Bank leaders need to mobilize their teams around proactive, disciplined actions to buttress the blow of the Paycheck Protection Program.
The COVID-19 crisis has seen unprecedented involvement of banks in important disaster relief programs, but it will also be bringing about the swiftest reversal of earnings performance in banking history.
Earnings challenges are coming to banks in all areas:
Loan growth outside of Paycheck Protection Program (PPP) loans and mortgage refinances will come to a screeching halt
Low rates are putting more pressure on net interest margin
Non-interest income is declining from reduced interchange and waived fee policies
Loan loss provisions are going from La-La Land low levels to the harsh realities of today
Cornerstone recently completed an earnings stress analysis of the roughly 4,400 banks under $50 billion in assets. Using quarterly comparisons from last year’s performance, we forecasted each bank’s income statement as follows:
Net interest margin contracted by 15 basis points
Non-interest income declined 15%
Loan loss provisions increased by 350% from the same quarter last year
These three reasonable outcomes of the “Great Pause” recession produce some concerning results by the fourth quarter of 2020:
More than 25% of these banks will have negative earnings
More than 44% of banks will have earnings less than 50 basis points
140 banks will have capital levels that have fallen below 8%. They may be looking for a dance partner or hiding from a regulator
So far, bankers have taken comfort in the soundbite that “this crisis is different” because of the strong capital levels and risk management rigor that has developed since the Great Recession. Tier 1 capital in the industry has grown by more than 350 basis points since the housing crisis. However, a lack of solid earnings trends leads to bad things when shareholders, board members and regulators begin to express their concerns and potentially disrupt the direction of the institution.
Additionally, many bank leaders are realizing that this crisis is a time to fundamentally question their business models and potentially restructure the institution as part of the current bad news. Focusing and aligning the organization for the future can pay real dividends a year or two out.
So, GonzoBankers, while the country may be progressively “reopening,” the storm clouds are growing around bank earnings. It’s time for leaders to crank up the earnings forecast model and proactively build a detailed action plan to improve the look-ahead as much as possible.
Cornerstone recommends six key areas of focus around which executives need to build detailed tactical plans – pronto!
1. Practice the art of surgical lending
While all banks will be inundated with PPP forgiveness tracking and getting their hands around which loans go bad, keeping some balance sheet momentum will be important. As the large banks announce freezing lending in some sectors, community and mid-size banks should bring more data and common sense to the table. Create rigorous analytic processes to determine how to deal with existing borrowers and how to guide prospective borrowers with straight-shooting advice.
Banks often decide to eliminate every ounce of lending risk at a time like this – but how will that differentiate an independent bank versus the bank behemoths? For instance, Wells and Chase just shut down all home equity lending. Wouldn’t a bank want to lend to a 790 FICO epidemiologist at a 45% loan to value ratio? Banks have an opportunity to be analytic and real for consumers and small businesses right now.
2. Systematically drive payments revenue
Declines in consumer spending and shifts from high margin (airline, hotel) to low margin (groceries) interchange categories have presented double-digit declines in this revenue for many banks. The problem today is that most banks are not applying a true product management discipline to the debit and credit business. By putting more rigor into the management of this revenue line and integrating it with marketing/usage campaigns, customer experience improvements and front-line training, banks can get a continuous lift in payments that they will miss if they remain passive.
3. Build transparency around I.T. spending
Information technology is the third largest expense in a bank behind employee and facility costs. Despite being one of the largest expenses, it has very little ongoing visibility to the C-suites. By creating better tracking of this spend and controlling initiatives via a formal business case process, less urgent I.T. costs can be reduced. Some legacy applications may be decommissioned, and external contractor and vendor spend can be tightened.
4. Proactively manage vendor contracts
The time is ripe for banks to reduce their vendor expense through diligent contract negotiations. Banks with major contracts up for renewal within the next three years have an ability to open discussions for immediate cost saves. Importantly, the current crisis is spurring vendors to “dangle” contract extension “deals” with extended terms in front of banks. None of these deals should be executed without a formal market analysis to ensure the bank is being rewarded fairly for its business in these hotly competitive times.
5. Benchmark every function and drive excellence
This is not the time for banks to conduct an uninformed “everyone cut 15% exercise” among departments. Rather, it’s time to drive the organization with measurable objectives and key performance indicators that define aspirational targets in every business and support area. The “next normal” will not allow for the levels of inefficiency that exist in a legacy banking operation. It is time to reimagine bank performance using data as the guide.
6. Think about bold delivery channel moves
With COVID-19, banks have just taken every single customer and employee through a crash course in digital disruption and remote delivery. Many executives will use this time to put a much sharper pencil to branches and close or realign their brick and mortar as quickly as possible. Recent surveys of Cornerstone clients show significant shifts in customer channel usage with many institutions predicting a portion of this new customer behavior will stick when branches can reopen.
Bank executives have been knee-deep in business continuity operations and then neck-deep in PPP activities. But the walls of the bank are about to shake with a major earnings challenge. Leaders need to mobilize their teams around proactive, disciplined actions to buttress this major blow. The winners of the next normal will come from the clear leadership that starts to rally right now. GonzoBankers, call the play: earnings improvement on two. Ready … break!
“In the midst of chaos, there is also opportunity.” – Sun-Tzu