Your Flight to Safety May Not Take You Far From Home
An Interview with American Bank’s Leon Royer
BY DAVID S. LEWIS
With the nation’s financial crisis in the headlines, and erratic moves in the stock market raising anxiety levels almost daily, people across the country and here in Montana are wondering to what degree the crisis is effecting local banks, lending, and the local economy.
In a recent interview, American Bank of Montana vice chairman, Leon Royer shed light on the crisis, drawing clear distinctions between the plight of large investment banking institutions like Washington Mutual, which collapsed along with others as a result of highly leveraged banking schemes, and local commercial banks that are more strictly regulated—forced to maintain higher capital ratios, which measure a bank's assets against its risk, assets that can be quickly converted to cash so that when necessary losses can be absorbed.
“Most of the securities that supported those subprime loans,” Royer said, “were in the investment community…there’s a big distinction between a commercial bank and an investment bank … most of those securities were in the world of investment banks and their clientele. I think that had minimal impact locally.”
Of the troubled institutions that recently failed, Bear Stearns, for example, was an investment bank and acquired by JP Morgan, a commer-cial bank. The failed investment firm Lehman Bros., now being sold off piecemeal, had the largest portion of its assets acquired by Barclays (based in the UK), another commercial bank. Goldman Sachs and Morgan Stanley, furthermore, are converting from investment banks into commercial banks. And then Washington Mutual (the largest savings association in the country), which recently went under, was acquired by a commercial bank.
The largest commercial bank to buckle was Wachovia, and was acquired by Wells Fargo, another commercial bank. The primary reason these failures occurred, Royer explained, was their low capital ratios, which are more stringently regulated for commercial banks.
Using American Bank as an example (which has branches in Bozeman, Livingston, Big Timber, Big Sky, and Whitefish), Royer explain-ed that 10 percent of his bank’s assets are represented by capital owned by the bank. “As a result,” he said, “if we have a problem, we have a shock absorber, and most local banks are that way.”
Morgan Stanley’s capital ratio at the end of June, though, was about 3.3 percent. Subsequently, 24.9 percent of Morgan Stanley was acquired by Mitsubishi Bank of Tokyo.
The American commercial banking system (as opposed to the invest-ment banking system) is tightly regulated. “Every quarter,” Royer said, “we receive a letter from the Feds saying we’re well capitalized, adequately capitalized, or inadequately capitalized.”
Investment banks have not had those kind of regulations. “They were just blowing and going,” Royer said, “and when they started absor-bing losses, they really couldn’t, because their capital was thin in relationship to their troubled assets.”
Royer told the Pioneer that American Bank of Montana did not own any of the now infamous Fannie Mae or Freddie Mac securities that were central to the meltdown.
“As you look at the security portfolios of most of the local banks,” he said, “you’ll see high loan to deposit ratios, which tells you that banks do not hold very much in securities, and that local banks did not have much Fannie Mae and Freddie Mac paper.”
Royer said that American Bank, like other local banks, is not a mortgage company granting 20 or 30 year fixed-rate home loans, which in the world of modern finance become securitized and sold to investors. He did say, though, that real estate lending comprises a significant portion of his bank’s business.
“The bread and butter of the local banking community,” he said, “is real estate based lending. I think that’s tightened up quite a bit in the last few months,” a situation likely to impact economic growth and job creation should it continue too long.
Royer said that frequently in the recent past such loans were transactional, as opposed to relationship- based. In the transactional scenario, banks entertain requests for loans from applicants who do not deposit at the bank. In the current climate though, non depositors have a low chance of getting credit.
“You have to have a relationship in order to borrow,” Royer said. “We are certainly loaning money to people with whom we have relation-ships and have worked with long term….[where there’s been] a lot of interaction between the customer and the bank.” A bank needs deposits in order to make loans, Royer explained. “There’s a finite amount of money available, so you’re going to make loans to people who are going to favor you with deposits.”
The shift from transactional loans to relationship loans is a signi-ficant departure from the way lending has been practised over the last several years, one that is having the effect of denying credit to would-be borrowers. Royer cited one example of a former customer who had moved out-of-state. When asked why he was seeking credit from American Bank of Montana, the man respon-ded, “because nobody is loaning any money.”
When asked for examples of the kinds of loans that are more likely to be turned down in the current environment, Royer said, “you’re certainly not going to be making very many loans for spec houses today, when the market is pretty much glutted. You’re probably not going to make a development loan, for land acquisition and to put in infrastruc-ture, and all the rest, because there seems to be plenty of supply. Those deals are gone.”
That’s due to the tightening of credit, Royer said, which happens in two ways, through lending standards and availability.
When asked, though, about individuals who blame the national crisis for having been denied loans, Royer emphasized that those loans may have been denied in the past as well. “There are some people who are blaming the [current climate] for their inability to get credit,” he said, “when, in fact, they should look at their own financial performance. If you’re running a business that is hemorrhaging money, and not making any money, and you go to the bank and say give me a loan, that’s a loan that would never have been made in the best of times.…A credit worthy borrower will always find credit.”
Linens and Things, the big box retailer folding in Bozeman and nationwide, for example, did not necessarily fail due to the current financial situation. Royer described the operation as “second tier, behind it’s competitor Bed, Bath, and Beyond.”
“Maybe they were way over leveraged,” Royer said. “If you’re opening new stores every week, and you’re the second tier player, and certainly Linens and Things was second tier behind Bed, Bath, and Beyond, just like Circuit City is second tier behind Best Buy, you’re the one who’s most vulnerable, because you’re putting more and more debt on your balance sheet and you have less equity to carry you in the event of a downturn,” a situation Royer likened to the problem of over leveraging in the investment banking world, and Linens and Things, Royer said, “was leveraging, leveraging, leveraging,” without its capital growing as fast as debt and overhead. “As soon as the revenue breaks and heads south,” he said. “you’re screwed, because you still have all the expense, but you don’t have the revenue anymore.”
Information about banks is available in the public domain, for those interested, through the Federal Deposit Insurance Corporation website (www.fdic.gov), which provides news updates and financial information on the nation’s FDIC insured banks. “That gives a pretty good idea [as to the health of individual banks],” Royer said, “but it certainly doesn’t tell the whole story."
Not surprisingly, Royer recom-mended local community banks as reliable places to safeguard assets in uncertain times (subject to due diligence), a recommendation that while seemingly self-serving is supported by the federal government through the FDIC.
“I think that right now, certainly, people are looking for a safe place to put their money, and with the Economic Emergency Stabilization Act passed a few weeks ago, FDIC coverage was increased to $250,000.” Insured savings, more over, for married couples can be expanded to $1 million by opening both joint and personal accounts.
Royer recounted an incident in which he, himself, experienced an unsettling delay in the delivery of funds from a brokerage institution two summers ago. Had the funds been on deposit in a local bank, he said, instead of having to repeatedly insist that they be forwarded in a timely manner, he would simply have approached his local bank teller, asked for his money, and the teller would have responded: Would you like that in 20s, 100s, or a bank check?
“I would have gotten my money immediately,” he said.
“In times of uncertainty,” he continued, “I think you should do business with people who can be respon-sive to what you need when you need it, instead of calling a toll free number somewhere.”
Royer said that one’s bank of choice could be a large bank like Wells Fargo or US Bank, a small one, or anything in between. “At least you’re dealing with a local presence that can, and has to, deliver immediately. That would be my advice to people.”
At the same time, he said, the economic situation currently challenging the country is “going to get cured with a good attitude, rather than with panic.”
With stock prices hitting extra-ordinary lows, and with some securities paying 8 and 9 percent dividends, that time might be on the horizon.