Pub. 6 2017 Issue 3

The CommunityBanker 10 Changing Market Dynamics’ Effect on Banks’ Balance Sheets By Scott Hildenbrand, Sandler O’Neill + Partners F E A T U R E hile changes in interest rates will al- ways be a major contributing factor to the planning process of bank manage- ment teams, recent opportunities in the capital markets and developments in the financial landscape have been increasingly influential in driving key balance sheet decisions for banks. Interestingly, even banks that have not participated in capital market activities are still being affected, as competitors’ decisions have changed the landscape for all participants. Understanding how constantly evolving mar- ket conditions are impacting your business will enable you to implement new strategies to best position your institution. The first quarter of 2017 saw the highest amount of capital raised since the second quarter of 2014, according to data from SNL Financial. While the credit crisis and the years following saw many defensive capital raises, the level and quality of such transactions has drastically improved in the years since. Subordinated debt and common stock raises have been increasingly more common, as many banks have raised capital for a variety of proactive reasons. Organic growth has thus far been the main use of proceeds—as is often said, “Growth demands capital.” Additional capital has helped banks remain com- petitive while allowing them to address regulato- ry issues due to high concentration risk, typically in commercial real estate (CRE). As investors and regulators have turned their attention to CRE con- centrations, banks are turning to the debt capital markets to support continued growth without having to consider other lending areas outside of their traditional scope and expertise. Further, as bank stocks across the board experienced a “Trump-bump” in late 2016, an increase in stock issuance is being used to fund M&A transactions. Similar to these issuance trends, M&A trans- actions have moved from defensive to more opportunistic transactions as equity prices have risen following the election. While the number of annual deals has decreased, the aggregate annual deal value has increased. This shows us that economies of scale seem to be the biggest driver of acquisitions. In fact, out of the 39 public and private banks to cross $10 billion since 2010, only 4 have grown organically, according to SNL Financial. Judging by the stock prices of the com- panies that used M&A to cross the threshold, it seems investors have approved of this strategy. While capital markets and M&A activity have enabled banks to boost earnings, tailwinds still re- main. The spread business suffers from a flat yield curve and cost of funds is under pressure from an increasing Fed Funds rate (deposits typically move with the short-end of the curve). On the as- set side, elevated loans-to-deposits ratios and CRE concentration limit potential loan growth, and the asset mix shift out of bonds and into loans has largely played out. Despite these tailwinds, mar- ket expectations have jumped following President Trump’s victory with many people believing tax relief and less regulation could become a reality in the near future. Meeting these lofty expecta- tions may exacerbate the potential increase to cost of funds caused by deposit-starved market participants. There are various ways in which banks are bat- tling against market forces to stay competitive. In response to a flat curve and fierce competition pressuring yields and terms on the asset side, more banks are using loan hedging programs to meet customer demand and manage interest rate risk on loans. Banks are also evaluating wholesale leverage to enhance earnings, despite seemingly uninspiring spreads. W