Artisan Unfiltered #5: Recession Roundtable

Four banking experts with four distinct POVs on the recession…including whether we’re actually in one. Check out the latest Artisan Unfiltered podcast for insights and advice from Jim Adkins, Jeff Voss, Ron Mercer and Dave Larson on what your bank should be doing right now - starting with listening to “Recession Roundtable: Artisan’s Advisors Weigh in.”

Transcript

Artisan Unfiltered #5: Recession Roundtable

Jeff Voss: Welcome to Artisan Unfiltered. It's a series of podcasts that focus on current topics in the banking industry. Today's discussion will focus on recent economic news surrounding whether we're in a recession or not. And more importantly, how banks can respond to the changes in the economy. My name is Jeff Voss and I'm here with my co-host Jim Adkins and two of our esteemed partners at Artisan Advisors, Dave Larson and Ron Mercer. 

Dave recently joined us at Artisan after spending 30 plus years in community banking and regional banks based in the Chicago market. Most of Dave's time was spent in the roles of chief credit officer and chief executive officer and board member of these institutions. Dave is well known to the Chicago banking community, and we look forward to working with him on a variety of board level assignments. 

Ron Mercer has been with the Artisan for nearly five years, serving on a variety of clients, performing acquisition, due diligence, loan review, and troubled loan advisory. Ron's career spans over 40 years first as an owner of a CPA practice in the Chicago market. And then for the last 20 plus years serving, the community banking industry as an outside director, and troubled loan specialist assisting numerous banks with their troubled asset workout strategies. 

So with that, welcome to you all. And we can get started with our discussion on, uh, state of the economy. So the first, first question I throw out there group is, are we in a recession or not?

[00:01:42] Jim Adkins: Well, I'll jump off. I'll jump off that diving board there and I think we are. And one of the reasons I do is I, I guess I'm a little old school when it comes down to performance, you know, we've had two down quarters in a row that's generally been accepted as a recession. And I know there's arguments, you know, foreign against that definition now, but I'm going to stay with it and say, we are in a recession.

For me, the matter is what, you know, how deep is it going to be and how long, uh, that's the way I view it. I don't know how the fellows on the call view, but I'm going to plant my flag right there.

[00:02:21] Ron Mercer: I'll go ahead and jump in. And also, uh, you know, I, it's always difficult. You mentioned when does it start? When does it end? And so I, I think it's difficult to set a definite period of time that we are in a recession today. We weren't yesterday and we're not going to be next week, but, uh, if we're not in one, now we are certain.

Coming towards one in, in my opinion. And so I think what, you know, we, we should start assuming we're in a recession and usually what happens is six months later, they tell you, you were in a recession six months ago. And I think that's, what's going to happen is, around the end of the year, we're going to be told that last summer you were in a recession.

And so I think that's the way we need to start planning. And now the real question and, I'm not sure there's anyone that I respect that would have say I definitely have this answer is when will it end? Obviously we've, we've been around long enough. We saw the recession in the 80s, the 90s, they were, you know, somewhat short and lived compared to the Great Recession.

And so is it going to last six months or is it going to last four years? And, and, and that's, that's the question we need to be thinking about.

[00:03:34] Dave Larson: Well, I don't think I'm going to differ too much, although I would, I, I just want to, in my mind, I often say it's early. Uh, and so it, it does depend a lot where we're, where we're headed. I would say that the annualized numbers for the, the, the, the client are. Are stronger, more, you know, grab the headlines.

But at the end of the day, the economy was down about GDP 0.4% in the first quarter and, uh, 0.2% in the second quarter. So that's 0.6% from where we were last year. That in itself, uh, is, uh, I don't think so bad again, he's look at the depth of recession. We've certainly had far worse recessions than that.

Although I don't disagree. I think with the Fed, uh, with inflation where it's at with the Fed set to do another, probably 75 basis points of one point half percent, um, of raises that would take prime to, to 7%, uh, and all the other rates that just credit card and so on. So I think that that definitely would, you would think that would continue.

We'd continue to see a slowdown. And then, uh, uh, Ron, as you said, it all depends upon how inflation reacts and, and you know, how long it takes for the fed to, to get to push through that.

[00:04:40] Jeff Voss: Yeah. I think the, the, the headwinds here, you know, are in the other number that you see every day, it seems like the CPI, the inflation number being over 9%, um, in the impact of that. And obviously the responses of that by the. Uh, raising interest rates at an unprecedented rate this year, you know, Fed funds is up over, I think it's up 2% since the beginning of the year, what we're facing right now is a, a flat yield curve at best.

Uh, even inverted I think was inverted yesterday, slightly out to 10 years. Um, you know, and the impact of all. And the, the numbers that you see aren't the numbers necessarily that you feel the CPI number, for example, being up 9%, uh, doesn't include certain key elements to it. I mean, it it's missing, for example, the energy prices that we're paying, you got energy prices that are up over 40% from a year ago, and those numbers are astounding.

And it was saying to you guys, uh, the other day, um, when I take a trip out to my, my other home, which is a, you know, a couple hundred mile drive, uh, I end up spending a hundred dollars each way and, and wondering whether I should be flying as opposed to, uh, driving at the, at this point, just the, the cost of everything is up.

You go to the grocery store, you, you, you buy, uh, any type of commodity these days. You're seeing the prices rising dramatically.

[00:06:18] Jim Adkins: Well, and I read an article just recently, I can't quote the article, so I, I don't want to get too deep into it, but, you know, they calculate inflation differently as well. I mean, they've always kind of excluded food and energy. Factors, but, uh, the calculation differs greatly from, you know, back in the 80s.

And, and I don't remember who wrote the article or the exact numbers on it, but if you went back and calculated inflation, like they did back in the late 70s, early 80s, the number went to like 14 or 15%. So, uh, I think your point Jeff is, is a good one that, you know, it looks one way, but it feels another way.

And, uh, you know, I'm a, I'm a believer. If we're talking about whether we're in a recession, we probably are. You know, and, uh, I think, um, you know, that that's kind of the way I look at it.

[00:07:09] Jeff Voss: So I was at a board meeting of a client of ours last week and regulators happened to be there. And it was an interesting, interesting, uh, take one of, one of the, actually two board meetings in the last couple weeks. And one of them was, um, the DIC and one of them was the OCC, but both of them had pretty consistent, uh, views on where we are.

They're not saying that the banking industry has credit issues. The focus of their attention is on non-credit related issues. But I guarantee you they're, they're still, they're still lurking in the background waiting to see information that would support a credit related problem so they can jump on it.

But the, the topics were banks. You know, you are, you are full liquidity. You need to do something with this liquidity. You know, go out there and make loans and I'm not sure, you know, whether that's the right decision at this point in time or not, but that's, that's really what I've heard from two separate, uh, regulators at these board meetings, uh, this past week.

[00:08:25] Jim Adkins: Well, this may be an instance where the banks are ahead of the, the regulators a little bit, you know, in terms of whether we're in a recession or not, because. I think I've seen and, you know, we've got a number of clients across the country and, and I I've seen a discussion about this and I've seen, you know, I don't know if I've seen dramatic pull downs or pullbacks rather across the board in terms of lending money, but I I've seen the beginnings of it.

I've seen people talking about it. And that usually means that it's on its way. And, um, you know, I think there are probably certain asset classes and I think Ron and Dave can really comment on. That are going to fairly quickly, you know, if they're not shut down now they're going to be shutting down.

[00:09:09] Dave Larson: I think that's an interesting point, Jim, as you, as you segue to asset classes, because clearly, um, you know, business is an industry will be impacted differently depending upon where they are in these, in the prospective inflation or supply chain issues. And, and then the whole, um, impact from, you know, we clearly on everybody's mind is office, uh, and depend on the market.

I was speaking to someone yesterday at a large, pretty large national bank, and very, very concerned about it. And he said, well, so far we, we're not, you know, people are paying or we're not in distress, but they have a lot of interest only loans. The CMO markets are locking up there. Aren't there aren't the takeouts for, uh, there were in the past.

And so what they're concerned about is as they, um, you know, they might build to continue servicing interest, but they can start advertising principle. They're going to have TDRs and stress there. And that will force, could force further tightening and, and optionality for, for lenders, with office portfolios or in that space or developers too.

And so I think you do have to look at the different classes and, and that, that will merge. I think the beginning to merge now, as you know, we get beyond too, beyond the, all the COVID money that the, when everybody's pockets, uh, disappears. Um, how do these damaged sectors respond after that?

[00:10:26] Ron Mercer: Yeah. If you think back historically, um, there's, there's been a trailing indication from both the regulators and especially from the appraisers, the appraisers do all of their work based on historical data. And on commercial property on multi-family, it's usually over the last two years, actually on residential, it should be within the last 12 months, hopefully even within the last six months, but still that's, it's, it's always trailing and you look back historically and you say, well, over the last 12 months or 18 months, this six flat sold for this.

And so that's what the appraisal stands for. And so they say, well, maybe there's not. Lending issue or a credit issue, but the real value today what's happened in the last 30 days or 60 days, uh, will show up six or 12 months from now. And so I believe that there there's some indication there, even though they may be saying there's no credit issues, I believe that's because if we look back to the 2006 and seven and. Uh, those appraisals and it's not that they're doing anything wrong. It's the way that appraisers are trained. And it's the way that it's set up to show historical data. They're not supposed to, uh, look ahead and give you values based upon what they think is happening today or what they think is going to happen next month or what the real market value.

Today, they, they give you an, an indication of what the value is indicated by the last period of time. And so therefore, I, I think, you know, that's another indicator that, that we might have some credit issues that are really here now that just not being shown yet.

[00:12:03] Dave Larson: Well, we do drive with the rearview mirror. Don't we?

[00:12:06] Ron Mercer: Yes, sir. Yeah, we do Dave. Yep.

[00:12:09] Dave Larson: Economics and credit to a certain extent as well. Cecil, I guess Cecil is challenging it.[LC1] 

[00:12:17] Jeff Voss: Yeah. Yeah. So, so what, what makes this recession different than, than the last one? The, the Great One. 

[00:12:33] Ron Mercer: Well, I don't think we know that yet. Uh, Jeff, in my opinion, um, let's just hope it's different than the last Great Recession. And let's just hope that it's more, what we've. Since the, since the depression, our recessions have been, I, I don't want to say almost healthy for us. But recessions are not the end of the world.

It's somewhat of a correction. The, the, the economy's been inflated artificially over the last year by, you know, free money and giving things out. And so sometimes the recession is a good little correction. The ones we had in the 80s and 90s sometimes that's what happened. The real estate market corrected a little bit.

And so let's just help that's what's happened. And I don't think we'll know that, you know, for, for a while, Uh, the Great Recession, just, you know, I, I remember, you know, uh, at least, you know, we, we were all actually very active in the Great Recession and every quarter, what you looked at last quarter and said the value of this property on March 31st is this.

And I think I've been as hard on it as possible in June 30th. You said, what was I thinking? It's not even close, it's worse than that. And 9, 9 30. It was worse than that. And so all, all we can do is at this stage. Keep plugging forward, in my opinion. And just hope that it's, you know, that it's a, more of a normal recession versus the Great Recession.

[00:13:56] Dave Larson: Yeah. I, I, I think so too. I think, you know, if you remember back to you with the great inflation epic of the 70s, there are many, many years of expectations and, behavior that, that underlie those, the depth, all that, the amount of that inflation. It's just been a, you know, we've only had a, you know, a year or so of real, real inflation here.

So I think the big question is how much of that is in expectations and can that be stopped? And that's obviously what the Fed is jumping on it for now. It took 'em a while, but they're jumping on it now and indicate that they're definitely going to make that their priority. Uh, so I, I think, yeah, I think, I think this could be a much more moderate recession.

I don't see the, the, the, you know, the Great Recession coming back here, unless there's some external event or some international issue. Uh, but I, but, so I do think there'll be more a question of what, what assets, what industries are impacted the most. And so maybe it's, you know, more, more sectors that get hit or hit harder. Um, as consumers pull back, for example, they stop, they, they cut back on, you know, um, on fast food or, uh, you know, other, other types of, uh, goods that, that you aren’t necessities. Whereas if you're in apartments and housing and, um, you know, apartments may look much different than they did in.

[00:15:18] Jim Adkins: Yeah, I, you know, my, my take on it, I think 2007 and Great Recession, there was very systematic. Compared to this one. And I, I think this one and I don't want to get political, but this one seems, uh, more policy driven, uh, to a certain extent. And, um, you know, that the systematic thing had to work its way out.

It took several years, uh, as everyone knows, we are on the table here, we were around the table. We were all involved in this in a very deep way. And I think we could probably, whether, you know, I don't know how deep this particular recession will be. I think we are going to be in one or we are. But I, I think it might be, uh, more correctable than the last one.

I think the last one just had to really work its way out because the system, uh, seemed to be pretty dramatically broken liquidity, dried up in a way that we've never seen. And this one, I think, you know, with maybe certain policies and things like that, I, I think hopefully this will be more short lift than the.

[00:16:17] Jeff Voss: Yeah, and I, I, I see, I see this call to recession. Um, I see this situation different in. it's a convergence of many different factors. Uh, not cause as much by behavior caused more by a situation. That number one, the pandemic created a situation where people weren't spending and it created, uh, pent up demand and desires to be able to go out and do things.

So you see consumer spending. um, but you also see shortages in the supply chain and the supply chain that's out there today is creating problems for people to be able to go out and buy them. They're paying over sticker price for automobiles, they're paying over list price for real estate. Um, I, I, I think it's a, it's a different feel to it than.

You know, back in the, in the oh 6 0 7 arena where everybody was just going crazy. If liquidity was out there and then all of a sudden it dried up. Um, I think people have a lot of liquidity today as evidenced by our, our bank banking system, you know, sitting with just boatloads of cash, trying to figure out what to do with it and, and it, and then to top it off, you've got the war.

You know, the war is creating pressures on commodity prices, you know, oil prices and it's, it's, it's a challenge, you know, it's, it's something that, that we have not experienced. And again, the question is, you said Dave and Ron, the depth and the length of, of anything. And hopefully the policies that we've put in place are going to allow us to, to move through this. Um, we're going to feel it though. I, I, I have no doubt that the industry's going to feel it and we are going to feel it as consumers.

[00:18:20] Dave Larson: Yeah, I, I would add on, I think too, it makes me think of stagflation. Do you, you get more of a, of a slowing economy then inflation hangs around for a couple years. And holds onto its position, uh, because inflation hasn't come down. I mean that it could look like a, you know, I'm not saying it could be severe stagflation, but that could be one scenario that looks increasingly a little more possible. 

[00:18:44] Jim Adkins: Well, and, and we were talking earlier about the participation rate. You know, we, everyone talks about the labor rate and it's 3.6 or whatever the number is, and it's low and all that. But the participation rate's very low as well. And you know, when people who have built up cash reserves, those cash reserves, aren't going to last forever.

I surprisingly, they, I I'm surprised they've last this long. And as soon as they get to a certain. Uh, you know, that spending consumer spending could drop even, you know, could drop, beyond what we might think, because cash reserves could dry up and, and, you know, here we are now, hopefully then those people go back to work.

But then of course, or at least steep work that would drive their unemployment rate back up. But, uh, I'm, I'm surprised that the participation rate is as. it is, you know, so must be the liquidity out.

[00:19:41] Jeff Voss: Yeah. No question. So, so one of the topics, um, is. Government's proposing a new spending bill, right. With, uh, a lot of money going into it here. And what they want to do is tax and spend. How do you guys feel about that in terms of helping us get out of a recession?

[00:20:09] Ron Mercer: Well, certainly if it's, if, if it was geared towards what they say, it's geared towards, let's just start with one, one topic, the infrastructure. The infrastructure in our country needs help. It is, you know, greatly, you know, in need of some repair. And so that would be a great way. Unfortunately, there's so many things connected to this bill and so much, you know, free, free money going out again, that it, it gives you pause and gives you concern.

I do think that we have waited decades. To spend some money on our infrastructure. We remember back in the 60s and the 70s, all the money spent on highways and, you know, just taking in Chicago, I 55, the way, you know, and then 3 55 and all the different highways that were built up.

And we haven't seen any of that in a long, long time. And so, you know, the infrastructure is in great need, but unfortunately I think there's a lot of free money. That's going to be wasted again.

[00:21:13] Jim Adkins: Unintended consequences. Right? Politics is about avoiding unintended consequences. I agree with you, Ron. I mean, you drive under a bridge and you pray because when you look at it, you just think, oh my gosh, how is that bridge standing up or staying up? But, um, you know, just could you spend money doesn't mean it's productive money and you know, here we are going to spend a lot of money and it's not going to, you know, hopefully it's meant for productive purposes.

I, my, my feeling is it could be a lot more productive and, uh, you know, I don't know if we're going to get the bang out of this spending that, that, uh, some people in Washington think we are.

[00:21:50] Dave Larson: I think, uh, you know, one aspect of this, which I have not seen as much coverage on, but I think we will soon are the impacts of all this spending, this continued deficit spending and rising interest rates. And the cost of service that debt, if you recall back, remember about 2015, it was almost a daily topic of the credit worthiness of the United States moods.

I think downgraded at like not or two, there was all this concern about deficits, you know, and deficits and so on. And then we, we went into the Trump era obviously and, and, and covered then obviously, then the fed disease enormously now. That the cost is…I don't have the statistic here. It's huge in terms of the amount of difference of what it's going to cost to service the debt every for every, you know, percentage point of, of, you know, rates up. so. I think that's be a very, it's another impact where, you know, we used talk about, you know, the crowding out, you know, will that emerge again, as rates go up, the government's going to this debt's out there and we've had historically other nations want to hold it. And the dollar's very strong, more so because we’ve begun to tighten and some of the European nations haven't although they're beginning to.So that's another variable that, that that's out. Once you've spent the money, once you borrowed the money, it's it, you know, there's not a lot you can do if you're particularly, if you're fighting inflation, So I think that, that, and there hasn't been that record.

Remember, modern monetary theory. Don't hear too much about that now, do we? Because that was the idea we could spend unlimited amounts and no, and rates were low. Rates were low right there, nothing happened. And, but now the rates are going up. And so I think it'll, it'll be real variable.

[00:23:25] Jim Adkins: Yeah. The, the case that they're trying to make, that the bill is going to lower inflation is a weak case. And, uh, you know, I not to get into the bill and, and all the details of it, but it's just, doesn't make a lot of sense to me. Um, but, uh, maybe they have a magic formula that we're not.

[00:23:49] Ron Mercer: Well, again, we we'd have to go back and we'd have, have to go back and find a bill that lowered inflation historically once, you know. Spending money, just never, uh, in my economic value let's just say is, is not, is not great, but spending money does not lower inflation and it, it would be tough for them to convince me that's going to be the case.

[00:24:16] Jim Adkins: Right. Right. And, and Senator, Senator Manson, you know, Jeff just saying Senator Manson, who I, you know, I I've got respect for Senator mansion and, he was making that case and, and I, I saw him in an interview and he was pressed to show his numbers. He didn't want to show the numbers and maybe, I don't know why not that he doesn't have the numbers, but, uh, again, not a convincing case that this is going to have an effect or a lowering effect on inflation. It may have an effect on inflation, but the wrong one.

[00:24:48] Dave Larson: Well, there's a letter out there. A hundred economists signed, um, concluding that it would lower inflation. So we, we must not know a lot.

[00:24:56] Ron Mercer: Right. No, and they're smarter. They're smarter than I am, but they've said that in the past.

[00:25:00] Dave Larson: And they've, and they've also drowned in rivers with a depth of only two inches. But at the end of the day, who knows, you just have, has to do is, is have a good risk management program. And, and, and you, you gotta lend through it.

[00:25:23] Jeff Voss: Well, that's, that's a great segue Dave, into, uh, kind of the next topic, which is what are our, what are our clients, what are the banks need to do, um, to protect themselves today? Um, what, you know, the news, the news is uncertain. Uh, you're getting conflicting news between the regulators and. What, what the news cash show and what the hard facts are, first of all, what are we seeing with our clients?

And then what do banks need to do to respond to this?

[00:26:03] Dave Larson: Well, I think, uh, you know, I was talking to a couple people last week D from different angles, too. Some from the line, some on the workout side, uh, I think, you know, clearly its banks are tightening, they're tightening on pricing. Um, they're tightening on, on recourse, particularly in the, in the real estate space.

Uh, and I'm talking more, probably more the middle market side. But the good news is that markets are still functioning. Banks are still lending of a tight aside from whether it's hospitality or office clean little sectors. People have pulled back a lot. Uh, but I, but I think what, what, what it means is you have a lot of optionality to, you know, refinance or know exit relationships that don't fit portfolio.

Uh, you have time now to work on issues. If you do have emerging issues in your portfolio, Uh, the economy's still, you know, moderate recession. This point, there are times you can really work with what you have and then can prove what you have in your portfolio. 

[00:27:01] Ron Mercer: Yeah, there are many things. I think, uh, you know, one of the areas I work in mostly is multi-family and there are certain indications. I think banks should be watching that. Uh, there's very little. Um, and analysis of it, if any, and that is the strength of the tenant. Let's just say a, multi-family take a 12 unit or 24 unit building.

They may be current, or maybe there's only one of them that are behind on their payments, but they're, the payments are only current because they've received some type of assistance in rental. That's going to run out. In the next six months or three months or at some stage, and, and they're not in position to make their rental payments.

And so when you see a vacancy loss today, still most vacancy losses on most appraisals are still 5%. And historically that's, you know, that's, that's true because they're not vacant, they're occupied. And, but many of them are being paid through government assistance. It's not going to be permanent. It's temporary government assistance of some sort with city of Chicago.

Where's the market that we work in a lot here. And that is, uh, so I, I, I think that the banks needs to be looking some type of analysis of the strength of the tenants and their propensity that the, that they can pay next year and the year.

[00:28:24] Jim Adkins: Um, well, I'll jump in here. I, you know, obviously concentrations are always important. Uh, I would look at concentrations that could. And negatively, well, not all concentrations are going to be negative, negatively affected by a recession, but I would, I would take a look at where I have concentrated, uh, assets.

Um, I would also look at, uh, construction, my construction portfolio and the assumptions that were made, uh, going into that construction, uh, uh, project. Uh, a lot of those construction projects are probably apartment type projects. And as Ron was alluding to you. How is that going to hold up, uh, as we get deeper and deeper in into recession.

So, uh, and I also think there's, you know, there's always risk in construction, but, uh, it's going to be, uh, if we get into recession rates continue to rise, uh, you know, there's going to be more strain on interest rate on the interest to reserve built into a project. And, uh, you know, the supply chain is also affecting these things.

So, uh, I would take a hard look at concentrations and I take a hard look also at my construction portfolio, you know, as we, you know, continue to debate, you know, how, how bad the recession is or whether we're even in one.

[00:29:44] Dave Larson: I was going to say, I think too, I think a real important aspect of this is really understanding what you have, which all starts with, with the quality. In, in the real time, accuracy of those ratings, if you don't know what you have in your portfolio, you can't take action to, to, to properly address it.

Uh, and, and when you come, when we've come through this, this long expansion and times have been good. I mean, the, the workout guys are out golfing and, um, or they're, they're, they're not working there anymore. Uh, there's just, I think you can, you can, uh, Behind it, you know, um, and just get to too casual about it. And I think you always want a culture that's, that's real, that just is built around that mile. Cause your risk management is only as good as your risk program. And that determines what gets looked at, who looks at it, who handles it, uh, and, and how much of an exposure you have against your capital.

[00:30:40] Jim Adkins: The blocking and tackling of, of credit administration., right? You know, the basics and, you know, when times are good, you know, you kind of do what you need to do and you keep, you know, you just kind of forget about maybe some of the discipline that you need. And I, you know, you’ve got to go back old school and, and look at that stuff.

I, I agree with Dave a hundred percent on, on those.

[00:31:03] Dave Larson: I saw a report the other day. It was a, a workout report that, you know, the it's it's July or August now. And the last comment was, you know, borrowed to refi by February of 22. Well, it's obvious that tells me two things. One. They're not updating the report, two management, isn't reading the report. Cause if someone handed me the report that had that comment, I'd be, you know, be like, You'd be upset about that. Cause that's, and that can go, that can relate to all aspects to whether they're, you know, what did you get their financial statements? Have you tested their covenants or, you know, how well you monitor them.

And, and so you also have to look at your exception reports, whether it's documentation, exceptions, uh, that the midst of the recessions, not the time to find out your, your title is impaired, uh, or, or did you know, uh, so on, um, as with, you know, covet monitoring, debt, service coverage, uh, all those aspects. A good culture will be current on those things and those, and those will all drive.

As you get that information in it will drive the quality of your risk rates and, and detect problems.

[00:32:07] Jim Adkins: I don't think there's a downside. Uh, you know, I look at things life, you know, upside, downside. I don't think there's a downside for assuming there's a recession. If you're a bank, you know, I think you can go ahead and say, okay, let's assume there is. And let's do all the things that Dave was talking about.

And Ron's talking about Jeff. And go forward on that basis. And, and if you overshoot a little bit and, and maybe overestimate the, the level of the recession then okay. Shame on you, but at least, you know, you're going to get ahead of it. And it, it, I think that there's no real major downside on that. So I, my recommendation is to assume that, you know, maybe not the worst, but that there is something out there and get back to the basics that I think there's no harm in.

[00:32:52] Ron Mercer: And following up on both your comments, Jim and Dave, there's no downside to starting early. If you're looking, let's just say you have several, several properties, uh, uh, with one lender. He probably has a separate couple of different institutions that he's borrowing from. And then, and there's maybe one piece of property that's has no liens on it and rent free.

And the person that asked first for that additional collateral is going to mitigate their damages and the person that sits around and waits till they really have a problem. And now says, can we get any additional collateral? He said, wow, just six months ago he gave that to X, Y, Z bank. So I would start early and start analyzing and start figuring out ways to mitigate damages on properties.

And again, there's not going to be a lot of them. Hopefully it's not going to be the Great Recession, but the few that are why not mitigate and reduce them by as much as you can.

[00:33:47] Dave Larson: Well, well said, Ron, I've seen that again and again. Uh, and, uh, it's, you know, you just can't emphasize that enough. Cause the other part I would say is, is the, you know, the throughput aspect because times have been so good, a bank might play around with a watch asset for three years, uh, or even a non accrual, you know, and not, not feel the need to really move on. When, when you get a downturn, those, those will start piling up. And then you're dealing with, you know, classified to capital ratios that, that, you know, take your, your exam ratings down and, and compare your other ways. So it's, it's a good culture to have that says, “Let's get on the problems now.” It doesn't mean you don't, you know, you don't take care of your customers and work with people and try to understand issues, but you want that kind of culture that, that deals with the issues and, and, and moves on.

[00:34:35] Jeff Voss: So, so banks are, are full of liquidity, right? We all, we all know what our clients' balance sheets look like and there's pressure on. And then to do something with that liquidity, um, talking about you guys were talking about some existing issues or problems. what should they do if they're, you know, they're, they're pressured to lend, structuring new deals.

Um, what's your advice on, on, um, you know, lending certain sectors? Should we stay away from certain things? Uh, tructure structuring the deal properly. Any comments on that as it relates to, uh, helping banks?

[00:35:20] Jim Adkins: Well, I, I would say, you know, going back to my earlier comment, I, I would definitely wonder if I want to add to concentrations, you know, significantly. So I find my concentration points and. And make sure that maybe I, I don't want to add to those. That that's probably one of the areas that I would move towards.Then of course the construction thing, uh, I think I would be careful there as I go forward.

[00:35:54] Jeff Voss: Any, any asset classes you'd stay away from today?

[00:35:59] Jim Adkins: Yeah, I would probably, you know, the retails is a mess. It has been a mess. Ron Mercer has a tremendous amount of background in evaluating those things. And he could probably talk for a long time about how much of a mess that is. So I certainly retail offices is not real strong. Dave has some good opinions on that.

He's got some experience in that area. So retail office and you know, the apartment, not everything can, not every apartment deal is going to work. And as the liquidity and the economy drive. People won't be able to make apartment payments, like they did rent payments. And so, yeah, I'd be careful with my apartment, uh, uh, portfolio as well.

[00:36:44] Ron Mercer: I think following up on that, I think the office market is in particular. Let's just stick with Chicago, the office market. I think before you make a loan, you need to analyze the leases that are there. Normally, if there's a lease that has three years left on it, or you know, anything more than a year, you say, okay, here's a lease and that's included in your NOI and calculated in, but now you need to look and say, how are, how much are they utilizing the space?

If they have 20,000 square feet today? They're only utilizing 10,000 of it. They're paying rent on 20,000 because that's what their lease states. But when their lease comes due in three years, they're, they're going to say, I only need 10,000 square feet now. And so I think we need to start analyzing more about what's going to happen, not in the next six months or 12 months, because most leases are longer term than that on large properties.

And so on the office space, I would, uh, I would beware and do some deeper analysis other than just your basic appraisal.

[00:37:44] Dave Larson: Yeah. And Jeff, to add onto your question, I think I would say it's, you know, whether or not to stretch, it starts with your loan policy and hope you have a good one, um, that, that really, uh, it matches your risk, risk profiles you're looking for and concentrations and coverages and so on. At the same time, I think in the market today.

I think that so to follow that, but I think the market is tidying. I don't think you should have to stretch today. And I don't, I would think most chief credit officers are not willing to stretch too much today. And so, so for me, high profile would be my unsecured exposures, any type of situations where lending on enterprise value or cash flows. Leverage is, is huge. I think one thing we haven't talked about is, you know, the impact too, on the higher rates on, on business' ability to service their debt. And so particularly I think in the leverage, you know, you've seen that in the credit markets, a leverage loan pricings tighten up a lot.

Those prices have come down in those loans. And for PE lenders, PE you know, they're I think they're definitely exposed as rates continue to rise. If you get the combination of a recession, they're going to feel it first, even though the business could be fine to a certain extent or, or okay. They still may have trouble servicing debt.

And those in those situations, you rely on an enterprise value and we've seen enterprise value can diminish very rapidly, so it depends upon the space lines, maybe more of a middle market bank. Community bank probably doesn't have as much of that, but they still have unsecured exposure. And those, those are definitely where, where I'd focus and earlier too, enhance them.

Now you might be able to now once the market's freeze up, everybody's tightened up. No, one's out that loan without a guarantee. A good guarantee.

[00:40:00] Jeff Voss: I guess I'd like to, uh, ask you guys, do you have any final thoughts, that you'd like to add? Any advice to the banks, uh, before we sign off?

[00:40:12] Ron Mercer: Well, mine would be just to reiterate my statement of starting early, you know, and the goal is always just to increase the classification. If you've just made it an unclassified asset, what can you do to move it up, to get it off that list? If it's just moving to non accrual. Now that is a difficult one to get something.

Off of non accrual is of the six month rule. There's lots of reasons, but it's still, the goal should be to move towards that and to start, and, and again, even talking to your clients about moving their loan to another bank, there are some, there are some merit to have, if you have a loan that maybe you're not the bank for them anymore.

And while times are still relatively good. They could probably move that loan and, and, uh, and, and, and start considering. So starting early and analyzing, uh, the, the loans just when they start right away, getting to unclassified would be my, my final conclusion on statement.

[00:41:12] Dave Larson: Yeah. I, I agree with all with all those points. Uh, and, and obviously from my years of experience, Ron seeing it work right. And seeing when it wasn't done properly, the, the cost of that, I think it, for me, at the end of the day, it's all about your risk management. There's nothing more, more like a recession to test the quality of your risk management program.

So it's all those things that make up, uh, make up that which starts with, with risk ratings, with the monitoring administration or portfolio, it's all, everything is driven up by your officers. That information has to flow up. They have to do their work, uh, reporting, um, all the monitoring, all those things everybody knows about.

And we all know it's important, but you've gotta do it. And the end of day, you gotta communicate, uh, whatever, you know, depend the size your bank, whether it's everybody's sitting around the table, reporting. Make sure that the problems are talked about early, so that you can deal with them early and, and you'll sleep much better at night.

[00:42:05] Jeff Voss: Great. Well guys, uh, again, thank you for joining us here in the, in the podcast. We thank all of you who will listen to this podcast. Just. Feel free to give Artisan Advisors a call. If you'd like any independent or objective reviews of your loan portfolios or any other type of consulting services, management consulting services, uh, we'd love to talk to you and see if there's a way that we can help you.

Uh, so with that, uh, we will sign off now and, uh, gentlemen, thank you again. And we will see you in the next podcast.

 [LC1]Cindy – can you make this out? If not, we may need to clarify

Artisan Unfiltered #5: Recession Roundtable

Jeff Voss: Welcome to Artisan Unfiltered. It's a series of podcasts that focus on current topics in the banking industry. Today's discussion will focus on recent economic news surrounding whether we're in a recession or not. And more importantly, how banks can respond to the changes in the economy. My name is Jeff Voss and I'm here with my co-host Jim Adkins and two of our esteemed partners at Artisan Advisors, Dave Larson and Ron Mercer. 

Dave recently joined us at Artisan after spending 30 plus years in community banking and regional banks based in the Chicago market. Most of Dave's time was spent in the roles of chief credit officer and chief executive officer and board member of these institutions. Dave is well known to the Chicago banking community, and we look forward to working with him on a variety of board level assignments. 

Ron Mercer has been with the Artisan for nearly five years, serving on a variety of clients, performing acquisition, due diligence, loan review, and troubled loan advisory. Ron's career spans over 40 years first as an owner of a CPA practice in the Chicago market. And then for the last 20 plus years serving, the community banking industry as an outside director, and troubled loan specialist assisting numerous banks with their troubled asset workout strategies. 

So with that, welcome to you all. And we can get started with our discussion on, uh, state of the economy. So the first, first question I throw out there group is, are we in a recession or not?

[00:01:42] Jim Adkins: Well, I'll jump off. I'll jump off that diving board there and I think we are. And one of the reasons I do is I, I guess I'm a little old school when it comes down to performance, you know, we've had two down quarters in a row that's generally been accepted as a recession. And I know there's arguments, you know, foreign against that definition now, but I'm going to stay with it and say, we are in a recession.

For me, the matter is what, you know, how deep is it going to be and how long, uh, that's the way I view it. I don't know how the fellows on the call view, but I'm going to plant my flag right there.

[00:02:21] Ron Mercer: I'll go ahead and jump in. And also, uh, you know, I, it's always difficult. You mentioned when does it start? When does it end? And so I, I think it's difficult to set a definite period of time that we are in a recession today. We weren't yesterday and we're not going to be next week, but, uh, if we're not in one, now we are certain.

Coming towards one in, in my opinion. And so I think what, you know, we, we should start assuming we're in a recession and usually what happens is six months later, they tell you, you were in a recession six months ago. And I think that's, what's going to happen is, around the end of the year, we're going to be told that last summer you were in a recession.

And so I think that's the way we need to start planning. And now the real question and, I'm not sure there's anyone that I respect that would have say I definitely have this answer is when will it end? Obviously we've, we've been around long enough. We saw the recession in the 80s, the 90s, they were, you know, somewhat short and lived compared to the Great Recession.

And so is it going to last six months or is it going to last four years? And, and, and that's, that's the question we need to be thinking about.

[00:03:34] Dave Larson: Well, I don't think I'm going to differ too much, although I would, I, I just want to, in my mind, I often say it's early. Uh, and so it, it does depend a lot where we're, where we're headed. I would say that the annualized numbers for the, the, the, the client are. Are stronger, more, you know, grab the headlines.

But at the end of the day, the economy was down about GDP 0.4% in the first quarter and, uh, 0.2% in the second quarter. So that's 0.6% from where we were last year. That in itself, uh, is, uh, I don't think so bad again, he's look at the depth of recession. We've certainly had far worse recessions than that.

Although I don't disagree. I think with the Fed, uh, with inflation where it's at with the Fed set to do another, probably 75 basis points of one point half percent, um, of raises that would take prime to, to 7%, uh, and all the other rates that just credit card and so on. So I think that that definitely would, you would think that would continue.

We'd continue to see a slowdown. And then, uh, uh, Ron, as you said, it all depends upon how inflation reacts and, and you know, how long it takes for the fed to, to get to push through that.

[00:04:40] Jeff Voss: Yeah. I think the, the, the headwinds here, you know, are in the other number that you see every day, it seems like the CPI, the inflation number being over 9%, um, in the impact of that. And obviously the responses of that by the. Uh, raising interest rates at an unprecedented rate this year, you know, Fed funds is up over, I think it's up 2% since the beginning of the year, what we're facing right now is a, a flat yield curve at best.

Uh, even inverted I think was inverted yesterday, slightly out to 10 years. Um, you know, and the impact of all. And the, the numbers that you see aren't the numbers necessarily that you feel the CPI number, for example, being up 9%, uh, doesn't include certain key elements to it. I mean, it it's missing, for example, the energy prices that we're paying, you got energy prices that are up over 40% from a year ago, and those numbers are astounding.

And it was saying to you guys, uh, the other day, um, when I take a trip out to my, my other home, which is a, you know, a couple hundred mile drive, uh, I end up spending a hundred dollars each way and, and wondering whether I should be flying as opposed to, uh, driving at the, at this point, just the, the cost of everything is up.

You go to the grocery store, you, you, you buy, uh, any type of commodity these days. You're seeing the prices rising dramatically.

[00:06:18] Jim Adkins: Well, and I read an article just recently, I can't quote the article, so I, I don't want to get too deep into it, but, you know, they calculate inflation differently as well. I mean, they've always kind of excluded food and energy. Factors, but, uh, the calculation differs greatly from, you know, back in the 80s.

And, and I don't remember who wrote the article or the exact numbers on it, but if you went back and calculated inflation, like they did back in the late 70s, early 80s, the number went to like 14 or 15%. So, uh, I think your point Jeff is, is a good one that, you know, it looks one way, but it feels another way.

And, uh, you know, I'm a, I'm a believer. If we're talking about whether we're in a recession, we probably are. You know, and, uh, I think, um, you know, that that's kind of the way I look at it.

[00:07:09] Jeff Voss: So I was at a board meeting of a client of ours last week and regulators happened to be there. And it was an interesting, interesting, uh, take one of, one of the, actually two board meetings in the last couple weeks. And one of them was, um, the DIC and one of them was the OCC, but both of them had pretty consistent, uh, views on where we are.

They're not saying that the banking industry has credit issues. The focus of their attention is on non-credit related issues. But I guarantee you they're, they're still, they're still lurking in the background waiting to see information that would support a credit related problem so they can jump on it.

But the, the topics were banks. You know, you are, you are full liquidity. You need to do something with this liquidity. You know, go out there and make loans and I'm not sure, you know, whether that's the right decision at this point in time or not, but that's, that's really what I've heard from two separate, uh, regulators at these board meetings, uh, this past week.

[00:08:25] Jim Adkins: Well, this may be an instance where the banks are ahead of the, the regulators a little bit, you know, in terms of whether we're in a recession or not, because. I think I've seen and, you know, we've got a number of clients across the country and, and I I've seen a discussion about this and I've seen, you know, I don't know if I've seen dramatic pull downs or pullbacks rather across the board in terms of lending money, but I I've seen the beginnings of it.

I've seen people talking about it. And that usually means that it's on its way. And, um, you know, I think there are probably certain asset classes and I think Ron and Dave can really comment on. That are going to fairly quickly, you know, if they're not shut down now they're going to be shutting down.

[00:09:09] Dave Larson: I think that's an interesting point, Jim, as you, as you segue to asset classes, because clearly, um, you know, business is an industry will be impacted differently depending upon where they are in these, in the prospective inflation or supply chain issues. And, and then the whole, um, impact from, you know, we clearly on everybody's mind is office, uh, and depend on the market.

I was speaking to someone yesterday at a large, pretty large national bank, and very, very concerned about it. And he said, well, so far we, we're not, you know, people are paying or we're not in distress, but they have a lot of interest only loans. The CMO markets are locking up there. Aren't there aren't the takeouts for, uh, there were in the past.

And so what they're concerned about is as they, um, you know, they might build to continue servicing interest, but they can start advertising principle. They're going to have TDRs and stress there. And that will force, could force further tightening and, and optionality for, for lenders, with office portfolios or in that space or developers too.

And so I think you do have to look at the different classes and, and that, that will merge. I think the beginning to merge now, as you know, we get beyond too, beyond the, all the COVID money that the, when everybody's pockets, uh, disappears. Um, how do these damaged sectors respond after that?

[00:10:26] Ron Mercer: Yeah. If you think back historically, um, there's, there's been a trailing indication from both the regulators and especially from the appraisers, the appraisers do all of their work based on historical data. And on commercial property on multi-family, it's usually over the last two years, actually on residential, it should be within the last 12 months, hopefully even within the last six months, but still that's, it's, it's always trailing and you look back historically and you say, well, over the last 12 months or 18 months, this six flat sold for this.

And so that's what the appraisal stands for. And so they say, well, maybe there's not. Lending issue or a credit issue, but the real value today what's happened in the last 30 days or 60 days, uh, will show up six or 12 months from now. And so I believe that there there's some indication there, even though they may be saying there's no credit issues, I believe that's because if we look back to the 2006 and seven and. Uh, those appraisals and it's not that they're doing anything wrong. It's the way that appraisers are trained. And it's the way that it's set up to show historical data. They're not supposed to, uh, look ahead and give you values based upon what they think is happening today or what they think is going to happen next month or what the real market value.

Today, they, they give you an, an indication of what the value is indicated by the last period of time. And so therefore, I, I think, you know, that's another indicator that, that we might have some credit issues that are really here now that just not being shown yet.

[00:12:03] Dave Larson: Well, we do drive with the rearview mirror. Don't we?

[00:12:06] Ron Mercer: Yes, sir. Yeah, we do Dave. Yep.

[00:12:09] Dave Larson: Economics and credit to a certain extent as well. Cecil, I guess Cecil is challenging it.[LC1] 

[00:12:17] Jeff Voss: Yeah. Yeah. So, so what, what makes this recession different than, than the last one? The, the Great One. 

[00:12:33] Ron Mercer: Well, I don't think we know that yet. Uh, Jeff, in my opinion, um, let's just hope it's different than the last Great Recession. And let's just hope that it's more, what we've. Since the, since the depression, our recessions have been, I, I don't want to say almost healthy for us. But recessions are not the end of the world.

It's somewhat of a correction. The, the, the economy's been inflated artificially over the last year by, you know, free money and giving things out. And so sometimes the recession is a good little correction. The ones we had in the 80s and 90s sometimes that's what happened. The real estate market corrected a little bit.

And so let's just help that's what's happened. And I don't think we'll know that, you know, for, for a while, Uh, the Great Recession, just, you know, I, I remember, you know, uh, at least, you know, we, we were all actually very active in the Great Recession and every quarter, what you looked at last quarter and said the value of this property on March 31st is this.

And I think I've been as hard on it as possible in June 30th. You said, what was I thinking? It's not even close, it's worse than that. And 9, 9 30. It was worse than that. And so all, all we can do is at this stage. Keep plugging forward, in my opinion. And just hope that it's, you know, that it's a, more of a normal recession versus the Great Recession.

[00:13:56] Dave Larson: Yeah. I, I, I think so too. I think, you know, if you remember back to you with the great inflation epic of the 70s, there are many, many years of expectations and, behavior that, that underlie those, the depth, all that, the amount of that inflation. It's just been a, you know, we've only had a, you know, a year or so of real, real inflation here.

So I think the big question is how much of that is in expectations and can that be stopped? And that's obviously what the Fed is jumping on it for now. It took 'em a while, but they're jumping on it now and indicate that they're definitely going to make that their priority. Uh, so I, I think, yeah, I think, I think this could be a much more moderate recession.

I don't see the, the, the, you know, the Great Recession coming back here, unless there's some external event or some international issue. Uh, but I, but, so I do think there'll be more a question of what, what assets, what industries are impacted the most. And so maybe it's, you know, more, more sectors that get hit or hit harder. Um, as consumers pull back, for example, they stop, they, they cut back on, you know, um, on fast food or, uh, you know, other, other types of, uh, goods that, that you aren’t necessities. Whereas if you're in apartments and housing and, um, you know, apartments may look much different than they did in.

[00:15:18] Jim Adkins: Yeah, I, you know, my, my take on it, I think 2007 and Great Recession, there was very systematic. Compared to this one. And I, I think this one and I don't want to get political, but this one seems, uh, more policy driven, uh, to a certain extent. And, um, you know, that the systematic thing had to work its way out.

It took several years, uh, as everyone knows, we are on the table here, we were around the table. We were all involved in this in a very deep way. And I think we could probably, whether, you know, I don't know how deep this particular recession will be. I think we are going to be in one or we are. But I, I think it might be, uh, more correctable than the last one.

I think the last one just had to really work its way out because the system, uh, seemed to be pretty dramatically broken liquidity, dried up in a way that we've never seen. And this one, I think, you know, with maybe certain policies and things like that, I, I think hopefully this will be more short lift than the.

[00:16:17] Jeff Voss: Yeah, and I, I, I see, I see this call to recession. Um, I see this situation different in. it's a convergence of many different factors. Uh, not cause as much by behavior caused more by a situation. That number one, the pandemic created a situation where people weren't spending and it created, uh, pent up demand and desires to be able to go out and do things.

So you see consumer spending. um, but you also see shortages in the supply chain and the supply chain that's out there today is creating problems for people to be able to go out and buy them. They're paying over sticker price for automobiles, they're paying over list price for real estate. Um, I, I, I think it's a, it's a different feel to it than.

You know, back in the, in the oh 6 0 7 arena where everybody was just going crazy. If liquidity was out there and then all of a sudden it dried up. Um, I think people have a lot of liquidity today as evidenced by our, our bank banking system, you know, sitting with just boatloads of cash, trying to figure out what to do with it and, and it, and then to top it off, you've got the war.

You know, the war is creating pressures on commodity prices, you know, oil prices and it's, it's, it's a challenge, you know, it's, it's something that, that we have not experienced. And again, the question is, you said Dave and Ron, the depth and the length of, of anything. And hopefully the policies that we've put in place are going to allow us to, to move through this. Um, we're going to feel it though. I, I, I have no doubt that the industry's going to feel it and we are going to feel it as consumers.

[00:18:20] Dave Larson: Yeah, I, I would add on, I think too, it makes me think of stagflation. Do you, you get more of a, of a slowing economy then inflation hangs around for a couple years. And holds onto its position, uh, because inflation hasn't come down. I mean that it could look like a, you know, I'm not saying it could be severe stagflation, but that could be one scenario that looks increasingly a little more possible. 

[00:18:44] Jim Adkins: Well, and, and we were talking earlier about the participation rate. You know, we, everyone talks about the labor rate and it's 3.6 or whatever the number is, and it's low and all that. But the participation rate's very low as well. And you know, when people who have built up cash reserves, those cash reserves, aren't going to last forever.

I surprisingly, they, I I'm surprised they've last this long. And as soon as they get to a certain. Uh, you know, that spending consumer spending could drop even, you know, could drop, beyond what we might think, because cash reserves could dry up and, and, you know, here we are now, hopefully then those people go back to work.

But then of course, or at least steep work that would drive their unemployment rate back up. But, uh, I'm, I'm surprised that the participation rate is as. it is, you know, so must be the liquidity out.

[00:19:41] Jeff Voss: Yeah. No question. So, so one of the topics, um, is. Government's proposing a new spending bill, right. With, uh, a lot of money going into it here. And what they want to do is tax and spend. How do you guys feel about that in terms of helping us get out of a recession?

[00:20:09] Ron Mercer: Well, certainly if it's, if, if it was geared towards what they say, it's geared towards, let's just start with one, one topic, the infrastructure. The infrastructure in our country needs help. It is, you know, greatly, you know, in need of some repair. And so that would be a great way. Unfortunately, there's so many things connected to this bill and so much, you know, free, free money going out again, that it, it gives you pause and gives you concern.

I do think that we have waited decades. To spend some money on our infrastructure. We remember back in the 60s and the 70s, all the money spent on highways and, you know, just taking in Chicago, I 55, the way, you know, and then 3 55 and all the different highways that were built up.

And we haven't seen any of that in a long, long time. And so, you know, the infrastructure is in great need, but unfortunately I think there's a lot of free money. That's going to be wasted again.

[00:21:13] Jim Adkins: Unintended consequences. Right? Politics is about avoiding unintended consequences. I agree with you, Ron. I mean, you drive under a bridge and you pray because when you look at it, you just think, oh my gosh, how is that bridge standing up or staying up? But, um, you know, just could you spend money doesn't mean it's productive money and you know, here we are going to spend a lot of money and it's not going to, you know, hopefully it's meant for productive purposes.

I, my, my feeling is it could be a lot more productive and, uh, you know, I don't know if we're going to get the bang out of this spending that, that, uh, some people in Washington think we are.

[00:21:50] Dave Larson: I think, uh, you know, one aspect of this, which I have not seen as much coverage on, but I think we will soon are the impacts of all this spending, this continued deficit spending and rising interest rates. And the cost of service that debt, if you recall back, remember about 2015, it was almost a daily topic of the credit worthiness of the United States moods.

I think downgraded at like not or two, there was all this concern about deficits, you know, and deficits and so on. And then we, we went into the Trump era obviously and, and, and covered then obviously, then the fed disease enormously now. That the cost is…I don't have the statistic here. It's huge in terms of the amount of difference of what it's going to cost to service the debt every for every, you know, percentage point of, of, you know, rates up. so. I think that's be a very, it's another impact where, you know, we used talk about, you know, the crowding out, you know, will that emerge again, as rates go up, the government's going to this debt's out there and we've had historically other nations want to hold it. And the dollar's very strong, more so because we’ve begun to tighten and some of the European nations haven't although they're beginning to.So that's another variable that, that that's out. Once you've spent the money, once you borrowed the money, it's it, you know, there's not a lot you can do if you're particularly, if you're fighting inflation, So I think that, that, and there hasn't been that record.

Remember, modern monetary theory. Don't hear too much about that now, do we? Because that was the idea we could spend unlimited amounts and no, and rates were low. Rates were low right there, nothing happened. And, but now the rates are going up. And so I think it'll, it'll be real variable.

[00:23:25] Jim Adkins: Yeah. The, the case that they're trying to make, that the bill is going to lower inflation is a weak case. And, uh, you know, I not to get into the bill and, and all the details of it, but it's just, doesn't make a lot of sense to me. Um, but, uh, maybe they have a magic formula that we're not.

[00:23:49] Ron Mercer: Well, again, we we'd have to go back and we'd have, have to go back and find a bill that lowered inflation historically once, you know. Spending money, just never, uh, in my economic value let's just say is, is not, is not great, but spending money does not lower inflation and it, it would be tough for them to convince me that's going to be the case.

[00:24:16] Jim Adkins: Right. Right. And, and Senator, Senator Manson, you know, Jeff just saying Senator Manson, who I, you know, I I've got respect for Senator mansion and, he was making that case and, and I, I saw him in an interview and he was pressed to show his numbers. He didn't want to show the numbers and maybe, I don't know why not that he doesn't have the numbers, but, uh, again, not a convincing case that this is going to have an effect or a lowering effect on inflation. It may have an effect on inflation, but the wrong one.

[00:24:48] Dave Larson: Well, there's a letter out there. A hundred economists signed, um, concluding that it would lower inflation. So we, we must not know a lot.

[00:24:56] Ron Mercer: Right. No, and they're smarter. They're smarter than I am, but they've said that in the past.

[00:25:00] Dave Larson: And they've, and they've also drowned in rivers with a depth of only two inches. But at the end of the day, who knows, you just have, has to do is, is have a good risk management program. And, and, and you, you gotta lend through it.

[00:25:23] Jeff Voss: Well, that's, that's a great segue Dave, into, uh, kind of the next topic, which is what are our, what are our clients, what are the banks need to do, um, to protect themselves today? Um, what, you know, the news, the news is uncertain. Uh, you're getting conflicting news between the regulators and. What, what the news cash show and what the hard facts are, first of all, what are we seeing with our clients?

And then what do banks need to do to respond to this?

[00:26:03] Dave Larson: Well, I think, uh, you know, I was talking to a couple people last week D from different angles, too. Some from the line, some on the workout side, uh, I think, you know, clearly its banks are tightening, they're tightening on pricing. Um, they're tightening on, on recourse, particularly in the, in the real estate space.

Uh, and I'm talking more, probably more the middle market side. But the good news is that markets are still functioning. Banks are still lending of a tight aside from whether it's hospitality or office clean little sectors. People have pulled back a lot. Uh, but I, but I think what, what, what it means is you have a lot of optionality to, you know, refinance or know exit relationships that don't fit portfolio.

Uh, you have time now to work on issues. If you do have emerging issues in your portfolio, Uh, the economy's still, you know, moderate recession. This point, there are times you can really work with what you have and then can prove what you have in your portfolio. 

[00:27:01] Ron Mercer: Yeah, there are many things. I think, uh, you know, one of the areas I work in mostly is multi-family and there are certain indications. I think banks should be watching that. Uh, there's very little. Um, and analysis of it, if any, and that is the strength of the tenant. Let's just say a, multi-family take a 12 unit or 24 unit building.

They may be current, or maybe there's only one of them that are behind on their payments, but they're, the payments are only current because they've received some type of assistance in rental. That's going to run out. In the next six months or three months or at some stage, and, and they're not in position to make their rental payments.

And so when you see a vacancy loss today, still most vacancy losses on most appraisals are still 5%. And historically that's, you know, that's, that's true because they're not vacant, they're occupied. And, but many of them are being paid through government assistance. It's not going to be permanent. It's temporary government assistance of some sort with city of Chicago.

Where's the market that we work in a lot here. And that is, uh, so I, I, I think that the banks needs to be looking some type of analysis of the strength of the tenants and their propensity that the, that they can pay next year and the year.

[00:28:24] Jim Adkins: Um, well, I'll jump in here. I, you know, obviously concentrations are always important. Uh, I would look at concentrations that could. And negatively, well, not all concentrations are going to be negative, negatively affected by a recession, but I would, I would take a look at where I have concentrated, uh, assets.

Um, I would also look at, uh, construction, my construction portfolio and the assumptions that were made, uh, going into that construction, uh, uh, project. Uh, a lot of those construction projects are probably apartment type projects. And as Ron was alluding to you. How is that going to hold up, uh, as we get deeper and deeper in into recession.

So, uh, and I also think there's, you know, there's always risk in construction, but, uh, it's going to be, uh, if we get into recession rates continue to rise, uh, you know, there's going to be more strain on interest rate on the interest to reserve built into a project. And, uh, you know, the supply chain is also affecting these things.

So, uh, I would take a hard look at concentrations and I take a hard look also at my construction portfolio, you know, as we, you know, continue to debate, you know, how, how bad the recession is or whether we're even in one.

[00:29:44] Dave Larson: I was going to say, I think too, I think a real important aspect of this is really understanding what you have, which all starts with, with the quality. In, in the real time, accuracy of those ratings, if you don't know what you have in your portfolio, you can't take action to, to, to properly address it.

Uh, and, and when you come, when we've come through this, this long expansion and times have been good. I mean, the, the workout guys are out golfing and, um, or they're, they're, they're not working there anymore. Uh, there's just, I think you can, you can, uh, Behind it, you know, um, and just get to too casual about it. And I think you always want a culture that's, that's real, that just is built around that mile. Cause your risk management is only as good as your risk program. And that determines what gets looked at, who looks at it, who handles it, uh, and, and how much of an exposure you have against your capital.

[00:30:40] Jim Adkins: The blocking and tackling of, of credit administration., right? You know, the basics and, you know, when times are good, you know, you kind of do what you need to do and you keep, you know, you just kind of forget about maybe some of the discipline that you need. And I, you know, you’ve got to go back old school and, and look at that stuff.

I, I agree with Dave a hundred percent on, on those.

[00:31:03] Dave Larson: I saw a report the other day. It was a, a workout report that, you know, the it's it's July or August now. And the last comment was, you know, borrowed to refi by February of 22. Well, it's obvious that tells me two things. One. They're not updating the report, two management, isn't reading the report. Cause if someone handed me the report that had that comment, I'd be, you know, be like, You'd be upset about that. Cause that's, and that can go, that can relate to all aspects to whether they're, you know, what did you get their financial statements? Have you tested their covenants or, you know, how well you monitor them.

And, and so you also have to look at your exception reports, whether it's documentation, exceptions, uh, that the midst of the recessions, not the time to find out your, your title is impaired, uh, or, or did you know, uh, so on, um, as with, you know, covet monitoring, debt, service coverage, uh, all those aspects. A good culture will be current on those things and those, and those will all drive.

As you get that information in it will drive the quality of your risk rates and, and detect problems.

[00:32:07] Jim Adkins: I don't think there's a downside. Uh, you know, I look at things life, you know, upside, downside. I don't think there's a downside for assuming there's a recession. If you're a bank, you know, I think you can go ahead and say, okay, let's assume there is. And let's do all the things that Dave was talking about.

And Ron's talking about Jeff. And go forward on that basis. And, and if you overshoot a little bit and, and maybe overestimate the, the level of the recession then okay. Shame on you, but at least, you know, you're going to get ahead of it. And it, it, I think that there's no real major downside on that. So I, my recommendation is to assume that, you know, maybe not the worst, but that there is something out there and get back to the basics that I think there's no harm in.

[00:32:52] Ron Mercer: And following up on both your comments, Jim and Dave, there's no downside to starting early. If you're looking, let's just say you have several, several properties, uh, uh, with one lender. He probably has a separate couple of different institutions that he's borrowing from. And then, and there's maybe one piece of property that's has no liens on it and rent free.

And the person that asked first for that additional collateral is going to mitigate their damages and the person that sits around and waits till they really have a problem. And now says, can we get any additional collateral? He said, wow, just six months ago he gave that to X, Y, Z bank. So I would start early and start analyzing and start figuring out ways to mitigate damages on properties.

And again, there's not going to be a lot of them. Hopefully it's not going to be the Great Recession, but the few that are why not mitigate and reduce them by as much as you can.

[00:33:47] Dave Larson: Well, well said, Ron, I've seen that again and again. Uh, and, uh, it's, you know, you just can't emphasize that enough. Cause the other part I would say is, is the, you know, the throughput aspect because times have been so good, a bank might play around with a watch asset for three years, uh, or even a non accrual, you know, and not, not feel the need to really move on. When, when you get a downturn, those, those will start piling up. And then you're dealing with, you know, classified to capital ratios that, that, you know, take your, your exam ratings down and, and compare your other ways. So it's, it's a good culture to have that says, “Let's get on the problems now.” It doesn't mean you don't, you know, you don't take care of your customers and work with people and try to understand issues, but you want that kind of culture that, that deals with the issues and, and, and moves on.

[00:34:35] Jeff Voss: So, so banks are, are full of liquidity, right? We all, we all know what our clients' balance sheets look like and there's pressure on. And then to do something with that liquidity, um, talking about you guys were talking about some existing issues or problems. what should they do if they're, you know, they're, they're pressured to lend, structuring new deals.

Um, what's your advice on, on, um, you know, lending certain sectors? Should we stay away from certain things? Uh, tructure structuring the deal properly. Any comments on that as it relates to, uh, helping banks?

[00:35:20] Jim Adkins: Well, I, I would say, you know, going back to my earlier comment, I, I would definitely wonder if I want to add to concentrations, you know, significantly. So I find my concentration points and. And make sure that maybe I, I don't want to add to those. That that's probably one of the areas that I would move towards.Then of course the construction thing, uh, I think I would be careful there as I go forward.

[00:35:54] Jeff Voss: Any, any asset classes you'd stay away from today?

[00:35:59] Jim Adkins: Yeah, I would probably, you know, the retails is a mess. It has been a mess. Ron Mercer has a tremendous amount of background in evaluating those things. And he could probably talk for a long time about how much of a mess that is. So I certainly retail offices is not real strong. Dave has some good opinions on that.

He's got some experience in that area. So retail office and you know, the apartment, not everything can, not every apartment deal is going to work. And as the liquidity and the economy drive. People won't be able to make apartment payments, like they did rent payments. And so, yeah, I'd be careful with my apartment, uh, uh, portfolio as well.

[00:36:44] Ron Mercer: I think following up on that, I think the office market is in particular. Let's just stick with Chicago, the office market. I think before you make a loan, you need to analyze the leases that are there. Normally, if there's a lease that has three years left on it, or you know, anything more than a year, you say, okay, here's a lease and that's included in your NOI and calculated in, but now you need to look and say, how are, how much are they utilizing the space?

If they have 20,000 square feet today? They're only utilizing 10,000 of it. They're paying rent on 20,000 because that's what their lease states. But when their lease comes due in three years, they're, they're going to say, I only need 10,000 square feet now. And so I think we need to start analyzing more about what's going to happen, not in the next six months or 12 months, because most leases are longer term than that on large properties.

And so on the office space, I would, uh, I would beware and do some deeper analysis other than just your basic appraisal.

[00:37:44] Dave Larson: Yeah. And Jeff, to add onto your question, I think I would say it's, you know, whether or not to stretch, it starts with your loan policy and hope you have a good one, um, that, that really, uh, it matches your risk, risk profiles you're looking for and concentrations and coverages and so on. At the same time, I think in the market today.

I think that so to follow that, but I think the market is tidying. I don't think you should have to stretch today. And I don't, I would think most chief credit officers are not willing to stretch too much today. And so, so for me, high profile would be my unsecured exposures, any type of situations where lending on enterprise value or cash flows. Leverage is, is huge. I think one thing we haven't talked about is, you know, the impact too, on the higher rates on, on business' ability to service their debt. And so particularly I think in the leverage, you know, you've seen that in the credit markets, a leverage loan pricings tighten up a lot.

Those prices have come down in those loans. And for PE lenders, PE you know, they're I think they're definitely exposed as rates continue to rise. If you get the combination of a recession, they're going to feel it first, even though the business could be fine to a certain extent or, or okay. They still may have trouble servicing debt.

And those in those situations, you rely on an enterprise value and we've seen enterprise value can diminish very rapidly, so it depends upon the space lines, maybe more of a middle market bank. Community bank probably doesn't have as much of that, but they still have unsecured exposure. And those, those are definitely where, where I'd focus and earlier too, enhance them.

Now you might be able to now once the market's freeze up, everybody's tightened up. No, one's out that loan without a guarantee. A good guarantee.

[00:40:00] Jeff Voss: I guess I'd like to, uh, ask you guys, do you have any final thoughts, that you'd like to add? Any advice to the banks, uh, before we sign off?

[00:40:12] Ron Mercer: Well, mine would be just to reiterate my statement of starting early, you know, and the goal is always just to increase the classification. If you've just made it an unclassified asset, what can you do to move it up, to get it off that list? If it's just moving to non accrual. Now that is a difficult one to get something.

Off of non accrual is of the six month rule. There's lots of reasons, but it's still, the goal should be to move towards that and to start, and, and again, even talking to your clients about moving their loan to another bank, there are some, there are some merit to have, if you have a loan that maybe you're not the bank for them anymore.

And while times are still relatively good. They could probably move that loan and, and, uh, and, and, and start considering. So starting early and analyzing, uh, the, the loans just when they start right away, getting to unclassified would be my, my final conclusion on statement.

[00:41:12] Dave Larson: Yeah. I, I agree with all with all those points. Uh, and, and obviously from my years of experience, Ron seeing it work right. And seeing when it wasn't done properly, the, the cost of that, I think it, for me, at the end of the day, it's all about your risk management. There's nothing more, more like a recession to test the quality of your risk management program.

So it's all those things that make up, uh, make up that which starts with, with risk ratings, with the monitoring administration or portfolio, it's all, everything is driven up by your officers. That information has to flow up. They have to do their work, uh, reporting, um, all the monitoring, all those things everybody knows about.

And we all know it's important, but you've gotta do it. And the end of day, you gotta communicate, uh, whatever, you know, depend the size your bank, whether it's everybody's sitting around the table, reporting. Make sure that the problems are talked about early, so that you can deal with them early and, and you'll sleep much better at night.

[00:42:05] Jeff Voss: Great. Well guys, uh, again, thank you for joining us here in the, in the podcast. We thank all of you who will listen to this podcast. Just. Feel free to give Artisan Advisors a call. If you'd like any independent or objective reviews of your loan portfolios or any other type of consulting services, management consulting services, uh, we'd love to talk to you and see if there's a way that we can help you.

Uh, so with that, uh, we will sign off now and, uh, gentlemen, thank you again. And we will see you in the next podcast.

 [LC1]Cindy – can you make this out? If not, we may need to clarify