Saturday, February 25, 2017

Netflixed: Co-Founder of Netflix Tells Bankers How It's Done

This past week I attended the American Bankers' Association National Conference for Community Bankers (NCCB). At such affairs, I like attending the general and education sessions for my own knowledge, and for the benefit of my clients and readers.

The NCCB was no different. If there was one session that struck me like a lightning bolt, it was the general session, with keynote speaker Marc Randolph. It was riveting, and challenging. And I'm not too sure bankers are up for the challenge. 

Riveting because he spoke about the founding of Netflix. The idea was not a lightning bolt, as Netflix co-founder Reed Hastings tells of his late fee epiphany when returning the movie Apollo 13. Rather, it evolved during long commutes between Hastings and Randolph. In other words, car pooling planted the seeds of Blockbuster's demise. This factoid is sure to get me social media shares from environmentalists.

The tale of the early years of Netflix is very instructive to an industry experiencing change. Think banking. The talk was challenging because Randolph's keys to being successful in such an environment may, and should scare bankers.

Marc Randolph's three keys to business success:

1.  Tolerance for Risk

Number one is already turning off readers. Low risk tolerance is suffocating. Why? It promotes a "no mistakes" culture. When you have low tolerance for risks and mistakes, you lose innovation. Who will stick their neck out in such a culture? Who will endure five failures to discover that one idea that turns your business model on its head and plants the seed for an enduring future? Bankers may hate the analogy, but Blockbuster was not willing to gut their main revenue source to build out and promote streaming. Does the term "disintermediation" in banking sound familiar?

2. An Idea

And it doesn't have to be a good idea. When Netflix decided to forego late fees their business took off. If Randolph was writing a letter to himself how he thought Netflix would evolve in five years it would not have read like it played out. But they tried anything and everything to get subscribers, and more revenue into their company. They had many failures. The idea wasn't an "in the shower" epiphany. But after trying several things, the one that stuck ended up being the hurdle that would eventually lead to what we have today. An idea. Not a good one. As Randolph mentioned, many of us have great ideas in the shower. Few of us get out of the shower and do something about them. In a culture with a low tolerance for risk, would one of your bankers step out of the shower and do something about their idea? Would such a person even work for your bank?

3. Confidence

It takes confidence to fail several times, and to get up and keep going. As Rocky once said, it's not how many times you get knocked down, but how many times you get knocked down, get up and keep moving forward. That's right, I made a Rocky reference. Say what you will about the Italian Stallion, when he was in the ring, he had confidence to go toe to toe with the best in the business. Think about little $5 million in revenue Netflix, going toe to toe against multi-billion dollar Blockbuster. 

I will close by paraphrasing Randolph. Business success is not about coming up with the best or even good ideas. It's about building a culture to try lots of bad ideas.

And with our own culture in banking, to try few ideas and even fewer that have not proven tried and true, do we have the culture to succeed in a changing industry.

Should we build such a culture? And if so, how?

~ Jeff

Saturday, February 18, 2017

Capacity Planning in Banks: Three Measurement Ideas

Joe Lender's loan portfolio grew $5 million last year. The Trust Department's revenues grew nine percent. The Market Street branch's core deposits grew to 64% of total deposits. All objective measurements for front liners.

But what about support centers? Loan Servicing, IT, Deposit Operations et al? Perhaps they look busy. I have actually heard that before. One CEO said he judges capacity by looking out of his office window at 6pm. Are there cars in the employee lot? Perhaps it's time to add resources. If not, the request for an additional FTE is denied!

How can executive management, most of whom did not come from support centers demanding more resources, decide if they should give it to them?

I have some ideas.

1. Number of Accounts and Operating Cost Per Account

One statistic I turn to for clues on the capacity of a support center is how they were operating at their peak. Let's discuss the accompanying table.

With the exception of one period with a slight upward blip, this bank has been losing checking accounts over the eight periods measured. Yet the bank has not been reducing aggregate costs because the operating cost per checking account is more than it was eight periods ago. According to these data points, this bank supported eight percent more checking accounts at 13% less cost eight periods ago.

This data point suggests an 8%-13% available capacity.

2. Benchmarks

Data are like humans. Rarely perfect. When data does not support our theory, we tend to point to its imperfections. So it goes with benchmarks. There are no apples to apples comparison with a basket of banks data compared to yours. But does it represent a relevant data point to consider? The chart below suggests another relevant point of information so an executive can determine the capacity of a support department.

In this bank's case, the number of deposit accounts per deposit operations FTE has been declining. When deposit accounts were greater, this bank achieved the benchmark median. As number of accounts declined, personnel did not, and this metric fell below the benchmark. At the current period, the bank is 7% below the median benchmark and significantly below the top quartile. Time to reduce resources, or at a minimum challenge the department to become more efficient?

3. Recognizing Economies of Scale

A third data point to consider when determining capacity in a support center is how much resources as a percent of the relevant balance sheet item does this center consume (see chart)?

I have written, spoken, and debated that to achieve economies of scale, you must reduce relative resource consumption as you grow. I have also pointed out that many financial institutions fail to achieve it. This is a key fact in why many mergers don't achieve the economic benefits touted on merger announcement day. To realize economies of scale at your bank as you grow, incorporate the discipline to reduce relative resource consumption per support centers.

Given the above table, should this executive increase resources available to the Deposit Operations Department?

I don't believe taking one data point of the three mentioned above would be enough. As I contend, there are imperfections to each, imperfections that you can rest assured the Deposit Operations Manager will point out to you when considering a resource request.

But the margin for error declines when you consider multiple data points to make a more informed decision. I'm not suggesting seeking data ad nauseam. There is a declining value to adding more data. At some point a leader must lead.

And in Schmidlap National Bank's case, the Deposit Operations Department can do better.

What other data should be considered in determining support center capacity?

~ Jeff

Friday, February 03, 2017

Guest Post: Quarterly Financial Markets and Economics Update by Dorothy Jaworski

Happy 2017, everyone!  Who is ready for all of the change that is about to be upon us?  A new President will be inaugurated tomorrow, January 20th, and Donald Trump has promised change.  He has used his slogan of Make America Great Again to show that his focus will be on the US and the US economy.  His election has already brought change to the financial markets, sending stocks rising 6%, as measured on the S&P 500 index, and sending interest rates to their highest levels in years.  Clearly, the markets expect change.  After Trump becomes President, the markets are expecting actions that will mean positive change for the economy,

Analyzing what change will mean to economic growth is clearly a challenge.  I wrote in October that there is no momentum and no catalyst to push GDP much above 2.0%.  The thought of change may have tried to do that, but change itself may not accomplish it.  For so long, we have been stuck at 2.0% growth.  Since the recovery began in June, 2009, real GDP growth has averaged 2.3%.  Most recoveries in the US have averaged far more than that.  This recovery is already 90 months old and growth has not yet reached its potential.  In the past ten years, the economy has not managed even one year of 3.0%+ growth.  So what has been holding us back?  First, we have inordinately high debt levels, especially in the federal government sector, of nearly $20 trillion.  Actual non-financial debt in the US totals about $70 trillion, or 370% of GDP.  Debt at multiples above 100% begins to hurt the economy.  Debt at multiples above 250% to 300% has been proven to dramatically slow economic growth and push inflation downward.  The last seven years are proof.  Debt is not going away, change or not, and will keep pressure on growth.

Secondly, productivity has been very poor over the past five years or so.  Since 2011, productivity has fallen by -.4%.  Compounding the issue has been a reduction in the labor force, with retirements removing skills from the workforce, discouraged workers, and skills mismatches resulting in people not able to find appropriate jobs.  Corporate profits have been held back as costs rose on a relative basis as productivity fell.  Third, the explosion in regulations over the past eight years has served to hinder businesses, especially new small business formation, and has drained valuable resources as compliance costs soared.  Bank lending has not been the catalyst it used to be for improved growth in this recovery compared to prior ones; maybe we can point at regulation after regulation being forced onto banks and higher, more restrictive capital requirements.  Maybe change will be coming.

What Will Change Look Like?
Change has already resulted in higher stock prices and higher interest rates.  I mentioned that interest rates have risen dramatically since Election Day.  The two year Treasury yield reached 1.26%, its highest level since August, 2009 and the ten year Treasury yield reached 2.58%, its highest level since September, 2014.  The quick jump in rates in late 2016 is reminiscent of the increases in 2013, with rates rising in both cases up 100 basis points in just over 100 trading days.  The markets must think that GDP growth will soar on January 21st.  I have news for them; it takes a lot longer for fiscal policy to translate to growth than you think.

President Trump has promised several policies that should improve economic growth, and Make the Economy Great Again.  He has promised the elimination of many regulations that are strangling businesses.  If bank regulations are lifted, lending and thus growth can improve.  Some regulations have had a negative impact on the markets, such as the Volcker Rule, which has reduced liquidity in the marketplace by restricting trading activities.  I have a theory that some of the rate increases and drop in bond prices were due to reduced liquidity and lack of market making.  I cannot quantify how much at this time, but I am sure it’s there.  Other regulatory reform promised by Trump involves energy production, which could improve growth and serve to keep gas and oil prices lower, keeping inflation at bay.

Corporate and personal tax cuts were promised, with the corporate rate dropping from 35% to 15%.  I don’t know if that large a cut would occur, but these actions will add to economic growth.  I saw an estimate that 50% of the effect of tax cuts flows through to growth in the first eighteen months.  To be truly effective, tax cuts should be paired with cuts in government spending so that there is not additional borrowing to fill the deficit.  In the early 1980s, the Reagan tax cuts took two years to push GDP growth above 3.0% and that was with a Federal Reserve, run by Paul Volcker, who was aggressively lowering rates.  Trump has a Fed, run by Janet Yellen, who continues to believe that they need to raise rates.

Rebuilding our infrastructure is another proposal, but I think government borrowing would increase- either from paying for projects or from tax credits to companies to do the work.  If government borrowing continues to increase, it will add to the crowding out effect on private investment, and not adding much to growth.  But I am in favor of much of this infrastructure improvement and am so tired of having to drive to dodge potholes.

Growth Forecasts
Economists are mixed on their reviews of the Trump proposals and change on GDP growth.  The latest Fed forecasts, released in December, 2016, have ranges for 2017 for GDP of 1.9% to 2.3% and 2018 at 1.8% to 2.2%.  Wait!  That is no better than the 2.3% since 2009.  And the Fed felt compelled to raise rates and to say they will keep raising them?  I think they must be looking at a few signs of inflation and thinking they must tighten now.  If inflation sticks, they will be right, since it will exceed their 2.0% target.  More than likely, high debt levels will keep it under control.  The latest Bloomberg survey, released in January, 2017, has GDP in 2017 at 2.3% with rising rates.  Wait!  That is no better than the 2.3% since 2009.   Some of the “higher” projections are from private economists, Dr. Don Ratajczak and Brian Wesbury with 2017 at 2.6%.  Dr. Ratajczak has 2018 at 2.9%.  The lowest I have seen is for real GDP below 2.0% for 2017, because high levels of debt keep growth and inflation at reduced levels.  With many of these forecasts, I wonder:  Why did rates rise so much?

Thanks for reading!  DJ 01/18/17

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, and Honoring Stephen Jaworski, 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.