Friday, December 23, 2016

Three Wishes for Bankers

If I had a genie in a bottle that granted me three wishes, I would shoot for grander goals such as world peace, end poverty, and ban Mariah Carey Christmas songs. But this is a bankers' blog, and I want to remain topical.

Most readers are accustomed to me being analytical. Searching for trends and truths in a sea of numbers. And it is true, that numbers weave a tale that should be told. But in this post, I would like to rub the bottle, unleash the genie, and go for three grand wishes for banking.

Wish 1: Banks and Credit Unions - Can We All Get Along?

I believe in compassionate capitalism. In an evolved capitalist society, in my opinion, those "do-ers" would maximize their abilities and their legal/ethical earning power, and give their excess to worthy societal goals. Altruism? Sure. There will be those capitalists that buy gold toilet seats or hold lavish spousal birthday parties on Sardinia to prove they are in love. But let's focus on the good, shall we?

According to a 2015 FDIC National Survey of Unbanked and Underbanked Households, seven percent of US households were unbanked, meaning they had no account at an insured financial institution, and 19% were underbanked, meaning they used non-traditional financial providers like pre-paid cards and/or payday lenders. This is a significant percentage of the populace, and ripe pickings for credit unions, that tend to have better success profitably banking these customers than do banks. 

For example, in my firm's profitability measurement service for community financial institutions, credit unions make 80-90 basis points pre-tax profit on consumer loans, while banks make an anemic 5-10 basis points. And banks' have an average consumer loan account balance of over $40,000, whereas credit unions are around $14,000. 

Credit unions tend to deliver profits on smaller balance accounts. Accounts, dare I say, that bankers are happy to yield to them because they are not well suited to serve those customers.

But the tax thing. Bankers' can't get over it. And with NCUA loosening their definition of who can join credit unions, you can see the point.

So here's my idea: Collaboration in a market between a bank and credit union to cure some social challenge.  For example, what if Schmidlap National Bank and Pipefitters Local CU teamed up to end poverty in their local market? Schmidlap could commit 10% of their pre-tax profit to contribute to local charities whose specific mission is to end poverty. The CU could commit 20% of pre-tax profit to do the same, creating greater parity on the expense side of the ledger, and uniting the one-time foes to make their communities better.

I know one Midwest bank CEO that will disagree. How about you?

Wish 2: Simplify

In every executive meeting, every operations manager meeting, every sales meeting, I wish bankers would ask "how can we simplify?". Simplify their processes, their systems, and for their customers.

We have enough complexity in the world. I spent half a day trying to get my Mom's iPad to interface with Alexa. I was so successful that Alexa gave us the time and the weather, and nothing else. My Mom had to enlist the support of the Geek Squad.

There is enough complexity in everyone's lives. Internally, we have been over-reacting to interpretations of regulation, hyper-complying to avoid an audit finding or, shudder, a matter requiring attention (MRA) on our exam. Externally we have been doing the same to customers. 

Finances, either personal or business, are more complex today than at any time in my life. And quite possibly, in anyone's life. Technologies that have been making finances easier are growing at a rapid rate. I believe customers want to interact with humans about their finances. But we can't heap all this complexity on them and expect them to reject easy to use tech solutions.

Financial institutions that come out on top will be the ones that figure out how to simplify their processes, their infrastructure, and their customers' financial lives.

Goal 3: Automate and Elevate

I did a back of the envelope estimate that a $1 billion in asset financial institution might have 240-250 full-time equivalent (FTE) employees. I also estimate that less than half of them would be customer facing.

The investment financial institutions make in support center functions that scream for automation is not sustainable into the future. In a prior post, I made one slam dunk prediction that robotics was coming. Repetitive tasks will be increasingly performed by an application or a robot. Reconciling the suspense account now done by an accounting clerk? An app. Five point checks on personal check capture images now done by a clerk in Deposit Ops? A robot. 

This will make available significant resources to invest in employees to perform higher level tasks either in support or the front line. How often do I hear executives hope their branch employees would elevate from efficient transaction processing to customer service and advice? Often. How often do senior lenders exhort their lenders to be relationship focused and not solely deal guys/gals? Regularly. And how often do I hear frontline staff wish that support staff would find creative ways to get things done instead of erect road blocks? Every performance improvement engagement team I have ever been on.

So, for financial institutions, always look for ways to reduce paper, automate repetitive processes, and invest greater resources into delivering the financial institution your customers deserve.

Those are my three wishes for bankers. What are yours?

Happy Holidays everyone!

~ Jeff

Monday, December 12, 2016

Banking's Total Return Top 5: 2016 Edition

For the past five years I searched for the Top 5 financial institutions in five-year total return to shareholders because I grew weary of the persistent "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. Right?

Not so over the five years I have been keeping track.

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 for those FIs that trade over 1,000 shares per day. This, naturally, eliminated many of the smaller, illiquid FIs. I also filtered for anomalies that result from recent mutual-to-stock conversions and penny stocks. 

Before we begin and for comparison purposes, here are last year's top five, as measured in December 2015:

#1.  Independent Bank Corporation (Nasdaq: IBCP)
#2.  Fentura Financial, Inc. (OTCQX: FETM)
#4.  Carolina Bank Holdings, Inc. (Nasdaq: CLBH)
#5.  Coastal Banking Company, Inc. (OTCQX: CBCO)

Here is this year's list:

Independent Bank Corporation celebrates its second straight Top 5 recognition, and BNCCORP celebrates its third straight year on this august list. Congratulations to them. A summary of the banks, their stories, and links to their website are below. 

#1. Independent Bank Corporation (Nasdaq: IBCP)

Independent Bank dates back to 1864 as the First National Bank of Iona. Its size today, at $2.5 billion in assets, is smaller than it was a decade ago. It is a turnaround story because the bank was hammered with credit problems between 2008-11, when it lost over $200 million. In 2011, at the height of its problems, non-performing assets/assets was nine percent. Today that number is 3.6%. Exclude performing restructured loans, and that number plummets to 0.62%. The result: those investors that jumped onboard at the end of 2011 were well rewarded. Their total return was greater than 1,500%. You read it right.

#2. Waterstone Financial, Inc. (Nasdaq: WSBF)

Waterstone is a single-bank holding company headquartered in Wauwatosa, Wisconsin. It has $1.8 billion of assets and operates eleven branches in the metropolitan Milwaukee market, a loan production office (LPO) in Minneapolis, Minnesota, and 45 mortgage banking offices in 21 states. The mortgage bank has more than 3x the employees of the bank. Year-to-date, the company has generated more fee income, at $95.2 million, than it has in operating expense, at $95.0 million. I don't know any other bank that accomplished this. I'm sure there are some. But I haven't heard the tale. This tale is true. That means their year-to-date $31.8 million net interest income after provision... is gravy. And that is a key reason why their five-year total return exceeded 1,000%!

#3. Summit Financial Group, Inc. (Nasdaq: SMMF)

Summit Financial Group, Inc. is a $1.7 billion in asset company headquartered in West Virginia, providing community banking services primarily in the Eastern Panhandle and South Central regions of the state, and the Northern and Shenandoah Valley regions of Virginia. Summit also operates an insurance subsidiary. In 2011, the company had net income of $4.1 million on assets of $1.5 billion. Today, the company has annualized net income of $16.8 million. A reversal of fortune from a 0.28% ROA to a 1.09%. How did they do it, from my perspective? 1: Margin expansion, and 2: Expense discipline. Annual operating expenses were $36.6 million in 2011, and are $33.2 million today. And that includes some of the expenses associated with an acquisition that is set to close shortly. So they grew. And spent less to do it. A bank that viewed its operating expenditures as investments. Amazing!

#4. MBT Financial Corp. (Nasdaq: MBTF)

In 1858, while Lincoln and Douglas debated for a US Senate seat, Benjamin Dansard started Dansard State Bank to operate from the back of Dansard General Store. Ultimately renamed Monroe Bank and Trust, this bank pre-dates the Civil War! Similar to IBCP above, MBT is a turnaround story. In 2011, non-performing assets/assets was at 7.7%. Today they are at 1.8%, and below 1% if you exclude restructured yet performing loans. The asset quality issues led to a $3.8 million loss in 2011. Since that time, nothing but black ink, leading to a year-to-date ROA of 1.10%, and ROE of 10.13%. How did they get there? A dramatic improvement in asset quality, a process and efficiency initiative that led to reduced costs and improved processes, and motivation. Insiders own over 22% of the company. That's motivation! Well done!  


BNCCORP, Inc., through its subsidiary BNC National Bank, offers community banking and wealth management services in Arizona, Minnesota, and North Dakota from 16 locations. It also conducts mortgage banking from 12 offices in Illinois, Kansas, Nebraska, Missouri, Minnesota, Arizona, and North Dakota. BNC suffered significant credit woes during 2008-09 which led to material losses in '09-10, and the decline in their tangible book value to $5.09/share at the end of 2010. Growth, supported by the oil boom in North Dakota's Bakken formation, and a robust mortgage banking business, is challenged due to  the decrease in oil and ag commodity prices. But earnings continue to increase in spite of the challenges. This has resulted in a tangible book value per share at September 30th of $22.51... a significant recovery and turnaround story that landed BNC in our top 5 for the third straight year. Your investment five years ago would have resulted in over an 800% total return!

Here's how total return looks for you chart geeks, with the lower green, and flat line being the S&P 500 Bank Index.

There you have it! The JFB all stars in top 5, five-year total return. The largest of the lot is $2.5 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.

Wednesday, December 07, 2016

IMO: American Banker's Community Bankers of the Year

On November 30th, American Banker named three Community Bankers of the Year. When I read about their selections, and reviewed their financial performance, I e-mailed Bonnie McGeer, Executive Editor at American Banker Magazine, to say that, in my opinion, they nailed it!

Not that they need my endorsement. But they did notice when I sniped at one of their past Bankers of the Year awards. Banker of the Year typically goes to larger financial institutions. But I digress.

When I read about Banker of the Year and other such recognition, I will typically look at the financial performance of the bank to see if the award holds water. There are few things more regressive to me than for a banker to receive recognition without accomplishment. It cheapens the award, and diminishes our view of the truly accomplished.

But this year was a bumper crop, I tell ya!

Mark became CEO of GABC in January 1999. So he's been at it a long time. When he got the job, the bank was $637 million in total assets, had an Efficiency Ratio of 62.5%, an ROA of 0.96%, and an ROE of 9.1%. Today the bank has $3.0 billion in total assets, an Efficiency Ratio of 61.2%, and an ROA/ROE of 1.20%/10.7%, respectively. So the bank performed well in 1999, and Mark has improved on it. The bank is a consistent, German-engineered performer. 

As good as those numbers are, Mark's real home run was his total return to shareholders (see chart). From the day Mark assumed the reigns at GABC until today, the SNL Bank Index had a total return of 90%. GABC's was 424%.

Let that sink in a bit.

Credit: I got that "German engineered" quip from GABC's financial advisor.

Kevin's story isn't punctuated by his bank's total return since he became CEO in March 2013, although it did mirror the index. An investor would have enjoyed a 74% total return in HOPE stock during Kevin's tenure, versus 77% for the SNL Bank Index (see chart). 

No, Kevin had an impact from the moment he joined the Board in 2009, first advocating for raising more capital, and negotiating the merger between Hope's predecessor, Center Bancorp and Nara Bancorp, another Korean-American focused bank. The deal closed in 2011, and BBCN was formed. After closing another deal for Wilshire Bancorp, a $4B bank, in the third quarter, Hope became what it is today.

Financial performance is similar to when Kim assumed the reigns in March 2013. Then, the bank had an Efficiency Ratio/ROA/ROE of 45.5%/1.28%/9.13% respectively. Using this year's second quarter to avoid the Wilshire special charges, those numbers were 46.8%/1.20%/9.67%, respectively. 

What impressed me most was the bank's turnaround since Kevin joined the board, the transactions he has negotiated to significantly grow the bank, and the 32% earnings per share increase since he took over. That's right, 32%.

When Tony took the reigns at Sussex Bank in February 2010, non-current loans/loans was 5.48%. Today they are 0.75%.  I should end this section right there. But I'll continue.

The bank had $452 million in total assets. Today it is nearly twice that size. Net income was approximately $1.2 million annualized. Today it's $5.6 million. Efficiency Ratio/ROA/ROE? Was 61%/0.21%/2.80%, respectively. Now: 68%/0.70%/7.79%. And the bank continues in a significant growth mode. 

And due to the bank's historically rural markets, he's #GeoJumping! See my firm's most recent podcast, minute 17:40, for a discussion on geo-jumping. I'm claiming the trademark.

An investor earned a 288% total return since Tony took the reigns, versus 115% for the SNL Bank Index (see chart). I'm one happy investor. Disclosure: I'm personally invested in SBBX.

And there are my reasons why I think American Banker NAILED IT!

What other great banks are out there that didn't win the hardware?

~ 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.

Saturday, November 19, 2016

Are You a Bank With Benefits?

The American Bankers Association (ABA) recently announced a new benefit to assist its employees with repaying student debt. Beginning next month, ABA will provide each eligible employee up to $1,200 per year toward the payment of student debt, in addition to their current compensation. According to the Society for Human Resource Management, only four percent of employers nationwide offer this benefit

Is this an altruistic statement regarding the $1.4 trillion of student debt in America, or a prudent employee benefit targeting recent college graduates that each average $30,000 in student debt?

I recently proposed this topic for my firm's podcast, This Month In Banking, which is released on the last Wednesday of every month. Shot down. Too boring. But hey, I have a blog too! And I think it is an extremely important topic in talent acquisition and retention.

According to the Bureau of Labor Statistics June 2016 report, salaries, commissions and bonus accounted for 68.6% of total compensation, and benefits accounted for the remaining 31.4%. This is an increase from 29.9% in 2013. So benefits is a large, and increasing proportion of total compensation.

What makes the ABA announcement interesting is: 1) it is a benefit specific for those that carry student debt, meaning mostly millennials, and 2) that they felt they should announce it.

I don't think it is a mystery that bank employees seem to be getting older. And that succession planning in our industry is an issue. Since the financial crisis our industry's brand as a go-to employer has been hurt. And hurt badly. 

How do we attract quality, younger people and then retain them to be the future leaders of our industry? 

What employees value is in the eye of the beholder. Younger workers, for example, value cash on the barrel-head. Less important would be insurance (health or life), and retirement benefits. Not that it is unimportant. According to the Willis Towers Watson Global Benefit Attitudes Survey (What a mouthful! Some marketing person should revisit that title.), only 42% of US respondents said they would opt for more pay/bonus as opposed to other benefits if they had the choice (see chart). So other employees have different priorities.

For younger employees, there are some startups that focus on benefits important to them, such as Gradifi, that focuses on student loan paydown. Imagine the recruitment and retention with this benefit!

But as this benefit becomes less important to employees, perhaps a migration to something more meaningful, such as a greater 401k match, a more robust health plan, or life insurance benefits. Is it practical to earmark certain benefits dollars per full-time employee, and let them select, in menu fashion, what is important to them? For example, the recent college graduate may opt for a student loan paydown benefit, and take a high-deductible HSA health insurance option, rather than the traditional plan.

I think what is clear is that benefits that are important to your employees differ over different times in their life cycle.

Can bankers devise a cost-effective benefits program that recognizes this, would help them attract the best talent, and keep them?

~ Jeff

Thursday, November 10, 2016

What Did a Trump Victory Do To Bank Stocks?

The S&P 500 futures plunged during November 8th's vote count when Donald Trump started pulling ahead. The nosedive gave the news media, who could hardly bare to report good news for Trump, some bad news to deliver. The market was betting a Trump win would be a disaster for equities.

But in a surprise turnaround, the next day when the dust settled and pundits were begrudgingly calling Mr. Trump President-elect, the market turned the tide. Traders were indecisive during the first 90 minutes of trading the next morning, and then came a buying spree that elevated the index to a gain of 1.43%. When things settled down, the final tally for November 9th was a 1.11% gain. So much for that Citi prognostication of an immediate 3%-5% haircut. How much do those analysts get paid?

But what happened with bank stocks? Surely there would be volatility with Trump's carping about over regulation. No industry suffered through more regulation since 2008 than the banking industry, right? And the Consumer Financial Protection Bureau, that reports to no one and has carte blanche to regulate institutions over $10 billion in assets, would surely not sit well in a Trump presidency.

Let's take a look. I analyzed the difference in stock prices of all publicly traded financial institutions that trade over 10,000 shares per day on US markets. I used October 31st as the base period, and the closing price on November 9th. Highlights can be found in the table below.

Disaster, averted.

In fact, the biggest loser in the systemically important >$50B category (SIFI) was a Canadian bank. Yes, I know they don't count towards our SIFIs, but still. A little humorous that a Canadian bank would suffer a decline. They are about to receive a significant amount of our celebrities! Looking further up the list for the next worst SIFI, I find National Bank of Canada, then Bank of Montreal. I had to go all the way to Huntington Bancshares to find a US-based SIFI. And they gained 2.9% from Halloween until November 9th!

I should note that three of our clients are in the Top 10 Gainers. I'm not trying to claim causation, just putting it out there.

The average stock price gain of all US publicly traded financial institutions between Halloween and November 9th was 4.2%. There was no catastrophe. No meteoric rise. Just another day at the office.

~ Jeff

Monday, November 07, 2016

Guest Post: Quarterly Economic Commentary by Dorothy Jaworski

The third quarter of 2016 was relatively quiet after the surprise of the Brexit vote at the end of the second quarter.  There is a Presidential election coming and perhaps people are exhausted by it.  I cannot wait for the political TV ads to end.  But, either way, we will have a new President come January, 2017.  As far as the markets go, volatility has tamed down and prices respond to economic data releases and Fed speak, but not much else.  All I keep seeing is mixed economic data.  GDP for the 2Q16 was +1.4%, following +.8% in 1Q16.  Surely the 3Q16 will be better, but the 4Q16 will follow with a weak reading if it follows the typical pattern of the past several years.

There is NO momentum and really NO catalyst on the horizon to push GDP up above 2% to a more acceptable level, like 3% to 4%, except maybe Lady Gaga’s new album.  Job growth has been stronger than average at +1.7% each year since 2010, despite a declining labor force participation rate.  However, the job growth is not translating into higher consumer spending.  I think that job growth is symptomatic of weak productivity, which has risen by less than half of 1% from 2010 to 2015, compared to an average annual growth of 1.5% from WWII to 2009.

Our Federal Reserve keeps talking about raising interest rates.  Why?  Maybe they believe they must because rates are so low.  I think they are overlooking the fundamental causes of the weak growth - low rate environment- the high debt-to-GDP ratios- involving government, corporate, and consumer debt- and existing in every major country in the world.

Government Debt
Debt keeps mounting, especially government debt.  Let’s look at the US.  In the past 10 years, $7.9 trillion was borrowed to cover deficits but debt increased by $11 trillion, if other “spending” projects are included.  The Congressional Budget Office projects deficits at $9.2 trillion in the next 10 years and total debt issued to be another $13 trillion!  We are already over the 100% debt-to-GDP level that causes indigestion.  Other countries are in the same boat- Japan, China, all of Europe, and Australia.  Why do I write about this debt?  Because it is the high government debt levels that are crowding out private sector investment and that are pushing GDP and interest rates lower.  High government debt levels are hurting productivity, corporate profits, industrial production, and consumer spending.

Government spending is also crowding out consumers and businesses.  Recently, I have read Dr. Lacy Hunt’s materials and seen the research that shows that government spending is actually creating a negative multiplier; that is, every dollar of government spending is hurting GDP growth.  As government spending rises, GDP has fallen along with investment and productivity.  All we need to do is look around; we are living it. 

Investment managers are sitting on a near record level of cash in their funds, currently at 5.8%.  Banks are sitting on huge reserves at the Fed.  We are stuck in this endless liquidity trap for now.  So what does it mean?  Slow growth and low rates should continue.

The Fed
Someone said to me that if the Fed doesn’t raise rates now, they won’t have any tools later to use to fight recession, when it comes.  I disagree.  The Fed can use Quantitative Easing, or “QE,” again to buy bonds to keep rates low.  Janet Yellen recently said she is open to the notion of purchasing corporate debt, as is being done by the ECB in Europe, provided that Congress agrees and approves it with legislation.  Another tool that was fairly effective in the years after 2008 was Forward Guidance, which involved Fed promises to keep rates low until specific dates in the future; this tool was one of Ben Bernanke’s faves.  There is also the negative interest rate path, tried by other countries, but unproven so far.

I have noticed that the future inflation gauge published by ECRI has been rising steadily for months, with increases being larger on a year-over-year basis.  The gauge tries to forecast inflation six to nine months from now and things would be bleak if the projections came true.  I am sure the Fed has taken notice, and they, like myself, are trying to figure out if this is transitory.  I believe that it is, because the producer price index is still low and prices are not yet ready to flow through to consumers, despite higher than average increases in wages.  Average hourly earnings have risen 2.6% compared to last year.  Another factor worth noting is that gold prices have risen 19% year-to-date in 2016, but are off their worst levels; this commodity could be a safe haven for Brits fleeing Brexit.  Inflation is not a problem right now; getting GDP growth to exceed 2% certainly is.

Rates are low for several reasons- low economic growth, high debt-to-GDP levels, low inflation, and low productivity.  What do I see as I look out into 2017?  Low growth, low rates, no momentum, and high debt levels will continue to dominate.  I don’t believe inflation is an imminent threat because growth is so weak.  The Fed doesn’t either, as they project inflation to be under 2.0% into 2018.  Most notably, they seem to agree with me that economic growth will continue to be low.  Or is it that I agree with them?  Stay tuned!

Thanks for reading!   10/24/16

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 Penn Community Bank and its predecessor since November, 2004. She is the author of Just Another Good Soldier, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure of devotion.

Saturday, October 29, 2016

Five Challenges to Your Bank of the Future and Ideas to Overcome Them

I recently spoke at a Financial Managers' Society (FMS) breakfast meeting on this subject and thought I would share my comments with you.

With all of our anguish, torment, debate, and deliberation about the future of our country, our industry, and our bank, here are some common themes that I have been seeing that can be improved should bank management commit to making them happen.

Forget the things outside of your control. These five themes are firmly within your ability to make a positive impact on your future.

1. We merge, citing economies of scale, but fail to realize them. In 2006, when the median asset size within my firm's profitability outsourcing service was $696 million, the operating cost per business checking account was $586 per year. In 2016, the median sized financial institution is $1.1 billion, and the operating cost per business checking account is $710. In other words, the financial institutions grew, and the cost per account grew. This is the theme across nearly every product category. Don't believe me, check your banks' expense ratio (operating expense/average assets) or efficiency ratio as you grew.

Idea: Create measurable incentives to support centers to provide more efficient support to profit centers and for risk mitigation. For example, deposit operations' expense as a percent of deposits should decline as the bank grows. Loan servicing expense as a percent of the loan portfolio should do the same. 

2. We over-invest in under-performing branches. I recently mentioned to a community bank management team that community financial institutions are slower to close branches because their decision making goes beyond the spreadsheet and market potential. Community bankers know the town mayor, and key business leaders. So they worry about other things that go beyond the fact that their branch in that market has little chance of being profitable. But allowing branches to operate at losses takes resources away from areas that need immediate resources, such as technology acquisition and deployment.

Idea: Develop objective analyses for entering markets. If the branch does not meet profit objectives within a reasonable period represented in the original analysis to open it, close it. Make it near-automatic.

3. Our brand awareness and customer acquisition strategy is moving at a turtle's pace, not the hare pace of the industry. In my firm's most recent podcast, we discussed the recently released FDIC Summary of Deposits data that showed, with all of the negative press surrounding large financial institutions, FDIC-insured banks with greater than $10 billion in assets moved from an 80.6% deposit market share in 2012 to an 80.7% today. This phenomenon was brought home when a banker told me that, in the Philly suburbs, Ally Bank was the most recognizable banking brand. Aren't they still owned by our government? 

Idea: Develop a clear message on what your bank represents and align your culture, and all sales and marketing channels to deliver your value proposition. 

4. We embrace complexity when we should be seeking simplicity. The decline in defined benefit pension plans combined with the increases in defined contribution (401k) plans, the abysmally low US savings rate (31% of non-retired people have no retirement savings), and the increasing complexity of running family and business finances presents an opportunity for community financial institutions to make their customers' lives simpler. We should start with ourselves. For example, when onboarding a customer, an FI can perform needs assessments, risk assessments (needed for risk management purposes), and customer capital allocation needs all at once, and add value to the customer relationship. 

Idea: At account opening, build an automated business process that includes the needed Q&A to assess customer needs that spurs post-account opening follow up, know-your-customer information, and risk assessments required to risk rate customers that assigns a rating that drives capital allocations to that customers' balances and rolls up to determine the bank's capital requirements.

5. We under-invest in the people that can build our bank. Because of over-investment in areas such as regulation and unprofitable branches, we under-invest in elevating the abilities of our employees to serve as advisers to customers, as highlighted above. Also, we tend to buy key people on the street, such as commercial lenders, rather than raising them within our bank, because of the time and resource investment needed to turn junior level people into productive commercial lenders.

Idea: Build a bankwide university that includes on-the-job training, web-based seminars, in-person training, and banking schools to create career paths for junior-level people that will reduce our need to buy senior-level people on the street, and elevate the skill sets of employees to actually advise customers, rather than only sell to them.

If I were to end this post with a theme, it would be urgency. We are past the time to lament about the interest rate and economic environment, and Dodd-Frank. They are outside of our control.

We are intuitively aware of the above challenges. The good news is we can do something about them. Address them this year, this month... no, this week! And your bank will move forward to an independent future for your employees, customers, and community. 

Did I miss any challenges within our control?

~ Jeff

Sunday, October 09, 2016

Evolution of Banking: Three Slam Dunk Predictions

The sheer number of strategic initiatives and technologies in the banking industry makes it very difficult to predict outcomes with any certainty. Not that me or other industry pundits don’t try.

I have been noticing some trends that are providing insights on our direction, evolution, and ultimate picture of our future.

Future Picture was coined by the US Military for defining flight mission success, and was brought to business prominence in Air Force pilot James D. Murphy's 2005 book, Flawless Execution.  Using his example of envisioning what success would look like, a bank’s Future Picture should be a detailed description of successful execution of strategy. I challenge bankers’ to describe their Future Picture.

It can be highly subjective and difficult, particularly in an era of unprecedented change. But I would like to share three strategic directions where the train has either left the station, or is boarding.

1. Branches must be larger to survive. According to my firm’s profitability database, branches generated revenue (defined as consumer loan spreads, deposit spreads, and fees) as a percent of branch deposits of 3.50% in 2006. Today, that number is 2.08% due to the interest rate environment, the regulatory environment (reducing deposit fees), and customer behavioral changes. Therefore, the average deposit size of branches grew, to over $60 million at the end of 2015 (see chart). This trend is not likely to change, as bankers are more apt to prune their network and increase overall branch profitability. And the customer. Don’t forget them. They use branches less, although many still identify branch location as important to bank selection.

2.  Technology expenditures will grow faster than overall expenditures. I recently performed this analysis for a client, identifying the “Data Processing” expense as a percent of total operating expenses for all FDIC insured banks as identified in their call report. Surprisingly, it represented only 4% of total operating expense.  Note this excludes IT personnel expense. But the number is growing faster than overall operating expense (see chart), meaning that IT expense is becoming a larger proportion of operating expense. It is disappointing that this trend is slowing so banks can meet their budgets and profit objectives, regressing back to old habits of cutting IT projects to make budget. But overall, banks are seriously evaluating technology to improve efficiencies and their clients’ banking experience.

3.   Robotics are coming. It was only recently I began to believe this. But there are opportunities being evaluated and implemented to automate repetitive processes to reduce overall costs, minimize risk, and speed the process. A couple examples where automation and/or robotics are ripe to improve processes include reviewing remote deposit checks, currently eye-balled by humans. Not scalable. The x-point evaluation could more quickly and effectively be accomplished by a robot. Another area where automation is coming is BSA case evaluation, where the bank’s BSA application identifies potentially high-risk client activity and a program goes through several standardized checks to clear the case or elevate it for human intervention, reducing the overall number of cases needing human review.

These aren’t the only changes. Just the ones that I believe are coming, no matter who tries to stop them.

So why try to stop them?

~ Jeff

Saturday, October 01, 2016

Thank You Mr. Stumpf!

Bank reputations were on the rise. After the financial crisis of 2007-08, led by making mortgage loans to people that had little resources to repay them, banks were climbing from the reputational abyss.

Then came September 8th, when the Consumer Financial Protection Bureau (CFPB), and the Office of the Comptroller of the Currency (OCC) jointly announced the issuance of a consent order to Wells Fargo that included $185 million in fines due to the widespread, illegal practice of secretly opening up customer accounts without the customers' consent. Fifty million of the settlement was to go to the City and County of Los Angeles, which brought a lawsuit against the bank a year ago for the same charge. For further discussion among my colleagues on this subject, click here for our podcast.

And the stench of that little news item is likely to sully the reputations of financial institutions across the country. Don't believe me? How many subprime mortgages did you make where your customers had little hope of repaying? And did the bursting of the housing bubble hurt your bank's reputation? 

Wells Fargo is so large, that many people view them as a proxy for the whole banking industry. Much like Apple or Samsung might be viewed as a proxy for the whole smart phone industry.

What does reputation get you? For Wells Fargo, it gets you $32.9 billion. Or lost them $32.9 billion. That is the decline in market value they suffered from August 31st to this writing. Thirteen percent of their market value, vanished like a puff of smoke in the wind.

According to Cutting Edge PR, sources of information that impact influencers (CEOs, senior business execs, analysts, institutional investors, etc.) are as follows:

Source of Information                          Proportion
Personal experience                                  64%
Major business magazines                        37%
Articles in national newspapers                35%
Word of mouth                                          31%
Articles in trade journals                           30%
Television news                                         14%
Articles in local newspapers                      14%
Television current affairs programs           13%

Is Wells Fargo lighting up the newswire? Yes. Will commentators start dropping Wells Fargo from the discussion and start generalizing that this is typical bank practices? I have little doubt.

I said it before in a previous post on branch incentives, and I'll say it again. Bankers should hold business line managers accountable for the service levels, profitability, and profit trends of their business units. When you begin to drill down and start measuring widgets, employees will gravitate to finding widgets. Which is exactly what Wells Fargo did.

And if you think this culture started recently. Guess again. Google the much lionized former Norwest and Wells Fargo CEO Dick Kovacevich that touted the "eight is great" cross-sell ratio. Stumpf has worked for Norwest/Wells for thirty four years. 

I guess eight isn't so great after all.

And the Schleprock cloud hovers above us all.

Thank you Mr. Stumpf.

~ Jeff             

Friday, September 23, 2016

Bankers: Bring On The Change

On the shores of the Ammonoosuc River, alongside the hotel where the famous Bretton Woods conference took place in 1944, I talk about the onslaught of change that has recently occurred, and will continue to occur in our industry.

Change: Is your institution ignoring it, trying to stop it, or adapting to it?

How much grief will I get comparing employees to beavers?

Saturday, September 17, 2016

Politics: Can We All Just Get Along?

I do not venture into politics much, either in this blog or in person. But our environment is so toxic, I would like to take a crack at identifying shared goals by most of us.

1. We all want to reduce the number of impoverished people. We have different ideas on how to do it. I think capitalism is a better solution than socialism, as the latter creates so much more of an underclass. Except for the bureaucrats. They tend to do well in socialism. The more you disperse economic power in a society, the better, in my opinion.

2. Many successful capitalists turn into jerks. I think, by and large, this is because they want to solidify their position, and the by-product is keeping others from achieving it. That is why in large corporations executives might make it difficult for up and comers, fearing they might be unseated by them. This is also why top executives get paid so much. I wouldn't stop companies from paying executives so much, but would insist on transparency and not allow a company to deduct executive comp that is greater than some multiple of company average compensation on their Federal taxes. But better to have many, many successful capitalists, than a few successful bureaucrats. Successful capitalists are the "do-ers" of society. They create jobs. Not government. If you don't trust me on this, study economics. At most colleges. Not all. I also want to encourage a society where capitalists do well, and give their excess to charitable endeavors. Like Warren Buffet is trying to make happen.

3. Our tax system is way too complex. I would make the personal and corporate marginal tax rate the same. Somewhere around 20%. I put a simple tax solution in a post way back in 2012. See it here. This will cause disruption among accountants and tax lawyers. Taxes would be so easy and transparent, these professionals wouldn't be needed by individuals or corporations. Think of all the tax compliance savings!

4. Government spending. Until we reverse the alarming trend of national debt to GDP, we must spend less than revenue growth, and balanced budgets have to be the norm rather than the exception. I wouldn't do a balanced budget amendment, because elevating infrastructure investments and spending during recessionary periods makes sense to me. But until that time, Federal spending growth should be less than GDP growth. Oh, and the last balanced budget under President Clinton was spurred, in part, by Pay-Go. That system where new "programs" would have to be paid for by eliminating other programs that cost the same or more. I would put that structural discipline in place right away.

5. Federal government operation. Our rules are ridiculous. Bills would be cleaner, and more linear. No slapping on stupid amendments for pork. If it has enough support, have the pork get its own bill. And bringing a bill to the floor for vote would be easier. One requirement I would insist on is having a litmus test for programs designed to help society. If they don't meet a pre-agreed upon social objective over a reasonable time period, they automatically die. No vote needed. We tried to fix a social ill. It didn't work. Let's move on. And not worry about those that lose funding sending out press releases that we don't care "for the children".

6. Speaking about lawmaking, there are way too many laws and regulations for society to follow. Nobody, and I mean nobody, knows them all. In fact, most if not all of us break the law every day. This creates a ripe environment for tyranny, that we see playing out in front of our eyes. Don't like someone? Figure out a law they broke and go after 'em. Think about it. If I were in charge, there would be less, and the objective would be far less, rules and regs to follow, reducing the ability of powerful law enforcement and government bureaucrats to move against its citizens. And making it easier to enforce and comply, both individually and economically. Watch the bureaucrats squirm about this one.

7. World relations. We want to influence societies to be free. But our own freedoms are being eroded by the growing body of laws and regs, mentioned above, and political correctness which has curtailed our ability to solve problems. So we should take care of our own problems to show the world that, as our society matures, we make corrections to enhance freedom. And create a worthy example that other countries would like to emulate. But dictators. We have to be active in keeping them in check. If we were isolationist, our world would be a different, and much worse place, in my opinion. But our international forays would be selective, proportional, and  given the resources and the fortitude to win. Isolated cells of terrorists need not worry about a US Army battalion. But they would have to worry if they actively seek to harm our citizens. Their end will not be pleasant. But it may not be all over the news media, either. Oh, and trade. Free trade works. Few economists believe otherwise. The rub is that they must be enforceable and punitive for cheaters, making cheating so unpalatable that parties to the agreements abide by what they signed. There is a lot of angst against free trade now, but as a society we voted for free trade by buying less expensive stuff that must be made by labor that is less expensive than our own. And lets face it, union work rules made us noncompetitive in manufacturing. Shame on us.

8. Elections. Any candidate that wants to run for office, must complete a two-page resume to a non-partisan website. Page one denotes the candidate's experience. Page two has the candidate's answers to five key questions for the office sought (i.e. federal questions for federal office), in 50 words or less for each question. This is so voters like me can review candidate's qualifications and positions before getting into the voting booth. In PA, where I live, there is a tough US Senate race underway, and the ads the candidates run are ridiculously irrelevant and designed to stir up emotion, and not make us better voters. I say ignore that idiocy. Read the two-page, vote smartly.

9. Safety Net. I'm all for a transitional safety net to help our fellow citizens pick themselves up and get on their feet again. I'm all against turning families into lifelong government dependents, which I think is the consequence of a safety net without the transitional philosophy. If someone hurts their elbow and can no longer do the manual job they once did, we don't re-train to do other jobs not dependent on the elbow. We put them on disability for life. C'mon. This makes so much common sense, that the cynic in me thinks those that support lifelong government assistance (either in word or deed) are just bribing people for their vote using other peoples' money. And relegating the lifelong "drawers" to the lower economic rung for life. Sad.

Why doesn't the media cover much of the above? Instead, they assemble a panel of talking heads to discuss a tweet. 

Not sure there would be many that object to the above. Ok, accountants and lawyers, and union leaders. Other than them, why is everyone else shouting at each other?

Who's onboard?

~ Jeff

Monday, September 05, 2016

Board Composition: What Does the Best Bank Board Look Like?

In April 2016, Delaware Place Bank in Chicago was placed under a Consent Order (CO). One article within the order read as follows:

"the Bank shall retain an independent third party acceptable to the Regional Director of the FDIC’s Chicago Regional Office (“Regional Director”) and the Division, who will develop a written analysis and assessment of the Bank’s management needs (“Management Study”) to evaluate the management of the Bank."

This is a common article and my firm performs several of these annually. The CO went on to say:

"As of the effective date of this ORDER, the board of directors shall increase its participation in the affairs of the Bank, assuming full responsibility for the approval of sound policies and objectives and for the supervision of all of the Bank’s activities, consistent with the role and expertise commonly expected for directors of banks of comparable size."

In the same article, the CO compelled the bank to elect an additional director with banking experience. And there lies the rub. By including this provision, the unwritten assumption was that appointing a director with banking experience will make this bank more safe and sound.

Will it? Is there evidence that proves it is so?

What makes an effective banking board? Is there one recipe?

We are often asked this question, either formally (through a Management Study or Board evaluation engagement) or informally, And the answer is, it depends.

It depends on the bank's strategy, geography, risk parameters, and personalities of existing board members. I have seen banks with former regulators on the board fail, and banks with farmers on their board thrive. I do not think there is one answer for all.

To further my point, I evaluated publicly traded, SEC registered banking companies between $500 million to $3 billion in total assets. I searched for the best, and not so much, ROE banks based on their five-year average ROEs. I excluded banks that had negative ROEs, recently converted during that five years from the mutual form (which elevates their "E"), or had standard deviations greater than 4 from their five-year ROE. In other words, they were consistently good, or consistently bad.

Then I reviewed their board composition. The top six results are as follows.

How does this differ from the bottom six? See their board composition below.

There were retired bankers in three of the six top performing banks. Wait! There were retired bankers in three of the six bottom performers. CPAs, another common piece of expertise desired on a high performing board, were on all six bottom performing banks. CPAs were only on two of the six top performing banks (assuming the CFO was a CPA, which was not mentioned in their bio). Attorneys were on four of six top and bottom performing bank boards.

The prize for most board billable hours goes to Robert Gaughen Jr., and Randy Black, CEOs of Hingham Institute for Savings and Citizens Financial Services, respectively, for having the most attorneys on their board. Perhaps the answer is not only have an attorney on the board, but lots of them.

There were no former regulators on the boards of the above banks. At least they wouldn't admit to it in their bio.

The point of this review is that there is no one answer as to what makes a good functioning board. In my experience, a board that maintains management accountability for business performance and ensures management operates within the risk guidelines established by the board and commemorated in bank policy, is a good performing board. It doesn't matter if that board includes a baker or candle stick maker.

What do you think makes a high performing bank board?

~ Jeff

P.S. I received an e-mail from a banker asking me the insider ownership of the above banks. So here you go! The bottom performing banks have a greater level of insider ownership. And from eye balling it, the bottom performing banks have a greater level of institutional ownership too.

Monday, August 29, 2016

Four Reasons for the 2007-08 Financial Crisis

A recent Bank Think post by ConnectOne Bank CEO Frank Sorrentino regarding restoring Glass-Steagall got me thinking about how far the debate has drifted from the root causes of the 2007-08 financial crisis.

There have been quite a number of research pieces offered as to the root causes (read a good one here by University of North Carolina). In researching this post, I sifted through some interesting, and some not so interesting opinions. Which reminds me that the old axiom "figures don't lie, but liars figure" may be closer to accurate than we would like.

Here is what I think caused the financial crisis based on what I read, what I experienced, common sense, and my interpretation of the facts.

1.  People borrowed more than they could repay if they experienced a modest financial setback.

If you know me personally, I will always put more weight on personal responsibility than the boogeyman. Yes there was some degree of fraud perpetuated on the borrowing public. But, by and large, people knew how much they were borrowing, what their payments were, and that some of their mortgage payments would rise if rates rose. 

In 1974, household debt stood at approximately 60% of annual disposable personal income. In 2007, that number climbed to 127%. It should be noted that in 2006, 40% of purchase mortgages were for investment or vacation property. But you won't see the real estate investor losing his/her shirt on 20/20.

Absolving people of personal responsibility is a problem in our society. As one of my Navy lieutenants once told me: "Be careful pointing the finger, because the other fingers are pointing back at you". Words to live by.

So, in my opinion, number one exceeds all others. It will not get me personal kudos in the news media.

2.  Credit risk was too far removed from the loan closing table.

This is the moral hazard argument, where the people that have the relationship with the customer, that stare the customer in the face and say "yes" or "no" to the loan, were not the same people assuming the risk should the customer default, in most cases. The shoulders where credit risk ultimately came to rest, investors, were placated by insurance and bond ratings. 

Community financial institutions make their debut here, as they purchased bonds, typically highly rated, backed by mortgages that also had insurance applied to them.

3.  There was a lot of money looking for investments, and Wall Street met the demand. Mortgage-Backed Securities (MBS) almost tripled between 1996 and 2007, to $7.3 trillion, as investors lined up to participate in the US housing market. This led to creative means to take a risky mortgage at the closing table, to a perceived "safe" investment in the bond market after it was combined with hundreds of other mortgages, parsed into traunches, insured by a bond insurer, and rated by a ratings agency. What could go wrong?

See the list of top 10 sub prime mortgage lenders from 2007. Note the absence of anything resembling a community bank. BNC was owned by Lehman Bros. EMC-Bear Stearns. First Franklin, a JV between National City Bank (emergency sale to PNC) and Merrill Lynch (emergency sale to BofA). Option One was sold to shark investor Wilbur Ross for its servicing rights. Ameriquest was purchased by Citi, and its origination arm shut down. The table indicates that loans were closed in these banks'/entities' names. A community financial institution that sells its loans in the secondary market would typically close the loan in its own name, and then sell it. So the absence of community financial institutions implies that these loans were originated by mortgage brokers or the listed banks themselves, and not a community FI. This is consistent with my experience. 

The MBS bond-creation engine was a well oiled, end-to-end machine designed to satisfy the appetite of investors.

4.  Government's participation in the mortgage market. Way back to the Great Depression, when mortgages were typically five-year balloons, the Federal Government has intervened in mortgage lending. When the five years were up, the government didn't want people tossed from their homes because they couldn't refinance due to economic hardships. A respectable goal. But this intervention played a role in what we have today, a separation between the borrower and the ultimate lender. 

Note that Presidents Reagan, Bush, Clinton, Bush, and even Obama openly encourage home ownership because it has a causal relationship with household wealth creation.

But the reason why community financial institutions shy from putting 30-year, fixed rate mortgages on their books is because there is no 30-year, fixed rate funding instrument. It creates unpalatable interest rate risk. 

If interest rate risk drives the wedge between borrower (i.e. homeowner), and the desired lender (i.e. local bank that retains the credit on their books), then perhaps a 5/1 mortgage should be the norm. This answers the interest rate risk problem, while allowing borrowers to keep their mortgage and therefore their home if they befall some economic setback after five years.

And note, a local financial institution has more flexibility to alter the terms of the loan if it is on their books, rather than owned by an investor.

Back to my original point regarding re-instating Glass-Steagall. What does this have to do with the four points above? We should ask the same question about every article within Dodd-Frank.

~ Jeff 

Friday, August 12, 2016

Bankers: Give Your Employees a Bucket of Balls

Very few financial institutions commit to the level of employee development found in some of our largest corporations. The fear, aside from the cost of a homegrown development program, is that employees will leave. I have news for you, you should be afraid the untrained will stay.

What banks do you know that have a formal employee development program?

~ Jeff