FLOATING SOME NEW YEARS RESOLUTIONS

As the New Year begins, it only seems right that we should float a few resolutions. While many people will probably add weight loss and spending more time with family into the mix, we thought a more banking-specific focus might make sense as well. As a result, here are some of our resolution balloons for 2007: 1) Risk Management – Banks should ramp up their risk management processes. The flat yield curve and lower credit quality will reward banks that use risk management as a performance enhancing tool. Risk management practices are already coming under greater regulatory scrutiny, so embracing such an approach can only help. Proper risk management has become a critical element of safety and soundness. 2) Loan Pricing – The days of booking loans at prime plus 1% (with a point up front) are nearly impossible to find these days. Given tighter spreads, bankers will need to study up on probabilities of default, loss given default and market credit spreads to get a better handle on pricing. This education will not only help bankers better align risk and return, but also help support the loan business. 3) NIM – Net interest margins have been declining for many quarters. So much so in fact, large national banks don't even talk about NIM anymore. Instead, these banks focus on risk-adjusted return on equity. While independent banks will still be heavily reliant on NIM, recognizing the industry shift away from it is important to understand and embrace. Banks will need to spend extra effort to expand business lines, while finding ways to boost fee income. Given that independent banks are locked in a bitter struggle for customers with the large national banks, understanding how tighter spreads can still deliver acceptable risk adjusted returns is extremely important. 4) Prudent Review – Banks should ensure emergency processes and procedures have been rigorously tested. If nothing else, Katrina and 9/11 have taught all bankers that it is important to have an emergency plan, test it and do so thoroughly. 5) Interest Rates – Strengthening the ALCO process is also advisable, as yields are expected to gyrate throughout the year. The median forecast of Wall Street Primary Dealers at this point is for Federal Funds to drop to 4.75%, as GDP slows to 2.4%. Bankers need to be prepared not only for such an eventuality, but also pre-test and pre-model the stress that could occur if the opposite of this occurs. Understanding what could happen to profitability in multiple scenarios, will give the bank more comfort such exposures can also be controlled. While we are not sure where this year is heading, having a partial roadmap in advance and getting a better handle on risk management can only help.