Mitch Woods: Hello and welcome back to Lending Made Easy. I'm joined once again by the dynamic duo of David Catalano and Bryan Peckinpaugh. And today's episode is all about the current state of our economy and its impact on banking and risk management. So as we stand in the final quarter of 2023, we Find ourselves in a unique economic climate.
Our GDP has seen a steady increase over the last few quarters up 2. 1 percent in the second quarter. However, at the same time, the influx of cash into our economy from folks saving throughout the pandemic has triggered inflation. We get to rising rates as a countermeasure. So what does this really mean for banks?
We've experienced an impressive 10 quarters of loan growth indicating a strong lending environment, but you know, it's not all rosy. We're starting to see a rise in some non-owner occupied real estate, MPLs and charge offs and an increase in the FHLB advances for banks as well. So today's episode, we're going to dive deeper into these trends, discuss their implications for risk management and exploring some strategies for navigating these challenging times.
So let's get started. So David I'll kick it off to you here. What are your takes on what's going on in the current economic environment? And, you were a banker today, what would you be most concerned about?
David Catalano: There's just a lot to talk about here. There's just a lot going on and it seems like the consumer won't give up. the jobs numbers keep coming out. Good. The unemployment's not as low as it should be. We really need to shave some, some employment off if we're going to get the inflation down to where we want it.
to the targeted rate of 2%. It's just hard to get that when you've got consumers with money and the money to spend. And then when we take a look at credit card balances, they're the highest they've ever been in recorded history. And credit card applications are also extremely high. And if you think about the COVID environment, there were times when student loans, mortgages, and rents, and all the stuff that would be recorded in a credit report were all put on hold.
So people that would normally have a 640 credit score may have had a 710 credit score, making those numbers up. The point is their availability of consumer credit was increased, enhanced as a result of the stimulus, surrounding the COVID pandemic. So, I just think we've got a lot of folks that have balances, beyond where they probably can sustain them.
And, the consumer's looking stronger now than they really should as a part of that. And consumer spending is a bit higher than it really should as a result of that. And if you just take a look at some of our, the bond market as an example, the 10 year treasury minus the 2 year treasury is negative.
So every time we've had a, inverted yield curve, we've had a recession. And the only difference, the only one that was recent was the 2020 recession. But we were about to go into one. Prior to COVID, and then COVID got us out of it, but we had a small recession there, in the March timeframe in 2020, and the tens minus twos was zero.
But prior to that, all the other recessions that are negative, so, we did get to a low of, minus, well, 106 basis points. So, the two year rate was a hundred, 1. 06 percent higher than the 10 year rate. that's just telling. Right. So what's coming up in the future and now you've got the, real estate issues, but I think before the real estate issues rear themselves further, you'll have issues with the consumer.
There's just so much debt. There's just so much debt out there. And then, on the real estate side of things, there's a lot of, there's a lot of real estate debt that's coming up for refinancing in the next two years. So we'll see how those valuations play out with lower rents and lower occupancies and where those, you know what percentage of the bankruptcies occur and you know how many of the Urban malls are going to be given back to their borrowers or to their lenders.
I'm sorry So we'll just see what's going on. It's a tough time If I was a bank i'd be concerned about deposits Retaining them retaining my low cost of funding. There's a fine line you walk between chasing off your depositors because you haven't addressed the rate issue While at the same time waking up those sleepy depositors who weren't going to move anyway And just took advantage of a higher rate.
So it's a tough environment In that regard, especially if you haven't been through a scenario like that in the past on the commercial lending side I would just be careful and look at businesses that have historically been, done well during recessions or at least held their own ground during recessions.
And I'd be very careful about real estate projects. But you know, that's very broad and a community bank or a commercial bank, a regional bank is going to focus on the markets they serve and they really need to get a sense on what's going on. In the markets that they serve, because all the markets aren't the same and all the operators aren't the same.
So, but just in general, those are the trends we see across the board.
Bryan Peckinpaugh: Yeah, I think what you closed with there, David, is a key piece here, which is, each institution has to look at their own reality and what they have in front of them based on what's on their books, what their strategies are, who they are as an institution, how they're working. Yeah. looking to grow or not grow, to determine the best path forward.
I think back to summer ish of 2020 and all of the banks that I was talking to at that time. And having gotten through the initial wave of PPP and people putting solutions in the market and crazy hours that everybody was working and talking with institutions back then and saying, what's next.
And we all knew there would be repercussions, but it was impossible to tell what or when, because we throw the word unprecedented around all the time and that has never happened. Certainly in any of our lifetimes that for all intents and purposes the global economy was shut down for a period of time, and trying to figure out the short and long term fallout of that just really isn't possible.
You can't predict that because there's nothing to predict off of, you talked about malls, David, you talked about mortgages, you talked about deposits. There, there's a certain aspect of this that, age old adages don't hold true anymore because the pandemic and its fallout accelerated potentially the dying of certain industries, certain long held beliefs.
We have to step back and say, is there a new normal coming? Will we go back to an old normal in some areas? Will it be a mix of both? And I think that's going to be different across a lot of the different sectors that you talked about. I think we certainly have seen a material shift into a new normal of, what office space means and what does that do to those who lend that type of money out?
when I was growing up the advice I had from my parents was you buy a home because that's the only thing that never goes bad, right? And we saw what happened in, in 07, 08 with that, will that come around? Can anybody get into that market anymore, that are, more newer entrance to the job market. Will they rent forever? Will that be a change in behavior? Will they see a different, value proposition, to how they use their money instead of investing in a home? You talked about deposits. We'll certainly see, or it will always see the North Star there on.
Gathering those low cost deposits. That's the easiest way to cheaply fund whatever you want to do as a financial institution. But we've had a run 20 ish years where that wasn't necessarily the case where I could get quote unquote free money, not from depositors. So we'll bankers be able to adjust to going back to historic interest rates, right?
I mean, it'll, the last 20 years have been the anomaly, not the last. 12 months. So, it'll be interesting to see where a lot of this shakes up. Again, as you mentioned, it'll be institution by institution, market by market, and a mix of new ways of thinking about things and returns to old norms.
Mitch Woods: I think about that too, Brian, right? It's market by market, but also deal by deal, right? Not every deal is the same. A deal here in our headquarters town of Indianapolis. Might look different on one side of town versus the other based on your customer based on the location based on a lot of different factors as well.
So I think to your point, it is a lot of looking at things through a new lens, but also going back to the basics of understanding your market and understanding the needs of your customer as well.
Bryan Peckinpaugh: Yeah. And Mitch and it won't, it won't just look different from, the West side of Indy, the East side of Indy, like you were talking about, If I'm a Bank A, that deal on the west side may look different than Bank A views it, or sorry, Bank B views it on the west side because they're different institutions, different funding mixes, different expertise in those, those niches that, that business might be serving.
So it is, it's going to be challenging, but it's going to certainly be more emphasis on data rich decisions. So we'll certainly see a shift away from the true historic views of, I think we've discussed prior on talking about the five C's of credit. I think it'll be a shift in the valuation of different aspects of that.
And people will look for more data to prove out those areas than they may have before. So, whereas I may have relied on a handshake and a smile or knowledge of them and their family. A shift towards, well, no, you got to prove it to me. I really need the data behind everything that I'm going to do and how do I get that?
Certainly part of all the conversations I'm having with financial institutions. How do I get more data? How do I get enriched data? How can I bring more things into my purview? Because I can't rely on just what did historically good look like for me
David Catalano: One of the things I would do if I was running a bank is I would look at the, the projects I have that I'm faced with over the next couple of years and I'd pull them forward. And that may sound like more capital expenditure than you need, but the best time to do a project is when no one has well, when people can go home early because they get their work done early because they don't have enough, work to do.
Meaning, your loan production, your commercial loan production's not as high as it used to be. Maybe your mortgage production isn't. So these staff members, they have time, in their week and whenever they do a new project, say for new loan origination software or some other solution like that, that creates a second job for them.
And that can be tedious and tiring and challenging and make that project come out less than ideal. Now is the time to be investing in your infrastructure. Community banking is not going away. It's never going to go away, at least in my life. We absolutely need community banks that are commercially focused.
We have lots of them today. Now is the time to do the project. Don't pull back because your markets are pulled back or there's uncertainty around your deposits. You will have deposits and you will get, blown growth back. This is America. You cannot stop it. It will never stop. It'll just slow down and ebb and flow and we're in one of those ebbs.
That's okay. We're going to flow again. It always happens. It always will. It's not going to change in our lifetime. I think that's one of the constants that we have. While we have, evolving, markets and things like that, one thing's for certain is that America's filled with entrepreneurs.
It's a vibrant land of opportunity. Now is the time to make those investments. Do not wait until you're busy again. and everyone's got, clients to work with and new loans To put on the books. That's just my take on it.
Bryan Peckinpaugh: and. Broadly speaking, I agree with you, David. I'm gonna add a caveat though, and I'll be curious your thought here. I would encourage you, yes to move forward with those projects that, that you have out there and you're planning to execute over the next few years, but only do so in the areas that differentiate you as a financial institution.
And I think that's a. A key piece of it. You mentioned banks with community or commercial focus, David community banks, if you have a commercial focus, if you believe that differentiates you in your, in the community, you serve absolutely double down on those commercial lending projects.
If you're not now may not be the time to do it, but focus on those areas of differentiation because to your point, David, I have that expertise with a little bit of bandwidth. I may have a few folks quote unquote on the bench that I can use to bring their expertise. To bear on implementing technology.
But if I don't have that expertise, if I don't have the smart people that can inform what I do, who might be able to see where the puck is going and help me configure solutions, deliver solutions that get me there, You're potentially running the the risk of automating bad processes, right? So I think it's definitely the time to focus on technology.
Definitely the time to figure out how do I leapfrog when we come out of this? But making sure you do it in those areas of expertise. Where that multiplying factor will be there where it's not even maybe a drag because I'm now following a process I shouldn't, or I'm getting into markets I don't understand or any of those downfalls of not having the expertise internally to be effective.
David Catalano: I agree with you a hundred percent. Absolutely. So you want to improve where you're focused, things that you know and understand, not necessarily go into a new area that you don't understand or don't have the folks on staff to help you get there. Cause you're right. You don't want to automate a bad process.
That would be really bad. Really bad.
Bryan Peckinpaugh: Time to be Charlie Charlie Munger and Warren Buffett, right? And double down on where you're smart and use that to to capitalize on a down market, not try to get into stuff you don't understand and run the risk of, falling even further behind.
David Catalano: Yeah, I agree with that 100%. But you and I have been involved in enough projects when people are really busy to know that's not the ideal time to be doing a project.
Bryan Peckinpaugh: Agreed. Agreed.
Mitch Woods: So Bryan, David, thanks for some great insights today. Any final words here before we wrap up the episode?
Bryan Peckinpaugh: Sure, Mitch. We talked about where the where the puck is going. It's definitely a slightly overused analogy. I think one, one thing I might leave people with is, more than ever. Now is the time to make sure we stay on the ice. I think there's a kind of a bit of a undercurrent in the market right now, hearing it from some banks of stepping off the ice of stopping playing because they don't know what some of the outcomes are going to be.
And I get that natural tendency, but again, being on the ice, continuing to play. Ensuring that you're mixing it up and you're right there in the trenches is critical to continuing to understand the game, which is what actually allowed Wayne Gretzky, where that quote comes from, to know where the puck was going and skate there first.
He didn't do that by sitting and watching, he did that by spending hours and hours on the ice. Playing the game, watching it evolve. So, so make sure you're staying in it. Talk to your partners in the market, talk to other smart people in the market. But continue to play so that you can see it evolve in real time.
And that'll be what actually allows you to figure out where that puck's going.
Mitch Woods: It does make me think of Wayne Gretzky, whenever you say that, it makes me think of, a movie from my childhood, The Mighty Ducks, and specifically the scene where the goalie is, afraid of the puck, right, and they have to, they duct tape him to the goal, and they just sit there and fire away and then by the end of it he's good, right, and I think that's what you're saying, right, like, a lot of people might be fearful of what's going on, but it's just a matter Of sticking with it, staying in the game and, identifying those ways to be strategic and, I think that's a winning strategy, right?
Investing in your infrastructure now, understanding what's working and just continuing to be persistent in that. So Bryan, David, thank you guys so much for your insights today. And thanks everyone out there for listening to today's episode of Lending Made Easy.