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BirdsEye View

It's been a while since the crash of 2008/2009 and its aftermath. During this period our economy experienced a severe recession and moderate recovery, and our industry has followed.

As the new administration is being formed, some encouraging signs can be interpreted for our industry. Most notably, the determination that the $10B cutoff is an arbitrary level.

What has transpired for the banking industry in the past eight years? How have we changed, and what's in store for us in 2017 and beyond?

It's much easier to look back. The past seems so much clearer than the future&

1. Credit can't get any better.

   The credit cycle has gone full circle, from NPAs system-wide peaking at 345bp of assets in 2010 to a low of under 100bp of assets now. The number of impaired institutions plummeted as a result from a high of 884 to 183 today. And industry allowance is a strong 1.34% of assets.

2. Margin has suffered during this low-rate environment.

   Our margin has declined nearly 100bp since it peaked at 400bp in 2002. We have come to realize that zero is a fixed rate. Our profitability followed, after a peak of 1.38% ROA in 2003 to under 1% today.

3. Regulatory burden spiked after the crisis.

   The cost of compliance (in a vain attempt to ensure we will not suffer another major financial crisis ever again) has skyrocketed, and I hesitate to say there is relief in sight yet. Compliance costs weighed heavily on banks of all sizes, but, due to scale considerations, they weight heaviest on the smallest banks.

4. Consolidation is accelerating.

   The industry has been shrinking by roughly 300 banks annually between 2009 and 2015. We are down 2,300 banks since the financial crisis, and 11,700 since 1984. I believe the current count of 6,200 will see continuing reduction in 2017 and beyond. Regulatory burden isn't the only reason for this shrinkage. Indeed, battle fatigue and unpredictable regulatory requirements have taken their toll. At the same time, technological innovation around changes of customer behaviors and FinTech disruptors also played an important role in inducing smaller banks to sell. These and other factors brought seller expectations more in line with many buyers' expectations, and consolidation ensued.

   Virtually all the consolidation took place among small banks under $100 million, whose numbers have been cut by 88%, or 12,000, since 1984.

   Even their largest brethren have been selling; the number of banks between $10-$50B in assets has been reduced by over 10% in the past 18 months.

   An interesting note: while the number of institutions declined, the number of branches has been stable for most of the period since 1984, and has only started declining three years ago, by small numbers (after peaking at nearly 100,000 branches). Continue digital and channel transformation will take a bigger bite of the branch network in 2017 and beyond, but timing is everything  no one wants to abandon their branch-bound customers ahead of their adjustment to more self-service behaviors.

   And another interesting note: During this period (since 1984) of major institution shrinkage, the industry total assets have quadrupled to nearly $16T.

5. New charters are extremely rare.

   Investors used to flock to our business, funding new banks in the expectation that they will be sold within 7-10 years at a significant premium. These hopes were justified for many decades, but no longer so. As a result, new charters have not been granted for about five years during the crisis, and the requirements for approving one have intensified.

6. Industry financial results have been improving.

   Despite these headwinds, our industry has performed relatively well. Earnings are at $164B, a respectable 7.5% growth. Expense controls and strong credit performance are the main factors behind this performance. Despite margin reduction ROE is up 30bp, ROA up by 3bp. These are impressive, yet ROA still falls short of pre-crisis performance by 25bp.

   However, as important as expense control is, it is a finite measure. Without revenue growth we have no future. Technological innovation and FinTech partnerships might open the door to breakthrough financial results from brand new sources going forward.

7. Other financial metrics also look good.

   Industry deposits, loans, equity and total assets are all up Y/Y, all at rates exceeding GDP growth.

Where will 2017 lead us? I certainly don't know what the future brings, but I'm willing to hypothesize.

1. Financial performance will continue to improve.

   The industry has certainly suffered major setbacks during the financial crisis, as has our entire economy. Things have improved significantly since, despite major regulatory headwinds. I believe the trend with continue. Banks will find financial tailwinds in effective acquisition consolidation and improved use of technology. They will also forge partnerships with FinTech companies that will leverage the customer base while improving product offerings and convenience. Loans will continue to grow (although not in all markets), especially as the non-depository asset-based lenders have exited the business due to lack of funding some years ago.

2. Regulatory burden will stabilize.

   Call it wishful thinking. I hope we might have peaked, especially with respect to all but the universal banks. While consumer-focused regulations will remain at the forefront of regulatory attention, other requirements might be slightly adjusted to reflect the differences between universal banks and non-SIFIs. Hopefully the administration will also reconsider what IS a SIFI, and is a $50B bank truly financially important to the entire system.

3. Consolidation will continue.

   The technical and compliance-related expertise required to run a bank today is so high that I believe consolidation will continue. The investment bankers tell us that even a $1B bank might not have sufficient resources to effectively manage these challenges. This might very well be the case. If so, the consolidation imperative will still be in force in 2017 and beyond.

4. Credit will moderately worsen.

   I think it is simply inevitable. Loans that have been made since 2013 are maturing and will inevitably experience some stress. CECL is still too far to have an impact on the Allowance, but the real world will!

5. The quest for fee income will intensify.

   For me, the crisis brought forth two important learnings:

   • Concentrations kill
   • NIM is not fully under any bank's control

   There were many others, but these two come to mind every time I reflect on this past cycle. We now know that a dollar of fee income is worth more than a dollar of NIM. Both are at risk from external factors (need I say "Durbin"?), but one is far more vulnerable than the other. Both financial performance and acquisition premiums have shown us in 2016 that fee income is critical to achieving stable financial results and to effective capital management. It is important to recognize that only core, viable fee income should be planned for. I hope we will not repeat the mistakes of the past by milking NSF fees, for example. A new crop of consultants is marketing "new, improved" NSF optimization programs, which allegedly are designed to be in the best interest of the customer. I advise caution  once bitten, twice shy!

6. Deposit value will increase.

   Retail bankers have been frustrated since 2008. They couldn't make money based upon most transfer pricing methodologies given the low-rate environment. During the last few years loan growth has outstripped deposit growth in many banks. Some banks could get deposits relatively easily, and many were not rate-sensitive. Other banks even elected to invite large depositors to withdraw deposits from their bank to help them with capital management.

   I believe this trend will reverse in 2017. While we will not get to 2005-7 levels, system-wide the loan-to-deposit ratio has been steadily climbing, while regulatory tolerance of wholesale funding has ebbed. The value of deposits as a funding mechanism, regardless to the transfer pricing implications, will rise. Even if rates remain low, deposits will become more valuable.

I'd love to know what you, the reader, think. Am I all wet? Am I missing some key developments underway? Thank you in advance for writing and sharing.

Here's to a terrific 2017 on all fronts  personal, business, national and global!