In Your Best Interest: An ALM First Podcast

11. Status of Community Banks with Nathan Stovall

November 12, 2020 ALM First Season 1 Episode 11
In Your Best Interest: An ALM First Podcast
11. Status of Community Banks with Nathan Stovall
Transcript
Speaker 1:

Clearly that was going to offer a bridge over a lot of problems, but I would have expected some deterioration at this point. You know, I wouldn't, I wouldn't have said that we're all. I don't think we're completely out of this yet. I think the jury still sorted out, but I do think that the credit trends have been really encouraging deferral balances have declined to virtually nothing. So that's been really good.

Speaker 2:

Welcome everyone to the 11th episode of in your best interest and Aon first podcast, a show that will explore common depository challenges, give you an insider's view of the latest market trends and share stories and insights from industry leaders. I'm your host, Mike Ehnes Weiler. We spent a lot of time on the podcast, discussing challenges. All depositories are facing in an era of social unrest, economic uncertainty, a global pandemic, and an interesting political climate. Today. We've gotten perspectives from ALM first, as well as prominent figures in the credit union community. This week, I'll be joined by Nathan Stovall from S and P global, and we'll be taking a closer look at what he is hearing on these issues in community banking. Nathan's primary responsibilities include covering and analyzing financial institutions with a focus on the banking industry. Nathan regularly writes about emerging balance sheet trends, trends in bank accounting, regulation, interest rate, risk capital actions, and M and a activity. He is the author of a monthly column focused on banking in the South. And the banking blog street talk is in-depth analysis of the banking industry, including a focus on smaller institutions can be found in SNL's research and analysis feature, which includes historical and forward-looking figures during his tenure. He is regularly covered and participated on the conference circuit, moderating panels and webinars focused on major issues facing banks. He has spoken at industry events, offering updates on bank fundamentals, market conditions, and forecasts for what lies ahead. Welcome Nathan, and thank you for joining us today. Thanks for having me, my pleasure to be here, you know, before we get into the theme of the day, which are challenges and opportunities in banking heading into 2021. Tell us a little bit about yourself, Nathan. Sure.

Speaker 1:

So I was a business journalism major in college. I thought I was going to be, uh, a newspaper guy, uh, came out, started working for a small company called SNL financial covering banks across the country. And I thought I'd be there maybe six months. Um, but that was about 17 years ago. I fell in love with, uh, the banking space. Um, uh, I drank the Kool-Aid so to speak, uh, and kinda the rest is history. Um, love meeting people across the country and, and learning as much as I can about banks.

Speaker 2:

So you started in SNL at some point along the way that became S and P global. Um, are you doing the same thing or what do you actually do at S and P?

Speaker 1:

Well, my role has changed a little bit over that timeframe, but the whole time I would say that I I've largely covered the banking industry. We became part of S and P in 2015. And about that time I transitioned from our news team to our research team, uh, our financial institutions research team in it. And as part of that, not only do I still write data-driven work following trends, but every quarter I publish projections for the banking industry as a whole, as well as community banks in aggregate with an idea of just trying to highlight what is driving profitability and what is impacting key strategic decisions at at banks. I also host the podcast myself, uh, please do in anybody listening here, uh, called treat talk, uh, which focuses on some of the key themes impacting banks in the investment community.

Speaker 2:

And if you haven't heard Nathan's podcast, it is awesome. You're 70 episodes deep right now. And it's been a, a great inspiration for me as we've, you know, now on our, in our 11th episode of, in your best interests. So keep up the great work and hopefully for those of you tuning in, if you haven't listened to it, it's a great opportunity to learn a lot more, take a deeper dive into what's going on in community banking. So having said that it's a start of bank's earning season, what are you hearing? What are you seeing any surprises to this point?

Speaker 1:

I think the biggest surprise is when you, if you told me we'd be six months into a pretty severe recession with double-digit unemployment for a Wong part of that period and seeing all those no deterioration in credit, I would have said there's no way. So while we had a lot of appreciation for fed actions, you know, nearly doubling their balance sheet$3 trillion in stimulus, uh, provided to, to the consumer, uh, through checks and expanded unemployment benefits. And of course, for Berets that banks have provided through the cares act, providing, uh, wound referrals, which we estimated reached about a trillion dollars, uh, by June 30 of the, a huge number nearly, nearly 10% alone, clearly that was going to offer a bridge over a lot of problems, but I would have expected some deterioration at this point. I, you know, I wouldn't, I wouldn't have said that. We're all clear. I don't think we're completely out of this yet. I think the jury is still sorta out, but I do that the credit trends have been really encouraging deferral balances have declined to virtually nothing. Um, so that that's been really encouraging and a really big takeaway. What, on the flip side, I don't think we had as much of appreciation for how much margins might be under pressure, how much excess liquidity was really going to eat in the profitability because sort of like credit, you thought, okay, this will be a short-term relief. And then eventually some pain will come with the liquidity. You said, this is kind of short-term, but some of it's going to be fleeting. It's hung around here. And most institutions have kept their powder dry. So that just really leads to a place where if you're parking at the fed or an eight, 10 basis points, and your cost of funds is 35 40, you're losing money on that trade. And so just so you know, margins get kind of crushed. And I saw a problem with my hundred and 30th research report today that said, earnings, be lower loan loss provision than expected excess liquidity hits margin. Almost every print could be described that way. So I mean, that that's really been the big kind of takeaway that I don't think people really appreciated that credit could be this good for this long and that liquidity would hang around so much.

Speaker 2:

Yeah. The credit being is good for so long. You know, it's interesting. I was talking to someone yesterday, uh, a bank president, and he said that, you know, one of the things they're waiting on is the PPP loans, um, to come in, he's waiting for the application so he can get those off his books, a sentence. Um, have, have you, what have you heard on the PPP front from the people you're talking to?

Speaker 1:

And that's another thing that why Mac the clock a few months, everybody felt PPP would be gone by the end of the year, almost all of it. Right. And what we've been hearing in term of fee recognition, which is another way of saying when this stuff actually is forgiven and it goes off books, most people were put in Q1, um, and, and their expectations. So not so much that soon. And I think some of that is around lack of clarity around the forgiveness process, both from the bank side, but also the, the borrower side that the question Mark for me is how much of it is sitting out there with bars who were fine to pay a 1% interest rate and hold onto the cash for a long period of time, because they're never going to get that deal again. Right. And I don't know if we have a lot of clarity there. I mean, I don't think it's all the money, right? I'm not even suggesting it's a large portion of it, but I think we started this thinking it had to be a very small fraction and it might be bigger than people had thought.

Speaker 2:

Are you seeing concerns from people who are more specialty lenders, they focus in on hotels or on other kind of specialty, um, industries that have been greatly impacted by, you know, the, the, the recession, the pandemic, what have you,

Speaker 1:

No doubt anybody greater exposure that risks industries, you know, whether or not they had seen problems, the date there's far more attention in, in scrutiny being paid there. And I, and I think one of the greatest measures is I mentioned where deferrals were in the fact that you've see them come down 75% with what's remaining, it's all around Atlas industries and hotels being a, a great place to put it, you know, and a lot of that just has to do with how the hotels make their money. I mean, not only are people not going as often, uh, but business travel is almost nonexistent and conferences are almost nonexistent and those are very, very profitable items for most hotels. In fact, I think is what drives their number. And so in the absence of that, it seems like it's going to be really tough for, for a lot of hotels to, to really sort of stay afloat. I, I think so that that's an area that we we've seen plenty of concern, uh, anybody who is more reliant on tourism, for sure. Anybody who has more exposure to retail restaurants, all the places you would think those are the ones that are reporting more, more problems, not necessarily in the porn, uh, from the point of non accruals, but increase in classified assets and the ones who are still asking for more relief in terms of deferrals. Yeah.

Speaker 2:

Yeah. Makes perfect sense. You know what, Ellen, first we hear a lot about and see a lot of excess liquidity credit concerns as we've talked about margin compressions, as you mentioned earlier, um, profitability concerns. What are you hearing from bank executives on different strategy ideas they are investigating and, or maybe embracing in this environment?

Speaker 1:

I think the smartest guys are really drilling down on, on both the liquidity piece and the credit piece, you know, maybe starting with credit, not just saying, okay, what's, what's my sector exposure per se, but trying to really look at the sector exposure and then create risk ratings within that being really aggressive and working with their bars, uh, the old line, first of all, losses is the best loss. I don't think that's kind of true. So providing relief to borrowers work could make sense if they do have some sort of on-ramp back, but, but if not trying to work to get to some sort of loss mitigation strategy, like, like you normally would similar kind of segmentation on, on the liquidity side, you know, what is driving this liquidity? Is, is it a bunch of commercial accounts doing this? Is this just a few people driving balances up? Is this a bunch of consumer accounts? Is there granularity and then running sort of what if scenarios on that? Okay. What happens if a certain portion of this leaves, this leaves the bank not necessarily leaves the system, but ends up in somebody else's hands and what does my liquidity position look like? There am I comfortable if X amount leaves based on the fact that this seems to be an excess balance against sort of this normal time at customer? Or do I need to plan for, for, uh, do I need to have a plan if that occurs and, and what I would say sort of building on top of that is that we're hearing people say, okay, if I look at what's access and I'm comfortable with it, meaning that I need to put more money to work because I'm losing money sitting at the fed, or maybe I need to reach further out the curve, uh, because the fed has told us they're not raising rates anytime soon. And even if they do, there's likely going to be loan demand that comes with that. So there'll be a good opportunity that comes with that. And it's too expensive for me to sit in this cash today. Yep.

Speaker 2:

Are you hearing any consensus or any, any themes as to how long people think this cash is going to stick around?

Speaker 1:

I really haven't honestly. And I think it's going to be, I think it's sort of bar specific, but some of it's PPP, you know, what's your view on that PPP balance in terms of customers actually utilizing cash. Um, but some of it, I think is also people building cash, stockpile, and cash out of an abundance of caution, whether that's consumers look at consumer savings rates, historically high record levels going back almost 70 years in April, may, June and July, which is just a staggering number. Uh, some of that obviously driven by, by stimulus, but how much has that rainy day money and the people sort of preparing? So what's your, what's your view of, uh, of the consumer there? Um, and in terms of them actually harvesting that cash, but I I'll say that broadly. I haven't heard a lot of people making the case that they think it's going to go away. Like maybe they thought three months ago. Uh, one of the thing, conversation that we're having beyond just sort of the deposit side of the business, look at how the securities portfolio is behaving. It's generating for more cash than historically as we know banks about half of their portfolios or more and MBS. And given that pre-payments are so, so high right now, that's just generating far, far more liquidity. So even if you think the posits are going to go your Curtis portfolio, which is more liquid than it normally is. And I think you have to take that consideration.

Speaker 2:

I was anecdotally, I was talking to a, a bank president yesterday and he said that they did a lot of payment deferrals on the consumer side. And they saw people who really never had savings accounts. They were essentially taking those payments that they were making, um, and just parking them, parking it in cash, um, in, in, in creating a savings plan for the first time. And I'm sure they're not alone, that a lot of institutions are seeing that. So any, any common practices or best practices of those who are doing better in this environment than others?

Speaker 1:

I think sort of classic example of those who are trying to make active, be as active as possible, whether that's looking inwardly in trying to figure out what's driving their portfolio, um, what's driving liquidity balances, what's driving credit performance. Uh, but the other piece would be thinking about what you can control. You know, we're sitting here talking about everything that sort of, you inherit through the economic environment. You can't control your expense base or, or work on that you can think about branch rationalizations. And we've seen some institutions come out there with 2020 5% cuts in terms of the branch networks with the eye that digital adoption is increasing. I mean, the, the line that folks have been using is that, you know, we've seen five years of progression around digital adoption in just a few months. And, and we, we have a mobile banking survey where we've been asking consumers wide variety of questions. And one of them is, you know, what's happened to your branch visits, post pandemic are down about 65%. Uh, we're we're 65% of participants said they're going far less. And that same cohort says they're using their mobile apps. And in turn for a lot of the things that they would normally go to the branch for. So I think you're seeing the consumer change and I think that's prompting some of the better banks to say, okay, this year is really tough. Maybe even next year is really tough. How do we limit costs and prepare for the future?

Speaker 2:

Are you seeing a lot more investment in, in kind of that or that digital transformation, so to speak?

Speaker 1:

We're, we're certainly seeing more attention. I don't know if I've seen is much in the way of investment dollars, but I, I think that the smart banks would be doing that if you haven't already, because the idea that this is a slow moving trend that we're getting to, I think that that's, that ship has sailed now we're here now. And if you're going to have any sort of retail strategy, I think you have to have this and maybe even have to have some sort of digital offering from a commercial piece as well

Speaker 2:

On a call earlier today. And, uh, it was M and a related, and it was, it was from our M and a advisory team in, in the comment was made that institutions that, that, you know, made it through the recession, but maybe haven't been as profitable as they should, or haven't, you know, the management teams, aren't quite where they need to be their pencils. Aren't quite as sharp. You know, this goal around now, we're seeing heightened M and a activity a lot more interest than maybe we had seen in the past few years. So it, and again, that's been more of our, our advisory practice with, with net interest, margin compression and lower multiples on institutions. What are you seeing on the M and a front?

Speaker 1:

We're not seeing much in the way of transactions yet, but we're hearing lots of chatter for exactly the reasons you just said. And there was a couple of things that are different this time than coming out of the great recession. Sure. No one really knows what credit quality looks like, but I think we can all kind of say what the, with a high degree of confidence that we're not looking at four years of inventory necessarily, or at least the same level of inventory of bad assets to work through. Like we did out of the great recession, you know, we don't have this massive housing bubble. We don't know how long it takes sort of the work through this stuff. So I think you get to the other side, we're quickly. Once we get some sort of comfort over what the actual price is to their earnings. Environment's really challenging as you talked about before from an earning standpoint, and you're not really going to get a pickup a Nim really soon. So it seems like, uh, a better way to actually drive earnings hires through M and a three, the digital branch reduction piece, you know, transactions heard great way to consolidate branches and then four on the valuation discussion coming out of the great recession, the bigger guys were trading lower valuations than the smaller guys. And so if it was a stock deal, it was really hard to get done and now that's not happening. You've actually got sort of the stars aligning there. So I think you'll see more. And I think you'll, you have more management teams have sort of gotten maybe religion on the need for scale on this piece too. So I just feel like you'll have more conversations come together and more transactions come starting maybe early next year, second quarter next year.

Speaker 2:

And that's consistent with what I've been hearing internally as well. You know, so we've talked about some of the challenges, you know, where are the opportunities you see for the industry heading into 2021?

Speaker 1:

It's certainly tough out there, but I think you get kind of a pass on this year and you might even get a pass first quarter, second quarter next year. So again, back to what, what you can control if, if you get a pass in terms of what earnings look like, because everybody thinks they're going to be bad. Anyway, now's the time to sort of think about positioning for the future. And some of that is, is thinking about creating the right customer facing experience. You know, I, I talked about digital from a retail standpoint, but there's certainly plenty of things you can do in terms of having the right products and services from a commercial standpoint as well. I think thinking about the right distribution channel, you want to have in positioning for that and really taking a look at what your expense structure is, and trying to think about how to make yourself leaner. And the reason why I say there's opportunities that now is because you can take a little bit of an upfront hit and no one's going to be upset with you doing it today. Um, and at the same time, I, I would think about, you know, how do I grow? And I would think hard about M and a either as a, or as a seller, because I think there is going to be opportunity for those who are moving in that direction. And then the last piece, you know, we, we mentioned PPP, a lot of smaller banks have all these new customers. I would make sure that I'm working to serve them as well as possible. It seems like smaller banks have gained new customers, potentially share there, make sure you don't lose them just because they came today. Doesn't mean that they're here forever. So let's, even if they're not going to make us a ton of money today, let's make sure that we're catering to them. So when things get back to normal, we have good customers there for us. So we can grow at a faster pace,

Speaker 2:

Any silver linings for the industry that you see as a result of this environment,

Speaker 1:

I think it's made us rethink some things or it's forced us to do some things that we had to do anyway, whether that is sort of efficiency, thinking about modernizing systems, thinking about contingency plans with everybody working from home, all different kinds of stuff that we probably didn't want to get to as much that now we absolutely had to do, uh, get really clever and dig into credit and, and ways that we haven't had to do in a while. And, and, and especially around balance sheet strategy. That's, it's the stuff that the Alco guys go crazy for it. And guys like you and me, I'm talking about, but not everybody does, but it's really making us think really hard about what our customer base looks like. And if you do the work now, I think it's really going to benefit you for a long period of time going forward. So that's, that's my silver lining is that it's forced us to do hard work that will benefit us for the future.

Speaker 2:

All right, Nathan. So here's the, here's the money question here? What's your outlook for 2021?

Speaker 1:

We, we think returns look pretty challenged and, and no small part because of higher credit costs. You know, while the biggest guys have, have already reserved for potential offices, because of things like Cecil, you know, smaller guys haven't had to comply with Cecil. So reserves are gonna have to continue to build. And we're kind of in the camp that, that charge offs peak late next year, but in 2021, and that we can kind of move on, uh, from there. And while there sort of be some lingering problems and margins will, will be depressed, uh, returns might not be as challenged in 22. Uh, but you kind of see earnings get nearly cut in half. So it's pretty tough scenario. Uh, but I'll tell you this from, from the public market standpoint, that's absolutely priced it. So, and in fact, it's probably even more negative than that. So as I said earlier, a it might sound very negative, but we're probably more positive than so, so there is an opportunity to sort of outperform broad expectations right now. Uh, if, if we're even

Speaker 2:

Well, that's a good place to end it. I always enjoy speaking with you, Nathan, and want to thank you for giving us some food for thought as we head into the planning and budgeting season and into 2021. Well, thanks for having me, Mike. I appreciate it.

Speaker 3:

Yeah.

Speaker 2:

I want to thank you again, Nathan, for sharing your thoughts on some of the challenges and opportunities in community banking. If you'd like to hear more from Nathan, be sure to follow and listen to his street talk podcast, which you can find on Apple podcast, Spotify, or wherever you listen to podcasts. At the end of each episode, I'd like to take a moment and let you know more about some additional resources we have available as always stay safe, stay healthy. And thank you for listening to in your best interest in ALM first podcast.

Speaker 4:

The content in this podcast is provided for informational purposes and should not be relied upon as recommendations for financial planning advice. We encourage you to seek personalized advice from qualified professionals regarding all investment decisions. Current and future holdings are subject to risk. Past performance is no guarantee of future results. Cash should not be copied, distributed, published, or reproduced in whole, or in part information presented here. And it's for discussion and illustrative purposes only, and is not a recommendation or an offer or solicitation to buy or sell any securities. The views and opinions expressed by the alien first financial advisor speakers are their own. As of the date of their reporting, any such use are subject to change at any time based upon market or other conditions. And Alun first financial advisers. Disclaims any responsibility to update such views. These views should not be relied on as investment advice because investment decisions are based on numerous factors may not be relied on as an indication of trading intent on behalf of any ALM for as financial advisor product, neither ALM first financial advisors, nor the speaker can be held responsible for any director, incidental loss and cured by applying any of the information offered. First financial advisors is an sec registered investment advisor with a fiduciary duty that requires it to act in the best interest of clients and to place the interest appliance port zone. However, registration as an investment advisor does not imply any level of skill or training.