Economic and Banking Sector Update Brian Hextell, Chief Credit Officer Audra Scharf, Relationship...

Economic and Banking Sector Update

Brian Hextell, Chief Credit OfficerAudra Scharf, Relationship Manager

May 16, 2013

Today’s Presentation

• Economic Commentary• Banking Sector Update• Collateral Requirements• Interest Rate Outlook

Economic Commentary

Economic Overview• U.S. Employment remains weak• Inflation remains tame• Improving housing conditions aiding household balance sheets• In December, the Federal Reserve said it does not expect to increase

rates until unemployment falls below 6.5%• The Fed projects the Fed Funds rate will not increase until mid-2015• World growth slowed in 2012• Largest downside risks have eased

– But austerity, deleveraging and policy risks continue in the U.S. and Europe• U.S. banking sector not fully recovered

As of: March 28, 2013

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World GDP• U.S. GDP revised to 0.4% in the 4th quarter

• Most Eurozone countries and the U.K. have entered recession

• Growth has been declining in Brazil, Russia, India and China (BRICs) since 2010

– BRICs experienced stronger 4th quarter 2012 growth

Source: Bloomberg, 2013



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U.S. Employment

• The U.S. employment picture remains weak even as the February unemployment rate moved two ticks down to 7.7%

• Total nonfarm payroll growth has exceeded 200K for three of the past four months

• Declining labor participation contributing to lower unemployment rate



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Housing Market

• Sustained recovery in the housing market since Spring 2012

• Existing home sales and home prices are both rising

• Case-Shiller Home Price Index recent bottom in March 2012

• Eight months of year-over-year growth in home prices first since September 2010

• Residential construction housing starts highest since Summer 2008



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Growth and Inflation• 2012 CPI of only 1.7%

• Low and falling energy prices in October through December following price surges in August and September

• Core and headline CPI increased in February

• ISM Manufacturing Index expanded the past three months following fiscal cliff uncertainty near year-end

Source: Bureau of Labor Statistics

Index MOM YTD YOY

Jul-12 228.723 0.0% 0.7% 1.4%

Aug-12 230.102 0.6% 1.4% 1.7%

Sep-12 231.414 0.6% 1.9% 2.0%

Oct-12 231.751 0.1% 2.1% 2.2%

Nov-12 231.025 -0.3% 1.8% 1.8%

Dec-12 230.979 0.0% 1.7% 1.7%

Consumer Price Index



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U.S. Consumer• Household Net Worth nearly fully recovered

after losing $16 trillion in 2007-2009

• Debt payments declining compared to personal income

• Consumer confidence trending up, but still low

• Growth in retail sales near historical levels


Source: Bloomberg, 2013 Source: Bloomberg, 2013

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Economic Summary

• Significant crisis averting measures in Europe have left many countries facing a long period of weak and sometimes negative growth

• Look for housing momentum and improved consumer confidence to continue in 2013

• Domestically, we appear headed, slowly, toward more normal economic conditions

• Geopolitical risks are rising again


Banking Sector Update

Bank Failure Trends

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• Bank failures should have peaked for this cycle at 157 in 2010 – based on previous comments from the Chairman of the FDIC

• Illinois incurred 9 and 8 bank failures in 2011 and 2012, respectively.

YearNumber of Bank Failures

2000 7

2001 4

2002 11

2003 2

2004 4

2005 0

2006 0

2007 3

2008 25

2009 140

2010 157

2011 92

2012 51

2013 (through 3/27/13) 4

TOTAL 500

Source: FDIC, 2013

FDIC Problem Bank List

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Source: FDIC Quarterly Banking Profile, 2/26/13

http://www2.fdic.gov/qbp/2012dec/chart8.htm

U.S. Banking Trends

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IL = Illinois Commercial Banks; U.S. = U.S. Commercial BanksSource: SNL Financial, 2013

U.S. Banking Trends

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U.S. Banking Trends

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Asset Quality Recovery Comparison

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Source: SNL Financial, 2013

1990s Banking Crisis 2000s Financial Crisis3-Year NPA Improvement: 2.00% 3-Year NPA Improvement: 0.73%

Reduction

U.S. Banking Trends

12/31/11 03/31/12 06/30/12 09/30/12 12/31/12

Current and Performing 88.0% 88.9% 88.7% 88.6% 89.4%

30-59 Days Delinquent 3.0% 2.5% 2.8% 3.1% 2.9% Seriously Delinquent60-89 Days Delinquent 1.2% 0.9% 1.0% 1.1% 1.1%90 or More Days Delinquent

2.8% 2.5% 2.3% 2.2% 2.3%

Bankruptcy 30 or More Days Delinquent

1.0% 1.1% 1.1% 1.1% 1.0%

Subtotal for Seriously Delinquent

5.0% 4.5% 4.4% 4.4% 4.4%

Foreclosures in Process 4.0% 4.1% 4.1% 3.9% 3.3%

Mortgage Portfolio PerformanceOCC Report on First-lien Mortgages Serviced By

Large National and Federal Savings Banks (Percentage of Mortgages in the Portfolio)

Source: OCC Mortgage Metrics Report, Fourth Quarter 2012

U.S. Banking Industry OutlookExpected trends• Asset quality improvement• Constrained revenue growth• Small decline in credit-related charges• Elevated regulatory, compliance and legal costs• Slow earnings growth • Little loan growth• Strong capital maintained• High liquidity continues

Collateral Requirements

FDIC Insurance

Dodd-Frank – Deposit Insurance• TAG Expired 12/31/12• TAG provided unlimited FDIC

coverage on certain noninterest bearing transaction accounts

• These accounts must once again be collateralized

FDIC Collateral Requirements

The Agreement must be:• In Writing• Signed by the Proper Parties• Approved by Bank’s Board of Directors

*Collateral Must be Held by a Custodian

Collateral

Security Agreement

• Between Depositor and Bank– Grants Pledgee a “Perfected Security Interest”– Describes:

• Types of acceptable collateral• Amount of collateral (e.g. 100% of deposits)

– Should reference the Pledge Agreement

Collateral

FDIC Advisory Opinion (FDIC-93-10)

“Circumstances Under Which the FDIC as Receiver Will Not Seek to

Avoid Security Interest or Collateral Pledge Under 12 U.S.C. 1823(e).”

Collateral

Pledge Agreement

• Between Bank and Custodian– Custodian agrees to hold pledged securities in a

segregated account – Custodian agrees to provide Pledgee with

monthly collateral statements

Collateral

Pledge Agreement

• Between Bank and Custodian– Control

• Depositor (Pledgee) must approve all withdraws and substitutions of collateral

• Pledgee can waive this right, but the agreement must state that in the event that the Pledgee notifies the Custodian that the Bank has defaulted on its obligations (“Event of Default”) , the Custodian must follow only instructions of the Pledgee

Collateral

Why is a Third Party Necessary?

• Oakwood Deposit Bank– Failed in 2004– Bank had pledged securities as collateral– The CEO was accused of posting the same assets for multiple accounts– Schools, villages and hospitals all lost money in the failure

Collateral

Common Collateral Mistakes

• Board minutes not received• Executed agreements not held by client• Monthly collateral statement not received• Collateral statement not reconciled to deposits• Pledged collateral is not allowed per investment policy• No third party custodian

Interest Rate Outlook

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Interest Rates

Source: Bloomberg, March 28, 2013

Tenor 09/28/12 12/28/12 03/28/136-mo. Change (basis points)

3M 0.094 0.008 0.074 -2

6M 0.129 0.094 0.104 -3

1Y 0.155 0.14 0.124 -3

2Y 0.232 0.248 0.244 1

3Y 0.307 0.35 0.35 4

5Y 0.626 0.709 0.765 14

7Y 1.05 1.138 1.213 16

10Y 1.634 1.702 1.85 22

Yields (%)

Interest Rate Outlook

• The Fed publicly linked future policy to an unemployment rate of 6.5%

• Based on the Fed’s projections, it does not expect to increase rates until 2015

• No guidance yet on the Fed’s approach for ending the asset purchase programs

• Next step is likely to scale back, not end, purchases– Prior to ending purchases, the Fed might first stop net purchases,

but reinvest maturing proceeds to keep the size of the balance sheet steady


Questions?

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