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LESSONS FROM THE 1980s
Richard Ware. CEO of Amarillo National Bank, bears the distinction of being one of the less than handful banks that survived the banking debacle in Texas in the 1980s. While I don't expect 2008 to bear a significant resemblance to Texas in the '80s, I believe the lessons he learned during the period, and was kind enough to share with me, are eternal and always be in good stead for any prudent banker. Here are his thoughts, with my comments behind each statement:
First comes denial. No one believes they have problems at first. There is always a period of denial or minimization of the scope of the problem. Be prepare to come to grips with any credit issues as early as possible; while you do not want to cry "wolf" too often, it's better to start correcting problems when there are still valuable assets to cover the outstanding credit, and not after the borrowing company is already a "dead man walking". Abide by early warning signs, from the typical past dues to overdrafts, untimely financial information and the non-revolving revolvers. Bank examiners were right 90% of the time. In the 1980s, bank examiners were right almost all the time, and bankers were wrong. Don't discount their perspective; they've seen cycles and, while not fool-proof, their input is valuable. The Greater Fool theory applies to banking as well. This is true even in today's market, when investors have been buying property with the sole intention of flipping it, only to be caught in the middle of the declining value spiral. There are some good buys at the bottom of the market. Don't be gun-shy when the market bottoms out. It's difficult to figure out timing, but it's not necessary to optimize your call. Pick the time after the bottoming occurs, and seek to lend those prudent borrowers that are now being dropped by "sector lenders" outside your community. Being conservative pays off, but ignoring market opportunities even in difficult sector with the right players does not. Banking is a cyclical industry, not a utility. Banks will fail when they make bad loans. We've seen this happen, but the last cycle was 20+ years ago. Capital cushion and residential mortgage modifications might reduce the failure problem this time (since even bad loans, when modified, do not need reserves against them), but we will see more bank failures in 2008 than we've had in a while. Only the strong survive. Ware suggests that low or no debt on the bank's balance sheet is a good definition of "strong". That is certainly one definition. Another is a well diversified loan portfolio, effective measurement across the bank of sector concentrations, and capital. Businesses must change to survive, and during hard times they make big changes. Don't expect things to be the same and return to their historical condition; they won't. Building your future on such expectations will not serve you well. An investment that makes sense only for tax reasons is unwise. Assuring the economic viability of any investment is prudent and necessary. Limited partnership end up being neither. They are not "partnerships" because your partners bail out. And, they are not "limited" because they drag on forever, and often losses aren't limited for the solvent partners. Look for companies that don't borrow more than their accounts payable, and use profit windfalls to pay down their debt. Don't make loans that don't pass the "smell" test (or, as I say, the "gut" test). They will come back to haunt you. Also remember that not all collateral is created equal (retail inventories, for example, are weaker as a collateral than, say, fully marketable fork lifts). Don't make unsecured loans. If the borrower declares bankruptcy, the bank's ability to seize assets and liquidate is there but can take a very long time. Mini-perm commercial real estate loans have a habit of turning into permanent perms. Make sure you underwrite them accordingly. If bank management uses buzz words like "re-engineering, "transitioning, right-sizing" etc, its employees and customers will probably suffer. There is much wisdom in this comment, as we've witnessed over the years when banks hire consultants with a sharp knife to re-engineer the company. All too often, the patient dies while the surgery is successful. Raw land loans aren't called raw" for nothing. Character is still the most important aspect of commercial lending. This might be a surprising comment given the comments above re collateral and solid, quantitative underwriting, but I feel it's spot-on. While you can't take character to the bank (no pun intended), no collateral in the world can make up for a crooked borrower.
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