Sunday, November 20, 2011
The November 14, 2011 issue of the New York Times carried separate articles dealing with the current state of the banking and newspaper industries. With a career in the banking industry that in recent years included financing a newspaper chain, I read each article with interest. The banking article dealt with how the industry is scrambling to replace the revenue now lost from the limitation on debit card transactions which comes after an earlier regulatory action that eroded income from overdraft fees. The article actually began on the front page of the paper and continued inside the business section. It went into detail about the clumsy and much publicized debit card fees that have since been rescinded for the most part. When you cut through all of the article, it described an industry that was basically saying “OMG (to use today’s texting terminology), we need more revenue to cover our cost”.
The first page of the business section carried the start of an article about John Paton the CEO of Media News Group, a chain of 57 daily newspapers that is rapidly moving its business away from print to digital media. While this transition may seem inevitable to outsiders, consider what the insiders must deal with in the process. Digital media product generates about 10% as much income as the comparable print product. The industry calls it trading in dollars for dimes. But, instead of fighting the declining trend in print revenue, Paton decided "it was time to start stacking dimes”. Contrast that attitude to the debit card fee fiasco. Most estimates I’ve seen put the cost of a debit card transaction in the range of a few pennies. The new limit reduced the amount charged by banks from $0.44 to $0.22. While it’s true that profit is being cut by roughly 50%, it still leaves this as one of the most profitable products anywhere…. at least that is still legal! So instead of discouraging the use of the product by imposing a fee, why not instead react by “stacking dimes”?
The bulk of the content of the two articles was published together on page 6 of the business section. There, just above the banking headline was a quote from a newspaper insider about John Paton. Paton, he said “deserves kudos for frankly acknowledging what other publishing CEOs’ won’t, which is that the cost structure will not be supported by the business model for much longer”. After reading that quote, I went back to the banking article and read it with a fresh perspective. What the banks were saying basically is that their customers are obligated to provide them with the necessary revenue to cover their cost structure. No they are not. No more than consumers of news are obligated to cover the cost of printing a newspaper in every city in America.
Monday, November 14, 2011
The American banking industry through the 1970’s operated within a patchwork of state and federal regulations that were largely rooted in legislation from the great depression of the 1930’s. Within that framework banks were limited to operating within a single state and in some states to a single location. Beginning around 1980 state regulations began to give way to demands to modernize the industry through deregulation.
The 1980’s became what I would characterize as the first wave of deregulation, or perhaps more correctly, reduced operating restrictions. During this wave banks found success through consolidation both internally and externally, both for the purpose of gaining operational efficiency. Merged banks consolidated branches and back office units. Operations and lending functions were centralized with smaller branch staffs focused on sales. Although it seemed quite challenging at the time, in retrospect it seems more like we were just “harvesting the low hanging fruit”.
The consolidation of the industry continued into the 1990’s when it combined with a re-energized economy to produce growing bank profits. After catching its breath with the internet bubble induced recession of 2000, the economy took off again, this time driven by increasing real estate values. During the 1990’s and well into the next decade, banks large and small continued to grow their profits. In addition to the benefits from consolidation, profits were driven by growing loan portfolios and fee income. If you look below the numbers just a bit, you could see that loan growth was largely driven by real estate across all categories. The real estate bubble that developed in the last decade was made possible by consumers’ willingness to go deeper and deeper into debt. For many community and regional banks their loan growth was concentrated in construction lending and commercial real estate in general. In terms of fee income, if you looked below the top number you could not help but note that much of the growth was coming from overdraft charges. As I summed it up at the time, banks were feasting on commercial real estate and overdraft fees. One of my favorite expressions is from a fictional economist who said, “Things that can’t go on forever, tend not to”. Indeed they did not. The real estate bubble burst and consumers finally reached their breaking point on debt and their tolerance of bank fees. Today banks are dealing with the aftermath of a collapsed real estate market and a reduction in fee income from overdrafts and debit card transactions.
This brings us to what I would call today’s “third wave” of the post-depression era banking industry. Most banks today are well into the process of recovering from the elevated loan loss provisions that they somewhat grudgingly began in the fourth quarter of 2008. Nearly every bank will be able to look to their loan loss provision for a lift in earnings in 2012. But, the lift will not be enough to restore earnings to prerecession levels. Even with the benefit of historically low funds cost, tepid loan demand will limit growth in net interest income. Fee income as we all know is now limited by both regulation and consumer backlash. This operating environment, in my view, will continue well beyond 2012. In fact, it could very well get worse. In a future article I plan to write about what may be the future for bank branches.
In this new “revenue challenged” environment the winners that will emerge will have two distinguishing characteristics. They will be exceptionally skilled credit grantors and exceptionally skilled at improving operating efficiency. A banker reading this sentence will likely respond by saying, “hey, we are already good in both areas”. No you are not! Not in the manner that will be required going forward. With the pressure building to find new loans, a bank will need to be able to land the good credits and leave the marginal ones to competitors. And, having tough credit approvers who are willing to just say no (maybe too willingly as if they enjoy it), will not be enough. Anyone can find a reason to say no to a credit, it takes skill to understand when and under what conditions to say yes. In a sense, this will be something of a back to the future process. The winning banks will be those that put forth skilled bankers that can discern credit and at the same time convince those good borrowers to do business with their bank instead of the competition. In terms of gaining operating efficiencies, let’s just say the industry is ripe for disruption. In yet another article I plan to write about a growing amount of money being invested by some very smart people with an eye to being very disruptive.
Tuesday, November 1, 2011
I returned to the banking industry in mid-2008. Since then I've been absorbed in my job as a workout specialists and after a long day of analyzing, writing, and talking, found it difficult to muster the strength to do yet more of the same in the evening. While I am still busy on the job, I have decided to find the time to add some thoughts here from time to time.
Actually, what brought this on was an accidental Google search that brought up my June 2008 post below about what I then observed as the de-leveraging of America. At the risk of indulging in a bit of self-congratulations, I must say it was "spot on". Just above that post is one about Hudson City Bancorp. I now see that their stock price has taken a beating this year, not because of poor lending habits, but the scarcity of earnings in our de-leveraging economy.
And WOW! The CountryWide acquisition turned out to be even worse than I predicted!
And WOW! The CountryWide acquisition turned out to be even worse than I predicted!
On another evening I plan to write about what I see as the banking industry being in the second phase of the post deregulation era.