More turmoil ahead for banking industry

Last week, Milwaukee-based Marshall & Ilsley Corp. reported a fourth quarter 2008 net loss of $403.9 million and 830 layoffs, an 8-percent workforce reduction.

For the full year, the parent company of M&I Bank lost about $569 million, or $2.19 per share.

Most of the bank’s layoffs occurred in 2008, but there were 221 new staff cutbacks announced last week. Of those layoffs, 109 were in Wisconsin and 76 were in metro Milwaukee.

“Our fourth quarter and year-end results reflect the extent to which the current recession has had an impact on our economy,” said Mark Furlong, president and chief executive officer of Marshall & Ilsley.

The announcement came on the heels of a December 2008 announcement by Chase Bank that it was laying off more than 250 workers from its Milwaukee home equity loan processing center.

Last year’s headaches for banks included the collapse of the housing market, along with subprime mortgages, Wall Street investments that gave up 40- to 50-percent losses and some of the largest banks around the country taking in multi-billion federal injections of capital to help stabilize their balance sheets.

This year, bankers expect a continuation of those problems and the looming threat of still undiscovered weaknesses in the commercial real estate and commercial and industrial sectors. “This is going to be a big year,” said Rick Lane, president and founding partner of Broadview Advisors LLC, a Milwaukee investment advising firm. “We’re going to find out about CRE (commercial real estate) and C&I (commercial and industrial) and how severe the credit cycle is going to be. Right now, it’s impossible to tell.

“The banks are in less of a position to withstand a bad credit cycle in CRE and C&I because the (residential) construction has deteriorated to such a degree. Now we’re phasing into a period where all eyes are on CRE and C&I lending, and we’re starting to see the CRE fray,” said Lane, who is also Broadview Advisors’ banking analyst.

Bankers pessimistic

According to a recent survey of 151 banks by the Wisconsin Bankers Association (WBA), 54 percent predicted that demand for commercial loans will decline for the next six months and 90 percent believe that the economy is still weakening.

“If bankers believe that the economy is still weakening, they’re going to think that commercial loan demand will be pretty flat,” said Kurt Bauer, president and chief executive officer of the WBA. “I believe that recovery could happen in the third or fourth quarter (this year), but we may not notice it until a couple of quarters after that.”

However, some segments of the banking industry are healthy and are lending money, especially to strong commercial and industrial (C&I) clients.

“The bad news is the obvious – credit is tighter, banks are looking harder at the financial performance of potential borrowers, they have raised prices and interest rates and they are looking to monitor performance,” said Emory Ireland, an attorney with the Milwaukee-based law firm Foley & Lardner who specializes in banking and financial transactions. “The good news is that for a good company – in the sense that they’re well-capitalized and have decent earning capacity – the banks are still open for business and lending money.”

“Congress is off base when they talk about getting banks to loan money again,” Lane said. “It’s the areas of non-traditional banking that have completely disappeared and I hope never comes back. This is an adjustment that the economy has got to make. A lot of lending went to low loan quality borrowers.”

Lending institutions that are in a strong financial position still have a significant appetite for commercial loans, said Russ Weyers, president and chief operating officer of Racine-based Johnson Bank. Weyers is also the chairman of the Wisconsin Bankers Association.

“The market for commercial lending is open, it just requires that business plans be solid,” Weyers said. “We have a tremendous pipeline of people looking to borrow and much of that is on the commercial side. In today’s economic environment, with the difficult challenges before us, prudent bankers are looking at things with more due diligence.”

‘Ultimate irony’

Regulators such as the Federal Deposits Insurance Corp. (FDIC) and federal bank auditors have stepped up loan regulation, Lane said, leading to an environment in which banks are being pressured by politicians to lend more aggressively while regulators are urging them to be more conservative.

“Isn’t this the ultimate irony?” Weyers said. “We have the Treasury and Congress who gave (banks) all this TARP (Troubled Asset Relief Program) money, yelling at them to make more loans, while we have regulators really coming down hard on standards and criteria. It’s like the devil and angels on alternate shoulders. But this happens every cycle.”

The tighter lending market will likely continue well into later this year, said Bill Bertha, Wisconsin market president for U.S. Bank.

“Credit officers across the board have their antenna up more than they did one year ago,” he said. “They are giving out harder questioning and harder due diligence and are being more cautious about what they are stepping into with their lending.”

The woes felt by many of the largest banks in Wisconsin and around the country in recent years have given opportunity to smaller community-based banks, said Michael Steppe, president of Brookfield Investment Partners, an investment consulting firm that helps manage banks’ investment portfolios.

“If you look in Wisconsin, the dominant banks … have much less of an appetite for loans right now,” Steppe said. “You don’t see them on the street. When you’re talking to small-business people, you don’t get the impression they’re on the street.”

Most of Steppe’s client banks have total assets between $500 million and $1.5 billion, and are averaging 20-percent loan growth for 2008, a trend he believes will continue in 2009.

“The whole field is changing,” Steppe said. “Big banks are struggling, small banks are thriving.”

Many large banks who are over-leveraged in residential and commercial lending may continue lower levels of lending this year, Bertha said.

“A lot of banks have become capital constricted and as a result, they have not been able to lend,” Steppe said. “We’ve seen that in this market and others around the country.”

Some banks have not worked through all of their bad debt, and a potential commercial real estate bubble looms heavily for some financial institutions, which could lead to TARP-fueled mergers and acquisitions among banks in metro Milwaukee, Bertha said.

“I think from an economic perspective, we’re in for a tough year, and it will have implications that were not as studious on their credit screening processes in the past or were greedy in reaching for out-of-market customers,” he said. “You’re going to get the FDIC to step in and say, ‘It’s over, merge with someone else,’ if there are quasi-problems with some of the banks around here. If that happens, there will be layoffs because of redundancy. I think there will be some fallout,  and it will be more tied to asset quality and where it takes us in 2009 and 2010.”

However, the non-transparent nature of many banks’ balance sheets could temper demand for bank-related M&A, Ireland said.

“The level of bank stock and prices at which banks are available for purchase have declined probably presents some opportunities for financially strong acquirers,” he said. “It’s difficult to determine what you’re buying in today’s market, but if you get the right one, you could do a real deal. But you have to be confident in what you’re doing.”