What Ever Happened to The Continental?

By Joe Wheeler, Plansmith

I’m not talking about the car; I’m referring to the bank. Back in 1984, then the seventh largest bank, Continental’s failure forced regulators to recognize that big banks could in fact fail and that they needed to find ways to cope with that possibility. The bank’s demise sparked debate about how large and small institutions should be regulated. Sound familiar?

Continental’s management implemented a strategy focused on commercial lending. As a result, they became the largest C&I (Commercial & Industrial) lender in the country. This growth strategy, and the returns it delivered, was applauded while stock prices doubled. Management and board were both referred to as “superior”. Traditional indicators (ROE, ROA, etc) were considered outstanding compared to competitors with the exception of equity which was only a little lower.

So what happened?

For one thing, their loan-to-assets ratio jumped 11% in four years. In this particular situation, this suggested rising risk. (The higher number of loans the greater risk of defaults)

A second area quietly pointing to potential issues was Continental’s ROA. It was stagnant.  Couple this situation with a rising loan-to-asset ratio and it points to the fact loans were being put on the books at lower and lower interest rates. Remember back to that period, interest rates weren’t just rising, they were atmospheric. Continental was implementing a “below market” pricing strategy at the same time it was opening the flood gates for loan growth.     

Fast forward to 2008 and consider IndyMac.  

Having a heavy concentration in a few types of loans, construction and exotic mortgages for example, creates exposure. While not commercially driven, IndyMac specialized in Alt-A mortgages which didn’t require much documentation. The forensics are still being completed, but we can assume credit losses that were thought to be concentrated in subprime mortgages spread to other home loans and debt once thought safe. One politician’s public concerns started a run on deposits ($1B in eleven days) and the FDIC had to step in. 

Suddenly, there’s no shortage of articles on, “What to do if your Bank fails”. The by-product of IndyMac will be a knee-jerk response by regulators implementing increased scrutiny of both banks and boards.  Are you ready?

It’s been said that the best defense is a strong offense. Community banks have traditionally stayed away from IndyMac-like lending practices. The problem is, regulators are not differentiating.  As a matter fact, they see commercial real estate loan portfolios at community institutions as the next big issue.  Building a strong offense now will help later. 

Regulators expect board members to be “educated” and “informed” about their bank. Giving them what they want can actually have a positive effect on overall performance. 

While not exhaustive, allow me, through today’s history lesson, to offer ideas you can use to avoid repeating the past. Review, discuss and document your banks:

• Top priorities and YTD results against them

• Historical growth patterns in the balance sheet

• Recent trends in loan-to-asset ratios

• Approved pricing assumptions versus actual rates on booked loans

• Loan concentrations

• Ability to gather deposits at reasonable costs

• Wholesale funding availability

• Boards access to data that depicts both sides of opportunities and issues

• Marketing campaigns reassuring strength and staying power

As Santayana said “Those who do not learn from history are doomed to repeat it.” It’s important to consider historical events that impacted the market. It’s also important not to encourage their replication. If you remember the Continental as a gas-guzzling antique with no place in today’s market, the only way you’ll go is up.

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