Saturday, March 24, 2012

What is it about Midwest Financial Institutions?

SNL Financial LP does an annual ranking of best performing banks using six core financial performance metrics that focus on profitability, asset quality and growth for the 12-month period ended Dec. 31, 2011. SNL measured each company's standard deviation from the mean of each metric. The standard deviations, which were each equally weighted, were then added together to calculate a performance score for each company. They then sorted the top 100 by asset class... less than and greater than $500 million in total assets.

I was pleasantly surprised to see so many of my firm's clients on the over $500 million list. I am patting myself and my colleagues on the back as I type, but readily admit, as much as I would like to take credit, it is the bankers that deserve the bravo zulu (well done in Navy parlance).

Interestingly, as I parsed through the data, I noticed that in the less than $500 million category were mostly Midwest banks (see table). If not a Midwest bank, then it was a niche bank. For example, the best performing bank in this asset category was Amerasia Bank, a Flushing, NY based financial institution focused on serving Asian-Americans in the borough of Queens.

Aside from niche players, I dug deeper to find out why Midwest banks dominated this list. I started at net interest margin, but found the SNL Midwest Banks average margin of 3.37% for 2011 was outflanked by the Southwest (3.57%) and the West (3.96%).

I checked how efficient Midwest banks were and found that they had the second best efficiency ratio, or how much in operating expenses it takes to generate $1 in revenue (i.e. the lower the better). Midwest banks had an efficiency ratio of 59% for 2011. But the West beat them with an efficiency ratio of 56%. Similarly, I reviewed net operating expense to average assets (net operating expense = operating expense less fee income), and found Midwest's ratio of 0.97% ranked closely to the Mid-Atlantic (0.99%) but was higher than the West (0.82%).

My last ratio analysis was asset quality represented by net charge-offs/average loans. Midwest, although doing well at 1.32%, was outperformed by the Southwest (0.89%) and New England (0.60%).

Having looked at the common ratios which identify why certain banks do well and others don't, it is unclear that one particular area is driving Midwest bank performance. But perhaps we can conclude that the Midwest did not experience significant real estate inflation and the accompanying asset quality issues, serve industries that have remained healthy during our economic malaise (i.e. agriculture), and have business models that foster good margins and strong expense discipline.

In other words, maybe Midwest bankers are so over-represented in SNL's less than $500 million class because they are.... good bankers.

Why do you think the Midwest dominates this list?

~ Jeff

Tuesday, March 20, 2012

Vblog: The Benefits of Niche Profit Reporting with David Acevedo

I regularly attend industry conferences and occasionally will particpate as an exhibitor. One of the benefits of spending long hours in the exhibit hall is to take advantage of the industry expertise plainly evident as you roam the aisles.

Today a financial institution CFO asked what we thought about measuring the profitability of certain niches, or SEGs in credit union parlance. None of my firm's clients were doing that, but I thought it was a great idea. So I sought the counsel of David Acevedo of 360 View to ask his opinion of the benefits of niche/SEG profitability reporting. Here is our brief interview at a relatively noisy exhibit hall.

How would you use such reporting to meet your FIs objectives?

~ Jeff

Saturday, March 10, 2012

Bank Cost Structures: Mostly Fixed

I recently taught Bank Profitability to a Washington Bankers' school. As part of the curriculum, we discussed the cost structure of financial institutions and how it impacts decision making.

True to the subject, we discussed using product profitability data to make decisions. For example, if a product is unprofitable, should we make changes to it or cut our losses? The answer is not so easy, in my opinion.

In reviewing the table below, one might conclude that we need to do something about business checking. How can such a core offering be ranked eight of ten in profitability? But, as with everything, there are reasons.

One is how profitability is measured. The method from the table is using funds transfer pricing to determine the spread generated from the product. In such a low interest rate environment, the funding credit is at historic lows. Aside from the interest rate environment, the product's profitability is determined by fully absorbed costing. This begs the question about the variability, or lack thereof, of operating costs.

Community financial institutions don't have much in terms of variable costs. Let's ask the question, what cost would be reduced by discontinuing this product? The answer... very little. Perhaps the core processor charges per account, and the business is on bill pay, also invoiced per account. But will we reduce branches without the product? Probably not and branches represent a significant cost to deposit products.

This is why leveraging your FIs infrastructure is so important to profitability. We have a step variable cost structure. That means we buy resources in bulk. Similar to buying a palate of Hot Pockets at Sam's Club, we add resources and then utilize the resources over time until they are exhausted. If properly utilized, the FIs operating cost ratios should decline over time, until the infrastructure becomes stressed.

How do you tell when your infrastructure is stressed? One CEO uses the parking lot theory. He looks out in the parking lot to see how many cars remain at the Bank after 6pm. I'm sure there are other, more sophisticated methods, but the overall point is that there is a consistent, downward trend in operating cost per account.

In terms of strategic decision making, understanding the FIs cost structure may motivate the FI to increase volumes in business checking, knowing that the marginal cost to add more accounts is minimal, and the revenue per account is significant (3rd greatest in the above menu). Not to mention that the average balance per account tends to be greater than most others. Discontinuing a product based on its fully absorbed profitability simply pushes the costs currently borne by the doomed product to other products.

How do you use your profitability information?

~ Jeff

Sunday, March 04, 2012

Job Description: Branch Manager

I frequently hear lamentations about the gap between the performance expectations of community financial institution (FI) personnel and performance results. A frequent challenge is that performance expectations are not documented in the form of job descriptions. Instead, expectations are often trapped between the ears of the supervisor or senior management.

This post is geared toward drafting a job description of the FI branch manager. Although I am not an HR expert, I am often engaged in discussions with FI senior management teams on what they expect from the person occupying this position. The job description does not include qualifications or compensation, as each FI can assess what is needed based on their own expectations.

Branch Manager

Summary of ResponsibilitiesRelationship management... Develop relationships with the branch's most profitable customers. Relationships should include knowledge of the customers' banking needs and their service expectations from their FI, evaluation of customer product use to determine optimal product utilization, and routine customer contact. The objective is a level of customer satisfaction that increases customer loyalty based on service and relationship, not price/rate.

Product knowledge and expertise... Develop and maintain significant knowledge of FI product offerings, with an emphasis on products most needed by the branch's target customers as per the demographic profile of the area surrounding the branch and the FI's strategic focus. Develop and maintain financial acumen in customer balance sheet and cash flow management to assist customers achieve financial success. The objective is to establish the branch manager as the subject matter expert of bank products within the branch market.

Community relations... Become the primary community representative by joining a minimum of two community organizations with an emphasis on those where the FI's target customers are likely to participate. Volunteer for a leadership position in at least one. The objective is to promote community involvement consistent with the FI's strategy and to expand the branch manager's relationships for future business development activities.

Business development... Grow branch customers at a pace faster than general market growth that is consistent with the FI's strategy. Manage branch business development efforts that include, but is not limited to, in-branch sales, outbound calling, prospect visitations, direct mail, branch-specific social media activities, etc.

Supervision... Supervise branch staff. Set performance expectations based on job descriptions and capabilities. Coach staff to exceed expectations. Manage staff training to include compliance, operations, and sales/product knowledge. Perform routine performance evaluations. Position subordinates to succeed within the FI. Coordinate with HR for developing optimal staffing levels, modifying job descriptions based on changing expectations, and filling open positions. Address performance deficiencies of subordinates.

Branch operations... Manage branch operations activities such as efficient and compliant transaction processing, correct and compliant account opening and closing, branch/teller cash, etc. Branch manager is not expected to perform these duties. Rather, the branch manager will supervise staff that performs duties and receives regular assessment on the operations of the branch from the branch operations manager and outside sources such as Audit and Compliance departments. Branch manager is responsible for the overall appearance of the branch, ensuring it is consistent with the image the FI wishes to present based on its strategy. Responsibilities include the branch physical plant. Again, the branch manager is not expected to perform these duties, but supervise personnel to ensure that they are satisfactorily discharged. The objective is for the branch to operate smoothly so branch staff has greater availability to deliver service that is noticeably better than the competition, and for sales activities.

Branch profitability... Branch manager is responsible for the overall profitability of the branch, and to establish a positive profit trend that is consistent with the FI's overall strategy.

Other duties as assigned.

What did I miss?

~ Jeff