Banking in the Balance: The Highs and Lows of Profitability in Today's Banking Landscape
Prediction: I expect a run on Etsy for bank executives to have some kind of wall art with the famous lines from the Charles Dickens novel, “A Tale of Two Cities.” “It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity…”
The FDIC just released banking industry data that shows profits fell 6% in 2022 from the previous year. Argh! It truly is the worst of times! Maybe even time to get out of this business, right?
Well hold on a second.
That same data also called out that in 2022 the banking industry pulled in a solid $263 billion in profit. Not bad at all; in fact, that nears the top of the list of all-time banking industry profits, with only one year (that was 2021, by the way) when the banking industry experienced higher profits.
I personally love the fluid nature of our business, and I love to think about how we can address these problems and think about them a bit differently. So, let’s take the next couple of lines from Mr. Dickens and see what we can learn from each other in this potential “age of wisdom,” and “age of foolishness.”
Being Prepared Is Always Wise.
One of the most common concerns that bank executives called out as they gave their Q4 numbers was that they are preparing for borrowers to get behind and for delinquencies and loan losses to increase in 2023 due with inflation and the current economy. It can be seen everywhere, from the struggle to bring in deposits to the utilization of the Fed’s short-term window for liquidity, and even when you’re just talking to the neighbor — the pinch for cheap and sustainable funds and the impact that those have on longer-term relationships is very real.
This concern resulted in banks adding back considerable provisions for their loan losses, which hit their profits again. This is a double whammy, in my opinion, but looking forward, by taking a solid (and complete) looks back, can help.
I know way too many banks that took their time implementing CECL and still too many that have not implemented some effective portfolio monitoring solution. I talk about both of those in the same breath, because at the macro level you need to understand what is happening to that portfolio with better vision. The “instincts of the past” are not going to survive the market or your shareholders expectations.
Likewise, you need to have a micro view of what is happening with those accounts in your portfolio by monitoring those trends. Successful banks and credit unions will be monitoring trends and buffering up their relationships so that when the winds come (and some predict very windy conditions in 2023), those consumer, small business, and commercial relationships will all come back to your financial institution instead of being scattered to the wind.
In A Changing Rates Environment, Matching (Or Pretending Nothing Has Changed) Is Foolish.
With the higher rates, banks have been able to charge more on loans. And because there was still a low cost of funds sourced with deposits during part of 2022, that helped banks actually widen the Net Interest Margin (NIM) in 2022 (which a wise banker told me would always work its way to zero).
But we see two things happening.
First, non-interest income is getting tighter. With both regulatory and market intolerance for fees, etc., banks are going to have to look for different sources of income to support overall profits.
Second, those deposits that gave a nice cheap cushion for your pricing are going away. At the end of 2022, deposits fell by 2.25%. Time to get some solid commercial loan pricing concepts in gear.
Granted, I am biased toward pricing. Pricing and profitability was my first responsibility when I started my banking career at Zions Bank (best bank in the West, in my opinion — but I love all my clients). But I am still amazed that decades later so many banks do not have a commercial loan pricing process in place. Maybe we got lazy as an industry with rates not changing and money being practically free. Either way, it’s time to look into developing a strong commercial loan pricing strategy, folks.
So Where Do We Go From Here?
So where do we go from here? I don’t know — I am just not that clairvoyant. But I think we have a lot more “best of times” ahead of us. I think that when we look at the last part of Dickens’ quote, “it was the epoch of belief, it was the epoch of incredulity,” it will be us looking back at this industry and knowing that we made a huge impact, and we will also amazed at the strides we have made. Join me on that journey!
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Posted on Friday, March 3, 2023 at 11:30 AM
by Mike Horrocks
With more than 25 years of experience in the financial services industry, Mike Horrocks possesses a unique and extensive blend of financial expertise, technology skills, process redesign abilities and solution management experience. Horrocks’ background enables him to create go-to-market strategies for new solutions, help clients convert strategies into revenue generating initiatives and forecast market direction.
As the Vice-President of Product Management at Baker Hill, Horrocks’ responsibilities include the identification and development of new market opportunities in the business of lending, risk management, and analytics for financial institutions. Mike holds a MBA both in International Finance and Venture Technology Management from Indiana University and a B.S in International Finance from Brigham Young University.
Before joining Baker Hill, he held executive positions within several other organizations, including Experian, Profit Technologies, SAIC, Broadway and Seymour (FIS), Zions First National Bank and Zions Data Corporation.
Horrocks is a member of many associations including the Risk Management Association and Bankers Without Borders. In his free time, he enjoys traveling internationally with his wife and five children.