Winning More Loans and Protecting Your Best Clients

[Intro]: Helping community bankers grow themselves, their team, and their profits, this is the community bank podcast.

Caleb: Coming to you from Atlanta, Georgia. This is the podcast by bankers for bankers, thanks for joining the conversation today. My name is Caleb Stevens, I work in our business development group. Again this week for Eric Bagwell, Tom you are with us in the studio again today. How are you?

Tom: Hey Caleb I’m doing great today, thank you.

Caleb: Well I looked at our stats. The other day and I pulled up a map of the country. It was really encouraging to see how many people who are listening to this show are not from Georgia or the southeast, a lot of folks up in Massachusetts, folks in New York, folks out on the West Coast California, Washington State thank you guys so much for tuning in. We really want this show to bring value to you, the community banker wherever you are, we’re based in Atlanta, but we have customers and relationships all over the country at the correspondence division we’re blessed to serve almost 700 community financial institutions, all over the country. So, thank you for tuning in. We really appreciate it if you haven’t subscribed on iTunes or Spotify, please do that just an easy way for you to be notified every time a show is posted and we think it would be easier for you, and better for us so give us a that subscribe button if you haven’t already on iTunes or Spotify. Well, Tom, I am excited for today’s show we’re going to be talking to the one and only Ned Kaufman probably the smartest banker that I know. I don’t know If you would concur or not but to me.

Tom: I think I would agree too.

Caleb: I could just sit and listen to him talk and half of it goes over my head but I’m like man you sound, that sounds really good.

Tom: You sound like you know what you’re talking about.

Caleb: You’re sound like you know what you’re talking about. He certainly does before we dive in, though, give us a little bit of an update on the economy, and what’s going on right now in the world of banking.

Tom: Sure, Caleb thanks. I think last week when we talked about the Fed had just come out from the Jackson Hole symposium and the big takeaway from that is that the Fed is probably going to be a little bit more lacs or lenient with letting inflation kind of drift above the 2% inflation target that they have set for so many years. There was a little bit of a muddled message from some of the other fed officials but the last few days, we’ve had what I call the brain trust and that’s Richard Clarida and Lael Brainard both came out and were pretty forceful of echoing what chair Powell had said at Jackson Hole and that is that they really want to kind of focus more on the full employment mandate. And if that means letting inflation run a little bit hotter than, you would normally think the Fed would want to run then so be it. They think the economic damage that we’ve suffered is pretty severe, and it’s going to take a while for that damage to be repaired. And so, it just, it just kind of seems to me, we are going to be in a lower for the longer environment they are going to try to get inflation up. They don’t necessarily do that on their own, but they’ll set the conditions to where if it can, they’ll certainly let it, let it get to 2% and a little bit above. The problem is you’re dealing with sort of a global disinflationary environment, and it’s going to be. It’s going to be a struggle. So it’s probably a multi-year project.

Also, just one more thing the Fed Beige Book came out this week and they don’t call it beige. Well, they call it Beigh probably because it’s a little bit boring read, but what it is a series of anecdotes. In each district where they interview, the businesses of those districts and they come back with some findings. And there was a little bit more concern amongst the respondents as far as the longer-term aspects of the economy and so the FED has been a little bit, kind of, leery about how fragile that this recovery is and where the economy is going longer term, and certainly the Beige Book kind of played right into those concerns. So, I think, again, you’re going to see the FEDs as being super accommodative, especially with the fiscal stimulus sort of fading away and that’s kind of theme I’ve been talking about the last week or two, but I think it’s just being driven home, even more, this week.

Caleb: It’s great. Well, kind of going off of that the credit quality concerns and the government money propping up the economy right now that’s really good Segway, the conversation we’re going to have today really on the lending side. On the loan portfolio side. Ed Kaufman is our Managing Director of loan hedging for center state bank really the mastermind behind the arc program which allows community banks to offer up to 20-year fixed rate loans to their borrowers, while at the same time booking a floating rate note on their balance sheet. All the while, not having to worry about hedge accounting Dodd-Frank reporting, that sort of thing. Ed is so smart and really have a lot of good things to say I think about the economy and what that means for lenders what that means for credit quality and how lenders can be proactive and still be on the offense and protect some of their best credits and even pick up some, some new customers during this time.

Tom: Yeah he’s and you’ll hear in the interview he’s a real like a student of banking and lending, in particular, so he’s got some definite viewpoints on where he thinks credit quality is going to be going in the next couple of quarters, and it’s going to be a sort of a sobering discussion I think but, again, the advantage that he has he travels the country so see he sees all areas, what areas are doing well, what aren’t doing so well but he’ll definitely give you some I think some eye-opening observations about what he is seeing and what he’s expecting.

Caleb: No doubt, we’re excited to play that interview for you right now. Ed thanks for joining us today. It is good to see you virtually all the way on the opposite side of the country.

Ed: Nice to see you too, thanks for having me.

Tom: Give us a little bit of your backstory, we were talking earlier about you’ve worked in Canada you’ve worked for large banks you’ve worked for bankers banks talk a little bit about your backstory and how you got into sort of the loan hedging world interest rate risk management capital markets, that sort of thing.

Ed: Sure, well my background is with large national banks, and up until I started working at a bankers bank. I had no idea there were banks under 200million in assets. And when they hired me the capital market guys hired me and started on Monday and Wednesday, CEO, Tom Evans called me into the office and said, Ed, what exactly we hired to do here? I told them were going to develop a hedging program for community banks and Tom is the former Navy guy’s Colonel, and he looked at me and goes son is not a derivative because you are not putting any of those in my balance.

And I said, Well, why did you hire me? He goes I didn’t hire you, the capital market guys did, find something else to do. Well fast forward in 10 years at that bank we put on about 5 billion. So we developed a program, that is tailor suited for community banks to be able to use a hedge. To provide a fixed-rate loan to a client. Until then the whole industry used documents and complex accounting. It’s really a work project for accountants, lawyers, and processing people, we’ve simplified it. Several banks across the country whether they were 100 million in assets from 10 billion in assets can take a loan smallest 250 thousand. And offer the customer the borrower a fixed rate up to 20 years. On the balance sheet, they retain an adjustable rate. There is no derivative accounting, there’s no swap settlement, no is the documents, simple banks don’t change the way they do business and customers have the ability to pay a fixed rate up to 20 years.

Tom: Just kind of what you’re seeing because you are out in San Francisco, but you travel across the country I mean to all points. So you get to see this economy from all different perspectives. Can you kind of talk briefly about what you’re seeing generally from clients in their loan portfolios as far as, are the risks of credit quality gathering to them right now, are they starting to get worried about that or is it still sort of in some areas and then developing more in other areas. Just give us kind of a sense of what you’re seeing in that area.

Ed: Yeah so, a lot of our bakers are not particularly worried about credit quality which makes me worried about credit quality, because we have a gap in cash flow right now. And I know some people say well in my part of the country. We haven’t closed down as much. We don’t see the slowdown, the way I frame it, it is pretty much in a big poll in this country. And you can designate a part of the poll that is a pissing pool and part where you don’t piss. When you start pissing in a part of the poll the whole poll gets polluted. And so there might be a farmer in Iowa that doesn’t feel it. But eventually if you manufacture widgets. Or you have a hotel based on travelers, or you provide a service, what’s happening in one part of the country will eventually affect other parts of the country, not equally of course. Because farmers that grow corn in Iowa, if they’re exporting into Canada or Brazil, they may not be affected as much. But ultimately it is an intertwined economy. And right now we do see bankers, that are concerned about portions of their portfolio. Definitely hospitality, some restaurant business is being impacted. Ultimately, if the fiscal stimulus is not there, I’m concerned that many businesses will see an impact, we are going to have a decrease in revenue impacting cash flow. And deterioration in credit quality. But I got to tell you, in many parts of the country, the bankers are not particularly concerned. Some bankers actually quite a Segway about the economy.

Tom: That’s concerning like you said and we were talking earlier with your colleague Steve Olson he was, we were just mentioning. You know the sort of that same effect, the stimulus that came in came with a bang with the cares act, 1.8-2 trillion dollars. And that’s, that’s fading away. So I think sort of this false sense of security is that we had this money, and now it is kind of going away and some of the programs that you’re seeing already in some of the airlines are already announcing some pretty large fair low numbers to begin October one when, when that stimulus measure wears off. So obviously you mentioned hospitality and leisure. Are there other sectors that you see that could be a gathering risk in the fourth quarter, for a lot of banks?
I mentioned briefly, we had talked about the office space where companies are getting used to the fact that they maybe don’t need that large footprint with work from home being fairly successful in lots of areas. You see that as sort of one of the sectors that may start to see some struggling in the fourth quarter with revenue.

Ed: Well, I don’t believe we are going to see that downstream effect in the fourth quarter because people typically sign 5, 10, 15-year leases. And it is hard to get out of them. And I think in high-density MSA, like Chicago, New York, San Francisco, even Dallas and Houston, Miami, Minneapolis, you’re going to see longer-term a decrease in demand for office space. Now fortunately many of the clients I deal with. We see in D-type markets, lower density, and they may see that impact but it’s going to take much longer to trickle down. But I think definitely, from a real estate perspective, you’re going to have a shift in demand for the clients that we deal with that have 5000 to 20,000 square foot buildings may take a long time for their cash flow to change.

Tom: Well sounds like Ed you’re thinking that this commercial real estate is certainly in for a change, but it is going to be sort of a slow-developing change whereas hospitality, obviously retail, travel has seen a dramatic change. And so, those sectors are getting hit, they got it first and they’re still going to be getting hit as soon as the stigma starts to roll off. Are there other areas of the real estate market that you, you’re kind of worried about longer-term than the ones we’ve already mentioned?

Ed: Well I’m also concerned about the act and we’ve seen that trade wars, don’t really help our farmers. I’m not sure they help our manufactures much either. But I indicated to you before that, it’s not a linear recovery, the longer we stay down the harder it is to come back to the pre-crisis level. So, from what I have been reading it may take two to three months to correct the pandemic. In a particular area, the longer we wait. To do that, the harder it will be to come back in all of these different sectors because what’s happening is, you’re scaring the economy permanently. You are getting people that are disenfranchised they’re further away from their connections, may not come back. They fall into poverty they lose their skills. So the faster this is corrected the better. The lack of fiscal stimulus in the second round is concerning me. We have I think literally underestimated the amount of stimulus we got with the first cares act. 2 trillion dollars is never been done in such a short period. It’s an enormous amount of money being put into the market, and then you add to it the amount of monetary system, where the Fed is vacuuming up all of these treasuries, mortgage bank securities, and even corporate debt. So I think we’re underestimating the impact of the shutdown.

Tom: And I think too, I was writing a piece for tomorrow about the jobs report for August comes out tomorrow morning. And they’re expecting, maybe about a million new jobs, but when you look at, we last 22 million in the two months of March and April. I think we’ve gained back. If you say a million tomorrow that’s going to be about 10 to 11 million that we bring back so not even half we’re just about half of the jobs coming back. And the momentum is certainly slowing in that area. So I’m kind of sure you’re concerned and that and that you know we may be setting you said maybe setting up for a shallower glide path on the recovery. And then it becomes harder and harder to get back to where we were before. I would say, kind of sounds like to me your, you wouldn’t want a lender right now to go reaching or going down the credit curve because that credit card is probably going to be shifting, even a little bit lower over the next two quarters to several quarters. Is that correct?

Ed: You know I think that one good effect of this pandemic if you can identify any positives. Is that undiscipline lenders have been snapped back, so people that we’re reaching out because we’ve had 11 years of an expansion. Have really curtail that type of activity. So we’ve seen interest-only loans, performer loans, high LTV loans, low cash flow debt yield down to 6%. That is really stuck. And so, smart banks are reaching for premium credits. credits that are the right size where the debt yield is 10% or higher. Now, what’s interesting about this is that historically, I never believed that policy makes a huge difference in the US economy at 22 trillion the largest in the world, highly intertwined. A lot of moving parts, what the executive branch does what Congress does really doesn’t have a huge impact. Maybe at the margin over the long term. But when you have a pandemic the policy response is very important because in 2 or 3 months, we lost such a high percentage GDP. And if it’s not the right size. We have a long-term impact it’s very difficult to retract. So all of a sudden you see a policy response that is very important now and is going to be determinant of how we come out of this. You know recessions come and go.
But how you respond to a pandemic and how you open up the economy. This is very important in my opinion.

Tom: Well that’s a lot of good information Ed before we let you go, we did want you to at least speak about that your art product I know this was a product you were, I guess instrumental and developing so you really know that that’s the bolts of it. So just kind of speak to how your product would be different than what they have probably seen in the past when you’re speaking of hedging.

Ed: Yeah, I’d love to, here is the analogy I use. If you guys live in Atlanta, you are in San Francisco occasionally and you see people who get polls in their backyards. People who get polls want to go swimming. They don’t care about how the backhoe works, how you pour the concrete, and the rebar, they just want to go swimming. And so for a banker, I say look, you don’t care about how the backhoe works. We have a program. Don’t worry about the derivative you don’t have a derivative. What you are going to get is a swimming pool, and here are the parameters and attributes to the swimming pool. You can walk in your best for the long term. So, the National Bank is not going to go after them anymore. You’re going to give them a 10, 15, 20-year fixed rate. You going to walk them in at your bank, they better be good clients, because you’re going to live with them for a long time.

Number two. Now you have an opportunity to cross-sell them. Number three, you going to walk them in at the lowest rates we’ve seen in history, so the borrower should be motivated. Thinking so why you going to give me a 20-year fixed rate, at such a low rate, I love you. I want to do business with you. You’re going to stabilize that service coverage ratio, so when rates go up, and don’t have to worry about higher payments for the borrower. And you’re going to grow with the client because our program is assignable assumable so that million-dollar today. Loan or maybe a 250,000-loan today that’s where we start the program. If the borrower comes back and says well my business is an increase, which would be music to a banker’s ears. Now we can do $2 million loans, 3. million, and guess what, that borrower still captive to you because they took that 20 years fixed rate in 2020. When rates were astronomical low. And maybe manipulated low by the Federal Reserve. That’s where they are, It’s a perfect opportunity to walk-in clients, your best clients.

Tom: Well Ed, we appreciate your time if folks want to learn more about the art program get in touch with you. What are some ways that they can do that?

Ed: Well, I think the best way if they want to reach out to us, we have an email it is pretty easy. Arc@centerstate.com. Just tell us you heard about the program, we’ll reach out to you.

Tom: Well, it’s always good to talk to you really refreshing to hear more of your insights on credit, what lenders need to be thinking about and we enjoyed our time thanks.

Ed: Thank you very much.

Caleb: Well thank you, Ed, for joining us, really, really helpful conversation and once again, half of it goes over my head, but Tom I’m glad you were there to kind of drive that conversation because that was some, some really helpful stuff y’all talked about.

Tom: I think so and as we’ve mentioned on the front end, you know he’s, Ed gets to see you know what’s going on in the country and not just one region so his concerns I think longer-term about credit quality I think should be taken not taken lightly because again, I think he’s, He’s got that knowledge and that experience to where normally is right more often than the wrong.

Caleb: Yeah. Well, one sector that really got disrupted has been the M&A world I felt like M&A was on fire. Last year in 2019 some of them, I don’t know if you may know the stats better than me. But it seems like we had more bank deals announced in 2019 than in recent memory that obviously has gotten drastically turned upside down and so to make sense of it all, we’re going to be turning to Brady Gailey our friend over at KBW and I believe he used to cover us as an analyst on the center state side as well, is that right?

Tom: He did for several years so he’s got a vast knowledge of our bank and, obviously, M&A in particular. So, you’re right, we went for years after coming out of the great recession where there was just no M&A activity at all for good reason. 18 and 19 it really accelerated and then the pandemic got like everything else in banking is turned it upside down, so we’ll be looking forward to getting Brady’s observations about that when we, we talked to him next week.

Caleb: It’s going to be fun. Thanks for listening and stay tuned.