Chief Investment Officer
Commercial Loan Automation
2009 outlook: a second look
Bank stock prices are tanking left and right. In the KBW banking universe, very few stars shine dimly (no one shines bright...). They are banks like Wells Fargo, Commerce of KC, People's United, Cullen/Frost and, to a degree, BB&T. The common denominator for all these banks is a strong franchise, deposit-based funding, and a generally boring balance sheet. The Market rewards franchise value and effective blocking and tackling. Fast-growing balance sheets proved yet again that, as they say in Texas, "What grows like a weed must be a weed". Tending to the basics and sticking to one's core competences and strategy are still the hallmarks of success during good and bad times.
Also, this is NOT the time to run afoul of the regulators. Stay ahead of their requirements and needs, and keep your board fully updated as well.
I have written before about the critical importance of managing the basics. It's time to revisit that idea once more.
Just had dinner with Liat in Chicago. The temperature was 9 degrees but I thought it was the warmest lace on earth. And now I'm in New Orleans with the Marketing Forum, where Paul and two of his buddies from Indiana University will join us to learn more about business. I'm proud!
I hope winter isn't too freezing where you're at, and, if so, it's a great excuse for a crackling, blazing fire. Enjoy!
Article synopsis: A very tough year ahead; back to basics is the order of the day: traditional underwriting, capital management, franchise-oriented balance sheet and risk mitigation.
2009 Outlook: A Second Look
The fourth quarter of 2008 is about to wrap up, and the results are in: this was a bloodbath of a quarter. Even the finest of banks have not escaped the bloodshed, and losses range from large to humongous in various categories: credit, goodwill, OTTI and other securities losses.
With that as a backdrop, what can we look forward to in 2009?
Uncertainty prevails. 2008 proved that most banks are unable to accurately predict their performance, especially loan losses and risk-based capital requirements, as recently as two days before quarter-end. This frustration will continue, as we generally continue to "look for the bottom". Traditional forecasting methods and fool-proof models continue to err to the point of becoming useless, if not misleading. Even age-old indicators, such as payments slow-down as a precursor to bankruptcy, are out the window, as both commercial and retail borrowers drop off and announce bankruptcy after many months of being totally current on their payments.
Earnings are under great pressure. Deposit costs are significantly depressing the margin, the backbone of community bank earnings, as deposit costs fail to rationalize. While loan yields improve, many are caught with variable rate loans without floors or prepayment penalties on the books, coupled with minor, if any, declines in deposit costs. The inevitable result - significant margin compression. Core funding pressures imply the trend will continue, and even some relief on loan pricing and terms won't help what's already on the books...
Fee income is also suffering, as consumers continue to tighten the belt and modify behavior after noticing those NSF charges and ATM fees mounting. Wealth Management fees, typically a percent of outstanding investment balances, are also meaningfully impacted, as balances decline with the stock market dropping, and, with them, fees.
Credit quality continues to penalize earnings in several ways:
- Reversals of accrued interest as loans reclassify into non-accruals
- Increased workout costs
- Increase capital costs through lower portfolio quality and higher risk-based capital
- Increased losses
- Increased write-downs of OREOs and other collateral as values continue to seek the bottom
Compliance costs continue to climb, with no relief in sight. For once, who can blame the regulators, given the state of the industry? Compliance costs can be found everywhere, even in the composition of your funding base (wholesale funding might be cheaper than core funding these days, but one cannot afford to gravitate too much toward that margin relief since they'll then trigger the wholesale funding ratio hurdle rates regulators are imposing these days).
At the same time, the Bernie Madoff situation, among others, demonstrates yet again that more regulation doesn't necessarily decrease risk!
Deleveraging takes its toll on ROEs as well.
Other sources of income have dried up. Securitization, a major source of income for both large and small banks, is all but extinct. Traditional buyers who securitized portfolios for smaller banks (most notably, Zions and its 7a and 504 small business program) are out of the market, and sellers must portfolio everything they make, thereby clogging up their balance sheet without the ability to leverage the same capital over and over.
Short term measures might "kill the patient", so beware. Cost cutting (and implied survival) is ubiquitous. With of without consultants, banks are looking for every way to cut costs in any possible way. While cost containment is certainly critical during these times of severely depressed earnings, this is also the time when we saw, during past cycles, great companies brought to their knees and to eventual death by over-zealous expense cuts.
Two thoughts on the topic: 1. Don't focus your compensation reduction cuts on the low level people; middle and senior management should be an integral part of such programs, especially as, in some instances, one executive's compensation can pay for upward of twenty revenue-generating employees. 2. Limit the number of meetings in your banks (cutting 75% of all meetings isn't always a bad thing&). The freed capacity can then be directed toward revenue-producing activities.
2009 earnings will be depressed. Given all the above, 2009 promises to be a very tough year. There are a few brought spots, as always:
- M&A will intensify. Capital-rich and strong banks will acquire their weaker brethren. Inappropriate TARP allocation will prolong the process in some instances, but, systemically, acquisitions will rise again.
- Capacity reduction will finally take place. Branch closures and lower de novo branching rates are upon us. Further, true customer migration to electronic means, and the subsequent reduction in the workforce, are about to be unleashed. This goes well beyond online account openings, and will possibly emulate the airlines' success of migrating so many customers to self-service technology for many key activities, including even baggage checking. Any airport can give you many great ideas on the execution of such a drive.
- This is the year of the community bank. Big is ugly these days. So many mega-banks are in trouble, that consumer confidence and faith are being redirected toward the SuperCommunity and community banks. The nation's largest banks are busy introspecting, cleaning up their internal messes or integrating huge acquisitions. This is prime time for community banks to grab market share without major pricing concessions on both the commercial and retail fronts.
- This, too, shall pass. Bankers are bracing for a tough 2009, but many anticipate a much longer cycle. I believe we'll hit the bottom of this cycle sooner than the 3-5 years quoted by some, and that especially non top-ten banks will find more opportunities toward the end of this year and into 2010.
2009 is the year of getting back to the business of core banking, core balance sheets and back to basics (I'll write more about this aspect in a future BirdsEye View), hunkering down and weathering the storm. I see in my mind's eye the book (and movie) "Into Thin Air", when an unexpected snow storm on Mount Everest claimed the lives of more than a dozen climbers. What's the difference between those who perished and those who survived? Those who perished, including the most experienced climbers in the bunch, took risks they KNEW they shouldn't have taken, and kept on climbing while injured or sick, or past the pre-determined turning back time. The survivors returned to camp, huddled in the wind-battered tents, melted snow to make weak but warm tea, and waited. Only one, left for dead, found his way back to camp by sheer will power.
We are no different. Some of us continued booking those Commercial Real Estate loans, breaking self-imposed limits or forgetting the basics tenets of risk diversification. Not all will come back from the brink. Some will follow WaMu, IndyMac and others who defied these old-fashioned principles. Others put the brakes on when the wind started turning, and are now nursing their wounds and working through the problems. A few who almost crossed the line, some with non-performing assets past the 5-8% critical path, will come back through sheer will power, hard work and luck.
Both climbers and bankers have learned a life-saving lesson" never forget the basics. Both, inevitably, will have amongst them some who will forget these lessons in the future.