Responding to Uncertainty by Focusing on Bank Fundamentals

In the face of a novel environment and great economic uncertainty, community banks should focus on their fundamentals – and their customers.

That’s the message from speakers throughout the first day of Bank Director’s 2023 Acquire or Be Acquired conference. More than 1,700 attendees started off Sunday with an overview of the challenging economic landscape, coupled with encouragement that there are opportunities for nimble operators.

“No way do I believe that size alone is a determinant of success,” says Tom Michaud, CEO of investment firm Keefe Bruyette & Woods, in the conference’s opening session. “Size hasn’t ensured success. Some of the finest banks I know are under $5 billion in assets.”

It all comes down to execution, and there is reason for banks to be cautious. It’s not clear if the economy will go into a recession or land softly, although Michaud says his firm is projecting a “softer” landing for 2023 and single-digit loan growth. The Federal Reserve has raised rates at a pace that most bankers have never experienced – a dramatic turnabout two years after the industry was deluged with $2 trillion of stimulus spending to address the coronavirus pandemic. But even with the prospect of slower growth, Michaud advises banks to keep their balance sheet clean and find opportunities to build capital.

“An industry that is catching its breath but remains profitable is a good place to be,” he says.

For now, this rapid whipsaw is the new normal in banking. Ahead of the conference, former Comptroller of the Currency Gene Ludwig told Bank Director that one truism in banking from the last half-century is that “the ups and downs come more frequently, and probably more severely, in shorter periods than they have in the past.” Technology and globalization have accelerated the pace of change, and banks need to be prepared for the volatility.

Ludwig speaks from experience. In addition to serving as comptroller in the 1990s, he founded IntraFi, a reciprocal deposit network formerly known as Promontory Interfinancial Network, and is now a managing partner of Canapi Ventures, a bank-focused venture capital fund that invests in financial technology companies.

Having seen a variety of economic and credit cycles, Ludwig advised management teams to operate their institutions for the long haul and resist the noise of one quarter or the next. For the former comptroller, this comes down to the fundamental focus on customers, community and deposits. “Is what I am doing, and how I’m operating, best for my customer? Am I doing that in fundamentally a safe and sound manner?”

Increasingly, low-cost deposits are an important aspect of those customer relationships. Technology has made it easier for deposits to move, creating competition for those once-sticky funds. “Bankers that cultivate good customer relationships and use modern tools are able to have more stable and lower cost funding than banks that don’t,” Ludwig said, adding that banks have a variety of methods and tools to encourage existing companies to keep their deposits.

The environment has shifted from unprecedented levels of liquidity flowing into banks to outflows. Total deposits in the banking industry declined for the second consecutive quarter, down 1.1%, or $206 billion, from the second quarter of 2022 to the third quarter, according to the Federal Deposit Insurance Corp. Driving the shift were accounts with balances above $250,000.

“Banks in general are going to have to start thinking about funding loans as they go along,” Michaud told Bank Director ahead of the conference. “Previously, they had this reservoir of excess funding that made it easy to make an incremental loan. Now they’re going to have to fund it marginally, and that’s why we’re seeing deposit costs rise.”

Many institutions consider themselves “relationship lenders,” but Mac Thompson, founder and president of analytics firm White Clay, points out that many bankers struggle to quantify the depth of their customer relationships. That is one imperative for community bankers to grasp ahead of a potential recession.

“Who is using your liquidity, who is using your capital and what are you getting paid for it?” he says during a lunchtime presentation. Relationship managers should know the answer to those questions by analyzing a customers’ loans and deposits. Thompson urges banks to focus on bringing customers’ operational accounts to the bank – the accounts that pay their bills – because those accounts may be harder to move in response to interest rates.

Customer loyalty goes both ways in relationship banking, and Michaud said this is one approach banks leverage when navigating the uncertain environment.

“Now’s the time for banks to be there for their best customers,” he said, especially as access to credit tightens. “Typically when they are, their best customers tend not to forget it.”