http://www.chicago.tribune.com/business/businessnews/article/0,2669,ART-4722 1,FF.html ]
Notion of traditional bank becoming obsolete
By Melissa Allison Tribune Staff Writer September 30, 2000 The record-setting economy that has lifted personal incomes and enriched the business world is leaving behind a sector that usually thrives when times are good: banks.
What might seem like isolated pratfalls, such as Bank One's credit card problems or Bank of America's sorry record with acquisitions, are beginning to look like warning signs for the entire industry.
Even as the economy continues its dazzling expansion, banks are losing their share of consumers' financial assets, and concerns are growing about the quality of loans they make. Those twin weaknesses could put banks in frightening straits if the economy falls fast.
Already bank stocks are hurting. After months of volatility, overall bank share prices are at the same levels they were in July 1998, and not even last month's Chase Manhattan-J.P. Morgan deal could inspire new optimism about the sector's future.
"All bets are off in a downturn," said Michael Mayo, a bank analyst for Credit Suisse First Boston in New York. "If we hit a recession, run for the hills."
Part of the problem is that shareholders expect more. The merger frenzy of recent years, sparked by deregulation, has raised expectations for strong, consistent returns, even as bankers struggle to cope with bigger, often unwieldy enterprises.
The stereotype of consistently profitable, community institutions has been replaced by the slick corporate conglomerate, run by executives more concerned about Wall Street than the local chamber of commerce. With increasing speed, the traditional notion of a bank is becoming obsolete, experts say.
As pressure from investors builds, bankers could be tempted to take more chances, making riskier loans to keep generating income—even as a slowing economy argues for caution.
Although banks have long had a hallowed place in the U.S. economy, the reality is that if banks do begin to falter, the effect on the nation's financial system would be less dramatic than ever. In short, banks are less important than ever.
Indeed, banks are losing market share with deposits and, in many cases, with loans, still a vital source of their income. By 1999, U.S. banks' share of consumers' financial assets had fallen to 9.9 percent—from 25.2 percent in 1975 and 19.2 percent in 1990—as the security of bank accounts lost out to dreams of better returns in stocks, mutual funds and other investments.
The last time customers pulled their money out of banks that fast was amid the catastrophic bank failures of the Great Depression. Ironically, it's the good times that have spoiled business for banks this time.
Besides putting their money where the returns are better, consumers and companies are borrowing elsewhere, sapping traditional banks of what used to be their only revenue stream. Consumers have turned to mortgage lenders, credit card firms and finance companies for loans. Meantime, businesses of all sizes have embraced the capital markets for their financing needs.
Banks are trying to adapt, partly by entering new lines of business, but they have not moved fast enough to keep pace with the strong economy.
They continue to receive regular warnings from regulators, including Federal Reserve Chairman Alan Greenspan, about deteriorating loan quality. Bankers insist that regulators are overdramatizing the situation.
Yet, even in economic clover, banks are posting surprising loan losses. Wachovia Corp., one of the country's most conservative lenders, earlier this year shaved hundreds of millions of dollars from earnings to compensate for bad loans it made.
Hits like that have turned most analysts sour on the industry. Among the first was Mayo, who two years ago began eliminating "buy" recommendations on all the bank stocks he followed.
He and others emphasize that, even if banks' deposits and loans deteriorate further, they are protected now by more capital and geographic diversity than ever—factors that could see them through an economic disaster without the massive failures of the 1930s and the early 1990s.
"Banks can withstand some pretty strong negative shocks and still survive, unlike during the savings-and-loan period and the early '90s, when there was a thin capital cushion against losses," said Randall Kroszner, a professor of economics at the University of Chicago Graduate School of Business.
The most recent threat to the U.S. banking system was the collapse in 1998 of a big-league borrower, the Long-Term Capital Management LP hedge fund.
Kroszner and others say the system could have weathered the fund's massive loan defaults. That prediction was never tested because the Federal Reserve stepped in to orchestrate the firm's rescue by a group of 14 banks to the tune of $3.6 billion.
Capital is stronger now because banks stockpiled it at the beginning of the 1990s economic expansion, when their earnings situation was better.
The surplus of capital, along with deregulation, spurred a frenzy of acquisitions among banks in the mid-1990s. That brought the country fewer, larger and more diversified banks, another strength that will shield them from failure in a downturn, said Tim O'Neill, chief economist for Bank of Montreal.
Very few Canadian banks failed during the Great Depression, partly because Canada's banks were large enough to absorb losses in confined areas, experts say.
By contrast, thousands of banks peppered across the U.S. went under, because they each depended on the small areas in which they operated. If a major company or vital part of the local economy sank, so did the small-town bank that served it and its employees.
Today it is hard to find a bank that is dependent on one industry, much less one company. There are fewer banks overall—8,581 in 1999, down from 14,146 in 1934 and 14,417 in 1985—which means that banks now cover more territory.
That's not to say that big banks cannot fail. Sloppy management and poor decisions can ruin any bank, as Continental Illinois National Bank and Trust Co. of Chicago proved in the 1980s.
But experts say banks in general will survive a downturn. Bank investors' portfolios, however, are another matter.
Already, investors have turned away from banks—or begun shorting their stocks. The industry is viewed as a remnant of the old economy, a slow-growth sector that is too susceptible to non-bank competition and rising interest rates.
Bad loans and other problems have led many institutions to fall short of analysts' expectations in recent months—shortfalls some see as evidence that banks are being careless and others interpret as a sign that expectations were too high.
"Earnings objectives were unrealistic to begin with," said Bert Ely, a national banking expert and consultant in Alexandria, Va. "Banking is a mature business by and large. The only way you can get double-digit growth is through acquisitions."
And even acquisitions can disappoint. In recent years, earnings growth expectations from major bank deals have fallen apart in the face of cultural conflict, draconian cost cutting and customer alienation.
The solution for banks? To morph into entities that offer a wealth of financial services but bear little resemblance to traditional banks, experts say.
They already have taken steps in that direction. Many are attempting to lure customers back with everything from mutual funds to annuities and securities trading—offerings that could help banks generate fee income to make up for the business they have lost.
"Fee income is where it's at," said George Morvis, a bank investor and consultant based in Chicago. "That's why Northern Trust stock has remained as good as it has in a period when banks are out of favor."
Trust and treasury management fees made up about 60 percent of total 1999 revenues at Chicago-based Northern.
Other banks are moving toward diversified financial services, and deregulation has helped, allowing them to get into the securities and insurance businesses in a way that was previously prohibited.
Citicorp paved the way in 1998 when it agreed to be bought by insurance giant Travelers Group, before deregulation even was passed by Congress. The blending of financial services firms continued on the same grand scale last month with retail banking powerhouse Chase Manhattan's plan to acquire J.P. Morgan, which has a strong foothold in investment banking.
Some banks will acquire firms that have the expertise they want, while others will build it themselves. Either way, there is no guarantee that they will succeed quickly in their new ventures and reap huge profits in arenas where investment bankers like Goldman Sachs and mutual fund giants like Fidelity already are entrenched.
The evolution simply means banks as we know them are disappearing into entities with a much larger scope.
As Ely puts it, "The term 'bank' is becoming obsolete."