2011 OUTLOOK

Most of you are busy putting the finishing touches on your budgets, or hoping you are... As the year draws to an end, what's in store in 2011? Here's what my crystal ball tells me.

We finally hit bottom. 2008 was the year of the shock. In spring 2009 many felt we are beginning to recover from the debacle. By fall 2009 we realized the abyss is getting deeper and the end is nowhere in sight. As 2011 approaches, the general sentiment is that most banks and borrowers have turned the corner. We finally hit bottom.

While bottom might not be a good place to be, it's better than the uncertainty of not knowing where it rests. Properties are beginning to move, albeit at dismal prices. Market levels are firming up, and are above what vulture funds have offered in the past year. In some cases banks wrote down troubled assets to market rates or below, such that recoveries are occasionally booked.

I'm no economist, but the following statistic I heard recently resonates with me: It will take 6 years of 3.8% GDP growth to get our unemployment back to 6%.

New industry norms are being set. Many are asking, what's the new average ROA level? ROE level? Given that E (equity) continues to rise due to regulatory expectations, and that R (return) continues to experience severe pressures due to extremely low rates, curbing of retail fee income, sluggish loan demand and heavy regulatory burden and compliance costs, the old 1% ROA and 15% ROE don't seem to fit anymore. Are we looking at 0.75% and 10% as the new solid performance? And, if so, what are the implications to bank stocks? I expect these questions will be more firmly answered in 2011.

Another year of weak performance ahead. Few banks are experiencing continued and rapid credit deterioration. Most have leveled off, and even those who continue to increase monitored loans are typically doing so at a decelerating rate. However, improving credit does not address the profitability problems. I expect 2011 to be the first year since the financial crisis when banks will refocus more aggressively on the marketplace and the customer, as workout activities become more contained and can be isolated from business development. This is comforting, but achieving strong performance will be an uphill battle. We, and our analysts, know that reversing reserves is not core earnings.

The antelope is working its way through the python. The good news is, a growing portion of impaired assets is now into foreclosure and OREO. The classified assets bucket is growing slower than in past years, and more of these troubled assets have gone through the process and are sold at reserve-level prices or above. There is a light at the end of this tunnel.

Deposits continue to grow, loans continue to stagnate. High liquidity, coupled with minimal loan demand and low yields on securities, intensified margin pressures which have plagued our industry for some time. We have accepted that 0% is a fixed cost... Despite dramatically low deposit rates, there is still no place to invest the money. Loan rates are beginning to soften as too many dollars chase too few credits, and I fear covenants and terms are next. Maintaining discipline and turning away low yield or poorly structured loans is more difficult than ever, especially since the alternative is 0.50% Fed funds.

Regulatory risk is the #1 risk in 2011. It is a sad statement that, of all the risks our industry is facing, the regulatory risk is now at the top of the list. Compliance has been a major factor in 2010, and I expect this trend to continue next year. I hear more examinations are focused more on compliance, and less on safety and soundness than in past years. Reg E, Reg B and Fair Lending issues top the list.

More community banks are getting involved in the Washington scene since so much of their profitability is at stake as Dodd-Frank and its 240+ regulations unfolds (By comparison, Sarbanes-Oxley only had 16). I also anticipate more banks will be subjected to regulatory stress testing, which will ferret out the last unrealistic banks and compel them to come to grips with their true asset quality.

Capital will continue to be a non-negotiable, which, in turn, will force some banks to sell. Micro-cap issuers have difficulty raising money in the first place, as their story is often unknown and their capital illiquid.

Market acquisitions will increase. More and more bank CEOs are saying, This isn't fun anymore. It's harder than ever to make a profit, the regulators are tightening up and the economy is moving sideways. Many predict a consolidation wave, and I'm in that camp. Egos of sellers and Merger Of Equal partners are melting, which will facilitate greater transaction flow. I think this will be especially true for smaller banks with battle-fatigued management.

There are many bleak expectations for 2011, but there are also some exciting ones.

Consolidation creates opportunities. The acquiring institution becomes more efficient and often wrings excess capacity from the system. Others within the market can enjoy the benefits of the inward focus that integration often brings about and snag market share.

Refocusing on customers is exciting, positive and morale-boosting. After three years of workouts, capital raises and cost cutting, it's time to get back in the market. The economy isn't flourishing, that's true, but it isn't languishing either. The green chutes that economists have been promising since 2008 might actually be real this time. Plus, those pesky deposits that we can't profitably invest are the foundation of solid banking and a true franchise value builder. 2011 is a great year to work hard to ensure these deposits don't melt away once confidence in the stock market is renewed and the economy perks up. Developing deliberate and disciplined plans on converting these deposits into true relationships is one activity that will pay dividends in 2011 and beyond.

Similarly, many RMs basically stopped lending and spent the past two plus years working out credits. Getting back to basic prospecting and organized calling programs is far more fun then the alternative.

Capitalizing on technology. Ten years ago we fought each other to become first in wallet. Plastic was the wave of the future. Today the battlefield has shifted to the mobile phone, the device of choice for Americans 8ä years old. It's the one technology tool you truly can't leave home without. Effective technology can displace costs and solidly connect our customers to their banks. Adoption speeds are unprecedented, and a thoughtful approach to integrating mobile banking and selected social media into your product line is needed in 2011.

Figuring out payments. As the profits are being wrung out of traditional payment vehicles, other opportunities arise. This is especially true regarding checking accounts, which really should not be called checking accounts anymore (almost anyone with kids age 18-30 knows they don't use checks and have no idea where their starter kit checkbook is). Change brings opportunity!

I will write more details about the opportunities before us in upcoming issues of BirdsEye View.

In sum, I expect this year to be a year of stabilization. There are bargains to be had- banks, customer bases and lift-out practice opportunities- and risks to be managed- regulatory first and foremost. Credit and capital are still king, but managing them both will be less painful in 2011. The bankers I see are beginning to look forward; they feel less like prisoners of past sins. This coming year is not a breakthrough year. I expect bank performance to be slightly better than 2010, but somehow it will feel a lot better than the numbers might indicate.