Deal making. Access to capital. Financial risk management. What’s coming in 2013?
At a Texas CEO Magazine Enlightened Speakers Series event in Houston, two leading Texas bankers, Kay St. John, Texas President of BB&T and Downey Bridgwater, Houston President of Comerica, offered their view of the coming year.
“Companies are not worrying about financing right now,” said St. John. “They are worried about taxes and regulations and the economy.”
She said it’s up to Congress to keep us from going over the fiscal cliff. If it doesn’t, we’ll go into a recession in 2013, with a two percent drop in the GDP and unemployment at nine percent, according to the Congressional Budget Office.
“The impact is going to be increased risk and severity of debt crisis,” she said. “If we don’t act soon to reassure the markets, the risk of crisis will increase and the options available to remedy or avert the crisis will narrow and become more stringent.”
On the bright side, St. John reported that small businesses are still borrowing, with $600 billion in small business loans outstanding, according to the FDIC.
Bridgwater cited three other areas of economic health: a housing recovery, auto sales, and a reduced ratio of consumer debt.
Auto sales could hit 15 million units this year, he said, which would break us out of the 14 million rut we’ve seen for the past several years. And with less consumer debt, he said people might be more prone to spend money on big ticket items, like cars and homes. “Hopefully, they do so prudently,” he added.
Companies should mind their spending carefully, said Bridgwater. “Preserve as much capital as you can,” he told the crowd. “It’s not really a great time to bet the farm with the level of uncertainty out there as entrepreneurs are likely to do. Maintain as much liquidity as you possibly can and access that liquidity.”
Although it’s a good time to borrow because of low interest rates, businesses must be sure to have an exit strategy to return to a level of liquidity as soon as possible.
“There will be a slow, but sustained recovery for the U.S.,” he wrapped up.
The following questions and answer session produced an interesting discussion.
Question: Downey, you mentioned a couple of sectors where borrowing is taking place like developers in the multi-family space, mortgages and automotive. Kay, what do you see across Texas?
St. John: Building student housing is a big sector for us. Eagle Ford Shale development in San Antonio is an important market.
Bridgwater: In addition to the sectors mentioned earlier, the energy service business goes into so many different facets, but also other industries like municipalities and we’re getting benefit across a broader spectrum of commercial industries. We continue to lend heavily in energy service.
Question: Let’s explore merger and acquisition a bit. If you are a business interested in making an acquisition, what do you recommend for liquidity and deal points?
St. John: I would suggest it is a good time because rates are low, but don’t over-leverage, have liquidity available and talk to your banker because we hate surprises. We have access to a great deal of research we can share with our clients, and it tells us a lot of industry information, so take advantage of what we can share.
Bridgwater: One of the things I learned looking at the financial models borrowers put together is – they always look great. Always. You have to make sure you have the right type of capital for that particular transaction because everything you plan is not going to happen – there will be deviations from the plan. So, be sure about the type of capital you use, it shouldn’t always be debt, and be sure you have long perspective investors to step up with you, whether recapitalizing or acquiring.
Besides all the elements of integration, you need to determine if the cultures are similar. If they are very diverse, and you try to put two very different cultures together, you’ll end up running off everybody you acquired and you ultimately will have paid too much.
Question: Can you talk about Dodd-Frank, Basel III (which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision) and your regulatory environment and how it impacts your institutions and your industry and the customers you serve?
St. John: Dodd-Frank has cost all banks substantial amounts of dollars and it still isn’t finished. We still don’t have all the banking regulations. It is driving some of the smaller banks that cannot get to compliance to look for partners. Comerica and BB&T are traditional banks and we’re not part of Wall Street and shadow banking. We’re plain vanilla bankers who come to work every day, make deposits and loans. Basel III is costing a lot of money to get compliant, too. Our capital levels are all going up.
Bridgwater: It’s also going to impact sub-limits on lines of credit, for letters of credit and other unfunded commitments and the type of capital we need. Things are going to get more expensive. It’s going to seem like we’re less interested in making certain types of loans, when in fact, we’re simply complying with new regulatory requirements and the new capital levels from Basel. As far as Dodd-Frank is concerned, it is unfinished and it’s still work in progress. I wish the regulators would just step back and take a breath and let what they have already implemented take effect.
Question: I’ve seen recent articles about the fact that interest rates are at such historic lows. Are we sowing the seeds of the next banking crisis by bankers putting out loans in this environment when rates have the potential to go up? When rates go up, it decreases the values of loans in your portfolios and lowers the surplus in capital ratios. Is this a real concern within the banking community? If rates go up, are we going to be back in the banking crisis we saw a few years ago?
St. John: That would happen if banks did nothing but fixed rate loans – you saw what happened in the S&L crisis of the 80’s because that’s exactly what happened. Banks don’t book everything on a fixed basis. We have risk management groups that manage our portfolios to hedge some of these issues. The most concern is mortgage loans and we sell those off in the secondary markets, so we don’t keep that fixed rate exposure. When we do offer fixed rate loans to commercial clients, we hedge it and protect ourselves. We don’t want to get upside down.
Question: You two both come from old line, established banks with conservative DNA. Is what you’re doing typical to the rest of the banking industry?
St. John: The more sophisticated banks, absolutely. The regulators have made this model. Basel III makes us have capital for certain types of assets. Are all banks smart? I can’t answer that question. The regulators will come down on interest rate exposure.
Bridgwater: As it relates to the type of business we both do, yes.
To your earlier question of interest rate risk – both our franchises manage that very well. Even with rates changing over the past couple of years, we’ve done a good job of managing that interest rate risk.
What you’re seeing in Europe is liquidity – that’s what will cause a bank to fail more than anything else. People are taking money out of the banks in Southern Europe and putting it into banks in Northern Europe. The problem is, they don’t really have a Federal Reserve, or a Treasury Department for the Eurozone – it’s a real strange situation that doesn’t have the checks and balances we have in the U.S.
Question: Houston has been known as an entrepreneurial city – we embrace startups. Can you comment on what the future looks like for startups? What role do your banks play in that?
St. John: The SBA, Small Business Administration, was designed for startups. We’re not there yet in Texas with SBA lending, because we’re only three years old here. We want to see companies start up.
Bridgwater: In terms of early stage companies, the real education that has to happen in Houston is with the source of the capital – VCs and Angels and other early stage investors. There’s a tremendous amount of capital here and it’s a good time to start a business in Houston. However, a lot of the capital is still directed toward traditional businesses like energy, construction or agriculture. There are a few others focused on new technology and life science companies – like bio and nano. There are some emerging trends, but we need to continue to attract new capital sources that will invest in those types of companies and those companies will stay here.
Over at the Texas Medical Center there are a litany of new companies but their capital comes from the other coasts. As is typical with that type of investment, those companies relocate to either Boston or San Diego. We need to make sure we capitalize on that tech transfer and keep those companies here in Texas. It’s easier said than done, but having an opportunity to educate investors and, more importantly, early stage investors, is critically important to our future here. Dr. Michael Porter wrote a book several years ago about clusters. We have a cluster around energy here in Houston, but we don’t necessarily have that in other sectors. We’re getting there in life sciences as they turn their discoveries into big products and stay here in Houston.
Question: We have the Associate City Controller from the City of Houston here with us today. Chris Brown is a Bauer College graduate and one of the city’s top financial experts.
Brown: From the perspective of local government, we’ve seen a great spike in sales tax income for the city – and while we’re still lamenting the property tax changes from property values – we just got word on the forecast for sales tax income and it’s up 23.5 percent for the City of Houston. The Comptroller’s office projection was only five to six percent annual growth, so this is very promising. The local economy is really heating up. I don’t know if it’s a leading indicator, but there is optimism.
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