Tuesday, August 29, 2017

Banks and Bungee Cords

Your relationships, your job, your life comes with baggage. I recently made the analogy that there are bungee cords affixed to your belt. Some hold you back. Some propel you forward.

And it applies to banks too.

In a traditional SWOT analysis, there are things within your control (strengths, weaknesses), and things outside of your control (opportunities, threats). But what are the forces that propel you towards your strengths and opportunities? Or towards your weaknesses and threats?

These forces are mostly within your control. Should you choose to embrace the challenge.

Do you?

Here are the forces I see for bankers that pull them back, toward their weaknesses and threats:

1.  Regulators. OK, I'm playing to the audience. But regulators don't want you to veer off the beaten path. Keep it plain vanilla. Build a bank that thrived in 1963. Ask those bureaucrats this question: "How many businesses have you run?" Because you would swear by their swagger they were Richard Branson or Elon Musk.  

2.  Seargents. If you have hired me, or have read what I have written, you would understand that I believe there are "old-schoolers" in your organization that cause tremendous friction to progress and change. 

3.  "No Mistakes" Culture. The amount of energy that banks commit to being 100% in compliance, find no audit findings, or, gasp, no Matters Requiring Attention on their exam, is monumental, in my opinion. Some operations managers' evaluations and, in some circumstances, variable compensation is dependent on clean audits. What does that get you? Hyper conservatism in compliance. And a whole lot of "we can't do it" from executives. It's killing our industry.

4.  He's/She's Not Ready. This is a common reason I hear why banks don't elevate forward thinkers to the executive suite. They fear those "crazy ideas" they have in management meetings, or the fact that they are willing to accept some risks old school bankers would not. Better to keep them suppressed deep in the bowels of our organization and let others pilfer our future customers than to risk innovation through calculated risk taking.

Here are the forces that I see can propel bankers forward:

1.  Allowing Experimentation. And, 'gasp', failure. I'm not talking "bet the bank" failure. But a failure that may bust your budget is not Armageddon. It is an opportunity to learn, and help you implement the next innovation. Not the reason to look back 10 years and think, 'we tried and failed 10 years ago and, dag nabbit, we are not goin' to try again!'

2.  Fire Seargents. They are not that important to your organization. In fact, they are destroying it. And when you give them their packing papers it sends a message to the masses... "We are a forward looking bank. Backward thinkers take notice."

3.  Continuous Learning. A bank that believes everyone, from the CEO to the newly hired loan operations clerk, should learn, will have a far better chance to being the one bank that survives the non-stop tide of bank consolidation.

4.  Run the bank by strategy, not by budget. Strategy forces banks to look far out into the future. Running by budget forces bankers to look to next year. Where is the puck going, versus where it is. We intuitively know that our industry would not have yielded so much market share to outsiders if we could think outside of our budget. 

So you have bungee cords hooked to your belt. Where are they pulling you?

~ Jeff

Sunday, August 20, 2017

Small Bank-Big Bank: Spending on People, Technology

I was recently slated to speak at an industry conference and I was diligently preparing when the organizer asked if I would be on a panel instead. Fine. But what about my diligent preparation?

I have a blog.

My remarks, should I have made them, were going to revolve around how much large banks spend on strategically significant resources compared to small banks. I took no bias into my search. I ran the data, and here are the results based on bank Call Report data.

The initial news was good. Smaller banks, either under $10 billion in total assets or the smaller group, under $1 billion, dedicate a greater proportion of their total operating expense to salary and benefits. The under $1 billion cohort spends nearly 9% more of their operating expense on employees. This would seem to be crucial, as I frequently hear bank strategy teams identify employees as a strategic advantage smaller banks have over larger ones.

Not so fast. I broke down salary and benefits per employee as well. And in that case, it appears as though the larger financial institutions pay more. The greater than $10 billion banks pay $103,235 per employee versus the under $1 billion banks at $76,411, a 26% difference. That explains why no hands went up at the Pacific Coast Banking School when the director asked how many students went to college to be community bankers.

To further the challenge for small financial institutions, the $1 billion to $10 billion cohort pays 12% more. So if the altruist wants to work for a community bank that is closer to its communities, they can make more with big brother. 

I understand that many, if not most under $1 billion banks are in rural areas, and therefore the salary and benefits disparity may be misleading. But we would be hard pressed to find a college senior that says they'll take a 26% pay haircut and work in Tombstone, Arizona. Although I'm sure there are exceptions.

I'm sure Tombstone is nice. I use as an example recognizable by all. Please refrain from angry comments and e-mails.

My second data search revolved around IT expenditures using the same asset size cohorts. Actually, the Call Report category is Data Processing expense. Although I've been poked for using this 70's-80's phraseology. You know who you are!

A note on the data. It does not include personnel.

The news looks good for smaller banks, spending a relatively larger proportion of their operating expenses on IT. But the larger banks are gaining ground, growing this line item at a compound annual growth rate of 10% over the past 10 years. The banks in the middle cohort spend relatively the least on IT.

What was alarming was how little this expense represented of total operating expenses. Reading industry literature one would think IT would dominate the expense ledger. Not so. 

But it will. 

Were there any surprises in the above tables?

~ Jeff

Saturday, August 12, 2017

Bank Loan Leading Indicators

I recently shared a long ride with a colleague discussing a Capital Plan project we were working on. In Capital Plans, you would typically use baseline projections, usually taken from the strategic plan, and apply adverse events that, based on the bank's balance sheet and strategy, can occur. Even if they are not particularly likely to occur. 

But it's planning. And planning for bad stuff is part of planning. Life isn't all sunshine and rainbows.

As part of our commute discussion, we talked about leading versus lagging indicators of adverse events in order to reduce the impact of such events. Many if not most adverse events are beyond the bank's control. Because risks don't typically come home to roost at the time the Board or Management decide to accept the risk. Lagging indicators are easy, such as the migration from 30-89 days past due, 90+ past due, and non-accrual loans.

But lagging indicators are history. It would've been nice to know that Lee Harvey Oswald was heading to the sixth floor of the Texas School Book Depository. Unless you're Oliver Stone. Then you're wondering who Lyndon Johnson is talking to. I digress. Stopping Oswald or diverting him likely would've ended in a different result.

Can banks identify leading indicators that can reduce risk at the right time?

I was never a lender. And my firm is not in Loan Review or other areas involved with the evaluation of credit. Nor are we an ALCO firm, estimating Interest Rate Risk or Liquidity Risk. But we do Strategic Plans, Capital Plans, Process Reviews and General Advisory that deals with how banks identify and mitigate risk. 

Credit risk remains the greatest risk to a financial institution by far, in my opinion. Not even close. Although examiners and consultants will tick off a laundry list of risks that could put your bank in peril, like reputation risk. The way reputation risk is likely to roost is through liquidity risk. Customers lose confidence in your bank and your liquidity position takes a nosedive. But has many financial institutions suffered as much reputational damage as Wells Fargo recently? And their liquidity ratio is over 40%. They have plenty of liquidity.

No, I'll stand by my credit risk statement. Take the IndyMac domino effect. They had credit problems that came home to roost, Senator Chuck Schumer wrote a letter to the OTS about the bank's problems, and due to the reputation risk customers made a run on the bank. Liquidity is what put them under. Credit is what pushed the first domino.

Identifying leading indicators for credit risk isn't particularly difficult. Finding research that makes the correlation is. But I will list what I think are common-sense leading indicators to credit risk that may very well be effective, and hopefully can be tracked and monitored automatically so we don't have seven risk management analysts on staff hunting and gathering data.

JFB's Credit Risk Leading Indicators
1.  Residential and Commercial Real Estate, and Construction Lending: Trend of days on market (by property type)

2.  Residential and Commercial Real Estate, and Construction Lending: Trend of the difference between initial asking price and actual sale price (by property type)

3.  Commercial and Consumer Lending: Trend of average balance per commercial checking (by NAICS code), and retail checking accounts

4. Residential and Construction Lending: Trend of price index for single family homes under construction

5. Residential, Commercial Real Estate, and Construction Lending: Average checking account balance trends for your customers in the Real Estate Development NAICS

6.  Commercial Real Estate and Multi-family Lending: Trends in occupancy rates.

These are a few that I have seen or make sense to me. Could they be downloaded into a dashboard so bank management could see the trends, and modify risk appetites to curtail new lending in categories that are showing yellow or red? And advise your bank's borrowers on how to navigate difficult times to preserve their business to fight another day?

Do you agree with the above indicators and what others should be considered?

~ Jeff