Bank Strategy Tweetup: Here's how I think it would go...

I recently read a funny post by Don Cooper on how he thought the birth of Jesus would have went if Joseph was able to tweet about it (see the link below). This got me thinking how a bank strategy session would go if we conducted it via Twitter. Below is an abbreviated tweet stream of how I envisioned it going down.

@bankceo Welcome to our first ever strategy tweetup! Today we will set bank strategy in 140 characters or less.

@bankconsultant I hope this strategy tweetup thing doesn’t reduce our fee.

@banklender Every second I spend in this mind-numbing strategy tweetup I can’t be with customers, having a power lunch, or be on the links.

@bankmarketer This strategy tweetup thing is the best idea EVER!

@bankfinance REMINDER: Request an ROI on this tweetup thing from @bankmarketer

@bankconsultant Ok everyone… let’s role with this tweetup idea. What are this bank’s key strengths?

@banklender Lenders

@bankmarketer Our website

@bankceo Me

@bankfinance We have no strengths.

@bankconsultant Moving on… what are weaknesses that we must address?

@bankmarketer Branch people, because they can’t sell.

@bankceo Branch people, because we have the wrong people in the wrong seats.

@bankfinance Branch people, because our cost of funds is too high.

@banklender Branch people, because they’re not lenders.

@bankconsultant Alright, let’s talk vision. If we were to look out five years, what should the vision of this bank be? Where do we want to go?

@banklender [eyes rolling]

@bankmarketer To be the best bank we could possibly be by positioning ourselves to create value for customers… and world peace.

@bankceo To provide superior service to our customers: retail, business, not-for-profit, ethnic, non-ethnic, under-banked, over-banked, [exceeds 140 characters]

@bankfinance I never got the “vision thing”.

@bankconsultant Alright, @bankfinance insists we get specific on financial targets. Where do we see this bank’s ROA in 3 years?

@bankceo We have to be careful putting a number out there bcause we don’t want the Board to pull this doc in 3 yrs and hold us accountable.

@bankmarketer What’s an ROA?

@bankfinance 2%! [Thinks to self: Do we have to pay @bankconsultant for this?]

@banklender The ROA would be great if lending didn’t have to pull this bank like we were Budweiser Clydesdales hitched to a beer wagon.

@bankceo Thanks to all 4 joining our first strategy tweetup. It was very productive and we clearly have our marching orders for the future!

The above, of course, is a figment of my imagination. However, if you're bank actually had a strategy tweetup, please notify me and we will be happy to put your guest post on these pages!

Have a great holiday season everyone!

~ Jeff

The Birth of Jesus: As tweeted by Joseph
http://bit.ly/908Tkq

Diseconomies of Scale

Have you ever driven on a highway by yourself and forget, if even momentarily, the highway you were on and where you were going? I hope most of you answered yes or I have to make a doctor's appointment. The same sensation you feel for that split second while driving is, at times, what I feel in some strategy sessions I am priveledged to attend.

A common discussion in these strategy sessions is 'how do we grow'? Frequently, I will ask 'why do you want to grow'? The answers typically come back with some variation of achieving economies of scale to leverage the infrastructure to enhance shareholder return. This is particularly true of today's banking reality, where regulators and politicians are heaping non value-added costs on financial institutions. So the easy answer is let's get bigger, right?

Of course there is some merit to growing to a certain size so adding another compliance officer or another branch doesn't tank this year's earnings. But the million dollar question is what is the "certain size"? A bank CEO once told me that his investment banker told him the ideal size was twice his current size, no matter what size he was at that time.

The table below, derived from averages of the last ten years of efficiency and net operating expense ratios, indicates there are advantages to being larger. But look carefully. The advantage diminishes as the asset size grows, to a point where it is not particularly compelling.

The drive for growth in banking always concerned me. Banking is driven by balance sheet, not the income statement like most industries. Banks revenues are the result of the size of its balance sheet. You want to grow revenue 10%, you must grow the balance sheet 10%, all things being equal.

Not so difficult, one might think, if you grow from a $500 million in assets financial institution to a $550 million one. But what if you're a $10 billion bank? Now you must grow another billion to get your growth. What do you do if your markets can't support that growth? You must buy other financial institutions or reach for growth outside of your power alley (either your geography or into lending areas where you have little experience). The result may be fine at first. But as Warren Buffett once quipped, "You don't know who's swimming naked until the tide goes out". Many financial institutions were found to be naked over the past year and a half.

Perhaps it is time to consider a different strategy. If, for example, slow but prudent growth leads you to grow your balance sheet, and therefore earnings, at five percent per annum. This is typically not an acceptable long-term return for equity investors.

But if you are generating sufficient profits, and you don't need to grow capital at a rapid pace to keep up with growth, you could pay higher dividends, delivering acceptable shareholder returns. In this manner you may be taking the growth your markets can deliver, without forcing you to seek growth that is beyond your control (i.e. M&A) or put undue risk on your balance sheet (i.e. lending outside your expertise).

There are strong leanings to grow. I know of banks that are located in the same small town. One grows faster than the other, and is very proud of the accomplishment. Senior management and the Board of the smaller bank lament that they have not grown as quickly. In this context, growing is not a business judgment or a shareholder return issue, it becomes an ego issue. There is no greater testament to the role ego plays in the size of a bank than to see Bank of America and Wachovia's drive to be the highest skyscraper on the Charlotte skyline. Wachovia was winning until their near collapse. But their building was impressive!

What size do you think is big enough?

- Jeff

The Folly of Peer Groups

A bank CEO once told me that peer groups get you to that lazy place. He was referring to being mediocre. Yet we continue to use peer groups in banking to guide us to where we want to go.

I am not against peer groups. My company uses them to determine where a company is at a point in time. But because financial information on competitors is so readily available in banking (we must report to the FDIC our quarterly results and it is available to all), we become over-reliant on them.

Regulators fall victim to this trap too. I have read countless exam reports that cite UBPR (Uniform Bank Performance Report) statistics as evidence that a bank is doing well or needs fixing. For example, an examination may cite a bank’s efficiency ratio as compared to peer as a reason why the bank is lacking profits (the “E”, or Earnings, in CAMELS ratings).

But UBPRs are done by asset size and region. See below for a snapshot from an Umpqua Bank of Portland, Oregon UBPR. Their peer group is all commercial banks with assets greater than $3 billion. That’s the only criteria. If Umpqua chose to measure success by these standards, they would surely strive for mediocrity. Something I doubt Ray Davis would be pleased with.

Suppose a bank has a significant wealth management division. This typically drives up efficiency ratios and would therefore compare unfavorably to peers without similar operations. Should senior management focus their efforts on reducing the efficiency ratio because a short-sighted examiner said so?

No, I would think that is not the way to run your bank. I frequently tell bankers not to let examiners run their business. What qualifications do they have to do so? But bankers can’t let peer numbers run their business either.

Comparison to peer ought to be the result of executing your strategy, not the impetus behind your strategy. We have a client that evaluated their position in their markets, their potential, and therefore their best strategy to succeed. Then they identified the peers that had balance sheets similar to the one this bank strived to attain. They dubbed this peer group their “future peers”.

They then evaluated their current position and identified peers that looked most like them today. They dubbed this peer group their “present peers”. As they implement their strategy, senior management is tracking their progress from their present to future peer. In other words, they utilize a peer group as a tracking mechanism for executing strategy, not to determine the bank they want to be. That came first. In my opinion, this is a very positive manner to use a peer group.

I think banks should use peer groups as diagnostic tools, to hold themselves accountable for top tier performance, and move towards those peers that may be executing similar and successful strategies. I do not think they should be used to determine the bank you want to be or to achieve “peer performance.” To me, this would be a recipe for mediocrity indeed. How does your bank/thrift/cu use peer groups?

- Jeff