Outlook 2021 - Clear as Mud

 Predictions and projections have always been risky business, for none of us can see the future.  Very few years have been riskier to predict than 2021, where so much is known.  Numerous key variables with far-reaching implications can take opposing – and unpredictable – turns.  For example:

• Will the economy recover in a V, W, U or flat shape?

• What will happen to travel and hospitality?  Will consumers be emboldened and start traveling again, freeing pent-up demand of a full year?  Will businesses resume travel and at what intensity?

• How will the new political climate impact the economy?  

•  What will happen to office space as not every employee will return to work at the office?

• How long will it take to vaccinate a sufficient number of people to stave off COVID?  

The direction of the answers to any of these questions can hugely impact what 2021 will look like – economically, socially and globally.

Based upon insights from my friend and mentor, Robert Albertson, Chief Strategist of Piper Sandler Companies, as well as my own industry observations, here are major trends I believe will characterize this coming year.

1. Top-line revenue growth will be difficult to achieve.

The economic outlook remains opaque, but one thing is clear:  2021 will not be a banner year for the US economy.  The virus has already taken its toll on several leading indicators, including durable goods, manufacturing index and participation rate, such that the first half of the year is likely to remain subdued at best.  It will take major systemic change across sectors to revive our economy beyond CARES Act stimuli (which, in itself, is a misnomer; these are survival bridges, not stimuli to create future demand or production capacity).  Even if we see a major infrastructure bill pass in January, a most unlikely event, it will take several months to put together the infrastructure for it and start spending the money.  For all these reasons, I’m expecting the first half of 2021 to produce primarily sideways results.  

Loan demand is directly tied to economic growth.  It is even more true as PPP loans get forgiven and, in effect, turn into capital infusion for many small and medium size businesses.  Consequently, 2021 promises to be a lackluster year for loan growth, and the primary way to achieve stellar results is by stealing share from less effective competitors.

2. Credit quality.  

Asset quality is THE question for 2021.  It can make or break the year for many a bank.  Yet the economy is hidden under layers of deferrals, grants and stimuli, where ordinary monitoring is insufficient to uncover early signs of trouble.  This is particularly true for PPP borrowers who might have performed well through the current hardships, but are sinking deeper into insolvency with every shutdown.  The depth of their financial resources is too shallow to withstand repeated blows. 

This is the time to consider new ways to evaluate your portfolio, with special focus on small loans.  Loan review has typically focused on >$1 million loans, but many of us now have meaningful growth in the smaller and micro loan segment.  It might be time to borrow portfolio-wide assessment techniques from FinTechs and credit card companies with an eye toward developing an early warning system for credit quality deterioration.

Further, single-purpose real estate will be under duress in 2021 and beyond, as office space glut will show itself in our largest cities and elsewhere.  This phenomenon is also true for branch properties, where banks start unloading single-purpose branches en masse.  Special attention should be paid to loans secured by non-convertible real estate.

3. Earnings growth.

There are three main paths to earnings growth:

• Taking share from other banks

• Cost containment

• Consolidation

This coming year will continue to offer opportunities on all three fronts.  The question is, will expense reduction be accretive long-term, or will you have to cut to the bone to meet 2021 expectations?  Branch closures seem to be the place to look for meaningful dollar saves, and are certainly in vogue with industry observers.  It is commonly accepted that we are over-branched in the US.  That assertion varies by bank, as well as by location.  We are amidst a population shift away from major metro areas; are you providing effective branch coverage where the population is going?  Should you trim your networks in population depleted areas and invest in the new growth markets?  Regardless, reevaluating branch coverage and density, as well as customer retention expectations, are important steps that should be taken this year.

One interesting opportunity is the growing willingness toward non-premium deals, both as MOEs and otherwise.  There is also far greater willingness to broaden the range of opportunities to be considered well beyond contiguous markets.  There is far more interest (and risk) in exploring acquisitions in market extensions and new markets, aimed at improving the longer-term franchise value and not necessarily at cost-savings.  Growth for growth’s sake alone is rarely a winning strategy, but achieving greater scale, especially with respect to technology, is a worthwhile motivation as well.

Another question of particular relevance this year is how important is earnings differentiation.  Some believe it will be less important in 2021.  Instead, higher tolerance for shoring up the franchise through M&A and greater investments in technology at the cost of current earnings might be winning strategies this year.

4.  Political impact of a change in administration.

I have learned the hard way that any comments on politics I make will be misinterpreted.  Nevertheless, we must acknowledge that the change in administration will inevitably lead to changes in regulatory philosophy and supervision which will impact us all.  We cannot prepare for the unknown, but we can become more mindful and buttoned-down with respect to risk management and compliance across the board, with special emphasis on the three lines of defense and consumer regulations.

5. Retain lessons learned during 2020.

While we cannot predict many of the variables that will shape 2021, we now know with certainty that our management teams and leadership can move quickly and react effectively to brand-new situations.  We know our employees are far more resilient than we gave them credit for.  We’ve learned how valuable human contact is across the board, including the work environment, and know better how to provide it without physical presence.  

The best opportunity we have to be successful in 2021 is to remember the lessons we learned in 2020 and act upon them to affect permanent change in certain key elements of our respective organizations, such as:

• Making decisions faster and based on partial and evolving information

• Doing things faster

• Increased tolerance for errors

• Setting in place early detection tools for problems, mistakes, fraud etc.

• Pulling the plug on mistakes, experiments gone wrong etc. quickly

• Increased acceptance of digital channels

• Acceptance of WFH as a workplace option

• Changes in information security, fraud prevention and other preventive tools to support the shift to different distribution models

• Increase FLEXIBILITY and openness to change and experimentation (without betting the bank)

Things have changed dramatically for all of us in countless ways.  2021 will be a year of continuous change, managing through uncertainty.  These are difficult times, fraught with risks and upheavals, but also full of opportunities we could not envision last March.  

This coming year can be used to focus on the strategic impact of COVID on your bank and the opportunities it brought; on implementing lessons learned and supporting our COVID-fatigued employees and communities as we slowly recover from the pandemic; on learning how to remain true to your brand promise across different delivery channels and how to continue making thoughtful decisions in a fraction of the time (and information) it took only a year ago.