New Trends, New Models in Banking: What It All Means for Leading Entrepreneurs and Private Families
Presented by Charles C. (Chuck) Fawcett IV, President, Private Bank
Executive Summary Banking in the U.S. was redefined in the early twentieth century through two main acts of Congress: the Federal Reserve Act in 1913 and the Banking Act of 1933. Those actions established three types of heavily regulated commercial banks: regional banks that focus on one geographical area and provide depository and lending services; major banks that operate in financial centers like New York, and are involved with international transactions and sophisticated financial services; and community banks that serve a small number of local clients. This model remained in effect, more or less consistently, for several decades. Then, major economic and financial developments beginning in the 1970s formed the backdrop for a tide of deregulation that ushered in a period of dramatic change. There followed a wave of innovation that left the sector fundamentally different. These innovations reduced costs and risks and improved products and services. They sprang up in virtually every aspect of the industry – products, services, production processes and organizational forms. They were brought about by advances in technology, financial innovation and diffusion in banking. Today even more radical change is under way. Mobile banking, remote deposit capture, contactless payments, and global cash management are just a few examples. Then the financial crisis struck. The biggest names in banking needed government bailouts. Credit contracted sharply. And a new era of regulation began. What does all the turmoil in the financial industry mean for the wealthy and their financial managers? This paper reviews the impact the financial meltdown has had on the industry, what status many banks find themselves in, and how to evaluate banks as providers of products and services and as investment possibilities for their clients. The review of the state of the banking industry arrives at these conclusions: • • • • •
Banks with an outward focus can best serve their clients. Banks that build personal relationships with their clients will offer the best value proposition. Banks designed to apply their unique strengths to specific markets can provide custom solutions. Banks with smaller staffs can better protect the privacy of their clients. Banks that serve target markets, report strong financials, have successful management teams and no legacy issues may make the best investments.
U.S Banking in Recent Times international transactions and sophisticated financial services; and community banks that serve a small number of local clients.
New Times Demand New Solutions Twenty years ago, the banking solutions available to financial managers were fewer and more familiar than those available today. Certainly there was plenty of change taking place then. Innovation has always accompanied banking. But it was generally more gradual and less disruptive. New offerings were more in line with traditional banking services.
The commercial banks that operated during this period were heavily regulated. The interest rates they charged, the states and areas where they did business, and the types of services they could provide were all regulated. This system continued, more or less intact, for several decades. That beToday we see a very different picture. Finance managers have a bewildering array of options in all gan to change in the 1980s. facets of their work, including the banking function. This means more choices, more learning, less Deregulation familiarity â€“ and with so much riding on their deci- A number of economic and financial developments sions. How did we get to this new era in banking? beginning in the 1970s formed the back-drop to a period of deregulation in banking. They included oil price shocks, double-digit inflation, and the The Evolution of Banking in the U.S. The United States has the largest banking system in Savings and Loan failures. Over a period of many years, several big steps were taken in banking dethe world. It encompasses nearly eight thousand regulation, including eventually the repeal of Glass banks holding over $13 trillion in assets. More -Steagall in 1999. than two million people work in the sector. Interest rate ceilings were lifted. The limitations on financial activities have been relaxed. And restrictions on the geographical scope of banks have been modified. As a result of these changes In 1913, the national government created the Fed- smaller banks became less competitive. Their eral Reserve System as the central U.S. bank, with number declined, many being acquired by the larger, more efficient banks. Today, the banking the authority to supervise banks and issue legal tender. In 1933, during the Great Depression, Con- world is more consolidated than a generation ago. gress passed the Banking Act, known as GlassWhat brought about this dramatic change? Many Steagall, which introduced various banking reforms, separated investment banking from deposi- factors. A globalizing economy, the international tory banking, gave the Federal Reserve the author- flow of money, industrialization in the developing ity to regulate interest rates, and created the Federal world, free trade, open markets, deregulation of business, market demands, and of course the relentDeposit Insurance Corporation (FDIC). less advance of technology have all contributed to the rapidly changing needs of business and governOut of this came three main types of commercial banks: regional banks that focus on one geographi- ments. cal area and provide depository and lending services; major banks that operate in financial centers like New York, and are involved with Banking used to be largely regulated by the states. That began to change in the early twentieth century.
New Eras in Banking New Bank Models Not only did the established banks get into the action – the first bank websites appeared in 1995; today more than 80 percent of banks offer transactional websites – but new types of banks have sprung up to serve targeted clients with unique banking services. Venture capital banks cater to the entrepreneur. Private banks tend the finances of wealthy families and businesses. Credit card banks make cash available to everyone. Even nonbanks, like companies as diverse as airlines and supermarkets, are willing to spot you cash or credit to help you buy their products.
Innovation In addition to the huge transformation in the structure of the industry, there was a wave of innovation that left the sector fundamentally different from only a few decades before. These innovations reduced costs and risks and improved products and services. They sprang up in virtually every aspect of the industry – products, services, production processes and organizational forms. They were brought about by advances in technology, financial innovation and diffusion in banking. A few examples. Telecommunications and information technology allowed the use of statistical tools for credit scoring and risk measurement. New products, like adjustable-rate mortgages, new production processes, like electronic bank-to-bank payments, and new types of banks, like venture capital banks, rapidly made their way into the industry. And the growing array of new services has been most amazing of all: ATMs, debit cards, telephone access, online banking, and pre-paid cards were all quickly accepted and have become standard features of banking.
But it doesn’t stop there. Banks found themselves competing not just with traditional rivals but with the unlikeliest kinds of start-ups begun on little more than a radical concept and an internet presence. So today there are new ventures offering a variety of easy-to-use payment models, some based on social networking using Web 2.0 technology. This lets consumers circumvent traditional banking channels. PayPal allows money transfers over the Internet. One provider is offering Facebook’s 500 million subscribers a peer-to-peer payment applicaThe changes have reshaped the U.S. banking indus- tion. These won’t replace the old, familiar bank. try. More innovations are being added every day. But like ATMs and online banking, they take away another point of contact with their customers. Mobile banking now allows account transactions If a banker from the 1920s had been set down in a through mobile devices such as cell phones and PDAs. Remote deposit capture is a web-based ser- bank in the 1970s he would have felt quite at home. They had probably removed the bars from the teller vice that lets businesses and consumers deposit window and updated the décor, but the buildings checks electronically, without going to the bank. Contactless payments are available through cards, were remarkably similar and the services nearly the same. If a banker from the 1970s, however, were key fobs and other devices with embedded chips suddenly dropped into the banking scene of today, that allow payment without a signature. Global he or she would be overwhelmed by the change. cash management, using foreign exchange and multicurrency accounts, can improve cash flow for ATMs, online banking, mobile access, internet transfers – these are radically different – a revolupeople and businesses with international transactions. tion. The industry has reinvented itself. Long built on the brick-and-mortar model, banks began to adapt to new demands and new possibilities.
Recent Financial Turmoil lated environment, banking has in the past two years endured a punishing meltdown followed by a predictable legislative movement to rein it in.
Meltdown So, innovation was humming along in high gear. Change was taking place at a dizzying pace throughout the industry, from top to bottom. Then the financial crisis struck.
What Does It Mean? What does all this mean for wealth managers? Big financial institutions found themselves in need How will this affect the banking services they need and the providers of those services? How should of government bailouts. The economy was staggered by deep contraction of credit. And the after- they regard banks as an investment option? math has brought about the broadest regulatory Many financial institutions are operating under a changes since the Great Depression. While the double whammy: digging out from the mess caused new regulations still need to be fully defined and interpreted, they are clearly sweeping in scope and by the unwise actions of the past and weighed down under the new burden of regulation. The significant in scale. How sweeping and significant? Here are the areas that the Dodd-Frank Wall situation is still playing out. But already there are some clear signals for banking customers and inStreet Reform and Consumer Protection Act advestors to consider as they weigh their banking opdresses. tions. Here are some trends we see. • The Financial Stability Council has the First, the recovery. For many banks getting their power to require increased reserves and break up large firms, and the responsibility balance sheets back in order will take time. They to watch out for risky lending practices and were staggered during the financial crisis. Their share prices declined. Their book values dropped. to eliminate expectations of further bailouts. And their capital levels suffered. •
Regulators will have the authority to create transparency and accountability for derivatives and hedge funds.
The law lays the groundwork for asserting federal regulatory authority over insurance, currently regulated by the states.
It requires companies that sell securitized products, like mortgage-backed securities, to retain a share in the credit risk.
Plus, it strengthens the Volcker Rule, transfers thrift supervision, makes stronger lending limits, and further regulates holding companies.
In short, after a quarter-century of explosive growth and dramatic change fostered in a deregu-
The Current Environment Monthly Offering Volume (in millions)
few years ago, banks traded in the market place at The situation is to some degree improved today three-to-four times book value. Now they comcompared with 2008. Nearly all financial indices mand only one-to-two times. are higher now than they were then. Bank valuations are up, but not as much as the broader market. Capital raisings for banks picked up in mid-2009 and recent raises have been successful. Still, just a
Source: SNL Financial and Stephens Investment Bankers Source: SNL Financial. Selected Bank and Thrift Follow‐On Offerings between $10mm and $500mm from September 1, 2009 to September 30, 2010 excluding those with > 6% NPAs and < 4.5% TCE.
The Current Environment Bank and Thrift Capital Raises
Price/Tangible Book Value
Source: SNL Financial and Stephens Investment Bankers SNL Small Cap Bank & Thrift : Includes all publicly traded (NYSE, NYSE Amex, NASDAQ, OTC BB, Pink Sheets) Banks and Thrifts in SNL's coverage universe with $250M to $1B Total Common Market Capitalization as of most recent pricing data. SNL Micro Cap Bank & Thrift : Includes all publicly traded (NYSE, NYSE Amex, NASDAQ, OTC BB, Pink Sheets) Banks and Thrifts in SNL's coverage universe with less than $250M Total Common Market Capitalization as of most recent pricing data.SNL Bank and Thrift : Includes all Major Exchange (NYSE, NYSE Amex, NASDAQ) Banks and Thrifts in SNL's coverage universe.
The Current Environment cle. Banks stand accused not only of “robosigning” unread documents, but of inaccurate loan calculations, bungled payment processing, and improper document recording. Perhaps it’s mostly a case of high-speed modern banking, using many of the innovations we’ve discussed here, outpacing the legal processes. Whatever the reason, it adds Governance. In the view of the regulators, the gov- another layer of pain for many banks. ernance of banks hasn’t worked. The problem ofAnd there could be another storm in the offing. ten stems from a fundamental difference in tolerance for risk among a bank’s owners, debt holders, Commercial real estate. A growing number of failand managers. The governance structure of a bank ures this year, especially among mid-size and smaller banks, have been attributed to nonperformdefines the relative powers and interests of the ing commercial mortgages. Is the problem mostly three constituencies and that directly affects the behind us? Or is there a looming commercial real level of risk a bank will accept and the steps it takes to manage those risks. The new regulations estate debt crisis? It’s too soon to say. But nervous industry analysts say in the next four years a make sure directors and managers understand the trillion-and-a-half dollars’ worth of commercial bank’s structure and risk management. real estate loans will term out – and nearly half Next, liquidity. Liquidity is a bank’s ability to those loans are under water. With rising vacancy meet obligations when they come due. Because rates and falling rents exerting a downward pressome banks were clearly overleveraged in the run- sure on commercial property values, the potential up to the financial crisis – they didn’t have suffipicture isn’t pretty. cient funds to meet their obligations when too As one would expect, the banking sector has witmany loans defaulted – higher liquidity requirenessed a significant decline in the establishment of ments have been set. While this may be prudent policy, and may help to avoid a future meltdown, it new banks during the past few years – the lowest adds further burdens to banks still recovering from this past year since 1996. Nonetheless, some of the newest banks are successful precisely because they the last one. don’t carry the baggage that many established Finally, pricing. Even the pricing of a bank’s prod- banks do. ucts and services are affected. Normally pricing is a function of what the market will bear. But now in some cases, most notably mortgages, the government is driving pricing through rate management. Whether this helps consumers remains to be seen. But in the short term at least, it further crimps banks in their effort to regain growth and profitability. Second, the medicine. As difficult to take as the illness was, the medicine isn’t much more palatable. The details of the Dodd-Frank legislation are still being worked out. But the impact of that law and the looming provisions of the Basel III Accord are beginning to emerge. Let’s take a quick look.
As if all this were not enough, now banks beset by meltdown woes have another crisis to deal with. Just when they thought they were coming out of the woods, along comes the mortgage default deba-
What to Look for in a Bank Yet that is the direction many banks have taken. With their concentration on keeping up with the latest technological trends, some have allowed advances in telecommunications and IT to transform their former relationship-focused enterprise into a data-intensive modern bank. If all you need is an Given the intensified regulatory environment and the increased pressures on capital, it’s clear to most ATM and online banking, any bank works. But if you handle complicated and sophisticated financial people in the industry that the banks who have been through the mill will continue to look inward portfolios, you will sooner or later need the perto solve their nagging, and perhaps growing, prob- sonal attention of a banker, not merely a dataprocessing system. You will need a relationship lems. That’s not at all surprising. with a financial expert who understands your needs and welcomes your questions. And that takes time Recent data show that non-productive assets conand commitment on both sides; it’s not something tinue to rise and net charge-offs remain high for banks as they work through high levels of nonper- that can be done quickly. The conclusion: forming loans. Problem commercial and industrial Tip No. 2: Banks that build personal relationloans remain very high in several key industries, indicating a bumpy road to recovery. And industry ships with their clients will offer the best value proposition. analysts report that risk management is the top global priority in the banking industry. Understandable, with the regulators after them. It follows that a bank willing to work with its cliAll this confirms the inward focus of many banks ents is willing and able to find the right solutions for their financial needs. This is not true of many in an effort to shore up their balance sheet. If a bank has to devote time and resources to rethinking banks. So, what should the wealth managers examine closely in choosing a bank? First, let’s look at the bank as a provider of financial products and services.
policies, processes and procedures, and to pruning and dissecting its loan portfolio, it’s not going to have much left for taking care of its clients and getting the next good client on the books. Institutions that can look outward and be in tune with what’s going on in the market can help their clients. So our first advice:
Larger banks are geared to two main segments. First, they serve Fortune 500 corporations. That means primarily larger transactions that only wellfunded companies can handle. Second, they pursue the retail market. Those operations are based on volume. They are profitable only if they bring in millions of consumers. The first market segment receives individual attention. But the second is offered a standard menu of services, with no concern to its particular requirements.
Tip No. 1: Banks with an outward focus can best serve their clients. The next point to make is that technology does not equate to service. True, online banking and mobile access are very convenient. Everyone likes them. But just as interactive voice response instead of a real person on the other end of your phone call to answer your questions can be less than helpful, so the overreliance on technology can detract from your banking experience.
What to Look for in a Bank Smaller banks do often work with local businesses on loans, deposit accounts and other products. But most community banks lack the balance sheet depth, the flexibility or the expertise to offer creative solutions, custom-designed to the unique needs of each client. Their off-the-shelf services satisfy some but not all their potential customers.
Those types of companies can often protect client data better because they minimize the access points to it. The lesson:
A vital concern of high-net-worth individuals, and therefore their financial teams, is privacy. This extends not only to account balances and investment choices but also to the timing of cash movements and transfers. It is imperative that families with substantial means protect themselves and their financial affairs from the curious, the commercial, and the corrupt.
You will also want to check on its profitability. Banks that not only make a profit but earn a good return on their capital are the best investments. Return on Assets and Return on Equity are two common measures of bank profitability. Leaders in these categories make good investments.
Tip No. 4: Banks with smaller staffs can better protect the privacy of their clients.
What about banks as an investment for your clients? What should you look for there? In short, One of the recent and welcome trends in banking has been the flourishing of a relatively new type of good plans, good people, good financials. company. It’s a bank that operates under a clearly defined model to serve a targeted market and pro- The essence of banking is money. It follows then that banks with ample capital and high-value assets vides the right solutions to meet its clients’ goals. are the best to deal with. Find out the bank’s Tier 1 Therefore: capital (its core capital); its Tier 1 capital ratio (its Tip No. 3: Banks designed to apply their unique core capital compared to its total risk-weighted assets); and its Tier 2 capital (supplementary capital). strengths to specific markets can provide cusThese are considered the best measures of its finantom solutions. cial strength.
Every bank has policies and procedures in place to protect the privacy of its clients’ information. But there is no getting around the fact that the bigger an organization is and the more people who work there, the greater the chance a client’s information could accidentally slip into the wrong hands. The size of a bank’s staff, then, may become a factor in how well it can protect its clients’ confidentiality. A specialty bank with a small number of people in the organization by design limits the number of people with access to personal data. From the standpoint of security, then, there are benefits to working with a niche organization.
What to Look for in a Bank There are, of course, many other measures of a bank’s attractiveness as an investment. A compelling business model and plan are essential – for managers of family wealth, a specialty bank serving that niche market offers clear benefits. A strong management team, marked by experience and success in the business, can deliver exceptional growth even through turbulent times. And if you combine these factors with a clean balance sheet – that is, no legacy issues – it is a sure sign of a topperforming bank. A bank with a clean balance sheet can always raise capital, even in times of tight money. So, when considering banks as investment options: Tip No. 5: Banks that serve target markets, report strong financials, have successful management teams and no legacy issues may make the best investments.
Conclusion The upheaval in banking that began two years ago is still being felt. All the bailouts, the interventions, and the reform legislation notwithstanding, many banks today are struggling to overcome their problems and return to acceptable profitability. This may take time. Industry leaders believe that the regulatory enforcements of Dodd-Frank and the Basel III Accord will squeeze margins and reduce Return on Equity. The number of bank branches is declining for the first time in a decade and more failures are likely. That will affect the number of current and future banks. Bill Schenck, our president and former Secretary of Banking of the state of Pennsylvania has stated: â€œAll of this regulatory reform and increased scrutiny on the part of the regulators has an especially significant impact for the industry in terms of costs. The banks that feel it the most are the community banks, the $500 million banks, that are having to go through costly efforts to comply.â€? That probably means more consolidation. Others agree, believing the cost of regulatory compliance will inhibit the future creation of smaller community banks. So the opportunities to invest in new banks will go up market in size. Because the fixed costs of launching a new bank will be higher, start-up banks of the future will be larger and there will be fewer of them. This will have an impact on the investments of high-net-worth individuals. Financial managers need banks that offer an array of solutions responsive to their needs. They may also look to banks as an investment option. For them, a good understanding of the state of the industry and a careful evaluation of a bankâ€™s strengths, status and offerings are essential to serving their clients well.
Presented by Charles C. (Chuck) Fawcett IV, President, Private Bank
Published on Feb 12, 2018
Presented by Charles C. (Chuck) Fawcett IV, President, Private Bank