Earnings season is underway, spotlighting a new reality for smaller banks in a long, hot summer.
“They’ve had to re-engineer managing their business from just two years ago,” Chuck Fagan, president and CEO of PSCU, told Karen Webster.
As these financial institutions (FIs) begin their budgeting for next year and beyond, they’re bracing for 30% to 35% reductions in profits, he told Webster.
It’s a reversal of fortune from the days before inflation set in, before competing for deposits sparked lending headwinds and pinched net interest income.
First things first: The much-anticipated deterioration of credit quality has not materialized.
Smaller FIs are seeing delinquency rates and charge-offs rise at a slower pace than the marquee, giant names in banking.
Credit unions (CUs) benefit from the fact that they know their members intimately, that there’s a sense of obligation on the part of borrowers to meet their mortgage and credit card obligations, Fagan said. There’s also the fact that CUs have been able to outsource some of their collections activity to providers, PSCU among them, to monitor the state of revolving debt, promote dialogue with borrowers, and keep payments from getting too far behind.
“Right now, we’re still at the ‘friendly reminder’ stage,” of collections, he told Webster, “and we’re not seeing people get six months behind yet. Financial wellness is something that the community institutions have focused on.”
But there are plenty of challenges elsewhere.
A few short months ago, in the wake of Silicon Valley Bank’s collapse, depositors flocked to the smaller players, the regional banks and the credit unions that seemed to offer some relative safety.
In the current environment, he said, a significant “lend-out” of deposits — topping more than 100% of deposits, in the event a bank borrows funds — has become commonplace. In the meantime, he said, as the velocity of lending has outpaced that of deposits, consumers are looking for the best rate environment. They’re willing to switch FIs for higher deposit rates.
“That’s in the ‘leveling off’ phase right now,” Fagan remarked of the deposit flight to smaller players, “and according to the CEOs I’ve talked with over the last several weeks, they’re fighting and clawing for every deposit dollar they can get.”
There have been a few bright spots, he said. Long-term certificates of deposits have been a solid business line, offsetting at least some of the declines in other businesses such as mortgages (which have dried up in the current environment and have led to layoffs at some CUs’ mortgage departments).
And on a higher level, he said, CUs — at least the larger ones, with at least $1 billion in assets — have been able to “bundle” services that appeal to the long-standing trust they’ve built with members, in order to compete with larger banks.
FedNow, launched last week, which will give FIs more opportunity to find new revenue streams (and customer loyalty) tied to payments. The greenfield opportunity is especially ripe to serve smaller business clients, he said, as credit unions can use instant payments to help these businesses improve their cash flows. Initially, he said, FIs may take a “receive-only approach to dip their feet into the water — and as they get more comfortable, they’ll get into sending and request for payments.”
Looking ahead, he said, the overall banking landscape seems poised to get a lot smaller. Recently Treasury Secretary Janet Yellen said she wouldn’t be surprised to see more bank consolidation.
Fagan noted that in the past three decades, the pool of community banks has been winnowed down from 15,000 to about 4,600. Some smaller banks, family run, have not necessarily had succession plans in place, and are looking for exit strategies. In other cases, capital requirements may prove onerous, and community banks have bought other banks in order to scale. We may get down to just a few thousand CUs and community banks by the end of the decade.
In the meantime, with one or two rate hikes on the horizon, he said, CUs will have to do what they can to control inflation. There will be “continued management on the cost side of the business for credit unions and community banks in order to achieve their goals for the year. It’s the right thing to do at this stage” to remain viable and competitive.
After all, as he noted to Webster, as they navigate a slew of current challenges, “the small credit union and the small community bank play a significant role in the health of the [financial] system.”
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