Welcome to Financial Institutions Insights, a publication of KeyBank's Financial Institutions Group. Each quarter we'll be delivering an e-newsletter dedicated to your success. We'll report on:
q q q
SUMMER 2008
LEARN MORE ABOUT OUR SERVICES FOR FINANCIAL INSTITUTIONS
Economic trends Regulatory developments that impact your business Innovative strategies designed to assist your institution in operating more efficiently and growing revenues
For instance, if you access the articles below, you'll learn how you can leverage Key's expertise in interest-rate hedging and check-image clearing to improve your bottom line. KeyBank is an expanding national provider of an array of solutions for financial institutions, including private-label derivatives, leasing and treasury management programs. Our sales force is deeply committed to each of our relationships, and we're thrilled to offer Financial Institutions Insights as just one more indication of how much we value your business. Jim Pridmore, Group Head, Financial Institutions
Economic Update
While no tangible economic recovery is yet in sight, banks' global growth prospects remain strong. Learn More
DID YOU KNOW ...
Interest-rate hedging addresses balance sheet, income needs
Interest rates near historic lows and the healthy appetite banks have for additional revenue sources are combining to position interest-rate hedging as a strategic opportunity for many financial institutions. Read the Entire Article
Check-image clearing: Ready for a new set of challenges?
With Check 21 and the rising costs of processing paper checks providing the steam, U.S. banks have resolved to climb aboard the image-clearing express. Find out how KeyBank's Image Cash Letter services can help keep your check-image clearing program on track. Read the Entire Article
• Our private-label programs enable clients to sell interestrate derivatives, leasing and treasury management services? • We've recently updated the Financial Institutions Group Web page and it now features contact information for all of our regional managers? • Regulation F capital ratio requirements are posted on our Web site and updated quarterly? • KeyBank offers financial institutions opportunities to purchase loan and lease pools?
Financial Institutions Insights is a service of KeyBank's Financial Institutions Group. The articles within this e-newsletter are for informational purposes only and the information contained herein does not constitute and shall not be construed to constitute tax or legal advice by KeyBank or its affiliates as to any specific matter or service. KeyBank makes no representation or warranty as to the accuracy, completeness or timeliness of such information. No part of this e-newsletter may be copied or reproduced in any way without the prior written consent of KeyBank. KeyBank • Financial Institutions Group • 127 Public Square, Cleveland, OH 44114 • 1-800-KEY-2YOU
Summer 2008
ECONOMIC UPDATE
Recovery Will Take Time, But Banks’ Global Growth Prospects Remain Strong
By Tom Russo, KeyBank Only a couple months have passed since the Federal Reserve rescued our liquidityaddicted financial system. Yet already there are optimistic forecasters insisting the bill for that episode has been paid in full. While some near misses end harmlessly, cyclical exaggerations as pronounced as the extreme under-pricing of risk and liquidity for a decade are more likely to require a more symmetrical time frame for resolution. Indeed, in this case, it should take at least a full economic cycle, and quite possibly even a generation, to restore equilibrium. Although there has been recent stability in a few forward-looking economic indicators, we do not agree that a tangible recovery is within sight. We do expect the landscape and planning horizon to which financial markets will need to adapt to include far greater sensitivity to the cost structure and pricing of credit, the systematic appreciation of event risk and the sustainability of each business model on far more limited liquidity. The gluttony that occurred in these areas over the previous decade resides at the opposite end of the spectrum from which today’s financial institutions will have to operate. To make matters slightly more challenging, we also expect that markets and the financial institutions operating within them may have to address a re-emergence of the secular trend toward inflation. On hiatus for 20 years, inflation appears to be re-establishing itself on a trend basis since 2002. A reversal of the low inflation environment used to model already distressed assets could pose new and lengthy hurdles to their recovery. We readily admit some difficulty envisioning a return to inflation while real estate prices are pressured, but would suggest the more powerful socioeconomic, political and demographic forces in place have laid the foundation for at least a reversion to the mean historical inflation rate, which is nearly 2% higher than current readings. On a more positive note, global growth prospects remain strong for financial institutions. While a sea change may be developing that displaces the United States as the world’s growth engine with the most sought after currency, and balance sheets need time to repair, the world continues to create and amass new wealth. Resource-rich nations need ever-increasing cash flow management, newly opened economies continue to grow a global middle class, and nations building infrastructure desire the expertise and advisory services originating here.
® 2008 KeyBank Financial Institutions Insights
Summer 2008
Interest-rate hedging addresses balance sheet, income needs
Interest rates near historic lows and the healthy appetite banks have for additional revenue sources are combining to position interest-rate hedging as a strategic opportunity for many financial institutions. The Federal Open Market Committee’s aggressive campaign to lower interest rates has enabled banks to offer more attractive debt pricing to clients. What’s more, the consensus among forecasters is that the FOMC isn’t likely to reverse course and raise rates to combat inflation for at least a couple more quarters. For many banks, interest-rate hedging products such as interest rate swaps and options are central to realizing the asset-liability management and revenue opportunities presented by not only the current low-rate environment but, practically speaking, any rate environment. Credit crunch challenges Today, banks can lock in a lower cost of funds to improve their own balance sheets, as well as generate much-needed fee income, through derivatives. Realizing these opportunities means first facing the challenges presented by tight liquidity conditions. “Due to the credit crunch, banks are needing to look to a broader array of credit partners in order to allay issues such as concentration and capacity risk,” explains David Sylvan, Head of Derivatives Marketing for KeyBank National Association and Tremont Capital Markets, a KeyBank subsidiary. The credit crunch has also limited banks’ ability to lend on a fixed-rate basis, but that’s where offering interest-rate hedging products to credit clients can help, Sylvan says. “The ability to offer clients floating-rate as opposed to traditional fixed-rate debt, and then having a provider on a partner basis synthetically fix that debt using derivatives, allows a bank to generate much-needed fee income and facilitate borrower flexibility.”
® 2008 KeyBank
Financial Institutions Insights
A competitive necessity In addition to enhanced fee-income potential, a derivatives capability gives banks another important touch point with clients to help solidify those relationships, Sylvan says. Interest-rate hedging is no longer an arcane set of tools used only by the very largest corporations to manage and transfer risk. The derivatives industry has matured and developed a wide user base, and today offers a variety of tools for transactions at relatively small-dollar thresholds. The need for these tools, even among middle-market companies, is great. “By failing to offer interest-rate protection products to their clients in some way, shape or form, a bank is probably putting itself at a competitive disadvantage,” Sylvan says. Interest-rate hedging products often find themselves in the limelight during times of great rate volatility, “but the ability to customize this product suite makes it something that needs to be considered regardless of the rate environment,” Sylvan notes. Become a derivatives provider One way your bank can offer interest-rate hedging products is by working with an outsource provider. KeyBank suggests that its financial institution clients with debt portfolios featuring a strong mix of domestic commercial real estate and commercial and industrial (C&I) debt partner with Tremont Capital Markets to address their interest-rate hedging needs. KeyCorp ranks 10th nationally among financial/bank holding companies with $82.8 billion in interest rate derivative contracts held for trading as of year-end 2007, according to financial Web site iBanknet.com. Through Tremont Capital Markets, Key can help bank clients with their own hedging needs, plus enable them to sell interest-rate hedging products to their business clients on a private-label basis. As a unit within KeyCorp, Tremont Capital Markets combines the financial resources of a large superregional bank with service levels you would typically associate with a boutique provider. Also, Tremont's proprietary technology platform offers a distinct and powerful set of data warehousing and management reporting tools. Contact me for more information about KeyBank’s interest-rate hedging products and expertise.
® 2008 KeyBank
Financial Institutions Insights
Summer 2008
Check-image clearing: Ready for a new set of challenges?
With Check 21 and the rising costs of processing paper checks providing the steam, U.S. banks have resolved to climb aboard the image-clearing express. Now that the Federal Reserve is rapidly consolidating its centers for processing paper checks, and image-clearing promises cost savings, efficiency and better funds availability, most banks have established a check-image clearing process, or at least have a plan in place for their check-image journey. Furthermore, having embarked upon a check-image clearing program, some banks are already discovering some obstacles along the tracks — the kind that could prevent them from reaching their desired destination of high-quality, cost-effective check processing. As one of the first banks to begin clearing check images through the Federal Reserve after Check 21 took effect nearly four years ago, KeyBank understands the new set of challenges that check-image clearing presents to banks. Here’s a look at some potential obstacles, as well as the quality procedures — “insurance” features, if you will — that Key has built into its Image Cash Letter service to protect clients from having their checkimage clearing programs derailed. Excessive rejects One of the frustrations banks encounter in check-image clearing is excessive rejects. Any clearing provider will inspect your check images to confirm they meet readability standards. Most, however, do so with systems that automatically send rejects back to the bank of first deposit. A high volume of rejects will put a significant crimp in the imageclearing benefits we noted at the top of this article. Key’s Image Cash Letter service addresses the challenge of excessive rejects by delivering image quality assessment with a manual review. By manually reviewing system rejects, Key is able to repair a high percentage of them.
® 2008 KeyBank
Financial Institutions Insights
“Our clients typically see a significant decline in the number of rejected items, which improves the availability of funds and internal efficiency,” says Jim Bann, Treasury Management Team Leader at Key. Duplicate items Weeding out duplicate items is critical to minimizing a bank’s liability risk related to checkimage clearing processing errors. You’ve probably heard about recent instances of sizable duplicate files being processed, and the significant problems that resulted for the banks attempting to correct those errors. To address this challenge, Key’s Image Cash Letter service offers a more thorough duplicate item detection process than most other clearing providers, including the Federal Reserve. While most providers only search for duplicates in image files received in the past day or two, Key looks for duplicates in the last 10 business days’ worth of images. Also, Key manually reviews, and accepts or rejects, individual suspect items, rather than entire files. “Our duplicate item detection procedures ensure that more of your items will continue in the forward presentment process, rather than having an entire file sent back to you as duplicates,” Bann explains. Misrouted checks Another challenge that can create liability issues for banks is the misrouting of checks, which can occur when check images are not correctly associated with the electronic MICR routing and transmit number and account number in the image file. Key addresses this critical concern with a feature in its Image Cash Letter service called code line validation. We use optical character recognition software to ensure the check images accurately correspond to the electronic MICR line data associated with them. Our operations team reviews suspected errors and either corrects or returns the items, which reduces expensive adjustments and minimizes a client’s liability risk. “All of these innovative ‘insurance’ features in Key’s Image Cash Letter service, aimed at reducing rejects as well as duplicate and misrouted items, apply to both forward presentments and inclearings,” Bann notes. Inclearings, originated return items The need to use multiple providers for check-image clearing services has presented another efficiency hurdle for banks. However, on the horizon is the possibility of consolidating image-clearing services with a single bank provider for greater cost savings. In addition to delivering check images to the payer bank, financial institutions need the image technology for inclearings and originated return items. Today, no bank provides all of these services, but Key already offers forward clearing to payer banks and image inclearing — plus Key plans to offer image services for originated return items by year end. Contact me to learn more about addressing the new challenges posed by a check-image clearing environment, and Key’s industry-leading Image Cash Letter capabilities.
® 2008 KeyBank Financial Institutions Insights