CONFAB: Community Bankers of Iowa

Using CBI platform regulators offer encouragement, express concern.While Iowa banks are strong, concern over cybersecurity and the impact of the agricultural economy linger as potential dark clouds on the industry horizon. Regulators speaking at the 45th annual management conference and annual convention of the Community Bankers of Iowa reassured bankers, yet urged vigilance as they summarized industry conditions during presentations at the Arrowwood Resort in Okoboji, Iowa, July 13-15..Ron Hansen, named Superintendent at the Iowa Division of Banking earlier this year, affirmed the strength of Iowa banks, noting that 99 percent of them are profitable. The average return on assets for Iowa banks is 1.19 percent. At 97.5, the percentage of Iowa banks with a composite CAMELS ratings of 1 or 2 is very high. Hansen said bankers and farmers are in better position than they were in the 1980s to weather a downturn in ag commodity prices.."Bankers do a much better job of basing their loans on cash flow, rather than collateral," Hansen said. "Borrowers, for the most part, have better balance sheets. Borrowers are more sophisticated and do a better job marketing." He also said bankers do a better job today than 30 years ago of lending on ag land.."While we don't want to be alarmists at the IDoB and say the sky is falling, we are watching the current ag environment with our eyes wide open," he said. "Strong yields in some parts of the state cured some of our ills in 2015. Rents and fertilizer costs have come down some but need to come down more, and seed and chemicals continue to be high.."Bankers are telling our examiners that many cash flows are break-even at best, as they have met with their borrowers for the 2016 crop year. Operators burned through a lot of their working capital in the past year. As a result, we are seeing some debt restructuring. It is important to identify carry-over debt, identify and analyze why it is happening, and have a viable, executable workout plan. We as lenders need to realize that we are in the risk business, how important risk management is, and think about worst case scenarios as we explore options. Carry-over debt is not necessarily classified but it has to be properly structured.".Hansen noted that in a few cases, bankers worked with their farm customers to renegotiate their land rent costs. "I know this wasn't real popular with landlords, but it needed to happen," Hansen said. Fortunately, farm real estate debt has grown much more slowly than farm real estate values, Hansen said, citing the fact as a major difference from the situation in the 1980s..At around 3.4 percent for the last two years, the net interest margin for all banks is tight. "It remains extremely important for banks to have a reliable interest rate risk model which accurately portrays their position," Hansen said. "Generally speaking banks have done a much better job of this in recent years, but we still run into a few banks that don't have bank specific data or have bank specific assumptions that are not supported by their bank specific data.".Hansen warned that banks in the Kansas City FDIC region are extending their maturities on securities in an attempt to gain yield. "At the same time, funding is becoming shorter term," he said. "The shift to longer term earning assets coupled with an increase in non-maturity deposits leads to greater sensitivity to higher interest rates.".Asset quality across the industry in Iowa has considerably improved in the last six years. "Adversely classified assets as a percentage of Tier 1 capital and ALLL — this is one of the key ratios we use in exams," Hansen said. "The classified to capital ratio as of the most recent exam date for all state chartered banks is 15.8 percent as of June 30. The rolling average for the last 12 months is 16.8 percent. This ratio peaked at 52.8 percent in 2010 and has worked its way down since that time. It is a ratio we will be watching closely going forward.".James LaPierre, Kansas City Regional Director at the FDIC, said the banking industry has been doing well and that the economy has generally been sound. "There have been some ag operating loans charged off. That is certainly a change, given we saw none for years," he said. "Things are not as good as they were but they are very good.".LaPierre told bankers that institutions with a concentration in ag loans will be subject to scrutiny. "We are going to spend more time on your portfolio looking at your borrowers and really looking at your underwriting criteria, making sure you are focused on cash flows." .He explained that FDIC examiners think of ag borrowers in three categories. "A" borrowers have no land rent expense, "B" borrowers only have minimal rent expense, and "C" borrowers have considerable rent expense.."The ones we are especially worried about are the ones we call Cs. These are younger or new farmers," he said. "There are stresses in all those categories but especially in those C borrowers.".Like Hansen, LaPierre shared information about farm borrowers who had renegotiated their rent at the behest of their banker. "I was in Cedar Rapids and I heard from some of our examiners who had been in banks where there were some concessions on rent in the eastern part of the state. They were not significant," he said..Cybersecurity a major issue.LaPierre and Hansen cited cybersecurity as a major industry issue. "I don't think there will be a time in the future when we are not talking about cybersecurity," LaPierre said. He noted one prominent industry core provider who he said "is under attack 24 hours a day, seven days a week" from hackers. He said the attacks mostly originate from Eastern Europe and Asia..LaPierre said many of the attacks directed at community banks are relatively unsophisticated, but they prey on the bank employee who is accustomed to providing good service. "The hacker will send an email to the employee, pretending to be the president of the bank," LaPierre explained. "The message will say, 'this is urgent, wire x dollars to such and such. Please do so immediately, I cannot be reached.' The employee follows through, believing they are executing the wishes of the president." LaPierre said good procedures at the bank can prevent this sort of mishap..Most malware and ransomware attacks happen when an employee clicks on an attachment in a hacker's email. Again, LaPierre said, thorough procedures can help banks avoid this kind of trouble.."Many software programs automatically assign the president of the bank administrative rights to the system," LaPierre explained. "If you don't ever use them, then instruct your IT people to turn that off. Hackers have been known to work through the president's administrative rights, knowing that they are seldom used and therefore unlikely to be checked on a timely basis.".Hansen said a recent demonstration he witnessed about the potential impact of a hacker attack impressed him. "I encourage you to have a discussion with your management about what would happen if you had to close your bank for a few days because a computer hacker shut your system down," he said. "I think this type of disaster is just as likely to happen in this day and age as a fire or tornado. This one exercise drove home to me that cybersecurity is not just an IT issue. It is absolutely a board issue and the viability of our banks is at stake.".Hansen told bankers FinCen reports the number of ransomware attacks to be on the rise. In 2014 there were 28 reported cases; in 2015 there were 44, and in the first quarter of 2016 there were 50..Hansen also urged bankers to promote banking as a profession. "Management success is an industry issue," he said. "It is incumbent upon all of us to talk to young people about considering a career in banking. I encourage each of our banks to go to their respective high schools annually and talk to students about considering careers in banking. I also encourage banks to consider an internship program.".The Iowa Department of Banking has its own staffing issues, Hansen said. "Staffing is the biggest internal issue facing the department," Hansen said, explaining that a third of his field examiners will retire or become eligible to retire in the next five years. He noted the department has had about 65 employees for a very long time even though the assets the department supervises have grown substantially. "This year, we obtained a budget increase from the legislature," Hansen said. "We recently hired two experienced examiners and have openings for four entry-level positions. Our goal is to build our bench in view of the looming retirements."