The Budget(s) for 2010

It won’t be long before that famous annual memo comes out – the memo from the bank’s chief financial officer announcing (oh goodie!) the beginning of the 2010 budget cycle. Strategic planning meetings are being held around the country, and soon it will be time to turn next year’s aspirations into cold, committed numbers.

It’s time to crank up the Excel pivot tables and worksheets. It’s time to send the budget worksheets spinning through everyone’s Outlook in-boxes. It’s time to think long and hard about what in God’s name 2010 might look like.

We all know it will be a year of keeping the hatches battened down. Capital preservation and restoration will still be the driving variable in the budget model. Growth in loans and deposits will be modest. In the first quarter of this year, the banking industry’s growth rate sunk to just over 1%. Expense control and driving every last penny through loan pricing and fee income strategies will be used to barely eke out modest financial targets.

For bank senior management teams, the 2010 operating budget will be one heck of a painstaking exercise. In fact, there are so many industry wild cards going into next year, it’s likely many budgets will be obsolete by the end of the first quarter. The updated, rolling, quarterly forecast will be a more critical tool for what many hope to be a post-recession year.

So, GonzoBankers, here’s a quick review of the wild cards we see our clients grappling with as they begin to develop next year’s budget assumptions:

Wild Card #1: The CRE Quicksand

Last Wednesday, the National Association of Realtors announced that commercial real estate activity had dropped to its lowest level in 15 years (Richard Marx had a hit single that year, to put in perspective how long it’s been). Amid the severe recession, demand for office and retail space has collapsed and the banking industry holds a mere $1.8 trillion in commercial real estate. At the end of the first quarter, the Fed reported that delinquencies on these loans had doubled from a year earlier to 7%. For banks, the uncertainty around CRE makes the targeted loan loss provision as slippery as a frog wearing suntan oil. Chief credit officers are cranking out the provision analysis like never before but it’s just too hard to know if the numbers being plugged will fall anywhere near reality next year.

Wild Card #2: Dead Man’s Yield Curve

Interest rates are always an unknown in the budgeting process. Even Miss Cleo with all her talents is going to have a tough time pinning down just how volatile things could get. As GonzoBanker has reported in the recent past (Inflation Fears are Far from Inflated), the massive increase in the money supply driven by Fed leverage simply puts banks in uncharted waters in terms of how interest rates will react.

Most forecasts today are calling for less than a 1% uptick in short-term rates (Fed Funds and Prime) next year, but think how far those forecasts could swing. Just last weekend, University of Santa Cruz professor Carl Walsh ended the Federal Reserve’s famous annual Wyoming beard-scratching and fishing conference with a warning that rates should be “increased quickly” once the economy gains equilibrium. “There is no support for raising rates at a gradual pace once the zero rate policy is ended,” he argued.

For banks, taking interest rate positions has been very tough, and most have tried to keep their appetite for medium term assets and portfolio fixed-rate mortgages in check. But remember, we are sitting at a 3.25% prime rate, and that’s just not normal for the long term. Let’s remember it was as high as 8.25% in 2007 and 9.50% back in 2000. A long recession floor followed by a snap uptick in rates when the economy starts to move is a very possible scenario.

Wild Card #3: The Great Depression of Regulation

Clearly one of the saddest events of the past year has been to watch banks take great pains (and hurt some employees) to cut costs, only to have a great deal of these cost savings eaten up by increasing deposit insurance premiums. The accelerating pace in recent weeks of bank failures in large names such as Colonial and Guaranty has placed new concerns on what it will take to “shore up” the industry’s insurance fund.

Bank analyst Richard Bove said last week he expects the FDIC to levy special assessments against banks in the fourth quarter of this year and second quarter of 2010. He said these assessments could total $11 billion in 2010, on top of the same amount of regular assessments. “FDIC premiums could be 25 percent of the industry’s pretax income,” he wrote.

For banks, understanding just how much these assessments will be is another wild card. 

At the same time, regulation is certain to increase operating costs for beleaguered banks next year. We are already seeing this impact with credit card legislation passed in May (the statement project headaches are abounding across the country). Additionally, the potential impact of future overdraft and interchange regulation are making the non-interest income figures harder to predict for 2010.

Dealing the Budget Cards

So GonzoBankers, the truth about next year’s budget is that it will be based upon some very big “IF’s”. Trying to maintain credibility with a board of directors and investors in this environment requires a candid explanation of these wild cards and staying nimble.

In recent months, I have seen many financial institutions planning to conduct their own mini stress tests around the aforementioned wild cards as part of their capital planning and budget process. For instance, they are running a version of the model with an increase in loan loss provision from a CRE “second shoe” that drops. They are running ALCO shocks of 400 – 500 bp, not just the typical 300 bp, to see just how resilient their balance sheet can be if a fast rising rate environment were to occur, and they are noting the real possibility of charges for regulatory assessments that will impact both earnings and capital. These types of contingency plans are also being run by credit unions, which face similar challenges and more assessments from failing natural person and weakened corporate credit unions.

The fact is, many banks will have a base case budget but then several other versions that show the band of possibilities for next year based upon this crazy landscape. Maybe 2010 will mark the beginning of recovery and the bottom that foretold better times, but for all, it will be a year during which updating the monthly forecast and being ready to implement contingency plans when budget assumptions change will be the mandate. Ladies and Gentleman, start your spreadsheets and best of luck!
-spw

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No Time for Bluffing

Cornerstone Advisors’ strategic planning specialists have helped numerous financial services institutions achieve stability and build a viable, measurable Strategic Plan for the future.

We offer the most comprehensive planning process available, having chronicled best practices in all operational areas for years.

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