Monday, December 24, 2018

Three Gifts for Bankers

The magi, thought to be named Gaspar, Balthasar, and Melchior, followed a bright star to find the Messiah. According to the Gospel of Matthew, they brought him three gifts: gold, frankincense, and myrrh. 

The journey wasn't easy for the magi. At first, they did not know where they were going. And when they arrived in Jerusalem, King Harrod tried to fool them into discovering and reporting the whereabouts of this King of the Jews. 

Although the magi's perils were greater and their journey quite a bit more significant than the modern day banker, I too see headwinds for community financial institutions, and wish for three gifts for them during this holiday season.

My Wish For Bankers in 2019

1.  I wish Artificial Intelligence ("AI") becomes real. The blaring horns about AI in the news and on social media is loud and frequent. I wish it was as loud and frequent within financial institutions. The truth is, we haven't had many wins yet. But it's coming. And my wish is that it comes soon. Because we continue to invest significant resources in operational functions that are the "keep the lights on" variety. Such as balancing accounts between disparate systems, solving for unread items, and trolling through accounts for suspicious activity. These are belt and suspenders type problems that the promise of AI should help solve. And in so doing, perhaps we can re-allocate resources that we tend to over invest in non-value added activities (see the below charts) and re-invest into a bank that delivers a truly superior customer experience, with highly trained and appropriately rewarded employees. 

2.  I wish employee development rises to be the top strategic objective for banks that want to distinguish themselves through their people. I hear some variation of employee development in strategy sessions often. And see progress in employee development much less so. The fear that investing in functional fluency and a career path might lead to employee departure is real. So employee initiatives remain at the forefront of budget cuts. What if you train them and they leave? I believe your biggest threat is to let them languish and they stay. It's a sure sign that the scales will remain tipped toward investments to keep the lights on, as alarmingly demonstrated in the charts above. And don't statistics support that it is less expensive to develop from within than pick up people off of the street?

3.  I wish financial institutions to remain independent because they've earned it! The accompanying chart should be quite alarming for bankers. I know it is for bank consultants! So often, with recent regulatory activism, a severe recession, rising costs and needed technology investments, and fear of the pace of change, financial institutions' are deciding to throw in the towel. But it need not be so! For shareholder owned institutions, determine the desired return of those shareholders and build a strategy to achieve it (long-term), whether through capital appreciation or dividends. And balance the interests of your constituencies: shareholders, customers, employees, and communities. For non-shareholder owned, you still must earn your right to remain independent, achieve acceptable profitability to add to your capital base, grow, and remain relevant to those other three constituencies. Make it part of every planning retreat. Because if you don't know where you want to go, you're already there.  

Those are my wishes for three gifts for bankers in the coming year. Instead of having three fellas from the east come and bestow them on you, make your own gifts. 

I want to thank all of our current and past clients for the gifts you have given me and my firm. We appreciate every one of you. And look forward to serving you and new friends in 2019.

~ Jeff

Thursday, December 13, 2018

Banking's Top 5 in Total Return to Shareholders: 2018 Edition

For the past seven years I searched for the Top 5 financial institutions in five-year total return to shareholders because I promote long-term strategic decision making that may not benefit next quarter's or next year's earnings release. And I am weary of the persistent "get big or get out" mentality of many bankers and industry pundits. If their platitudes about scale are correct, then the largest FIs should logically demonstrate better shareholder returns. Right?

Not so over the seven years I have been keeping track. The first bank over $50 billion in assets was SVB Financial Group, at 208th on the list. The much heralded JPMorgan Chase: 229th. 

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 out those FIs that trade less than 1,000 shares per day. This, naturally, eliminated many of the smaller, illiquid FIs. I also filtered for anomalies such as recent merger announcements, mutual-to-stock conversions, stock dividends/splits without price adjustments, and penny stocks.

As a point of reference, the SNL US Bank & Thrift index total five year return was 45%.

Before we begin and for comparison purposes, here are last year's top five, as measured in December 2017:

#1.  Old Second Bancorp, Inc. (Nasdaq: OSBC)
#2.  Independent Bank Corporation (Nasdaq: IBCP)
#3.  Summit Financial Group, Inc. (Nasdaq: SMMF)
#4.  HMN Financial, Inc.. (Nasdaq: HMNF)
#5.  Parke Bancorp, Inc. (Nasdaq: PKBK)

Here is this year's list:

Carolina Financial Corporation is the $3.7 billion in asset holding company of CresCom Bank, which also owns Atlanta-based Crescent Mortgage Company. The Bank has 61 branch locations throughout the Carolinas. In 2015, the Company was recognized as American Banker's #1 bank for three-year ROE. This is clearly a turnaround situation, as the bank lost over $12 million in 2010, over 20% of its capital (ouch). Its non-performing assets to assets at that time... 9%. But once they turned things around they took their deferred tax asset back onto their books and did three acquisition. Today, NPAs/Assets is a stellar 0.46%, and the Company sports an ROA/ROE year-to-date of 1.27% and 8.91% respectively. These comeback kids have delivered a 398% total return to shareholders over the past five years. Welcome to the list!

#2. Oregon Bancorp, Inc. (OTC Pink: ORBN)

Oregon Bancorp, Inc. is the parent company of Willamette Valley Bank, a community bank headquartered in Salem, Oregon. The Bank operates five full service offices. It also operates 13 Home Loan Centers in Oregon and Idaho. ORBN was $236 million in total assets at September 30 and barely eeked through our trading volume screen, trading about 1,300 shares/day, on average. But the Company is on pace to make $8 million this year (YTD annualized). Eight million! On a $236 million balance sheet. Demonstrates the potential value of a mortgage origination platform, if you can take the volatility. Year to date gain on sale revenues was $27 million. All of 2017 was $29 million. That is up from $6 million in 2014. So I ask readers, can you take the volatility? Because ORBN's year to date ROA/ROE was 3.63% / 32.08% respectively. You read it right. This type of knock the cover off the ball performance resulted in a five year total return to shareholders of 318%. Wow!

Farmers and Merchants Bancorp is the $1.1 billion in asset holding company for Farmers & Merchants State Bank (F&M). It has been serving the financial needs of individuals, farmers, businesses, and industries in Northwest Ohio and Northeast Indiana since 1897 through its headquarters in Archbold, Ohio and 24 additional branch offices. I always search for the "why" when banks excel in total return. For F&M, steady, superior financial performance appears to be their story. They've grown EPS at a compound annual growth rate of 12% over the past five years. Their year to date ROA/ROE is 1.41% and 11.49%, respectively. Thanks to good old growth and balance sheet management which saw their net interest margin expand from 3.49% in 2015 to 3.80% today. All of this blocking and tackling led to a five year total return to shareholders of 310% and the number 3 spot on the JFB total return list for 2018. Great job! 

#4. Fidelity D&D Bancorp, Inc. (Nasdaq: FDBC)

Fidelity D&D Bancorp, Inc. is the $950 million in asset holding company for Fidelity Bank that serves Lackawanna and Luzerne Counties in Pennsylvania through 10 community banking office locations providing personal and business banking products and services, including wealth management. And to them I say... finally someone from my hometown of Scranton breaks into the JFB top five in total return! How did they do it? You wouldn't have known they were destined for shareholder greatness in 2009 or 2010 when they logged consecutive years of losses due to credit woes. But bounce back they did! In 2011, they achieved an 0.85% ROA and a 10% ROE. One year after the climb! And they have consistent improvement since then. Today they are riding a 1.21% ROA and a 12.30% ROE. They have been a regular on the American Banker Magazine's top 200 ROE banks for five years running. And they were recently named as one of Forbe's top in-state banks, which uses customer experience metrics rather than straight financials. All of the hardware resulted in a 295% five year total return to shareholders. More hardware for you!

#5. Plumas Bancorp (Nasdaq: PLBC)

Plumas Bancorp is the $771 million holding company for Plumas Bank. Founded in 1980, Plumas Bank is a full-service community bank headquartered in Quincy in Northeastern California. The bank operates twelve branches, eleven in California and one in Nevada. It also operates four loan production offices, three in California and one in Oregon. Plumas Bank is an SBA Preferred Lender. In 2009, you wouldn't think they would survive, let alone make the JFB list nine years later. They lost $9 million that year, which was 25% of their capital! With the injection of Preferred Equity and Sub Debt they picked themselves up, drove down their non-performing assets/assets ratio from 7.48% in 2010 to 0.45% today. The Company grew EPS at a 29% compound annual growth rate since 2013, and is now sporting an ROA and ROE of 1.86% and 23.61%, respectively. Pretty good. That's why they returned 280% to their shareholders the past five years!

There you have it! The JFB all stars in top 5, five-year total return. The largest of the lot is $3.7 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.

Friday, November 09, 2018

Teflon Tim: You Can't Mess With Wells Fargo

Could the past two years have been worse for Wells Fargo (WF)?

According to an appropriately snarky Gonzo Banker post by Scott Hodgins, Wells' blunders are epic:

September 2016 - Disclosed that they created two million bogus accounts without customer consent to hit the bank's "eight is great" cross-sell targets. That fiasco cost them over $800 million in fines and legal settlements.

September 2016 - Wrongfully repossessed service members' cars. Some of whom were deployed overseas. Thirty million in fines and restitution.

March 2017 - Failed the OCC's community lending test causing "significant harm to customers."

February 2018 - Regulators limit WF growth due to "widespread consumer abuses and compliance breakdowns." 

April 2018 - Agrees to $1 billion in settlements for auto loan and mortgage abuses.

The spate of bad news led to Wells launching a nationwide ad campaign to repair its image.

And since then:

They admitted altering business customer data to address anti-money laundering compliance. Fined by the SEC for pushing inappropriate investment products. Finally got their financial crisis fine. Admitted to 400 wrongful housing foreclosures. And yesterday the Wall Street Journal reported that the OCC notified Wells that "the bank also has failed or isn't expected to meet deadlines on around two dozen technology-focused OCC regulatory warnings... that have been issued since 2014 or earlier."

How many people are in their public relations department? You would think not nearly enough.

Or is it?

I recently addressed a bank client's all officer meeting to discuss industry trends. As part of my comments, I presented the following table of New Jersey Deposit Market Share. I also included the USA deposit market share.

Wells maintained its market share from June 2017 to June 2018 in both New Jersey and nationwide.
In spite of the cascade of bad news, the bank ceded 72 basis points of deposit market share in New Jersey and only 10 basis points nationwide. And this was while they were imposed with a growth
restriction. No wonder why Teflon Tim is smiling in his investor relations pic. I thought it was the green tie. Luck of the Irish. That sort of thing.

So what is it about the bank that has allowed it to endure such bad news, such regulatory scrutiny, and such a mountain of fines and restitution? Superior technology? Nationwide network? The stagecoach?

Wells' challenges are a blinking light for a larger problem. Notice the bigger banks all held serve and maintained leading market share. As community banks, we have not developed a strategy to break through.

So the operative question is, should we be more focused on slaying dragons in our strategic and operating plans? Or, should we be content swatting at gnats? Because the dragon should be wounded.

What do you think?

~ Jeff 

Sunday, October 28, 2018

Bankers: Don't Buy the Hype. Let Fintech Equity Investors Bear the Cost of Experimentation.

When JPMorgan Chase released its 2016 annual report, in which the celluloid CEO Jamie Dimon proudly acknowledged spending nearly $10 billion on technology, the talking heads erupted. Ten billion! Must be good. Jamie does it.

And from that moment the conventional wisdom was and is: community banks can't compete. I just heard it on Friday. A team of investment bankers told a community bank board, "how do you compete with that?" 

I have ideas. Watch/listen to my most recent vlog.

Who should bear the cost of experimentation?

~ Jeff

Thursday, October 25, 2018

Guest Post: Financial Markets and Economic Update by Dorothy Jaworski


The economy is on a roll!  Economic growth picked up strongly in the second quarter, with a reading of +4.2%, as momentum from the tax cuts and deregulation pushed spending and investment higher.  Third quarter growth is also expected to be around +4.0%.  Business and consumer optimism have been high.  Indeed, equity investors have been optimistic, too, sending stock prices higher this year, although these gains have not come without some extreme volatility earlier in October.  Bond investors, on the other hand, are a miserable bunch.  The Federal Reserve continues their tightening
campaign, raising short-term interest rates another .25% in September, to bring the Fed Funds rate to a range of 2.00% to 2.25%.  The Fed has now given us eight rate increases totaling 2.00% since December, 2015.  By the way, I want to run down the street screaming, “Stop!”  At the same time, longer-term rates have risen about .20% to .25% in the past month, while inflation has been falling.  Go figure.  The ten-year Treasury has topped 3.00% and many economists call for its continued rise.  Only a few call for stable or falling rates.  Just remember this:  Rising rates are always the culprit that derails economic growth, ultimately resulting in a reversal for the Fed and falling rates.

We now have four quarters to go before we set a new record length of economic expansion.  I believe that we will.  GDP has increased an average of 2.2% since the current recovery began in June, 2009.  The longest expansion on record was from March, 1991 to March, 2001, with growth of 3.6%, engineered by Maestro Greenspan.  That time period was not without its challenges, especially when the Fed raised rates unexpectedly in 1994.  They may have raised rates too much but quickly realized their error and eased to keep the recovery intact.  We face challenges, too, but we have a good chance of setting the new record in 2019; even if growth slows, I believe it will be back to the 2% trend line through the middle of next year.   The Fed thinks we will make it, too.

Standing in the Way of Growth

I read Dr. Lacy Hunt’s latest newsletter and was surprised when he wrote that the economy appears to be on a downward trend and that long-term rates will fall.  Of course, he does not say when…The Federal Reserve’s raising of interest rates has been a drag on the economy.  Fiscal stimulus in the form of tax cuts, especially for corporations, led to spikes in investment and spending.  But how long can that be sustained as rates rise?  Interest sensitive sectors like automobiles and housing are already slowing.  The yield curve is much flatter this year than last.  The spread between ten year and two year Treasuries is .24% at September 30, 2018 compared to .84% at September 30, 2017.  The curve is not close to inverted yet, but if it does, it will be a precursor of tough economic times ahead.

Government debt poses a threat to growth, but more on that later.  Trade wars and tariffs dominated the market discussion in the third quarter with talk quieting down for now.  Politics is causing concern both here domestically with our upcoming mid-term elections in November and around the world with places like China and the Middle East.  Finally, the dreaded rising oil prices, now at $70 per barrel, always have the potential to derail growth. 

Too Much Debt

Here I go, sounding like a broken record again.  I harp on debt too much, but I strongly believe that it is the primary reason that GDP has only been able to average +2.2% since 2009, compared to 3% to 4% growth in other recoveries.  Debt creates a drag on GDP, especially if it is not productive in generating income.  US Government debt is at 104% of GDP at the end of the second quarter of 2018 and the ratio is likely higher in the third quarter.  Treasury debt exceeds $21 trillion and the growth is on an unsustainable path.  Studies show that GDP growth is sub-par in scenarios where debt is above 90% of GDP for over five years.  Just look at Japan and Europe and see how sluggish their economies have been.  China has slowed from its potential growth rate as debt mounts.  Even US growth is weaker than average.  As rates move higher here at home, do not forget all of the countries that tie their currency to the US dollar.  It is stronger and rates are higher, making it tougher for them to repay debt.

It is not just government debt that is of concern.  Here are some staggering numbers:  Since the financial crisis of 2008, worldwide debt has increased by $70 trillion to $247 trillion, or 236% of world GDP versus 207% in 2008.  US household debt is at $13.3 trillion, up from $9 trillion.  Student debt has more than doubled from 2008 to $1.5 trillion and auto loans are higher at $1.25 trillion.  Just when you think I don’t have any positives, here is the good news on employment and inflation.

Record Low Unemployment

Wow!  The unemployment rate fell in September to 3.7%, matching a low rate first attained in September, 1966 and one that is only slightly above the rate of 3.4% in September, 1968.  This has been great for the economy and is quite an achievement by the Fed, but it is also a source of their constant worry about a low rate of unemployment that could lead to high inflation.  Those who advocate the Phillips Curve relationship would worry.  Those of us who don’t believe in it aren’t too concerned.   It has been great for the economy to see millions of workers obtain jobs and spending ability to push our economy further.  There are over 7 million job openings nationwide.  We still have a large pool of available workers, at over 11 million people, who could jump in to fill jobs.  This “excess capacity” keeps inflation in check.


Speaking of inflation… Admittedly, inflation was trending higher early in 2018.  Wage growth on a year-over-year basis scared everyone with a reading of +2.9% and subsequently settled back in a range of +2.6% to +2.8%.  The consumer and producer price indices were rising vigorously, at +2.8% and +3.1%, respectively, but now the year-over-year changes are falling back to +2.7% and +2.8% for August.  The inflation picture in China was very scary in early 2018, with the “world’s manufacturer” reporting producer prices rising at 7.8% in February; in September, price pressures there have eased to 3.5%.  A leading inflation index published by ECRI was also rising annually earlier in 2018, but is now falling.  Still of concern are oil prices that are up 21% and gasoline prices that are up 11% to 13% year-to-date.  Housing price increases continue, but at a decelerating pace.  Should inflation worry us?  Of course.  But is there a risk of huge inflation?  Not right now.  This will also help us get to the expansion record.

The brightest spot in the economy right now is the movie industry, bringing us films featuring Lady Gaga and Queen, two of my favorites!  I also have two great nephews, ages 2 and 4, who want their Aunt Dorothy to take them to see The Grinch.  

Thanks for reading!  DJ 10/17/18

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.

Tuesday, October 09, 2018

Financial Institutions: What Drives Value v2

In a follow up to my last post on the subject, that was driven by my friends from Performance Trust, I was asked in the comments section of that post if there was a correlation between non-interest bearing checking accounts and price-to-tangible book multiples.

That nugget was asked by Mike Higgins, a bank consultant from Kansas City, who penned a guest post on these pages in the past. Rather than answer Mike in the comments, I opted for the wider audience distribution of a standalone post.

It's my blog. I can do what I want.

I am somewhat limited to how financial institutions report their deposit mix. Call report categories are easiest, and the closest metric is transaction accounts to total deposits. I thought this would give us what we needed.

So, is their a correlation between a bank's relative level of transaction accounts to their price-to-tangible book trading multiple?

See for yourself.

The data, courtesy of S&P Global Market Intelligence, is all publicly traded US banks with trading volumes greater than 1,000 shares per day, and that have non-performing assets to total assets less than 2%. That filtered out most of the very small, inefficiently traded financial institutions, and those with asset quality issues. I also eliminated banks that had NA in the transaction accounts/total deposits ratio.

The filters resulted in 306 financial institutions, which I divvied up into quartiles based on transaction accounts to total deposits. The top quartile, with 56.78% transaction accounts to total deposits traded at 208% price to tangible book at market close on October 4, 2018. The bottom quartile, with 24.71% transaction accounts to total deposits, traded at 145% price to tangible book. The line is linear. Which reads funny as I proofread.

So I would say: yes, community bank investors reward banks funded with a higher proportion of checking accounts with greater trading multiples. So when I wrote in June 2018, in a post titled Branch Talk, my Point 1 was that banks needed to build a cost of funds advantage by having a relatively higher proportion of checking accounts, the above chart is why.

In reviewing the data that fed the above chart, size was likely not a significant issue. All of the numbers above are medians, not averages. And the median asset size from bottom quartile to top were: $1.6B, $2.2B, $3.2B, $2.1B. Wells Fargo and JPMorgan, the nation's largest FIs, were both in the 3rd quartile.

A bonus table:

So there is a neat line in Return on Average Assets too. Price to earnings is not so neat, but I find it rarely is. Still, the message is clear. More checking, better performance, higher trading multiples.

Do you see it differently?

~ Jeff

Wednesday, September 26, 2018

For Financial Institutions, What Drives Value?

Not all financial institutions are publicly traded. But there are enough of them to help those that do not trade to measure what metrics drive the value of their franchise. 

So what metrics drive value? Umrai Gill, Managing Director of Performance Trust in Chicago presented his findings to the Financial Managers Society at their East Coast Regional Conference this month. Some results were surprising.

He first cited a survey performed by PT, asking their clients "what are the generally accepted drivers of institutional value?" Without identifying ranking or more details about their survey, the preponderance of responses were as follows, in no particular order: loan-to-deposit ratio, investment portfolio size, net interest margin, efficiency ratio, return on average assets (ROAA), return on average tangible equity (ROATE), capitalization, and asset size. 

Some were not very interesting to me, such as investment portfolio size, which might have been influenced by PT's specialty. Others might have been too investment community-like, such as ROATE, which doesn't count high premiums bank buyers pay for bank sellers that results in goodwill on the buyers' books, which is deducted from their regulatory capital. But others struck my curiosity to see if there were correlations between the metric and market valuations. 

And I thought I would share with my readers.The charts in the slides below was PT's analysis of data from S&P Global Market Intelligence based on June 30, 2018 financial information using market data from 08/17/18.

First, the metrics that showed correlation to price to tangible book values. Not surprising, in my opinion.

Asset Size

Efficiency Ratio

Profitability / ROAA

Next, the ratio that did not show a correlation to price to tangible book multiples, at least not over 3.5%. I was a little surprised at this one.

Net Interest Margin

Lastly, and most interesting from my point of view, were ratios that showed mixed results. In other words, they showed positive correlation to price-to-tangible book ratios, up to a point. After which, they showed a correlation, but not what bankers would hope for.

Tangible Common Equity / Tangible Assets

Loan-to-Deposit Ratio

The highest market multiples were afforded to banks with a 70%-80% loan to deposit ratio. Now that may be related to size of institution, as the very largest, JPMorgan Chase (67% loan/deposit ratio) and Wells Fargo (76%) tend to have lower ratios. But there is likely something to the fact that a bank that still has strong liquidity as represented by a relatively lower loan-to-deposit ratio in a good economy has room to improve earnings by growing loans faster than deposits. While the less liquid must price up their deposits to get funding.

And capital, well, I refer you to a prior post where I clearly stated there was such a thing as too much capital. Investors will not pay a premium for hoarded capital. Performance Trust's research puts that sweet spot in the 9%-10% tangible common equity / tangible assets range. Enough capital to grow and/or absorb recessionary losses without selling off assets at a discount to bolster capital during hard times.

Where are your sweet spots?

~ Jeff

Sunday, September 16, 2018

Are Bank Products Simple, Fair, and Transparent?

I was on a road trip discussing banking with a colleague, and I mentioned that bank products are anything but simple, fair, and transparent. He said, “sounds like a blog post.”

I have never heard a bank customer say, “gee, I wish my bank relationship was more complex.” Yet we charge business checking fees based on a complex analysis, offer a 7-month special CD only to roll it into a lower yielding 6-monther if the customer isn’t attentive, and require high-interest checking customers to have 10 debit transactions, e-statements, and a partridge in a pear tree to get that rate. Sound simpler, fairer, and more transparent?
On the other side of the coin, bank customers don’t necessarily understand what it takes to run their accounts profitably. Dear customer, the Federal government requires financial institutions to monitor your account for suspicious activity and report anything untoward. That costs time and resources that drive up the cost for your checking account. That is why every overdraft fee, interchange transaction, and minimum balance fee counts. Your government drives up bank costs.
It costs $423 per year for a bank to run a retail interest-bearing checking account, based on my firm’s product profitability database. To cover that cost solely on the spread that your balances generate would require an average balance of $21,363 in your account. All. The. Time.
I have written on these pages that I thought the past practices of relying on customers to be asleep at the switch and accept rates significantly different than market rates will soon be over. Banks must shift business models to pay depositors something closer to market rates for “accumulation accounts”, which are accounts for long-term savings such as an emergency money market account, or a CD ladder.
Cost of funds advantages should be built on having relatively higher “store of value” accounts such as checking, or special purpose savings where convenience and safety are more important to the customer than accumulation.
So I don’t point out a problem without proposing a solution, I have an idea for a Simpler, Fairer, and more Transparent small business banking deposit product. Call it the Jeff For Banks (JFB) Business Banker Account. As I mentioned in past posts, I’m a narcissist and I’m trying to get something named after me.

JFB Business Banker Account
The product is a combined store of value checking account, and an accumulation money market and/or sweep account. But no sweep here into a repo where we have to pledge investment securities against balances. That wouldn’t meet the simple test.
Banks can pay businesses interest on their checking accounts. So I propose banks segment business checking accounts by their resource utilization, and create minimum balances based on this segmentation. So the college bar that drops off bags of money each morning at the local branch has a higher threshold before it doesn’t get charged a monthly maintenance fee and receives interest.
So the average balance for high utilization quartile account might be $70,000, above which the account receives a competitive interest rate, and below which the account is charged a monthly maintenance fee. Here is what the math might look like for Pete’s Corner Bar.

JFB Business Banker Account Profitability Estimates
1 Average Balance $92,102
2 Checking Average Balance 70,000
3 Checking FTP Spread* 1,463
4 Money Market Average Balance 22,102
5 Money Market FTP Spread* 197
6 Total Account Spread $1,660
7 Fees** $540
8 Annualized Operating Cost per Account* $784
9 Pre-tax Profit $1,416
10 Pre-tax ROA 1.54%
11 Equity Allocation* 1.00%
12 Pre-tax ROE 154%
13 Total Account Cost of Funds*** 0.30%
*Per TKG product profitability peer data
**Assumes one incoming/outgoing wire/month
***Money market balance * 1.25%

The bank would still charge per use fees for things like wires, ACH’s, overdrafts. And receive interchange income. But the spread should cover items presented plus profit for the bank. Imagine having 10,000 of the JFB’s Business Banker Account. Instead of 1,000 of this account, 2,000 of that account, 4,000 of another account, and 3,000 old grandfathered accounts. Which would be easier for your branch and business bankers to explain to your customers? And marketing people tell me that bankers sell what they know.
Does the JFB Business Banker account pass the Simple, Fair, and Transparent test?

~ Jeff

Saturday, August 25, 2018

The Real Reason for Bank Scale: Trading Multiples

"Get big or get out." "You must be twice the size that you are to succeed." These are bromides that some industry talking heads might be telling you. I hear it and read it frequently. And in today's social media, non fact-based opinion society, if you say it enough, people may start to believe it.

I moderated a strategic planning retreat with a bank that achieved top quartile financial performance. Their growth was solid too. Their asset size was less than $500 million. A director challenged me: Does our size matter so long as we continue to perform the way we have performed? My answer: Not really, with one exception.

Trading multiples. I referenced this phenomenon in a 2013 blog post, Too Small to Succeed in Banking. In that post I opined, "As we migrate towards greater institutional ownership, stock liquidity is becoming increasingly important." What I said then likely remains true today. Institutional owners (funds, etc.) now own two-thirds of shares outstanding in publicly traded US banks. 

But why does this matter to my sub $500 million in assets bank client?

So I ran some charts for you (courtesy of S&P Global Market Intelligence).

The bottom table was a bonus so readers can see that at the end of 2017 bank p/e's relative to the S&P 500 p/e surpassed their 10-year median in every asset category. Significantly so for banks $500 million to $5 billion in assets. So, on a relative basis, valuations are higher. 2008 was an anomaly because the S&P 500 companies traded at stratospheric p/e's because they had no "e".

Back to my main point. Over the past 10 years, banks that have less than $500 million in total assets have traded at lower price-to-tangible book multiples. In every year. And the differences in multiples match up nicely by asset size. The price-to-earnings chart is a little murkier based on the choppiness of earnings. However, investors tend to value smaller financial institutions more on book value than earnings. A good earner, like my client, tend to trade at relatively low p/e's because they have great earnings. 

Does that sound right? Earn better, and get rewarded with a lower p/e?

Fair is in the eye of the beholder. If you remove nearly 2/3 of the potential shareholder base because you have little daily trading volume, then you have less buyers seeking your shares. Supply and demand.

And that is where the economies of scale argument has merit. If you intend to remain independent, and continue to perform well and grow sufficiently, then you are likely delivering total returns acceptable to shareholders. Even without trading multiple expansion.

But if you would like to acquire a nearby financial institution, and you are trading at lower trading multiples than other would-be acquirers, you would be at a disadvantage. Your "currency" isn't worth as much as your larger competitors. Which may also make you vulnerable to an aggressive buyer's offer to buy you, if the buyer is large and has much better trading multiples than your bank.  

Fortunately, unsolicited offers are not common in our cordial industry. But we shouldn't rely on it.

~ Jeff