Thursday, December 28, 2023

Bankers: Here's What We Do

I work for The Kafafian Group, a community financial institution consulting firm based in Bethlehem, Pennsylvania. Many of my readers might not know what my firm does, so I want to dedicate this post to the problems we help community bankers solve.

Here is what The Kafafian Group does:

Performance Measurement- We measure a financial institution's line of business and product profitability on an outsourced basis. We feed customer profitability systems. We do this on an outsourced basis, meaning we custom build the model based on how the institution is managed. If line of business profitability, we follow the institution's org chart. If product profitability, we follow their

product list. We do the costing, funds transfer pricing, report building, and education. We have yet to fail setting up a client on their own profitability system. And we've built our own solution because we found other solutions so challenging. We offer an online portal where clients can view their reports down to the general ledger level. And they can download anything they see within the portal for their own analysis and dashboards. If you want the head of commercial lending or retail banking to take ownership of the continuous improvement of their spreads so the bank can improve its net interest margin, you must first measure it. Our competition in this line of business are software solutions providers. But our real competitor is indifference. You no longer have to be indifferent to how well those responsible for deposit or loan generation are also responsible for continuous improvement in deposit or loan spreads.

Contact Ben Crowley if you want this level of accountability at your institution: Benjamin T. Crowley - The Kafafian Group, Inc.

Strategic Planning- Unlike Performance Measurement where there are very few competitors to us, there are many competitors in strategic planning. We bring a team approach to the engagement using our knowledge from our industry experience and other lines of business to benefit clients. We tailor our service to the needs of the client without dogmatic and rigid processes, although we do suggest processes that work. We believe strategic plans should be made with the best possible data, using the best that your management team has to offer in terms of strategic direction. We suggest one-on-one interviews to avoid group think and uncover critical issues that are difficult to determine in groups. We make suggestions based on our experience, both in banking and with the hundreds of financial institutions we have had the honor to serve. We draft your plan based on data, interviews and a group retreat. We guide your institution into creating an operating plan, or the "how" to strategy execution. We develop projections based on what success would look like in plan execution. The plan should identify the institution you strive to become and chart your path to getting there. Without direction, any road is the right road. With a well thought out plan, course modifications can be made with confidence. Resources can be allocated efficiently. And personnel can be hired and developed with successful plan execution in mind. Some financial institutions consider strategic planning a regulatory exercise or look to do it themselves to save money. Is there a more important question than "what do we want to be?" and "how do we intend to differentiate?" An outside facilitator can ensure planning gets done in a disciplined process that gives your financial institution the best opportunity to succeed at serving its stakeholders.

We also perform ancillary services such as an institution's Risk Appetite statement, clarifying the risks the board and management are willing to take in plan execution. We also do Capital Planning, identifying how much capital will be needed for plan execution and capital impacts of various adverse events and how the institution would enhance capital should those events come to pass. We perform 360 strategic alternative reviews, identifying who a financial institution can reasonably purchase and how much they can pay, who would be strategic partner candidates, and who can buy the institution and how much they can pay. We do this unpassionately because knowing this information helps management teams create aspirational plans. We also do regulatory business plans for de novo banks, mutual to stock converting banks, and banks switching charters.

Contact me if you would like to discuss strategic planning or any of our ancillary services: Jeffrey P. Marsico - The Kafafian Group, Inc.

Process Improvement- In every institution we have served with process improvement services we have found onerous processes, inefficient technology utilization, and silos prohibiting a near frictionless employee or customer experience. Most of these engagements result in cost savings as resources are allocated to unneeded processes, or technology can do the job. Most seasoned bankers have been through these types of engagements and have a bad taste about them because overbearing consultants come in and make declarations and pronouncements. Not so with us. We take a partnership approach where we keep supervisors informed every step of the way so there are no surprises. We think the engagement goes smoother and our recommendations more informed if we ask, for example, the head of wire transfer why the system isn't used to its fullest or why the institution is applying belts and suspenders processes to sending a wire. Supervisors may not agree with one of our process improvement recommendations, but they'll know about them before they end up in our report. It is a solemn responsibility that the institution be better situated with scalable processes when we leave from a process improvement engagement than when we started.

Contact Jill Pursell if you are considering improving processes for scalability, near frictionless customer and/or employee experiences, and/or cost savings: Jill A. Pursell - The Kafafian Group, Inc.

Financial Advisory- Whole bank mergers and acquisitions, fee-based lines of business, branch transactions, fairness opinions, valuation services for private financial institutions, 360-degree strategic alternatives analysis, are all part and parcel to our Financial Advisory line of business. One client told us he felt he was getting JPMorgan service from a community financial institution consultancy, a duty we continuously sharpen in a changing environment and a badge we wear with honor. We consider this line of business complementary to our consultancy so we are responsive to client needs without the typical reticence to engage in talks about combining for fear of going down a slippery slope. Once a client determines to pursue a transaction based on the facts of it, we pursue it to achieve success based on the client's definition of success. We put our experience and transaction accomplishments against any in the business. 

Contact Rich Trauger if you are considering a strategic combination or any of our ancillary services: Richard B. Trauger, Jr. - The Kafafian Group, Inc.

Management Advisory- We do a menu of different things based on our individual and collective skill sets that are difficult to categorize but fall under the Management Advisory umbrella. Examples of engagements we are or have executed on: interim executive officer, management assessments, board evaluations, executive coaching, technology implementation, organizational structure, general ledger mapping, data needs and governance, regulatory assistance based on formal orders or memorandums, etc. Our talented staff with over a century of banking and bank consulting experience are drawn upon to successfully complete the engagement to the client's satisfaction. 

Contact Chris Jacobsen if you are considering an engagement that may fall under our expertise to see if we are a fit. Christopher Jacobsen - The Kafafian Group, Inc.

That's it! If you are a client, we sincerely thank you for your trust in us and leveraging our capabilities to improve your financial institution.

If you're thinking of becoming a client, please contact us. We are not pushy salespeople calling you weekly wondering "where are you at?" If we are a fit for your needs, let's roll!

Happy New Year!

~ Jeff

Saturday, December 16, 2023

How Did Your ALCO Model Hold Up?

My firm did a sample data run for a client that included all commercial banks in NY, NJ, PA, and MD between $500 million and $1.5 billion in total assets to see how various banks did in balance sheet and income statement ratios during the course of the Fed tightening run from year end 2021 until the third quarter 2023. Some interesting insights relating to their 1-year cumulative repricing gap that the banks reported on their call reports:

  • At 12/31/21, of the 68 banks that met the criteria, only 10, or 15% had a 1-year cumulative negative gap. This is defined as rate sensitive assets (assets that are expected to mature or reprice within 1 year) less rate sensitive liabilities (liabilities that are expected to mature or reprice within 1 year). If rates went up, so the theory goes, the 85% of banks with a positive 1-yr cumulative gap, should see net interest margin go up as assets reprice faster than liabilities. This made sense because the Fed Funds Rate at this time was 0-25 bps and bankers positioned their balance sheets accordingly.
  • At 12/31/22, after 450 bps of Fed rate hikes, 48 of the 68 banks, or 71%, had a better net interest margin for the quarter ended 12/31/22 than the quarter ending 12/31/21. Since 85% of them had positive one-year cumulative gaps, their ALCO assumptions mostly worked.
  • At 9/30/22, only 13 banks, or 19% showed a negative one-year cumulative gap. Meaning 81% thought their net interest margin would increase in a rising rate environment. Between 9/30/22 and 9/30/23, 53 banks, or 78%, had a lower net interest margin. How could their ALCO assumptions be so wrong?

  • By 9/30/23, the 1-year negative cumulative gap had nearly tripled to 30, or 44%. Interesting because the Fed Funds Rate was zero-25bps at 12/31/21 and almost everyone knew rates would inevitably go up. It makes sense that so few considered themselves liability sensitive at 12/31/21. I'm actually surprised so few (44%) consider themselves negatively gapped right now. Declining rates are far more likely than rising rates. The most recent Fed dot plot predicts Fed Funds declining in 2024.

When I asked my colleagues what they thought, here is what a couple of them had to say:

If I recall from my ALCO committee days… ALCO models largely did not rate shock 450-500 points and if they did, that type of move seemed quite far out of the realm of possibilities.  In a 200-300 model, spreads would have mostly held up. My guess is that the duration of money market accounts in most ALCO models were in the 3-6 year time frame but when rates went up 500 points in the real world, these longer duration "core deposits" actually left the bank or repriced much faster than anticipated as banks worked to retain these accounts.  Also, many banks were using CDs to retain these accounts and shifting deposits out of these longer duration products into 6-12 month CDs shortened the liability duration averages (in models) and increased the liability sensitive nature of most banks.

Deposit duration assumptions in ALCO models built for 'normal' markets simply did not hold up in recent quarters.

~ Ben Crowley, Managing Director, The Kafafian Group, Inc.

I think bankers overestimated the loyalty of their depositors following the pandemic & PPP, coupled with a sustained low rate/high liquidity environment. These factors led to a false sense of security that low-cost deposits were there to stay. When the national and super regional banks began raising rates they were reluctant to follow – until it was too late. They quickly learned that customers were not loyal and deposit attrition happened so fast that they had to raise rates more aggressively than anticipated to retain remaining deposits and attract funds to replace what they had lost.  

Service is important. But you still have to price competitively.

~ Chris Jacobsen, Managing Director, The Kafafian Group, Inc.

~ Jeff

Sunday, December 10, 2023

Banking's Top 5 Total Return to Shareholders: 2023 Edition

What a difference a year makes! Although the 2022 Top 5 are holding their own and two of them remain in today's Top 5, the 2021 edition included one bank that failed (SVB Financial Group) and one that is voluntarily liquidating (Silvergate). So as with all lists, and especially banking lists where risks don't rear their ugly head until calamity, readers should evaluate each financial institution on their own. I am here to count numbers, and if they have the best five-year total return to shareholders within the criteria mentioned below, they are on the list.

For the past twelve 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 29th overall. Although one might argue that First Citizens BancShares of Raleigh is a SIFI as it climbed to the 19th largest in the country with its Silicon Valley Bridge Bank acquisition from the FDIC, and that the FDIC designated SVB as systemically important.

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 2018 forward), mutual-to-stock conversions, and penny stocks. 

As a point of reference, the S&P US BMI Bank Total Return Index for the five years ended December 7, 2023 was 23.32%.

Before we begin and for comparison purposes, here are last year's top five, as measured in December 2022:

#1.  Communities First Financial Corporation (Now FFB Bancorp) (OTCQX: FFBB)
#2.  Coastal Financial Corporation (Nasdaq: CCB)
#3.  OFG Bancorp (NYSE: OFG)
#4.  First BanCorp (NYSE: FBP)
#5.  The Bancorp, Inc. (Nasdaq: TBBK)

Here is this year's list:

#1. M&F Bancorp, Inc. (OTCPK: MFBP)  

M&F Bancorp, Inc. is the bank holding company for M&F Bank, headquarted in Durham, NC. The bank was founded in 1907 and has operated continuously since 1908 with branches in Durham, Raleigh, Charlotte, Greensboro, and Winston-Salem. It is a Minority Depository Institution (MDI) and is one of only a few North Carolina banks designated by the U.S. Treasury as a Community Development Financial Institution (CDFI). As both an MDI and CDFI, it applied for and received $80 million from the Emergency Capital Investment Program (ECIP) distributed by the U.S. Treasury to be used to help underserved communities bounce back from the Covid-19 pandemic. Prior to the ECIP investment the bank had $370 million in total assets and $40 million of equity. It had $447 million of assets and $121 million of equity at September 30, 2023. So the relative size of the ECIP investment was very significant. The additional capital, according to the bank, will be used to support businesses in low-income communities that have been disproportionately impacted by the pandemic and further its mission to provide capital, resources, and support communities that continue to be affected by systemic neglect. Prospective shareholders must believe in them, resulting in a 601% 5-year total return to shareholders. Well done and best of luck leveraging the ECIP capital for good!

#2. The Bancorp, Inc. (Nasdaq: TBBK)

Founded in 2000, this $7.5 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. They posted a 2.53% ROA and 26.12% ROE year-to-date and that surpassed their aspirational goal (which they disclosed) of having a >2% ROA and >20% ROE. They put it out there and got it done! And have delivered a 334% five-year total return to their shareholders and their second straight Top 5 accolade! 

In 1921, Citizens Trust Bank opened its doors on Auburn Avenue in Atlanta. Its founder, Heman Perry, served as the first chairman of the board. The bank was the brainchild of Perry because he was denied being served in a white-owned store. So that Black businessmen could own and operate businesses independently of white-owned financial institution, Perry and four other partners, collectively known as the "Fervent Five", formed Citizens Trust Bank. Like M&F Bank above, CTB received over $95 million of ECIP, in addition to a $5 million investment from TD Bank as a result of its MDI and CDFI status. As a result of these investments, the bank has grown over 65% since 2019. Although deposits declined 20% since year end 2022, the bank has delivered a 2.01% year to date ROA and a 23.10% ROE. This growth and performance resulted in a 303% five-year total return. Well done Citizens Bancshares and Citizens Trust. You are doing well by doing good!

#4 First Citizens BancShares, Inc. (NasdaqGS: FCNC.A)

First Citizens Bank was founded in North Carolina in 1898 as the Bank of Smithfield. In 1935, R.P. Holding was elected Chairman and President of First-Citizens Bank & Trust, a family legacy of leadership that lasts to this day.   First Citizens includes a network of more than 500 branches and offices in 30 states spanning coast to coast, and a nationwide direct banking business. In January 2022, First Citizens did a tangible book value accretive merger of equals with CIT Group. And followed that savvy deal with another tangible book accretive deal by completing the failed Silicon Valley Bridge Bank acquisition in the first quarter 2023. For the third quarter 2023, net interest margin was 4.10%, ROA was 1.42%, and ROE was 14.95%. All this accretive deal making and prudent management has resulted in a brass ring for shareholders in the form of a 261% five-year total return. Congratulations!

#5 FFB Bancorp (OTCQX: FFBB) 

FFB Bancorp is the bank holding company for FFB Bank. You might recognize it from being number 1 in in last year's Top 5 as Communities First Financial Corporation and Fresno First Bank. No merger. They changed their name. The Bank opened in 2005 dedicated to meeting the banking needs of Central California businesses and individuals through their sole location in Fresno and online. At the end of 2021, prior to the Fed starting to raise interest rates, the Bank's yield on loans was 4.99%. For the YTD ended September 30, 2023, after the Fed raised rates 525-550 basis points, the yield on loans was 6.30%, or a 1.31% increase. For deposits, the Bank's cost of funds increased 34 basis points for that same period, from 7 basis points to 41. How you ask? Sixty five percent of their deposits are non-interest bearing. Takes pressure off in a rising rate environment. Net interest margin went from 4.22% to 5.09%. Looks like their interest rate risk model was spot-on. This performance led to a five-year total return to shareholders of 204% and a second straight year on the JFB Top 5. Congratulations! 

There they are. Interesting that two of the top 5 were MDIs and CDFIs that received ECIP capital. I am rooting that they will continue to deliver to shareholders as they serve their higher purpose improving the economic mobility of their customers. 

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

~ Jeff

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

Tuesday, November 28, 2023

Describe the Future of Banking in Buzzwords

I asked Google Bard, a large language model tool, the following: "Describe the future of banking in the United States in buzzwords." Here is what it came up with...

Sure, here is a description of the future of banking in the United States in buzzwords:

  • Hyperpersonalization: Banking services will be tailored to the individual needs and preferences of each customer, using data analytics and artificial intelligence.

  • Embedded finance: Banking services will be integrated into everyday activities, such as shopping, paying bills, and managing finances.

  • Decentralized finance (DeFi): DeFi technologies, such as blockchain and cryptocurrencies, will disrupt traditional banking models and create new opportunities for financial inclusion.

  • Open banking: Open banking APIs will allow third-party providers to access and share customer financial data with their consent, enabling new and innovative banking products and services.

  • Banking as a service (BaaS): Banks will provide their core banking infrastructure and services to other companies, such as retailers and telecommunications providers, to expand their reach and offer new products and services.

  • Voice banking: Voice assistants will become a primary way for customers to interact with their banks, providing convenient and hands-free access to banking services.

  • Data-driven decision-making: Banks will use data analytics to make better decisions about product development, marketing, and risk management.

  • Artificial intelligence (AI) and machine learning (ML): AI and ML will be used to automate tasks, improve customer service, and detect fraud.

  • Cybersecurity: Banks will continue to invest in cybersecurity measures to protect customer data from cyberattacks.

These buzzwords represent some of the key trends that are shaping the future of banking in the United States. Banks that are able to adapt to these trends will be well-positioned for success in the years to come.

Should I start to worry?

~ Jeff

Thursday, November 16, 2023

How Will We Fund That Low Rate, Low Covenant Loan?

Emily McCormick's (Bank Director Magazine) most recent Common Threads newsletter post on LinkedIn got me thinking. How did that 5.5%-6% loan, described by Jeff Rose, CEO of Ambank Holdings, get to committee or even make it past the lender?

Banking is one of those businesses that requires bankers to be less stupid than their competitors. And when competitors start funding 6% loans with 5% money, they start pulling those in their competitive eco-system with them. Or they'll lose the loan. At closing, we don't know how well that loan will perform during an economic downturn. But we priced no credit spread into it. Heck, we didn't price cost into it, or interest rate risk, or liquidity risk, or risk-adjusted return on capital. 

So how can such a loan make it past the lender on that sales call?

Culture. As one bank CEO once told me, "you can't believe the improvement in lenders' negotiating ability when you tell them it's ok to lose the loan."

I recently spoke at the ABA Bank Marketing Conference on why product management is greater than product (a chapter in my book, Squared Away). In such a culture, you would have a director of product management, likely the CMO. But the product managers themselves would be sprinkled throughout the bank as close to the product as feasible. So the product manager for, say, the commercial real estate product would be an up-and-coming middle manager in that department. And he/she would be tasked with the continuous profit improvement of the commercial real estate product.

In comes Lender Hotshot wanting to do that 6% deal. If transfer priced at the FHLB blended 4-year borrowing then Hotshot would be assessed a 4.9% cost of funds, generating only 1.1% spread. If the prior quarter's CRE product spread was 3%, then Hotshot's loan would reduce the profitability of the product. If Hotshot went further out on the yield curve and was assessed, say, a 5.3% cost of funds, now he/she would only get a 0.7% spread on that loan. Multiply that by all the hotshots you have out there trying to produce volume.

But if Hotshot is only held accountable for volume, he/she is all good, right? Hotshot sits high on the lender production board.

But if the culture is continuous improvement, and the yardstick is profit, would this be so? If Hotshot was held accountable for the continuous profit improvement of his or her loan portfolio, credit quality, spread growth, would they even consider doing that six percent deal let alone bring it to their boss or a loan committee where committee members would ask "why so thinly priced" or "why the seven-year deal." The unspoken answer: "I have a $25 million production goal and this is what needs to be done to get the deal done." We created this culture.

In the product management culture, it would matter. That sharp SVP of CRE would have an interest in appropriately priced deals. He/she would interact with Hotshot to determine if there are product features that could help get deals done that don't reduce the profitability of the CRE product.

And Hotshot would get their quarterly profitability report, that not only measures their book of business, but also highlights those lenders that are top quartile in terms of profitability, spread growth, profit improvement. Maybe Hotshot will want to be on those lists. Maybe Hotshot is incented to be on those lists. Maybe Hotshot has been given permission to walk away from that six percent deal. Armed with that leverage, maybe they can get a better deal from that borrower. Or at least not hurt the profitability of his/her portfolio, the CRE product, or the bank's net interest margin.

But to get that culture. You have to measure it.

~ Jeff

Friday, November 03, 2023

Guest Post: Financial Markets & Economic Update 4Q23 by Dorothy Jaworski

Financial Markets & Economic Update - Fourth Quarter 2023


Summer Update

On this warm October day, I am staring at my Bloomberg screen, still heartbroken over the Phillies Phailure.  Now, all of our hopes ride with the Eagles.  Interest rates are all elevated, with the 2-year Treasury yield at 5.01% and the 10-year at 4.85%, which is up by over 100 basis points since June 30, 2023.  Most of the inversion between these two yields is gone.  The 3-month T-Bill is at 5.45%, so there remains some inversion to the 10-year yield.  Stocks are down again today and have been down all week.  Gold has reclaimed $2,000 per ounce and its status as a safe haven, with all that is going on with war in the Middle East.  Too bad Treasuries are not as much of a safe haven.  Markets sent Treasury yields higher in reaction to huge deficit spending and a Federal Reserve intent on pushing rates higher, keeping them “higher for longer” with large price risk as everyone has learned for the past three years.

Some argue that, because we saw real GDP rise by +4.9% in 3Q23, that the economy is robust and strong.”  Yes, it was for that quarter, but, if you read my last newsletter, the summer of fun meant that quarter would be stronger, as the last stages of pandemic pent-up demand saw excess savings spent with abandon.  YOLO- You Only Live Once!  People traveled on vacations with their newly renewed passports, enjoyed entertainment (can you say Taylor Swift and Barbie?), and ate out at their favorite restaurants.  Now the harsh reality will sink in and El Nino is sure to give us a cold winter.  Inflation is still elevated, even while it slowly declines from 2022’s peaks.  We will continue to fall toward the Fed target of 2.0% but it takes time and patience.


Index of Leading Economic Indicators

I just finished studying a chart of the year-over-year changes in the index of leading economic indicators, or “LEI,” going back to 1960.  For every period of sustained y-o-y declines in LEI, recession has either begun or followed quickly.  The LEI fell again in September, 2023 by -.7% and is down y-o-y by -7.8%.  The index began to decline in March, 2022 (no surprise that the Fed started tightening that month), and has been down for 18 months in a row; the LEI is down -11.1% since March, 2022 to 104.6.  In July, 2022, the LEI began to decline y-o-y, yet we have not been in recession or see one imminently.

The chart showed eerily similar patterns of declines in 1990 and 2000-2001.  Unsurprisingly, the largest declines occurred starting monthly in March, 2006 and on a y-o-y basis in September, 2006 and continued to November, 2009.  The largest monthly decline took place in May, 2009 at -27.2% y-o-y with the index reaching a low of 75.7.  We all remember the Great Recession, which began in 2007, but the LEI knew it as early as March, 2006.  This time will be no different and patience is required.

By the way, there are sister indices to the LEI, the coincident for current conditions and the lagging index for 6 to 9 months ago.  Both are relatively stable, indicating the economy has been and currently is okay.


Are Rates Restrictive?

Do you remember what it means for Fed policy to be “restrictive?”  It means getting the Fed Funds rate above inflation so that a positive number, or real rate, would result after subtracting inflation from the Fed Funds rate.  Every inflation measure that I track closely is below current Fed Funds of 5.50%, resulting in restrictive rates of varying degrees.

Fed Funds is 1.40% over September’s annual core CPI of 4.1% and 1.80% over annual headline CPI of 3.7%.  Fed Funds is 3.10% over 3Q23 core PCE of 2.40% and 2.60% over the PCE deflator of 2.9%.  Fed Funds is 1.10% over the annualized 3Q23 employment cost index of 1.1% and is 1.30% over the most recent data for wage growth of 4.2%.  So, yes, rates are restrictive.  And the FIBER leading inflation index and M2 money supply are both falling year-over-year, by -1.2% and -3.6% respectively, so inflation will continue to trend downward.  Fed Chairman Powell stated “You know restrictive only when you see it.”  Well, you be the judge… I believe that the Fed is done raising rates; they just don’t know it yet.  And looking ahead to the 2024 Presidential Election, they clearly would want to be on the sidelines.


Risks to the Economy

We were growing real GDP 2.1% to 2.7% for the four quarters ended 2Q23 and then experienced an outlier of +4.9% in 3Q23.  Yeah, the summer of fun.  Consumer spending accounted for one-half of GDP.  Businesses built inventories adding 1.30% to GDP.  Housing made a small positive contribution after a string of negative quarters.  Much of the data was weak, so it’s doubtful that we can keep repeating this pace.

The risks are many.  We have an aggressive Fed threatening more rate hikes.  Long-term interest rates just increased by 100 basis points in the past few months, in a time when inflation is falling.  Government spending and huge budget deficits are upsetting investors.  Mortgage rates are now close to 8.00%; affordability is at its lowest point since 1989, according to the National Association of Realtors.  Low inventories of homes has hurt sales.  No one will give up their 3.00% mortgage for an 8.00% one.  Usually high interest rates would put a damper on home price increases and we might expect prices to outright decline.  But not in this market.  Prices are stubbornly high and rising, with August y-o-y increases of +2.2% for the Case Shiller 20, +2.6% for Core Logic, and +5.6% for the FHFA. 

China is having its own economic troubles and supply chains could suffer again.  And what a time for the UAW to go on strike- demanding outsized pay raises and slowing production at the Big Three automakers and hurting their suppliers.  Thankfully, they appear to be close to agreement.  According to Cox, one-half of Americans cannot afford a new car.  Sales will be affected by both the strike and affordability.

Some banks have tightened credit and there is also weakening demand for bank credit as small businesses are hurting from higher costs and higher interest rates.  Huge amounts of government debt and business debt, including commercial real estate, are repricing over the next two years at higher rates.  Real bank credit (excluding inflation) has been falling for the past 12 to 24 months.  Generally, GDP would be falling in this situation.

Finally, one more thought about the Fed.  They have raised interest rates by 5.25% since March, 2022, let almost $1 trillion of their bond portfolio mature without replacement and allowed M2 money supply to decline y-o-y starting in December, 2022 for the first time since the 1940s and at the fastest pace since the 1930s.  September was -3.6% and July and August were both -3.9%.  Leads and lags for M2 changes are thought to be 12 to 18 months.  The Fed has been pushing inflation lower, but, if they really believed in policy lags and looked at the LEI and M2 y-o-y declines, they would ease right now.  I wonder what Maestro would do.


Where is Recession?

Be patient.  It will come.  High interest rates- both short-term and long-term- an aggressive Fed, the LEI, and an inverted yield curve are all precursors of a recession.  The yield curve is less inverted than it was earlier this year, due to large increases in longer-term rates.  This actually plays into the recession forecasts.  The inverted curve is the precursor of recession, but it is the re-steepening of the yield curve that is the sign of imminent recession.

I mentioned the LEI earlier.  It has been falling on a monthly and y-o-y pace that is always associated with recessions- big ones and small ones.  Do not ignore this and other indicators as they always teach us something.

M2 is falling.  Inflation is responding by falling.  It was the massive increase in M2 in 2020 and 2021 (and beyond!) along with pandemic-related supply chain disasters that led to inflation.  It will be the decline in M2 that reduces it.  The FIBER leading inflation index is still falling on a y-o-y basis, and is currently -9.2% from its high in March, 2022.

The major surveys, including ISM, S&P, and the local Philly Fed, continue to show weakness in terms of current conditions and outlook.  Inflation has tamed down in most of them.  Stock markets have been very volatile and are mostly down since the summer months.  Are they all sensing that the summer of fun is over?  Profits have been mostly positive for the 3Q23, but probably not enough to make the past 12 months positive.  We shall see.


I was in Switzerland in July and I regret that I did not have the time to visit CERN, the home of the Large Hadron Collider.  The LHC has been running heavy ions through the system for the past five weeks, ending on October 30th.  What will we learn from this?  Maybe the LHC really is changing our world, turning economics upside down, and leading to outcomes that are unexpected given our knowledge of the past.  As always, thanks for reading!


D. Jaworski 10/28/23

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, October 30, 2023

3 Ideas for Your Deposit Strategy

The 2022-23 Fed monetary tightening caused disruption to our depositor base. We either lost deposits to Treasuries, money market mutual funds, or disintermediated into higher cost deposits within our bank. In this video short, I suggest three ideas to improve your deposit strategy as follows:

1. Identify "dead money" in your depositor base and pro-actively deepen your relationship with them.

2. Create "companion accounts", as described by our friend Neil Stanley from The CorePoint, to lure the money we've lost back into our bank.

3. Manage the mix. Determine which accounts are "accumulation" versus "store of value."

Listen to the three-and-a-half-minute video for greater context. Or contact me at or 717.468.3208. 

What are your ideas for a deposit strategy? 

Sunday, September 24, 2023

A Banker's Dream Dashboard

We talk about what we would like our bank to be, to our customers, employees, community and shareholders (if we have them). We build a strategy that is more often than not preaching differentiation versus cost advantage. We analyze our customers, markets, and our personnel to devise a plan that has the potential to deliver to our stakeholders.

Then we go back to our day-to-day and do none of the things we talked about. We go back to managing support functions on their budget, delaying strategic investments that could make them more scalable, efficient, and not people-dependent to mitigate the threat of the availability of talent. Because the investment wouldn't yield results until the end of year two, and we got a budget to keep.

We go back to incenting lenders on volume, even though we have a strategic aspiration of being in the top quartile of net interest margin. Our brand, according to our latest Net Promoter Score, should allow us to succeed at not having to be "best price." But we incent on volume because, hey, lenders are accustomed to volume goals, and we can't measure spreads per lender. 

We measure branch managers on deposit growth or open-close ratios. Again, it's easy to pull those numbers. And branch managers don't have the sophistication to understand a branch profit and loss statement, right? And we can't measure that anyway.

So our accountabilities fall on the same old things that are not particularly in alignment with our strategy and likely have unintended consequences that hold us back. 

You manage what you measure. And we are selling ourselves, our people, our customers and shareholders short by only measuring what our systems can do. Imagine if a branch manager owned their P&L, and therefore were empowered to make rate exceptions, fee decisions, and budget decisions that are balanced to continuously improve the profitability of their branch. It would certainly bring customers closer to decision makers, which can be a competitive advantage for the community financial institution if only it benefitted from strategic execution.

As I see it, holding employees accountable for their actions, all the way down the line, consistent with strategy, will build that execution culture so many institutions crave. Yet it remains elusive. It doesn't have to be.

I've constructed a branch dashboard that I think will motivate branch people to work every day at improving the financial performance of their branch, and therefore the bank, while giving them ownership of decision-making to benefit all stakeholders.

Imagine that conversation with the regional manager or retail executive about how to improve the numbers that they see everyday on the dashboard. They would know those customers with the highest deposit balances yet not the highest cost of deposits. Keeping those customers satisfied would do much more to help branch profitability than the rate shopper that wants top of market. That would drive up the branches cost of deposits, decrease its spread, and profitability. But the high balance customer that doesn't demand top rate, but competitive rate, is worth knowing and increasing deposit costs to maintain that relationship.

Now, we wait until that customer calls to complain. That's our strategy. Wait for our high balance yet profitable customer to call and complain about the terribly low rate we are paying them. It's an unsustainable strategy. Empower our relationship managers to make decisions that balance the needs of stakeholders. 

But to do that, we must measure consistent with our strategy. And reward those top quartile performers we know are at our bank. If we only measured to be consistent with what we believe we know. If we don't measure it, we can't manage to it. 

We can measure it, and should.

~ Jeff

Friday, July 28, 2023

Career in Banking Advice from The Pro's

I recently moderated a Risk Management Association (RMA) panel focused on managing risk in today's environment. Since the panel were seasoned bankers, the audience also wanted to hear some nuggets of wisdom about managing their careers in banking.

The question I asked: If you could give career advice to your 25 year-old self, what would it be?

The panelists were: 

Mike Allen, President of Harford Bank. A career banker with multiple financial institutions, including the long-admired Mercantile from Maryland, Mike elevated up the credit and lending vertical to his current position.

Kevin Benson, President of Rosedale Federal S&L Association. Kevin was a regulator before becoming senior lender at Rosedale, and ultimately to his current position.

Mark Semanie, Maryland Market President, Wesbanco. I first met Mark when he was CFO of a community bank, rising to COO of a different bank that was acquired by Wesbanco, giving way to his current position. Mark did not come into banking until his mid 30's.

Three great leaders, all from different backgrounds. Here is my take on how they responded to my career advice question.

Thursday, July 13, 2023

Sins of Our SIFI

Another day, another big bank faux paus. On July 10, the Consumer Financial Protection Bureau (CFPB) issued a consent order (CO) against Bank of America, N.A. (BofA), claiming, among other things, that BofA opened credit card accounts for new customers without their consent. The next day, the Office of the Comptroller of the Currency (OCC), exacted a $60 million fine for prior sins that were based on a 2022 exam and subsequent consent order regarding double fees charged to customers as a result of ACH representments.

Not a red-letter day for BofA.

But can it be for the community banks that would covet the customers that make up the $1.9 trillion in BofA deposits?

If past is prologue, we shouldn't get too excited. Wells Fargo was slapped with a similar CO back in 2016, while they were third in the nation in deposit market share. They're still third. Even though a subsequent CO limited their growth to under five percent. The good news is they only grew deposits 2.1% annually, while others in the top 10 deposit market share averaged 7.1% annual growth. But still, Wells grew deposits $169 billion since receiving their 2016 fake account order, which has been subsequently lifted.

So, as I told a banking friend, however community financial institutions react to BofA's wrongdoing, or don't react, it should be different than what we did in reaction to Wells' 2016 CO.

It's not like the BofA news isn't bad. Let me give you some of the CFPB language in the CO in Article IV, subsections 24-31:

Respondent's (BofA) Violations of Law Regarding Account-Opening Practices

24. During the Account-Opening Findings Period, Respondent offered an array of Consumer Financial Products or Services, including savings and checking accounts (deposit accounts) and credit cards.

25. During the Account-Opening Findings Period, one factor that Respondent considered when evaluating financial center employees’ overall performance and incentive compensation was the number of new Consumer Financial Products or Services that were opened and used by the consumer.

26. During the Account-Opening Findings Period, in response to sales pressure or to obtain incentive rewards, Respondent’s employees sometimes submitted applications for and issued credit cards without consumers’ consent. These acts or practices were contrary to Respondent’s policies and procedures and involved a small percentage of Respondent’s new accounts.

27. It was Respondent’s practice to obtain consumer reports in the course of considering consumers for new credit cards.

28. Respondent used or obtained consumer reports to consider consumers for new credit cards even when the consumers had not applied for or did not want the products and where Respondent did not otherwise have a permissible purpose for the consumer reports.

29. During the Account-Opening Findings Period, Respondent sometimes generated associated fees from credit card accounts opened without consumers’ consent. 

30. Respondent’s acts or practices described herein may have negatively impacted consumers including through fees charged; impacts to consumer credit profiles; the loss of control over personal identifying information; the expenditure of consumer time and effort investigating the facts and seeking closure of unwanted accounts; and the need to monitor and mitigate harm going forward.

31. Respondent has addressed a root cause of Relevant Account-Opening Practices—individual sales goals and sales-based compensation—by eliminating sales goals both for compensation incentives and for performance management for financial center employees primarily responsible for the sale of consumer credit card accounts as of January 1, 2023.

So What?

In a separate CO, the OCC cited violations of law against BofA for charging customers a $35 overdraft fee, and if re-presented by merchants the next day and there were still insufficient funds, charged an additional $35 fee for the same item. This practice was said to have ended in 2021.

Representment issues and the disclosures were recently a regulatory hot-button issue in bank exams. And, truth be told, others may have done it without even knowing it was being done. These double-fees were not very big to a traditional community financial institution and it is possible when the deposit accounts were set up, they were not set up to identify representments when automatically assessing fees. 

But still, the timing of the CO coinciding with the fake accounts opened as a result of the sales culture within BofA is certainly a bad look.

The question; will this bad look result in community financial institutions finally making a successful case to younger depositors and small businesses that their deposit dollars belong with them and not the SIFI banks?

I hope so. But hope is not a strategy.

~ Jeff

Monday, June 12, 2023

Does Your Bank Matter?

My firm is debating the direction of the banking industry so we can present, discuss, and debate with our clients, particularly how they can succeed in the current and emerging environment. In the past, I have advocated for "stakeholder primacy"; if you mattered to your employees, customers, shareholders and communities you would surely have an enduring future. If an enduring future is what you aspire to.

If you mattered to your employees, your retention rate for those you want to retain will be greater than your competitors. Higher retention usually means greater employee satisfaction through employee development, engagement and empowerment, career opportunities, competitive compensation and benefits, work-life balance, and overall satisfaction with how your bank is making a difference. These higher performing employees reduce process friction and customer pain points, delivering a superior customer experience.

If you matter to customers, you would understand their individual needs and deliver banking services to them without them having to think about it or worry about it. If they have an issue, they know who to call and that person is empowered to solve it for them without being bounced around. They are comfortable that their bank and banker will balance the needs of the customer with the needs of the bank and its other constituencies. They feel good banking with you because you serve some higher purpose in your community. They won't dump you for small rate variation or loan terms. They are your greatest promoters, reducing new customer acquisition time and resources.

If you matter to your community(s), you would be missed if your bank was not there. If you are dedicated to elevating the financial wellbeing of your customers, for example, then their net worth and overall financial happiness will improve over the long term. You help elevate those in need to a sustainable level. You lift low-to-mod income households to middle class households, and so on. You are committed to the financial literacy of all that bank with you. Yes, without your bank, there would be a hole in your community. 

Better employees that stay with you to serve your higher purpose in your community are delivering a superior customer experience to customers that are comfortable paying you for the service you deliver and the value you bring to them and the community. This delivers superior financial performance to shareholders. I've discussed how to calculate earning your right to remain independent in a prior post, and banks should do this regularly to ensure they are holding themselves accountable to deliver to shareholders.

But the brass ring is to matter not just to shareholders. But to matter to all of your stakeholders.

Below is a list of the largest of the 223 bank merger deals that happened in 2013. Ten years ago. Do stakeholders miss these banks? When you build your strategy, build one where you will be missed if you were gone. It's a great legacy.

~ Jeff

Friday, June 02, 2023

Predicting the Next Banking Crisis Is a Fool’s Game. Not Learning From the Last One: Equally Foolish

 //Jeff Marsico remarks to the 2023 New Jersey Bankers' Association Annual Convention: May 19, 2023//

Four decades ago, the prolonged savings-and-loan crisis devastated the industry. Between 1980 and 1995, more than 2,900 banks and thrifts with collective assets of more than $2.2 trillion failed. More recently and by comparison, the mortgage meltdown and subsequent global financial crisis took down more than 500 banks between 2007 and 2014, with total assets of nearly $959 billion.

Outside of those two crisis periods, American banking failures have generally been uncommon, at least since the end of the Great Depression. Between 1941 and 1979, an average of 5.3 banks failed a year. There was an average of 4.3 bank failures per year between 1996 and 2006, and 3.6 between 2015 and 2022. Before SVB, Signature, and First Republic, in fact, it had been over two years since the last bank failure.

Because our industry has been fairly stable except for a few extraordinary periods, doesn’t mean we can’t learn from tough times as both crises had long germination times and were predicated on factors that were both known and observable. 

The recession of 1990 was caused, in part, to the decade-long S&L crisis. The crisis stemmed from a variety of factors, but none contributed to the meltdown more than inflation and the attendant interest rate increase. The early 1980s was a difficult time for the United States, as consumers faced rising prices, high unemployment, and the effects of a supply shock—an oil embargo—which caused energy prices to skyrocket. The result was stagflation, a toxic environment of rising prices and declining growth, sinking the economy into recession.

To fight inflation, the Fed raised rates aggressively (familiar?). And S&L’s had long-term, lower yielding mortgages funded by shorter term deposits. The old borrow short, lend long strategy. Struggling to raise asset yields, S&L’s turned to commercial real estate, junk bonds, even art to combat rising deposit costs. 

I want to read to you the FDIC’s conclusion from their An Examination of the Banking Crisis of the 1980’s and Early 1990’s. This will be fun.

“The regulatory lessons of the S&L disaster are many. First and foremost is the need for strong and effective supervision of insured depository institutions, particularly if they are given new or expanded powers or are experiencing rapid growth. Second, this can be accomplished only if the industry does not have too much influence over its regulators and if the regulators have the ability to hire, train, and retain qualified staff. In this regard, the bank regulatory agencies need to remain politically independent. Third, the regulators need adequate financial resources. Although the Federal Home Loan Bank System was too close to the industry it regulated during the early years of the crisis and its policies greatly contributed to the problem, the Bank Board had been given far too few resources to supervise effectively an industry that was allowed vast new powers. Fourth, the S&L crisis highlights the importance of promptly closing insolvent, insured financial institutions in order to minimize potential losses to the deposit insurance fund and to ensure a more efficient financial marketplace. Finally, resolution of failing financial institutions requires that the deposit insurance fund be strongly capitalized with real reserves, not just federal guarantee.”

My lesson learned to the regulators, read your past lessons learned. To you, manage your interest rate risk. Before becoming desperate and trading interest rate risk for credit risk. This crisis hatched the more sophisticated ALCO tools we have today. Currently, not many (if any) financial institutions have experienced negative spread as they did in the early 80’s. Yet.

The dot-com bubble recession began in March 2001 and lasted only 8 months. High-tech employment fell from 12.1 percent of all jobs in 2001 to 11.3 percent in 2004, a decline of 1.1 million jobs, as the high-tech sector was harder hit by the bursting of the bubble and its aftermath than other sectors of the economy. By comparison, non-high-tech industries lost 689,000 jobs between 2001 and 2002 but recovered the lost jobs by 2004.

What caused a dot-com bubble? In the late 90s, low interest rates made speculative equity investments more attractive than bonds, and at the same time, innovative internet companies grew in popularity among retail investors, professional traders, venture capitalists, and the like (familiar?). When the Taxpayer Relief Act of 1997 passed, the top capital gains tax rate was lowered, providing yet another incentive for equity speculators to pour money into the fledgling internet industry. The Y2K scare also had companies pouring money into tech firms.

Between 1995 and its peak in March 2000, the Nasdaq Composite stock market index rose 800%, only to fall 740% from its peak by October 2002, giving up all its gains during the bubble. Lesson learned, meteoric rises are often accompanied by gravitational falls. And it is so difficult to be the odd-one out at the cocktail party full of those that participated in the ascent… during the ascent. Taking your own punch bowl away when the party is getting good takes fortitude.

The Great Recession, in contrast to the relatively short dot-com bubble recession, officially lasted from December 2007 to June 2009, the longest recession since the Great Depression. What caused it? Economists cite as the main culprit the collapse of the subprime mortgage market — defaults on high-risk housing loans — which led to a credit crunch in the global banking system and a precipitous drop in bank lending. Who would’ve thought lending $1 million to a San Francisco cab driver to buy a house at 100% loan to value would go bad?

And quite frankly, I did not know there were so many tranches to mortgage-backed securities. Although community banks did not lend to sub-prime borrowers in any meaningful way, did we participate? In many respects, community banks were caught in the cross-fire through the purchase of those mbs instruments – and subsequent trial through public sentiment. We took a serious reputational hit. 

According to the FDIC, the causes of the 2008-09 financial crisis lay partly in the housing boom and bust of the mid-2000s; partly in the degree to which the U.S. and global financial systems had become highly concentrated, interconnected, and opaque; and partly in the innovative products and mechanisms that combined to link homebuyers in the United States with financial firms and investors across the world. Capiche? (credit default swaps anyone?).

In 1991 FDICIA was passed into law. It had a provision that prohibited assistance to failing banks if FDIC funds would be used to protect uninsured depositors and other creditors (hmm, think about that in light of recent events)—but the act also contained a provision allowing an exception to the prohibition when the failure of an institution would pose a systemic risk.

In 2008, by relying on the provision that allowed a systemic risk exception, the FDIC took two actions that maintained financial institutions’ access to funding: the FDIC guaranteed bank debt and, for certain types of transaction accounts, provided an unlimited deposit insurance guarantee. In addition, the FDIC and the other federal regulators used the systemic risk exception to extend extraordinary support to some of the largest financial institutions in the country in order to prevent their disorderly failure, setting precedent for what we now know as Too Big to Fail (TBTF), or Systemically Important Financial Institutions (SIFI).

Although community banks did not play a significant role in subprime lending, the runup and subsequent decline in real estate values had a profound impact on their safety and soundness. Most of the more than 500 financial institutions that failed were community banks. When your construction loan is greater than what a builder can reasonably recover, when your home or commercial mortgage is larger than its value, you’re going to have bad loans. We knew there was tremendous hubris in the subprime market. We thought since we were only tangential players, we were insulated. What we found out is the interconnectedness of real estate values and the contagion that it can cause. 

Remember K Bank in Maryland? In 2006, the then $686 million in asset bank made $8.8 million, or 1.38% on assets and 16.38% on equity. They were killing it in construction and development loans. At industry events they had that wry grin saying, “yeah, we perform better than you.” After losses of $24 and $23 million, respectively in 2008 and 09, the regulators in 2010 said enough is enough. M&T assumed their $411 million of loans and securities with a $289 million FDIC loss-share agreement. Let those numbers sink in a bit. It didn’t take long for the profit GOAT to become, well, an actual pig. Lesson learned, beware of how a runup in asset prices might impact your assets and diversify accordingly

After the Great Recession, we had over 10 years of economic expansion, albeit anemic economic expansion. Economists were rubbing their crystal balls trying to accurately predict when the next recession would begin so that they could seal their celebrity on CNBC. But it never came. Instead, Covid came.

So many extraordinary things happened during Covid that I’m not certain if they will ever repeat themselves in our lifetimes. Most lessons were for bureaucrats. I think we have enough experience to know bureaucrats don’t learn well. They learn short, forget long. 

A substantial yet brief recession ensued. Followed by extraordinary government support that came in multiple trillion dollar plus fiscal stimulus packages so competing administrations could outdo one another on government assistance funded by ridiculous sums of debt, largely purchased by the Fed. Money supply expanded wildly. This amount of stimulus shielded our loan books from experiencing any material losses.  

And what happens when the government prints money? Inflation. I think I learned that in economics 101 or reading anything written by Milton Friedman. Perhaps bureaucrats would benefit from a brief stroll through an econ book. Not written by Paul Krugman.

Recall that the S&L crisis was caused, in part, by inflation and the subsequent rapid rise in interest rates orchestrated by the Fed. Well, this time, the Fed raised rates faster because they misdiagnosed inflation as transient. Or, the cynic might read it as, our Chairman is up for renomination and we won’t raise rates until he owns the gavel.  

The Fed Funds rate was zero in December 2021. It didn’t take a rocket scientist to predict rates would go up. And we positioned our balance sheets accordingly. And in December 2021 our liquidity positions were so strong we didn’t know what to do with the money. Good times.

Some of us took our liquidity and bought longer-term bonds – at historically high prices - to try and increase yield. Most banks consider their securities portfolio as first and foremost for liquidity. When you elevate yield over liquidity, bad things can happen. Don’t get me wrong, giving up yield for liquidity could also be bad. But there are different degrees of bad. But, no worries, right, AOCI was excluded in regulatory capital ratio calculations, and we could hide some of that interest rate risk in HTM securities. 

Then we realized we needed a special exemption from our FHLB’s regulator to borrow money from our FHLB if our GAAP equity or tangible equity was below zero. I remember being at a Bank CEO Network event in Denver when CEO’s learned of this knowledge nugget. Some seemed panicked. 

But we still had plenty of liquidity, right? Rates were rising fast, but we weren’t raising our deposit rates accordingly. Our deposit betas were phenomenally low. We thought our customers would stay with our bank, no matter what.  We bragged about it in our earnings releases.

Then depositors woke up. First municipalities and larger commercial customers, and more sophisticated retail depositors. Even I started to wake up. I don’t get angry at my bank that often, but when I found out I was earning .01 percent on my money market account when the Fed Funds rate rose to five, I was angry. My bank was taking advantage of me because I didn’t babysit my money. They will not be my bank for long.  I – like many – will use technology to move my money but keep my account open – costing the bank money.  

But what of SVB, Signature, and First Republic? Three different banks and business models. All were enviable in some sort of way. All suffered extraordinary runs on their bank due to large unrealized losses on both HTM and AFS securities, peculiarities in the p/e world, uninsured deposits, crypto, and old school panic via new school technologies and social media. 

For community banks, it’s not as much about the uninsured deposits or even the AOCI. We were concerned about the panic. The extraordinary measures taken by our government and us in employee and depositor communications, makes panic less likely.

Our pressure on deposits was because we let the difference between what we paid depositors and what they could earn in alternatives become too large. And we should’ve been able to predict this – but we did not want to be honest and thought our customers were all ours. At the end of tightening cycles, deposit betas have risen like hockey sticks. And given the transparency of deposit pricing and the ease of moving money from our bank to alternatives, why did we think it would be different?

Our lesson learned in this most recent crisis, in my opinion: don’t let market rates get too far ahead of what you pay depositors, unless you think it’s worth those two or three quarters of superior cost of funds to aggravate your depositors and force them to seek alternatives and lose trust in you. Be extremely cautious elevating yield over liquidity in your securities portfolio… I would’ve liked to have been a fly on the wall at SVB when they decided to deploy their extraordinary liquidity position in long-term (and relatively low yielding) bonds without hedge. Revise our contingency funding plans to ensure that the liquidity will be available if 400 of our banking friends are waiting in line at the same time and at the same window. And ensure our business continuity plans or crisis management plans includes a communication plan to employees and customers to restore confidence in our bank even when confidence in banking has been shaken.

So, to summarize my lessons learned from every crisis in the last 35 years:

- Manage your interest rate risk;

- Meteoric rises are often accompanied by gravitational falls. Recognize the rise;

- Beware of how a runup in asset prices might impact your assets and diversify accordingly;

- Don’t let market rates get too far ahead of what you pay depositors;

- Be extremely cautious elevating yield over liquidity in your securities portfolio;

- Revise our contingency funding plans to ensure that the liquidity will be available if there is a run on your liquidity resources; 

- Ensure our business continuity plans or crisis management plans includes a communication plan to employees and customers to restore confidence in our bank.

So what of the next crisis? Will it be non-residential real estate? We’ve had pretty frothy real estate runups – in terms of rental rates and insurance expenses despite increasing vacancy rates. Will it be commercial office space as the pandemic chased workers out of office buildings only to have them slowly return, if they return at all? Will it be retail commercial real estate, as the pandemic accelerated our preference for online shopping making zombie mall owners desperately looking for alternatives? Spread of the Ukraine war? 

So many questions that we at The Kafafian Group toyed with the idea of having a fun conference to debate emerging risks to banking called “Predictapalooza” where we would have industry pro’s stand up and make some “what if’s” to help us shape our risk management practices. Outside the box what if’s, such as what are the chances and how should we prepare for, I don’t know, a worldwide pandemic?

I don’t know what the next crisis will be. And I’m skeptical about those that say they know.

What I do know is that almost everyone in this room has been through every crisis I discussed. They were all different. They all forced us to learn from them and make adjustments on how we managed our balance sheet and our banks. And they’ve all made us better bankers and more capable to handle what “crisis” comes next.

We learn and we move on. It’s all we can do.