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Between Rocks and Whirlpools: Bank Strategy 2010
Directors’ AssemblyMarch 9, 2010
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Required DisclosuresThe following information is for informational purposes only and was prepared from sources believed to be reliable but is not guaranteed as to accuracy and is not a complete summary
or statement of all available data. The views or opinions expressed in this material are solely those of the speaker/author and do not necessarily represent those of Janney Montgomery
Scott LLC.
Janney Montgomery Scott LLC is a broker-dealer registered with the US Securities and Exchange Commission and member NYSE, FINRA, and SIPC.
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Speaker Credentials: Roger G. Powell
Academic
B.A. Economics 1971 Davidson College, Davidson, NC
Certificate, Advanced Management Program 1978
North Carolina School of Banking, Chapel Hill, NC
Experience
Investment Banking
Banks / Thrifts
Mortgage Companies
Credit Card
Issuers
Processors
Commercial Finance
Janney Montgomery Scott (2008 - )Alex. Brown & Sons1 (1990-1999)
Investment Research
Banks / Thrifts
Mortgage Cos
Credit Card Cos
Asset Managers
Alex. Brown & Sons (1983-1990)The Powell Group (1972-1976)
Corporate Development / Strategic Planning
Deutsche Bank AG2 (2000-2007)United Carolina Bancshares (1976 – 1982)
Native of Fayetteville
Former Scoutmaster, Troop 17, Christ Church, Charlotte
Interests: family, American history, antique maps, conservation and outdoor activities
1 And successors: BT Alex. Brown and Deutsche Bank Securities d/b/a
Deutsche Bank Alex. Brown
2 Global Private Client Group and Deutsche Bank Alex. Brown, a business unit of Deutsche Bank Securities Inc.
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Rocks and whirlpools: the sailor’s fear…
National Maritime Museum Picture Library, Greewich, England
Adm. Shovel’s fleet on the Rocks of Scilly, 1707
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Rocks and whirlpools…
Admiral Cloudsley Shovel – a 26 year veteran of the most advanced and powerful naval power of the time – lost his flagship, his life and ~2,000 sailors and marines along with a large part of his fleet on the Scilly Isles in 1707.
He knew the islands were there – they are well known to English, Irish and Cornish sailors – off of Cornwall at the entry of the Irish sea.
He did not know where he was and an storm drove the fleet upon the rocks.
This disaster, the greatest in the history of the British fleet, incited the Lords of the Admiralty to offer a prize for the maker of an accurate chronograph in order that navigators could accurately compute their longitude.
As a banker you know the rocks in your course – the known risks of the business. You must always know where you are relative to those risks by using the best techniques of navigation. Do not let a storm throw you upon t he rocks.
Adm. Shovel’s fleet on the Rocks of Scilly, 1707
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Rocks and whirlpools…
Maelstrom of Lofoten, Norway
New-York Magazine; or, Literary Repository
Of the celebrated WHIRLPOOL called the MAELSTROM on the Coast of Norway, Vol. II No. XII Dec 1791
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Rocks and whirlpools…
Whirlpools rise from action of tide and wind, generally in narrow channels.
The most famous is off the coast of Norway and was named ‘Maelstrom’ by Dutch sailors.
A small vessel can be destroyed by its action.
To avoid a whirlpool requires adquate flotation and power to avoid its force.
The tide of regulatory vigor has set with full force; the wind of the economy has blown Force 5.
Capital is a bank’s flotation; earnings is its power. It takes both to avoid the vortex of the Maelstrom.
Maelstrom of Lofoten, Norway
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Rocks
You know where they are.
Where are you?
Can you be blown upon them?
Whirlpools
Arise with winds of regulation and economic tides; you will not see them until you are upon them.
Are you large enough to survive?
Do you have enough flotation, i.e. capital?
Can you power, i.e. earn, through them?
Goal: avoid the known risks; be able to survive the unknown.
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Position
versus changing competition
relative to your balance sheet risks
Capital
to survive
to thrive
to earn
Control
of operations and risk position
of message and information
of future
For 2010 Strategy cycle: focus on critical themes
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Secular
Banks lose share to capital markets
Consolidation creates highly competitive markets
Capital markets pricing and structure degrade overall bank pricing
Portfolio mix responds to disintermediation of cards, cars and mortgages
Cyclical
Risk cycle takes away momentum
risk realization exceeds trend after a decade below-trend
Asset quality and capital issues distract management
Competitive banks have opportunity
Regulators as referees
Position: versus competitors
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Banks lose share to capital markets
Position: versus competitors
Shifting Shares of Major Non-Bank Players in Credit Provision[Ex cludes Credit Market Assets Held by Federal Reserv e]
Banks(Commercial Banks, Bank Holding
Cos., Thrifts, Credit Unions)
Government Sponsored Enterprises
"Private Label" MBS Issuers, and Consumer Credit &
Business CreditABS Issuers
Pension Funds
Insurance Cos.
Money MarketMutual Funds
Other Credit Providers
0%
20%
40%
60%
80%
100%
1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
Percent of Total Credit Market Assets Held by Financial
SectorCredit Providers
Source: Figure A1. in Susan Hickok and Daniel E. Nolle, "The U.S. Financial System in 2011: How Will Sufficient Credit Be Provided?" Economics Working Paper 2009-6, Office of the Comptroller of the Currency (Nov. 2009).
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Position: “A Banking Battleground”
Source: New York Times, March 6, 2010 “A Banking Battleground”
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Capital markets pricing and structure degrade spreads
Position: versus competitors
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Portfolio mix responds to
Position: versus competitors
* OTS –
Supervised Savings Associations do no identify agriculture loans.
Source: FDIC Quarterly Banking Profile 4Q:02 and 4Q:09
Residential30%
Commercial & Industrial
19%All Other Loans
14%
Construction5%
Agriculture *1%
Leases3%
Other Consumer10%
Credit Cards6%
Commercial Real Estate12%
Residential25%
Commercial & Industrial
17% All Other Loans19%
Construction6%
Agriculture *1%
Leases2%
Other Consumer9%
Credit Cards6%
Commercial Real Estate15%
December 31, 2002 December 31, 2009
Loan Portfolio Composition
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0.00
0.50
1.00
1.50
2.00
2.50
3.00
Mar-8
4
Mar-8
5
Mar-8
6
Mar-8
7
Mar-8
8
Mar-8
9
Mar-9
0
Mar-9
1
Mar-9
2
Mar-9
3
Mar-9
4
Mar-9
5
Mar-9
6
Mar-9
7
Mar-9
8
Mar-9
9
Mar-0
0
Mar-0
1
Mar-0
2
Mar-0
3
Mar-0
4
Mar-0
5
Mar-0
6
Mar-0
7
Mar-0
8
Mar-0
9
0.00
0.50
1.00
1.50
2.00
2.50
3.00
Below-trend risk realization ends
Position: versus balance sheet
Source: Federal Reserve Bank of St. Louis
Average ’84-’09 = 0.84%
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Asset quality and capital issues distract management
Position: versus competitors
Source: SNL Financial.
1
6
24
0
5
10
15
20
25
30
> $10 bn $1 bn - $10 bn < $1 bn
Banks Headquartered in NC with NPAs / Assets > 4% at 12/31/09
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Opportunity for active banks to take share by becoming a strategic partner
Historical advantage of commercial banks: information advantage
View of cash flows
Intimate business analysis
Collateral ties
Regulators are the referee
Regulatory vigor animates the board room
Banks become the ‘whipping boy’
of the economy
The savings & loans are no longer the instrument of housing and economic policy
Winners / Losers
Position: cyclical opportunity
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Secular Trend
Reversal of trend to lower tangible equity levels
Basel II was height of trust in risk models and infinite liquidity
“The new 10% is 12%”
and etc.
What ROE translates to premium share price?
Portfolio mix responds to disintermediation of cards, cars and mortgages
Cyclical Factors
Access degraded, especially for ‘micro-cap’
and smaller
Trust preferred reverts to single-issuer –
no longer ‘just-in-time’
for all
Internal capital growth depends upon earnings retention
Capital
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Reversal of trend to lower Tier 1 Risk Based Capital levels
Capital: seek higher levels
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
16.00
18.00
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Source: SNL Financial.
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What ROE translates to premium share price?
Investor attention turns to ‘pre-provision normalized earning rate’
If asset quality is seen to be stable or improving, THEN bank earnings matter
SPDR S&P 500 Index ETF: 21.2%
trailing ROE a/o 2/28/2010 (β~1.08)
SPDR KBW Bank ETF: 0.14%
trailing ROE (β~2.35)
Investors have abandoned ‘micro-’
and ‘nano-cap’
stocks
Large-cap = $8 billion common equity value and larger
Mid-cap = $1 < $8 billion common equity value
Small-cap = $250 million < $ 1 billion common equity value
Micro-cap = $50 million < $250 million common equity value
Nano-cap = less than $50 million common equity value
Capital: what is good performance?
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$0 $20,000 $40,000 $60,000 $80,000 $100,000 $120,000
Common
Preferred
TARP Preferred
TRUPS
Subordinated Debt
Senior Debt
<$1.0B 554 126 1,491 16 35 176
$1.0B - $25.0B 11,045 1,412 3,752 405 297 404
$25.0B - $100.0B 6,330 1,800 - 935 1,500 960
>$100.0B 94,331 64,137 30,000 32,984 710 24,775
Common Preferred TARP Preferred TRUPS Subordinated Debt Senior Debt
Capital Raising in 2009 By Institution Asset Size ($MM)
Source: SNL Financial.
Market access degraded, especially for ‘micro-cap’ and smaller
Capital: equity market access degraded
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Internal capital growth depends upon earnings retention
Capital: growth relies on internal equity retention
Source: Janney Montgomery Scott LLC
11.67% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0% 90.0%0.25% 3.75% 3.33% 2.92% 2.50% 2.08% 1.67% 1.25% 0.83% 0.42%0.50% 7.50% 6.67% 5.83% 5.00% 4.17% 3.33% 2.50% 1.67% 0.83%0.75% 11.25% 10.00% 8.75% 7.50% 6.25% 5.00% 3.75% 2.50% 1.25%1.00% 15.00% 13.33% 11.67% 10.00% 8.33% 6.67% 5.00% 3.33% 1.67%1.25% 18.75% 16.67% 14.58% 12.50% 10.42% 8.33% 6.25% 4.17% 2.08%1.50% 22.50% 20.00% 17.50% 15.00% 12.50% 10.00% 7.50% 5.00% 2.50%1.75% 26.25% 23.33% 20.42% 17.50% 14.58% 11.67% 8.75% 5.83% 2.92%
Dividend Payout Ratio (%)
ROA
(%)
Rate of Growth Supported by Equity Retention at 6% Constant Equity/Assets
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Secular Trend
Tolerances are small in low growth environment
Margins remain under pressure
Fee sources under attack
Internal controls must tighten in response to demanding operating conditions
‘Big Bank’
risk management systems become ‘best practices’
Cyclical Factors
Regulatory pendulum swings to full vigor
Governance issues take higher profile (SarbOx
and fiduciary law developments)
Public relations demand high resolution
Control
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Tolerances are small in low growth environment
You must manage the details all day every day
Margins remain under pressure
Pricing degradation is permanent –
find a niche where you can
Fee sources under attack
Populism and consumerism go hand-in-hand and marry in post-recession scenarios
Internal controls must tighten in response to demanding operating conditions
While you must retain marketing momentum
‘Big Bank’
risk management systems become ‘best practices’
How can you efficiently implement enterprise risk management?
Control: secular factor response
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Regulatory pendulum swings to full vigor
Position statements from Washington may not jibe with examination outcomes
Governance issues take higher profile (SarbOx
and fiduciary law developments)
Financial statement certification is serious
Prudential management is serious
Public relations demand high resolution
Say only what you mean to say
Be able to defend everything that you say
“Never write if you can speak; never speak if you can nod; never nod if you can wink”.-attributed to Martin Michael Lomasney (December 3, 1859 -August 12, 1933), Boston politician
“never put it in email”-
attributed to Eliot Laurence Spitzer (born June 10, 1959), New York politician
Control: cyclical factor response
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Between Deer Island, N.B. and Eastport, Me
Rocks and whirlpools…
‘Old Sow’ – the largest whirlpool in the western hemisphere
Watch out, you sport kayakers!
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Janney Montgomery Scott Contact Information
JMS Contact Telephone Email LocationCliff Booth, Head of FIG Practice 410-583-5992 cbooth@janney.com Baltimore / Philadelphia
Ed Losty, Head of Bank Practice 757-564-9737 / 215-665-4491 elosty@janney.com Virginia / Philadelphia
Roger Powell, Managing Director 410-583-5993 / 215-665-6687 rpowell@janney.com Baltimore / Philadelphia
Jay Junior, Managing Director 215-665-4497 jjunior@janney.com Philadelphia
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