Mid-Year Review

Having passed the halfway mark of 2004, trends emerge in bank performance and range of opportunities.

Overall, SuperCommunity Bank earnings improved in 2004, even before the Fed raised rates, as their margin stabilized and other sources of income continue to grow. One of those sources is the mortgage business. The business has recovered somewhat from the predictable bust, which took place about a year ago. While the slowdown in mortgage originations certainly hampered companies that relied heavily on mortgage originations as a fee income driver, it helped others that approached the business more creatively and capitalized upon the slowdown to build up their own origination forces and capture greater market share.

One element that impacted banks that invested heavily in MBS following the slowdown in loan demand in the past couple of years was rising rates and the expectations they'd rise faster. Others who borrowed from the FHLB has suffered even more. Several banks sacrificed a full year's earnings to clean up their balance sheet, particularly the funding sources, and start 2005 fresh and unimpaired by impossible margin challenges. As credit woes lightened throughout the industry, asset/liability issues are rising as well as basic portfolio management challenges. Some banks, including some in the top 50, have been compelled to sell the institution for the impact rising rates are likely to have on the balance sheet.

Deposits continue to grow in most markets despite better stock market results. The reason, in part, is the uncertainty that has been validated through the recent market volatility and decline. At the same time, many banks that are enjoying deposit growth do so through CD-like savings account (often named after precious metals such as platinum, titanium etc.). These products often attract rate surfers who are looking for better rate without the restrictions on how long they'll have to park their money at the bank. The teaser-rate losses associated with these products are yet to prove a source of long-term loyal customers for most banks.

The war for free checking rages on, especially in markets that have been smothered with de novo branches, most notably, Chicago. While the growth in checking balances and fee income has been impressive for some, the price of that growth and the sustainability of customers is still questionable. Some banks demonstrated a clear, highly focused strategy for depsit acquisition that has panned out in the past and is likely to persist in the future. Others are simply dipping their oar in the waters, and the risk they are incurring is significant.

As rates rise, commercial borrowers are changing their tune from pressing for variable-rate loans to going for longer term fixed rate commitments. At this point, bank discipline is being taxed, as borrowers claim that other bank competitors will meet their structure and rate requirements. Some might lend at any price (and terms), but those who do will pay the price in the long run.

Banks are seeing many opportunities as the year rolls on. As always, focus is rarely found yet a proven strategic imperative. Selectuing a few lines of business and executing extremely well on those remains the best opportunity for 2004 and beyond, since the large bank mergers are no longer the gift that keeps on giving& Strategic focus and flawless execution need to be the mantra, and those are very difficult to come by.

Early divestiture of failing business ventures has never been banks' forte, but it becomes even more important as banks venture into new niches and product lines in their quest for more fee income and reduction of margin reliance.

This is a great time to consider franchise-value expansion through new ventures that will cement and further leverage the bank's core franchise. Thjose are elements for which the market will give you a premium in the long term value of your stick (in addition to the current income they generate). Consider adding the long term premium into your IRR calculations, in addition to the current income. It will help you make the right decisions for the long term.

This is a great time for community banks to better execute on their relationship promise. The mega banks are no longer inward-focused. They are acutely aware of the plans other banks have on capturing some of their customers, and are taking steps to foil such plans. A good example is Bank of America's commitment to make the Fleet deal work. This is not only because past deals have not fared too well for BofA in the short term, but also because the major competitors in Fleet's markets have set ambitious goals for customer cannibalization, and Bank of America is determined to defend the relationship. This battle is raging in most major markets nationwide, either through acquisitions or through free checking campaigns. The SuperCommunity Bank cannot and should not ignore these developments, but rather leverage their unique position in the market to capture share from both sides. One excellent way to do so, which many speak of and few execute well, is leveraging the small business market for both deposits and loans. Pricing products to induce borrowers to put their deposits in the lender's bank is not a new idea, but only few banks, such as Frost or Sterling TX, remain firm on that expectation. This strategy is always in vogue, but especially when the market for loans is heating up.

The remainder of the year has much promise in it. One key element in realizing the potential is not to be absorbed by Sarbanes/Oxley considerations. Those will be paramount as the year draws to a close, but keeping the eye on the business at hand while ensuring compliance is key to future success.