Overexpansion by Banks Hits Brick Wall of Reality: The Point of Negative Returns

Banks have finally come to a realization there does not need to be a branch on every corner. If this story sounds familiar it is because the same discussions took place in 2000.

Here are some interesting comments from the headline story Bank of America to close Hudson branch on Friday.

Bank of America spokesman James Mahoney: "Over the longer term, as customer demands evolve, we see a fewer number of branches that provide more services."

Analyst Richard Bove of Rochdale Research: "While the bank is likely to close the branches, the reason being given is simply farcical," Bove wrote in a research note Tuesday. "The branches will be closed because they are not economically viable."

Pruning Branches to Strengthen the Banks

Barron's picks up the story in Pruning Branches to Strengthen the Banks.

Some banks have been deemed too big to fail. But could some banks simply be physically too big? That seems to be the case with Bank of America (BAC), which was reported to be planning to shut 10% of its 6100 branches. According to the Wall Street Journal, which broke the story in Tuesday's editions, B of A's customers increasingly are opting for online and mobile banking transactions. Moreover, half of the bank's deposits are being made via automated teller machines, up sharply from just one-third six months earlier.

But veteran banking analyst Dick Bove of Rochdale Securities disputes that a shrinkage in B of A's vast branch network would be driven by technology. Economics will be the main factor reining in the ubiquitous red-and-blue branches, he says.

Whatever the motivation, America's big banks are apt to learn the lesson being absorbed by Starbucks (SBUX) -- you can reach the point of diminishing returns from expansion. And once the culling begins, the resulting vacancies in these prime retail spaces can only worsen the downward spiral in commercial real estate as well as employment in banking.

Only now, well into the 21st century, has electronic banking become the norm for retail bank customers. But Bove avers that they had shown a distinct preference for old-fashioned bricks-and-mortar branches. Opening more branches expanded deposits, which earlier in the decade could be deployed profitably owing to low deposit rates and robust mortgage lending at a generous, five-percentage-point spread.

Now, Bove continues, the situation is reversed. B of A has too many deposits (12.2% of the nation's total, boosted by the acquisition of Countrywide Financial), and he says the bank doesn't really want to make loans. At the same time, the yields on its assets are falling faster than deposit rates, which can't drop much further.

Point of Negative Returns

I have to side with Bove on this one: "While the bank is likely to close the branches, the reason being given is simply farcical. The branches will be closed because they are not economically viable."

Cheap money from the Fed created a false economic signal of prosperity and growth. The grand party went on for close to seven years. The bust is likely to be at least that long so don't expect miracle recoveries.

More space will be coming available from Bank of America, Citigroup (C), Wells Fargo (WFC), and others. The sheep always line up. If one bank starts closing branches the rest will too.

Expansion for expansion's sake failed miserably, as it always does. And the Fed forever blowing bubbles of increasing amplitude is the primary reason.

That said, it's important to note that commercial real estate in general is the key take away from this story. Indeed, the same over-expansion problems that plague banks also apply to Starbucks (SBUX), Home Depot (HD), Lowes (LOW), Target (TGT), Pizza Hut (YUM), and for that matter, nearly every business on the planet.

So while everyone else is putting their party hats back on, celebrating the end of the recession, I caution the "horn tooters" this is not an ordinary recession.

I touched on this in the Incredible Shrinking Boomer Economy.

"If Bernanke is correct that it takes 2.5% GDP growth just to keep the unemployment rate constant, and McKinsey is also correct in its 2.4% forecast, we will be stuck with 10% unemployment for decades."

At some point the economy will bottom. Perhaps it already has. However, the Brick Wall of Reality, the Point of Negative Returns, is still large and in charge. A "Job Loss Recovery" looms. There is little reason for businesses to expand beyond inventory replenishment nor is there any good reason for banks to increase lending. And if one reads between the lines, various members of the Fed sound increasingly aware of that fact.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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