As banks struggle to replace reduced retail earnings and higher regulatory and compliance-related costs, where should banks be looking for growth?

 

 

Some banks may already be stretching their credit criteria to take on greater risk. Last week’s Wall Street Journal reported that JPMorgan Chase is financing a “Manhattan office tower without any pre-leasing.” The article noted that this type of “spec” financing is unusual: “A wave of such construction in the 1980s left numerous towers around the U.S. empty in the early 1990s, resulting in a more cautious approach since.” If fact, this particular deal may be very attractive, yet it also indicates the short-term memory of bankers as well as their willingness to bend risk management criteria. In working with clients that bought failed banks through the FDIC shared loss program, we saw how many of these types of deals can blow up.

 

In recent months other articles point to loosened credit standards:

 

• In February, American Banker reported that “Auto lending continued to expand…as more loans were made to borrowers with shaky credit.”

 

• An April Fortune article stated that more than one million people with damaged credit received credit cards in December 2011, up 12 percent from 2010.

 

• Last week’s Financial Times featured an article titled “Intangible assets eyed as collateral by US banks” and went on to explain that “Several U.S. banks want to tap the value of the intellectual property holdings of their borrowers as a way of trimming their capital requirements.”

 

• Finally, Worth magazine in its February-March Expert Advice column headed one comment, “Are bankers really just hopeless idiots?” and explained as follows: “They are once again making covenant-lite loans to dodgy borrowers, agreeing to leave out important terms that limit borrowers’ abilities to overleverage themselves. The last time these were available was during the LBO craze immediately before the financial crisis, during which many of them went toes-up. Is this yet another reason to short the banks?”

 

 

Beyond the suspect actions related to risk management, the press is full of articles that suggest future revenue streams are limited and, in some cases, under attack. To cite a few:

 

• Financial Times (June 13): “PNC expects mortgage losses to rise” due to Fannie and Freddie repurchase demands.

 

• Financial Times (June 11): “Refinancing is proving divisive for lenders” as “bigger banks are benefiting from the new mortgages to the detriment of smaller rivals.”

 

• Wall Street Journal (June 18): ” Credit card complaints to be available online.”

 

 

More revenue areas appear to be threatened, whether by bigger banks using their pricing power to gain share, increased transparency and regulation, or greater conservatism on the part of historically attractive borrowers. Many banks are trying to counter these and other trends by increasing pricing and fees on current customers, risking further alienating an oftentimes already unhappy group.

 

Another article published in the past week points to a direction for banks struggling to find a sustainable growth path. Last week, the Wall Street Journal highlighted a story, “Migrants keep small business faith.” It tells of the role immigrants are playing in smaller communities around the U.S., whether in retail or professional services. One Indian dentist bought a practice in Cicero, New York. He borrowed $600K to purchase the practice and another $30K for x-ray machinery. However, to our knowledge, relatively few banks are focusing on this sub-segment.

 

Here are ten reasons, going well beyond the immigrant story above, why banks looking for steady earnings and growth should consider giving small business and lower-end middle market companies (SMEs) their highest priority:

 

• This segment allows for a relationship and cross-sell focus that can capture the personal and business needs of the owner and employees.

 

• Overall relationship returns can exceed 30 percent on equity.

 

• Many SMEs value advice, allowing true relationship banks the opportunity to distinguish themselves.

 

• The biggest banks have a relatively poor reputation in this area (Los Angeles Times of January 2, 2012 headline: “Bank of America severing some small business credit lines”).

 

• The majority of small businesses do not borrow, allowing for low cost funding and potentially high return fee income.

 

• During the last downturn, banks with strong credit disciplines continued to perform well with this segment.

 

• The required product set is relatively straightforward; for most SMEs product innovation is less important than responsiveness and customer service.

 

• Non-banks are increasingly attracted to this market, emphasizing their knowledge of the needs of SMEs and the quality of their customer service. If banks fail to step up with this segment, they risk losing another customer franchise.

 

• Job redefinition, organizational streamlining, and increased centralization of various processes can dramatically reduce the costs related to originating business with and serving SMEs. These changes significantly improve current economics.

 

• The community, regulators, and the press expect banks to service this market, particularly in light of the perceived bailout of the banking industry.

 

 

The list of attractive features of the SME market could go on. Yet most banks continue to, at best, take a tentative approach to this segment. One recent exception is reported in this week’s Crain’s New York Business: “Citigroup chases midsize NYC business.” As the article mentions, revenues in corporate banking were down about 20 percent last year while credit card revenues declined 10 percent. Senior management now rightly sees the “commercial banking business as a key growth opportunity.”

 

However, for Citi and other banks, implementation and execution, rather than stated goals or intentions, will be the key to success.