This time last year, bank analysts were growing bearish about the prospects for banks in the year ahead, wearing furrowed brows as the yield curve flattened.
Yet 2006 turned out better than most of us could have hoped. Stock prices inched upward, following earnings gains that had seemed maxed out to many industry observers. Housing slowdown? Maybe so, but bank branching raged on. Slowing deposit growth? No slowdown in banks scurrying to offer the freest free checking account, the lowest low-cost credit card, the most convenient hours of operation. Still, the outperforming banks were those that kept their eye on two critical indices: fee income growth and expense control.
The name of the game in 2007 will be about holding market share while decreasing costs and, especially for banks with a significant stake in housing, increasing fee revenue. This is very different from past cycles, where an inverted yield curve caused banks to ratchet up loan rates, fight to keep down savings yields, slap fees on anything that moved, and not worry too much about losing customers.
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Bare-knuckled competition for loans, deposits, and branch convenience. Amid growing evidence of overbranching, the frenzy to branch will slow this year, but not by much. What is increasingly clear is that branches can only be justified by deposit growth and the development of the customer base. That means that banks will remain aggressive in loan pricing and in offering free checking and other no-fee services to their customers. Faced with competitors that make increasing fee income difficult on existing products, the most successful banks this year and beyond will develop entirely new sources of fee income.
Little change in federal regulation. With a change in leadership so dramatic that Massachusetts Congressman Barney Frank is in and longtime House Financial Services Committee head Jim Leach is out, one might expect a batten-the-hatches response from the banking industry. Not to be. Look for a relatively easy transition for banks in both the House and the Senate, where Senator Christopher Dodd (D-Conn.) takes over the banking committee chairmanship. And from the SEC, some breathing room on Sarbanes-Oxley, at least for community banks.
Aftershocks on CEO compensation. Outrageous salary, bonus, options, and severance plans awarded by Pfizer, Home Depot, and others have put a spotlight on boards and established a new definition of what is reasonable. Directors everywhere will need to think twice about awarding the shareholdersu00e2u20acu2122 assets to a departing CEO, no matter how badly the need to get him out the door. More attention will be given to aligning the interests of management and shareholdersu00e2u20ac”a concept long accepted in principle, but often forgotten in establishing bonus and option plans for top management. Still, compensation is an area where, with very few exceptions, bank boards have proven more responsible than the boards of companies in other sectors.
New worries about credit quality. Who knows where it startsu00e2u20ac”the head of the OCC expresses concern about the housing slowdown; a respected banker foresees a slower 2007; a bank increases loss reserves for reasons unrelated to the quality of its loans. Wherever it begins, it hasnu00e2u20acu2122t ended. If you have a microphone in your hand, be prepared for questions about credit quality. And be prepared for ruthless punishment by the market if credit quality shows actual slippage.
New products: Youu00e2u20acu2122ll see good ones, like remote deposit and check imaging, that have customers and bankers alike benefiting from new technologies; evolved products, like checking package accountsu00e2u20ac”still the best way weu00e2u20acu2122ve seen for a bank to offer free checking while at the same time generating major fee revenue from its DDAs; and really bad, before-their-time products like mobile phone banking, a 3.0 product for a 1.0 audience, a product at this stage of the game in search of a market.
What we wonu00e2u20acu2122t be hearing this year are those recurring predictions of the demise of the community bank. New charters continue to thrive as other banks in the market consolidate, and many community banks continue to take market share from their larger competitors. Efficient technology, competitive products, and the simple fact that a significant percentage of Americans prefer dealing with a locally owned bank, combine to give community banks a healthy long-term prognosis.
All in all, expect a pretty good year, while you cut costs to the muscle not the bone, branch only opportunistically, innovate only with proven products, and refuse to yield an inch on market share.