On the Road Again
I am at another bank investment conference and inspired to write this edition, actually while I am sitting in Times Square, NYC. It is interesting that senior bank management of publicly traded banks now seem to be on a perpetual "road show." This reflects the dramatic shift to institutional ownership of the public banks. With the apparent improvement in credit quality, the dominant theme by management teams is the challenge of making money and growing their loan portfolios going forward.
The NIM
Probably foremost on bank executives' minds is the ever-shrinking net interest margin or NIM. With the Federal Reserve's prognosis for a protracted low interest rate environment through 2015, low demand for quality loans and a shift to a higher proportion of lower yielding investment securities, future profitability levels will be challenged.
The Search for Non-Interest Income
With interest margin compression and soft loan demand, banks have really become focused on growing their non-interest income. We have seen this in a variety of ways from SBA lending, wealth management services, different forms of mortgage banking or brokerage and enhanced fees and services. While community banks will never achieve the 50/50 split between interest income and non-interest income enjoyed by the megabanks, it is clear that they must shift to a higher mix of non-interest income in order to offset the lingering low interest rate environment and compressed margins.
Loan Portfolio Challenges
Growing a bank's loan portfolio with quality loans continues to be a major challenge. The growth in the more profitable and larger real estate loans experienced in the past decade has been severely tempered by the recession. While there still may be opportunities in this segment going forward, clearly caution and the absence of concentrations are the watchword. Also, a more diversified portfolio with a mix of C&I, commercial real estate, SBA and some consumer lending seems to be the direction most community and regional banks are taking. One of the current challenges is the demand by good borrowers to eliminate floors and lower loan rates and have extended terms, further eroding skinny margins now and into the future.
The Pressure to Make a Buck
Now that the economy is slowly turning and we are moving from survival to profitability, the pressure is on all banks to grow earnings. This is most evident in the publicly traded banks where the attitude is very much "what have you done for me lately," with expectations for earnings growth quarter-over-quarter and year-over-year. I think it is imperative that banks not cave into this pressure and take undue risks, particularly in their investment portfolios.
The Investment Portfolio Shift
With enormous low cost deposit liquidity in the banking system and soft loan demand, there has been a significant shift over the last several years in balance sheet mix, with many banks now having 20-50% of their assets in investment securities. These securities present different risks and challenges than loans, and now have become a powerful component of a bank's balance sheet. Referring to the pressure to grow earnings discussed above, it is easy to see how some banks could be tempted to take undue risks or make longer term investments to reach for a greater return. That could be a huge mistake if not managed thoughtfully and properly. Making sure your board of directors understands these risks is critical.
Capital Management
Another challenge facing banks is what to do with strong capital positions in the face of nominal growth. How do you best manage the capital through retention for organic growth or acquisitions, stock repurchases or enhanced regular or special cash dividends? There is a careful balance that must be struck here as investors are starting to demand higher levels of ROE now that the economic crisis is in the rearview mirror. But, remember Basel III and that capital is still king.
What Keeps Management Up at Night?
This is a really great question which was posed and answered by one of the presenters at the investment conference. On the list were: Dodd-Frank; Basel III; the CFPB and compliance costs in general; the sluggish economy; historically low interest rates; the still uncertain real estate market; industry consolidation; interest rate risk; and the recessionary winds fueled in part by the economic instability in Europe. Quite the list.
A Word to the Wise
It is clear that there is no clear path to the future. However, having a keen awareness of the multiple influences affecting the banking business is a great start. Banking in its simplest form is still acting as a financial intermediary and successfully managing risk in the process. The future will no doubt present challenges and opportunities for thoughtful bankers.