Sunday, November 03, 2019

Improve Bank Boards Through A Disciplined Nomination Process

"Rigorous, peer-reviewed studies suggest that companies do not perform better when they have women on the board. Nor do they perform worse." ~ Katherine Klein, University of Pennsylvania

Do you know how difficult my life might become for the above quote? Just yesterday I received a newsletter from a highly regarded executive recruiting firm that said "publicly traded companies with a diverse board of directors generate higher return on investment (ROI) than those that aren't as diverse."

Klein, who did this analysis in 2017, disagrees and says that most citations of gender diversity being either highly correlated or even a causation to better performance are performed by consulting firms and/or information providers... i.e. they are not peer reviewed. And correlation to high performance is not statistically significant.

We're Already Here

That is not the politically correct thing to say. Jill Pursell from my firm wrote a thoughtful newsletter on the subject regarding new and pending legislation compelling gender diversity. We are already deep in this rabbit hole.

So let's make the best of it.

I have observed that the best functioning boards are not dominated by one or two voices, that operate at the level of what a board should operate at, and challenge each other and management. Perhaps I would add community contacts to the list for a community bank board. But I don't think the list speaks to race or gender specifically. 

Larry Fink, CEO of BlackRock, said this of board diversity: "Boards with a diverse mix of genders, ethnicities, career experiences, and ways of thinking have, as a result, a more diverse and aware mindset. They are less likely to succumb to groupthink or miss new threats to a company's business model. And they are better able to identify opportunities that promote long-term growth." Larry's funds are invested in virtually all publicly traded banks. And this is his thinking. 

And it's pretty close to my own thinking regarding reducing the likelihood of groupthink. I have a friend, let's call her Jane. I would guess that Jane and I think similarly about 99% of the time. We are each other's mind doppelganger. I don't think it would be helpful having her and me on a bank board because our backgrounds and world view are too similar. How would we challenge each other? Who was it that said if two people think alike, one of them is unnecessary? 

Back to Fink's thinking. One key challenge I have observed that prevents boards from achieving the level of diversity that he speaks of, and achieving "best functioning board" attributes that I mentioned above, is our nominating process. Most new board members are nominated through a board Governance and Nominating Committee. 

And how they come up with prospects is ad hoc, in my experience. As in, "hey, we need a CPA on the board. Jeff, know anyone? Yeah, I golf with my accountant. Let's see if he's interested." This has led to boards that suffer from groupthink, and lack diversity, in my opinion. To support the point, look at the accompanying picture of me and my friends at a Penn State hockey game. 

Creating A Board That Avoids Groupthink

So let's fix it. Let's be more disciplined in the nominating process. Here is what I suggest...

1.  Do an annual assessment of board needs that includes professional backgrounds, experience strata, customer demographics, and geography. 

2. Use third parties to identify prospects that best fit board needs. This could be chambers of commerce, associations, community organizations (such as Rotary), or even recruiting firms. The key here is you want to develop a diversity of thought, challenging dialogue, at the right level (the level the board should operate at). Do not be limited, or even driven, by who other board members know. That elevates the risk of groupthink, exactly what we are trying to avoid.

3. Get rid of age limits. Wouldn't it be terrible to kick off the 70 year old, thoughtful, and community connected board member for the younger person that barely speaks and opens their board package on board day? Listen to David Baris, CEO of the American Association of Bank Directors, on my firm's podcast regarding this subject. 

4. Perform individual board member assessments that includes the ability to bring in diverse views. CalPers, California's pension fund, estimates that board members get too cozy with one another after 12 years of service. To mitigate this threat, create a fair and disciplined assessment process that gives high scores for bringing diverse views. 

Assigning quotas so bank boards appoint by race and gender does not necessarily deliver the "best functioning board" that I described above. However, implementing the above four suggestions will likely result in a more diverse board. There have been more women than men college graduates since the 1980's. A random walk through Chicago's O'Hare airport shows that there is an increasing diversity of professionals pulling their roller boards. And as our markets become more ethnically diverse, so will our boards if we want our board to better reflect our communities. The end result should be a board that does not suffer groupthink and delivers more positive outcomes.

Any other suggestions on what a "best functioning board" is, and how to achieve it?

~ Jeff

Sunday, October 27, 2019

Uninteded Consequences of Executive Change in Control Provisions

You're a top performer at your bank and an executive from a competing bank wants you on their team. You recently got a new boss, and it isn't gelling. So the offer is timely.

You check out the competing bank. Do your due diligence. You respect their executives. Their numbers look good. Heck, you've lost a few deals to them. This bank deserves serious consideration for a job switch.

Hold on! You check their proxy statement. The CEO is 67. And he/she has a 2.99x change in control (CIC) contract. Nope. You're out. This bank's gonna sell so the CEO can pull the golden parachute rip chord. Why would they walk away with a gold watch when they can get paid for three years while sipping boat drinks in the Bahamas?

This hypothetical situation is an unintended consequence of executive CIC payments. The incentive gap between selling the bank and retiring while remaining independent is perceived as too big. 

Reasons for CIC Arrangements

There are legitimate reasons for change in control contracts. Meridian Compensation Partners, in their 2017 Study of Executive Change in Control Arrangements list the following reasons:

  • Keep the Executive Neutral to Job Loss. The primary purpose for CIC arrangements is to keep senior executives focused on pursuing all corporate transaction opportunities that are in the best interest of shareholders, regardless of whether those transactions may result in their own job loss.

  • Retain Key Talent. Corporate transaction activity may create uncertainty for critical executive talent. This uncertainty may create significant retention risk for a company. An executive with sufficient severance protection may be less likely to leave voluntarily to seek other employment in the face of transaction-related uncertainty.

  • Maintain Competitive CIC Benefits. A majority of large public U.S. companies provide their senior executive officers with some level of CIC protection. Thus, companies provide CIC protection to attract and retain the top talent, especially in industry sectors undergoing substantial change or consolidation. 

Unintended Consequences

Aside from making it more difficult to get top performers to come to your bank when the CEO nears retirement, there are other unintended consequences. Other executives that may be retired in place (RIP) may hang on a little too long waiting for a buyer to come knocking and trigger their CIC payments. They are less likely to be making difficult decisions that will cause disruption yet might move your bank forward and position the bank for long-term success during this waiting period. 

Middle managers and high potential employees can read proxy statements too. Imagine the regional branch manager that wants to propose a change in hiring practices and development plans to turn branches into high performing sales and advisory centers. It will be difficult, but it is what customers are demanding. Should we do it? Nah, CEO is about to pull the chord. Multiply that perception several times over, and you have a bank that is losing pace with the market, making a sale a fait accompli. 

Shareholders celebrate the CEO's birthday too. I invest in bank stocks and have looked at a CEOs age on more than one occasion as a decision-point. This could artificially increase the valuation, making a sale more likely because the bank would have to earn its way into an inflated valuation. And shareholders may have bought in with the anticipation of a sale.

Development plans that help your high potential employees follow an executive track are shelved because of budget pressures. I am generally a cynic but most CEOs I know act in the very best interest of their bank. But what if, in the back of their mind where we rarely visit, they know that if they keep deferring the long and purposeful journey of developing multiple homegrown executives capable of becoming the next CEO, the board will opt to sell because there are little to no succession options. Under Jack Welsh, GE always had two or three people ready to go. Big company, I realize, but something to think about.

What To Do

What should you do about it? I asked a couple of executive recruiters and they didn't help me out. So I came up with one on my own. Unique, yes. A little out there, yes. Consistent with building a long and enduring business model, I believe yes.

Offer a Retirement Stock Plan (RSP) to ALL employees. Before you stop reading, let me describe it and run the numbers. One reason that institutional shareholders complain about CIC arrangements is because they put money in an executives pocket at the expense of shareholders. When a bank sells, the buyer assesses its value, then subtracts deal expenses. And a big deal expense is executive contracts.

But what if there was an incentive to stay and build the bank for the long-term, and retire? And instead of it only being available to executives, make it available to all employees that have been with you a minimum amount of years and retires.

This will put a premium on your talent management processes. Much like GE that shed 10% of its workforce each year using employee evaluations as the means to identify the 10%, a bank that implements an RSP must motivate high potential and otherwise good employees to stay, while having a process to improve or remove low performers so they don't hang on to get their RSP.


It all comes down to a spreadsheet. Suppose Schmidlap National Bank, a $1.5 billion in asset bank, implements an RSP that pays 50% of a retiring employee's salary in Schmidlap stock if they retire after a certain age and have served between five and ten years at the bank. It would pay 100% of salary if they are there more than 10 years. Schmidlap can restrict the stock to protect against employees "retiring" and going to the competitor.

Here is what I think it would cost:

Many of the assumptions are aggressive, such as one executive retiring per year (at the average salary of all executives, including the CEO), and other employees retiring as a VP or AVP. If 5% of Schmidlap's 250 FTE employees retire annually, that's 13 per year at a $1.5 billion bank. That seems aggressive to me too. But I didn't want to undershoot the cost.

Based on my assumptions, this would cost Schmidlap $1.0 million per year and represent a 5% reduction in net income, and a 2.6% increase in operating expenses. I think banks can look hard within themselves to offset this cost with a mix of process improvements resulting in cost savings, and asset growth. My firm recently did a process review for a similar sized bank and made recommendations for $3 million in improvements, most of which were annual and recurring. We just taped a podcast with an emerging core processor that has 50% cost savings from your current core costs as a target. If half of the RSP was paid by growth, that would be $25 million in growth if it was added with a 2% incremental ROA.

I think the benefits would far exceed the costs. For one, it is a stock grant plan that adds to the bank's capital position to support growth. Second, it puts executives and employees on an even keel. It benefits both. Third, it reduces the incentive for the CEO and other executives to "pull the chord" and sell when they near retirement, which in turn helps the culture throughout the bank to manage it with an eye toward building a long-term future. It's a culture builder.

This doesn't mean the bank won't sell. If it hasn't earned its right to remain independent, that option remains on the table. And executives wouldn't be able to collect both a CIC and RSP at a sale event, in my opinion. Most states have laws that boards should consider all constituencies when making decisions: shareholders, customers, employees, and communities. An RSP would benefit all employees that gave a significant portion of their professional lives in service to the bank. 

What do you think? Any other ideas out there?

~ Jeff

Sunday, October 06, 2019

In Banking, Soft Skills Remain Blah Blah Blah

Weakness: Middle Management. I hear this often. Why is it so common in community banks?

I have opinions. Peter Principle is alive and well in banking. We elevate superior performers in their functional position to leadership positions to which they are ill prepared. We promote them to the level of ineffectiveness.

But that doesn't mean that the experienced and high performing loan servicing person cannot become a great manager of Loan Servicing. It means that the skills to motivate those under you to perform at their peak are different than pushing yourself to perform at your peak. But it takes more than revising their business card and giving them an office to get from here to there. It takes organizational effort.

My local newspaper featured the director of training and development at a long-standing construction company. In the article, she spoke of emotional intelligence and body language. Not skills that were critical to maximizing the tickler feature of your Jack Henry core. 

The construction company had $414 million in revenue. Enough to have a high level person that is the Director of Learning and Development. So what does a $40 million in revenue community bank do?

Do I Think Leadership Is Important?

I searched this blog for what I have written on Leadership. Here is what I came up with:

Lead Like Lincoln. Identifying attributes that made arguably our greatest president so great.  

Do We Care About Leadership? Discussing the military's take on leadership development.

Leadership: In My Own Words. My uninhibited opinions on leadership in a changing industry. 

Do you think I believe this is an important discipline?

What To Do

Back to middle management being a weakness. When I hear this in strategic planning retreats I look in the face of bank executives and quote one of my Navy division officers: "Careful pointing your finger, because the other three are pointing at you." To translate Lt. Proper's quote, it means that if your middle managers are not strong, perhaps it's because of you.

Here is what I suggest that you do about it...

1. Develop. Always develop high potential employees for the next level. If the next level includes supervising others, then their development plans should include how best to do that given your bank's culture. There are scores of programs out there to develop people into being great leaders and managers. Choose a reputable one that fits your bank's philosophy on maximizing the abilities of those that report to you. It doesn't have to be within our industry. The Positive Coaching Alliance program that I took when learning how to be a girls lacrosse coach has made a significant impact on me, for example. It taught me how to "fill the emotional tank" of those that report to me. Most college business programs have leadership and management courses, but the noise of college might have diluted their impact. So why not have the employee do a white paper on leadership and management best practices for re-enforcement? Don't just assume they get it if they went to college. But your approach may be different.

2. Empower. This means that you allow mistakes. But in so doing, create an environment that learns from mistakes. Nothing is more deflating than something going wrong and all that the employee does is defend their actions. That means that you have created an environment where they think they are in trouble. Instead, create an environment that when things go wrong, we look at why. Was the data used to make the decision incomplete? Did we miss on the execution? Allow mistakes, and reflect on them to make us better the next go round. Don't create the environment where mistakes lead to a stern discussion. So many cumbersome bank processes where born from a 'no mistakes' culture. And it stifles a high potential employee's development and the continuous pursuit of doing things better. 

3. Cheer. The assistant manager of Loan Servicing is so good that you are afraid to lose her. So in that ops meeting the COO gives kudos to automating insurance tracking, and you nod. Your assistant manager came up with the concept and led the execution. But you know that Loan Admin is looking for a new leader, and you don't want to lose your superstar. You got nobody in the wings! And you really didn't follow "1" above because you couldn't afford to have your assistant manager away for a couple days anyway. When I was in the Navy, a part of leadership's evaluations was how well your subordinates promoted. This led to unintended consequences like inflated performance reviews, but the concept was correct, in my opinion. If you are a manager and leader, then you should be advocating for your high potential employees' upward mobility. 

Those are only three ideas for building a stream of potential future leaders. Building the capability of developing high potential employees into future leaders is the best way to preserve and advance your culture. Because if you are forced to always go outside of your bank to fill leadership positions you will dilute your culture and deflate your employees trying to reach the next level.

You can do this.

~ Jeff

Monday, September 02, 2019

Bank Branches: A New Model

This design or that design. Digital, pods, low square footage. All the talk around the branch of the future is about design, staff levels, square footage, and technology. 

Yet the people that carry balances, the boomers and older, can't figure out where to go when they come in for a teller transaction. And the younger generation want help managing their budget, using the improved technology tools, and applying for loans.

Sorry youngster. But look at our cool design! 

The slimming of our branch networks, both in number, square footage, and number of staff was used to increase our technology spend, compliance costs, or dropped to the bottom line.

Well I propose something different.

A Different Branch Model

I have a habit of asking almost every head of branches I encounter if they experienced, at any time in their career, a support center person transferring to a branch. In all of the years I've been asking, only one said yes. Because of a toxic boss in the support center. Otherwise, crickets. 

Why? Why doesn't anyone transfer to branches? Why is the branch so important to the execution of strategy, yet nobody wants to be there?

The reasons I hear most are: hours, pay, accountability. They want to transfer to the back office for greater pay, regular hours, and little accountability.

And I have personal insights because I was once a branch manager. Granted in the mid 90's. But still. Then as now, it was a stepping stone for me. No intention of remaining in the branch. The pay wasn't enough. And it was organizationally a thankless position. No thank you. 

Has it changed?

But I propose it should. Because what I hear in community bank strategy sessions, the branch is an important if not critical portion to an enduring future. Why? That one-on-one relationship can't easily be replicated by technology, a bot, or a phone call (when not accompanied by an in-person relationship). 

Survey after survey continues to show that a local branch is important for customers or would-be customers, no matter the age. 

Yet we're blowing it. 

We continue to make the branch a waypoint for our most promising employees. So here is what I propose:

1. Increase the pay- At least two branch employees should earn household breadwinning pay. Right now, the way we pay branch managers, either they are supplementing family income or are young without the outsized financial responsibilities of supporting a home and family. We think increasing teller pay, in the face of rising wages led by larger banks, is enough. It's not. It's branch leadership that needs to earn breadwinning pay. This may increase compensation expense in branches. According to my firm's profitability database where we measure hundreds of community bank branches, each branch generated 2.19% in total revenue as a percent of deposits (spread plus fees). And the median branch deposit size was $61 million. To cover the extra costs, that $61 million branch would have to be $65 million. Would greater talent with the ability to deliver on what people want a branch for in today's environment get you there? I think so. And then some.

2. Rethink the hours- Nothing that customers say they want branches for requires 44 lobby hours and an additional eight drive-thru hours. How about 7-3 M-T, and 11-7 Wed-Thurs and 9-5 on Friday? That allows time for early morning people to bank and after-work people to bank and see your bankers for their more sophisticated problems. Put an inter-active teller machine (ITM) in your man trap or drive up for doing transactions during other hours. This would allow branches to have four FTEs, assuming one is absent at all times for training, customer visits, PTO. You can make up some of the costs of paying people more by having fewer people. Floaters can cover crunches.

3. Design should match emerging needs for branches- Taj mahals are not necessary unless you are using a hub and spoke where the hub is in larger towns, and spokes in lower footprint branches such as the 1,000 square footer. But pay attention to design to make sure you convey the look and feel consistent with customer needs and what you want them to think about you. Check out Associated Bank's design (a couple pictures from their annual report). They took part of the savings from reducing their number of branches by investing in the look and feel of the remaining branches. Check out my post from nearly four years ago on branch décor for more on this. And oh yeah, don't spend money on making your branch a destination. Because people don't want to hang out in bank branches. 

4. Automate support functions- Want to save money? Look at HQ. The promise of AI looms large.

If we believe in strategic alignment, that our day-to-day actions should be consistent with our strategy, then we need to re-think how we feel about branch staff. Because I don't know many banks that want their branches to be staffed with our lowest compensated, highest turnover employees. 

Yet here we are.


~ Jeff

The bank branch is dead. Long live the branch.

Regions New Branches

Chase Branch Design

Sunday, August 04, 2019

How To Do Product Management Without Product Profitability

Quick answer: I don't know.

I posited this question on Twitter because product management has come up during various financial institution strategic planning sessions. I also don't know of many new banking products since I've been in the business. See my post on that subject here from nearly two years ago.

But product management is a function that is performed, at some level and degree, in most financial institutions. Even if they have no title Product Manager. But if you don't measure product profitability, I'm not certain what financial institutions are managing to.

The video below discusses how Product Managers can use profitability information to improve the profitability of products and ultimately their institution.

How do you do Product Management?

~ Jeff

Thursday, August 01, 2019

Guest Post: Financial Markets and Economic Commentary by Dorothy Jaworski

Financial Markets & Economic Update- Third Quarter, 2019

Summer is upon us and I cannot wait to get to the beach for vacation.  What an amazing ride it’s been this year for bonds!  Interest rates continued their steep decline into the second quarter.  Longer-term interest rates are down more than a full 1.00% since their highs last November.  GDP was +3.1% in the first quarter of this year, but many are projecting growth of less than 2.0% for the second quarter.  Housing looks weaker, with much lower year-over-year increases in prices and volatility in new and existing home sales.  Business confidence and manufacturing fell during the second quarter, mostly the result of trade wars.  China reported growth of +6.2% in the second quarter, which was the lowest there since 1992.  All of this led to interest rates falling month after month in 2019. 

Although business confidence fell from the uncertainty, stock markets were reaching new record highs on many of indices.  One exception was small cap stocks, which did not fare as well as larger companies, due to the Fed raising rates.  Consumers are benefiting as the unemployment rate is at 3.7% in June, wage growth is at +3.0%, and job openings are plentiful; there are openings of 7.4 million, which is over 1.4 million higher than the number of unemployed persons.  The Federal Reserve has expressed concern, through Chairman Powell, that inflation has not met Fed targets of 2.0% and is at risk of falling.  Core PCE has only exceeded 2.0% in eight of the forty-one quarters since 2009.  The Fed may lower interest rates to give inflation a boost.  Think about that for a minute…

Leading Indicators & Yield Curves

The index of leading economic indicators, which forecasts growth six to nine months from now, has stabilized in the past few months, after a very weak series late in 2018.  The “LEI” was unchanged in May, after rising by +.1% in April, +.2% in March, and +.2% in February.  We should continue to have slow GDP growth later in 2019, based on this indicator.

The leading inflation indicator, or ECRI future inflation gauge, has been falling on a year-over-year basis and is forecasting low inflation six to nine months from now.  The “FIG” has been dropping all year, with year-over-year changes in June of -3.6%, May -3.7%, April of -2.2%, and March -2.6%.  Fed Chairman Powell, you are right.  The forecast for inflation is that it will be weak.  Slow growth, low inflation, it sounds like a broken record…

One of the best leading indicators for the economy, surprisingly, is the Treasury yield curve.  Steep, or positive, yield curves predict economic growth and higher interest rates.  Inverted curves indicate slow growth, or recession, to come along with lower interest rates.  Flat yield curves show stable rates.  We are between the flat and inverted yield curve now, based on different sections of the curve.  The 5-year to 2-year and 10-year to 3-month yield spreads are now at 0%; the latter was inverted by .20% one month ago.  The 10-year to 2-year spread is at .26%; this is usually the first spread to invert, yet it remains positive.  Today, the yield curve is telling us that growth is coming under pressure but it is not forecasting recession at this time.

The yield curve can remain flat or inverted for very long periods of time.  For example, the inverted curves that preceded the two recessions since 2000 remained that way for over a year (average of 13 months) before steepening.  The spreads of the 10-year to 2-year and 10-year to 3-month also have a long lead time before signals of a downturn are seen.  The 10-year to 2-year spread inversion precedes a decline in the LEI by 9 to 12 months.  Both spread inversions precede recession by 13 months (as in 2000 for the 2001 recession) to 26 months (as in 2006 for the 2008-2009 recession).   By the time recession begins, the curve will be steepening again.  Historically, the Fed has been slow to cut rates after the curve inverts, but Fed Chairman Powell indicated a willingness to cut rates sooner rather than later.  This can prolong the recovery and postpone a recession.  It may also be an acknowledgement that the last rate increase at the end of 2018 was too much or that the neutral rate was much lower than they believed.  (Thanks to a Zero Hedge article for these timeframes).

A New Record

OMG, we made it!  Economic growth continues this month, marking 121 consecutive months of growth, setting a new US record for expansion.  We just beat out the March, 1991 to March, 2001 record of 120 months, making this the longest expansion since 1854.  But we did so with growth that was unusually slow compared to the prior record.  Since June, 2009, GDP has risen a cumulative +25%, compared to +42.6% from 1991 to 2001.  Job growth was slower as well, with jobs having risen +12% since 2009, slower than the rate of +17% from 1991 to 2001.  (Thanks to a CNBC article for these statistics).

The Outlook

I am sticking to my forecast of real GDP growth of +2.0% to +2.5% this year, following +2.9% in 2018 and +3.1% in the first quarter of 2019.  Although the economy is looking a little bit tired, I believe that consumers will continue to spend, with retail sales rising, albeit with some volatility.  Job growth should continue and increasing wages and falling gas prices will encourage consumer spending.  Inventories should not contribute as much to growth as they did in the first quarter, so a ratcheting down to the level that we have experienced since 2011 of +2.2% is a conservative projection.  I am assuming that businesses rise out of their pessimism, manufacturing and housing pick up, and that some kind of trade deal with China gets completed.  And government spending will continue at high levels.  Inflation should remain below the Fed’s target of 2% and this will keep longer-term rates low.

Speaking of high government spending reminds me that the biggest issue in this current economic recovery has been the high amount of debt at all levels- government, business, and consumer.  As I have written before, high debt levels put a cap on GDP growth, with low inflation and low interest rates.  High debt keeps the velocity of money low (still at 1.46), which weighs on GDP.   Just ask Dr. Lacy Hunt.  By the way, we will be seeing him at a seminar during August!

Recession is likely 13 to 26 months away.  We are in a prolonged period of low interest rates and have been since 2009.  The Fed tried for three full years to break us out of the pattern but they did not ultimately succeed.  We fell right back to equilibrium, as we always do.  We are in for a period of low interest rates, until recession is behind us.  If rates rise in the interim, these higher rates cannot last.  The Fed will ease, but it is a guessing game as to when.  Some say they will ease later this month.  That’s fine and they will probably follow it with another cut later this year.   

There’s nothing to worry about, right?  Nothing that a few days on the beach cannot solve…

Enjoy the summer!  Thanks for reading!  DJ 07/16/19

Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy has been with Penn Community Bank and its predecessor since November, 2004. She is the author of Just Another Good Soldier, and Honoring Stephen Jaworski, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure of devotion.

Tuesday, July 23, 2019

Why Did Oritani Sell For No Premium?

On June 25th, Oritani Financial Corp (ORIT) common stock closed at $16.21 per share. The next day they announced they were selling to Valley National Corp. for $16.29 per share. Virtually no premium. And less than ORIT traded one year ago. Why?

I was not part of the discussions regarding the transaction, and am not an advisor to either bank. I have no inside information to share. Only some observations and opinions. 

ORIT has historically been a high performing financial institution in a highly concentrated deposit market. For the calendar first quarter 2019 they had a 1.22% ROA, which was down from 1.31% in fiscal 2018 (ORIT is on a different fiscal year). Their efficiency ratio... fuggetaboutit! Thirty six percent for the quarter ended 3/31. 

So why did they receive 138% of book value, and 14x earnings when nearby (5 miles between headquarters) Stewardship Financial Corp. (SSFN) announced their sale to Columbia Financial (MHC) for 167% of book value, 17x earnings, and a whopping 77% premium. This transaction was also announced in June. ORIT is 4x the asset size of SSFN.

There are many factors that go into pricing merger transactions. Cost savings opportunities, attractiveness of markets, niches or specialties, seller's capitalization, buyers' stock valuations, etc. And in fact, ORIT was relatively highly capitalized compared to SSFN, with a leverage ratio of 12.92% versus 9.48%. That plays a role in price/book merger pricing. But ORIT consistently outperformed SSFN in financial performance. Yet received a lower valuation.

Bank Brand Value

You may recall I wrote about the value of brand in a post entitled: Bank Brand Value: Calculated! And I am very familiar with financial institutions in the Mid-Atlantic. So I suspected a key factor leading to the no-premium deal between ORIT and Valley might be related to ORIT's brand value. 

So I did the calculation described in the linked post (see table).

I searched for regional peers with total assets between $1 billion and $10 billion. I then filtered for loan peers that had multi-family and commercial real estate loans greater than 60%. ORIT's was 92%. These are highly competitive, transactional loans. And in the New York metropolitan area, are significantly originated by loan brokers and bid on by banks.

Even though I searched for peers with high levels of these types of loans, ORIT earned seven basis points less than peer in Yield on Loans minus NPAs/Assets, negatively impacting bank brand value (BBV). 

For deposits, I searched in the same region and size as loan peers, but controlled for banks that had total time deposits as a percent of deposits greater than 30%. ORIT's was 42%. The Cost of Interest Bearing Liabilities was the same as the deposit peer group. So it did not add or subtract from BBV.

So, although I filtered for financial institutions with a similar balance sheet composition, ORIT had an inferior Yield on Loans minus NPAs/Assets, and equivalent Cost of Interest Bearing Liabilities.

Leading me to the opinion that, among other factors, ORIT received no premium because it had a negative BBV.

Why do you think the bank received no premium?

~ Jeff