With lenders getting back to basics and regulators wielding new strength, it's easy to see how, down the road, banking might offer all the earnings excitement of the public utilities industry — that is, not much.
Gone are the Wall Street-style investments in exotic securities, mortgages for homeowners with unverified incomes and syndicate-type deals that lure small banks into products and regions beyond their grasp.
In are profits from spreads on loans made against balance sheets, along with service fees and ancillary businesses such as wealth management, payment services and basic trading.
If changing lending standards and market dynamics suggest a less exciting industry, they should at least generate a higher degree of earnings predictability.
Tighter credit standards provide a twofold benefit to banking companies with the capacity to extend new loans. A simple supply-and-demand equation supports better pricing, and the new standards should lead to a moderation in profit-eroding loan losses.
Another thing in bankers' favor, at least for the near term, is the government's large-scale attempts at stabilization, which give the industry an advantage it did not have in previous times of crisis.
"In 1980 we had the prime rate at 21%, and we had Treasury bill rates at 17% and 18%. Being a banker, you were paying more for the money that you were turning around and lending, if you could find a buyer that could qualify," said Bill Bradway, a banker-turned-analyst who now runs Bradway Research LLC in Framingham, Mass. "Now we're in an environment where regulators are very focused on making sure that bankers have a decent enough spread."
Should that trend peter out, loans made today at healthy spreads would no longer look as profitable. But even as borrowing costs rise, bank pricing should remain intact, as a result of the decline in nonbank financing.
Short-term funding models have fallen by the wayside, and the risk appetite of capital markets investors is not yet dependable enough to support the debt load of American borrowers. The result is a tectonic shift in the lending market that leaves a wider opening for banks.
"Balance-sheet lenders are going to be able to charge a higher spread, and though the capital markets will compete against that, the capital markets will not be as competitive as they have been over the last 25 years," said Gerard Cassidy, a banking analyst with Royal Bank of Canada's RBC Capital Markets. "It'll be more volatile, because you've got to worry about interest rates. But I think on-balance-sheet lending is going to get a premium."
The dislocation in the capital markets has an added benefit for the banking companies that compete in that market. As evidenced by last quarter's numbers at JPMorgan Chase & Co., Barclays PLC and others, the fewer remaining competitors have found it easier to make money in basic trading businesses that seemed far more commoditized before the crisis.
Capital markets trends may not have much impact beyond the biggest financial institutions, but smaller ones — especially community banks — have other opportunities for expanding their loan portfolios.
Bank mergers and acquisitions, which analysts expect to pick up in the next 12 to 36 months, often hold promise for deposit poachers. And Bob Seiwert, head of the American Bankers Association's Center for Commercial Lending and Business Banking, said bankers should position themselves to take advantage of ownership changes at small and midsize businesses as more baby boomers retire.
Citing 2008 survey data from Barlow Research Associates Inc., Seiwert said that one in four business owners is planning for an ownership change in the next five years. New ownership gives bankers a chance to win business that might have been parked at a rival institution for decades, he said, and business owners who sell out can suddenly become more attractive as wealth management clients.
Wealth management and other nonlending businesses like payment services and insurance brokerage will remain a pillar of banking profits. But observers say the industry needs those businesses to serve as more than just a countercyclical bright spot in times of credit stress or shrinking loan margins.
When margins were falling in the years before the credit crisis, the payment and wealth management businesses "were carrying us along the way," Richard Davis, the chief executive at U.S. Bancorp, said this month at the UBS Global Financial Services Conference. Now, he said, old-fashioned lending is strengthening, while the recession and stock market turbulence are hurting nonlending businesses.
"For the last couple of years none of our four cylinders have been operating 100%," Davis said. "I'm looking forward … [to] the opportunity to have all four moving like they should."