I will occasionally quote Sun Tzu from his seminal book, The Art of War. I am not trying to imply that winning battles and winning in a
competitive marketplace is the same thing. One leads to lessons learned,
perhaps a loss of wealth, but never death and conquest.
But Sun’s wisdom cannot be ignored. He was a Chinese
general, strategist, and philosopher that lived over 2,000 years ago. His
book is a must read at military academies and business schools alike.
One such quote I would like to share and discuss practical
application is:
“If you know the enemy and know yourself, your victory will
not be in doubt.”
I use this quote as it relates to a financial institution’s
situation analysis, environmental scan, or whatever you choose to call it. What
I believe Sun meant: the general that knew his enemy’s weaknesses, and
exploited them, and knew the enemy’s strengths, and avoided them, wins.
And I believe this to be the case with your competition.
I am moderating a planning retreat for a client this week.
And in so doing, we have prepared a peer group financial condition and performance
analysis for the bank’s strategy team. But it doesn’t go far enough. Executive
Management’s personal knowledge of, and research into the strengths and
weaknesses of their competitors is essential to building a strategy to expose
their weaknesses and dodge their strengths.
Some information will be based on competitive actions in the
marketplace. Much of it, however, can be gleaned from publicly available
information.
Let’s go through the data with one such competitor.
FFKT Farmers Capital Bank Corporation (the “Company”),
Frankfort, KY
FFKT is a financial holding company which had four
wholly-owned bank subsidiaries at year-end 2016. The Company provides a wide range of
banking and bank-related services to customers throughout Central and Northern Kentucky.
It had four bank subsidiaries including Farmers Bank & Capital Trust
Company ("Farmers Bank"), Frankfort, Kentucky; United Bank &
Trust Company ("United Bank"), Versailles, Kentucky; First Citizens
Bank (“First Citizens”), Elizabethtown, Kentucky; and Citizens Bank of Northern
Kentucky, Inc. (“Citizens Northern”), Newport, Kentucky. In February 2017, the
Company merged United Bank, First Citizens, Citizens Northern, and FCB
Services, Inc. (“FCB Services”) into Farmers Bank, the name of which was
immediately changed to United Bank & Capital Trust Company
(the “Bank”).
At year-end 2016 the Company had the following wholly-owned
nonbank subsidiaries: FCB Services, a data processing subsidiary located in
Frankfort, Kentucky; FFKT Insurance Services, Inc., (“FFKT Insurance”), a
captive property and casualty insurance company in Frankfort, Kentucky; and
Farmers Capital Bank Trust I & III, established to issue Trust Preferred
Securities (“Trups”), a hybrid Tier 1 Capital instrument.
How do I know this without having inside information about
the Company and Bank? It’s in their Annual Report. FFKT is not a client, and I do not know any non-public information about them.
The Company had asset quality problems, which they appear to
have beaten. In 2013, their non-performing asset/asset ratio was near 5%, down
to 2% today. Still high relating to other financial institutions, but the trend
is very favorable.
The Company did two things to increase profitability either
at the end of last year, or early this year. One was to consolidate bank
charters from four to one, the cost of which was accrued mostly during 2016 and
was executed in February of this year. The other was to restructure its balance
sheet by pre-paying senior debt, deleveraging its balance sheet and increasing
its net interest margin.
And it has worked. Investors' patience paid off in a second
quarter ROA of 1.08% and a 9.40% ROE. Where will the Company turn to keeping
the positive trend? Since investors have been patient for the Company to
rebound, it is fair to assume that there is little appetite for strategic
investments that don’t have very quick payback periods. And upon review of the
balance sheet, there is opportunity to improve today and impact financial
performance in the very near term.
The Company’s yield on earning assets was 3.92% for the
second quarter, placing it in the 25th quartile amongst its peers.
The culprit is a low loan/deposit ratio that has been as low as 67% in the past
five years, but has grown to 73% in the second quarter. Although the loan
portfolio has not grown much. The increase in loan/deposit ratio was mostly
attributed to sparse loan growth combined with deposit decline. Commercial Real
Estate ("CRE") loans grew from 29% of total loans in 2013 to 38% in the second quarter.
So the bank is growing CRE loans to improve its yield on
earning assets.
I discerned all of this from public information either in
their SEC (Annual Report) or FFIEC (Call Report) filings.
But there’s more. In their Annual Report, the Company
disclosed its CRE underwriting criteria as follows:
Commercial Real Estate
‘Commercial real estate lending made up 41% of the loan
portfolio at year-end 2016. Commercial real estate lending underwriting
criteria is documented in the lending policy and includes loans secured by
office buildings, retail stores, warehouses, hotels, and other commercial
properties. Underwriting criteria and procedures for commercial real estate
loans include:
● Procurement of
Federal income tax returns and financial statements for the past three years
and related supplemental information deemed relevant;
● Detailed financial
and credit analysis is performed and presented to various committees;
● Cash investment
from the applicant in an amount equal to 20% of cost (loan to value ratio not
to exceed 80%). Additional collateral may be taken in lieu of a full 20%
investment in limited circumstances;
● Cash flows from the
project financed and global cash flow of the principals and their entities must
produce a minimum debt coverage ratio of 1.25:1;
● For non-profits,
including churches, a 1.0:1 debt coverage minimum ratio;
● Past experience of
the customer with the bank;
● Experience of the
investor in commercial real estate;
● Interest rate
shocks for variable rate loans;
● General and local
commercial real estate conditions;
● Alternative uses of
the security in the event of a default;
● Thorough analysis
of appraisals;
● References and
resumes are procured for background knowledge of the principals/guarantors;
● Credit enhancements
are utilized when necessary and/or desirable such as assignments of life
insurance and the use of guarantors and firm take-out commitments;
● Frequent financial
reporting is required for income generating real estate such as: rent rolls,
tenant listings, average daily rates and occupancy rates for hotels;
● Commercial real
estate loans are made with amortization terms generally not to exceed 20 years;
and
● For lending
arrangements determined to be more complex, loan agreements with financial and
collateral representations and warranties are employed to ensure the ongoing
viability of the borrower.’
So the bank has rigorous underwriting criteria for CRE loans done within policy. I have found this typical for banks emerging from credit problems.
Growing the portfolio fast enough to improve near term
performance, and being mindful that they don’t want to revisit their credit
problems of the past, indicates that this Company may be willing to sacrifice price for quality, therefore making them aggressive pricers in the market to get deals done. What I
term the “it’s better than we’re getting in the investment portfolio”
philosophy.
Competing banks should take note, and position themselves to win business
accordingly, either on speed, service, structure, or deeper relationships with borrowers.
All of this information and more are publicly available
about your competitors, even if they are not SEC filers. All must be Call
Report filers.
Could I be wrong? Of course. But the combination of publicly
disclosed information on a competitor, plus your bankers’ knowledge of how they
act in the marketplace, can give you a competitive advantage over them should
you invest the time into the research, and respond accordingly.
Know your enemy.
~ Jeff