In this episode of the Purposeful Banker, we look at how banks should handle tricky budget questions during COVID-19. Forecasting future revenues and expenses is tough even in the best of times for banks, but the current pandemic has added an extra layer of difficulty.
Jim Young: Hi, and welcome to The Purposeful Banker, the podcast brought to you by PrecisionLender, where we discuss the big topics on the minds of today's best bankers. I'm your host Jim Young, Director of Content at PrecisionLender. I'm joined again today by Dallas Wells, our EVP of Strategy.
Today's topic is one that frankly almost no one likes, but everyone has to deal with; budgeting. Forecasting future revenues and expenses is difficult, even in the best of time. Trying to do it during a pandemic, good luck. Thus this headline in a recent American Banker article was pretty much spot on. It was, "Pandemic Throws Wrench Into Banks Budgeting."
Dallas I'll admit though, when I... And this is I came in with my vendor lenses on, and I originally assumed it was going to be about how banks are deciding that that budget to spend on digital tools in the next coming month, but that pretty much was not at all the type of budgeting they're addressing here. So can you give us sort of the cliff notes of what they're talking about?
Dallas Wells: Yeah. Believe it or not this one was not just about you Jim, there were some other factors involved.
Jim Young: It's weird.
Dallas Wells: Yeah. Really what they're talking about is the big pieces of a bank's P&L, so net interest margins at the top line. We just saw earlier today the print from FDIC on industry totals for net interest margin, and their quote on it was these are the lowest margin numbers we've ever reported. So low rates, Triple P loans and decent size volume at 1%, lots of other loan loss issues that do end up factoring into margins there a little bit as things get put on non-accrual, et cetera. The revenue pile is way down. Loan demand is high, but the loan demand that banks are willing to make is probably pretty darn low, at least our numbers say so.
So the top line revenue number is really in a lot of trouble. And so even beyond things like technology spend decisions, banks are having some much more painful budgeting discussions, which is, do we need to close some branches? Do we need to get rid of some staff? Do we need to cut some lines of business? It's the classic response to a recession, but it is where can we cut to make up the revenue shortfall? On top of revenue numbers being down, you've also got some pretty hefty loan loss provision numbers that have hit the first two quarters of this year, and banks are forecasting those to continue happening for at least the next couple of quarters. If you look at the numbers that places like Accenture are forecasting those could get really painful. And you could be talking about the industry as a whole posting some negative earnings numbers, at least here in North America and probably in Europe as well.
It's one thing to make a little less money than you did last year, because times are tough, but when you actually start talking about losses and eating into your capital base, banks are going to fix that problem. And so budgeting this year is less about like, "Hey, how many people do you need to hit your growth numbers?" And instead it is how many people can you cut and still keep the lights on. Those are the painful conversations going on in lots of places right now.
Jim Young: Well, back off a little bit on my original statement, maybe wrench is not quite the right analogy because that assumes that it's tricky and maybe this isn't tricky, it's straightforward and it stinks, I guess. Do you know what I'm saying? This isn't a, "Hey, what should we do?" It's like, "No, it's pretty clear what we should do. It's just a bunch of stuff we don't want to do."
Dallas Wells: Yeah, it's painful. I think a lot of banks feel like it is painful, but there's a clear playbook here. It's one that they've run through every economic downturn for the last hundred years and it's what they do again. But there are others that are saying actually this time does feel different. The reason is this is a global pandemic and there's this human element to this that is a little different than just the natural business cycle. There's lots of otherwise healthy businesses that have been really thrown into existential crisis mode here. I think banks are in many cases feeling like they have some fiduciary and maybe even, I don't know if you could say a corporation has a moral obligation, but some sort of moral obligation as their bankers to help them through this, and that includes their own employees. It was no fault of your call center staff that the pandemic hit. So do we really want to get rid of 20% of them just to make our number?
I think there's a lot of management teams that are wrestling with that of kind of what are our investors going to expect from us versus what is kind of our role in this economy, and especially in our local markets with our own employees to maybe do what we otherwise feel is right, which is to just kind of try to stand strong through this, and we have the balance sheet to do so. We're in really good shape coming into this. So I don't think it's inevitable that it has to end in something that the banks just don't like doing, but they know they have to.
Also there's I think the fair discussion that really what this pandemic has done is kind of fast forward some trends that were already in motion around digital transformation. And so you can't just start blindly cutting, not blindly, but you can't just start kind of roughly cutting staff when you need some expertise, you need to invest in some new systems, you need people to help make those transitions. If you've got folks that are worried about their job and are all of a sudden doing the work of two or three people because you fired their coworkers, those transformations that were going to be hard anyway, may become impossible, and you jeopardize some of those investments that you're making.
I agree, throws a wrench into banks budgeting, is probably the understatement of the year because it is not just, "Gosh, we got to just grit our teeth and do this," there's some real high level long-term strategy decisions that are being made here in banks and they have to be made in really short order, in a really accelerated time frame. This is tough. This is a rough one for the whole industry.
Jim Young: Yeah. You talked a little bit about the digital systems and that sort of thing and it reminds me of a story that we wrote about in Earn It from the previous financial crisis, and it was sort of to illustrate the need to have systems that can tell the left hand at the bank, what the right hand's doing. The illustration we used back then, once the crisis hit, you had lending saying, "We're calling a halt. We're basically cutting way, way back on this." While meanwhile, the deposits team is just taking in deposits hand over fist, bringing them all in because that's what they're supposed to do and they're not connecting with the other side saying, "We should probably coordinate this."
I was looking at this article and they talked about that savings rates were going up and that more and more deposits are coming in. Is this the same sort of scenario playing out all over again?
Dallas Wells: It's awfully similar. I think banks have been better and more proactive about dropping rates. First of all, we were starting from a lower spot than we did last time, so there was less room to be made up there. Also consumers are a little more conditioned to the fact that we're just in a really low rate environment and we've been here for a while, so if my deposit rates pay 40 basis points instead of a hundred, I get it, it's the market reality. So I think it's not necessarily about rates. Banks have been pretty good about that.
If you look back at just about every bank in the U.S. certainly, but probably globally, a big chunk of their 2019 strategic planning, the process that they were doing last year at this time was about how do we grow deposits. So they hired new teams. They started work on some new styles of branches. They started rolling out new products. They put goals in place, and sometimes even compensation structures in place that were going to reward bringing in new deposit balances. Well then we hit March and the whole world gets turned upside down and deposits just come flooding back into the system.
And so the question is how quickly can banks shift their strategy? And not just the C-suite decides, "Okay, we need to do this slightly differently," but then get that communicated across the entire employee base and rolled through all the ... the metrics are different. The goals are different. Maybe even the bonus structure needs to change somehow. Do you really want to keep paying somebody to bring in new deposits just because that's what you thought was a good idea in September of 2019?
The word "agile" gets used way too often and it's lost some of its meaning. That's really what I think what people are trying to capture when they're talking about being nimble or being agile as a business, that it's not just about hiring a bunch of developers to put post-it notes on a board and say, "They're doing stand-ups and they're scrum masters, and they're doing agile." That's not what agile is. Agile is being able to quickly change direction, and that includes with just business processes. Most banks are still not very good at that. This crisis has moved way faster than anything we've seen before. Even the financial crisis. If you go back and look at the timeline of that, it was a slow motion train wreck, where banks did have some time to make adjustments to things like that. They didn't do a great job of it, but they had time.
This one, there was no time. It was an instant change. And so what you're seeing is which banks have the culture and the infrastructure to be able to quickly pivot and get everybody rowing in a different direction now than they were just a couple months ago. Some banks are good at it, and some aren't.
I think it's some a systems thing, it's some a management thing, it's some a culture thing. It's not even a big bank, small bank thing. We've seen some big banks move really quickly, and some small banks that still haven't admitted that this is a thing. So it is really an institution by institution thing and I think still a problem.
Jim Young: Alrighty. Man, you hit me with some of these and it's like, ooh, I'll try to keep the conversation going.
Dallas Wells: So uplifting lately, right?
Maybe kind of dark, yeah. All right. Well, here's one that maybe is uplifting. Although to be honest, it just left me confused. We were sitting here talking about branch closures is one of those kinds of things it's almost just Pavlovian this point. You tick it off on the terms of we've got to cut this, we've got to close branches. But then there was an article in S&P about how in July branch openings for the first time in nine years outpaced closures.
Now we're sitting here talking about all these other things that make it sort of logical that you would see branch closures on the rise. Is this a statistical anomaly or is there an argument? I don't know, maybe it's a commercial real estate play at this point? I imagine you could probably come up with some a lot cheaper in July than you could before. I guess I'm wondering how does that fit into all of this.
Dallas Wells: Part of this is we just talked about agility. You have some kind of baked in anti-agility in the banking business. So branch openings, if you think of it in terms of most businesses, if you're running a chain restaurant, you kind of respond to real-time market demand. And when things are going good, you keep opening locations, and when things slow down, you quickly close them. And the only constraint you have is lease terms and even that can be dealt with. A lot of that's driven by cash flow. Can you afford to open a new location or is cash flow bad? So you got to stop the bleeding in some places.
Banks, except for in true failing bank run on the bank kind of crisis, banks don't have liquidity problems. They don't have to worry about making lease payments. They have literally vaults full of money and digital vaults full of money. They can kind of create liquidity out of thin air. So they can cover the cost of those things. There are lots of regulatory issues of even getting permission to close a branch. It's not your own decision. Either your regulators have to sign off on that and make sure that you're not abandoning a market that still needs service and support. There's a lot that goes into it. There's a long delay between when a management team makes a decision and a branch actually opens or closes.
I think what we're seeing in July is actually decisions that were made a long time ago, most definitely well before the pandemic. I think that's the reality.
Now, there are though, some banks that are talking about not necessarily a net addition of branches, but just rethinking their branch network and making them less about debits and credits and a place where you have to mechanically open an account, and instead making them centers of selling and cross selling and advice and true high value service instead of we need your signature so please come into the branch. Those kinds of problems I think are being solved elsewhere, through cheaper, more efficient and more consumer friendly digital channels.
I think there's going to be a lot of turnover in branch networks. I don't think it's necessarily growing of branch networks. There's going to be lots of changes there in the typical footprint of a branch and the typical staff that are there. Those things are actively going through some major changes. But I think most of what we're seeing in the June, July numbers is old decisions that are just now coming online. For a bank it's got to feel a little weird. You're doing a grand opening of a branch that you may not actually open the lobby for it because you don't actually want people in there. So definitely some strangeness there.
Yeah. All right. Well, we'll try to end this on a little bit more of a positive note here. Some interesting comments from Todd Nagel. He's the CEO of IncredibleBank
, which is a $1.6 billion bank based out of Wisconsin. In this article, he's quoted several times and he's talking about opportunities to expand customer base and to take on some higher risk deals, provided your bank is being paid appropriately. He sounds sort of like someone who says, "Now, we can do some business here." Is he a lone voice in the wilderness or does he actually represent a portion of banking leaders?
Dallas Wells: I don't think he's alone in this. I think that goes back to some of the is it inevitable that that banks have to kind of shrink their way through this discussion we were having earlier. There's both some obligation here and I think some opportunity. So a couple of specific areas. You saw the community banking segment have an outsized impact in Triple P loans. They kind of punched above their weight there.
I think a lot of them saw that as, "Hey, this is a pain. We're not really going to make any money on this as a transaction, but it's a way for us to be supportive and to help and to kind of give back to the market, and as our upside for doing all that, maybe these are some relationships that we can cherry pick from the bigger banks or from the bank down the street." Whoever told them, "No, we don't want to mess with your Triple P application or didn't respond or didn't have the digital applications working correctly, whatever the case may be, whoever wasn't there for you, we were there for you. And so why don't we become your permanent bank and not just your Triple P lender?"
I think that that was sort of using the government program as the mechanism to do that. But I think that same pattern is going to be available going forward. This is another thing that Accenture touched on in and one of their recent reports, and we can link to that since I mentioned it a couple of times, but I think it's really good. One of the things that they mentioned in that report is that they feel like there's some long-term strategic value and sort of brand equity that banks can create here by stepping up for their clients when they desperately need them.
They kind of lay it out in multiple phases. There's the government support phase that we are just wrapping up, at least here in the States, a lot of the programs are winding down. It's not clear that we're going to have another round of stuff just yet. And by stuff, I just mean stimulus, support programs, government lending programs. Instead it may be upon the market to solve for those things. And so banks are going to step into that void. Some are going to make the strategic decision to just jump right into it and they're going to have some additional exposure and some risks, but there's also a lot of upside. They can absolutely gain some market share. They can gain some customers that maybe they would have never had the ability to win before. It may not be so competitive. There may not be the same sort of pricing pressures that they're used to. So they're viewing it as one of those rare opportunities to step into the void and do some growth where they don't have to just buy the growth with skinny margins.
So I don't think Mr. Nagel is on his own here. It'll be interesting to see which banks decide to kind of cower in the corner and shrink. That's not a criticism. It can be a sound strategy. And which ones decide to kind of step into the wave here, step into the risk and try to grow through it, again, that's not necessarily the right approach either. It'll be interesting to see which banks choose which way. And ultimately, a couple of years down the road we'll know what the right decision was, but definitely a fork in the road here for the industry.
Jim Young: Well, and then I guess also based on what you were saying, which ones decide to do one and then switch to the other.
Dallas Wells: Yeah. Or who can shift gears when they read it differently along the way?
Jim Young: Yeah. Yeah. Well, it will be interesting to see.
That'll do it for this week's show. Dallas, thanks again for coming on.
Dallas Wells: You bet. Thank you, Jim.
Jim Young: Thanks so much for listening.
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Until next time, this is Jim Young for Dallas Wells. You've been listening to The Purposeful Banker.