We wonder how much the creative destruction on Wall Street is actually hitting Main Street. So far, it seems, the answer is not much.
In fact, the greater the distance from a global financial center and the attending media fire hose, the less the relative importance or perhaps, better — the perceived importance — of the rescue and the wants and needs of Wall Street generally. This is particularly true for American communities which have experienced significant hardship, like the good people of Southern Louisiana.
In 2005, many Americans learned about Louisiana and New Orleans for the first time courtesy of Hurricane Katrina. The people of that particularly beautiful slice of Middle America suffered terribly as a result of the storm and its aftermath, but now the economy around New Orleans is seeing the benefit of billions in federal aid and renewed private sector growth. For people in New Orleans, the troubles on Wall Street seem like the events on another planet – although the Main Street effects of the credit crunch, namely street-level fear and uncertainty, are visible enough among all types of people.
The IRA recently spoke with Reginald H. Smith, Jr., President and Chief Executive Officer, Metairie Bank and Trust Company in Metairie, LA, about the state of the banking industry and the LA economy, and how his institution had handled Hurricane Katrina and the collapse of the subprime markets starting last year.
The IRA: Thank you for speaking with us Ric. Let’s start with your view of the bailout for the big banks and how it affects your institution. What’s the view of the bank rescue legislation from Metairie, LA?
Smith: We feel like a spectator watching the hometown team in a football game right now. We are caught up in the excitement and we have a real interest in the outcome, but we are not in the game. So far, nothing has come out that directly benefits us although it does benefit the banking industry and that indirectly benefits us. We are certain that we will paying higher taxes and deposit insurance premiums as a result of it, and that will be our challenge although we had nothing to do with creating the problem. If someone wanted to help those of us who were not part of the problem, how about reducing our taxes for the next couple of years to reward us for being good businessmen?
The IRA: We don’t hear a great deal of worry. How has your market environment changed in the past few months?
Smith: We’ve never been much of a rate play on the deposit side at Metairie. We’ve always been positioned as a safety and soundness choice for people. People used to care about rates, but in the last month that’s changed. They don’t care. We have people locking in deposits with our little institution well in excess of the new insured limits. They kind of get us. We are small enough that people can wrap their heads around us and understand our business. But I will say that this is the first time in forty years in the banking industry that I’ve seen this sort of thing going on in the marketplace.
The IRA: We’ve been discussing this issue of public fear with people for several months. Our friend David Kotok of Cumberland Advisers (click here to see the latest version of Cumberland’s map of the NY Fed’s balance sheet) observed that during the 1980s, you had insolvent banks that were still liquid and remained open. People knew there was a problem at many S&Ls, for example, and there were some events in states like MD and OH where the public was unsettled, but no systemic panic. Whereas today you have street-level fear around the US. Is that accurate? How would you contrast the two periods based on your experience?
Smith: Very much so. I agree that there was not nearly the level of panic in the 1980s that there is today. My impression is that part of the difference in the 1980s was due to the localized nature of the crisis. I saw the crisis hit TX, OK, and LA as a much younger banker. We were hit by the double dip of the oil crisis and then TEFRA…
The IRA: Ah, TEFRA meaning The Tax Equity and Fiscal Responsibility Act of 1982? Some argue that TEFRA reduced taxes, but the numbers from the US Treasury suggest that TEFRA was revenue positive, that is, actually raised taxes.
Smith: Well, here in LA those two factors had a huge impact on our real estate markets. We already had a soft market at that time and with TEFRA you immediately saw a devaluation of the real estate market, literally overnight. You could not trade your position. Investors could not trade properties to mitigate their risk. It was ugly, but it was not reported on in the media with the intensity that we see today. People are much more gut-level worried about things today as compared with the 1980s, at least that’s what I find.
The IRA: This is the second interview we’ve done in the past month where the effect of the media has been cited as a negative factor in the financial crisis. We love all of our colleagues in the press, but watching beat reporters become expert in banking overnight is ugly too. Just look at the number of times we’ve had to correct a publication for citing us in a story about the FDIC running out of money. To be fair, most people just don’t understand how these agencies work or interact with the Treasury. Do you think the media is part of the problem, especially when they get big stories about things like deposit insurance wrong at a time of high public anxiety? Or should we chalk up the buffoonish blunders of the media to innocent naiveté and the foibles of a democratic society?
Smith: Yes and no. We should not make a blanket indictment of the media, but consider the difference in intensity between media today vs. say ten years ago. With the entrance of the internet and the MSBNC and other media, the intensity of the media coverage actually drives fear. We see this with hurricane coverage. Ten years ago, you heard there was a hurricane developing in the Atlantic but that wasn’t until the storm actually developed and was passing Cuba. Now we literally sit here and watch it on real time basis from right off Cape Verde Island. You start off not worried about it, but with each news report and television update, the worry increases. By the time the storm gets to the Gulf, people are in a frenzy.
The IRA: Which is precisely what the media wants. They want you to keep that TV on 24/7 and for you to follow the hurricane or the financial crisis every step of the way.
Smith: I think that’s what is happening with the banks right now. The news cycle is so intense now that it fills up with news on the financial crisis. It is a real crisis, I don’t want to minimize the importance of what’s going on, but when you superimpose the financial crisis on a political season, people become just steeped in the latest events in the media, especially reports on big bank failures on Wall Street.
The IRA: People in the New York area are more than a little crazed, ourselves included.
Smith: Take IndyMac, for example. I have not had time to go over their numbers, but even though the bank had financial issues they did not seem to have a liquidity problem until the letter was released by Senator Charles Schumer (D-NY) and everybody said “Oh my God, I’ve got to get my money out.”
The IRA: Yes, not one of Chucky Cheese’s finest hours. We suspect that Schumer knew that IndyMac was to be resolved and released the letter to benefit from the publicity. It is said the most dangerous ground in Washington is between Chuck Schumer and a TV camera. He actually made some sense during the bailout, however. Early in the process. Schumer was talking about using the funds authorized by Congress for equity infusions into banks instead of asset purchases.
Smith: No bank can survive if 100% of depositors come in and take out their funds because that’s not how our banking system works. It is a fractional reserve system that is based on the principle that not everybody wants their cash at the same time. We could not survive without government help if 100% of our depositors showed up and wanted all of their money. So all of a sudden that focus came on IndyMac and they could not survive the run that developed. The same pattern seems to be true in some of the brokerage houses as well. I am not high finance. I run a small community bank, but when fear takes over from the facts, then solvent institutions with plenty of worth can’t perform in the short run.
The IRA: We are finally seeing the Fed and Treasury come to the realization that they were not doing enough to address this crisis going back to last year. People like Jim Cramer were touting banks stocks in 2007, even after the failure of New Century Financial.
Smith: The day we’re listening to Jim Cramer on the TV as our financial expert, he’s on NBC and I used to respect them. But if he’s the guy I am going to see put forward as an expert on investing and the economy, then I’m going to have to get out of the business.
The IRA: You don’t like our friends at CNBC?
Smith: Part of Cramer’s shtick is that he creates buzz, excitement about a stock or other investment situation. When he was talking once about the Fed needing to lower interest rates to help 30-year mortgages, I thought to myself “These are two totally different markets. What do you mean?” But such views are accepted as gospel because hey he’s on TV.
The IRA: The speculative class has grown more and more impressed with their own importance over the past few years. Cramer is merely an icon, a cartoon character. And now that we are taking the air out of the speculative economy, the relevance of the speculator pundits will also ebb. As Russell Crowe said to Joaquin Phoenix in the film Gladiator , “the time for honoring yourself will soon be at an end.” At least that’s how it looks from the Hudson Valley of New York.
Smith: I cannot imagine what it must be like to live in New York at this stage of the game.
The IRA: It’s fun. We’re having a great time. We have dozens of colleagues who are out of work and trying to regroup, which they will. We are seeing a lot of CVs and trying to forward same to interested parties. There are some very talented people on the street right now. They will get re-absorbed back into the business as old names are destroyed and new ones are created. The power of the US financial community lies in the ability to change and innovate. In our view, the post-bailout world could become a renaissance for smaller, more focused banks and funds.
Smith: But you’ve got to have friends who are jumping out windows?
The IRA: No, mostly the windows don’t open in New York buildings. Look, people are upset and confused, but once the dust settles a bit you will be a lot of new construction in the financial world. The Street needs to refocus on supporting real economic activity and not engaging in building speculative structures. The ignorance of the Cramer’s of this world is that they believe that this market offers value to investors. I love listening to Cramer talk about how the Fed should provide liquidity to Wall Street, which is not true. The Fed was created to provide liquidity to the real economy when Wall Street periodically destroyed itself. Now we are seeing the real economy forced to bailout largely speculative markets such as credit default derivative contracts that are not written to hedge actual exposures. Thus the continuing bailout of AIG (NYSE:AIG) by the Fed, for example.
Smith: I’ve been at some of the larger banks during my career. I much prefer the smaller banks. But in the late 1990s, when all this stuff about stated income, stated value loans started in the marketplace and they stopped verifying what people were telling them. People don’t intentionally deceive you in most cases. They always overstate their income or the value of a home because mostly they don’t know the precise figures. But when you as a lender are basing a decision solely on the representations of a borrower and no other documentary evidence, then there are going to be problems in that portfolio.
The IRA: This is the part of the subprime blame game that is most difficult to reconcile, namely the huge degree of collective delusion on the part of Congress, regulators, the various industry groups and agencies, and the public behind the push for “affordable housing.” The use of innovative financing techniques such as no doc loans and automated appraisals was just the end result of a much larger effort to promote “affordable housing.”
Smith: Down here in LA we thought it was kind of crazy, but what do we know? We just see it as the chickens coming home to roost.
The IRA: Tell us about your competitive environment. Are your chief competitors local institutions or regional/national chains?
Smith: We’re in the metropolitan New Orleans area, so we have all of the big franchises such as JPMorgan Chase (NYSE:JPM), Regions (NYSE:RF), Capital One (NYSE:COF), who took over Hibernia which had about 35% market share at one stage. We compete with some large locals like Whitney (NASDAQ:WTNY) and Iberia Bank (NASDAQ:IBKC). And we increasingly compete with a host of smaller institutions, especially as we have expanded to the dry ground north of Lake Pontchartrain. Another competitor that we are dealing with now in the southern part of the state are the credit unions that are converting to open membership. That is a big issue in our market.
The IRA: This issue of allowing tax-exempt credit unions to compete with banks is bound to provoke a fight in Washington. The wide use of S-corps for bank charters illustrates that the industry is tax sensitive. Maybe all the banks should just become credit unions? How do you see this issue unfolding? Will credit unions that opt for open membership lose their tax exemption?
Smith: That is the model from the evolution of the S&L industry when they wanted to de-regulate and expand their product offering. When you had mutual S&Ls financing people’s home mortgages, then there was a valid public policy role for a tax exemption. But as the S&Ls matured and converted into stock corporations, they properly lost the tax exemption and became big-time competitors to the banks, but on an equal tax paying field. That’s all we’d like to see. I love competition. I can compete all day long on an even basis. But I can’t compete with somebody who does not have to pay any taxes and does not have to bear the costs of CRA and compliance.
The IRA: The regulated banks are comparable to the incumbent telephone company and the credit unions are the cable providers.
Smith: It’s a challenge. I have pondered getting a bunch of banks together to form a credit union to cater to a certain membership, such as our employees. We probably could not get approval of a credit union charter from the NCUA.
The IRA: But the point with respect to credit unions is that this is yet again another case of regulatory arbitrage, where one legal avenue is somehow advantaged vs. another. Reminds us of the argument that says that democrats and republicans have devolved into the party of the lawyers/regulators vs. business interests. The credit unions and banks each have their respective lobbies in Washington, but the competitive tension is now as much a function of government regulation as the skill of a particular bank or management team. But the next couple of years could see a lot of furniture being rearranged. How do you see the regulatory landscape changing?
Smith: We just had a meeting at the Fed talking to some of the representatives of the various agencies. One of our stories was that when you look at this blueprint for national financial restructuring and everybody’s going to get a national charter and have a single regulatory structure, but it is these very federal regulators that got us into trouble in the first place. The state banking people and the FDIC are basically the ones who kept the smaller, state-chartered banks in line. There is no way we could get into any concentrations or excesses in terms of exposure, the issues you see killing the larger banks, because we are supervised by real regulators.
The IRA: Yup. That’s why we are always heaping praise on the folks at FDIC, who live in the real world of insurance and insolvency. OCC and the Fed, to us at least, seem to have been largely captive of and even advocates for the large Sell Side firms and the very market structure choices that have now destroyed a good deal of our financial system. The political pressures on the OCC and Fed, however, are a function of that fact that most of the industry does have national charters.
Smith: Correct. Some 80% of the deposits in the country are concentrated in the top twenty or thirty banks in the country. You do have to look at that.
The IRA: We were having a conversation with Josh Rosner from Graham Fisher in New York. He advanced the idea that if the Treasury ends up controlling any of the larger banks, that rather than trying to run these vast public utilities that instead the government break up these mega banks and thereby increase competition and also reduce concentration. The resulting 50-100 large banks would be better capitalized and probably far less risky than the large banks are today.
Smith: It’s an interesting idea, but not one that I see gaining much traction because the world banks are not set up that way. There is a need to have the mega-banks to have players who are big enough to compete in world markets but they must be more evenly regulated because their very size makes them more of a threat to our economy when there are problems. Giving them a pass on sound banking principles just because they appear to have unlimited access to the capital markets works fine when the capital markets are viable, but the current crisis shows how vulnerable the capital markets are when problems arise.
The IRA: So you don’t sound optimistic about a grand compromise when it comes to regulatory reform?
Smith: It’s like anything else in politics. There is a lot of political decision making that gets made in the name of good government.
The IRA: Yes, but the republic is not meant to be efficient. We love watching market pundits demanding immediate action in Washington. Efficiency is the antithesis of democracy, at least one that embraces checks and balances as a core governance model. What has changed for your bank over the past year?
Smith: The interesting thing is that I figured that we would take in more than we would lose as people sorted out the deposit insurance equation, moving money here and there to get under the $100,000 and now $250,000 limit. This wave of fear in the public mind put people in play in the local market who might not have included us in their banking list in the past. What I never figured on was the number of people who have come in, often in person, because of our reputation for safety and soundness, a reputation going back more than 40 years. And these sorts of customers kind of get us as I said before. Our small size, the fact that our key players are very visible in the community play a very positive role in this process. We still have the deal where if you call the bank and ask for the president, I pick up the phone. For a long time that image has been built up in the community, so much so that we have new customers bringing us deposits far in excess of the FDIC ceiling from some of the larger players in our market area.
The IRA: So you don’t feel like Metairie is at a disadvantage due to size? Is there a risk premium being assigned to these larger banks in the mind of the public?
Smith: The typical case is somebody who is a sophisticated business person or owner, who knew some people at our bank and just woke up one morning and decides to give us their business, almost entirely based on safety and soundness concerns. That’s the type of account’s we’ve been getting. The $250,000 increase in FDIC insurance is not helping me at all.
The IRA: Your situation nicely illustrates why smaller banks have resisted increasing the insured limit on deposits.
Smith: We had some people come into the bank worried about the insured limit, make no mistake, but they type of business we are seeing now is different. They don’t even care about FDIC insurance. The situation is dynamic, but to answer your question, we are more than holding our position and even growing.
The IRA: Well, when you have an 11% leverage ratio and 80% core deposits, life is good. The 35% non-interest bearing deposits is not bad either. The table below shows the results for Metairie Bank & Trust vs. the IRA Bank Stress Index as of the end of Q2 2008. Overall, the bank is below the index stress level for 1995 and well-below the 1.4 current industry benchmark value. Metairie is above the current industry average stress benchmark only in terms of efficiency. The index value of 0 for loan defaults reflects the 2bp of default reported in Q2 2008.
Chart can be found here. Smith: Our profile reflects our positioning. We compete against a number of excellent community banks in this area. Our advantage is core deposits. And we use those deposits to the max because we are the low cost lender on the absolutely pristine credits. So if somebody has a half million or million dollar or two million dollar commercial real estate secured loan and they’re putting in 30-35% equity and they cover debt service at 1.25-1.50 times and even better if they have a national tenant, those loans naturally come to us because we balance that asset against our core deposits and give them a 10 or 15 year fixed rate. Our competitors can’t do that because they are funding themselves with hot money of various types. So we exploit the one real advantage we have as a small bank.
The IRA: Metairie’s nominal financial performance in terms of ROA and ROE is not stellar, but neither is it is volatile. The very low loan default rate and triple-digit RAROC tell the story in our model, however. (Readers click here to see the full profile for Metairie Bank for Q2 2008 from The IRA Bank Monitor). Ric, talk about the economy in LA and the recovery from Katrina.
Smith: We suffered after Katrina, both for the bank and the community. There is no question that in addition to the people we were glad to see move to TX, we also lost some good people as well. You got be tough to be a New Orleans or LA resident because we have to deal with hurricanes and the like. That being said, we have a lot of money that is in the economy today and will be in the economy for the next three to five years due to the federal response to Katrina. This is money that was appropriated a year after Katrina but is only now hitting the economy because of the development/design stage and other planning required. The projects are starting to happen now. We also did not see the degree of housing bubble here in LA due to Katrina. Right as some of the super hot markets were going crazy, we were trying to find the highest land. There was not that much real estate speculation in this market area, with the notable exception of the western St. Tammany Parish market that we just entered. We don’t do development loans. So while the other banks were bashing their heads in we just went after the professionals and the people who look for good rates on loans and are willing to put equity into them. But as whole, we’re OK. The Port of New Orleans is in a moderate cycle, which is a big driver for our local economy. But a moderate cycle adds a lot of jobs and income to the area. We’ll take a hit on tourism because of what’s going on with the national economy, but we are getting a lot of people from the 600 mile radius who drive in for recreation. So we never get the big thrills of the highs and lows that you folks do on the coasts, but that’s fine by us. The late 1908s were an exception that was driven by the oil bust.
The IRA: We find the same thing a lot in our travels. In communities up the Mississippi all the way to Chicago, there was remarkably little speculative bubble in these real estate markets, but in areas like FL, AZ and CA and the entire Northeast, the speculative bubble peaks of 2005 and 2006 are now giving way to 30-40% declines in prices, especially for properties above the conforming limit. And the media makes it sound as though the entire country is going into the dumper.
Smith: There is no percentage in the news media putting a reporter on the streets of downtown Omaha, NE, and talking to people who say that everything is fine here. We here in Middle America are kind of wondering what all the hubbub is about.
The IRA: So if the increased insurance limit and other expedients don’t help Metairie, what is your view of this whole mess in Washington? Does the idea of the government taking equity positions in banks change your view of the world?
Smith: The government had to do whatever it took to calm the markets and they are still not calm yet. The government had to throw some water on the fire to calm people down and get them to behave rationally again. If I were one of the big guys like JPM, a solid player, or Citigroup (NYSE:C), who has had issues for years and has never been a pinnacle of strength, and I could get a free pass on going over the deposit market share cap as part of some political deal, I’d be trying everything I could right now to do it because the deposits are enormously valuable. People will start to worry about concentration in the banking industry again after the crisis.
The IRA: Back to the earlier point, do you think that the government should use the opportunity of owning big equity chunks in C, JPM and other money centers to break up some of these banks? Aren’t you living proof that big is not better and in fact may be unsound?
Smith: Big is better only if the capital markets are working. Big is better when you have many more sources of funding than does a community bank. A large money center bank has hundreds of choices when the markets are functioning. A small bank like ours has realistically three or four funding sources. We don’t have the ability to go out and issue paper. We just started to build up our telephone service because of the increased demand we are seeing for deposits from outside our service area coming to us because of our reputation. If the capital markets are functioning then the big guys have all the options, but when they make stupid decisions suddenly they become crippled. Markets are not always or even mostly efficient, so there is something to be said for simple organizations that are sustainable in a crisis environment and that model is clearly the community banks like Metairie.
The IRA: Good place to leave it. Thanks for spending time with us Ric.