The Rise and Fall of Retail Banks

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 |  Includes: BAC, C, HSBC, PNC, USB, WFC
by: Investment U

By Justin Dove

There was a time when a trip to the bank would take quite awhile. Friday payday lines were sometimes unbearable. Banks even stocked lollipops to keep restless children quiet during the long waits.

Skip to 2011 and many bank branches are a ghost town. There are rarely long lines and the staffs are noticeably smaller. Technology enables many people to avoid branches altogether. Direct deposit, ATMs and online banking make it too easy to skip an extra errand in our busy lives. But branches losing foot traffic is more symbolic than anything. After all, the bank will still collect income on investments of deposits. They’ll also still cash in on numerous fees (which continue to rise).

However, there are some reasons to believe we’ve already seen the peak of these mega-financial institutions. For instance, retail banking profits are down more than 50 percent from the pre-crisis peak. According to a report by banking consultants Novantas, “it is now clear that revenues will not return to former levels.”

To understand where banks are headed, we need to understand history.

The Great Retail Banking Shift of 1994

Things started shifting greatly in the world of retail banking in 1994. Around the time “Forrest Gump” and “The Lion King” were lighting up box offices, Bill Clinton signed a landmark act into law. The Riegle-Neal Interstate Banking and Branching Efficiency Act allowed banks to be connected across multiple states.

This led to the rise of large U.S. retail banking networks such as Bank of America (NYSE: BAC) and Wachovia. But it doesn’t end there.

In 1999, the Gramm-Leach-Bliley Act went into law. This controversial piece of legislation repealed certain aspects of the Glass-Steagall Act of 1933 and the Bank Holding Company Act of 1956. Most importantly, it allowed commercial bank holding companies to dabble in other areas of the financial sector.

In the aftermath of the Great Depression, our legislators found that there was a conflict of interest in investment bankers serving as officers of commercial banks. Gramm-Leach-Bliley overthrew that notion. The early 2000s brought on the great consolidation of our financial institutions. It created “too big to fail.”

Banking Industry Learning Lessons the Hard Way

This consolidation created an unprecedented period of wealth and prosperity for large retail banks. For instance, a commercial bank called Citibank became Citigroup (NYSE: C) when it merged with Travelers Insurance Group. It eventually further consolidated to encompass Smith Barney and Primerica.

It seemed like a great thing at the time. If you had bought shares of Citibank stock in January 1997 for about $45, you’d have made a small fortune. The value of the stock would increase more than four times after numerous splits. And that doesn’t include annual dividends eventually eclipsing $20 per share!

There was a ton of money being made on Wall Street. There was also a perception that banking was safer because it would be much harder for these conglomerates to fail.

We all know how that turned out.

The plight of the banking industry is reminiscent of a stubborn child not heeding the advice of a wise grandparent. Legislation such as Glass-Steagall was in place for a reason. Our forefathers knew the harm that consolidation could bring. And just like a stubborn child, we had to learn our lesson the hard way.

Global Banks Leaving U.S. For Emerging Markets

On August 1, HSBC (HBC) announced that it’s selling half of its U.S. branches and laying off 10 percent of its workforce over the next two years. These cuts are said to allow HSBC to reallocate more resources to emerging markets.

Citigroup announced in March that it’s going to spend billions on spreading its influence in emerging markets.

Global banks are coming to the realization that boom-times are over for U.S. banks. For instance, Bank of America just reported a worst-ever $8.8 billion net loss for Q2 last month.

Certainly the economy is having a profound effect on banks. Low federal rates are keeping CD rates abysmal, leading to extremely low deposits. Stricter loan guidelines and tons of bad mortgages due to an ailing housing market are also hurting business.

But there’s also pressure for recent legislation. Late last year, changes in Regulation E took effect. These changes made banks much more transparent about charging fees on electronic transactions. It was great for consumers getting hammered with overdraft fees, but put a dent in profits.

Then there’s the Dodd-Frank legislation looming. Lobbyists and appeals courts are holding off much of the impact. But the thought of raising capital requirements and increasing required payments to the FDIC has banks cringing.

Bank of America, Wells Fargo (NYSE: WFC) and little brothers like U.S. Bancorp (NYSE: USB) and PNC (NYSE: PNC) are all trading near 52-week lows. All are also trading much, much lower than pre-crisis levels.

Government has been unable to break up these large behemoths, but shareholders may succeed.

Big Oil companies such as ConocoPhillips (NYSE: COP) and Marathon Oil (NYSE: MRO) recently decided a split was in the shareholders’ best interests. Changes in the landscape of the oil industry brought on such adjustments.

If bank stocks continue to perform so badly, banks may not have any choice but to break up in a similar fashion.

The Future of Banking Isn’t “Business as Usual”

Shaping the landscape of the economy would certainly have a profound impact on bank earnings.

  • Increased interest rates will drive more people to save and capitalize on CD rates.
  • A better housing market will create better mortgage business.
  • Better results from stock and bond markets will help the investment arms.
  • More employment and wealth will also help banks generate more income.

Unfortunately, none of that appears to be imminent right now. The changing landscape of banking is making it hard for these banks to operate business as usual. There’s also the threat of futuristic NFC payment structures such as Google Wallet. If people use smartphones to pay for things, banks could eventually be left out of the equation.

Expect banks to improve somewhat with the general U.S. economy. However, they’ll never return to the glory days of the mid-2000s. Because of this, you may see some splits akin to the oil industry.

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