Commercial Loan Automation
Small Business Banking
a wise investor's view of banks
Mark Lynch of Wellington recently spoke at one of our CEO Forums. The man is brilliant! His concise and focused thinking is inspirational, and his ideas are both provocative and ring true. Some of his insights are summarized below. You might have read them in previous BirdsEye View, but all I can say is, “great minds”.
- Banking regulations are here to stay. Since 1836 we have “enjoyed” new banking regulations or major reform every 20-40 years. Given this history, and considering the fact that politicians get little benefit from voting on banking regulations, we should assume that our hand is dealt, and learn to deal with it.
- The reason for big branch systems is evaporating. Technology, Check 21, consumer behavior changes and even advancements such as Square are significantly curtailing the reasons for our retail customers to visit our branches. In addition, this changes the underlying purpose of many of those customers who do choose to visit the branch. Implications to branch size and interior design are profound.
- The equilibrium in the mortgage business is not sustainable. Fannie and Freddie support has artificially propped the market for some time. This is exacerbated by foreclosure snags in many states which, in turn, have slowed down the cleansing process. Where “real” home prices are no one knows…
- The government needs buyers for their increasing bond issues. While today this is merely an intellectually curious fact, tomorrow it might turn into a regulation that will require banks to hold a certain percent of their securities portfolio in Treasuries as a liquidity measurement measure. Is it true that only the paranoids survive?
- Even if inflation arrives, and higher rates with it, bank profits are not guaranteed to rise. Studies show that the common-wisdom correlation between absolute rate levels and bank profits is largely a myth. Plus, as we all know, the shape of the yield curve has as much to do with bank spreads as the absolute rate levels.
- Minimal loan growth. Analysts say that loan demand is sluggish. I say it is almost non-existent. Thus, when a commercial borrower of almost any credit worthiness raises their hand, way too many banks jump at the opportunity to bid. As banks become more desperate for loan growth, so do the pricing and terms deteriorate.
- Central banks can’t do more. Whatever levers remain at their disposal are disconnected to the market and will be ineffective. Plus the definition of risk-free is changing, given sovereign debt crises. The result – high market volatility for months and quarters to come.
- Legacy loan losses are gone except for residential real estate. Asset quality continues to improve by and large, and loan loss reserves are curtailed accordingly, producing non-core earnings and returning our industry to profitability.
- Low loan growth will lead to greater emphasis on cost reduction and M&A. If the net interest margin can’t improve, cost levels must give way. M&A can help as well through branch and back office consolidations and greater economies of scale throughout the new enterprise.
- Mass market retail banking is difficult in major metro markets. Being a top 3 market-share player is highly conducive to success. Playing the small business card will give you only 10% of the market at best, based upon past experience.
- Investors buy stocks, not bank, so pricing is key. Even when investors like management and the bank’s balance sheet they won’t buy unless there is meaningful upside in the stock.
- Investors buy balance sheets over income statements.
- Deposit spreads (tremendous option value) – proxy for good customers.
- Activity and transaction fees – much more under bank control than net interest margin.
- Averse to trading risk or interest rate risk – no matter how consistent these earnings are, they will be considered non-core.
- Averse to CRE due to correlation to losses – even geographic diversity doesn’t help.
- What investors look for:
a. Fortress balance sheet
- Core deposits, well priced
- Bigger market share
- Strong culture. Definition: “Culture is what your people do when you’re not watching.” Culture is NOT a reflection of one dynamic individual.
- Six bank core competences. Banks can be good at six different major management areas:
O Sales ability
O Expense control
O Rate management
They generally need to do a couple of these things effectively at any given point in time. Plus, they need to always be effective in dealing with the regulators.
- No model works forever. While sticking to one’s knitting and doing what you do well is the right way to go, it can also lead to stagnation and obsolescence. The ability to innovate and adapt without losing one’s culture and identity is key to long-term success.
- Expense management. Community Banks typically run NIE to assets, which is 150-200bp. higher than global banks. They need to lower that spread.
Mark Lynch doesn’t have a direct line to God and neither do I. But his common-sense observations should be considered by us all.