IMO: American Banker's Community Bankers of the Year

On November 30th, American Banker named three Community Bankers of the Year. When I read about their selections, and reviewed their financial performance, I e-mailed Bonnie McGeer, Executive Editor at American Banker Magazine, to say that, in my opinion, they nailed it!

Not that they need my endorsement. But they did notice when I sniped at one of their past Bankers of the Year awards. Banker of the Year typically goes to larger financial institutions. But I digress.

When I read about Banker of the Year and other such recognition, I will typically look at the financial performance of the bank to see if the award holds water. There are few things more regressive to me than for a banker to receive recognition without accomplishment. It cheapens the award, and diminishes our view of the truly accomplished.

But this year was a bumper crop, I tell ya!

Mark Schroeder, German American Bancorp, Inc. (GABC)

Mark became CEO of GABC in January 1999. So he's been at it a long time. When he got the job, the bank was $637 million in total assets, had an Efficiency Ratio of 62.5%, an ROA of 0.96%, and an ROE of 9.1%. Today the bank has $3.0 billion in total assets, an Efficiency Ratio of 61.2%, and an ROA/ROE of 1.20%/10.7%, respectively. So the bank performed well in 1999, and Mark has improved on it. The bank is a consistent, German-engineered performer. 

As good as those numbers are, Mark's real home run was his total return to shareholders (see chart). From the day Mark assumed the reigns at GABC until today, the SNL Bank Index had a total return of 90%. GABC's was 424%.

Let that sink in a bit.

Credit: I got that "German engineered" quip from GABC's financial advisor.

Kevin S. Kim, Hope Bancorp, Inc. (HOPE)

Kevin's story isn't punctuated by his bank's total return since he became CEO in March 2013, although it did mirror the index. An investor would have enjoyed a 74% total return in HOPE stock during Kevin's tenure, versus 77% for the SNL Bank Index (see chart). 

No, Kevin had an impact from the moment he joined the Board in 2009, first advocating for raising more capital, and negotiating the merger between Hope's predecessor, Center Bancorp and Nara Bancorp, another Korean-American focused bank. The deal closed in 2011, and BBCN was formed. After closing another deal for Wilshire Bancorp, a $4B bank, in the third quarter, Hope became what it is today.

Financial performance is similar to when Kim assumed the reigns in March 2013. Then, the bank had an Efficiency Ratio/ROA/ROE of 45.5%/1.28%/9.13% respectively. Using this year's second quarter to avoid the Wilshire special charges, those numbers were 46.8%/1.20%/9.67%, respectively. 

What impressed me most was the bank's turnaround since Kevin joined the board, the transactions he has negotiated to significantly grow the bank, and the 32% earnings per share increase since he took over. That's right, 32%.

Anthony Labozzetta, Sussex Bancorp (SBBX)

When Tony took the reigns at Sussex Bank in February 2010, non-current loans/loans was 5.48%. Today they are 0.75%.  I should end this section right there. But I'll continue.

The bank had $452 million in total assets. Today it is nearly twice that size. Net income was approximately $1.2 million annualized. Today it's $5.6 million. Efficiency Ratio/ROA/ROE? Was 61%/0.21%/2.80%, respectively. Now: 68%/0.70%/7.79%. And the bank continues in a significant growth mode. 

And due to the bank's historically rural markets, he's #GeoJumping! See my firm's most recent podcast, minute 17:40, for a discussion on geo-jumping. I'm claiming the trademark.

An investor earned a 288% total return since Tony took the reigns, versus 115% for the SNL Bank Index (see chart). I'm one happy investor. Disclosure: I'm personally invested in SBBX.

And there are my reasons why I think American Banker NAILED IT!

What other great banks are out there that didn't win the hardware?

~ Jeff

Note: I make no investment recommendations in my blog. Please do not claim to invest in any security based on what you read here. You should make your own decisions in that regard. FINRA makes people take a test to ensure they know what they are doing before recommending securities. I'm sure that strategy works well.

Bankers: How Should It Be?

I have been sitting on an airport tarmac for 45 minutes. Twenty-first in line. Waiting for a re-route from the tower to avoid the rain drops. Such is the way that it is.

But how should it be?

In banking, do we ask ourselves how it should be?

My firm analyzes bank processes to identify how it is, versus how it should be. But the question goes deeper than how a wire is done versus how it should be done. Answers are typically “it depends”. And what it depends on is in the eye of the beholder. Is the beholder the employee? The customer? The regulator? The shareholder?

Last year I did a blog post Build Your Own Small Business Loan Platform. In it I described having a series of options to fund small businesses. Some options were on the bank’s balance sheet, some not. What the post does not say is just because you could advance a loan to the customer, doesn’t mean you should.

Take the following example:

Suppose Jane and John Doe, owners of J&J Bikes, come into your bank for a mortgage loan. The bike shop has been doing well the past couple of years and the Doe’s want to upgrade their lifestyle into a bigger house.

So they find one. And come to your bank to finance it.

Your bank has a robust menu of mortgage loan programs. And the Doe’s are pushing their limit on loan-to-value, and debt-to-income. But based on the last two bumper years at the bike shop, they are feeling pretty good about their future and moving to a new, tony neighborhood.

You recognize that the Doe’s business is cyclical, and suffers revenue setbacks during recessions. Their ability to service the mortgage payments on their dream home would be significantly impaired if their revenue dropped as little as 20%.

But they would qualify for the mortgage with one of your loan programs. Since your bank sells the mortgage to investors, and you would meet the investor’s underwriting criteria, the risk of the Doe’s defaulting would fall on the investor. And your mortgage originators only get paid on closed loans.

Do you do the loan?

How it should be…

A relationship driven bank would be concerned about more than the risk of the investor putting back the loan to the bank. It should be concerned about the potential downward spiral of the Doe’s should the bike shop befall hard times and they can no longer service the mortgage.

The Doe’s are not the financial experts that know what would happen if they can’t make the mortgage payments. You are.

So you counsel them on the pitfalls of pushing their financial limits to live in a large home. Values of larger homes fall more in recessions because buyers become scarce. So if they can’t make payments due to a recession impacting their bike shop, they may not be able to sell their home at its current value either.

You tell them to look at past recessions, and the bike shop’s decline in revenue. And look at homes where they can sustain the mortgage in hard times.

I’m not suggesting telling them no, you won’t do it. But be the financial counselor your strategic plan wants you to be. The Doe’s may not appreciate your advice initially. But you would be their trusted advisor for a long, long time.

Or you can put them in that new high LTV loan program from your aggressive investor so you can pay your originator and hit the budget.

How should it be?

~ Jeff

Why Does a Fintech Darling Need a Bank?

According to a recent American Banker article, WSFS Financial Corporation struck a deal with Zenbanx, a Silicon Valley-based neobank, mobile only player. Zenbanx offers a unique, multi-currency bank account that targets world travelers or those that frequently send money overseas. Its founder is Arkadi Kuhlmann, the former CEO of ING Direct. 

Arkadi was a frequent speaker on the FinTech rubber chicken circuit, being viewed as a visionary industry disruptor. 

I suppose he was. First online bank, the imminently recognizable Orange Account, yadda yadda yadda. Mr. Kuhlmann has basked in the Orange glory. Except the bank never achieved greater than a 0.55% ROA and a 6% ROE. Say what you will about ING Bank USA, but don't say it was very profitable. And it sold in 2012 for around book value. So its brand didn't blow away its buyer, Capital One, either.

But I digress. The point of this post, and I do have one, is that Zenbanx needed a bank to get off of the ground. Should we be surprised? The much lauded Simple sold to a bank (BBVA). Moven account holders use CBW Bank, a small $22 million in asset bank based in Kansas. Fee income driven by interchange fees account for 96% of CBW's revenues. That bank has an 8.90% ROA. You read that right. If Moven driven deposits keep coming in, CBW may have to raise capital to support the balance sheet.

There are others that are part of a bank or rely on them to distribute their wares. See the table from SNL Securities regarding various features of online accounts from FinTech and banks alike.

Why do FinTech firms rush to banks? I have my opinions. Leading among them is deposit insurance. Followed by regulation. With a firm dose of capital. Banks have or are well-schooled in all three. FinTech firms are not and do not. So they seek out relationships with financial institutions, and build a business model that can live on parts of the payment system, ceding other parts to their bank partners.

Banks get a slice of the payment stream, as in CBW's case. And they get the spread from balances being delivered by FinTech "disruptors", like Zenbanx. The risk is that these disruptors become wildly popular, and start to over-take the partner bank's traditional balance sheet, turning it into something it is not and does not wish to be.

That was my first reaction to the announced Zenbanx-WSFS deal. WSFS has fared well since its near failure during the early 90's S&L crisis, and weathered the 2007-08 recession relatively unscathed. And they entered the partnership carefully, keeping regulators fully apprised of the relationship so they hopefully don't run afoul of BSA-AML laws and regulations. The bank has done well as a community bank.

Let's hope after their FinTech partner becomes more mature, WSFS remains a community bank.

~ Jeff 

A Financial Institution Investment Banker Had Questions. Here Are My Answers.

My colleagues and I are frequent speakers at industry events. At one such event, a financial institution investment banker approached my colleague and handed him a list of questions he would like answered during his speech. My colleague gave it to me the next day, and I provided my answers thinking he wanted them. Not really. Just thought I would be interested in the questions. So I think: Blog Post!

The list of questions read like the script used to convince banks they can't go it alone. But I'm a cynic. And should give the investment banker the benefit of the doubt. Here we go...

1. What should a financial institution's target levels be in the following?

Return on Tangible Equity (ROTE): ROTE is a crap ratio. Not my term, but one told to me by a bank stock analyst, and I agree with him. If you don't want intangibles, don't do premium deals. If it was such a good deal, then measure ROE. ROTE is just an investment banker talking buyers into doing expensive deals and to not be accountable for the intangible.  

But to answer the ROE question, the long-term average should be >10%. Why? Because an investor in an equity security should expect a 10+% total return. So it serves as a proxy, of sorts. It is different, for each bank however. What if a bank trades at 125% of book? Then a slightly greater than 10% ROE would be required to deliver a 10% total return. It's math.

Note that I said long-term ROE because it should be better in a strong, expanding economy and worse in recessions AND periods of strategic investment. Dropping ROE to 8% to make strategic investments so the financial institution can elevate it to 11% makes total sense to the CEO and Board that manages for long-term performance. Not so much to the CEO and Board worried about his/her next analysts' call.

Tangible Equity/Assets: This depends on the financial institution's risk profile. They should calculate their unique "well-capitalized" by estimating the risk on their balance sheet per balance sheet item, now and as projected. I like the Basel III approach of setting a base level that they don't want to go below (4.5% in Basel III's case) with a 2.5% buffer in place in good times so when times are not so good, the buffer serves its purpose. But the risk buffer should be set by each institution based on the risk on their balance sheet and projected to be on their balance sheet. My guess is that if every bank did this, their target capital range (base + buffer) would be between 7%-9%.

ROA: Greater than 1% should be achievable by most financial institutions, as so many are currently doing it. For institutions with meaningful fee-based businesses, the number should be greater because a profitable fee-based business will deliver "return", without adding "assets".

Efficiency Ratio: This is totally dependent on the business model and growth trajectory. Not many investors complained about the old Commerce Bank (NJ) efficiency ratio of 70+% when they were delivering 20+% profit growth.

Organic Growth Rates: If they exceed their markets, then they are above average, right? So it depends, in large part on their markets. Earnings growth should exceed balance sheet growth. That's positive operating leverage that so many financial institutions struggle with. Earnings growth plus dividend yield should be close to or exceed 10%, in my opinion. If markets can't support it, expand, take it from the competition, or acquire!

2. What is the total non-interest expense to have full internal staffing? 

I have no idea how to answer this one Mr. Investment Banker.

3. What is a financial institution's cost of equity? 

I bet he was looking for a CAPM calculation, as I see this often in investment bankers' presentations. But no. I'm a simple man.

For slower growth, conservatively run banks I would estimate ~10%. For fast growth and/or banks pursuing a higher risk strategy, I would estimate 13%+ for common equity, as investors should demand more for that business model. For convertible preferred, I would estimate the coupon until the conversion date, then the cost of common equity. If it is not mandatorily convertible, then it's the coupon plus the cost of common equity mentioned above. Convertible preferreds are ridiculously expensive because they dilute common returns while sitting back clipping coupons, in my opinion.

4. What asset size is critical mass? 

You know when there is a rule, and someone throws up an exception to the rule that might represent 1% of the total universe subject to that rule? Banking has plenty of exceptions to the critical mass asset size estimates bandied about by bankers, consultants, and investment bankers. My firm's first podcast highlighted the average size of all Sub S banks in the US as $273 million. Small. Yet their average ROA was 1.36%. Sub S banks represent ~ 1/3 of all financial institutions in the US. 

So there are myriads of exceptions to the economies of scale conventional wisdom. I would say, however, that banks with <$500MM in total assets have unique challenges relating to technology investments, stock liquidity, and management succession that will make things difficult. They also suffer significant stock trading discounts to larger banks, even though they may perform better. The change in community bank shareholders from retail to institutional also works against smaller banks, as institutional shareholders typically have float requirements (i.e. so many shares must trade per day). That's where the small banks challenges lie, in my opinion. Not in their ability to deliver superior financial performance. Because they are doing it.

5. Should banks form a bank holding company (BHC)?

I've already taken up enough of my readers' time than to answer this boring investment banker question.

What are your opinions of the above questions?

~ Jeff

A Solution for Closely Held Banks

If you are a family bank and want to sell your shares without selling the bank, what do you do? So was the question that my colleague, Sharon Lorman, put to me in my firm's very first podcast edition of This Month In Banking (follow link to listen!).

The question is not for family banks alone. But all banks that are privately held or have one or a few very large shareholders. How do those shareholders exit if they need liquidity for whatever reason?

This month, Old Fort Banking Company in Tiffin, Ohio gave us an answer... form an Employee Stock Ownership Plan (ESOP). Old Fort, founded in 1916, was run for generations by the Gillmor family. Dianne Gillmor Krumsee is the current Chairman. Looking to divest a portion of her stake, the bank's CEO, Mike Spragg, proposed establishing an ESOP to buy $15 million of her shares and therefore preserve its independence and the Gillmor family legacy.

An ESOP is a trust that is a qualified retirement plan designed to provide employees with an ownership interest in their company by investing primarily in stock of the employer. The ESOP is funded with tax-deductible contributions by the employer in the form of company stock, or in the case of the Old Fort ESOP, with cash that was used to purchase company stock. In this case from its Chairman. The bank's press release did not specify if the ESOP was leveraged, meaning it borrowed to fund the purchase. My guess is that it was leveraged with a loan from a financial institution or Ms. Krumsee herself. Either way, Old Fort would have likely secured the loan.

The bank can then make tax-deductible contributions to the ESOP to service the loan. As the loan is repaid, shares held by the ESOP are released and allocated to employee accounts.

Their may be tax benefits to the selling shareholder. According to Internal Revenue Code Section 1042, an owner of a closely held C corporation can defer, and potentially eliminate, all state and federal capital gains taxes on their sale of stock to an ESOP. This is done by reinvesting the sale proceeds in a Qualified Replacement Property (QRP) within 12 months of the sale. Don't take my word for it. Check with your tax adviser. That's another test I didn't take.

Chase has an excellent ESOP primer that I checked out for this post. Check it out for more information.

The benefits of an ESOP go beyond tax benefits for the seller and independence for the bank, in my opinion. Studies show that employees with ownership stakes in their companies tend to run the companies better... i.e. they perform better. A recent FDIC analysis concluded this. 

Indeed, I checked all the Sub S banks in the US, which are mostly closely held banks with significant employee and family ownership, for their financial performance. The table represents my findings.

For its part, Old Fort had a 2015 ROA of 0.96% and ROE of 10.90%. Not too bad for a $475 million in asset bank. By comparison, FirstMerit, also of Ohio, had a 0.91% ROA and a 7.90% ROE for the same period. Oh, and FirstMerit is $25 billion in assets. And just threw in the towel by selling to Huntington Bancshares (ROA: 1.01%, ROE: 10.60%, Total Assets $71B).

The twist for Old Fort, is the $15 million share purchase represented a 45% stake in the bank, which required the ESOP to apply to be a bank holding company. Which it did. And apparently succeeded, because the transaction closed last month.

Well done to Ms. Krumsee, Mr. Spragg, and all the employee-owners at Old Fort Banking Company for executing on an idea to perpetuate the family involvement, provide liquidity, and keep their well-run bank independent.

~ Jeff

Former Pennsylvania Secretary of Banking Lays Down Ideas on How to Love Your Regulator

Glenn Moyer, the former Secretary of the Pennsylvania Department of Banking and Securities (pictured), spoke at a banking industry event this past week. His subject: How to love your regulator. Glenn is a senior advisor to my firm and I suggested the topic. He rolled with it.

Regulator relations is a pressure point in our industry. Some of the more common complaints include regulatory guidance that seems to change with the breeze, and community banks being treated like “too big to fail” (TBTF). So Glenn’s comments were timely. And since he was the immediate past Secretary, and a former bank CEO, his comments were insightful. 

Here are four of his talking points that hit home.

1.  Never ask your regulator “What would you like me to do?"

This indicates to your regulator that you are out of ideas. That your management team is out of ideas. That perhaps you had no ideas to begin with. From my perspective, I would worry that the regulator would answer you. Glenn’s experience aside, how many other regulators have run a bank?

2.  Communicate your strategic direction to your examiner in charge (EIC). And include his or her boss in the conversation.

This is particularly true if you are charting a path that is different than in the past, or is somewhat unique. Regulators do not like to be surprised. Imagine an examiner coming into the next exam to find that you suddenly entered into reverse mortgage lending and the portfolio has grown faster than all others. That might inspire a higher zoom magnifying glass to see “what else” you have been up to.

3.  A repeat MRA (Matters Requiring Attention) is never good.

In my practice we occasionally hear bankers lament that they have been unfairly treated by their examiners on relatively minor issues. When we peel back the onion to uncover why the regulatory scrutiny on small potatoes, we find MRA’s that were contained in past exams. So examiners asked that the bank clean something up, and later come back to find out the bank did nothing to clean it up. Why would we be surprised by a reduction in our CAMELS?

4.  Document the collegial tension between independent directors and senior management.

This goes against the grain of boards that like to demonstrate unity and therefore have unanimous votes. Voting aside, regulators like a board that challenges management's strategic decisions. Particularly decisions that increase the bank's risk profile. Board minutes are an interesting animal. Actually, having read volumes of board minutes, I may have overstated "interesting". But if there is healthy debate about the bank entering a new line of business such as reverse mortgages, include the highlights of the debate in the minutes. Don't just state "Director Smith moves to approve entering the reverse mortgage business. Director Jones seconds. Vote is unanimous." Don't give the impression that your board is a rubber stamp. Because regulators rely on your board to protect the safety and soundness of your bank. I think I read that somewhere in a Director Roles and Responsibilities pamphlet.

What do you say about how to build a great rapport with your regulator?

~ Jeff

Compete With Yourself

Our daughter worked from our kitchen table this past week because the Pope was visiting Philly and her firm advised her to get out of town. I worked from home one day, so we got a chance to go up to the local college, workout, and beat back the age monster together (see picture).

She was a college athlete (softball). And she said it was more difficult to workout as an adult because there were no goals and you didn't get the quick gratification of seeing success on the field. Instead, she said, she found success competing with herself. Doing more crunches than her last workout, putting an extra 10 pounds into her lifts. 

This got me thinking about a speech I heard by George Brett, the legendary third baseman for the Kansas City Royals. George said he had a problem with today's baseball player: lack of hustle. He told the story of how he would compete with himself when he grounded out, seeing how far he got down the line before the ball hit the first baseman's mitt. Same with fly balls. How far could he get to second before the outfielder made the catch. Imagine that with today's player who is more likely focused on his stats compared to others.

But wait! Isn't that exactly what we do in banking?

The most ubiquitous culprit is the Uniform Bank Performance Report (UPBR). Not sure if there is an equivalent in the credit union world. If so, let me know. But every quarter senior executives pour over the UBPR to see how they did against similar financial institutions. How similar? Asset size. So if an ethnic, SBA-focused financial institution is the same size as a rural, ag-focused bank. Boom! On the same UBPR.

Differences in business models aside, are we satisfied comparing ourselves to other financial institutions? Five years ago I wrote on this topic in a post titled The Folly of Peer Groups.  I suggested comparing yourself to institutions that are like you, and institutions that you aspire to be like. But today I'm suggesting going further.

Compete with yourself. Continuous improvement. Asking yourself each morning how to be better at the end of the day than you are at the beginning of the day. That if you fail at something, don't count it as failure but as a lesson learned. And share your lesson learned with colleagues so they can benefit from your experience. 

You lead by example. It must have been difficult for a Kansas City Royal to trot to first base on a ground out when the star player hustled so he can be three steps away from the bag when thrown out instead of four. That type of leadership impacts a culture that doesn't show up on a UPBR. But it will.

I don't think the greatest companies or the greatest leaders run peer groups to make sure they are better than average. Side note: Wouldn't that make a great epithet on your tombstone? "Here lies Jeff. He was better than average." Not really.

When I coached lacrosse, I had pre-season meetings with parents. In those talks, I set parent expectations. One was that I don't compare players to the player next to them. Parents fall into traps thinking that as long as their child played better than the one next to them, their spot was assured. But what if the less talented girl hit 95% of her potential? Being one of the best on the team and only hitting 60% of your potential is not a win.

And we should stop treating it like one.

~ Jeff

Bankers: What should the magi bring you?

The Gospel of Matthew reads (Chapter 2):

"When Jesus was born in Bethlehem of Judea, in the days of King Herod, behold, magi from the east arrived in Jerusalem, saying, 'Where is the newborn king of the Jews?' We saw his star at its rising and have come to do him homage."

King Herod dispatched them to Bethlehem. Matthew's Gospel goes on to say:

"And behold, the star that they had seen at its rising preceded them, until it came and stopped over the place where the child was. They were overjoyed at seeing the star, and on entering the house they saw the child with Mary his mother. They prostrated themselves and did him homage. Then they opened their treasures and offered him gifts of gold, frankincense, and myrrh."

I'm no biblical scholar, so I am not aware of any significance to the three gifts bestowed on Jesus by the magi. Three wise men, men of stature, traveling long distance, with nothing to guide them but a star, to bestow a gift to a child, a child born under the most humble conditions, was symbolic enough.

But the gifts were chosen by the givers. We can all reflect this Christmas on what three gifts we would give to improve the lives of those around us. Not gifts such as the fruitcake, or piece of jewelry. Something more profound.

This got me thinking about what three gifts I would like to give to bankers, if I had such power. Here is what I came up with:

1. The Gift of Leadership

Leadership is not managing the day to day affairs of the bank. Leadership is motivating others to follow you through difficult and uncertain circumstances, keeping firmly focused on a vision. In no other time during my career in banking, has there been a more difficult and uncertain road ahead. Banking needs leaders that form a vision, communicate it so effectively your team lines up behind you, and pursues it with incredible passion.

2. The Gift of Talent

Banking used to be more about efficiently processing transactions and less about helping customers navigate financial complexity. As a result of automation, transactions are handled less and less by human hands. Efficient transaction processing is more likely executed in the IT department than on the teller line. At the branches, and at our customers' offices, there is a need for bankers to make customers' financial lives less complex. We need the talent so we are capable of doing it.

3. The Gift of Prudence

Yes, bankers must be prudent in developing and executing their strategy. But if I could bestow prudence, I would first focus on bank regulators. We long for a regulator that interprets laws for their intention, and implements rules that follows the spirit of the law with a watchful eye towards minimizing unintended consequences. Have you ever sat at a mortgage closing? The volume of documents and disclosures that few borrowers read are the result of imprudent regulation. Did it help us? We are on the precipice of making the same mistakes again. It would be a beautiful gift to have regulators that know this and act accordingly.

So, in the spirit of the magi, I offer three gifts to bankers. I wish I had the power to make it so. What gifts do you want from the magi?

Merry Christmas everyone!

~ Jeff

Job Description: Business Banker

I frequently hear lamentations about the gap between the performance expectations of community financial institution (FI) personnel and performance results. A frequent challenge is that performance expectations are not documented in the form of job descriptions. Instead, expectations are often trapped between the ears of the supervisor or senior management.

This post is geared toward drafting a job description of the FI business banker. Although I am not an HR expert, I am often engaged in discussions with FI senior management teams on what they expect from the person occupying this position. Often, senior management would like business bankers to build total relationships with businesses within the FI's market area. Instead, they often get commercial real estate transaction specialists, leaving small and medium sized businesses that don't own real estate in no-man's land between the branch manager and the "lender". The job description does not include qualifications or compensation, as each FI can assess what is needed based on their own expectations.

Business Banker

Summary of Responsibilities: Relationship management... Develop relationships with business's within the position's assigned market area. Relationships should include knowledge of the customers' business, industry, banking needs and their service expectations from their FI. Evaluate customer product use to determine optimal product utilization, and make routine customer contact. The objective is a level of customer satisfaction that increases customer loyalty based on service and relationship, not price/rate.

Product knowledge and expertise... Develop and maintain significant knowledge of FI product offerings, with an emphasis on products most needed by target customers as per the demographic profile of the area surrounding the FI and the FI's strategic focus. Develop and maintain financial acumen in customer balance sheet and cash flow management to assist customers achieve financial success. The objective is to establish the business banker as the subject matter expert of bank products within the bank's market(s).

Community relations... Become the primary community representative by joining a minimum of two community organizations with an emphasis on those where business owners are likely to participate. Volunteer for a leadership position in at least one. The objective is to promote community involvement consistent with the FI's strategy and to expand the business banker's relationships for future business development activities.

Business development... Grow customers at a pace faster than general market growth that is consistent with the FI's strategy. Interface with other FI departments such as branches and marketing to maximize effectiveness of business development efforts. Participate in social media efforts by contributing blog posts and managing FI-branded Twitter account geared toward small business.

Portfolio Management... Business bankers should manage 100-200 relationships, dependent on size and nature of relationships. Portfolios should include all forms of business lending within the FIs capability and strategy and consistent with risk appetite. Deposit portfolio should equate to at least 50% of loan portfolio. Business banker will lead the customer support team that includes portfolio managers, loan administration and loan servicing personnel.

Credit Quality... Business bankers are responsible for the quality of the loans they book. All loans shall be consistent with the FIs risk appetite and within loan policy, unless approved as exceptions to policy. The business banker will be the first to contact borrowers for non-compliance with loan covenants and the first to initiate collection on delinquent loans. However, loans scored as "doubtful" or worse shall be managed by the FIs workout department. A portion of the business banker's incentive compensation is subject to a multi-year holdback to offset loan losses.

Business Banking Department Profitability... Business bankers are collectively responsible for the overall profitability of the Department, and to establish a positive profit trend that is consistent with the FI's overall strategy.

Other duties as assigned.

What did I miss?

~ Jeff

Bank Super Bowl Ads 2012

First, check out this creative yet sleepy First Bank ad. If you need to go to the bathroom, feel free to do so:

Amarillo National Bank puts their CSRs through a workout. This, my friends, is a training program:

E*Trade, the gold standard for Super Bowl bank ads... speed dating. Awesome:

Would my marketing readers, being given the keys to the Super Bowl jumbo tron, offer this lack of creativity:

Not a 2012 commercial, but this is my favorite Super Bowl bank ad... E*Trade's milkoholic Lyndsey. This netted Lyndsay Lohan some coin, as she sued E*Trade because it was a little too close to home. May suffer from a broken link because E*Trade and Lyndsay must not like it advertised:

http://youtu.be/5QS9rIZcjaw

Lest we forget, here are the top 10 Super Bowl ads from 2011:

What was your favorite all time? Post the link!

~ Jeff

In Pursuit of Return on Equity

When performing ratio analysis to determine a company's profitability we should remember that a ratio has at least two data points: a numerator and a denominator. It doesn't matter if it is banking, retailing, or widget making.

In banking, the standard profitability ratio has long been return on equity (ROE). That is... until the financial crisis of 2007-08. It was in the aftermath that capital, the denominator in the return on equity calculation, resumed its place as king.

Where has the pursuit of ROE led us? Yes, it made us focus on profitability, the numerator in the equation. But it also resulted in us looking at bank equity. The smaller the E, the better the ROE, right?

Bond salesman loved the concept. They encouraged their bank clients to borrow from their respective Federal Home Loan Banks (FHLB) or chase high cost deposits to fund the bonds they sold for minuscule spreads. The logic: blow up the balance sheet, eek out incremental profits, and reduce the E. Genius! And equity analysts, who coincidentally worked for the same firms as the bond salesman, loved it too.

During the period 2002-07, when loan growth outpaced the ability to fund it, FIs took on more FHLB borrowings and high cost deposits. This was a higher spread concept, because loans typically had greater yields than bonds. Loans also typically had greater credit risk. FIs did provision for such losses, but accounting rules and how the SEC enforced them did not allow FIs to "over-reserve", whatever that means. This was determined by the high profile case the SEC brought against SunTrust in the Fall of 1998 for managing earnings through the loan loss provision. Read a summary of it from the Atlanta Fed here. The Fed research piece on the subject, written in 2000, is almost comical to read given what has happened.

So, in pursuit of ROE, banks leveraged up their balance sheet. They thinned their capital leaving them more susceptible to distress during economic hard times. This distress was clearly evident when I recently performed some "where are they now" research on the highest performing ROE FIs in 2006, the last normal year prior to the crisis (see table).

A note on the data. I searched all publicly traded banks and thrifts that existed in 2006 and sorted them by the highest ROE. But I also ensured that their prior year ROE was similarly high, in order to weed out one-time gainers. In other words, I wanted consistent, high ROE FIs.

The results are telling. Of the top 10 ROE FIs of 2006, only three are currently profitable. Two are under a regulatory agreement. The remaining five failed. Yes, failed.

How does an FI, sitting atop the ROE chain, fall so far so fast?  As mostly always the case, it was bad loans. But many if not most FIs have had loan troubles. What made so many in this group take the perp walk to the FDIC? I already mentioned their inability to put extra away for a rainy day via the loan loss provision. But the pursuit of ROE encouraged levering up the balance sheet to leave little in excess equity to absorb the losses. Inadequate loan loss allowance, relatively low equity. The recipe for disaster in bad times.

I think ROE will re-emerge as ONE important indicator of profitability. But I don't think we will make the same mistake twice. Having the past three years as history in our loan loss allowance calculations, our regulators and the SEC will probably permit us to be more aggressive in provisioning. Needing the federal government to chip in capital because we did not have enough to withstand the storm is resulting in higher capital requirements, and lower ROE expectations. Analysts take note.

What do you think should be the primary measure of FI profitability?

~ Jeff

It's a Wonderful Life

This 1946 Christmas classic is a story about the impact one man made on his family, his business, and his community. It goes beyond the fate of the Bailey Building and Loan. It teaches us to take stock of our lives, to be helpful instead of hurtful, and be thankful for what we have instead of stressed over what we don't.

But It's a Wonderful Life is also a testament to the importance of community financial institutions (FIs). The classic scene of the run on the Bailey Building and Loan after the 1929 stock market crash depicts the basic principals of community banking, how FIs work, and how important character plays in bank lending and community development.

What you don't see here is the villainous Mr. Potter's diatribe on how the Bailey Building and Loan advanced loans to "riff-raff", and was unwilling to foreclose when the "rabble" ran into difficulty making payments. Instead, the Bailey's modified the terms to help borrowers make it through tough patches.

What you also don't see is the bank examiner showing up to review the bank's books. Note the examiner wasn't plowing through the loan portfolio and criticizing this underwriting anomaly or that. He was there to ensure what the bank reported in its footings was accurate. In the end, Uncle Billy Bailey loses $8,000 when depositing the funds in the correspondent bank; Mr. Potter's bank. It was the mismatch in footings that landed George Bailey in hot water with the examiners. It wasn't lax underwriting, or troubled debt restructurings.

When the Bedford Falls community pulls together to raise the missing $8,000, they toast George as the "richest man in town". The bank examiner actually contributed to the pot of money. My how times have changed.

It's a Wonderful Life portrays the significance a financial institution plays in elevating the socio-economic status of local residents. The working poor increase their wealth by owning cars so they can get to work, to go to college or technical school, and/or to achieve home ownership. The middle class can improve their wealth by upsizing their home, going to grad school, and/or starting a business. Many of these loans don't fit the one-size fits all underwriting criteria of government bureaucrats whose sole objective is to cover their butts should asset quality falter in an institution they examine. "Rabble" need not apply.

In this sense, regulators that examine our financial institutions are the modern day Mr. Potter. But in order to help businesses work through difficult economic times, to help families stay afloat during periods of unemployment, and to help communities re-adjust to remain economically vibrant during changing times, we need more Bailey Building and Loans, not less.

Is anybody listening?

~ Jeff

Note: Since this post, the NY Times wrote an article about a modern day Bailey Building & Loan: Bank of Cattaraugus. Cattaraugus, coincidentally, is in upstate NY, near Buffalo. Perhaps not too far from the fictional Bedford Falls. Although I salute the Bank for its success in helping local people, I do believe community FIs can achieve long-term success through the profit motive, which is consistent with operating in vibrant communities.

http://www.nytimes.com/2011/12/25/nyregion/the-bank-of-cattaraugus-new-york-states-smallest-bank-plays-an-outsize-role.html?_r=1&adxnnl=1&ref=nyregion&pagewanted=all&adxnnlx=1325347237-Q5F/vRUqZwymOgvBcu0zFg

The 17 Fundamental Traits of Organizational Effectiveness

I recently read Harvard Business Review's 10 Must Reads on Strategy and reviewed it in this blog. One of the "must reads" was The Secrets to Successful Strategy Execution by Gary Neilson, Karla Martin, and Elizabeth Powers from Booz & Co. I dedicated one blog post: naming it Common Sense to Successful Strategy Execution because I didn't think it was a secret. In this post I would like to write further on the subject, focusing on the 17 fundamental traits uncovered during Neilson, Martin, and Powers' research. 

The below table was drawn from research from more than 26,000 people in 31 companies. The Booz consultants distilled them in the following order of importance...

A note about the study: The Booz consultants tested organizational effectiveness by having participants fill out online diagnostic that contained 19 questions... 17 traits and two outcomes. The traits were ranked and indexed to a 100-point scale to determine their relative importance to organizational effectiveness.

In the study, 61% of respondents in strong-execution organizations agree that field and line employees understand the bottom-line impact of their decisions. This figure plummets to 28% in weak-execution organizations. For community FIs, this is terrible news, as so many rely on top-level profit reporting to determine success or failure. Does the deposit operations manager know the implications on product costs for adding a software component? Doubtful. Does the lender understand the profit implications to his or her line of business by authorizing the waiving of a fee? Unlikely.

A similar analysis can be performed on your organization as a whole, focusing first on the top traits and working your way down, ensuring your FI moves toward affirmative responses to each trait. Once completed, FIs can then incorporate the 17 traits into executive performance reviews.

Imagine an FIs board of directors using the above table to evaluate the effectiveness of its CEO. Or a CEO to evaluate the effectiveness of his or her direct reports. Simply putting the 17 traits in a spreadsheet, and responding on a five-point scale of "strongly agree" to "strongly disagree" would certainly motivate the person evaluated to create a strong execution culture in his or her organization. For proponents of the 360 review process, subordinates can also respond, giving the Board or CEO insights beyond their own perceptions and bias.

This blog has dedicated countless posts to strategy. If an FI is to promote an execution culture, it begs the question "execute what"? It reminds me of legendary Tampa Bay Buccaneers coach John McKay's response when asked about his team's execution after a lackluster performance: "I'm all in favor of it." My point is, and I do have one, when evaluating the organization and its executives on execution, it should be executing long-term strategy. That implies the FI has a long-term strategy to chart the course to compete and succeed in a rapidly changing industry.

What are your thoughts on developing an execution culture?

~ Jeff

Note: I tried to make the table as large as I could. If you would like a larger version, e-mail me.

Book Report: HBR's 10 Must Reads on Strategy

A Written on the cover is a definitive statement made by an entity that has supreme confidence in itself: "If you read nothing else on strategy, read these definitive articles from Harvard Business Review." Wow. And while we're at it, if you read no other blogs on banks, read Jeff For Banks. As much as I would like to believe it's true, I would also have to believe that a higher authority is leading the Denver Broncos on their improbable run. You and I both know that's not true... ???

But if a compendium of essays on vision, strategy, and execution written by luminaries such as Michael Porter, Jim Collins, and Michael Mankins interests you, then this book is for you. I'm pretty much a strategy junkie, and this book gave me fix after fix, every time I powered up the Kindle.

What I liked about the book:

1. Covers, in good detail, disciplines such as strategy development, strategy execution, decision rights, balanced scorecards, and vision;

2. Many essays were in "how to" format, such as how to develop your strategic principle;

3. Summarized key points in Idea in Practice segments.

What I didn't like about the book:

1. Not much. But if I had to pick something, it would be that the essays were penned by academics and/or consultants. It is instructive to hear from practitioners too, although the book is chock full of real world examples of idea implementation.

Do I trust Harvard Business Review to select the appropriate compendium on strategy? Well, no. I'm sure they have their bias and it flows through not only to the essays selected, but also the authors, as many are associated in some way with HBR. But I can't argue with any of their selections, and I am better for having read the book. I think you will be too.

~ Jeff

Book Report note: I will occasionally read books that I believe are relevant to the banking industry. To help you determine if the book is a worthwhile read for your purposes, I will review them here. My mother said if I did not have something nice to say about someone, then don’t say it. In that vein, I will only review books that I perceive to be a “B” grade or better. Disclosure: I will typically have the reviewed book on my Amazon.com bookshelf on the right margin of this blog. If you click on any book on the shelf and buy it, I receive a small commission; typically not enough to buy a Starbucks skinny decaf latte with a sugar-free caramel shot, but perhaps enough to buy a small coffee at Wawa.

The Grand Mishandling of Strategic Projections

After nineteen years in financial services, I am finally witnessing the tide turn in bank and credit union strategic planning. What once was an annual budgeting exercise, is now beginning to take the more productive path of identifying and paving the way to the financial institution (FI) of the future. The one that makes clear either-or choices to ensure future relevance for their customers, employees, communities, and shareholders (if stock owned).

But the fate of strategic plan projections, for the most part, remains mired in the old-school budgeting process. When asking senior leaders what success would look like if they executed their plan well, the answer is all-too-frequently what leaders reasonably think they can achieve. In other words, success looks like next year's budget.

In February, I proposed that FIs evaluate strategic alternatives as a regular part of the strategic planning process. To use the present value of future earnings streams to determine if the strategy is actually adding value. Developing strategic projections so you have an extremely high likelihood of achieving them may not yield the answer you want. What if your Board expects senior management to increase the value of the FI by 10% per year, and you project a 5% increase in earnings because you feel comfortable you can succeed? You will erode the value of the franchise.

The Board may decide to turn the keys over to someone capable of increasing franchise value. See the chart below for the decrease in the present value of tangible book value per share versus the nominal increase in tangible book. If you were a Board member of this franchise, what would you do?

In my opinion, FI strategic plans should have three scenarios:

Scenario 1: Stretch. These projections should depict "what success should look like" in executing your strategy. I am not proposing creating projections that cannot be achieved, a risk that an investment banker told me often happens when FIs evaluate their strategic alternatives. If I were to handicap these projections, I would give senior leaders at least a 40% likelihood of achieving them. The more strategic leaders gain credibility with the Board and their shareholders (if publicly owned) at achieving stretch goals, the greater the likelihood the FI earns its independence. Creating overly optimistic or "hockey stick" projections only erodes credibility with your constituencies. "Stretch" are the projections that should be discounted to determine the present value of the strategy.

Scenario 2: Base. These projections take more the form of budgets. They are estimates of what senior leaders reasonably believe they can attain. As mentioned, present valuing these projections may not yield the answer you want. But in setting Board and regulator expectations, these projections are likely to be around 70% achievable.

Scenario 3: Stress. These projections serve to identify the things that can go wrong, and their impact on your FIs balance sheet and capital ratios. FIs tend to do this within their ALCO process regarding swings in interest rates. But interest rate risk is only one form of risk that can pose significant challenges. By modeling the most likely stressors, senior leaders can develop contingencies in advance to improve their balance sheet and profitability.

In my experience, FIs tend to use scenario 2. Why? In my opinion it is because they want to manage expectations, and it is how it has always been done via budgets. Another reason may be the uncertainty in projecting out several years. Banking, unlike many other industries, has significant macro issues that are beyond bankers' control which impact their balance sheets and income statements. Because of these uncertainties, we shy away from what our financials will look like in the future.

But if, through strategic planning, we set our sights on the bank we want to become, we should model what that would like like in our financial statements. Not doing so dilutes our credibility and accountability to our Board, our shareholders, and ourselves.

How does your FI use strategic projections?

~ Jeff

Note: The above chart represents the actual tangible book value per share of a Northeast FI from 2005-2010. If the Board of this FI expected a 10% annual return, they were sorely disappointed.

Common Sense to Successful Strategy Execution

The title of this post is a modification to the original, The Secrets to Successful Strategy Execution, originally published in Harvard Business Review in 2008 by Booz & Co. consultants. As the authors noted in the article, "A brilliant strategy, blockbuster product, or breakthrough technology can put you on the competitive map, but solid execution can keep you there."

The authors' research, querying 125,000 employees from over 1,000 companies, identified four fundamental building blocks to create an execution culture. These are:

1.  Clarify Decision Rights. Sometimes called empowerment, this building block is critical for quick, effective decision making. Have you ever worked for a boss that frequently questioned decisions you made? The result: you push the decision up the chain of command so you don't get blamed for mistakes. This behavior is endemic in a dysfunctional organization that requires senior leadership to make even the most mundane decisions. This, in my experience, is a common challenge with community financial institutions (FIs). Clarify the kinds of decisions that managers and rank-and-file can make at every level, and don't second guess those decisions when made. Learn from mistakes, but don't punish or second guess less than optimal decisions. Because we all make them.

2.  Design Information Flows. If we are to push decision rights down the chain of command, we must provide the necessary information to make informed decisions. Clarifying decision rights does not mean creating a culture of winging it. To supplement the culture for successful execution, ensure the needed information flows across organizational silos and up and down the chain of command. This is a challenge in financial institutions, as our silos are Superman strong. For example, in a recent meeting I attended the head of retail banking was pleased at the level of new account acquisition. However, we did profitability measurement that demonstrated the aggregate number of accounts barely budged. Why? Nearly as many accounts closed as were opened. Had Finance shared information with Retail, perhaps this trend could have been uncovered earlier and Retail could have implemented strategies to stem the outflow of customers.

3.  Align Motivators. I would report that this is the easiest to put in place. But I would be wrong. So many FI strategy sessions include revamping their incentive compensation system to align with strategy. I wrote a post specifically about branch incentives on these pages. But FI's remain doggedly attached to compensating on volume versus profitability for lenders, and the traditional holiday bonus for staffers. If you want to create an execution culture, develop incentives that motivate strategy execution.

4.  Change Your Structure. I teach Bank Organizational Structure at two banking schools *yawn*. In those sessions I dream of an FI that organizes according to their strategy versus legacy. FIs are starting to look at their org structures to determine if it inhibits strategy execution, a promising development. But history remains, and change is slow. Take small business banking as an example. Most FIs are struggling to serve this important customer base well because responsibility for service rests squarely between commercial and retail. Small businesses typically don't borrow or use credit cards and home equity loans for early stage funding. Not fertile ground for commercial lenders. Branch bankers are uncomfortable talking about cash management or financing with the small business owner. What results is a confusing web of responsibilities in serving small businesses. If you want a to foster successful strategy execution, ensure your organizational structure is consistent with your strategy.

There you have it! Four common-sense building blocks to create an execution culture. Thankfully, FIs are more often looking to develop strategies for a sustainable future instead of looking only one year down the road through their budget. Executing on such a strategy is critical for us to remain relevant to our customers, our employees, and our communities.

What do you see as critical to successful strategy execution?

~ Jeff

Occupy Wall Street: Occupy This!

The Occupy Wall Street gang seems to garner more press coverage than the state of the U.S. economy, the presidential election, and the MLB playoffs combined. In terms of media excitement, only the trial of Michael Jackson's doctor competes.

Who are these people and what do they want? The press can't even figure it out and spin it to something cohesive, even though they really, really, really want to. But it has something to do with economic justice, whatever that means. Whenever talking heads say "___fill in blank____ justice" it makes me nervous. It usually relates to socialism and according to all of my college economics professors, socialism doesn't have a great history of success. Though I admit that I could not understand many of my econ profs.

My first division officer in the Navy told me that if bad things were happening to me, look to me first before I start pointing the finger elsewhere. I think both bankers and Occupy Wall Streeters are falling into a whining trap. If Occupy Wall Street truly represented a movement to improve the economic status of lower and middle income families, here is where I think they should focus their energy, and also what banks can contribute:

1. Learn robotics. Factories provided blue collar workers with middle income wages. We ignored the signs of globalization, and instituted wage scales and inefficient work rules that made manufacturing things overseas much more attractive to companies (and buyers of the goods manufactured). So we let manufacturing leave our shores for cheaper labor and more flexible work rules. But the loss of manufacturing jobs in the U.S. has stabilized. If we are to grow manufacturing with middle income jobs we need to master robotics to make plants more efficient and attractive for companies to work here. According to Maxizip.com, a robotics technician can earn $30,000-$45,000. Do you want to do something to help the U.S. economy and your family, consider robotics. If not robotics, then research good paying blue collar jobs (see here) and focus your efforts there. And for Pete's sake, be flexible. If you install doors on GMC trucks, don't go on strike if asked to do dashboards on Chevy's.

2. Start a business. Economic cycles of yore resulted in many more business startups than the current one. One reason, in my opinion, is politicians' continually extending unemployment benefits. If you keep paying somebody not to work, it saps the sense of urgency for would-be entrepreneurs to seek opportunities to be their own boss. During periods of heavy uncertainty it is typical for opportunities to identify and fill a need to arise. Don't let the drug of the monthly check keep you on the sidelines. Do some research, write a plan, and start a business. You want bankers to suck up to you, see what happens when you get a successful business up and running.

3. Go to business school. If you would like to earn similar money to Wall Streeters, go to business school and earn it yourself. There is a misconception that people that work in finance were born with silver spoons in their mouths. To be fair, there are some on the Street that were born on second base and think they hit a double. But I know from experience that many if not most came from much humbler beginnings, went to B school, and worked hard to get where they are. Most Americans that are in the lower to middle economic categories do not pay full fare at business school. Some may go for little or no cost. So if you want to Occupy Wall Street, why not do it from inside the building instead of out.

This is a banking blog. So how can bankers improve the economy, their communities, and expand opportunities for Occupy Wall Streeters? Here is how I think:

1. Run an Angel Fund from your holding company. "Bankable" businesses typically have a profitable operating history or real estate with significant equity. This makes startups that don't have real estate to lend against unattractive to banks. So how can banks get capital to entrepreneurs with a great idea, solid business plan, and reasonable chance for success? How about run an Angel Fund that focuses on startups within the bank's markets? The bank need not be the only investor, but can run it profitably through management fees, the "ups", and diversification.

2. Do SBA lending. So many bank clients shy from SBA because of strict rules, paperwork, and fear of not receiving the guarantee if the business defaults. But there are ample vendors to do SBA lending for you and can be flexible in how the program is structured. If you don't want the risk, simply receive a marketing fee for bringing the vendor to the customer and providing an opportunity for that early stage business in your community to receive a government backed loan.

3. Run a business plan contest. How many times have you driven down the street and see a new business that you doubt will succeed? Many entrepreneurs jump in with both feet prior to doing research, writing a business plan, and having the capital in place. The discipline of doing so improves the likelihood of success. Why doesn't your FI run a contest in your community for the best startup business plan and award a meaningful prize, such as $25,000, to get the business off of the ground. The Nashua Bank in New Hampshire ran such a campaign and the CEO said it was a great success. The discipline of performing the research and drafting a business plan will help all participants, not just the winner.

There! Three things that would be more constructive than carping about bankers' pay by Occupy Wall Streeters and whining by banks about the state of the economy. Let's get off the whine and into the game!

What do you think would be more productive use of time for FIs?

~ Jeff