2010 OUTLOOK:  FIRST TAKE

The last quarter of 2009 has been a loss quarter form the banking industry, as, I anticipate, the entire year.  The fall Forum season was the bleakest in memory.  CEOs who were cautiously optimistic in the spring revised their outlook and are hunkering down for another difficult year.  Despite spotty encouraging economic news, I agree with the general sentiment  with some notable exceptions.

Next year indeed will be a very difficult year.  Losses will follow as non-performing assets continue to rise (from 3.2% to 3.6% in 4Q09).  Many predict a Commercial real Estate melt-down, and others anticipate consumer credit defaults.  I agree that both are likely to occur, which means that banks with significant CRE and/or consumer exposure will be hurting in 2010.  Further, banks with deferred tax assets might also face capital issues as valuations get rewritten.  Last, major owners of Trust Preferred securities could face even deeper write-downs.

Keefe, Bruyette has developed the New Misery Index, consisting of unemployment plus households in distress (as opposed to the old Misery Index, consisting of unemployment plus inflation).  The new index reflects the record (and growing) number of consumers who will remain under significant financial stress in 2010.

Consequently, the banks that have faced their issues early on, cleaned up their balance sheets, shored up their capital and have strong acquisition and management skills are well positioned to capitalize upon the opportunities 2010 will present.  Conversely, the banks who are still knee-deep in CRE and other assets that are likely to deteriorate, and especially those whose credit woes are coupled within thinning capital, will find 2010 to be a difficult, if not terminal, year.  These, and other banks with credit exposure, will continue to focus on asset quality and strengthening their balance sheets in 2010.

On top of adverse market trends, the regulators will continue to expect 8% and 12% capital levels, and are likely to formalize this requirement in 2010, thereby increasing pressure on thinly capitalized banks and those who have significant credit exposure.  While capital markets are still open, the price of raising capital has been increasing in the last quarter of 2009, and could become prohibitive, if not altogether unavailable, to distressed banks.  Overall, the cost of regulation and compliance will increase with growing consumer protection regulations and other regulatory burdens, which are likely to push another tier of banks who are teetering on the edge into failure.

This coming year will see a more clear delineation of winners and losers across all bank sizes. By year-end 2010, I believe we will witness a group of mid and small cap banks who emerged as clear winners and who are even better positioned to take advantage of opportunities in 2010 and beyond.

The coming year will bring several positive opportunities:

·                    The capital markets for mid and small cap banks have opened wide in 2009.  A staggering $140B was raised by the large banks, and smaller banks have followed.  While some anticipate tightening capital markets in 2010, and others expect even a full dry-out, I believe that mid and small cap banks with strong management and a clear strategy will find capital availability in 2010 as well.  It is those banks that have FDIC assisted acquisition opportunities, and who have come to grips with their credit woes early, that will be able to raise even more capital, albeit at dear prices.

·                    Assisted acquisitions will rise.  The FDIC ended 2009 with a bang, seizing more banks toward year-end and accelerating the pace of takeovers.  FDIC is now fully staffed and its people trained and ready to go.  There are 400+ banks with $200B+ of assets that have Texas ratios in excess of 100%.  The opportunities for accretive deals in 2010 will be even greater than weve witnessed thus far.

·                    Market share is there for the taking, as credit-embattled banks continue their inward focus and market retreats.  Stronger banks, and those banks who have previously successfully invested in their brand identity, are positioned to take share from their brethren who have not done so.

Next years profitability trends remain unclear until certain credit markets, most notably real estate and consumer, trough and rebound.  At the same time, winners will emerge across all asset sizes, and once-in-a-lifetime opportunities continue to blossom for those who are capable of seizing them.