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Is banking ready for a resurgence?

It’s time to check community banks’ muscle tone

"There’s really not much that indicates we’ve learned anything new over the last several cycles,” says veteran lender and CEO Ed O’Leary. Each week in his blog he strives to fix that. "There’s really not much that indicates we’ve learned anything new over the last several cycles,” says veteran lender and CEO Ed O’Leary. Each week in his blog he strives to fix that.

There’s been a lot of talk since President-Elect Trump began to announce his cabinet choices concerning the near-to-intermediate-term performance of our national economy. GDP growth rates have been anemic. They seem “stuck” in the 1.5% to 2% range and have been for the last few years.

As I follow the discussion, I see that there are those who feel confident that rolling back “unnecessary” regulation and instituting a substantial revision of the tax code—especially the reduction of marginal tax rates for business—will produce substantial and immediate results.

The skeptics are much less confident that any short-term progress can occur in the rate of GDP growth. They cite the “graying” of the workforce and a flattening of productivity growth as factors that will at least in the next few years significantly inhibit meaningful progress.

Importance of this economic debate

The stakes are enormous, for two reasons.

First, a significant improvement in our national economic activity will generate substantial growth in tax revenues. More business activity means more tax revenues for the U. S. Treasury.

Second, a bullish outlook on economic activity (and tax revenue growth) becomes “baked into” our assumptions on fiscal policy.

What happens if we expect significant growth in tax proceeds and that simply doesn’t happen? We’ll have the growth in the budget deficit and the debt as a consequence of our assumptions.

Then there are the cautious individuals who acutely remember the pain of the last few years driven by lackluster gains in economic activity and everything downstream from that, including reduced tax revenues, employment levels, and the myriad indicia of economic prosperity.

I have an optimistic bias on many, if not most things. I share this with most bank lending officers. However, today’s voices of caution seem more appropriate than those who are very optimistic.

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Can banks make the most of opportunity?

Don’t get me wrong. I think that in many ways we are starting with a clean slate on some old issues and the long-term outlook is quite bullish. I just wonder how quickly all of this might occur to give our economy a strong shot in the arm. In that sense, I’m certainly more cautious than many political and economic commentators on the current state of our affairs.

Yet I’m also old enough to have experienced some unexpected improvements in our national and regional economic conditions. These include business that was better than forecast; profits that beat budgets; and just some good, honest “luck” in our day-to-day activities.

So I pose these questions.

1. What if conservative voices are overstating current circumstances?

2. Suppose Congress is successful in substantial tax reform, especially relating to marginal rates of taxation to improve American competitiveness with foreign companies?

3. What if we figure out how to successfully repatriate the trillions of dollars in profits sitting in the offshore bank accounts of American corporations?

4. Could we actually enjoy a renaissance in economic activity—an old-fashioned sense of “a rising tide lifting all ships?”

5. And might this come sooner than any of us can imagine?

This has immediate implications for community and smaller regional banking companies. Is the infrastructure in place—people, systems and expertise to handle a gusher of loan activity?

Have we slimmed and scrimped too far?

I raise these issues in the wake of eight years of banking industry contraction. The casualties and the resulting damage have been enormous but perhaps mainly visible only in hindsight.

Here are a few examples:

• A general reduction in formal credit training by many companies due to cost constraints.

• A reduction in the number of young workers willing to consider banking seriously as a long-term career.

• An unwillingness (or perceived inability) to “afford” the systems upgrades to compete effectively with each other not to mention our much larger bank competition.

• An attitude of ceding the future of small business lending to larger bank and non-banking competitors.

But now we could be on the threshold of some truly extraordinary opportunities. A partial rollback of Dodd-Frank’s onerous provisions could unleash energy and productivity not considered possible only a few weeks ago. A strong resurgence of loan demand for productive sorts of business opportunities will require resources that have been allowed to wither at many institutions.

What banks should be thinking about

I think the most pressing need will be the empowerment of our people. Many of them have only seen in their working lives so far a decidedly negative environment—and an overly cautious lending atmosphere.

But thinking beyond that, what about loan review staff, credit analysts, documentation specialists, and customer contact staff who can talk intelligently about lending opportunities or be trained to make opportune referrals?

If I owned your bank, I’d likely be looking at the quality of credit training activities and making sure that loans can be underwritten sensibly and prudently. We’re on the road to losing our sharp-edged ability. At a number of banks, I suspect that it has atrophied somewhat.

Then, I’d keep an eye on the whole issue of ethical behaviors. Many of the “big boys” have stubbed their toes—or worse—in recent memory.

How does your bank line up in terms of ethical norms and behaviors reflecting those norms? This is not a hard subject on which to be diagnostic. The “fix” is something else, but it starts with a candid assessment. We should talk about that sooner than later.

Think about it: The big banks constantly reinforce our community bank business models with their versions of “my way or the highway” and their voracious appetites for fee income.

Act now

We have a great opportunity but it won’t last forever. Maybe in the next 18 months or so we can showcase to our customers what we’re really capable of doing.

To do nothing will cede the market place to those who do not wish us well and are perfectly capable of burying us if we’re not proactive.

We don’t have a lot of time to prepare. So let’s get after it. This is a challenge that we can meet.

Ed O’Leary

Banking Exchange Contributing Editor Ed O'Leary, a veteran lender and workout expert, spent nearly 50 years in bank commercial credit and related functions, working with both major banks as well as community banking institutions. His last job before retiring was as the CEO of a regional bank headquartered in Alburquerque, N.M. He earned his workout spurs in the dark days of the 1980s and early 1990s in both oil patch and commercial real estate lending. O'Leary began his banking career at The Bank of New York in 1964, and worked at banks in Florida, Texas, Oklahoma, and New Mexico. He served as a faculty member and thesis advisor at ABA's Stonier Graduate School of Banking for more than two decades, and served as long as a faculty member for ABA's undergraduate and graduate commercial lending schools. Today he works as a consultant and expert witness, and serves as instructor for ABA e-learning courses. You can e-mail him at etoleary@att.net. O'Leary's website can be found at www.etoleary.com.

In mid-2016 O'Leary's "Talking Credit" blog received a bronze excellence award for the Northeastern Region from the American Society of Business Publication Editors.

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