Tuesday, December 27, 2022

Finovate Best of Show 5 Years Later

Among bankers, there is anxiety. Anxiety from outsiders promoting newfangled technologies that must be adapted in order for their bank to be relevant. Anxiety from insiders chiding them to innovate because this customer or that customer asked about some piece of technology their other bank has. Anxiety from conferences that feature young speakers touting shiny objects.


There is little benefit to anxiety if it doesn't result in action. And knowing where and when to act is critical in a changing industry like ours. The more we create and later hone the formula for making strategic decisions that result in positive action, the less anxious we will be.

For example, if you empower employees to present innovation ideas to your executive team or a committee, do so in a systematic way. Have the employee build a business case. A business case that you would have created the template and provided instructions on how the employee should proceed in getting their innovation idea considered and possibly adopted. Not a process so cumbersome it inhibits adoption of great ideas. But cumbersome enough to provide the needed filters to not chase shiny objects. Such as...

1) Must we do it (as in CECL)? 2) Is it consistent with strategy (as in demanded by high lifetime value (LTV) customers)? 3) Will it make us more efficient in how we run the bank (lower expense and/ or efficiency ratio)? 4) Will it improve the customer experience (and extend customer longevity, shorten sales cycles, improve pricing power)? 5) What is the cost? And, as you will note from the rest of this article, 6) Longevity of solution(s) provider.

Only then would you move to the solutions to solve the problem or innovate. But what solutions? Does it depend on the last conference attended by an employee? How much longevity does the solutions provider have?

This is increasingly on the minds of bankers. Many solutions providers in the fintech space are very young, don't have many installations, and have yet to turn a profit. Does it mean they are not viable alternatives to your bank? Not necessarily. But bankers want to ensure if they partner with a solutions provider, they will be viable into the future. And ideally would not have sold to a big three core processor that increases core dependency.

That is why I occasionally look at Finovate best of show companies. To see where they are now because they were much ballyhooed by a top trade show in the country for fintech solutions. It should be instructive to bankers that evaluate solutions and implement a disciplined innovation culture, without creating such roadblocks that slow bankers down into becoming the bank they need to be for long-term relevance.

Finovate Best of Show: Fall 2017

Five years ago, these were rated the best. I include the description from Finovate five years ago, and where they are today.


2017 Finovate Description: Envestnet was recognized for its Financial Health Check that leverages account and transaction-level data to measure and score overall financial health across multiple dimensions including spending, savings, borrowing, and planning.

Today: Envestnet continues to transform the way financial advice and insight are delivered by powering financial advisors and service providers with technology solutions that work toward expanding a holistic financial wellness ecosystem. It has over 108,000 advisors working for more than 6,000 companies including 18 of the 20 largest banks. Although reporting positive EBITDA in the four years and year-to-date (9/30/22) since being named best of show, it has reported net losses in two of the four full years and year to date. 


2017 Finovate Description: Finn.ai was chosen for its Virtual Banking Assistant, powered by artificial intelligence and available via channels ranging from Facebook Messenger to Amazon Alexa. It makes everyday banking simple and easy for customers.

Today: Finn AI was purchased by Glia in June 2022 where it remains a leading AI-powered virtual assistant platform for banks and credit unions, partnering with major FIs including ATB Financial, BECU, United Federal Credit Union, EQ Bank, Civista Bank and Truist Momentum.


2017 Finovate Description: Jiffee won best of show for its tap & pay mobile technology that turns any device into a payment terminal, enabling for consumers to pay anywhere and everywhere without relying on plastic credit and debit cards. 

Today: Jiffee is a white-label mobile payment and authorization platform that securely confirms the identities of both parties on either side of a transaction. Jiffee is owned by Neontri, formerly Braintri, a private fintech based in Warsaw, Poland that entered the U.S. market in 2019. There were no financials available and no list of U.S. users on their website.


2017 Finovate Description: Sensibill was selected for its +Pulse solution that helps spot revenue opportunities from on- and off-card purchase data, providing targeted prospect list for personalized, in-app campaigns. 

Today: Canada-based Sensibill is a customer data platform designed specifically for the financial services industry with an AI-powered, ethically sourced first party data with real-time actionable insights that help FIs drive personalization at scale. They claim over 60 million users across over 150 FIs in North America and the U.K. In October 2022, Sensibill was acquired by fintech aggregator Q2.


2017 Finovate Description: SpyCloud was selected for its monitoring and alert service that helps organizations better understand their employee and customer digital footprints by giving them visibility into their exposed credentials actively being traded in the underground.

Today: Spycloud's products leverage a proprietary engine that collects, curates, enriches and analyzes data from the criminal underground, driving action so enterprises can proactively prevent account takeover and ransomware. Its customers include half of the ten largest global enterprises, mid-size companies, and government agencies around the world from its Austin, Texas headquarters. It has been funded with four rounds for over $58 million, the latest raise occurring in 2020. 


2017 Finovate Description: Chosen for its social good platform for consumers and businesses that turns the spare change from shopping into micro-donations to philanthropic causes. 

Today: As best I can tell, Sustainably, a U.K. based 2016 startup that helped businesses and consumers earmark spare change from purchases to their charity of choice, shut down this year. Although this fintech did not make it, the idea could advance an FIs higher purpose by helping their customers fulfill their higher purpose.


2017 Finovate Description: Voleo was selected for its social trading app that makes it easy for people to invest together, saving time and money, while simultaneously leveraging the collective wisdom of networked investors to pursue market-beating returns.

Today: According to its website FAQ, effective June 2020, Voleo USA, Inc. closed its US brokerage. Although they claimed their user base swelled dramatically, Covid-19 had cut off traditional funding sources and since they were not yet profitable, their parent company indicated it was unable to continue to support the operating losses.  

Of the seven Finovate Fall 2017 Best of Show, three continue to operate independently. Two were acquired, and two shuttered. This exemplifies the anxiety bankers experience when selecting partners. There is vendor risk that the solution might not make it, as is usual when partnering with relatively new firms/ solutions. Take solace that your partner selling to a larger technology firm is usually a good thing, perpetuating the solution and its evolution.

However, there is risk. And bankers must assess the risk when selecting a solution partner. But only after going through the disciplined process outlined at the beginning of this article so you have a better chance of avoiding shiny objects.

~ Jeff

Friday, December 16, 2022

Banking's Top 5 Total Return to Shareholders: 2022 Edition

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

Not so over the eleven years I have been keeping track. The first bank to crack the Top 5 over $50 billion did so in 2020. As a reference, the best SIFI bank in five-year total return this year was JPMorgan Chase at 82nd overall. 

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 more than those that make those investments. I call this "pulling into the pits" in my book: Squared Away-How Can Bankers Succeed as Economic First Responders. Short-term focus is a common trait of banks that focus on shareholder primacy over stakeholder primacy.

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. I changed this from 2,000 shares as it was pruning too many fine institutions. But the 1,000 shares/day minimum naturally eliminates many of the smaller, illiquid FIs. I also filtered for anomalies such as recent merger announcements as a seller, turnaround situations (losses suffered from 2017 forward), mutual-to-stock conversions, stock dividends/splits without price adjustments, and penny stocks. 

As a point of reference, the S&P US BMI Bank Total Return Index for the five years ended December 9, 2022 was -1.21%.

Before we begin and for comparison purposes, here are last year's top five, as measured in December 2021:

#1.  Silvergate Capital Corporation (NYSE: SI)
#2.  MetroCity Bankshares, Inc. (Nasdaq: MCBS)
#3.  Triumph Bancorp, Inc. (Nasdaq: TBK)
#4.  Live Oak Banchsares, Inc. (Nasdaq: LOB)
#5.  SVB Financial Group (Nasdaq: SIVB)

Here is this year's list:

Communities First Financial Corporation is the bank holding company for Fresno First Bank, which opened in December 2005 dedicated to meeting the banking needs of businesses, professionals, and successful individuals in Central California. Its headquarters is the only location. Each employee has an ownership stake in the bank through its Employee Stock Ownership Plan. In 2021, the bank expensed over $530 thousand to the ESOP to benefit employees. Twenty-six percent of the bank is owned by the Board, Executive Management, and the ESOP. I would call that stakeholder alignment. Since 2016, over 50% of total deposits are non-interest bearing, driving superior cost of funds and net interest margin. In addition, the bank developed a niche in the payments business, sponsoring multiple independent sales organizations (ISOs) specializing in bankcard and ACH payment solutions, generating $2.5 billion in processing volume in the third quarter of this year. All this generated a year-to-date ROA / ROE slash line of 2.23% and 29.56% respectively, and a 225.3% five-year total return to shareholders. Welcome to the top of the heap!

Since 1997, Coastal Community Bank, the wholly owned bank subsidiary of Coastal Financial Corporation, has delivered a full range of banking services to small and medium-sized businesses, professionals, and individuals throughout the greater Puget Sound (Washington) area through a traditional community bank branch network in its three-county market. The bank consists of two segments: 1) the traditional community bank, and 2) CCBX, which is its Banking as a Service (BaaS) division started in 2018. Prior to starting CCBX and for the year ended 2017, the Company had $806 million in total assets and $5.4 million in net income for an ROA of 0.73%. As of or for the year-to-date September 30, 2022, the Company had $3.1 billion of total assets, $36.7 million net income (YTD annualized), and a 1.27% ROA. Their CCBX segment continues to evolve, with 19 active partners, two in testing, five signed letters of intent, and three in wind-down as the bank focuses on larger and more mature relationships. What has this bifurcated business model delivered? A 221.5% five-year total return and #2 on the JFB Top 5! Well done!

#3 OFG Bancorp (NYSE: OFG)

San Juan based OFG Bancorp is a financial holding company under U.S. and Puerto Rico banking laws and regulations. Founded in 1964, OFG's banking subsidiary, Oriental Bank, is one of Puerto Rico's largest banks, and is focused on the island and the U.S. Virgin Islands. OFG also has Trust and Insurance services, which represent 1.9% and 2.6% of total revenues, respectively. The Company has grown to $10.1 billion in total assets at September 30, 2022, fueled by organic growth and acquisitions. The bank has a diversified loan portfolio of residential, commercial, and consumer loans. Most consumer loans are auto loans which represent 28% of the total loan portfolio. Loan yields for the YTD ended September 30th was 7.32%. Which compensates for an annualized net charge-off rate of 1.16%. Risk versus Reward. Demand deposits represent 61% of the deposit base, driving a net interest margin of 4.96%. The result: a 1.57% ROA and 15.25% ROE and a robust 219.4% five-year total return. Awesome!

#4 First BanCorp (NYSE: FBP)

First BanCorp is a full service financial institution with operations in Puerto Rico, the British Virgin Islands, and Florida. Its vision is grounded in the principle that investing in its employees, supporting the communities it serves, and providing an outstanding experience to customers is paramount to being successful and delivering shareholder value long-term... i.e. they pursue stakeholder primacy, and here they are in the Top 5 total return to shareholder list. At $18.4 billion in total assets, it is the largest among our Top 5 all stars. Their net interest margin popped 30 basis points from year end 2021 to present because the balance sheet is chock full of core deposit funding accompanied by a heavy dollop of variable rate loans. This helped drive down their efficiency ratio to under 48%. But there's more! In their investor deck they told shareholders that the efficiency ratio was likely to gradually rise to 50% as they continue to invest in people, technology, and capital projects. In other words, they are pulling into the pits to further pursue stakeholder primacy and make the investments needed for a long-term future. Refreshing! Oh and they delivered 203.5% five-year total return to shareholders. That too.

#5 The Bancorp, Inc. (Nasdaq: TBBK) 

Founded in 2000, this $7.8 billion financial institution remains one of the few banks in the U.S. that specializes in providing private-label banking and technology solutions for non-bank companies ranging from entrepreneurial start-ups to those in the Fortune 500.  They provide white label payments and depository services (think Paypal, Chime) and deploy that funding into specialized lending programs such as lending to wealth management firms, commercial fleet leasing, and real estate bridge lending. Note their asset size, because their value as the BaaS bank for Chime is that they are under $10 billion in total assets and not subject to the Durbin Amendment portion of the Dodd-Frank Act that fixes interchange income pricing. It has not been all sunshine and rainbows for TBBK. They were under an FDIC consent order from 2014 through 2020 relating to their BSA and OFAC compliance and their relationship with third parties seeking access to the banking system. Bankers considering becoming a BaaS provider to such third parties should read this order. Also, The Bancorp posted a $96.5 million loss in 2016, just outside the window the JFB Top 5 looks back to determine if it's a turnaround that drove total return. There probably is some of that in their ranking. But they posted a 1.69% ROA and 18.30% ROE year-to-date and have an aspirational goal (which they disclosed) of having a >2% ROA and >20% ROE. They put it out there! And have delivered a 202.2% five-year total return to their shareholders. Welcome back! 

There they are. Interesting that three of the top 5 have some sort of BaaS operation. And there are two Puerto Rican banks. There were two major hurricanes, Maria and Fiona, during this measurement period and I'm confident that this impacted trading activity in these banks' stocks, although I can't articulate how. 

The evolution of this august list tells me that having something other than "plain vanilla" is driving performance and shareholder returns. 

I would be remiss not pointing out that the #1 total return bank for 2020 and 2021, Silvergate Capital Corporation, had a five-year total return of 71.6%. Not bad considering the -1.21% for the same period for the S&P US BMI Bank Total Return Index. But Silvergate's current 1-year total return was -87.1%, knocking it decidedly off the JFB Top 5 list (currently ranked 45th). Putting most of your eggs in the crypto basket has its highs and lows. Perhaps diversify?

~ Jeff

Note: I make no investment recommendations in this article or this blog.

Thursday, December 08, 2022

Guest Post: 2nd Quarter 2022 Financial Markets and Economic Update by Dorothy Jaworski


Financial Markets & Economic Update -Fourth Quarter 2022

What a year 2022 has been!  Thanksgiving is this week and we can all be thankful for our families and friends.  May we all enter this holiday season joyously.  We are closer to the end of inflation and employment is still strong, with job openings exceeding unemployed persons by several million.  We’ve seen tremendous market declines in both stocks and bonds, volatility, and a Federal Reserve who is raising interest rates at a breathtaking pace.  Short-term rates have risen from .25% to 4.00% so far and the Fed says they are not done yet.  Housing markets have suffered, with mortgage rates climbing up to 7.00%.  We are thankful that there has been some recovery in stocks and bonds over the past two weeks.

My biggest concern with the Fed is that they are continuing to pile on outsized rate hikes and are not spacing them out to consider the typical six- to nine-month lag in their policy moves.  As Milton Friedman famously wrote: “Monetary policy affects the economy with long and variable lags.”  Thus, the Fed needs to anticipate and assess the damaging effect of large rate hikes on the markets and on economic activity.  I was rejoicing when I saw their latest FOMC statement from early November, which included wording about the pace of future hikes (they tell us there will be more): “The Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”  Maybe they will wait and assess the effect of the four big .75% hikes in June, July, September, and November; based on lags, we are not fully seeing their impact yet.  As Philadelphia Fed President Harker said recently: “Inflation is known to shoot up like a rocket and then come down like a feather.” 

The Fed is raising rates to reduce aggregate demand to fight off inflation, even though they themselves waited too long to raise rates and inflation began as a supply-chain-driven problem, when production of goods could not keep up with new demand.  The downside to all of the rate hikes is that we face a high risk of recession in 2023.  Consumer spending and business inventory financing will be hurt by higher interest expense and it will take a toll on savings and corporate margins, respectively.



Milton Friedman also wrote that “inflation is always and everywhere a monetary phenomenon.”  Money supply, as measured by M2, was growing in 2020 by over 20% year-over-year and in 2021 by 12% to 20% due to the Fed injecting liquidity through its bond buying program of $100 billion per month and the federal government passing continued Covid-19 relief bills, placing trillions of dollars into the economy.  It is no wonder that demand surged.  And M2 growth started 2022 at 12%, with the Fed still buying its $100 billion of bonds through the month of March, even though they knew inflation was a serious issue.  And now M2 growth is down to 1.3% in October, which is below the range we experienced during the prior 10-year recovery of 3% to 5%.  The Fed has reduced their balance sheet by $900 billion so far in 2022; a decline of $1 trillion is the equivalent of 1.00% of tightening.  Remember this “hidden tightening” as you see the rate hikes piling up.

Rates have risen since March 2022.  The CPI peaked at +9.1% year-over-year in June and is now +7.7% in October, which is a good declining trend but still too elevated.  The Fed’s preferred measure is the PCE deflator, which was +4.2% in the third quarter compared to +7.3% in the second quarter and +7.5% in the first quarter.  The core PCE (excluding food and energy) has fallen to 4.5% in the third quarter from +5.6% in the first quarter.  The CPI and PCE measures differ in the amount of housing and shelter used in the calculation; CPI has a weight of 42% for housing and 32% for shelter, which the PCE indices use 15% to 16%.

I mentioned earlier that the Fed was raising rates to reduce aggregate demand.  They cannot control the supply side, which has been particularly hard hit for goods from China, as their Zero-Covid policy locks down entire cities.  More analysts are pointing at energy policy as one of the main contributors to inflation, when government stopped drilling expansion of oil and natural gas and distribution networks such as the Keystone Pipeline to pursue a “green” agenda full of batteries, solar power, and wind.  The problem is that we are not ready as an economy to turn on a dime away from fossil fuels and businesses are reluctant to make the necessary capital investments to drill for more oil.  When Russia invaded Ukraine last February, the price of oil shot up to $110 per barrel in June but has since returned to pre-invasion levels at $77 per barrel.  Transportation costs have increased leading to an increase in the price of just about everything, especially food, where prices are dependent on the cost of goods getting to their final destination.  Food and energy prices have been damaging to family budgets.


Leading Indicators

How are the leading indicators doing?  There is some good news for inflation but worse news for the economy.  The index of leading economic indicators has continued to fall further, with October at -.8%, following September’s -.5%, and is now down for eight consecutive months.  This indicator accounts for the lag in Fed policy and projects six to nine months in the future. 

The FIBER leading inflation index also continues to fall, but this decline is good news for inflation.  The index turned down in May 2022 and is now -8.0% in October, following -5.8% in September.  This index also looks out six to nine months.

Stock markets have declined most of the year before stabilizing recently.  The Dow Jones and S&P 500 averages are down -6% and -16% respectively.  Nasdaq has been the worst performing, at -28% year-to-date.  Stocks are a forward-looking mechanism, based on projections of corporate earnings.  PE ratios 12 months forward are currently at 17.5 times for the S&P 500, which is slightly over the historical average of 16 times.  Bond markets have also declined from the relentless Fed interest rate hikes, with the Treasury aggregate price index down -12.7% in 2022.  The Fed said they will look for financial stress and may be getting their wish as we have witnessed crashes in Bitcoin and other “digital coins” and the sudden collapse of the FTX exchange.

Housing is leading the way lower as one of the most rate sensitive sectors of the economy.  Mortgage rates soared to above 7%, up from 3.25% at the beginning of the year; the higher rates have backed down slightly in the past couple of weeks but are still contributing to a fall in affordability.  New home sales surprised to the upside in October, but existing home sales keep falling.  Inventories remain tight for existing homes and much higher for new homes.  Commercial real estate is also under some pressure with projects proving uneconomical at higher borrowing rates.

Consumer savings rates are down to 3.1% in September as consumers dip into savings to afford higher priced goods.  Consumer credit has continued to rise at a time when credit card and borrowing rates are all up dramatically.  These signs, as well as personal income that has not kept up with inflation, are ominous for the consumer.  Labor markets have held up well so far but we are starting to see cracks.  Fed Ex, Amazon, and many technology companies who are dependent on consumer spending are cutting costs and laying off employees.  And they are doing this right before the holidays.  Employment is a lagging indicator and its weakness has been shown in fewer payroll jobs each month, with October at +261,000, but household employment declined by -328,000 jobs, pushing the unemployment rate up by .2% to 3.7%.

Finally, the Treasury yield curve is now inverted at both critical points.  The 10 year to 2 year Treasury spread is -.76% today and the Fed’s favorite measure, the 10 year to 3 month spread is at -.57%.  An inverted yield curve is a historically reliable indicator of future recession by six to 12 months on average, although it may be much longer.  In 2023, we will be there.  Long-term Treasuries will be seeing the recession first and typically will decline before short-term rates, which is happening now. 


The Outlook

NBER will declare a recession when four conditions are met:  falling production, falling real personal income, falling real business sales, and rising unemployment.  The first three conditions are very weak.

The Fed has acknowledged cumulative effects of rate hikes and lags in policy, but increases of nearly 400 basis points in nine months in a 2% (at best) economy cannot be good.  Recession probability is now very high for 2023 and will get higher if the Fed continues to increase rates.  There are signs in leading indicators, business surveys such as ISM, S&P, and Philly Fed, and actual reports that inflation is declining.  Unemployment should increase slowly from layoffs, hiring freezes, and cuts in job openings.

The yield curve is inverted in both important spread measures- the 10 year-2 year and the 10 year-3 month, and history tells us that recession follows inverted curves with a lag.  Government debt remains high, at $31.3 trillion currently, or 120.5% of GDP.  Remember, debt levels greater than 90% put pressure on GDP, leaving it at subpar levels.  GDP is about even to up slightly for 2022, after negative first and second quarters and a surprising increase of 2.6% in the third quarter with another increase possible in the current quarter.  I don’t expect better growth in 2023, and I don’t think the Fed does either, but they won’t say so.


“It is worth remembering that it is often the small steps, not the giant leaps, that bring about the most lasting change.”  Queen Elizabeth II


Thanks for reading!  D. Jaworski 11/23/22

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.

Monday, November 21, 2022

Debunked! Are Bank Merger Approvals Taking Longer?

I enjoy my Twitter community because I get diverse views on banking, sports, politics and entertainment. One of my Tweeps, Rick Childs, a Crowe partner, recently tweeted about the amount of time it is taking merger deals to get regulatory approval. His numbers are raw, and buck the conventional wisdom that regulators are dragging their feet on approvals. A conventional wisdom that our clients are asking us about, so it is tremendously beneficial to have actual data, instead of my standard answer: "we haven't noticed it at smaller bank deals." Data rules.

Conventional wisdom must result in actual wisdom, right?

Average Months From Announcement to Closing

Average Months From Announcement to Closing (Terminated Deals Separate)

Average Months From Announcement to Closing by Asset Size

Average Months From Announcement to Closing by NPA/Assets

Average Months From Announcement to Closing by Tang. Eq./Assets

Average Months From Announcement to Closing by ROA

Average Months From Announcement to Closing In-State vs. Out-of-State Acquirors

Average Months From Announcement to Closing for Merger of Equals

There you have it. Merger deals are taking no longer from announcement to closing this year versus recent history. Terminated deals intuitively take longer because the regulatory approach is not to reject the merger, but to inflict pain on the parties until they withdraw their application and subsequently terminate, a process that obviously would take longer.

Larger deals are taking longer, as has been the case in recent history. I should note there is likely a smaller universe to calculate averages, that likely skew the numbers for >$50B bank deals. Also intuitive is bank deals where targets have lower capital levels and profitability (ROA) took longer.

Not intuitive is that there doesn't seem to be a correlation between the seller's asset quality and time to complete a deal. And rounding out Rick's deep dive into the merger completion timeline rabbit hole, MOE's and out-of-state transactions take longer for approval.

There you have it. Now bankers don't have to rely on investment banker opinion as to the length of time it takes deals to get done. 

Thank you to Rick Childs and the Crowe researchers for keeping us steeped in facts!

~ Jeff

Friday, November 04, 2022

Bankers: Can You Create a Culture of Operating Discipline Even if You Have No or Few Shareholders?

Do shareholders give publicly traded financial institutions an edge over their private and non-shareholder owned financial institution brethren?

I posed this question while speaking at a recent conference. The following slides were used to make my case.

            Source: S&P Capital IQ for Banks-Savings Banks and Credit Unions between $1B-$10B in total assets. YTD=June 30, 2022.

Banks-Savings Banks (SBs) between $1B-$10B in total assets have a slight edge in Yield on Loans to the similarly sized CUs, which makes sense because there would be more commercial loans and relatively fewer residential loans than Credit Unions. Credit Unions held an edge in the Cost of Interest-Bearing Liabilities until 2020 when their cost eclipsed that of Banks-SBs. This might speak to the deposit betas being higher in Credit Unions than banks, as CUs would tend to have less core business and municipal accounts. All of this led to a slight edge in Net Interest Margin in Banks-SBs. Eleven basis points YTD to be exact.

Credit Unions, however, have a noticeable edge in Fee Income to Average Assets, 1.14% YTD versus 0.64% for Banks-SBs. Before my bank friends acclaim "aha, credit unions charge more fees than banks!", I will say you would be correct in fact but the context is nuanced. Although it is my experience that CUs do collect a relatively greater amount of deposit fees than Banks, this can be partly attributable to the average balances per account at CUs. They are lower than banks. It is intuitive that they would collect more deposit fees.

This nuance would be totally lost on Rohit Chopra of the CFPB. So naturally CUs are in alignment with Banks-SBs against the CFPB's crusade against "junk fees." 

Back to my point. CUs generate as much if not more revenue off of their balance sheet than banks. So why is their profitability in the form of Return on Average Assets ("ROA") noticeably and consistently inferior to banks? Twenty-seven basis points YTD inferior. Even though they pay no federal corporate income taxes?

Look no further than their expense ratio (non-interest expense / average assets). YTD the Bank-SB expense ratio was 2.27%. CUs was 2.86%. A 59 bps difference! If the median size credit union from the $1B-$10B group I analyzed achieved the bank versus the credit union expense ratio, the CU would make $11.8 million more in profit.

The CU would counter that they are a not for profit, and don't have sharholders as a constituency. Mutual banks would counter with the same. And while true that shareholders are not a constituency for either, I call bullshit on either of them not needing profits. Retained earnings is their least expensive form of capital. In some cases, their only form of capital. And for those uninitiated in balance sheets, retained earnings are generated from profits!

Now, perhaps, the lost $11.8 million is somehow benefiting one of the other three stakeholders: employees, customers, or communities. It wouldn't be benefiting customers in terms of fees or interest rates, as the analysis above shows. And the $11.8 million is from the expense ratio which has nothing to do with rates or fees.

It could be benefitting employees in the form of better compensation, benefits, etc. Or in the form of better technology. But I know of no credit union that pays their employees materially above market wages or has materially better tech than their banking brethren. I don't have the data or CU by CU analysis to make a definitive BS call, but let's say I'm skeptical.

Where I think the excess $11.8 million resides is buried in bureaucracy and infrastructure. They don't have to answer to shareholders, so the discipline of maximizing profitability for the benefit of stakeholders so often enforced by shareholders is not part of their culture. 

And it's a shame. Because if they had that $11.8 million, imagine the tech investments, employee initiatives, core deposit special dividends, or community support they can provide. 

For those that are not shareholder owned or are privately held, implement cultural operating discipline so you have the resources to be relevant, even important to the other stakeholders.

~ Jeff

Saturday, September 24, 2022

3 Ideas on Bank Branching

I moderated a strategic discussion at a recent banking conference. In that meeting, the CEO of a community bank said he offsets his branch costs by leasing branches out to unrelated businesses, like a masseuse. I thought he was joking.

He wasn't.

The anxiety community bankers feel about consolidating branches is palpable. What if you are the only bank in town and creating a banking desert? How about if you bank the local municipality? What if one of your directors is the town manager? Will the regulators frown on us closing a branch in a rural and/or low to moderate income town?

In survey after survey, retail and small business customers consider branch location as important in determining where to bank. This gives a lot of anxiety to fintech promoters. "Chime has 12 million accounts!" Failing to mention the average balance per account might get one of those account holders a couple cases of beer and pay the cell phone bill. 

Large banks, who are community banks' most impactful competitors, are consolidating away from low population density areas. Community banks consider branching a differentiator. This will put community banks at a significant disadvantage with pricing, as the direct operating expenses of the branch as a percent of its deposits averaging 90 basis points, according to my firm's profitability outsourcing service.

That's 90 basis points the bank can't pay in interest to depositors that Ally Bank can. How can the community bank compete?

Here are some ideas.

3 Ideas to Improve Branch Performance

1. Lease space to complementary businesses- I'm not sure I would do the massage parlor, but I'm also not sure I wouldn't. We have far more square footage in our branch than today's bank customer demands. The last cohort of branch-heavy transaction customers were forced to use online and mobile during the pandemic, and it makes no sense to design branches to serve that diminishing crowd's needs. Put some investment into partitioning to lease to the local insurance agent, lawyer, or wealth manager. The lease expense could offset branch direct operating costs and could provide the branch with an embedded center-of-influence referral source.

2. Staff with high powered bankers covering two markets- I think if we were brutally honest with ourselves, are our branches staffed with people that are so well known in the towns they serve that they are also the head of the local Rotary, or on the school board? Community banks have been slow to flip the script on the people demanded in branches. Efficient transaction processors or super star business developers and customer advisors? Be honest. What if we staffed with the latter, which would likely cost more (but also should result in greater deposit balances per office), and have that branch team cover two branches. Are there laws that require each branch to have 40 lobby hours and four extra drive through hours? Staff a branch with a manager, assistant manager, and two personal (universal) bankers and have the manager be the king/queen of one of the locations and the assistant branch manager the king/ queen of another. Split the hours. Install an ITM in a man-trap or inner drive thru lane so transactions can be processed when the lobby is closed. Keep your commitment to the town.

3. Proper Measurement- "We have loans there!" "We bank the municipality!" These are objections we hear in the branch consolidation discussion. These are emotional arguments. If you measured branch profitability, you would know which branches do and don't make money. You could allocate residential and commercial loans into the branch in your reporting to answer the question: "With loans added, are we profitable in this location?" Proper management accounting systems could look at branch profitability with loans (market profitability), and without them because branch managers are not responsible for the commercial and residential lending in that town. But we typically don't do it. So branch decisioning degrades to emotional arguments about this or that customer, or how the bank will be perceived if they consolidate that location. How would you be perceived if you starved strategic investments because you are supporting an unprofitable branch? 

Do you think branching serves as a differentiator in your markets? If so, how do you propose improving their overall performance?

~ Jeff

Friday, August 26, 2022

Anchors in Banking: Three Things to Do About Them

I suppose when I use the term anchor, of the 11 definitions offered by Merriam-Webster, "something that serves to hold an object firmly" is the closest to my meaning. And not in a good way.

In this Jeff For Banks video blog, listen to my thoughts on anchors at your institution. And what to do about them. Because we need to move forward. Which is difficult to do if you have anchors.

~ Jeff

Wednesday, August 24, 2022

Guest Post: 3rd Quarter 2022 Financial Markets and Economic Update by Dorothy Jaworski

Financial Markets & Economic Update -Third Quarter 2022


The Federal Reserve waited too long before beginning its fight against inflation.  We are all paying higher prices for food, clothing, gas, oil, cars, services like travel and eating out at restaurants, and goods of all kinds.  Until early this year, the Fed’s focus seemed to be the unemployment rate and recovery from the pandemic.  Now inflation is here and we hate it!

We spent too long waiting for the Fed to figure out that inflation was not “transitory” (to use Chairman Powell’s infamous phrase) and that inflation was, in fact, building momentum.  The transitory narrative worked for about a month last year, before inflation started taking off with a vengeance.  Supply chain issues and missteps caused much of the inflation by keeping goods in short supply, which resulted in higher prices.  We had an oil crisis, a gas crisis, and an electricity crisis all at once.  The Consumer Price Index headline peaked (for now) at +9.1% year-over-year in June, 2022 before falling back to +8.5% in July.  Producer Prices were +9.8% in July over the prior year and was +11.3% in June.  CPI and PPI, excluding food and energy, are currently just below +6% year-over-year.  Relief from declining oil and gas prices gave us some breathing room, but the Fed still has lots of work to do with inflation trending at 4 to 5 times its target of 2%.

The Fed let inflation ride from last summer until March, 2022, when they took a baby step of tightening by .25%.  In hindsight, it appears that this move was already too late to make a meaningful impact on 2022 inflation pressure.  Even more egregiously, the Fed continued to purchase $100 billion of Treasury and Agency bonds in the market each month through March, 2022!  This money was added even when it was known inflation was accelerating, and along with the fiscal stimulus handouts of cash, added fuel to the inflation fire.  As pandemic spending began to recover, the Fed slowed money supply growth in 2021 from 25.8% to 12%-13% for the second half of 2021, and to single digits by June of 2022.  The Fed has also announced they will allow their bond portfolio to begin running off at a pace of $47.5 billion per month until September, then at $95 billion per month after September.  

Hindsight is 20/20 and they realize that they need to get interest rates higher- thus the .50% and .75% hikes in short-term rates in May, June, and July and get money supply down quickly.  Cumulatively, the Fed Funds rate has been raised by 2.25% to 2.50%.  They’ll meet again in September and will be deciding how much to raise rates.  I would expect them to raise rates to at least 3.50% at year-end 2022.


GDP and Recession

The effects of Fed actions are realized with a lag of six to nine months, so I’m guessing there will not be much question about recession by then.  We experienced two negative quarters of GDP, which is the textbook definition of recession, in the first and second quarters of 2022, by -1.6% and -.9%.  Inventory changes were the predominant factor in the negative growth.  If companies grow inventories too much, they may have to reduce prices to liquidate them.  Walmart, Target, and Amazon can tell you this is true.  But NBER is the organization that gets to call the recession; it will peg the beginning and end, based generally on four factors:  falling production (GDP already is falling), falling real income (real disposable income is down 18 months in a row), falling real sales (slow declining trend), and falling employment/rising unemployment (not yet here- still seeing strong payroll growth).

We are seeing three of the four conditions for a NBER recession call already met.  The sole hold-out is unemployment, still low at 3.5%, and payroll growth of +528,000 in July, 2022.  The household report was weaker at +179,000 in July, following a decline in June of over -300,000.  Employment is a lagging indicator, with household reporting leading the payroll numbers, and eventually job cuts, layoffs, and hiring freezes will hurt employment growth, along with the inability to find talent.  One negative factor in our economy and affecting productivity is the level of those Not in the Labor Force, which topped 100 million in July.  NBER and our textbooks both predict that unemployment will rise at least .50% during recession, which is a cost of almost a million jobs.

We do need to understand that recession or the risk of recession will not stop the Fed from raising interest rates, liquidating their bond portfolio, and reducing the money supply.  M2 year-over-year growth has slowed to +5.9% in June, 2022, compared to +12.4% in December, 2021, and 21% to 25% during the pandemic months in 2020.  Prior to the pandemic, M2 growth ranged from 3% to 5%, which seemed to be a steady non-inflationary pace.   The Fed will keep raising rates to show their resolve to the markets that they will fight inflation or else inflationary expectations can soar pretty quickly.  So far, they are relatively steady, with the 10 year Treasury and TIPs measure showing inflation at 2.48%.  Meanwhile the 5 year Treasury- TIPs is 2.76%.

It is not just the US that is under threat of recession.  China’s economy is declining as housing/real estate and manufacturing are under pressure.  Europe is also under the gun as high prices for energy have sapped spending power.  Big heat waves struck the US and Europe during July, with temperatures exceeding 100 degrees for a time.  I can attest to the heat in Metz and Paris, as one day it was 100, the next was 102.  Then it would cool to 98 or 99.  Many areas of Europe are suffering from lack of rainfall.  The Rhine River, a mainstay of all the economies along the river as well as the favorite of river cruises, is so dry in areas that ships can no longer navigate.  Lack of rain is also hurting agriculture and hydroelectric plant production.  Pray for rain!  And pray for the grapes that will soon become wine!


Leading Indicators

What are leading indicators telling us?  The biggest leading indicator of all is the stock market, with its negative performance year-to-date.  The S&P 500 is down -10% and the Russell 3000 is down -11%, but have recovered from the lows in June.  The stock market is certainly pointing to down times in the economy and corporate profits.  Another leading indicator is the Treasury yield curve, which is currently inverted between the 2 year and the 10 year yields by -.45%.  The 3 month to 10 year yield spread is still positive, by .24%, but with one more Fed rate hike will turn it negative.  My preference has always been to follow the 2-10 year spread as a recession indicator, which is market determined.  The Fed prefers the 3month-10 year spread, but they control the 3 month.

The index of leading economic indicators, published by the Conference Board, was down -.8% in June and was down five of six months in 2022.  This bodes ill for the economy six to nine months from now, and coincides with the six to nine month lag in Fed policy.  The leading inflation index, published by FIBER, gives a glimmer of hope about inflation.  In May, the index turned down on a year-over-year basis for the first time in several years, and has been down three months in a row.  Commodity prices have also fallen recently, contributing to the small drops in inflation.  As I said, a small glimmer of hope...

Many surveys, such as ISM, S&P, and Philly Fed manufacturing and services, are showing declines in July for the Prices Paid component.  University of Michigan also shows that consumers think inflation will fall after the coming years; one year inflationary expectations are at 5.0% and 5 to 10 year expectations are at 3.0%.


Other Impacts

One silver lining of rapidly rising interest rates is the relative strength of the US Dollar versus other major currencies; the dollar has continued to be very strong and the dollar index is up +11.6% year-to-date.  A strong dollar serves to keep import prices lower than they otherwise would be, and kept inflation from becoming worse.  But the strong dollar has raised prices more rapidly in the rest of the world and the emerging markets are facing a crisis with high interest rates and potential defaults on debt.  Foreign investors not only suffered from market declines, but their US holdings also were down from exchange rates versus the dollar.  On our trip to France, the exchange rate was close to 1 to 1 between the US dollar and the Euro so we were pretty happy.  As mentioned, China’s and Europe’s economies are struggling- China with a real estate crisis and declining production and Europe with an energy crisis.

And speaking of debt, the US Treasury total now exceeds $30.4 trillion, or 122.6% of GDP at the end of the second quarter of 2022.  Ratios above 90% of GDP have been shown to seriously detract from GDP, which was evidence with average GDP of +2.2% to +2.3% between 2010 and 2019.  Debt levels keep rising so I believe our longer-term potential will now be below 2.0%.

And a word about the housing market- it has been, in a word- devastated.  Housing starts, building permits, new and existing home sales, pending home sales, and builder sentiment indices are all down sharply so far in 2022.  Price changes are still near the highs of +20% year-over-year as inventories on existing homes remain very low at 3.0 months’ worth of sales.  New home inventory is too high at about 9.0 months.  There is no happy medium.  Higher rates and recession will pull down the large price increases.


If we are not in recession already, we soon will be.  The data is pointing that way and the Fed will continue to raise rates.  Just think, before they had even tightened a tiny bit in March, GDP was already down.  They will keep raising rates until inflation is falling substantially.  They must show the markets they will fight hard.  They will keep raising short-term rates, while longer-term rates keep declining in response to recession and recession risk.  Even recession won’t stop the Fed, at first.  But recession will stop inflation.  It does every time.  Thanks for reading!


Large Hadron Collider Update

Everyone’s favorite machine is back up and running!  Since 2018, the Large Hadron Collider, or “LHC,” was down for maintenance and upgrades so that particles could smash at 6.8 trillion electron volts, or “TeVs,” for a total of 13.6 trillion TeVs when the protons collide.  The LHC restarted on July 5, 2022 and will run for four years until being shut down for maintenance in 2026.

The LHC fires protons at each other at almost the speed of light along the 17 mile tunnel under the Swiss and French Alps, where magnetic fields move the protons around.  The debris cloud when the protons collide reveals subatomic particles for study.  Linear accelerators were added to strip the electrons from the protons.  Also, upgrades were added to the software to sort the data that is felt to be useful for study; this is accomplished by artificial intelligence.  To date, only about 10% of the data has been analyzed; this can now be raised by 3 times.

There has not been much excitement since the discovery of the Higgs Boson particle in 2012.  New discoveries include new particles and scientists are attempting to explain dark matter, which makes up 95% of the universe.  So hopefully, someone will tell us what this all means and what it will do for us or teach us.



D. Jaworski 08/17/22

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.

She also was our guest on my firm's January 2022 podcast, This Month in Banking. To listen to that episode on interest rates and the economy, click here or go to wherever you get your podcasts.

Sunday, August 14, 2022

Operation Choke Point 2.0

In 2012 the Obama administration launched "Operation Choke Point" ("OCP") which was designed to ensure banks considered the risk of banking payday lenders that were engaged in abusive practices. It sounded laudable enough, with the goal of OCP, according to federal officials, to combat fraud by preventing criminals from accessing financial services.

But what it turned out to be is nothing more than old fashioned thuggery where the government would use the safety and soundness mandate so their regulatory bodies could pressure financial institutions from doing business with disfavored industries.

What were disfavored industries? The FDIC's quarterly Supervisory Insights for Summer 2011 had a list! It has since been modified and the list removed because it was too obvious what they were doing. But here are some of the "high risk" industries on the list: ammunition sales, ATM operators, coin dealers, dating services, drug paraphernalia, firearm's sales, fireworks sales, home-based charities, lottery sales, pawn shops, payday lenders, pharmaceutical sales, racist materials, surveillance equipment, tobacco sales.

This was an obvious attempt to bully banks into making it so risky to do business with disfavored industries that many banks, under fear of enhanced regulatory scrutiny, stopped doing business with them. OPC formally ended in 2017. But the bad taste lingered.

So much so that the acting Comptroller of the Currency of the prior administration, Brian Brooks, proposed a rule in November 2020 that would forbid banks to blacklist legal industries. But in January 2021, the new OCC announced it would pause the "Fair Access" rule that was intended to prevent another Operation Choke Point. Because we are going after "climate related businesses." Again, legal businesses that are politically out of favor.

Imagine the community bank that is experienced in lending to fuel oil businesses in or near its markets because it's comfortable using trucks, tanks, and oil inventory as collateral. Now, under the guise of "transparency", mandatory disclosures, and risk mitigation regulators begin asking more and more intrusive questions about the banking relationship with these local fuel oil businesses. 

They find your underwriting or risk mitigation techniques deficient. Issue matters requiring attention in your exams. And although your loss experience has been very good with these businesses, you are finding it troublesome to continue to bank them. Or, minimally, you will have to increase their credit costs to make up for the added scrutiny you are required to give. So you back out. And other local lenders aren't anxious to take up the mantle and relive your experiences. This could put significant pressure on the local fuel oil companies so many residents rely upon. No matter. Climate risk.

Now, imagine there is a change in presidency. And the current president has his/her own industries he/she disfavors. And evolves from "climate risk" to [insert risk de jour]. I encourage you to read Jenna Burke of the Independent Community Bankers Association's piece on this issue in their latest Independent Banker magazine (link: Jenna Burke: Leading the climate risk charge – Independent Banker). Interesting was the section "Lack of Empirical Data." As if that matters. :) 

Even if you want banks to stop lending to the local fuel oil company, you must be able to see the predictable consequences of picking and choosing disfavored industries and then bullying banks through regulation to stop doing business with them.

Because the "climate risk" ruse is exactly that. Let bankers determine if lending to this industry or that is risky. Not politicians or bureaucrats. Because that, my readers, is the slippery slope to tyranny.

~ Jeff