BHCA Speakers: Expect more pain before improvement

The recession may be over, but banks can expect additional market deterioration before things begin to improve, said Ron Feldman and Bill Conerly, luncheon speakers at the October 6 session of the Bank Holding Company Association's fall seminar in Bloomington, Minn.. Feldman, a senior vice president of the Minneapolis Federal Reserve Bank, gave an overview of conditions in the Ninth Federal Reserve District, placing the current downturn in perspective.. "Relative to anything we've seen in a decade, it's clearly bad," Feldman said. "But if you take just a little bit longer perspective, so far things are not as bad as they were in the late '80s and early '90s. You don't have to go back to the Great Depression or anything like that," he said.. "Everything I'm seeing suggests that conditions are going to get at least a little bit worse before they get better, and then they're going to stay stagnant," Feldman said. "That is, they're not going to improve at a particularly high rate — they might just stop getting worse.". Feldman covered key indicators of market conditions, including bank ratings, charge offs and capital. He said the Fed is seeing a lot of double downgrades and that "ratings today are much worse than they were just 10 years ago." The Fed is also seeing "an overall degradation of conditions and asset quality," for core non-performing asset measures, he said. Capital has not suffered the same falloff as loan performance, and Feldman said institutions are still able to raise capital.. "While it's true that conditions overall are not great, I think for most institutions there's still a lot of long-term value, and I think people are finding shareholders to put more money in," Feldman said.. Conerly, an economist and bank consultant, said the recession is probably over. "Three of four coincident indicators point up," he said. The fourth indicator is unemployment, which nationally stands at 9.8 percent.. Conerly also described a housing glut driven not just by foreclosures but also by unemployed immigrants who left the country after losing their jobs. Conerly said that divorced couples are weathering the recession by staying together in one house even after their divorce; adult children are moving back to their parents' homes for now. Cycling through the housing surplus could take a year, Conerly said. .Differences in downturn. Feldman said this recession differs from the last major district downturn in that it hasn't been caused by agricultural assets. Even ag banks in difficult situations are not there as a result of farm lending.. "The majority of those [institutions] are not in problem condition because of their agriculture loans. They tend to be in problem condition oftentimes due to participations," Feldman said. "I think people were rightly looking to diversify their portfolios. Unfortunately many people diversified into areas that didn't perform as well as may have been expected.". Describing the average loan portfolio of district banks, Feldman said that percentages of residential real estate and C&I loans hadn't changed much, but "when you get to commercial real estate you see a really enormous increase for the average bank," he said.. "It goes from single digits to over a third of the portfolio. That was offset by a pretty substantial decline in agriculture-related loans and consumer-related loans," he said. "Construction and land development are what's driving the crisis.". The other major difference in district conditions is "the illiquidity of the community banking sector," Feldman said.. "By illiquidity, I just mean relative to the reliance on core deposits," he said. "What we're seeing here is the movement away from core deposits to fund asset growth.". Feldman said that liquid assets had declined to 20 percent of assets, and "on the liability side there's more vulnerability in terms of funding being withdrawn.". Feldman said trouble arises from "a combination of weak asset quality combined with dependence on wholesale funding." He added that "most institutions have found a way to survive any scare that they had through that combination, but it clearly makes it more difficult." .Outlook for the economy. Conerly said he expects a good third quarter followed by 3 to 4 percent growth.. The Fed will "tighten hard," raising rates three points next year. If it doesn't "we'll have an inflation problem in 2011," Conerly said.. The economy is "nine feet down a 10-foot hole, but it's not in recession because we've stopped going down," Conerly said.. He said that discretionary consumer spending will be the first sector to rebound, followed by big-ticket consumer spending, exports, residential construction, non-residential construction, and state and local government spending.. Conerly said the recession marked a change in "the great moderation" in business cycles, which began in the mid 1980s. He predicted a period of "higher cyclicality" and encouraged bank leaders to do more economic contingency planning "because we're in for some fluctuating times.". But he was sufficiently certain of an upcoming recovery to prompt attendees to focus on business challenges beyond bare survival, including: re-staffing and training employees, preparing for the financial stress of growth, and managing vendor performance as business accelerates.