Growth despite pressure on the margin

By christina p. o’neill

In a year in which many banks and credit unions saw healthy growth, consolidation and competition were the keywords.

Every banker we contacted mentioned common trends. Besides the yield curve, they’re watching what the Federal Reserve does with incremental discount rate increases. They’re also increasingly alert to a slowdown in market activity in regional home sales. That wouldn’t be a problem if the economy hadn’t been so dependent on consumers’ purchasing power, leveraged by home equity lines of credit, over the recent years of the economic recovery.

Competition in the commercial lending market was intense in 2005, and bank executives expect that trend to continue. They also almost universally say that local and national economies are strong, with healthy GDP and low unemployment. However, they voice common concerns about the region’s cost of living, including housing, health care and energy costs. Future job creation worries them as well.

Citizens Bank: Job creation starts at the bank

Providence-based Citizens Bank is very active in job creation. It was named the No. 1 SBA lender in Massachusetts and New England for 2005 — its fifth consecutive year with the top designation – as well as the top lender for emerging markets, minority and women-owned businesses. The bank made 1,229 SBA loans this year, totaling $55 million.

At the beginning of the year, Citizens launched a $100 million fund offering low-interest loans to companies committing to creating or expanding jobs in New England. Borrowers must create a minimum full-time job for every $40,000 borrowed at the fixed interest rate of 3.5 percent.

Market share based on deposits rose from 12.87 percent to 14.35 percent in 2005, according to FDIC data. Customer deposits increased by $2.5 billion, and the bank experienced a $2.1 billion gain from organic growth, according to Robert Smyth, chair, president and CEO of Citizens Bank of Massachusetts.

For 2006, Smyth says, the bank expects to see a strong global and domestic economy during the first half, expanding 3.5 to 4.5 percent on an annualized basis, and continued increased demand for commercial loans, similar to that of 2005. The Federal Reserve will likely continue to increase short-term rates incrementally during the first half of the year.

A cloud on the horizon would be a decline in global liquidity, Smyth says. Companies that are now cash-rich would lose liquidity if the world’s central banks accelerate the incremental increase of short-term rates. Closer to home are concerns about the high cost of health insurance and access to skilled labor.

Critical to the forecasting of net income growth for banks in 2006 is the sensitivity of a bank’s balance sheet to repricing of deposits and loans. He expects yield curves to behave fairly much the same in 2006 as they have in 2005 — flat, he says.

Sovereign Bank: A good

middle ground

John Merrill, market president, Commercial banking, Massachusetts for Sovereign Bank, concurs that banks’ margins are getting squeezed, causing many — even mutual banks, long considered to be "safe havens" in terms of job stability – to re-evaluate their expense structures.

For the first nine months of 2005, Sovereign reported net income of $510.7 million, compared to $316.1 million for the same period a year ago.

The banking industry is now in an awkward part of the interest-rate cycle, where the lower-interest, fixed-rate loans for which many competed over the last two or three years can’t keep pace with the higher interest rates that banks must now pay to attract deposits, Merrill notes. While large banks can manage the gap a bit better through use of derivatives and other market instruments, Merrill says, smaller banks "are kind of stuck."

Sovereign, he says, rests on an attractive middle ground. It has been on the acquisition trail in the last two years, buying First Essex Bank and Compass Bank in 2004 and integrating them into its system in 2005.

Its purchase of Brooklyn-based Independence Community Bank Corp., announced in October, brings the bank to $80 billion in assets and vaults Sovereign into the No. 9 spot in the New York market. It also gives Sovereign a continuous footprint up and down the eastern seaboard. Merrill says it’s easier to spread economies of scale over an $80 billion enterprise than it is a smaller one.

Additionally, Merrill says, Sovereign’s strategy of breaking its regional banks into smaller "markets" and staffing them with regional leaders delivers big-bank clout in a community-banking platform.

But playing the role of "a big community bank," as he describes it, also means Sovereign is concerned about the housing market. The apparent cyclical cooling of the region’s housing market concerns him less, he says, than the long-term prospect of baby boomers aging over the next 10 to 15 years — and seeking to downsize their homes. "They’re going out and buying their retirement home which they hope will be their permanent home, and eventually all these 3,000, 4,000 square foot Colonials will go on the market, and who’s going to buy them?" asks Merrill. "Hopefully there’s a new technology growth industry that’s going to help us with that. Otherwise, baby boomers are going to retire, move down south and the young people are going to follow the jobs."

To help that process, Sovereign instituted a Massachusetts Jobs program, in conjunction with the state Treasurer’s office, to help growing companies that are creating the jobs, to get easier access to the capital they need. Next month, the bank will announce loans that it has made under the new program.

Webster Five: Back to stability

For Webster Five Cent Savings Bank, as for many others, 2005 has been the year of the flat yield curve (see sidebar).

But the bank is still on a growth path. Through the first nine months of the year, Webster Five reported $462 million in assets, compared to $435 million as of the same date a year ago. Webster Five will open a Shrewsbury branch early next hear, and it expects to add several new positions next year.

If the Federal Reserve stops or slows increases in the discount rate, mid- or long-term rates may increase, which would act as a stabilizer for the real estate market, according to CEO Richard Lawton. While homes may stay on the market longer under such a scenario, he doesn’t expect property values to plunge as they did in the early ‘90s.

His scenario is based on the following "ifs." Inflation must be kept under control. Unemployment stays fairly low, nationally and regionally. The nation enjoys a healthy GDP for 2006. Finally, banks need a and a stable or slightly widening yield curve, which would reduce pressure on margins.

He expects demand for commercial banking services to stay strong, with lots of competition. On the retail side, residential and consumer lending may slow as rates rise. Competition will increase on the retail side as consumers shop for the best CD and tiered deposit rates. Meanwhile, energy costs and price correction in the real estate market, coupled with rising mortgage rates, may dampen consumer spending, Lawton says.

Fidelity Bank: enjoying a boom year

Fitchburg-based Fidelity Bank has had a banner year in 2005, exceeding its goals in almost every category, reports President Edward Manzi. The bank’s loan portfolio increased 25 percent and deposits increased 14 percent. Fidelity, which recently opened a new office in Worcester, also broke ground for a new branch and corporate office facility in Leominster, near Route 1 and I-190. It added staff and has been attracting more applicants for key positions, Manzi reports. The bank’s financial advisory product, LifeDesign, is gaining more customer support.

In the year ahead, Fidelity expects to grow organically within its market footprint in both personal and business financial services, from basic banking and lending to insurance and investments, Manzi reports. He says that an informal survey of local business people indicates that they are "cautiously optimistic" and plan for growth. The construction of Fidelity’s new corporate office and branch will be a major undertaking, expected to be completed by yearend, he says. The bank will add new staff for both this office and its commercial lending capabilities, he says.

Fidelity expects double-digit percentage increases in its business banking and commercial lending areas in 2006. The bank, which has six branches, not including the new Leominster construction, is apparently filling a niche for business people who may feel they have fewer options as the result of past mergers. In retail banking, the bank will grow despite heightened competition. In the mortgage and lending area, future volume is less predictable, but Manzi says the bank expects continued market share growth because of a competitive product offering.

Digital Federal Credit Union: On a growth path

Digital Federal Credit Union, the region’s largest, passed the $3 billion mark in assets for the first time in 2005. Membership increased to 270,000, a growth rate of nearly 11 percent for the year. DCU opened new branches in Framingham and in Nashua, NH. It introduced several new mortgage options and a new equity line, as well as online membership enrollment - and also introduced Identity Theft Hotline, a free ID theft resolution service for DCU members.

On the commercial side, DCU introduced a tiered-dividend business checking product, Premier Business, which pays tiered dividends on daily balances of $20,000 or above. It opened a property and casualty insurance subsidiary, DCU Financial Insurance Services LLC, to serve its members.

DCI also updated its web site design and now sends account statements electronically to 120,000 members. In addition, it is offering a new insurance guide on its web-based StreetWise Consumer Education program, along with regular updates on consumer topics.

For 2006, DCU expects growth at the same or higher rate of 2005, according to Tim Garner, vice president of marketing and strategic planning, due to continued strong member referrals. It plans to open three new branches in the coming year, two of them in Worcester, where DCU has more members than in any other city or town. It will be hiring new employees to staff those branches. While Garner doesn’t have a specific sales forecast, DCU is setting challenging growth goals in all areas.

Higher operational expenses will be a given in 2006, he says - for energy, postage, compensation and benefits - but he believes the increases "will be manageable." Short term interest rates should be more stable this coming year than they were in 2005, a good sign. Long-term rates are less certain, he predicts, because of foreign demand for U.S. Treasury securities. Housing will remain strong, he says, but will be less of a seller’s market. "Competition will be strong, diverse, and coming from many directions – but that is the normal state of things," he says.

Christina P. O’Neill can be reached at coneill@wbjournal.com