Banking & finance.

AT OUR FOURTH ANNUAL ROUNDTABLE ON BANKING AND FINANCE, Utah Business brought together a group of industry leaders to discuss such issues as banks' roles in economic growth, the new face of the banking industry and the prevention of identity theft. These leaders forecast a generally positive outlook in departure from thoughts over the last few years.

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Participants: Harris Simmons, CEO, Zions Bank; Dale Gunther, President, People's Utah Bankcorp; Richard Beard, President, Bank of American Fork; Jim Anderson, President, Bank of Utah; Rick Gross, Senior VP, Key Bank; Kelly Mathews, Executive VP & Economist, Wells Fargo; Clark DeWaal, Associate Professor, BYU; Carl Barton, Partner, Holland and Hart; Greg Larson, Managing Director, Ridgeview Capital; Jeff Thredgold, Economist, Zions Bank; Ed Leary, Commissioner, Utah Financial Institutions; Scott Anderson, President, Zions Bank; John Allen, President, Sun First Bank; Curtis Taylor, President, Heber Valley National Bank; Craig Zollinger, President, Bank One; Howard Headlee, President, Utah Banker's Association; Cece Mitchell, Regional President, First Community Bank.

Special thanks to moderator Hal Heaton, finance professor at BYU, and sponsors Holland and Hart.

LET'S START WITH CONSUMER CREDIT. NEWS BROADCASTS HAVE BEEN TALKING ABOUT THE OVEREXTENDED CONSUMER. KELLY?

MATTHEWS: We had an interesting year in '04. Most of us a year ago thought that if we were fortunate enough to have a rapid increase in job growth that it would be accompanied by higher interest rates. But as the year wore on, and certainly, there were some ups and downs, we enjoyed the best of both worlds. That is, we had a much more rapid job growth phenomenon than I had anticipated. But even with the Fed tightening short-term interest rates, long-term interest rates generally stayed low so the mortgage area and the automobile area continued to do very, very well. So we saw the consumers continue to be able to refinance and buy. We had a tremendous year in construction. Automobile sales were very strong. How their margins were is maybe another question, but the volume was very strong.

WHAT DO YOU FORESEE FOR 2005?

MATTHEWS: We are back to the same situation we were a year ago, with the weak dollar--even if oil prices come down a little bit, which I believe they will drop below 40 before they get up to 50. I think that's a higher probability--that at least 50 basis points on the ten-year treasury will occur, which would push mortgage rates up by a similar amount. While that probably won't be enough to seriously alter the construction environment, I anticipate we will see higher interest rate environments this year.

THREDGOLD: It's important to note too, that while we had a significant rebound in Utah employment, the quality of jobs that were added was quite good. We are up about 32,000 jobs in the last 12 months, nearly a three percent growth rate. But the majority of the gains were in professional and business services and construction, to a lesser extent in manufacturing, the legal sector, financial activities, health care.

ANY OTHER COMMENTS ON THE CONSUMER SECTOR? OVEREXTENDED CONSUMERS HAVE BEEN ABLE TO HANDLE THEMSELVES BY REFINANCING AND TAKING OUT MORE AND MORE MORTGAGE DEBT. NO ONE IS CONCERNED ABOUT THAT?

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J. ANDERSON: I agree they are probably overextended and a significant increase in interest rates will cause significant problems in the consumer sector. They will continue to borrow.

MATTHEWS: Even though our bankruptcy rates and our delinquency and foreclosure and residential real estate are among the highest in the nation, we have made definite improvements. The increase in bankruptcy is essentially nil, and we've improved about 50 basis points reduction in both delinquency and foreclosure rates in residential real estate. So, hopefully, the job growth increase will enable us to improve in these qualitative measures of consumer financial health as we move on through this year.

THREDGOLD: Some of the national media make a point that because the refinancing boom is largely over, we are going to see a sharp slow-down in consumer spending. Realistically, a lot of people have had two and three chances to refinance mortgages, and in each case have cut their monthly payments. So you get the one time stimulus from cashing out or whatever it might be, but you get the ongoing reductions in monthly payments, which help you for many, many years to come.

Some of the consumer credit numbers are a little distorted, especially in the credit card area because many people are like me, they charge everything they can to a credit card because of the incentive to generate points or miles or whatever, and then pay them off at the end of the month. So some of the credit card measures of debt are much more distorted than they have originally been.

LEARY: The FDIC report that came out on the profile of Utah, they indicated that Utah had the fifth highest deposit growth. Now, they don't break it down to whether that was commercial deposits or consumer deposits. But it's intriguing that even taking out the ILC deposit, Utah FDIC insured institutions were the fifth highest growing in deposits over the year.

WHAT DO YOU ANTICIPATE ON THE COMMERCIAL SIDE THIS YEAR IN UTAH? WILL THEY EXPAND? BORROW?

J. ANDERSON: We see a lot of our customers increasing their purchases of fixed assets, buildings and equipment, that they have postponed for three or four years. And we see a real increase in sales and orders and revenues.

BEARD: We see strong growth in our portfolio, and we see it continuing.

THREDGOLD: We've seen some very strong numbers on the office side. The vacancy rate, and especially in the downtown district, Class A space has declined fairly sharply. Net absorption, especially in the second half of the year, was the strongest in about the past four years. In addition to the rebuilding of the two downtown malls. Hamilton Partners is probably likely to go ahead with their facility sometime in the next 18 to 24 months on Main Street. I think you are seeing much more optimism on the commercial side than you saw in the last three or four years.

THE NATIONAL PRESS HAS MENTIONED THAT, AT LEAST ON THE S & P 500, BIG COMPANIES HAVE MORE CASH ON THEIR BALANCE SHEET THAN THEY HAVE HAD IN A NUMBER OF YEARS AND THEY SEEM RELUCTANT TO SPEND IT. IS THAT TRUE FOR UTAH OR DO YOU SEE A CHANGE IN ATTITUDE ABOUT WILLINGNESS TO SPEND CASH ON THE COMMERCIAL SIDE?

MATTHEWS: I would agree that many businesses--maybe even the whole sector in general--use the opportunity of the last three years to strengthen their balance sheet, to restructure debt, to reduce debt quite differently, perhaps, than the consumer sector. So there has been a significant improvement in quality of balance sheet in the business sector. They have to balance the ongoing necessity of continuing to emphasize productivity and cost containment in that area, as well as hoping that the circumstances are such that they can increase sales. It's not exactly clear in every circumstance that if they build it that volume is going to automatically be there. So they are still being a little bit careful, but I think that the liquidity is there, and if it becomes clear that there is enough demand to generate the increase in top-line volume growth, they will meet that capacity need.

S. ANDERSON: The Utah office of the Small Business Administration had a 55 percent increase in SBA loans in their fiscal 2004 year, which ended at the end of September over their fiscal 2003. At the same time, the Utah District--if you look at SBA loan losses--ranked number 52 out of 70 districts. So it's one of the lowest loan loss areas in the country for small businesses and one of the highest growth areas.

WHAT ARE THE GENERAL BANKING THEMES IN 2005 FOR BUSINESSES?

SIMMONS: It continues to be a wonderful time to finance equipment and expansion. Term rates remain in really amazing shape. And coming into a period where the economy is growing, it would appear to be a great time to finance expansion.

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LARSON: We raise a lot of capital for middle-market companies, and we are seeing a lot of growth equity capital. We are seeing a lot of companies that are interested in taking on additional growth equity because of their optimistic view of what revenue generation will look like in the coming years.

We are also seeing probably too much capital in the equity markets chasing too few good opportunities. So valuations continue to go up considerably. I think we are going to see a couple of years at least of maybe even irrational exuberance on behalf of the private equity firms, placing capital above market or very attractive valuations--let's say that--from middle-market companies.

THE LAST COUPLE OF YEARS HAVE BEEN TERRIFIC FOR FINANCIAL INSTITUTIONS. PM CURIOUS ABOUT TREND DIFFERENCES BETWEEN UTAH AND THE NATION. THERE HAVE BEEN MANY ARTICLES ABOUT A REAL ESTATE BUBBLE, AT LEAST ON THE COAST. I DON'T SENSE ANYTHING LIKE THAT IN UTAH. IS THERE ANY PLACE THAT UTAH IS GOING TO BE DIFFERENT THAN THE REST OF THE NATION?

SIMMONS: I think we are favorably poised for some of the kind of migration from the coast that we saw in the '90s. We have not seen the kind of run-up in real estate values in Utah that you've seen in markets generally in Southern California and Las Vegas and Phoenix. So the value proposition in residential real estate is good in Utah relative to a lot of the surrounding major population areas in the West.

ARE WE LIKELY TO BENEFIT BY BUSINESSES LEAVING HIGH-COST AREAS AND COMING TO UTAH?

SIMMONS: Potentially. The cost of housing is a huge component in the real cost of living, and we have a very competitive environment there right now. It ought to be an attractive place for people to move and businesses to relocate.

TAYLOR: In Wasatch and Summit Counties, we've seen a real consolidation in real estate prices over the last two or three years until the last six months or a year. Now, we've seen a reversal of that trend in the past several months or year even, we see, in some cases, what might be called dramatic increases in real estate values in Summit County and certainly some healthy increases in Wasatch County.

RESIDENTIAL OR COMMERCIAL OR BOTH?

TAYLOR: Driven by residential development and construction. And so, do we have a bubble? In some ways we are recovering from a slump that we've experienced in the last few years, but it seems to me to be mostly a healthy and measured increase, other than in Summit County, which has some areas that are a different world unto themselves.

MATTHEWS: The biggest factor in terms of how Utah differs from surrounding states emanates back from our demographic profile, that is the number of kids we have. The implications are that we face significant increased education costs, along with lots of other infrastructure. The implications for business are that we simply must grow as fast as we can.

ALLEN: Washington County has seen a 20 to 30 percent increase in residential values in the last eight or nine months. Commercial hasn't seen the same--it isn't equal. So we see an upsurge in residential but not commercial.

TAYLOR: Part of what we have seen in Wasatch and Summit County is that the housing inventory has dried up. When prices didn't inflate, there were a lot of purchases. Now, there is a real ramp-up in their area, trying to catch up with inventory and the demand.

From a regulator perspective, what is unique about the western states, vis-a-vis the nation, and some of the higher growth rates, including Utah or Salt Lake City within the last few years, remains our real estate lending concentrations and the port-folios of financial institutions. Real estate lending remains one of the mainstays of financial institution lending in the West and in Utah. Whether or not that constitutes a regulatory concern is always a subject of much discussion. If it goes to excess, yes it would be. And everybody is always afraid of a bubble, that when real estate prices, real estate values, start dropping, what happens to the financial institutions? At this point, we are comfortable with where we are.

THREDGOLD: Real estate appreciation over the next couple of years will be a dramatic difference from what it's been the last few years. Utah real estate, for the twelve months ending in September, was second only to Texas in being the worst appreciation in the country. Over the last five years, we were the worst appreciation market in the country with prices, on average, up about 19 percent, versus about 48 percent for the country. Given a combination of much stronger Utah economic growth, the migration of what we call 'talented' people and their money from Southern California, I think we are going to see much better home price appreciation in Utah, especially in the mid- and upper-range. If I was a real estate lender in Utah right now, I'd be very comfortable. If I were a lender in Southern California, I'd be scared to death.

LET'S TALK ABOUT THE STRUCTURE OF BANKING IN UTAH. DO WE SEE ANY CHANGE? DO WE SEE SMALLER BANKS AT A COMPETITIVE DISADVANTAGE TO BIGGER BANKS? DO WE SEE ACQUISITIONS?

LEARY: Let me focus first on the regulatory burden. It is a political thing, but it's a bona fide thing that's being picked up nationally. Vice Chairman Rich of the FDIC finally quantified it. Since 1989, there have been 801 new rules affecting financial institutions. It's a staggering number. The argument is made that it's disproportionately burdensome to smaller financial institutions. The national banks, the very large banks have a broader base in which to absorb the costs. The smaller the bank gets, the more that cost structure is very detrimental to its profitability.

DO YOU SEE THAT LEADING TO CONSOLIDATION AMONG SMALLER BANKS?

LEARY: It is one incentive for consolidation. But there are many valid reasons why small banks believe, and I firmly believe, there will always be a niche for community banks.

Within Utah, we have a couple of banks that are talking about merging. There are forces that would lead them to believe that in certain cases they can do better if they were to merge. Probably the good news is that we are seeing new start-up banks. As institutions merge, there seems to be an abundance of qualified management, readily available capital, and people willing to put up that investment risk, and start up new banks.

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There is probably a trend towards what I would call 'specializing' or 'limiting' those banks. While they may start up as an historical, retail community bank, there are some that are saying, 'I don't want to be that. I don't see that market for myself. I want to focus in or specialize in particular areas.'

SIMMONS: One of the most important signals that community banks are vital and that there will continue to be a place for them, is in valuations. The PE multiples of community banks tend to be higher than the banks which would otherwise acquire them. What you can read into that is they are experiencing better growth than the larger banks. And that's been going on for some time.

If you look at the largest banks and adjust them for mergers, as a general rule, there has not been net growth in those larger institutions. It's really taking place in the smaller institutions, and that's because there are a lot of customers who are more comfortable doing business with smaller banks.

ZOLLINGER: We clearly believe at the national level consolidation will continue and maybe accelerate. As the economy strengthens, banks looking to gain economies of scale, banks looking to garner a larger geographic footprint and to get into new profitable business segments, I think will drive consolidation at the national level.

LARSON: I read of Wells Fargo opening Hispanic branches, and you are seeing a lot of demographic shifts in particularly the Hispanic makeup of Utah and Nevada and other places.

SIMMONS: I've been incredibly impressed and pleased to see the institutions in this state aggressively reaching out to serve these communities and these populations. They do come from a culture where there's not a lot of trust in financial institutions, and so it's a broad initiative to help them understand the safety, the soundness, the stability, the trust that they can have in banks in this country and in this state, especially, and the benefits that accrue to them and their families and their standard of living by getting involved with a financial institution and depositing their money in an FDIC insured institution rather than keeping it in their home and all the dangers of that or using high cost providers, the check cashers and things like that.

HEADLEE: The opposite is true, too. People who have lived here their whole lives sometimes take for granted the importance of a strong banking system and the role that it plays in all these issues that we've been talking about. The fact that you can put your money in, you can count on it coming out, and you can plan and make adjustments for economic situations is just so critical. Over time we forget that the strength of the banking industry is really tied to the strength of our whole economy and the strength of our families and what we are able to achieve.

WHAT DO YOU ANTICIPATE FOR THE PROFITABILITY OF BANKING?

SIMMONS: It should be a very good year for the industry. One of the really amazing things about the period we've been through is that banks have experienced really good credit quality through a very slow time. Now, it's been helped by the fact that rates have been low, and so particularly real estate borrowers have not suffered as they may have done in a higher rate environment. But the industry as a whole is healthier today coming out of a period of slow economic growth than it has been in a very long time, and that bodes well as we go into a period where the economy is growing at a better rate. I think we are seeing a flattening of the yield curve, which, in other words, short-term rates are rising, long-term rates are remaining about where they've been. So you don't get much difference between short- and long-term rates, and that becomes, for many banks, a difficult environment to make money in. But the economy will be stronger than it's been, generally.

ANY COMMENTS ON IMPACTS OF REGULATION? ANY CHANGES YOU ANTICIPATE?

J. ANDERSON: Decreased profitability.

THAT'S OFTEN ASSOCIATED WITH INCREASED REGULATORY ACTIONS.

BEARD: I think we set up an adversarial situation that doesn't necessarily need to be there. Regulators need to be realistic, and I'm pleased to hear that there is some discussion about the real impact of regulation. We as bankers view regulation--if it's good regulation--as being productive for all of us. It goes back to the issue we were talking about earlier of trying to make sure that the perception of the public is that the custodians of the wealth are, in fact, sound and secure. Our task as bankers is to try to work in conjunction with regulators to create regulation that makes sense to the industry, and that's easier said than done.

ARE THERE ANY PARTICULAR REGULATORY ACTIONS THAT YOU FIND ONEROUS?

HEADLEE: Most of the new ones. There is a tremendous amount of pain right now with a number of new regulations. I think the question about Basell II, it's just another one that--there are probably some here that have a better idea of how that will have a chain reaction effect in our markets that we haven't though of yet. We are still wrestling with some of the issues that Scott talked about in terms of knowing your customer and suspicious activity reports and Sarbanes-Oxley and directors and all that stuff. So all the new ones are the ones we are having trouble with. It's very expensive and it is relevant to our customers because it ultimately has to affect them. They have an interest in this.

LEARY: If you want to focus on Basell II, you would normally think that a state like Utah, at least the regulatory department in the state of Utah would have no involvement. Ironically, because of the industrial banks, Merrill Lynch is one of the institutions nationally expected to comply or wanting to comply with Basell II capital requirements. So a department like ours out of Utah ends up working with all the large states as to the state response, state initiatives with regard to Basell II. It's some of the carry-down effect and what will transpire down the road from implementing Basell II. The concern to most other banks, other than the large national banks, is if there is a mechanism for those very large national banks to determine if their risk capital is less than the standard norm across the country. That puts them at competitive advantage to all other financial institutions. I don't know the outcome. We regulators are working through the implementation issues. It's not a "done deal" in the--at least in the US yet. But carrying it out will become a very large challenge.

SIMMONS: I think it's going to become very political before we are finished because it will create winners and losers. It potentially puts the government in the business of credit allocation. In theory, it ought to create more rational pricing by removing subsidies by having better rates on less risky classes of loans and higher rates on more risky classes of loans. And it involves some complex, statistical modeling, and it's costing a lot of money for larger institutions gearing up to deal with it. We are spending millions of dollars in our company because we intend, actually, to use the internal ratings-based models. Those who don't, I think, are going to end up at a competitive disadvantage.

LEARY: I don't know if there is any conclusion from it other than it's a story definitely just in the beginning chapters.

ANY COMMENTS ON CHECK 21?

S. ANDERSON: Check 21 was put in place to streamline the check processing process and reduce paper in the industry. The cost of that on a national basis is $70 billion. A check can be handled 28 different times during the process. I think the other issue is that the 9-11 experience showed what could happen to our financial structure if planes are grounded and we can't transport the paper checks back and forth to process them. Check 21 allows these checks to be processed electronically. And then they could be replaced with a duplicate copy or an IRD document that has the same impact under the law as the original check does. It could have some positive impact on fraud in that the checks will be cleared more quickly, and you will know if they are good earlier. But another impact will be that it will take away some of the float. Consumers will no longer have that luxury.

MITCHELL: I think we are seeing that part of it, at least at the community bank level, because our customers are getting--even if they are not getting the IRBs, they are getting the checks converted to ACHs by a lot of the companies, and its turning it a lot faster than it used to. My overdrafts keep going up and up and up because they are not ready for it.

SIMMONS: I think the Internet is one of the great democratizing things that's ever happened in this industry. It's allowing banks of all sizes to use the technology. I don't think it's exclusively available to large banks. I think it changes the way you deal with customers, but at the end of the day, a personal relationship is going to be important. It's just that the daily transactional--sending somebody down to the bank to make a deposit, I believe is likely to change in the next few years.

TAYLOR: Just following on that comment for our little community bank in Heber City, the equipment we needed to purchase, digital imaging equipment, to be prepared to implement Check 21, also permits us to have online images of checks available to customers. Now our little bank has online images available, which we didn't before.

I ASKED MY FINANCE STUDENTS LAST SEMESTER, "HOW MANY OF YOU HAVE WALKED INTO A BANK IN THE LAST TWO MONTHS?" ONLY TWO PEOPLE RAISED THEIR HANDS. I KNOW THAT'S CONSUMER BANKING, BUT THE POINT IS, IF YOU DON'T NEED A PHYSICAL PRESENCE THERE, THAT MIGHT SHIFT THE COMPETITIVE STRUCTURE OF BANKING.

LET ME GO ONTO THE NEXT ISSUE--IDENTITY THEFT. HOW PERVASIVE IS THE CRIME, AND WHAT ROLE DOES THE FINANCIAL SERVICES COMMUNITY PLAY IN HELPING TO FIGHT IT?

S. ANDERSON: This is going to be a huge problem. I remember correctly, there were ten million incidents of identity theft in 2004 in our country. It's the highest growing crime in the country. And we see it in a lot of forms and in a lot of ways.

Yesterday, I received an e-mail from London, and it said that this person was 75 years of age, his wife just died, he's critically ill, and he's decided to take four million pounds that he has saved and wants to give it to me to let me give it to the less privileged. And all I need to do is send my full name. Send my phone, fax, and mobile number. Identify my profession, my age, my marital status, my Social Security number, and my banking details. You know, while some can look at that and laugh, others will send this material, and they will have everything to recreate that person's identity and siphon money out of their account.

HEADLEE: We are focused in two areas. One is prevention through education. One is, once it's occurred, how to unwind it as quickly as possible--bring it to a conclusion and help the person reclaim their identity. I'm the chair of the Attorney General's task force on public outreach on this specific issue. Last week we unveiled Utah Bankers' Association's fishing public awareness campaign through brochures to all the banks to their customers and posters and things like that.

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Specifically, fishing is a very complex issue. There are a lot of different ways that identities get stolen. But the state is putting together a Website, where if you become a victim, you enter your information. It goes out to all the law enforcement agencies. Your case is started. We pool all the cases together so we can see trends, and we can find common criminals.

There is a very significant initiative that's going on in the state right now. The banks are playing an integral role, along with the Attorney General's Office, to prevent, but then again, to help, once the problem occurs, to help the person out of that situation as quickly as possible. Prevention is the key, and education is the only way to do that.

TO WHAT EXTENT SHOULD THE BANK BE HELD RESPONSIBLE IF A CUSTOMER DOES SOMETHING LIKE GIVING THEIR DATA ON A FISHING E-MAIL? IS THAT THE CUSTOMER'S PROBLEM OR THE BANK'S PROBLEM?

HEADLEE: The reality of it is, the customer's problem is the bank's problem. What banks struggle with every day is that we have good customer relationships out there that fall prey to these things, and in an effort to maintain those relationships, we work hard to resolve the problem. But we have a serious interest in trying to educate people and trying to prevent this from happening.

WITH ALL THE ADVANCEMENTS IN TECHNOLOGY AND THE INCREASED USE OF ELECTRONIC BANKING, WILL WE SEE AN END TO THE TRADITIONAL BRANCH? WILL IT CAUSE A SHIFT IN THE COMPETITIVE EDGE?

DEWAAL: I took a similar survey last semester in a banking class I taught at BYU, and I asked everyone if they had used Internet banking. Every hand went up but one. The hand that didn't go up was mine. Many of those students were from places outside of Utah, and they were continually banking with the places where they were from.

Before I retired, I worked for Deutsche Bank in Hong Kong, and the bank had made a survey in Germany about internet banking versus branch banking, and the results of the survey were disconcerting. We found out that about 20 percent of the respondents wanted only Internet banking, 20 percent wanted only bricks and mortar. The 60 percent in the middle wanted both. But my sense is that the younger population is so comfortable with electronic transactions that those numbers have to change over time.

GROSS: Our bank made a similar attempt at trying to drive online banking, and we also found that there is a definite need for the client to come in on a face-to-face basis.

IS THAT GENERATIONAL? CERTAINLY PEOPLE OVER A CERTAIN AGE WANT TO HAVE THAT BANKER SITTING ACROSS FROM THEM. I DON'T SEE THAT WITH THE STUDENTS I HAVE IN CLASS.

GUNTHER: I'm not sure those students are borrowers yet. There is a big difference if you are borrowing money, you really need to sit down with somebody.

DEWAAL: But is that a need of the bank or the need of the consumer?

GUNTHER: It's probably the need of both.

HEADLEE: There is going to be a day when those people want to look someone in the eye and understand what they are getting into and what it means and that they are getting into a borrowing relationship with someone that they like and trust and get a feel for things as they develop in the relationship.