Banks in the Time of COVID: What to Watch in 2021

While we have been dealing with COVID-19 for nearly a year (and lockdowns have made it seem much longer), we only have two quarters’ worth of financial data that really reflects the impact of the pandemic, from the second and third quarters of the late and unlamented 2020. With year-end results due soon, a few data points may prove especially useful in discerning effects that may long outlive this virus.

Overdraft Fees

Overdraft fees are worth tracking for multiple reasons in light of their mid-2020 behavior. Overdrafts are essentially a form of short-term (and high-cost) credit—the more respectable cousin of payday loans. As such, one might have reasonably expected such fees to spike as the country locked down and unemployment surged.

Overdraft usage may have spiked as well, but to their credit, banks aggressively waived such fees. While the median year-over-year increase in overdraft fee revenue at the 50 largest banks bounced around in the 2-4% range in each of the four quarters preceding 2Q20, the same banks posted a median year-over-year decline of 47% in the second quarter and a still sharp 30% decline in the third quarter.

It will be interesting to see whether (and if so, how quickly) overdraft fees continue to normalize. Potentially mitigating bankers’ desire to get back to profit maximizing in the incoming Biden administration; in general, much fewer changes in bank regulation from administration to administration than commentary would suggest, but the posture of the Consumer Financial Protection Bureau (CFPB) remains something of a partisan lightning rod, and so seems likely to become significantly more proactive. Since overdraft fees are disproportionately borne by the less affluent, they tend naturally to attract the CFPB’s attention, the upshot being that banks may continue to err on the side of forbearance. To the extent that this is true then the rate of normalization of overdraft fees may be a helpful indicator of the financial recuperation of lower- and middle-income households.

Bank Branch Consolidation

Branch consolidation looks set to be another long-tailed effect of the pandemic. The ubiquity of smartphones had already locked a secular decline in bank branches into place long before 2020, but at a comparatively stately pace. In the six most recent quarters, the 25 largest publicly-traded banks consistently posted year-over-year median declines of 2-3% in their total branches.

As more people were forced to adopt online banking and branch traffic collapsed, however, banks began to sharply accelerate their branch consolidation strategies. On October 15, 2020, for example, Chicago-based First Midwest Bancorp announced plans to permanently shutter 17 branches in 2021—equivalent to 15% of their entire branch network. Other banks have made similar announcements and it seems certain that more will do so in 2021.

As we observe this step function in the trend, several interesting questions arise:

• Is this a one-off decline or does the pace of branch closures remain elevated in the industry? Branch closures are surely subject to declining marginal utility, but nobody can say with certainty how far the industry’s branch footprint remains from equilibrium.
• Does the internal branch cutting weigh on bank acquisition valuations? Branch closures are among the main drivers of bank merger efficiencies, and if banks are harvesting those gains on their own, shareholders still win, but prospective acquisition premia may come in below historical benchmarks as a result.
• Do banks cut too much and pave the way for new competitors opening de novo branches? There is historical precedent for banks getting so focused on cutting costs that they undermine their own competitiveness. Many banks that attained world-beating efficiency ratios in the early 1990s found in retrospect that they had done so by eviscerating their capacity for revenue growth; having devoured their seed corn, it was they who were harvested in the bank merger boom in the second half of the decade.

Shrinking Loan Portfolios

One factor that may entice banks to cut as much as is prudent, and then keep right on cutting, is the sustained shrinkage of their loan portfolios, which is another data set that will be worth keeping a close eye on in 2021.

Loan growth held up in the first part of 2020, but as the lockdown began to bite, growth turned negative; the median linked quarter annualized loan growth rate for the 30 largest banks was -4.3%. The Federal Reserve’s weekly H.8 data offers a more precise look at the timing. Total loans and leases in the banking system grew to a peak of $10.85 trillion in early May, but then declined 4.3% through the remainder of 2020.

Revolving consumer loans (primarily credit cards) posted a more dramatic decline, falling 12.8% from the mid-March peak through year end. Perhaps even more remarkable is that revolving loans continued to decline through the holiday shopping season; from the week of Thanksgiving through Christmas, when credit card lending typically enjoys seasonal strength, loans declined by 0.2%.

The effect on bank loan-to-deposit ratios has been dire; the system-wide ratio plummeted to 64% by year end from 76% at the start of 2020. One way banks have mitigated the pain of low-interest rates in the post-crisis years has been to shift more of their balance sheets from low-yielding securities to higher-yielding loans; in 2020, Sisyphus’ boulder rolled all the way back to the bottom of the hill.

Equally striking is that even as the country has seen a wholesale shift toward working from home and shopping (and banking!) online, commercial real estate (CRE) has been a comparative bright spot. While CRE lending also turned negative for the 30 largest banks in the third quarter, the median decline was just 0.8%, outpacing overall portfolio shrinkage by a tidy 3.5%. The H.8 data tells the same story system-wide; total CRE loans grew 3.8% on the year.

It will be interesting to see whether either (or both) of these trends reverse in 2021.

On the revolving debt front, there is surely some segment of the market that, chastened by the risks that reared up in 2020, continue to deleverage and make their finances, and perhaps their lives, more anti-fragile. Yet there is likely a vastly larger segment that has had its fill of isolation and will eagerly embrace renewed opportunities for dining, travel, and other discretionary spending. If the vaccine works as hoped, then revolving debt growth may quickly recover lost ground.

Less certain is the outlook for CRE portfolios. Nobody can say with confidence what will be the long-term impact of the involuntary experiments of 2020 with working from home and shopping online for substantially everything. Humans are social animals and so a fair bit of mean reversion is surely in the cards, but demand for office space and the acceptable density of the cubicle farms contained therein remain very open questions. It will take time for answers to emerge, and ripple through valuations and bank portfolios. In the meantime, it would not be shocking to see the comparative strength of CRE loan growth reverse itself.

Conclusion

Presumably, we all will learn more about the long-tailed impacts of the pandemic in 2021. Bank data on overdrafts, branch closures, and loan growth may offer some useful lessons.