Saturday, December 07, 2019

Banking's Top 5 in Total Return to Shareholders: 2019 Edition

For the past eight years I searched for the Top 5 financial institutions in five-year total return to shareholders because I promote long-term strategic decision making that may not benefit next quarter's or next year's earnings release. And I am weary of the persistent "get big or get out" mentality of many bankers and industry pundits. If their platitudes about scale are correct, then the largest FIs should logically demonstrate better shareholder returns. Right?

Not so over the eight years I have been keeping track. The first bank over $50 billion in assets was JPMorgan Chase at 33rd on the list. Bank of America was 83rd. 

My method was to search for the best banks based on total return to shareholders over the past five years. I chose five years because banks that focus on year over year returns tend to cut strategic investments come budget time, which hurts their market position, earnings power, and future relevance than those that make those investments.

Total return includes two components: capital appreciation and dividends. However, to exclude trading inefficiencies associated with illiquidity, I filtered out those FIs that trade less than 2,000 shares per day, 1,000 more than past Top 5's. This, naturally, eliminated many of the smaller, illiquid FIs. I also filtered for anomalies such as recent merger announcements, turnaround situations (losses suffered from 2013 forward), mutual-to-stock conversions, stock dividends/splits without price adjustments, and penny stocks. The "turnaround situations" is new this year, as it was clear that some entrants to the Top 5 were there because they started from a very low place.

As a point of reference, the SNL US Bank & Thrift index total five year return was 65%.

Before we begin and for comparison purposes, here are last year's top five, as measured in December 2018:

#1.  Carolina Financial Corp. (Nasdaq: CARO)
#2.  Oregon Bancorp, Inc. (OTC Pink: ORBN)
#3.  Farmers and Merchants Bancorp, Inc. (Nasdaq: FMAO)
#4.  Fidelity D&D Bancorp, Inc. (Nasdaq: FDBC)
#5.  Plumas Bancorp (Nasdaq: PLBC)


Here is this year's list:



#1. FS Bancorp, Inc. (NASDAQ: FSBW)


FS Bancorp, Inc. busts onto the JFB Top 5 in a big way, at #1! It is the Mountlake Terrace, Washington holding company for 1st Security Bank, a $1.7 billion in assets community bank with 22 branches that encircle the Seattle Sound. FS also has the advantage of having lifelong banker, mentor, footie fanatic, Italian chef, and friend Joe Zavaglia on its board. Their vision is simple: "Build a great place to work and bank." They actually started as a credit union. But in 2004 they converted to a mutual savings bank, and then in 2012 converted to shareholder owned. In 2017, they raised an additional $26 million to facilitate growth, at $47/share. Today they trade at sixty one bucks! And it's not like their price is getting ahead of them. That's only 9x earnings, and 147% of tangible book. Their year to date ROA/ROE was 1.37% & 11.90% respectively, driven by a 6%+ loan yield built on a diversified loan portfolio that includes a significant consumer component, mostly indirect home improvement loans originated in multiple states. This drives a 4.6% net interest margin, fueling their financial performance, and delivering a 266% five-year total return to their shareholders. Well done! If Joe was truly my friend, should he have given me a call to participate in that 2017 offering?



#2. Fidelity D&D Bancorp, Inc. (Nasdaq: FDBC)


Fidelity D&D Bancorp, Inc. is "moving on up" *insert The Jeffersons theme song here* from #4 last year to #2 on the Top 5 Total Return list. In fact, Fidelity missed the top spot by less than 1%, delivering a 265% five year total return. Here's another bank that I'm happy to see on the list. Two weeks ago I was at Cara Mia's having a chicken parm two blocks from their headquarters in Dunmore, Pennsylvania. Dunmore's a suburb of Scranton where I grew up. Fidelity eclipsed the $1 billion in assets mark this year, and delivers a 1.20% ROA and a 12.07% ROE. Pretty impressive. Shareholders have rewarded the effort with a 22x earnings and a 245% of tangible book valuation, compared to a 13x earnings valuation for the SNL U.S. Bank & Thrift Index. This gives them strong acquisition currency to augment organic growth. Congratulations to the Fidelity Bankers for moving up the charts and delivering to your shareholders!



#3. Plumas Bancorp (Nasdaq: PLBC)

Another repeat on the JFB Top 5, Plumas Bancorp moved from #5 to #3. It is the $888 million holding company for Plumas Bank. Founded in 1980, Plumas Bank is a full-service community bank headquartered in Quincy in Northeastern California. The bank operates thirteen branches, eleven in northern California and two in Nevada. It also operates four loan production offices, three in California and one in Oregon. Plumas Bank is an SBA Preferred Lender. The bank was a financial crisis turnaround story, yet now they are simply a great performer. Year to date ROA/ROE were 1.83% and 21.09%, respectively. Their net interest margin was 4.86%. How you ask? Their cost of funds was 12 basis points. Twelve basis points! CD's only account for 5% of total deposits. That's why they returned 239% to their shareholders the past five years!



#4. First Capital, Inc. (Nasdaq: FCAP)


First Capital, Inc. is the parent company of First Harrison Bank, a community bank headquartered in Corydon, Indiana. It was established in 1891 as Savings and Loan Association of Corydon, changed names a couple of times, acquired three banks since 1999, and now is an $818 million in assets bank with 18 branches in Southern Indiana and Bullitt County, Kentucky. It's difficult to find a theme as to why First Capital delivers an ROA/ROE of 1.29% and 11.53% respectively other than blocking and tackling combined with thoughtful growth through both acquisition and organic. FCAP has a relatively high valuation at 255% of tangible book value and 22x earnings, likely the result of superior financial performance and membership on the Russell 2000. Plenty of dry powder for future acquisitions. All of this blocking and tackling earned their shareholders a 230% total five year return. Nice!



#5. Meta Financial Group, Inc. (Nasdaq: CASH)


I knew I was in for a unique business model based on Meta's ticker symbol. They are a $6.2 billion in asset financial institution based in Sioux Falls, South Dakota. They do have a traditional community bank with only 10 branches sprinkled in and around either Sioux Falls or Des Moines, Iowa. There's where the "traditional" ends. They are so unique I encourage you to read their investor deck here. On the funding side, Meta offers tailored solutions to facilitate money movement, enabling payments providers to grow their businesses and build more profitable customer relationships by creating and delivering payments solutions. On the lending side they provide customized business capital solutions nationally for small and mid-sized businesses with innovative lending to niche markets. This includes asset based lending, insurance premium financing, leasing, and factoring among others. That's a mouthful. A mouthful that delivered a 1.62% ROA and a 12.64% ROE! And a 212% five year total return to their shareholders. Welcome to the Top 5!



There you have it! The JFB Top 5 all stars. The largest of the lot is Meta at $6.2 billion in total assets. No SIFI banks on the list. Ask your investment banker why this is so.

Congratulations to all of the above that developed a specific strategy and is clearly executing well. Your shareholders have been rewarded!

Are you noticing themes that led to these banks' performance?


~ Jeff





Note: I make no investment recommendations in my blog. Please do not claim to invest in any security based on what you read here. You should make your own decisions in that regard. FINRA makes people take a test to ensure they know what they are doing before recommending securities. I'm sure that strategy works well.





Sunday, November 24, 2019

Time Tried, Panic Tested. The Forgotten Story of the First National Bank of Keystone

September 1st, 1999, regulators from the Federal Deposit Insurance Corp, at the behest of the Office of the Comptroller of the Currency, descended on a small coal mining town in Keystone, West Virginia.

The town, already depressed from coal's decline, had a population of 600. Clearly, blue-suit regulators stood out. The bank, First National Bank of Keystone, was $1.1 billion in assets, had 87 full-time equivalent employees, and accounted for two-thirds of the town's tax revenue. 

The blue-suits were not well-received. In fact, during the OCC exam that led to the bank's failure, federal marshals were called in to keep regulators safe. Harassment included a bellicose management team, scowls from the townspeople, and threatening sidewalk art outside of the bank. 

In 2015, nearly sixteen years to the day of the failure, the last defendant, Terry Church, was released from prison

Church, part of "Knox's Foxes", was a Vice President of the bank and President of the mortgage subsidiary, which was at the center of Keystone's problems. She effectively ran the bank and its operations. Because the then-President was Billie Jean Cherry, the former town mayor, and paramour of J. Knox McConnell, the mastermind behind the bank's meteoric growth and the "Knox" behind "Knox's Foxes". McConnell died suddenly two years prior to the bank's failure.

Why Knox's Foxes? Because McConnell hired only women, stating he didn't want any relationship entanglements at the bank. He did not note the irony that he had a relationship with a board member. He was also ok if two women entered a relationship. 

I'm not making this up.

The Bank's Rise

McConnell came to the bank in 1977 from McKeesport, Pennsylvania. Another depressed town due to the general economic malaise that bedraggled the region when the steelmaking industry moved elsewhere. So McConnell was comfortable in a depressed area.

The bank was small when he arrived, it had $17 million in total assets, and grew to a reasonable $85 million in 1990. At the time of the bank's failure in 1999, the bank had $1.1 billion in total assets. Allegedly. One point one billion in total assets from one branch in a depressed town with a population of 600. 

How did McConnell do it? In 1990, the bank ramped up its HUD Title I loan program. These loans were primarily for home improvements, and if over $7,500, required a lien on the home. The government guarantee allowed for a secondary market in these loans. Meaning they could be packaged and sold to investors. And so went the birth of First National Bank of Keystone's meteoric rise.

They purchased these loans from lenders all over the country. How else can you blow your balance sheet up (pardon the pun) from a dying coal town? Nationwide lending! The bank, or more accurately its mortgage subsidiary, eventually run by Church, packaged these loans, securitized them, and sold them on the secondary market. Booking the valuable "gain on sale of loans". They kept some. But sold most. 

Keystone expanded its lending to include high loan-to-value mortgages and home equity loans. So it's balance sheet by the time it failed was chock full of these loans plus the Title I loans they did not sell. Or so we thought. 

How did the bank fund a $1.1 billion balance sheet from a town of 600? Nationwide brokered deposits. 

And the bank was doing fabulously. In 1998, its last full reporting year, it had net income of $69 million. On $1.1 billion in assets. A 7.15% ROA! It had $102 million in interest income! And, due to it's securitization and sale of loans, it had $73.5 million of fee income. All from Keystone, West Virginia.

The Bank's Fall

But oh, its balance sheet was not all it was cracked up to be. I could not uncover if McConnell was complicit in what went down and his "Foxes" just continued the charade, or if the Foxes were the brain child behind it. And by Foxes, I'm not implicating all bank employees. I'm specifically talking about Billie Jean Cherry, and Terry Church. However, it seems unlikely that McConnell didn't orchestrate the fraud. He set the tone for antagonizing regulators. And the bank had over $800 million in assets at the time of his death.

In 1998, the OCC gave the bank a Consent Order. No worries though, because the bank was fabulously profitable and management was in the business of ignoring their aggressive overlords. Cherry and Church kept the loan machine churning, and paid lackluster attention to the OCC. And anyone that has experience with the OCC, knows that ignoring them is like ignoring a crazy boyfriend or girlfriend's texts.

The OCC required Cherry to step down as president, deeming her incompetent for the job. They suggested one of their own to step in. In 1998, Keystone directors appointed Owen Carney as president, who had spent 28 years with the OCC.

Carney started work on February 1st, and lasted two months. Bank officials told him that employees were unhappy with his management style, and they controlled enough stock to keep him off of the Board. In hindsight, Carney said in an interview that he believed bank officials forced him out for reasons that had nothing to do with his management style. They feared he would discover the fraud. 

Ya think?

As a side note, one reason Cherry and Church had enough stock to control the vote was because Cherry gained control of McConnell's estate. She subsequently looted it and went to jail for it, and denied McConnell's will to donate a significant part of his wealth to his alma matar, Waynesburg University in Pennsylvania. Even though Cherry and McConnell had a 30 year relationship, Cherry married someone else one year prior to McConnell's death. 

There really should be a movie.

The OCC's 1999 exam was the final domino. The last straw, The end of the road. During that exam, the OCC decided to verify the loan portfolio. Typically, regulators would rely on the financial audit to verify assets and liabilities, among other things. 

But the OCC had been criticizing the bank's accounting practices for years, issuing exam MRA's and informal memorandum's compelling them to fix it. First McConnell, then the dynamic duo of Cherry and Church, ignored regulator admonishments. 

Until the OCC decided to check things out for themselves.

Where'd the Loans Go?

When the OCC finished looking, they couldn't find $515 million in loans. On a $1.1 billion balance sheet. I'd say that was material. You?

When they started asking bank officials "where are they?", they received nothing but sneers. And that's when the federal marshals were called in. Things weren't going well, and they were about to get worse.

Worse because, knowing the gig was up, Church asked her husband, who was in the construction business, to pull his trucks next to an old school building where the bank stored its documents, so the Foxes could dump boxes of records into them.

And what happened after they ended up in trucks? They were buried in a 100 feet long, 30 feet wide, and 10 feet deep trench dug at Church's house. Dirt was poured over them, and they were seeded so it didn't look like what it was. Nice touch, right?

Still not making this up.

And Now, the End is Near

Nearly half of the bank's assets were MIA. They had been likely sold in the secondary market, and never removed from their books. Meaning the bank was booking interest income on loans it did not own.

Recall that in 1998 the bank recognized $102 million in interest income. But with $515 million of phantom loans, the real number was likely less than half. Making the bank, effectively, insolvent.

In comes the blue suites.

Out goes employees. And to jail goes Church, Cherry, and Michael Graham, another mortgage subsidiary employee. Someone must have loosened the "no men" philosophy of Knox McConnell to let Graham in the door.

Graham flipped and got the lightest sentence because he didn't re-write and forge McConnell's will. That was Church and Cherry. Cherry died in 2008 while still in jail. And Church was released in 2015. I could not find her whereabouts. She's 66 years old now. Other Knox's Foxes involved in the fraud and pleaded guilty were Melizza Quizenbeury, Barbara Nunn, Lora McKinney and Ellen Turpin.

There was one other criminal case that emerged from the bank collapse. Norma Faye Canipe met Church in prison. After her release, Canipe went to Keystone (why would anyone go to Keystone) and attempted to sell off Church's ranch. The infamous ranch with the football field sized trench that once was the final resting place of the bank's mortgage documents. The problem was the government owned the property because it was bought with Church's compensation from the bank... i.e. ill-gotten gains.

Today, Keystone remains depressed. Even more so since it's biggest employer and major taxpayer was mercifully taken over by an out of area financial institution.

And the bank's tagline, "Time Tried, Panic Tested" is now a punchline.

You can't make this stuff up.


~ Jeff



Want to read more?

Pittsburgh Post-Gazette story:
http://old.post-gazette.com/regionstate/19991020knox1.asp

Compliance Alert story:
http://www.calert.info/details.php?id=263

Bluefield Daily Telegraph on Church's sentence shortened:
https://www.bdtonline.com/archives/sentence-shortened-for-former-keystone-bank-exec/article_a83d38c8-94af-5892-8631-789f78d05756.html

Bluefield Daily Telegraph article on Church's release from prison:
https://www.bdtonline.com/news/last-officer-from-fnb-of-keystone-collapse-released-from-prison/article_72453348-60da-11e5-9dc3-cbc1c801225a.html

Washington Post article on scandal:
http://www.washingtonpost.com/wp-srv/WPcap/1999-10/19/073r-101999-idx.html

Charlestown Gazette on article from 2018 on Keystone decline:
https://www.wvgazettemail.com/news/once-a-booming-town-keystone-struggles-to-hold-on/article_fc44b588-61be-5e11-a6cf-04262135dd21.html

LA Times Oct 1999 article:
https://www.latimes.com/archives/la-xpm-1999-oct-31-mn-28294-story.html

Anatomy of a Banking Scandal book:
https://www.amazon.com/Anatomy-Banking-Scandal-Failure-Harbinger-Financial/dp/1412862795/ref=sr_1_1?crid=606F6CL7BTF2&keywords=anatomy+of+a+banking+scandal&qid=1574188253&sprefix=anatomy+of+a+banking%2Caps%2C148&sr=8-1

American Banker article Oct 1999 after Church is jailed:
https://www.americanbanker.com/news/failed-banks-files-found-buried-2-execs-jailed

BankEncyclopedia 1998 financials:
http://www.bankencyclopedia.com/The-First-National-Bank-of-Keystone-6771-Keystone-West-Virginia.html

Office of the Inspector General Material Loss Review:
https://permanent.access.gpo.gov/lps83314/oig00067.pdf

2019 West Virginia University blog post:
https://news.lib.wvu.edu/2019/09/04/the-incredible-story-behind-the-collapse-of-the-national-bank-of-keystone/



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.

Math


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.


Thoughts?


~ Jeff



The bank branch is dead. Long live the branch.
https://www.forbes.com/sites/forbesfinancecouncil/2019/04/10/the-bank-branch-is-dead-long-live-the-bank-branch/#6d595a2f32d0

Regions New Branches
https://www.youtube.com/watch?v=wycNfFk6Dic

Chase Branch Design
https://www.youtube.com/watch?time_continue=45&v=yCe9yPKyd9Y