Like many bankers around the country, Ray Davis has been spending much of his time grappling with the balance-sheet effects of a devastating financial crisis, while also trying to peek around the corner to what banking might look like, post-crisis.

The picture is murky, at best. Davis, the chief executive of Umpqua Holdings Corp. in Portland, Ore., foresees higher capital requirements, tougher regulatory enforcement and a surge in consolidation activity. He also thinks banking will be more competitive, less profitable — and less flashy. "We might see a return back to the basics: collect deposits and make good loans; to hell with the rest of it." But Davis also is quick to concede that his best guesses are just that: guesses.

"We're all trying to figure out what 'normal' will be going forward," he says. "All we know is that things will be very different."

Some significant changes appear obvious. The regulatory scrutiny will be greater, the number of banks will decline. It will take time to rebuild securitization markets — and investor confidence in them.

The question is, a few years from now, just how much will the crisis have changed the environment banks compete in, and the way they go about their business? U.S. Banker asked a number of bankers, economists and other experts for their thoughts on where the industry is headed and what the landscape might look like three years or so from now. Some bankers might like what they hear, others won't. Tony Plath, a banking and finance professor at the University of North Carolina, Charlotte, is sure of one thing: "The business isn't going to be as much fun as it has been."

Core economic concerns: Interest rates and housing.

By 2012, Richard DeKaser, former chief economist for National City Corp. and now head of Woodley Park Research in Washington, D.C., predicts GDP growth of 3 percent, with unemployment rates dropping to about 6.5 percent. Consumers will be feeling better about their personal circumstances and spending (and borrowing) more — albeit more cautiously than in the past.

That should be good news for the all-important housing market. The National Association of Realtors projects that prices will fall an additional 16 percent in 2009, and then slowly begin to climb. By 2012, it foresees a median home price of $180,000 — about the same as in the fourth quarter of 2008.

DeKaser predicts that pent-up demand for new homes will spark a surge in construction, with housing starts rising to 1.3 million by 2011, compared to 600,000 this year. "New homes will be in very short supply, so we'll see a good rebound in construction activity," DeKaser says. That implies that demand for construction and mortgage loans should pick up nicely, while credit quality improves.

Among the biggest worries for banks is balance-sheet management. With today's low rates and burgeoning federal budget deficits, "it's difficult for me to fathom an environment a few years from now where inflation isn't running rampant," says Carl Chaney, CEO of the $7 billion-asset Hancock Holding Co. in Gulfport, Miss. Higher inflation would spark a jump in interest rates. "We want to be positioned so that when rates do start to rise — and we think they'll rise rapidly — we're not caught holding the bag" funding long-term fixed-rate loans with higher-rate deposits. Not everyone is convinced. DeKaser says inflation will be "low and moderate by historical standards;" bond investors, for now at least, are pricing things that way as well. "The market thinks we're looking at 2 percent inflation for the next decade." Cross your fingers.

Regulatory streamlining: Not so fast.

If you thought the crisis might finally bring some rationality to the nation's patchwork regulatory system, think again. Things could actually get more complicated, and are certain to be more expensive.

Banks will be required to maintain higher loan-loss provisions and capital ratios. "There's a lot of talk about 12 (percent) becoming the new 10," confides one banker. The industry might complain, but its lobbying efforts will be hindered by a political climate rife with public anger over government bailouts and the housing collapse.

Structurally, the thrift charter — along with the Office of Thrift Supervision — could be history, and the Federal Reserve could emerge as more of a "systemic" regulator, with the horsepower to keep watch over big, complex financial institutions. That would tidy things up a bit, and hopefully restore some investor confidence in the industry. Eliminating the OTS could also discourage charter shopping, which some believe was a root cause of the crisis.

Even so, don't expect huge changes. Former Fed Chairman Paul Volcker, now an Obama administration advisor, has said he'd like to eventually see an approach that "looks more like the Canadian system than it does the American system." But Canada has just one primary regulator. Good luck trying to wrest power from the alphabet soup of federal and state agencies.

In tone, however, the U.S. regulatory apparatus could mimic some of what goes on north of the border. Canada's regulatory style is "more paternalistic and interventionist" than here, says Seamus McMahon, head of McMahon Advisory, a New York bank consulting firm. "There's not a lot of risk-taking and not a lot of growth, and everyone is happy with that."

McMahon predicts U.S. agencies will get more hands-on in their dealings with bank balance sheets, going as far as suggesting in strong terms that certain categories of lending are taboo. He's also among many who foresee a routine of ongoing, automated stress tests, similar to the ones that made headlines for big banks this spring, only reaching down deeper into at least mid-sized institutions. "We'll see a regime of extremely rigorous, continuous measurement of risk," he says. "It will add a whole wing onto the house of reporting requirements."

Before all is said and done, we could actually have more oversight agencies. A proposed Consumer Financial Protection Agency could impose limits on the fees banks charge for things like non-sufficient funds, and require rate caps and better disclosures on lending products, such as credit cards - moves that would eat into income. "The days of being able to charge excessive fees and above-average rates for consumers to [support] the commercial side of the business are over," warns Plath.

Jim Rohr, CEO of PNC Financial Services Group Inc, in Pittsburgh, says having a separate regulator for consumer protection, in addition to a primary safety-and-soundness agency, could complicate compliance efforts. "The idea of serving two masters that are bound to be in conflict with each other could be problematic," he says.

Growth and profits: What will be the new normal?

A recent report by Accenture, the big consultancy, reckons that a well-managed, "high-performance" bank that achieved a return on equity of 26 percent during the first seven years of this decade will be doing well to generate a 15 percent ROE in 2012. The big culprits: higher capital ratios, de-leveraging, higher funding costs and increased loan-loss provisions. Combined, those four areas could take a whopping 20 percent off of ROE.

Making up ground will take a sharp cost-cutting ax, (including, for some, business and branch divestitures), as well as better use of customer-management and pricing optimization strategies and better risk-management. But it won't be easy: Aside from the regulatory changes, the most striking feature of banking in 2012 could be a renewed emphasis on balance-sheet lending, with banks operating — and performing — more like they did in 1985 than 2005, albeit with greater technological sophistication.

"It's going to be a completely different type of industry," Plath says. "We're returning to basic, old-fashioned spread lending, and there's no way a spread-lending bank can generate a return on equity above 20 percent. It defies the law of reason."

Growth will be tougher to come by, as well. Some key loan categories, including commercial real estate and construction and development, likely won't return to their glory days for a long time due to the economy. Fee income will be down. And higher capital requirements, along with stiffer market expectations, will force big banks that got by leverage and hybrid capital to raise more precious tangible common equity and hold more loans on their balance sheets.

In a more risk-averse environment, many believe that above-average asset and earnings growth — once the key to higher valuations — will be looked upon with skepticism. "If you're growing at 20 percent a year in a commodity business, and everyone else is growing at 5 percent, the assumption will be that you're taking too much risk," McMahon says.

Capacity: Is there room for 8,200 banks in this kind of environment?

Probably not. Over the next three years, the number of bank failures is expected to reach well into the hundreds. If poor asset quality doesn't get the rest of them, an inability to attract required capital in this new environment could. It will be tougher to launch a new bank, too.

"If you have slower growth and diminished per-share profits due to the higher capital requirements and a changed operating environment, who is going to invest in banks?" Plath asks. "There won't be enough profitability going forward to sustain 8,200 banks. If we're lucky, the number might be 4,500 or 5,000."

Bankers have be able to read the writing on the wall for some time now. At American Banker's Best in Banking dinner last December, Banker of the Year honoree Ken Lewis told the audience: "We will be a smaller industry with fewer overall workers and claiming a smaller portion of national income and gross national product. That's not a bad thing."

Lifetime Achievement honoree Jerry Grundhofer hit the theme harder: "Banking is a commodity business where controlling costs and expenses is critical and bankers need to understand that banking, especially for larger banks, is not a 10 percent revenue growth business over the cycle," he said. "Banks who have that kind of growth will probably pay the price for that at some point in the future."

McMahon predicts we'll eventually be left with six-to-10 giant players with national reach and broad product sets on one end, and a smaller, more efficient group of community banks on the other.

In a twist on that long-prophesized "barbell" industry structure, however, expect a new class of leaner mid-sized competitors to emerge — roll-up style — from today's rubble. "We'll see a lot of banks in the $1 billion to $10 billion range joining forces to create companies in the $30 billion to $40 billion range," says Hancock's Chaney.

For banks with strong management teams or business strategies — or some sort of lock on their home markets — this won't necessarily be bad news. "You'll have a better playing field, with fewer banks and better yields," says David Zalman, CEO of $9 billion-asset Prosperity Bancshares in Houston.

Prosperity has achieved much of its past growth through acquisitions, and Zalman is salivating over the prospect of buying struggling whole institutions or local branches of national players in need of capital. While higher capital ratios will stabilize things in the short-term, "they'll eventually create a bubble in the price of banks," he predicts. "Three years from now, you'll have an overcapitalized banking market and people will be looking to put that capital to work through acquisitions."

Community banks: Will they have a competitive advantage?

Bradley Rock, CEO of $2.4 billion-asset Smithtown Bancorp in Hauppauge, N.Y., and a former president of the American Bankers Association, worries that a combination of higher capital requirements and greater compliance costs could drive some community banks out of business.

"The question government needs to answer is, 'Is there a value to having several thousand community banks, or are we just better off having a handful of giant institutions?'" he says.

But smaller banks enter this new world with a couple of important advantages: strong relationships and underwriting discipline.

Plath expects that regulators will eventually get more creative with their capital requirements, employing "tiered capital structures" that force bigger, riskier banks to hold more capital than smaller players, and keep community banks competitive. "The large banks won't be able to compete with unrealistic pricing for deposits and loans," says Harris Simmons, CEO of Zions Bancorporation in Salt Lake City. "That should be good for everyone else."

What will become of securitization and other finance innovations?

The securitization market has all-but dried up, but DeKaser argues that it will return stronger than ever due to enhanced oversight.

"The underlying merits of the originate-and-sell model — the spreading of risks and the loan volume [it enables] — still have integrity," he explains. "We're not going to throw the baby out with the bathwater. Banks simply don't have the capacity to directly finance all of the loans they can underwrite."

Look for more rules. The Obama administration has proposed a so-called "skin-in-the-game" provision, which would require lenders to hold at least 5 percent of the loans they originate — some predict the figure could rise to 20 percent — to instill greater risk-taking discipline. The shadow banking system — the network of non-bank companies providing bank-like services — will continue on, as well, but with greater oversight. Off-balance sheet entities will still exist, but will be subject to much greater scrutiny.

Bankers are fond of noting that unregulated mortgage brokers originated the majority of bad housing loans. Those types of lenders will exist, but under a regulatory microscope, and almost certainly won't be as plentiful, giving banks the opportunity to make more and better loans themselves.

"The risk premium on lending will be much better going forward, because there's less competition," says Gary Townsend, CEO of Hill-Townsend Capital and a former bank analyst.

Globalization: Can we expect a foreign invasion?

Basel II might no longer be relevant, but the need for a coordinated global approach to regulation has never been more apparent. Even so, it might not happen, posing a challenge for big banks. Corporate clients that want a custom derivative product but can't get it at home, for instance, could go to Singapore or Abu Dhabi for it. That could leave banks here exposed to hidden risks.

Once things stabilize, stronger foreign banks are expected to cash in on the crisis by acquiring more assets on the cheap.

All banks might need to act locally, but they will also need to think globally. What can they learn, for example, from a bank like CheBanca!, a high-tech, low-cost retail bank launched in Italy in 2008 that Accenture held up as an example of a bank that is effectively using the Internet and small contact centers — rather than full-blown branches — to attract customers?

Any other new competition to worry about?

Opposition from a powerful banking industry may have kept Wal-Mart out of the banking business a few years ago, but a weakened industry might not be so successful. In this type of environment, don't be surprised if retailers, restaurants and other "dark horse competitors" reconsider trying to get in on the action. In the United Kingdom, for example, Tesco, one of the world's largest supermarket chains, is already very active in banking, and, in its recent report, Accenture says it expects more non-banking companies to become "niche players" in some markets, including the U.S. These days, "you could easily imagine McDonald's or Wal-Mart being in the banking business," says Terry Moore, managing director of Accenture's North America banking industry practice. "They see an awful lot of [customer] traffic and have higher trust ratios than banks do nowadays."

Regulatory authorities might actually be more willing than in the past to consider their applications. In the wake of the crisis, Plath says, one big question, is "why should banks retain the preeminent role in intermediating credit, when they screwed it up so badly?" A big conglomerate like Wal-Mart "actually has the capital to handle the risks involved in banking." Clearly, a lot of pure financial institutions can't say the same.

The branching boom is likely over. Is leveraging technology the key to success?

Finding bottom-line results will require banks to get more aggressive on cutting costs, says Accenture's Moore. Look for a lot of action on the technology front. More banks are likely to accelerate the outsourcing of their technology and product needs, and negotiate tougher on their vendor contracts. Many are also likely to cut teller employment and branch counts.

Moore says more banks will need to more effectively exploit the Internet and other alternative channels to save money. "It costs 15 cents to open an account online, versus $65 on paper," he notes.

On the revenue side, expect smart banks to place a greater emphasis on building deeper relationships, not more, using account aggregation, customer relationship management tools and the like to delve deeper into customers' wallets.

This won't be easy. Jacob Jegher, a senior analyst with Celent, says customers have responded to the crisis by spreading their finances across more institutions — presumably to minimize their risk of getting caught up in a failure.

Front-end innovation, on everything from mobile banking and social networking to customer-segmentation strategies and "relationship pricing," will be needed to gain bigger wallet shares from customers. Rohr notes that usage of online bill-pay is growing at 35 percent a year. "If you're not investing in what the customer wants, you won't be competitive when we get through this cycle," he says.

But it will be a lot like squeezing a turnip. Accenture suggests that smart use of pricing optimization software, which evaluates myriad variables to determine the maximum price a customer is willing to pay for a product before looking elsewhere, could add 1 percent to a strong bank's ROE.

Jegher says banks slashed their spending on new IT investments by 14.4 percent over the past year to control costs. "Most of the innovation today is coming from nonbanks," such as vendors, he says. And that's okay. Increasingly, banks need to focus on brands and relationships, experts say, leaving the manufacturing of products and back-office systems to someone else. "All of that stuff is a commodity," Plath says. "The value of a banking franchise is in people and relationships."

If all this sounds familiar, it is. "Banks have been talking about this stuff for a long time, but didn't need to execute against it because they were making money," Moore says. "Now, banks are worried about survival. There's a sense of urgency to these ideas that didn't exist before."

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