'07 Forecast: banking
Right-side up growth in an upside-down market
By phyllis hanlon
The banking industry operated under overcast skies in 2006 due to a slow housing market and depressed yield curve. Financial analysts foresee some breaks in those clouds next year.
Gus Faucher, senior analyst at Moody’s Economy.com, anticipates an improving climate for money center banks, but continuing challenges for regional financial institutions. "Big money banks have asset management, stock trading and investment divisions, while regional banks don’t have as much in the way of equity markets," he says.
To attract new customers and retain current ones, banks may concentrate on expanding services and products, such as asset management and insurance products, Faucher says.
Mark Fitzgibbon, CFA and director of research at Sandler O’Neill & Partners, LP, cites two significant headwinds that will affect the 2007 banking market. One is the yield curve, which he anticipates will remain flat or slightly inverted through the first three quarters, weighing on profitability. In a normal yield curve, short-term bonds pay less than long-term bonds. In a flat yield curve market, they pay about the same despite different maturity dates. This means banks can’t borrow short-term, invest long-term and realize a good spread between the cost of borrowing and the interest they pay to depositors.
The second thing impacting the 2007 banking outlook is the slowing housing market, particularly in Massachusetts (see sidebar). "Credit qualifications will decrease from the current pristine level and credit costs will rise," he says. He anticipates that the economy in general will slow and that businesses will be less inclined to borrow; he expects credit quality to deteriorate in 2007, and that there will be more problem loans than we’ve seen historically. Some preliminary signs of this change were apparent in third quarter 2006, he says.
Growth and consolidation
The region’s bigger banks – the superregionals headquartered outside Massachusetts – report robust growth during the year, due to the creation of new products and services. The smaller regionals are more cautious about 2007. Last month, two of the region’s smaller banks merged in an effort to gain critical mass in what they cite as an increasingly competitive market. Westborough Bank and Hudson Savings Bank will be close to the $1 billion asset mark as a combined entity. For other institutions, the flat yield curve could be a damper to acquisitions. Virtually all the bankers interviewed for this article cite new, customer-friendly products and personalized service as their path to profitability in the year ahead.
Bank of America, which has 303 banking centers and more than 1,350 ATMs in Massachusetts alone, demonstrated robust growth in 2006 due to new programs and services, according to Edwin Shea, Jr., Worcester’s marketing president. Shea anticipates organic growth largely focused in the United States, while overseas operations will expand in 2007. In 2006, BoA merged with MBNA, the largest credit card issuer worldwide. Customers can open affinity cards tied to the Red Sox, Patriots, LLBean and many other organizations, teams and clubs through BoA banking centers.
Providence, RI-based regional Citizens Bank, with $37 billion in assets with 264 branches and 625 ATMs across the Commonwealth reported 20 percent growth in its commercial banking portfolio since last year. Robert Smyth, chair, president and CEO, anticipates several challenges in 2007, specifically a weak housing market that will mitigate the 4.4 percent unemployment rate. "It will be very important for the economy to remain intact so that loan volumes and credit quality remain strong," he says. Nonetheless, FDIC data released in October reports a $1.6 billion increase in deposits at Citizens.
Sovereign Bank, with about $25.9 billion in assets, 37 Massachusetts branches is the 16th largest banking institution in the country. John Merrill, market president, Commercial Banking for Massachusetts, predicts a good year for Sovereign despite the yield curve. He says he expects moderate growth in the banking industry that will mirror the economy. Sovereign intends to focus on its convenience strategy and increased service levels. It has eliminated many fees for commercial customers, new services and access to credit with a 24-hour turnaround on loans for small and mid-size businesses, and its partnership with ADP allows it to offer a large-business model of payroll product to small businesses.
Housing woes worry banks |
The region’s slowing housing market worries everyone from bankers to homebuyers. "There is speculation as to whether we’ve bottomed out," says Steve Groccia of Bay State Bank. "The time houses spend on the market has increased, which is driving prices down. Foreclosures are way up. This hurts the economy."
Analyst Mark Fitzgibbon agrees that the housing market has slowed to a crawl, particularly in Massachusetts. "We are already seeing the impact of higher interest rates in the housing market," he says. "Some builders have gone bankrupt."
Barnstable and Berkshire counties, with many second-home mortgages, showed the highest foreclosure rates in the Commonwealth in 2006, Fitzgibbons reports. "People tend to let their second home go first, which results in rising delinquency and foreclosure rates," he says. "This is consistent with prior cycles. The consumer appetite for debt has been satiated by mass home equity and principle residence refinancing."
Flagship Bank President Jim Garvey cautions homebuyers seeking mortgages to read the fine print. "You have to know who you are doing business with," he says. Non-bank lenders have free rein and may observe unprincipled practices, he says. "The banking industry is regulated and has been since the 1930s. That’s why you don’t see scandals."
Groccia says mortgage companies can charge one-tenth the price that banks can. He labels reverse and interest-only mortgages as suspect products, and says that companies that offer them can reopen after regulators shut them down.
John Merrill of Sovereign Bank Massachusetts warns against interest-only mortgages. "Trying to afford mortgage payments is pretty challenging when rates go up," he says.
Mark Crandall of TD Banknorth suggests that the refinancing craze is over, and that the region is moving toward a more traditional purchasing market. Meanwhile, the refinancing craze brought out predatory lending practices, the effects of which we’re still seeing, he says.
Analyst Gus Faucher expects consumers to turn to credit card borrowing in lieu of home equity loans. "There will be a continued evolution of our financial system," he says. "The lines have been blurred. And there’s no reason why that should stop."
P.H.
A good year ahead despite an upside-down market
According to Jim Garvey, president of Flagship Bank, 2006 was one of several economically solid years, despite the flat yield curve and a "funky rate environment." He notes that a 3 month treasury bond yield is far below prime. "This is illogical, an upside down market," he says. But Flagship is seeing a commercial loan growth of 11 percent and is budgeting to see earnings increase next year, he says.
Garvey predicts the need for bricks and mortar locations will diminish due to direct deposit and increased debit card use, but emphasizes the continued importance of convenience and good customer service. He says what differentiates one bank from another is the staff, despite nationwide loan competition from companies such as Merrill Lynch and Wells Fargo.
Mark Crandall, executive vice president, division manager of commercial banking at TD Banknorth Massachusetts, says he expects physical as well as organic growth for TD Banknorth in 2007, despite personnel and fiscal challenges in the year ahead. "As an industry, banks have not done enough to recruit and develop young people just entering the workforce," he says. TD Banknorth plans to actively pursue new talent next year, recruiting from some of the high quality educational institutions in the Commonwealth.
The plethora of banks in the state poses an obstacle to economic growth in what Crandall calls "an irrational market." He says, "We have too many banks chasing too few loan opportunities. As competition increases for loans, it becomes incumbent on banks to make sure we do the right thing for the bank and for the customer in terms of risk."
Cautious optimism in a challenging environment
Bay State Savings Bank, a local bank with seven branches as well as a branch inside Auburn High School and its downtown Worcester location and $300 million in assets, is more cautious about the future. Steven Groccia, senior vice president for commercial lending, says his bank, like many others, faced the challenge of making budget goals in 2006 due to the flat yield curve. Over the last six years, Bay State Savings, for which retail customers represent 65 percent of its overall business, has been actively promoting its personalized commercial lending department to drum up more commercial business.
Bay State wants to raise awareness of its ability to handle loans of up to $4 million. "Ninety percent of our loan requests are less than that. Not everyone is aware we have that kind of funding available," says Groccia. A typical loan request ranges from $250,000 to $2 million. He expresses a desire to create a niche product in the coming year, possibly a line of credit for the medical or legal profession.
Ware-based Country Bank for Savings, which has more than $1 billion in assets, launched some exciting projects this year, according to Arthur Bopp, CFO and senior vice president. In addition to its existing 13 locations and thousands of ATMs, Country Bank will open a branch inside the new Wal-Mart, currently under construction in Leicester. "We are looking to solidify the bank market as far as geography is concerned," says Bopp. Country Bank anticipates further branch expansion in the future should opportunities arise.
Bopp expects little change in the banking landscape in 2007. "The industry as a whole will see continued consolidation, albeit slower than in the past," he says. The rate scenario will affect both the commercial and mortgage markets, he predicts. He adds that investment possibilities will vary across the state, depending on economic conditions in that geographic area. Like many banks, Country Bank has experienced a slowdown in deposit growth. "The biggest challenge in 2007 will be finding and maintaining affordable sources of funding to fulfill customer needs," Bopp says.
Phyllis Hanlon is a freelance writer. She can be reached at polishpen@mac.com
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