Wednesday, December 26, 2012

Banking's Total Return Top 5

Last year I searched for the Top 5 financial institutions in total return to shareholders because I grew weary of the "get big or get out" mentality of many bankers and industry pundits. If their platitudes about scale and all that goes with it are correct, then the largest FIs should logically demonstrate better shareholder returns.

Not so last year, and not so again this year.

My method was to search for the best banks based on total return to shareholders over the past five years... capital appreciation and dividends. However, to exclude trading inefficiencies associated with illiquidity, I filtered for those FIs that trade over 2,000 shares per day. This, naturally, eliminated many of the smaller, illiquid FIs.

For comparison purposes, here are last year's top five, as measured during September, 2011:

This year's list is in the table below:

 The two report A-listers are BofI Holdings, Inc., and Bank of the Ozarks, Inc. Special mentions are Signature Bank that was #7 this year, and German American Bancorp that was #9. No slouches there.

BofI Holdings Inc. and its subsidiary BofI Federal Bank aspire to be the most innovative branchless bank in the United States providing products and services superior to their competitors, branch-based or otherwise. In its latest investor presentation, BofI highlighted it's expense ratio (operating expense as a percent of average assets) compared to peer as 1.67% versus 3.17%, respectively, and efficiency ratio (operating expense as a percent of total revenue) compared to peer as 35% versus 63%, respectively. So, as a branchless bank, BofI has leveraged its significantly lower operating expenses into profit. That profit led to the top spot in five year total return to shareholders, two years running. Well done!

In 1979, George Gleason, a 25-year-old attorney, purchased controlling interest and assumed active management of the bank as Chairman of the Board and Chief Executive Officer. At the time, the bank had a couple dozen employees and total assets of $28 million. Today the bank has more than 100 offices in seven states. It's growth since 2010 has been fueled by seven purchases of failed banks. This has led to $863 million of covered loans (loss share arrangements with FDIC), and a yield on such loans of 8.69%, according to its latest investor presentation. This has led to a mind blowing net interest margin of 6.01% for the quarter ended September 30, 2012. OZRK moved up three places in total return to shareholders from last year's ranking. Well done!

New to the august list is Access National, whose mission is to provide credit, treasury management and private banking services to emerging businesses with revenues of up to $100 million... very specific, and refreshing given that so many banks cannot choose a specific niche for fear of alienating other constituencies. Those buckshot banks don't have much representation in this top 5 list. Coincidence? You decide. Another interesting fact is that Access National's management team, which owns 15% of the bank, is relatively young, ranging in age between 41 and 53 years old. To be fair, Access National is headquartered in Reston, VA, one of the best banking markets in the country. Focused mission, young management team, great markets... great ingredients in a success recipe.

Founded in 1834, Hingham Savings' mission is  to provide the finest in community banking, with integrity and teamwork. This usually earns the jfb blah, blah, blah statement since we can affix that mission to 90% of the banks across the US. But slow and steady wins the race, in this case. Hingham's ROA from 2007-2011 was 0.63%, 0.81%, 0.93%, 1.05%, and 1.14% respectively. It's third quarter 2012 ROA was 1.15%. Slow, steady improvement. By the way, 0.63% represented it's lowest ROA in a 10-year stretch. But looking at their performance, it's fair to ask... "what financial crisis?" Hingham's tagline, "Simple Banking. Honest Value. Happy Customers" is consistent with a typical industry theme described by one of my colleagues: "boring banking is beautiful". It's this simplicity and consistent performance that most likely resulted in their superior, long-term total return to their shareholders.

Texas Capital Bank delivers highly personalized financial services to Texas-based businesses with more than $5 million in annual revenue. Recognizing the inherent link between business owners and their personal wealth, TCB manages the personal wealth of Texans with net worth of more than $1 million. Similar to three of the five banks on our list, TCB is a relatively recent addition to banking, being founded in 1998. Actually, since Bank of the Ozarks has significantly changed since it's FDIC acquisition spree, one might include them in the list of "new" banks. TCB is largely a growth story, and mostly organic growth since it has not been very acquisitive. Since 2007, operating revenue has grown at a 22% compound annual growth rate (CAGR), while non-interest expenses grew at a 17% CAGR. This positive operating leverage generated net income CAGR of 32% during the same period, supporting their Top 5 position in total return to shareholders. Well done TCB!

There you have it! The jfb all stars in top 5 total return. Congratulations to all of the above that developed a specific strategy and is clearly executing well. Your shareholders have been rewarded!

Do you think there are themes that have 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 out.

Friday, December 21, 2012

Bankers: What should the magi bring you?

The Gospel of Matthew reads (Chapter 2):

"When Jesus was born in Bethlehem of Judea, in the days of King Herod, behold, magi from the east arrived in Jerusalem, saying, 'Where is the newborn king of the Jews?' We saw his star at its rising and have come to do him homage."

King Herod dispatched them to Bethlehem. Matthew's Gospel goes on to say:

"And behold, the star that they had seen at its rising preceded them, until it came and stopped over the place where the child was. They were overjoyed at seeing the star, and on entering the house they saw the child with Mary his mother. They prostrated themselves and did him homage. Then they opened their treasures and offered him gifts of gold, frankincense, and myrrh."

I'm no biblical scholar, so I am not aware of any significance to the three gifts bestowed on Jesus by the magi. Three wise men, men of stature, traveling long distance, with nothing to guide them but a star, to bestow a gift to a child, a child born under the most humble conditions, was symbolic enough.

But the gifts were chosen by the givers. We can all reflect this Christmas on what three gifts we would give to improve the lives of those around us. Not gifts such as the fruitcake, or piece of jewelry. Something more profound.

This got me thinking about what three gifts I would like to give to bankers, if I had such power. Here is what I came up with:

1. The Gift of Leadership

Leadership is not managing the day to day affairs of the bank. Leadership is motivating others to follow you through difficult and uncertain circumstances, keeping firmly focused on a vision. In no other time during my career in banking, has there been a more difficult and uncertain road ahead. Banking needs leaders that form a vision, communicate it so effectively your team lines up behind you, and pursues it with incredible passion.

2. The Gift of Talent

Banking used to be more about efficiently processing transactions and less about helping customers navigate financial complexity. As a result of automation, transactions are handled less and less by human hands. Efficient transaction processing is more likely executed in the IT department than on the teller line. At the branches, and at our customers' offices, there is a need for bankers to make customers' financial lives less complex. We need the talent so we are capable of doing it.

3. The Gift of Prudence

Yes, bankers must be prudent in developing and executing their strategy. But if I could bestow prudence, I would first focus on bank regulators. We long for a regulator that interprets laws for their intention, and implements rules that follows the spirit of the law with a watchful eye towards minimizing unintended consequences. Have you ever sat at a mortgage closing? The volume of documents and disclosures that few borrowers read are the result of imprudent regulation. Did it help us? We are on the precipice of making the same mistakes again. It would be a beautiful gift to have regulators that know this and act accordingly.

So, in the spirit of the magi, I offer three gifts to bankers. I wish I had the power to make it so. What gifts do you want from the magi?

Merry Christmas everyone!

~ Jeff

Thursday, December 13, 2012

jfb Toons: Bank Strategy Execution

Welcome to my first installment of jfb Toons, a cynical look at how financial institutions operate.

In this version, I migrate from the strategy development retreat to how that strategy is translated to day to day execution. I am occasionally confronted with facilitating plans for clients, only to come back one year later to find little has changed.

If I were to fill in the gap between strategy development and how it is executed, this is how I think it would go...

~ Jeff

Sunday, December 02, 2012

Preamble to a Bank Strategic Alternatives Analysis

Bloggers pepper me with insights on how to be a more successful blogger. One such insight is to create a compelling title. In this regard, this blog's title is an outright fail. Try to say it three times fast!

I recently sat in front of a client board committee reviewing the bank's strategic alternatives (see a prior post on performing such analysis here). Before you think this bank is on the auction block, think again. This bank's board was delivering on its fiduciary duty to shareholders to maximize value.

Before getting into the details, I prefaced my analysis on where a strategic alternatives analysis fits in the overall scheme of executing strategy. Because, my readers, it occupies a far too important perch than you might think.

The following is my paraphrased preamble to the analysis:

"Strategic Alternatives Analysis is a critical component to strategy development and execution. For example, we see various planning tools as subsets to your overall strategic plan: Marketing and IT Plans, ERM/Risk Appetite, Capital Plan, Budget, and a Strategic Alternatives Analysis. All are linked.

'We espouse multiple projection scenarios when developing strategy. The first, we typically call the base scenario. The base represents the likely outcome of executing your strategy. In banking parlance, this is the basis for your budget. It is the starting point for the remaining scenarios. You should have a 50%-75% confidence level you can achieve the base scenario.

'The second is the stress scenario. Here you are trying to gauge what could go wrong based on relevant and defensible stressors, such as credit or interest rate shocks. This scenario is important to determining the risk-level of your strategy and the adequacy of your capital to withstand shocks. Your capital plan, of course, will have additional scenarios to identify the most attractive capital augmentation strategies should the stress case come to pass.

'The third projection scenario is the stretch. When developing strategy, it is critical to envision what success would look like upon successful execution. Rare is the case that achieving your vision would result in solely hitting your budget. You want to envision what success would look like in financial terms, too. Your management team should have a 30%-50% confidence level you can achieve stretch goals. Stretch projections should be your base for a Strategic Alternatives Analysis.

'Evaluating strategic alternatives goes beyond what you can pay for a target or what a buyer can pay for you. True, it is an important element of it. But the decision to buy should be based on your perceived inability to achieve stretch goals on your own. It is a lower risk strategy to achieve earnings and tangible book growth organically than through acquisition. But if your strategy does not deliver the shareholder value improvement you desire, then perhaps buying a competitor can bridge that gap. The strategic alternatives analysis shows the targets you have the greatest opportunity to buy.

'How do you know if you should sell? This analysis will show what buyers can likely pay. Normally, and in this case, the values are greater than where your bank currently trades. So, absent additional analysis or other considerations such as employees and customers, you should sell, right? Not so fast.

'Stretch projections should be discounted back to present day to determine the present value of successfully executing your strategy. If such an analysis delivers a present value in acceptable proximity to your take-out value, then your Board may conclude that it is best to remain independent and execute your plan. This keeps the keys to your shop in your hands, where you may have greater confidence than in somebody else's hands. Without developing stretch projections, how would you know if and when to sell? How would you know that there is a value gap and your management team must develop more aggressive strategies? You wouldn't. You would be guessing.

'This is the critical link to strategic planning and strategic alternatives analysis. It keeps the management team focused on delivering value to shareholders, keeps the Board focused on their fiduciary duties, and models successful execution of strategy, in financial terms. It is the very definition of your right to remain indepenedent, or is the basis to putting M&A as a critical component to your strategy."

Does your FI perform routine strategic alternatives analysis?

~ Jeff

Saturday, November 24, 2012

Shark Tank: Bankers' Edition

Reality shows are generally not my thing. Don’t get me wrong, I’m often subjected to the genre because I submit to family preferences. How else would I know that Emmitt Smith is quite the twinkle toes. But, while channel surfing, I discovered Shark Tank.

On Shark Tank (see the clip below), entrepreneurs pitch their ideas to a panel of angel investors, known as sharks, to win funding for their enterprise. The sharks, one of whom is Mark Cuban, the colorful owner of the Dallas Mavericks, pillory the entrepreneur with questions about their product(s) and business plan. After the Q&A, they decide if they want to fund the venture, and at what level. Watching and listening to the questions, answers, offers and counteroffers is fascinating.

I recently read a NY Times You're the Boss Blog article regarding how banks can fund small businesses. It made me think of Shark Tank. Businesses evolve through various stages. In early stages, entrepreneurs struggle to get funding. It’s generally too risky for a bank loan. So, early stage funding typically starts with owner’s capital, then to friends and family if it gets that far, then to angel investors. Banks will entertain a loan typically after a few years of successful operation. There are exceptions, however. The SBA loan program was designed to get earlier stage capital to entrepreneurs. But generally, young businesses need equity, not debt.

Many banks are headquartered or have significant presence in communities that are experiencing economic difficulties. This impacts loan quality, loan demand, growth, and profitability. But most banks remain on the sidelines when it comes to small business formation. The businesses formed today, appropriately capitalized, will be those that sustain our communities in the future. Some of the fastest growing companies today are not that old...i.e., VistaPrint, Netflix, etc.

These businesses needed capital. Many top new companies are located in California’s Silicon Valley, and not coincidentally, that is where many venture capital firms are located. As traditional providers of capital, can banks participate in funding early stage ventures? I say yes because of community banks’ unique position in our communities.

But funding early stage businesses does not have to be with the traditional bank loan, or even an SBA loan. These are equity investments, higher risk seeking higher return. I think banks can sponsor their own version of Shark Tank. Not as sole investors in an angel fund, but as investors and managers of an angel fund, much like the sharks of Shark Tank. What would be bankers’ objections:

1. It is an impermissible activity… jfb response: Put it at the holding company. Many banks manage mutual funds in their trust companies, don’t they?

2. It wouldn’t be profitable… jfb response: I wonder how venture and angel funds do it? A small, $10 million fund can earn a 2% annual fee ($200,000) and 20% of the “ups” (fund returns). So if an angel fund averaged a 10% annual return (low for venture fund standards), the revenues to the manager of the fund would be $400,000 ($200,000 annual fee plus 20% of the $1 million annual return). You couldn’t manage a $10 million fund for $400,000/year?

3. We would have to turn down more businesses than fund… jfb response: True! But it would force startups to develop a business plan to chart their future and present to the sharks. Even if the venture doesn’t win the funding, the entrepreneur would have thought through the business more thoroughly. How many times do you drive by a new business that you don’t think will make it? Through this process, those that get turned down may turn their entrepreneurial spirit to a more sustainable venture, or burn with a greater desire to prove you wrong!

The benefits, in my opinion, would be:

1. Get more funding to promising startups. One of the top reasons for business failure is lack of capital.

2. Turn your community into a business incubator. Bring enough publicity to your process, you are likely to get more businesses seeking funding. Do you see having more, higher quality startups in your community as a good thing?

3. Build a sustainable future for your community. The employers of today are not likely to be the employers for the next generation in your local area. Acquisitions, changing consumer preferences, and general corporate inertia make today’s strong business into tomorrow’s dinosaur. Remember the Palm PDA? Strong, vibrant communities should always be looking to the next ventures that will sustain them into the next generation.

What do you see as advantages and disadvantages of a community bank sponsoring its own Shark Tank?

~ Jeff

Saturday, November 17, 2012

Deposit Fees: Now Is The Time

Aside from my Navy days, I have been in banking all of my life. But I don't balance my checking account. Instead, I run the family budget through a spreadsheet, check my account activity online, and hope for the best. Last week the best got to me. I overdrew my account because I failed to log an auto repair in my trusty budget spreadsheet.

Did I bounce checks? No, because I have a small line of credit to cover such eventuality. It's not the first time I've done this. For the convenience of moving money from the LOC to checking to cover incoming items, my bank charged me a $10 transfer fee: usury rates if a sanctimonious US Senator took to the microphone. But I was happy to pay for it to cover up my miscue.

I recently read an interesting article in Bank Director magazine by Mike Blanton of StrategyCorps. He specializes in designing and promoting profitable checking accounts for financial institutions. In the article, he cites an April 2012 study by Market Rates Insight that identifies fee services that our customers want to use and would be willing to pay for. Scoring high were so-called Lifestyle Financial Services... add-on services that are convenient to, or a concern of our customers. See the table below.

This makes sense to me. In an era where lawmakers and regulators attacked our ability to charge overdraft fees, new opportunities seem to have arrived. If banks implement these value added fees, it will go a long way to improve the profitability of the checking account.  

Improvement is imperative. I wrote a blog post two years ago regarding the importance of fee income to the profitability of the checking account, citing my firm's profitability peer group showing deposit fees as a percent of average deposits declining 22 basis points between 2005-2010. We have yet to recover those fees.

When loan demand outpaced deposit growth we were content charging little to nothing for depositors to bring their money to us. We trained them to be price sensitive, and to demand "free". Now that loan demand is weak and most financial institutions are highly liquid, it is time to evaluate the fees customers are willing to pay because they value the service(s) our bank provides.

What are you doing to improve the profitability of the checking account?

~ Jeff

Saturday, November 10, 2012

The Jeff For Banks Federal Income Tax System

This is not a political blog. I do not express political opinions, at least overtly. Because I have opinions. Oh I have opinions. But this presidential election season had me whaling and gnashing teeth for it to be over, much like that toddler on YouTube. I would much prefer to analyze personal relationships on Jersey Shore than be subjected to more taunts and finger pointing from presidential hopefuls. Much less having to read about it on Twitter and Facebook. So for Thanksgiving, I'm thankful it is over. Or is it?

I thought Wednesday would mark a new day. But no. Now I have to hear about the Fiscal Cliff. The result of Congress and the President not being able to do their jobs earlier resulted in this mess now. So now we're back at it.

Well let this blog save you time and effort Mr. President and Mr. Speaker. I am putting forth the Jeff For Banks (jfb) Federal Income Tax system that is fair, easy, and balanced. Lest I hear from the Oracle of Omaha about how he pays a lower tax rate than his secretary, I have your fix Mr. Buffett.

Here it is:

Rows 1 - 4: All income is taxable, whether it be from earned income, interest, dividends, or capital gains. There is no distinction between them.

Row 1: Pre-earned income deductions include health insurance and retirement plan contributions. Each will be capped at a certain level, so those with greater disposable income can't sock suitcase fulls of cash away, and those that have Taj Mahal medical coverage can't use all as a pre-tax deduction. I am not married to treating this prior to row 1. I can compromise. These deductions could be included in the income numbers in Row 1-4 and deducted in the deductions section. But for treatment similar to today's, I have deducted them prior to Row 1.

Rows 5-8: Aside from pre-income deductions listed above, there are only three deductions. Boom.

Row 5: Households can deduct the poverty rate for the same size family for the area which you live, up to a maximum amount of children. So if you're a good Catholic family and fielded a baseball team full of kids, too bad. I'm not subsidizing you. Control yourself. 

Row 6: You maintain the mortgage interest deduction up to the median house value where you live. So if you bought a McMansion and have a $300,000 loan, but the median home value where you live is $200,000, then you can only deduct two-thirds of the mortgage interest you paid. No deduction on second homes. Sorry Mitt.

Row 7: An ideal America would have its citizens earning what their skills and efforts would allow, taking what they need, and giving the rest away to help those less fortunate. Unfortunately, if high earners did this today, it could drop their effective tax rates below that of their secretaries. We all know how that turned out in the court of public opinion. Poor Mitt had an effective tax rate of 17%. But he gave $4 million to charity last year. If he only kept it in his pocket, or offshore account, his effective tax rate would have been higher and he could have avoided the whole fracas. But no. So we have to cap the deduction on what we give to charities. The jfb system proposes 10% of total taxable income up to a maximum of $100,000.

Not for profits will hate this idea. But I propose it to shut Warren Buffett up about his tax rate.

Economists might not like the idea, saying losing this deduction or that will sap the economy. But isn't our economy sapped already?

Politicians will hate the idea, because it will make us think we can go back to the days where politicians actually had real jobs and were only in session part time. Without all this tax code tinkering, they may not have enough to do. Not that they have a lot to do now. Maybe they can slowly dismantle the ridiculous amount of laws on the books that we have to comply with, and law enforcement is tasked with enforcing.

There you have it. The jfb Federal Income Tax System. It sets one rate, 20%, with few easy to calculate deductions. Heck, if the IRS got its act together, it could have an app on its site so we can do it in 15 minutes or less. Think of all the tax code compliance costs that would hit the bricks.

Let's just do it.

~ Jeff

P.S. Since this is a bank blog, I should make a link to banking. Put the amount of money you now spend on tax compliance in the bank and sleep soundly at night. There.

Saturday, November 03, 2012

The Case for the Big Branch

I had a very interesting conversation with a bank client today. He called me to discuss, among other things, his bank's expansion strategy. During the discussion, I mentioned that I had recently driven by one of his branches and that it was the biggest in town. What he said about it inspired this post.

Being the biggest branch in town, in terms of square footage, is not something cheered among industry pundits these days. Indeed, if I were to summarize the sentiment, it would be that future branches would be much smaller, but with big a** signs. Those were another bank consultant's words, not mine.

This CEO isn't buying it. He said that since that branch underwent a $1.5 million renovation, its deposits grew by 40%. In prior years its deposit totals had remained in a relatively tight band. He opined that it is "amazing what visibility, access, and egress" does for a branch. He also said that his business owner customers demanded a nearby branch.

But he did not think the branch had to be in the same town as the business. The next town over would due.

Now that makes sense to me. If it costs, on average, $600,000 per year in operating expenses to run a standard branch, wouldn't it make sense to build a large, marquis-type branch in every other town that cost $800,000 per year? By abandoning the every town strategy, you effectively save $400,000 per year.

I looked at a few banks that I know that do very well with their branch networks but were not clients so I can opine based on public data and not inside knowledge. One such bank, First National Bank & Trust of Newtown (PA), had a similar branch as my client's (see photo).

This is FNB&T's New Hope office. It is two towns, or nine miles, from the nearest office. The New Hope office is an end cap to a very nice strip mall that has excellent traffic patterns and easy access. According to FDIC data, the branch grew from $41 million in deposits at June 30, 2007, to $70 million at June 30, 2012, a 70% increase.

Lest you think that price promotions drove their growth, this bank's time deposits as a percent of total deposits declined during that time. Oh, and time deposits/total deposits is currently 18%. So, even though I can't tell the exact deposit composition of the New Hope branch from public data, I would doubt that CD's drove this branch's growth. It is not in FNB&T's DNA.

Before we jump hard onto the mobile is king bandwagon, perhaps we should pause to think about what my client told me today. It only took 10 minutes of non-scientific perusing to find another bank's branch to validate his strategy. Perhaps, then, the branch is not dead.

~ Jeff

Sunday, October 28, 2012

Big Data or Big BS in Banking

Banking is becoming increasingly and irreversibly data driven. The amount of information we collect on customers exceed most industries, with the possible exception of the medical industry. Much like medical, the information we collect is highly personal. Since outsiders (i.e. thieves) want our money, this data is constantly under hacker siege.

But, in my experience, bankers don't often effectively use the data they have for good. By good, I mean to improve customer service, market intelligence, and bank performance. Instead, we have core processors and component systems that don't communicate well, or are not used to their fullest potential. I reflected on this while reading a Harvard Business Review article on Making Advanced Analytics Work for You. The article contained three benefits from big data: Multple Data Sources, Prediction and Optimization Models, and Organizational Transformation. I thought of three similar approaches that are more applicable to banking.

Here is what I came up with.

How Financial Institutions Can Benefit From Big Data

1.  Manage Risk

Boards of Directors/Trustees, regulators, bureaucrats, consultants, etc. all have ideas on how to manage risk. Some are mandated, so I don't have anything further to say there. But data to help manage risk should be simple and effective. By effective, I mean it should lead to the decision to mitigate, accept, or reject the risk. Interest Rate Risk reports are a good example of data required to make this decision. But what are we trying to accomplish with IRR reports? I would say we are trying to estimate the impact to net interest income from interest rate fluctuations. By knowing these impacts, we can manage our balance sheet accordingly to mitigate the risk. But the 100-page report that includes items such as economic value of equity calculations seems unnecessary to me. I know of no bank that is valued in this manner. Let the quants disagree.

2. Measure Performance

Again, this can be a simple endeavor. There are managers that do detailed reporting to manage the performance of their direct reports, such as manual closed account reports that take time to prepare, and often don't lead to actionable items. But what if, instead of measuring branch managers by such granular information as account closings, you managed them on revenue growth. That is what one of our clients did using a similar report to the below table. Imagine the behavior changes and profit improvement that could ensue if branch managers owned their income statement.

3. Marketing Data

Think of a gung-ho business banker that wants to expand his or her client base and portfolio. Can he or she peruse the customer base via NAICS code around a geographic area to look for opportunities to expand relationships and profitability with existing customers? Is this data merged with non-customer data, so he or she can see businesses within a geographic footprint to bring in new customers? Can he or she see the customers of the bank's insurance, or investment subsidiary? Even if the bank aggregated the data, can the gung-ho banker access it without navigating some bureaucracy? I doubt it. We need to feed our front line this data so they can institute effective business development efforts to improve their performance.

These are the top three uses of Big Data for banking, in my humble opinion. In a time when we are deluged with huge volumes of information, how we capture and distribute relevant data is more important than the amount of data we capture. Narrow your needs, and build the applications to use data effectively and you will have an advantage over your competitors.

Do you believe that the sheer amount of data available inhibits effective use of data?

~ Jeff

Friday, October 19, 2012

Guest Post: Third Quarter Economic Update by Dorothy Jaworski

The Fed Strikes Again

I spent a lot of time during September reviewing and articulating many reasons why the Federal Reserve should restrain itself and not continue with additional easing. First of all, if they continue to buy securities, they are removing many of the high quality securities from the marketplace, possibly causing a disruption or shortage in the markets. They risk the potential of severe inflation and rapidly rising interest rates if the banks begin to put the currently idle reserves to work in the form of loans and the Fed does not tighten accordingly.

They risk the loss of credibility as they try to unwind their portfolio by dumping securities onto the markets, raising interest rates, and breaking their promises to keep rates low. Then, after ignoring all of my advice, the Fed went ahead at their meeting of September 13th and acted anyway, extending their “promise” another six months to keep the Fed Funds rate at low levels until mid 2015. Really? The Fed can barely project the next twelve months, let alone the next thirty months into the future.

They did succeed in lowering the entire term structure of interest rates once again, even while we remain incredulous. We may be skeptical, but the markets keep telling us: Don’t fight the Fed!

The Fed also embarked on their third quantitative easing program, now dubbed “QE3,” in which they will buy $40 billion of mortgage backed securities per month until unemployment comes down. This open ended buying campaign has been facetiously called “QE infinity” by some pundits and will add to their already gigantic investment portfolio, which already includes the $2.3 trillion of securities amassed during QE1 and QE2.

And don’t forget that they are still finishing the $667 billion Operation Twist Program by year end 2012, where they sell shorter maturities and buy longer term ones to push interest rates lower. Or should I say “manipulate” interest rates lower? Gone is our best indicator—the yield curve—which the Fed has turned into a useless string of percentages. Granted, the Federal Reserve is not the only presence pushing long term rates lower; weaker economic data and the flight to quality into Treasuries for safety during the European debt crisis lowered rates as well.

If I said it once, I said it one thousand times: “My biggest fear is that the Fed is sowing the seeds of the next crisis with their flatter yield curve tricks, leaving many investors holding these low yielding long bonds when rates rise in future years, unable to get out without substantial capital losses.” I know I risk sounding like Charles Plosser, but so be it.

It seems to me that reducing burdensome regulations and not implementing harsher capital requirements would be more effective alternatives to incentivize lending than pushing all yields toward zero while buying up all of our bonds.


Written into the law in 1977 is the dual mandate of the Federal Reserve: price stability and maximum employment. Where this surprising third goal came from, I have no idea, but Ben Bernanke added it in August during a recorded speech for a Cambridge, Massachusetts conference. He said that to measure economic progress, we need to gauge “happiness,” because, after all, the ultimate objective of Fed policy decisions is promoting “the enhancement of well being.”

Really? Maybe Ben is thinking of the Constitution and the pursuit of happiness. He said we should use a measure of happiness like that used by the tiny Himalayan nation of Bhutan, which utilizes a Gross National Happiness index rather than a Gross National Product index for its 700,000 people.

Bhutan, a Buddhist nation between India and China, began calculating the Gross National Happiness, or “GNH,” Index in 1972. “The GNH Index is meant to orient the people and the nation towards happiness, primarily by improving the conditions of not-yet-happy people.” The Index incorporates satisfaction, living standards, education, physical and mental health, safety, community, family and social ties, and leisure.

In all, there are 33 factors that go into the Index creation. The latest available numbers that I saw were from 2010 and they showed 10% of the people were unhappy and almost 41% were indeed happy. The rest of the people are somewhere in between. In March, 2012, the Bhutan GNH Index was on a UN meeting agenda, no doubt to promote the idea of promoting well being over weak economies. We should all be so lucky.

Ben Bernanke pretends that he is happy, but he must be getting quite angry. He started easing in 2007 and has thrown every easing tool in his playbook at us and unemployment remains stubbornly high. The unemployment rate has fallen to just over 8%, not because of great job growth but because of people dropping out of the labor force in droves.

GDP growth crawls along at a mere 1.3% in the second quarter of 2012. Inflation is running at about 2% per year. He just dumped QE3 and another “promise” on us. He may get angrier still if things don’t improve soon. If he could create jobs rather than money, we would all be a lot happier.

Gas Prices, the Economy, and Housing Bright Spots

For the third year in a row, we saw economic growth slow throughout the summer. Job growth has noticeably slowed in recent months and the unemployment rate remains above 8% in August. Oil prices spiked to near $100 per barrel and gas prices sit close to $4 per gallon right now, as they have in two of the past three years.

Hurricanes during August, tensions with Iran, and Arab unrest across northern Africa are among the commonly cited reasons for the continued high prices. Consumers usually cut back their expenditures on other items when we reach these price levels and that is what we expect would be happening again this time, leading to some of the recent weakness in manufacturing data.

Housing price data is turning into the surprise of 2012. All of the national indices that I track, including the Case Shiller, FHFA, and CoreLogic home price indices have turned positive on a year-over-year basis. The strongest indices have been FHFA, +3.7% in July and CoreLogic, +4.6% in August. The Case Shiller rose year-over-year by .6% and 1.2% in July, for the 10 city and 20 city indices respectively. Distressed sales are becoming a lesser portion of total sales. Is the long awaited turning point in housing upon us?

Maybe it is nationally, but Bucks County (PA) has yet to participate. For the most recent available data from the Prudential Fox survey, Bucks County home prices, as of the end of June, were still down year-over-year by 2.2%.

The rise in home prices may serve to lift consumer confidence and with it, demand for home buying. The Federal Reserve is determined to lower mortgage interest rates through its new QE3 buying program, spurring more demand. The inventory of unsold existing homes is 6.1 months worth of sales, which is a normal supply.

The rise in home prices will also gradually improve some of the underwater mortgages, which were 10.8 million with negative equity in the second quarter of 2012, according to CoreLogic. Maybe appraisers will not be afraid to increase a price estimate for a change.

So, once again, I remind you that the economy is slowly moving ahead. With such a large amount of easing by the Federal Reserve, we should expect this scenario to continue. Much uncertainty still exists as to whether Congress will extend the tax cuts that are set to expire on January 1, 2013. Most consumers and businesses will likely take a wait-and-see attitude toward the Presidential election as well. So stay tuned!

Thanks for reading. DJ 10/03/12

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 First Federal of Bucks County since November, 2004.

Friday, October 05, 2012

Banking's Curious Lack of Profits in Fee-based Businesses

Remember the good old days when bankers talked big about their fee income prowess? And bank stock analysts issued glowing reports about revenue diversification, and the banks that get “it”. As a side note, if anybody knows what “it” is, please let me know. Because in the fee based business game, “it” appears to be wasted effort.

Why? Because most of us are not making serious money, if we’re making anything at all, from our fee-based lines of business (LOBs). What do I base this on? My firm has been measuring the profitability of LOBs and products since our inception. The average profitability of fee-based products was -10% during the first quarter of 2003, and is –7% during the first quarter of 2012. Are there exceptions? Yes. But on the whole, we have laid a giant egg.

This sad truth reared its head in profit improvement engagements that I worked on. Banks that have meaningful fee based LOBs typically dropped little to the bottom line. We recommend changes to not only get profits to where they should be, as defined by RMA’s common sized income statement (see table for Insurance Agencies), but also to absorb some overhead/support costs from the bank.

I like using RMA numbers because 1) bankers use these statistics to evaluate borrowers by industry, and 2) they are an amalgamation of profit performance of largely private companies by NAICS code. Sure, I could use publicly traded companies. But we have to be cautious comparing a community financial institution’s brokerage operation to Charles Schwab.

But publicly traded companies can be instructive. They typically operate independently, containing HR, IT, and Marketing Departments. These departments are not usually found in community FIs brokerage arms. That is why it is important to measure these units’ profitability with an overhead/support allocation. They rely on HR, IT, etc. from the bank. They should pay for it.

I am not against fee-based LOBs. In fact, managing finances, employee benefits, and risk is becoming increasingly complex for individuals and businesses… i.e. our customers. Developing expertise can clearly be consistent with your FIs strategy.

But they must be developed and managed to deliver meaningful profits to the bottom line. Succeeding will increase the amount of business you do with existing customers, make them stickier, and your FI more valuable to them. It will also increase your profits, reduce dependence on the spread, and reduce the relative size of your big three balance sheet risks… credit, interest rate, and liquidity.

Increase profits, make customers stickier, and decrease risk. Worth it? I would say so.

How about you?

~ Jeff

Saturday, September 29, 2012

Guest Post: Why Banks Fear Blogs by Dana Dobson

Banks have been dragging their feet about blogging since the beginning, rather than embracing the opportunities it offers. They are consumed by anxious questions:

• How do I protect customers and our technology infrastructure from phishing attacks to get customers to click links that lead to malware?

• What if one of our representative blogged a statement that was used as investment advice by a reader?

• What if I miss a customer’s complaint or I don’t document it properly?

• What if we fail to issue the proper disclosures? Can the bank be cited for a compliance violation?

• What if we get negative comments?

At the same time, bank regulators raise issues that are cause for concern. For instance, fraudsters and hackers become more sophisticated every day and seem to be one step ahead of security gurus. Most users, they fear, do not take into consideration the relative ease with which any form of electronic message can be redistributed in an uncontrolled manner. Alas, some bankers may communicate with customers without full knowledge about regulatory compliance issues.

For example, a business development officer, branch manager or commercial lender, each of whom is tasked to achieve aggressive sales goals, might create a personal LinkedIn account for the purpose of prospecting for new business and innocently promote rates and other features without including the required disclosure language.

All fears about blogging can be put to rest.

All that needs to be done is to present to management how any perceived risks should be addressed. Susquehanna Bank and Arvest do an excellent job of this by posting guidelines directly on their blog sites. Additionally, every bank marketing and compliance officer should work together to create a written policy that answers all the “fear” questions to management’s satisfaction. Marketers who are on top of the compliance issues that arise in print, broadcast and website advertising can easily manage blog content effectively and to the advantage of their organization.

These days, a company is in the minority of it doesn’t blog. People make buying decisions by using the Internet to learn about the products and services that best meet their needs. Banks who are holding out on blogging are missing an important tool to share their brand with prospective and existing customers.

Dana Dobson is an award-winning freelance copywriter who specializes in writing for banks and financial institutions. A former bank marketing executive, Dana has written a white paper entitled, “Banks & Blogging: Why they should, why they don’t, and how to go about it.” For more information, visit

Tuesday, September 25, 2012

Your Branch in Your Pocket

I am attending the annual ABA Marketing Conference, where I spoke on how marketing can focus efforts on improving profitability and moving their bank forward.

The program had plenty of learning opportunities. One was the best attended general session in conference history, Brett King on the future of banking. Brett is the author of Bank 2.0, Branch Today, Gone Tomorrow, and the forthcoming Bank 3.0 and is what I would term an industry futurist, predicting and staying ahead of where he perceives the industry is going.

In the below clip, Brett speaks of the friction in our system that is slowing our adoption of change. He used the example of Compliance friction, that often thwarts efforts for online account opening and other technology adaptations. He makes the point, quite correctly in my opinion, that there is an irreversible trend in our industry away from customers coming to our branch, and calling us on the phone.

That puts a premium on building our bank's team on customer and prospect outreach, visiting them on their turf, with convenient technologies. Because if we wait for them to come to us, they're likely to go somewhere else.

Are you trying to reverse the trend and encourage customers to come to your branch? If not, how do you reach them?

~ Jeff

Saturday, September 15, 2012

Customer Profitabilty in Banking: Do you do it?

According to an ABA survey (see table), I doubt it.

I am speaking at the upcoming ABA Marketing Conference next week. Well, maybe not as much speaking as appearing. Mary Beth Sullivan and I are appearing as guests of Susquehanna Bank's Susan Bergen, in an Oprah like talk show format. I suggested Saturday Night Live's Point-Counterpoint format, but it was rejected. To appease my objection to appearing on Oprah, they orchestrated my entrance to a Pitbull song. I did not know who Pitbull was.

Our discussion will revolve around an ABA survey done this summer regarding actions banks have taken, or intend to take, to improve profitability. One question that didn't make the cut in the interest of time, was the one represented in this post's table: Does everyone in management know profitable versus unprofitable customers the bank serves today?

If you were in the corporate headquarters of McDonald's, you would be alarmed at the results. If you are in banking... not so much alarmed as happy that so many others remain as in the dark as you. I think lack of knowledge of profitable customers comes from three things:

1. Getting such a number requires investment in resources your FI currently does not have:
2. The regulators don't require the information; and
3. Even if you had the information, what would you do about it anyway?

All are related. FIs earn money on the spread. In order to create spread, FIs focus on creating a basket of the highest yielding assets within risk parameters, while funding them with a basket of the lowest costing funding. Why do you need some fancy profitability information to tell you that?

Problem: Various assets and liabilities take differing amount of operating expenses to accumulate. Also, based on risk, different assets and liabilities require different equity allocations. If your attitude is that the "incremental" cost of chasing this business or that is minimal, you may very well be mis-allocating your precious resources to low profit customers.

For example, we have a client that served the bar/restaurant business in a college town. These establishments brought decent balances to the bank. The problem: we found employees that spent half their day sorting through the bag-fulls of cash delivered every day. Could the bank allocate that operating expense to a campaign to acquire and serve higher profit customers? Without determining the profitability of those customers, we would never know about the opportunity lost.

I think it's time to change the paradigm from acquiring the highest yielding assets and the lowest costing liabilities based solely on interest earned or cost of funds. We should instead focus on acquiring and serving baskets of the highest profit customers. Doing so will efficiently allocate resources, improve our profitability, and enhance our FIs value.

~ Jeff

Monday, September 03, 2012

Banker Quotes: As Told to Me v4

I learn a lot from bankers and industry experts as I visit their offices, speak to them on the phone or at industry events. Occasionally they will offer an insight that I think my Twitter followers would find interesting. Since I estimate my Twitter community only reads about 10% of their tweet stream, and so many of my blog readers do not follow Twitter, below are selected quotes that I tweeted since version 3.

Note that if the quotes exceeded 140 characters, I would have abbreviated or substituted some words to make them fit. So if you are a CPA and want to count, a few of the quotes may exceed the 140 here, but not on Twitter. I quote bankers anonymously to protect the innocent.

1. Bank Senior Lender on branch traffic: It's like groundhog day. They see the same people every week.

In addition to declining branch transactions, in-branch sales opportunities are pressured by the above reality.

2. ALCO Consultant: If your bank is making loans, forget about retail and fund with an FHLB advance.

Sad but true that the combination of operating expense and interest expense to generate retail deposits exceeds the cost of getting on the phone and calling your FHLB. But does it make your bank more valuable? In lieu of Hudson City Savings Bank sale price, I’m not so sure.

3. Me to bank credit consultant: What's the best leading indicator of a loan problem? Consultant: The borrower doesn't return your call.

How do you fit that square peg in your ERM round hole?

4. Bank chairman to me: It's difficult to have vision when you're fighting alligators.

This short-term thinking may be a key driver in future consolidation… community FIs with no vision for a sustainable future.

5. Bank chief credit officer relaying to me an OCC comment: "We haven't issued an asset quality upgrade in quite some time."

This is a telling statement since industry credit metrics have been improving for at least a year.

6. Bank exec to me: The public is starting to come around that community banks do not have to be thrown under the bus like big banks.

Thank you, public.

7. Bank CEO: That bad loan is in Seaside Hts. Me: Maybe it's Snooki. CEO: You know she's pregnant.

Who says bankers are out of touch?

8. Bank chairman to me: It would be interesting to know our branch's profitability.

Do you think?

9. Me to Chief Credit Officer/CCO: Isn't having a 3% delinquency rate on a 7% yield portfolio OK? CCO: The 7% thing would never happen.

Sad, but true. If you can’t get the yield for the risk, perhaps you should let the next guy/gal do the loan.

10. Bank retail chief: Saying customer service is our differentiator is a 'me too' position.

You mean everybody doesn’t have superior customer service?

11. Bank CEO: I think 4 FTE's is the right number for future branches.

Note that he was thinking out loud in a session designed to improve branch profitability.

12.  Bank CEO: My most demanding job is playing pen pal with my examiners.

To say that we have been forced to engage in flattery with our regulators is an understatement.

13. Bank loan consultant: There is too little a difference on yields between the best and worst rated credits in bank loan portfolios.

See my comment on getting paid for risk.

14. Bank consultant: Your strategic plan projections should drill down to a value proposition.

Agreed! Your plan should deliver increasing shareholder value, discounting projected earnings to present day value.

15. Bank examiner: When evaluating an acquisition, assume that every loan portfolio is worse than you think it is.

Told to a CEO who relayed it to me... and perhaps the Day 1 loan mark will be worse than you estimated.

16. Senior lender to me: Does it make sense to have my lenders calling on businesses for operating accounts when we are so liquid?

My answer was to hunt when the hunting is good, not when you’re hungry.

17. Me: Maybe Dodd-Frank will result in reduced compliance costs because CFPB streamlines regs. Bank CEO: That's not going to happen.

But the Treasury Department said it was going to happen.

What are bankers telling you?

~ Jeff

Wednesday, August 29, 2012

Where will banks get their next dollar of capital?

Retained earnings.

I make a living helping financial institutions be as profitable as feasible. Why? To perpetuate their business model. This is how I feed my family.

But profits have been under pressure since 2008. First, FIs experienced pressure in their investment portfolios, purchasing Fannie Mae preferred's and other FIs trust preferred securities. Next, our over-exposure to construction and land development loans came to roost. Then commercial real estate fell under pressure as the economy teetered and rent roles declined.

Many banks had to replenish lost capital. The government stepped in to help, and taught us to ignore the guy/gal that knocks on our door and says "I'm from the government, I'm here to help." Absent or in concurrence with government-injected capital, FIs sought fresh capital.

But retail investors were nowhere to be found. This was one of the points made by Lisa Schultz of Stifel, Nicolaus, Weisel, an investment banking firm that specializes in FIs, at a recent Pennsylvania bankers conference.

Ms Schultz said retail investors were absent for all industries, not just FIs. She opined that they opt instead to invest in mutual funds, hedge funds, etc. Therefore, all of the action to attract capital was in the institutional market. I made this point in a past blog post, opining that the change in our shareholder base would be a significant factor driving future bank consolidation.

The change in shareholder focus, as presented by Ms. Schultz, is represented in the tables below. But this changing focus is from the institutional shareholder perspective... not the retail investor. The future investor will be concerned with quality growth that enhances shareholder value, combined with dividend policies that are mindful of capital preservation. I'm not sure how an FI will meet the 20%-30% capital appreciation, combined with sufficient liquidity, to meet "future", i.e. institutional, investor demand.

As if the shifting focus of the institutional investor wasn't challenging enough, what about the difference in what retail versus institutional investors value, and how they plan to exit their investment (see table below).

Tough luck finding your institutional investor at the local coffee shop bragging that they own stock in your institution. They could care less about how much resources your FI dedicated to the local food bank.

Here is what I think community FIs can do now to prepare for this shift in attitude:

1. Maximize retained earnings to reduce the need to visit the capital markets.

We have gotten a multi-year pass in generating profits because of the financial crisis and the subsequent teetering economy. Now it's time to cowboy up. How productive are your front line employees? How efficient is your back office? How well have you leveraged technology? Have you over-reached with your compliance program? If you don't have the answers, you better start looking for them.

2. Get a real investor relations program.

Investor relations is marketing. Marketing is much more than advertising. And your marketing message must be delivered long before you ever need capital. You must spin a story that gets locals excited about your bank. Yes, financial performance will play a significant role, but a supporting role to the story you tell about how your FI is a critical component to local communities. Retail investors may have shifted to investing in mutual funds, but the local community bank is probably one of few chances locals can invest in a company down the street.

3. If you must tap the institutional market, choose your partners carefully.

Ms. Schultz specifically addressed this issue in her presentation. Search for institutional investors that share your FIs objectives. Where did this fund invest? How long did it hold the investment? How did it exit?

4. Prepare for the exit strategy from the time of investment.

Receiving significant institutional investor dollars does not mean a fait accompli in terms of having to sell your FI so the investor can get out of the stock. However, if you don't plan for the investor's exit when they make their investment, the clock may run out when they are ready to go. Make evaluating strategic alternatives a regular part of your strategic planning, developing financial projections for a stretch case, base case, and stress case. See my post on this subject here. Also, make financial performance, investor relations, and stock trading liquidity a part of your strategy from the git go. If not, you'll find your FI might have up and went.

Where will your FI get it's next dollar of capital? I would like to know.

~ Jeff

Friday, August 10, 2012

Strategy drives structure... in theory only?

Strategy drives structure, so says Peter Drucker. Do you believe him? Does your strategy drive your structure?

I taught Organizational Structure this week at the North Carolina School of Banking. I was the one in the room with the accent, by the way. But I digress.

I created a case study of a bank called Blue Collar Bank, a New Jersey thrift whose vision was to be the #1 financial institution for working families in its markets. The assignment was to develop an organizational structure conducive to executing its strategy.
For the sake of time, I could not call each student to present their results, so I asked for volunteers. One student bravely came to the front of the class and presented an organizational structure that looked like the below chart.
I have never seen such a structure. When the student first described it, I imagined that this could be an Apple or HP structure... a company that was strong in product management. Imagine having Marketing and IT reporting to the executive in charge of Product Management and Distribution?
Upon reflection, this structure has merit. I have heard from multiple heads of IT that they lack clear direction in managing projects... which ones to undertake, and in what order. IT steering committee projects are driven by anecdotes and compliance. What if the project list is driven by the bank's strategy and managed by an executive responsible for delivering the right products over the right channels to target customers as described in its strategic plan? That would be revolutionary to our industry!
IT and other traditionally operational areas in FIs often report to other operational executives that are focused on making sure the back office runs efficiently. Now that most of our customer interactions are occurring through electronic channels, doesn't it make sense to re-think this structure?
Hats off to this creative student. Is it no surprise that he works for a marketing company that supports FIs, and is not a banker?
What are your thoughts on FI organizational structures?
~ Jeff
Note: Below is a picture of the books at the UNC Chapel Hill bookstore. In case you were wondering about the seriousness of that rivalry.