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.