Chief Investment Officer
Commercial Loan Automation
second-third quarter outlook
It's hard to believe it's April already, and time to revisit my November outlook for 2007. My best guesses as of now are outlined below. By and large, I've been "on the money" except for that pesky yield curve, which persistently refuses to normalize. Where am I off? please write back!
It's definitely spring in California, and I hope the flowers are blooming wherever you are. Do check out what I'm serving my family this springtime at our Passover Seder. The menu and my father's inimitable recipe for matzo balls soup are posted on BirdDroppings. The soup is indeed the remedy for all, and almost as effective as chocolate to heal all ailments. Guy, my son, has a month-old cold he caught from Isabella, his daughter and my granddaughter, so I'm fixing a bucket of soup for him "to go" right after Seder. It should be noted that Guy's priorities are "on the money", though, since his favorite dish is my chocolate souffle (for the recipe, check our the recipe archive on www.anatbird.com).
Also on BirdDroppings Liat wrote what Passover Seder means to her. She melted my heart and I trust she'll do the same to yours.
Have a great holiday weekend, and may Spring be with you!
Second-third Quarter Outlook
I can hardly believe it's past the end of March, but the calendar doesn't lie. It's time to take another look at the year unfolding before us, and see whether the outlook has changed.
The margin is still not normalizing. Contrary to my expectations, the yield curve remains stubbornly flat, and margin challenges beleaguer even the finest of banks. The asset sensitive ones have wrung all they could out of the rising rate environment, and now we all share in the agony of the flat curve, with no relief in sight.
Attempts to lengthen retail deposits have been generally unsuccessful, as consumers, like us, await yield curve changes and see no premium in lengthening maturities.
We are all asking "Have we peaked yet?", but I now know better than to answer
More banks are holding off providing guidance on the margin, reflecting the industry-wide inability to predict where we go from here.
Overall, bank margins dropped to a 17 year low in 3Q2006.
We still have huge variances in margin performance, and numerous banks enjoy margins with a 5% or more handle, but everyone is paying the price for these numbers, either by hanging on to a pricing discipline and losing deposits and customers, or by competing for funding and loans while watching the margin compress further.
The year of the deposit (again)
Loan growth continues to outstrip deposit growth nationwide. Deposit growth is there, but banks are not getting their fare share of the pie. System-wide bank deposits as a percent of total assets declined from 90% in the '50s to 60% today.
This decline is exacerbated by our continuous commitment to keeping deposits literally at all costs, while teaching customers to shift funds from low cost to high cost accounts. At the same time, deposit-rich sellers are commanding record-high prices, which reinforce unhealthy deposit gathering behavior.
As industry leaders continue to garner huge deposit share in the internet banking battle, many other banks are seriously considering the "me too" approach that hurt our industry so many times in the past. The first and second major players in the market, arguably ING Direct and Citibank, have executed successfully but are experiencing some difficulties as the market segment they are courting gets saturated. Meanwhile, many others are considering entry into the online deposit gathering game, and I fear some will end up with serious addiction to high yield deposits they can't afford.
What continues to puzzle me is the failure to execute on the small business segment, whose average deposits are typically ten times the average retail deposit.
At the same time, innovative strategies to address growth segments such as the unbanked and the Chexsystems rejects are encouraging, and a harbinger of the successful strategies yet to come.
Last, some banks are mopping up the Remote Deposit Capture field, with strong focus and effective execution, while others are still grappling with perceived compliance issues without a strong commitment to the product.
Credit is finally getting worse
As predicted in my 2007 outlook, credit if finally beginning to fray. Liberalized terms, covenants and razor-thin pricing have come home to roost. The cycle is finally turning, and not only on sub-prime lending. Construction loans, mortgages and other credit types are showing meaningful deterioration in some markets. Non-accrual loans are up 8% system-wide, the biggest increase in 6 years mostly in mortgages. Interestingly, charge-offs declined in 2006, exclusively thanks to a decline in credit card charge-offs, the domain of the mega-banks.
No banks failed in '05 and '06, but one did in 02/07. Predictions of credit woes are abound, and many expect them to intensify throughout the year and peak in 2008.
There is little risk-based pricing in our industry, and it's a fact that is difficult to overturn with many irrational competitors.
The good news is, loan growth is robust in most markets, led by C&I lending as CRE loans ebb. This is a great opportunity for our industry to return to its roots, gather deposits from its borrowers and rebalance the loan portfolio.
The big banks are performing better.
The industry had another record year of profits, and the largest banks are to be credited with this fact. The ten largest US Banks hold nearly 40% of all domestic deposits and 51% of all industry assets. Their income is well diversified, with community banking rarely contributing more than 50% of the earnings. This diversification, which reduces their reliance on margin income, coupled with access to cheap wholesale funding sources, helped our mega-banks to have a great year in 2006, and a strong first quarter in 2007. I believe this trend will continue throughout the year, until the yield curve pressures ease and more SuperCommunity Banks commit and act on diversifying their revenue streams.
The payment business continues to shine
The debit card/credit card opportunity looms large in the near future, and, again, the mega-banks are ahead of the game. Only nimble community banks can pre-empt the giants in their local markets and snag share through activation promotions and loyalty programs combining both plastics to build customer loyalty and interchange income. Remote Deposit Capture remains a "hot" item, but the lines will be drawn in the sand by the end of the year as to market share and the position of innovation in many customers' minds.
Acquisitions continue to heat up
More banks can demand, and receive, 30% plus premiums for their deposits. As more banks get battle fatigued from fighting the compliance battle and wringing more costs out of their system to eke out the next penny for their shareholders, some just figure the business isn't as much fun as it used to be. More sellers are in the market, but so are the buyers, so I do not anticipate prices to rationalize in 2007. It will be a big year for the aggregators and the investment bankers.
Anything new on the regulators' mind?
Can you spell BSA? There is no change in the regulators' posture on BSA/AML, and even compliance guidelines are still not clear to many. On the other hand, SOX 404 is becoming routinized (but not much less expensive), which does reduce the angst among many CFOs.
Surprisingly, business continuity in terms of avian flu and similar disasters is still on the map, and HR directors are asked to produce business continuity plans in the case of an epidemic outburst. The argument that, if an epidemic was to take place, no customers will come to the bank, doesn't seem to ease the regulators' concerns.
In sum, the industry continues to be profitable, but it's the larger banks that are outperforming the community banks, a phenomenon we haven't seen for some time. Smaller banks continue to be challenged by the environment, as reflected in one analyst's growth universe: only six beat the Street, only seven met, and the rest adjusted downward, which is the general trend.
In sum, 2007 will be a difficult year, with some possible margin relief toward the fourth quarter. In the meantime, cost cutting drives are underway in many companies, and they will help, but not fully address the underlying issues of margin dependency and undiversified revenue sources.
There are enough income growth elements, especially in the payments arena, which can shore up the sagging interest income. However, this is a good time to strategically consider your income sources and how to diversify them going forward.