I recently spoke at a NJ Bankers Association event about the things I learned this recession (see blog post regarding subject). Since writing that missive, I realized I left one out.
My company does line of business and product profitability reporting for community banks. What I have learned from performing this service is that very few products deliver the level of profits typically sought by high-performing banks. This approach to profitability has demonstrated its flaws during the current recession. As Warren Buffet once said, “you don’t know who’s swimming naked until the tide goes out”.
The accompanying chart highlights various levels of product profitability achieved by banks and thrifts that subscribe to my company’s profitability outsourcing service. I rolled up products into nine traditional product categories and then determined which product groups delivered satisfactory profitability, were merely profitable, or were unprofitable.
Of the nine product groups, banks only had one that delivered a greater than 1% pre-tax return on product portfolio, and thrifts had two (the snapshot was for 3rd quarter, 2009). Commercial real estate lending was the common profit driver for banks and thrifts.
In spite of increased provisions for loan losses, commercial real estate lending continues to drive profits in the industry. This was the case prior to the recession also, although more products were profitable. The pre-tax ROA for those peers was 0.50% for banks and 0.29% for thrifts. This highlights the flaw in a business strategy of having very few profit drivers in a bank. When one tumbles, there is no other product group or line of business to pick up the pieces.
It reminds me of the fast food dollar menu. Occasionally, I’ll go to Burger King for the best deal for a buck in the land, the double cheeseburger. I pull through the drive-thru, tender my $1.06 (got to pay the governor), and drive off. That was not the customer visit intended by the creators of the dollar menu. There is no way to make a profit on that transaction.
We as bankers must identify what is our dollar menu and the level of profits we expect to achieve for all other items. Senior leaders must hold people accountable so their line of business or product achieves or exceeds expectations. Absent measuring and holding ourselves accountable, we run the risk that our whole business may end up on the dollar menu.