Few banks are attaining a sustainable competitive advantage these days. A substantial number have lost and are continuing to lose market share and, with it, fundamental earning power.
Without the prospect of economic growth to support them, many bankers are bedazzled by wide margins and captivated by cost cutting, both of which can actually diminish long-term prospects. Mergers and acquisitions only hide the problem.
More than half of the 100 largest banks in the United States reported either a decline in loans or an increase that didn't keep pace with inflation in 1992. Their largest corporate customers have long since gone the way of the capital markets. Their smallest retail clients are served equally well outside the banking system.
Handwriting on the Wall
Mortgage loans, credit card debt, automobile leases, and other homogeneous products are easily originated and financed elsewhere. Money-center, regional, and community banks have seen the lights go out at the high end of the loan spectrum and know that they are flickering at the low end.
Conventional wisdom has it that everything else - installment loans, small-business credit, receivable and inventory finance - will never leave their sights.
Nothing could be further from the truth. Interim construction lending, long the domain of the banking industry, is fast moving to "the street." Real estate investment trusts are coming back, this time without the leverage that the banks themselves provided in the 1970s. Well-capitalized pawn shops, no less, are thriving as intermediaries.
Easy to Raise Debt, Equity
In the Midwest, where seller financing on single-family homes is a rarity, nonbank intermediaries aggressively seek to discount contracts for deed. Medium-size companies have no difficulty raising quasi-debt and quasi-equity.
A lumber company here recently floated $10 million in subordinated term debt at a 10% yield by selling it off in $2,000 pieces through a second-tier investment house. A country bank privately placed noncumulative, nonconvertible preferred stock to help it through some rough times.
On the liability side of the balance sheet, the situation is also dim. Most new money is migrating into stocks and bonds, mutual funds, money-market accounts, and other instruments which have nothing, per se, to do with banks.
Deposits Drain Away
As with loans, over 50% of the top banks in the country saw their deposits either fall or not match the meager rate of inflation last year. As with loans, regional and community banks also see deposits slipping away.
Still, profits are way up. Net income rose over 100%, and the market value of almost all major banks increased by at least 25% in 1992. However, this growth was generally uninspired.
Revenue increases were driven by wider spreads brought about by declining interest rates. Cost of funds fell faster than interest income, and bankers, through no effort of their own, enjoyed the benefit.
And what about costs? The top 100 banks experienced an overall decline in bad debt provisions of 19% in 1992 and it is well known that operating expenses trended downward, though with all the acquisition activity taking place it's hard to compute.
Cost Cutting Has Limits
Expense control is a logical strategy, arguably the only strategy if a bank is losing assets and deposits, margins notwithstanding. The problem is, productivity can't be managed forever by reducing expenses.
At some point, those reductions become self-perpetuating. Lower expense leads to lower income leads to lower expense. Without investment, the system eventually disappears into thin air. A number of divisions within banks - equipment leasing, as but one example - are generating safe and attractive returns in great markets.
However, because management cowers from risk or is caught up in restructuring, these businesses are denied resources by all but the most enlightened. GE Capital, notable among many other nonbank competitors, is dancing through the night while most banks have yet to open their eyes.
Merger Misconceptions
Acquisitions keep the illusion alive. Based on widely available formulas and active markets, most banks can bought and sold "fully priced." It's no secret that high premiums are justified by the costs that can be stripped out following purchase. Sellers get enriched in the process.
Employees get terminated or are left to do more with less. Shareholders get diluted; stock prices don't move up much. Executives get to announce that they are building the "franchise" even though, as we have seen, the underlying trends tell a much different story.
In a study of 134 bank mergers the Fed, not too long ago, found that nine out of 10 did no better than they could have as stand-alone institutions.
What is keeping this whole thing together? Probably blind loyalty.
Even though many customers were abandoned by their banks over the last five years, more than a few continue to pay 18% for credit card accommodations or for overdraft protection. Many accept 2% for their savings balances or as earnings credit for services not directly billed.
Manufacturers pay 2% over prime to finance Fortune 500 receivables. Mortgage companies leave big bucks on the table to get their inventories financed ostensibly with their own escrow balances, by banks. Governmental admonishments and sagging stock prices suggest that regulators and shareholders are beginning to question the reality of all this.
So where does the industry go from here? Those who haven't taken advantage of the nearterm opportunities should do so with full understanding of the limitations.
Those who have exhausted this potential, should invest to evaluate markets to assess competitive position and to develop and implement plans to recapture share through better products, marketing, and service.
Those who have decided that they can't "beat 'em" should "join 'em," either by selling out to another bank or repositioning their business to meet nonbank competition head-on, even if it means giving up the charter.
Mr. Miles is managing director of Waypoint Associates Lid., a consulting firm in Wayzata, Minn.
