Alexei Smirnov [1]

Banking is big business in Tennessee. Business Tennessee recently brought together some of the top minds in the field, including leaders of some of the state’s top financial institutions, to discuss banking issues facing the industry and Tennessee business.

• Julian Bibb partner Stites & Harbison

• Mike Edwards Tennessee banking group manager First Tennessee

• Doug Cruickshanks, president & CEO FirstBank

• Rob McNeilly chairman, president & CEO SunTrust Bank Nashville

• Ron Samuels regional president & CEO Regions Financial Corp.

BTN: What’s the view of the U.S. economy and how it’s doing right now?

Cruickshanks: Ron, I know you want to talk about the United States going broke.

Samuels: I’ll take a quick stab at that. The number one thing that has probably surfaced after 17 straight Fed rate hikes is the question, “Is the end near?” And I think the sentiment currently would say that it probably is, and that the flat yield curve remains. Add in the Middle East, with oil approaching $80 per barrel, and you’re looking at a serious and unpredictable situation, which makes investors very nervous. Anytime that happens, you’re going to start seeing that trickle down and tightening, and people are having to make choices already with their budgets and regarding their expenses. When you look at how much it costs to fill up that tank of gas today, some people are going to have to adjust and that trickles down.

Cruickshanks: I agree. I think the outlook is far more optimistic in Tennessee, but the impact of oil on society is far more than just filling up your tank, obviously. Every food product you eat takes oil—it takes oil to produce the fertilizers, run the tractors, get it to the market. It takes oil for the plastics to wrap it in—and so forth. I’m very concerned about the deficit. I don’t think the deficit can be sustained, although there are some pundits that will tell you that the deficit is a percent of GDP and not as much of a concern as the rise in the deficit would otherwise indicate. I think the most important thing for the U.S. economy is to maintain world confidence in our stability because well over 60% of our debt is held overseas. If overseas investors stop buying our treasury bills and our treasury bonds, the Fed increases can stop, because they’ll go up all by themselves to extraordinary heights.

McNeilly: I’d add one concern that we probably share in the banking industry—the reliance on financing residences on a floating rate type of product, either on an adjustable rate mortgage, or on a home equity line that is tied to some index like prime. At one point in time, about 70% of the mortgages being done over the last couple of years were ARMs, and those are relatively short-term with significant potential for rate increases, and I see that as a challenge in the future.

Cruickshanks: A research firm called the Loan Performance Group says that in 2005, 26.7% of all new mortgages were made “interest only.” So not only do you have the variability of adjustable rates, but you’ve got consumers now buying houses and not making any principle payments.

Edwards: There are some concerns, but there is no doubt that the U.S. economy is showing its resiliency. There are some dark clouds looming on the horizon, but overall, the economy is still in pretty good shape, though maybe not as robust as it was in some earlier quarters.

BTN: Is it sometimes possible to gauge which sectors of the economy are overheated by how aggressively banks are lending? Are there any areas that seem to be fully leveraged at present?

McNeilly: I don’t profess expertise here, but it seems like there is an awful lot of financing of condo-like projects going on, specifically in Middle Tennessee, and my understanding is that much of that is more speculative now than it was in the past. There’s just an awful lot of supply that is going to be coming online in the next 18 months or so.

Edwards: Commercial real estate is a concern for us, but it is in the corporate markets with deals put together by the largest companies in Tennessee that are oversubscribed very aggressively. This spreads to the lenders, and the protections—the structure to the lenders—is probably out of line compared to where it should be. So, the corporate market is where we’re probably most concerned. That’s the large-end business—some public, some very large private, and there’s a lot of money chasing those deals. Not just bank money but also other sources of money, followed by commercial real estate.

BTN: The housing boom seems to be cooling off nationally, but what are you seeing around Tennessee?

Bibb: I think that there are some really positive things happening on the national scene, but when you compare what is happening in Middle Tennessee—it doesn’t compare. We are experiencing, in my mind, a continued very positive economic development in growth and jobs, in production, and some of the lowest unemployment rates in the nation. Its effect on the housing market is substantial. In terms of banking and lending, and what’s going on in the real estate development community, I still don’t see an end to that demand for Middle Tennessee.

BTN: Maybe that’s why we have so much competition among banks in the Midstate market?

Bibb: I think there is a tremendous competition among the banks. All of Tennessee is dealing with the fact that other banks that have not been traditionally involved in our community are sending in teams to look at doing banking enterprises here.

McNeilly: We have a relationship with one of the largest homebuilders by volume in Middle Tennessee, and their numbers will not be off this year from a record 2005. And their preliminary plans for ’07 are similar. Those are generally first-time homebuyers, like townhouse units. On the other end of the spectrum, I heard a story the other day from one of our mortgage real estate originators that one of the relocating Nissan executives is purchasing a home in excess of a million dollars—and he’s a first-time home buyer because he couldn’t afford the real estate in California. So that gives you a perspective on some of the wealth that is moving here—it goes beyond the initial announcement. We see that as something that will continue.

BTN: What are some areas in Tennessee where you see concern?

Cruickshanks: In 2005, 83 counties in Tennessee lost population, five increased in population, and seven were flat. So I don’t think there is any question that Middle Tennessee is absolutely on fire right now. Many of the declines in the smaller counties are residuals of losing textile jobs and other basic manufacturing jobs that have left—not just left the area but have left the United States, but that has had an impact. The economy and the future of Middle Tennessee is just extraordinary. There is also a tremendous increase in small and mid-size banks moving into Memphis, which is a result of having to our west and to our southwest two very low-growth states in Arkansas and Mississippi. Some decent-sized banks in those states find themselves in zero-growth economies, and they look to Tennessee and say, “Look how good things are there. Let’s go build some branches,” and they’ve been paying significant prices. The whole Memphis market, while not quite as robust as Middle Tennessee, is doing very, very well.

Edwards: We are seeing growth in all the major metropolitan areas in Tennessee. The name of the game these days in all the markets is economic development. Whether it’s Partnership 2010 in Middle Tennessee, or similar organizations in the other markets of the state, we’re all chasing economic development very aggressively across Tennessee.

BTN: Let’s talk about business lending. A nice opportunity for mezzanine investors was created eight years ago when bank credit standards got stricter. How would you compare the bank industry’s appetite for business lending now as compared to a couple of years ago? Bibb: My perspective is that the lending community is maintaining high standards, but they’re fortunate in that being in Tennessee. We’re blessed to have very strong companies to lend to, and I don’t think that the lenders are relaxing safety and soundness policies to make loans.

McNeilly: The fact that the regulators put the spin on the media that banks have either tightened or loosened their credit standards is probably not as accurate, and their influence is probably not as great, as one might believe. We’re all in the business of making loans, whether that is business, personal or otherwise, and doing so in a sound and safe underwriting type of capacity. A tremendous amount of liquidity has been on the sidelines after about 2000 or 2001. It has been patiently waiting for some sign that the market will rebound with some kind of confidence. While they’re waiting, there’s been a dearth of venture capital, which the banks have never traditionally lent equity money anyway. The challenge that we see in business lending is that we banks look at cash flow as the primary resource, and the sale of the asset or conversion of the sale of the asset as our secondary source of repayment. That works well if you’ve got an accounts receivable and a piece of equipment, but the challenge for us is lending to companies that provide services that really aren’t supported by a more capital-intensive balance sheet. What is the secondary source of repayment if the primary intended source doesn’t work out? Samuels: I think Rob hit on an interesting point. I’ve never seen banks relax, as the media might suggest, their lending criteria. Certainly some things changed from the old days, when “good old boy” lending was prominent, but we have consistently tried to maintain credit quality at the top levels, and it’s been difficult when you’ve got competitors coming in from all over the market. Look around Nashville today at the competition for a good solid transaction. You’ve got people from Boston, New York, Philadelphia—just about every major market has a loan production office. We can’t do anything but work off of a small spread, so you’ve got to be very good at this.

BTN: What’s going on in the area of online security? What’s the payoff for banks there?

Cruickshanks: During the last four or five years, we have spent far more money paying outsiders to try and hack us and get to customer information. Now that’s being just a bit flip. These companies specialize in intrusion inspection, and they see the best practices. I’ve been very pleased with the number of folks that come to us online. We’ve got to make sure that we stay ahead of the crooks.

Edwards: Safety and security is what the banking industry is known for. What’s our payoff? Our customers will have the confidence to use it. There is dramatic cost. Unfortunately, the bad guys are out there trying to figure out how to beat us everyday, whether they’re the guys that we hired to check our systems like Doug was talking about, or they’re the real bad guys trying to get to our customers and our customers’ money. Safeguarding it is what we’re about, whether it’s physically at the branch locations or online. We’ve put into place things like the secret word program, which only our customer will know. If you ever watch the old spy movies, you go through some questions, and then say, “Okay I trust them.” We’ve given that kind of program to our customers who use our online service.

BTN: Switching gears, Ben Bernanke has been heading the Federal Reserve since February. Any early impressions of his stewardship of the Fed?

Samuels: Let’s just hope he doesn’t go too far. We’ve already seen these rate increases. I think people are pretty nervous right now.

McNeilly: We’ll only know after it’s over, how he did. Let’s just hope he’s as smart as Greenspan.

Edwards: There’s no doubt that he has the background, the résumé and the resources. Of course, the Fed is not a one-person organization. It has a tremendous amount of very smart, focused and talented people working there. He’s no doubt the person that speaks on behalf of the Fed and the Fed governors, but he has a good team of people behind him. He seems to be trying to hold the course, relative to Greenspan’s original approach. I guess the economy has proven that inflation will absolutely destroy the economy’s momentum, and we have to be focused on this. Their number one priority, it seems, is inflation control.

BTN: Any key legislative changes that the banking industry has scored in the recent past in the Tennessee General Assembly, or are you eyeing any of those changes for the next legislative session? Samuels: Certainly, one thing that happened this past legislative session that I thought was a good thing, and I think we all did, was the Good Funds Law, which related to third-party real estate loan closing. That was a plus.

BTN: What does that do for you all?

Samuels: We’re now back, I guess, to where closing agents here can accept checks designated as cashier’s checks or teller’s check. They had put language in there that really limited acceptance at closing.

BTN: I see. Are there any big national changes?

Cruickshanks: There’s a debate about whether Wal-Mart should be allowed to get into the banking business, and I find it a very interesting debate. The longstanding precedent for not letting Wal-Mart get into the banking business is separating commerce from finance, and there are plenty of good reasons for that, and plenty of good reasons to oppose Wal-Mart getting into the banking business. The banks fear Wal-Mart, which I almost take as an insult, because Heaven knows, if we cannot deliver better service than Wal-Mart can, that doesn’t speak very highly of our banks. I’ve been challenging my teammates here, should FirstBank oppose Wal-Mart going into the banking business, just from a philosophical standpoint? I don’t think Wal-Mart makes a big deal of having a greeter at the door, but that’s the last time you get any service after you walk in there, and generally the greeter doesn’t know where the tennis balls are, anyway.

McNeilly: I’m with SunTrust, and I would take a slightly different tact, although philosophically I tend to agree with Doug. We have partnerships with banks in some of their stores, and a consulting company that helps them. Right, wrong or otherwise, they have convinced our corporate decision-makers that their desire is only to have an industrial bank to process debit and credit card transactions. We have leases in those Wal-Marts. While it wouldn’t surprise me if they change their argument, if they were successful, at least they’ve been able to convince their corporate banking partners otherwise.

BTN: As Regions and AmSouth are in the process of combining operations, what banks do any of you think are likely candidates for consolidation in the Tennessee market—that are players in Tennessee?

Samuels: I’ve got my hands full with what’s going on right now. But when you start looking around the state and you go to the largest independents, First Horizon is certainly a franchise that’s very attractive out there—so they always get mentioned.

McNeilly: You’ll probably see some more consolidation. It’ll be interesting to see how disciplined the purchasers are. And nobody really wants to hear this or has much sympathy for us, but in the current rate environment, and the yield curve, it’s very difficult for us to make money. And when you take that philosophy and apply it going out into the future, that you’re going to actually accelerate earnings to pay the premium, or to repay the premium you paid to acquire the bank, that’s a tougher argument these days.

BTN: Anything you’d like to ask each other before we sign off?

Cruickshanks: Where are we in the credit cycle? I think in Middle Tennessee we’re in pretty good shape. I worry about the consumer. As Mike pointed out earlier, the number of variable rate mortgages we have and with the number of interest-only mortgages, this has been an extraordinary period in my banking career. We’ve had just a long, long, long run of increased earnings and increased deposits and increased loans with minimal asset quality problems. My past-dues are as good as they’ve ever been, but when times are real good, you just wonder, how long is this going to last?

Samuels: Doug, I think you’re right. When you look at the commercial loans growth, just overall, it has been pretty robust. You’ve got higher long-term interest rates that are probably going to suppress the demand for consumer lending products, and we’ve got residential mortgage and home equity lines converting over to fixed-rate, termed, credits, low-cost transaction accounts. Balances will continue to decline in the industry, so you’ve got a very interesting time for us right now.

Bibb: I agree that the consumer lending market is up, but it is up in all aspects—it’s up in credit card, it’s up in second lien positions, as well as primary lending, and that’s the segment of the market that is probably most sensitive to rate adjustments.

Samuels: When you look at the higher deposit costs, combined with the continued price competition that we get on loans, with the flat yield curve, it would suggest that the net interest margin contraction continues.

BTN: Interesting conversation, gentlemen. Thank you.