under the Constitution, hearings and testimony were not subject to Sunshine laws. Nonetheless, my contacts in and around the Beltway tell me this is what happened:

Years of excessive pay to elves, the production of too many, poor quality toys that no one wanted, and the legacy costs associated with pension and healthcare benefits for retired reindeer and elves had left Santa’s northern pole operations in shambles and facing bankruptcy. Moreover, his failure to recognize shifting consumer tastes and preferences offered an opening to alternative holiday celebrations with Kwanzaa and Chanukah each stealing significant share.

“Everyone on the Hill knew it was over the moment that those hooves hit the tarmac at Ronald Regan International.”

My contacts report intense lobbying leading up to Christmas gave Santa a decent shot at getting a bridge loan under the TARP program. Santa had skillfully played down the notion that it was a bailout, but rather the preservation of a dream held by millions of children and a way of life. “Of all the countries I serve,” said Santa, “America is the only one where putting all reason aside to give others what they need – if just once a year – is a tradition that should and must be preserved.”

Opposition flared however.

Mitt Romney said, “Without that bailout, Santa will need to drastically restructure how he does things. With it, he will stay the course — the suicidal course of declining market shares, insurmountable labor and retiree burdens, technology atrophy, product inferiority and never-ending job losses for elves,” Romney said. “Santa needs a turnaround, not a check.”

Richard Shelby, a Republican from Alabama wondered aloud about the existential nature of the proposed funding “Will it be used to improve Santa’s business model — which has been a failure or is this just life support?”

Treasury secretary, Henry M. Paulson Jr., implored lawmakers to oppose using any of the $700 billion financial bailout for Santa, which he said would set a dangerous precedent. “We can’t support someone who, for starters dresses the way Santa does, but more substantively, who lives in a bubble, is completely disconnected from Main Street, and has used has used Byzantine methods which no one quite understands to amplify the risk imbedded in his operations.”

Ultimately, it was Santa himself who dashed any hopes for TARP funding when –poorly served by his advisors in the North Pole – he arrived in Washington via his own personal sleigh. Perhaps seeing their chance to deny funding and win a public relations war, lawmakers were quick to denounce Santa, suggesting that he should have ridden in one of the Big Wheels tricycles that are produced right in his North Pole factory.

"There is a delicious irony in seeing a private sleigh flying into Washington and Santa coming off with a tin cup in his hand, saying that he’s going to be trimming down his operation," said representative Gary Ackerman, a Democrat from New York.

"I'm not an opponent of private sleighs by any means,” said Representative Patrick T. McHenry, a Republican from North Carolina. “But the fact that you flew in on your own private sleigh to Washington is a bit arrogant before you ask the American taxpayers for money."

My contacts tell me that everyone on the Hill knew it was over the moment that those hooves hit the tarmac at Ronald Regan International. Lawmakers were distracted by the problems facing automakers and banks, and though they gave the big guy with the funny hat and beard some time and a good public scolding he walked away with his sack, usually reserved for toys, rather empty.

Henry Paulson allowed Santa to save face however by suggesting the Polar Redevelopment Commission for Integrated Northern Enterprises or PORCINE might be funded and provide him a source of future liquidity.

But this must be the season of miracles, since almost everyone I know got at least a little something, attended a few parties and did their best to make merry. Somehow Santa pulled it off, though I understand he is making no promises whatsoever about making our dreams come true in 2009.

Relax

To all my friends and colleagues, executives at portfolio companies and all the other professionals I’ve met lately who are in a state of agitation over the socialization of the American banking industry, I would humbly and respectfully suggest they take five and relax

It’s not all that bad. Really.

My confidence on this point stems largely from the history of banking in the United States. Yes, there’s been turmoil, now and in the past.

“But when I look at the wider canvas, I see continuous and successful adaptation to change.”

For instance, the branching restrictions developed in the 19th century were designed to ensure that no bank could amass an undesirable concentration of power or choose remote locations that would deter depositors from redeeming notes. This is a quaint notion today, but was absolutely vital when all business had to be conducted in person. Banks responded by modeling themselves to service single, discreet markets. The real beauty of this was that when the economy consisted of a patchwork of regional economies debt capital was distributed wherever it was needed by thousands upon thousands of banks. The economy thrived in a granular as well as aggregate sense, and so did the banks that supported it.

Later when the completion of the transcontinental railroad meant transcontinental commerce, so-called “chain banks,” were formed which were confederacies of banks all owned principally by the same investors. These were followed in 1890 by the first bank holding companies.

When the S&L crisis hit, and the notion of regional lending and deposit gathering presented very real risks and limitations, banking consolidated through the creation of intra, inter and national branch systems. It wasn’t always pretty, but it worked. For instance, while the number of banking companies in the United States between 1982 and 2007 contracted at a compounded annual rate of 2.8%, average bank profitability expanded at a compound annual rate of 11.3% every year, according to aggregate data extracted from archives on the FDIC’s site.

So what does the future hold for banking? It’s difficult to say any more than one could predict the landscape for the industry in the midst of the savings and loan crisis. But it will change, survive and ultimately prosper.

Marketing, Front & Center

Investors frequently ask me what I look for in a bank. I cite among my top criteria facility in marketing. Now with the industry in peril and massive consolidation likely at hand, this is truer than ever.

Despite how obvious this seems to me, I’m always amazed at the ongoing resistance to the notion of marketing and the vital role it plays banking. It’s not everywhere mind you. Many bankers have embraced marketing and are sophisticated practitioners. The there’s still a lot of hold-outs though who believe that for banks, marketing is nothing more than a distraction and a side show.

Sometimes these guys remind me of old guard telephone company employees who are still waiting for Ma Bell and black rotary phones to come back.

‘The fact is, there’s ample evidence that marketing is the tip of the spear for successful depositories.’

This evidence comes in the form of consolidation. You don’t see many auto or media or consumer products companies merging with any degree of success. One reason for this are the risks associated with product integration. Just ask Daimler’s Dieter Zetsche.

But in banking the industry is consolidating with apparent ease. And the reason for this is the relative absence of product integration issues. Every bank has checking, CDs, and savings. With very few exceptions, they all have branches. And every bank has some combination of consumer, business or real estate lending. None of these products are proprietary and any banking organizations can offer these services.

To my way of thinking, this is tantamount to admitting that the products and services banks offer are basically commoditized. And if you believe this, then it’s not too great a leap to suggest the only difference between Bank A’s checking and Bank B’s is the positioning of the product in the consumer’s mind. What position this product occupies, or does not is attributable solely to marketing.

The fact is that marketing in banking is not new, and has been a driving force in the business since it’s earliest days. In 1870 The Second National Bank of New York opened the first “Women’s Department” catering exclusively to women. The department was predicated on the notion that while many women did not work, they nonetheless had a significant influence on the family’s finances.

In the 1890s banks began offering so-called school banking programs which enabled students to open accounts through their schools. By 1930, some 36 million children were enrolled. It’s probable, that some of these schoolchildren are still banking customers today.

And let’s not forget that one of the largest banks in the country, Bank of America, was started on what was basically a marketing segmentation ploy. That is, forerunner The Bank of Italy, opened in San Francisco in 1904 to address the needs of immigrant Italians.

So in many ways marketing is imprinted on the genes of banks. Given the low to no barriers to entry, it has to be. But getting back to the concerns of investors, what can and should be a source of concern for investors and acquirers however is when it’s not imprinted on the genes of the bankers themselves.

Word Play

With everything that’s happening on Wall Street and now Washington, there’s no shortage of words.

Commentary is everywhere. And it’s taking all shapes and forms. Vitriolic diatribes, analytical prescriptions, darkly social satire.

What’s interesting to me however is that despite the volume of commentary, much of its tone and tenor turns on one or two absolutely vital words. To wit, the near ubiquitous use of the word “government bailout,” to describe the plan proposed by Treasury Secretary Henry Paulson.

To me, the senators and congressmen who used the word bailout have done a disservice to their constituents. Using the word bailout, to me, is like swinging a machete. It’s much too simplistic. A bailout does not describe – in any way that informs – the nuances of the predicament that that we find ourselves in. Really, the folks who used, and continue to uses the term bailout, to me, simply want to play the blame game.

And this has hurt us all as Congress has been unable to reach consensus on the right direction. In a way, who could blame them? Even if they understood the necessity of the plan, with their constituents calling in and overwhelmingly denouncing a “bailout”, how do they vote for it?

And from my perspective as a private equity investor, I don’t see anyone on Wall Street getting bailed out. In fact, some of them have been the biggest losers. Hank Greenberg has lost approximately lost $5 billion on his AIG stock this year. Many of the people so closely associated with the current crisis – Stan O’Neal and John Thain of Merrill Lynch, Richard Fuld of Lehman Brothers, James Cayne of Bear Stearns – have lost hundreds of millions. These men lived by the sword and right now they are dying by the sword.

So the word bailout is troubling to me. Because its enabled its users to engage petty rivalries, when in fact access to credit is a national asset. Preserving this asset benefits all of us, in particular the small businesses, mom and pop operations, families who use credit cards, or who buy homes, or cars.

One of the problems with something that always been there your entire life is that you begin to think it’s free and that it exists, well, because it exists. I think the folks who believe we are bailing out Wall Street fall into this camp. The fact is there’s enormous infrastructure behind the credit that we all access and use so frequently. Ensuring that infrastructure survives is not a bailout. It’s just a simple necessity.