Monday, November 18, 2013

Bankers: What is the value of your strategy?

A colleague and I recently had a healthy discussion about what agenda items to include at strategic planning retreats. He was strongly in favor of showing summary level financial projections for "business as usual" at the financial institution. Showing value creation, or erosion, from doing the same things you have been doing will highlight the need for staying the course or strategic change, in his opinion.

He is right. So often we get bogged down in philosophical debates on what to do about branches, technology, loan growth, expense control, and yes, vision, that we forget that whatever strategic direction the group decides should find its way, long term, to the FIs bottom line to increase the value of the franchise.

It does not matter if you are a stock held bank, mutual bank, or credit union. Your strategic direction should increase the value of the franchise, whether you measure aggregate value (mutual, credit union), or shareholder value (stock bank). Why would you initiate strategic change if it doesn't result in increased value? Even the non-stock bank/CU wants to live another day. Perhaps their Boards of Trustees have a lower capital appreciation hurdle. But doing nothing and eroding the value of the franchise is a sure sign that you will not have the resources or relevance to continue serving your other, non-shareholder constituencies into the future.

So what is enhanced franchise value? Since I have been involved in banking, investors focus on two metrics: price/earnings and price/book. The market places a multiple on these metrics. For example, I used Tompkins Financial Corporation's core earnings per share in the below table. The market currently values TMP at 14.8x earnings. Assuming the market continues to value TMP at 14.8x, you can arrive at the per-share valuation of the stock. For you non-shareholder owned institutions, use an industry p/e and apply it to your aggregate earnings to come up with your franchise value.

The projected business as usual eps grew at a compound annual growth rate (CAGR) of 5.4%. The Board may have determined that this was not enough. So strategic change must take place. After debating strategy and what success would look like in executing strategy, the bank was projected to increase earnings at a 10.4% CAGR. The Board's expectations on capital appreciation was 8%, because the bank's dividend yield was 3.32%. This would equate to a shareholder total return of 11.32% (8% capital appreciation plus a 3.32% dividend yield). The strategy, therefore, is projected to increase the value of the franchise.

Now, my firm does not serve TMP so the above numbers are only hypothetical. Except that I used actual core eps from 2007-12 for the business as usual row. I also have no inside information on what the Board of TMP expects in capital appreciation or total shareholder return. I only use the above as an example.

But in the throes of developing strategic direction, and the future of your bank, is it not important to demonstrate, in financial terms, what success would look like and how it adds value to business as usual?

What are your thoughts?

~ Jeff

Note: Even though my bank stock portfolio is currently making me look like an investment genius, mostly because of industry-wide price performance, I make no investment recommendations in this blog, or anywhere for that matter. You should not invest in any security based on what I type on these pages.

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