No Time for Complacency

January 31st, 2018

valuation-1-31-18.pngThe bank industry is no stranger to change. In just the past few decades, deregulation, telephone banking, ATMs, the internet and mobile phones have all caused banks and bankers to adjust how they approach their trade. But while the fundamentals of banking have remained the same throughout all of this, with the changes confined largely to the way banking products are delivered, one gets a palatable sense from attendees at Bank Director’s Acquire or Be Acquired conference this year that the industry is on the verge of a more transformational realignment.

In the short-term, bankers are upbeat about last year’s historic tax cut. You have to go back to World War II to find the last time the corporate income tax rate was as low as 21 percent. Few industries will benefit more than banks from this reduction, as three out of the four biggest taxpayers on the S&P 500 are banks. The net result is that profitability in the industry, measured by return on assets, is expected to increase by 20 basis points in one fell swoop.

The benefit to banks from the tax cut won’t just be on the expense side. In an audience poll on the second day of the conference, 84 percent of attendees said that they expect small businesses to recycle tax savings into new investments, be it better technology or higher wages for their employees. If this comes to fruition, it would pour fuel on the economy, pushing up wages and accelerating inflation. The desire to keep price increases in check, would incentivize the Federal Reserve to raise rates more aggressively, thereby pushing up net interest margins and thus revenue and profits throughout the bank industry.

This is one of the reasons that bankers are so optimistic about 2018. Bank stocks have soared over the past 14 months, pushing valuations up to the highest level in a decade. Bankers who own stock in their banks have seen their balance sheets respond in kind. For banks that have considered a sale, this presents a previously unexpected opportunity to cash in by drawing a markedly higher price for their shareholders from a merger or acquisition.

Yet, there are two underlying currents of concern. The first is that the improved outlook will lull bankers into complacency. With profits up and shareholders feeling rich, investors fear that bankers will feel less urgency to change. But as Tom Brown, CEO of hedge fund Second Curve Capital, reminded attendees earlier in the conference, bankers should be careful not to confuse a bull market with brains.

Banks have survived countless innovations that have washed over the industry in the past by adapting to them and incorporating them into their existing business models, but the changes afoot now, be it big data or mobile banking, strike at the very heart of those business models themselves. In a separate poll of audience members at this year’s conference, 83.5 percent of attendees said that big data is the new oil. The implication is that it could usher in changes as significant as the industrial revolution.

This is a point that Dennis Hudson III, the chairman and CEO of Seacoast Bank, a $5.8 billion bank based in Stuart, Florida, drove home in an interview with Bank Director. Customers are becoming less sticky. Many customers no longer walk into branches and younger generations in particular now value banks less for the ability to store money and more as the means to facilitate secure, real-time payments. Banks that don’t adapt to these realities could find themselves in the same situation as horse buggy drivers who dismissed the automobile as a toy for hobbyists.

When you also factor in the maturity of the consolidation cycle, which could leave under-performing banks with few suitors and competing against bigger and more sophisticated rivals, this may be one of the worst times in the history of banking to grow complacent. Consistently throughout the conference there was talk of the haves and have nots. The haves are banks that earn industry-leading returns and thereby serve as attractive acquisition targets or are in a position to be serial acquirers in their own right. The have nots, on the other hand, are banks that lag the performance of their peers, lack the resources to devote to innovation and could thus find themselves standing alone when the proverbial music stops playing.

Further underlining this point is that, for the first time, the nation’s biggest banks are growing customers organically, attracting them with simple and sophisticated mobile banking offerings and competing aggressively for consumer deposits as they comply with new liquidity requirements. This is a meaningful inflection point. Previously, community and regional banks benefited from the acquisitive ways of the biggest players in the industry, which shed customers as the banking behemoths worked to digest their acquisition targets. But now, with the three biggest banks in the country locked out of the acquisition game as a result of the 10 percent cap on deposits, they are focused inward, bringing them into more direct competition with smaller banks.

The overarching takeaways from this year’s gathering of over 1,000 bankers are accordingly twofold. The near-term looks promising for banks, with more money hitting the bottom line from the recent historic tax cut. But banks should use this to accelerate their transformation into the financial institutions of the future, not as an excuse to rest on their laurels and buy back stock.

John J. Maxfield is a freelance writer and regular contributor to Bank Director.