Banking School: The ivory tower could be yours.

I am sitting at Gate 124 in Orlando waiting for my ride home from a long journey. Prior to Orlando, it was Dallas. In Dallas, I taught bank profitability and strategic planning at the ABA School of Bank Marketing Management. The school is a two year program designed to transform up-and-coming marketing professionals into well rounded bank leaders.

I have written a post on these pages regarding training programs (see Are your employees ESWS qualified?). My firm asked Are you training for the gold? in one of our quarterly newsletters. Clearly this topic remains on my mind.

Much like the Kansas City Athletics was the training ground for the New York Yankees, large banks served as the training ground for community bankers. Those big bank training programs are long gone. In strategy sessions today, senior leaders are wondering how to replace aging bankers that benefitted from those programs.

I have a few suggestions.

1.  Get your own training program. Lack of resources is the most often cited reason for community FIs not training their own. Their are several resources outside of your FI with outstanding and targeted curriculum taught by qualified instructors. National trade associations are a great resource for training your employees to be the leaders of your FI. See the ABA, ICBA, CUNA, and other trade associations to review what they offer and the relevance to your institution.

2.  Develop a curriculum by functional position. In my experience, many if not most FIs develop ad hoc training programs that reward high performing employees for a job well done by sending them to a school or conference in a nice location. But if execution of your strategy is largely in the hands of your employees, perhaps you should be serious about giving them the tools to execute that strategy. What skills do they need? How much can be accomplished in-house or via on-the-job training (OJT)? Are we teaching them to supervise, coach, communicate, and/or build a book of business. I perceive a training curriculum to be a focused mix of OJT, in-house classroom, coaching, and outside training (either industry training or academic training).

3.  Recognize high potential employees. One way to do this is to send them to a conference or school in a nice location. But another clear recognition is to prepare them to be leaders at your FI. Train them for the next level, or for another functional area. One risk we have in banking is keeping high potential employees in one functional area, developing a myopic view of your institution and our industry. Perhaps a controller or CFO should go to marketing school because they speak such a different language. In fact, there was a CFO at the ABA marketing school. Imagine that!

4. Recognize that training goes beyond the curriculum. Bankers that don't directly compete with one another openly share best practices with their colleagues. I saw it in action at the marketing school. Another benefit is developing lifelong industry contacts that you can call on for different perspectives. See the photo for a visual of the camaraderie that goes on at these schools. This not only builds morale, it can help your FI by expanding the knowledge base outside of your walls.

This may be the fourth or fifth time I have written or spoken about industry training. I intend to keep working the subject because there is not any other initiative you can undertake, in my opinion, to build a competitive advantage and to sustain your institution for future generations.

~ Jeff

Guest Post: 4th Quarter Economic Update by Dorothy Jaworski

Before looking ahead to 2012, I can’t resist the traditional temptation to look back at the past year. The markets in 2011 were dominated by earthquakes and the tsunami in Japan, spikes in gas and oil prices, historic Federal Reserve actions where they “promised” to keep rates at their current low levels until mid-2013 and “Operation Twist,” where they are selling their shorter maturity holdings and buying longer term ones in an effort to drive down long term interest rates, and a debt ceiling and deficit debacle where our leaders in Washington cost our nation its precious AAA rating.

These events led to the stock market taking a beating of -12% to -14% in the third quarter, but a fourth quarter recovery of +8% to +12% and a Santa Claus rally of close to +1% saved the day. Volatility, anyone?

Actually, the Dow Jones Industrial Average was the only major stock market index in the world to increase in 2011. The S&P 500 index came in a close second at a change of zero. Europe suffered losses on average of -6% to -17% while Japan, China, and other Asian nations saw declines of -15% to -25% on average. Returns in the bond market were much greater.

Our weak economic growth of about 1.5% in 2011, Federal Reserve actions, and constant worry and fear about the European sovereign debt crisis caused our “beyond crazy low” rates to fall further, with the 10 year Treasury yield ending 2011 at 1.88%, after falling 144 basis points during the year, and returning about 10% to investors.

These rate declines may seem incredible, except when you consider that the Federal Reserve has their foot on the gas with quantitative easing programs I and II, their “promise,” and their $400 billion “twist” operations. Their ultimate goal seems to be a reduction in mortgage rates to help spark a housing market recovery; mortgage rates lagged the change in Treasuries in 2011 by falling 105 basis points. As they say, “don’t fight the Fed,” especially when they are “over-easing.”

Businesses fared okay in 2011. They survived tight credit, lack of confidence, and over regulation to take GDP to record levels, to take corporate profits to record levels, and to make lots of cash so that they can hoard it on their balance sheets to the tune of $2.1 trillion at the end of the third quarter. They are not alone as hoarders; banks hold an equal amount in excess reserves at the Federal Reserve.

Collectively, in May of 2011, we came to the realization that we have spent $3 trillion in the past fifteen years fighting his brand of terrorism, but we finally got Osama bin Laden. For him, terror came in the dark of night in the form of our Navy Seals. Geronimo EKIA.

Consumers fared okay in 2011, too. Unemployment fell to 8.6% in November, 2011 from 9.8% in November, 2010, although we are still seeing people exit the labor force, or go “MIA,” which is highly unusual during a recovery. Consumer spending rose, albeit slowly at times, in every month except one (June) during 2011.

Shoppers came out in force on Black Friday to set new spending records for that day at $11.4 billion, up 6.6% year-over-year. Auto sales have returned to annualized levels above 13 million. Just don’t mention the value of their homes and they will be okay. And who can forget getting up in the middle of the night in April to watch live as Prince William married Kate Middleton—a boost indeed to economies everywhere!

Looking Ahead to 2012

The sheep followed their annual ritual of falling all over each other to get their GDP forecasts out for 2012. They can be a pessimistic bunch, especially the group from AP. Here are their forecasts:

- Federal Reserve 2.5% to 2.9%

- Blue Chip Economic Indicators 2.0%

- National Association of Business Economics 2.4%

- Associated Press Survey of Economists 1.3%

- Wall Street Journal Survey of Economists 2.3%

We remain in the midst of a recovery that is fragile and susceptible to shocks. But I will emphasize that slow growth is not recession. Don’t let the pundits make you think it is. GDP is at a record level of $15.2 trillion (current dollars, seasonally adjusted). Corporate profits are at a record 13% of GDP, compared to the average since 1947 of 9.5%. Job creation has been slow, but steady. In the first six months of 2011, payroll employment grew on average by 131,200 each month, while household employment grew on average by 21,300 each month.

For the period of July to November, the pace for payrolls remained about the same on average at 132,200 and household employment increased dramatically to average 249,200 monthly. The employment picture is slowly improving.

Consumers spent freely for the holidays and it remains to be seen whether they remain in a festive mood or return to their dour deleveraging habits. The Federal Reserve is determined to keep interest rates low so consumers can borrow or refinance cheaply, and just maybe people will buy houses to get the excess inventory off the markets.

As far as the bond markets go, rates, while they can still go lower, probably will not because they are already less than the most recent core rate of inflation of 2%. Mortgage rates may not fall further as investors seem averse to such low rates that bring with them greater duration risks.

As far as the stock markets go, prices, while they can go lower, probably will not because the price earnings ratio of the S&P 500 is already below average at 12 times and the dividend yield of 2.1% is greater than the ten year Treasury yield of 1.88%. GDP is at a record dollar level and corporate profits are at a record when compared to GDP.

There are always wild cards such as the “next” crisis, reduced government spending, and the Presidential election this year. Don’t give up on the economy—there are enough positive signs of future growth and a Fed with their foot on the gas pedal. Stay tuned!

And, in case you have not noticed, she has been quietly moving into mainstream America, with a primetime Thanksgiving night special and a performance on TV on New Year’s Eve wearing what appeared to be a giant birdcage. Lady Gaga is about to announce and embark on a 2012 tour and I am there!

Thanks for reading! DJ 01/03/12

Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy has been with First Federal of Bucks County since November, 2004.

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 

The Elephant in the Room: Branches

In keeping up with industry reading it is clear to me that we, as an industry, are perplexed at what to do about branching. The recently released FDIC Summary of Deposits showed the second year of branch decline. The most recent ABA study on delivery channel preference showed online banking eclipsing branch transactions for the 55+ set. That's right... old people letting their fingers do the walking.

But the #1 or #2 reason cited by small businesses and individuals as to why they select their bank remains branch location. When I ask executives what makes a branch successful or not, the top two reasons continue to be branch location or personnel, not necessarily in that order. Confusing? Yes.

But the progressive talk about the future of the branch at times lacks common sense, in my opinion. This dates back to an interview I did with American Banker about a community FI that was opening coffee shop branches. I gave a twofold comment: 1) I saluted the FI for being creative; and 2) I doubted it would work, particularly in the locations and relatively conservative markets where they tried it. AB published the first and the second didn't make the editorial byline. The coffee shop experiment turned out to be a disaster, and the FI was later sold.

I recently had a Twitter conversation with a banker about branches that lack tellers. According to feedback from bankers that tried this concept, customers were confused when they walked into the branch. That made sense to me. We like the familiar... i.e. the teller line. But branch transactions have fallen off of the proverbial cliff. Do we need a long line full of bored tellers reading Nora Roberts novels? No. But perhaps we need a couple teller windows to process transactions and bring comfort to those of us that like familiarity.

As we evolve, I envision the comfort of knowing there is a branch nearby to continue. But the people who occupy those branches should evolve to those that can open accounts, troubleshoot problems, advise customers, develop business, and occasionally process transactions. This branch will probably be smaller, and less expensive to build out. Smaller is certainly a theme I am hearing from bankers and industry professionals. If you are of a mind to continue trying to make the branch into a destination to drive traffic, let me introduce you to Sisyphus. Going to the bank is a chore. Boom.

So what about these big branches that we all have? An industry stock analyst told me that big banks have advantages over small banks because they can pay for increased compliance expenses by closing branches. The community FI may not have this luxury. But big banks have challenges here, in my opinion. Many have built palatial branches that have no discernible value except as a bank branch.

The poster child of this concept is Commerce Bank of Cherry Hill, New Jersey which was acquired by TD Bank (see photo). Their brand is wrapped around their number of branches, the primo locations of their branches, and the look of their branches. But if branches become less important, and big banks can consolidate one branch with the one in the next town over, what are they going to do with the palace? These branches are very expensive, are fixed assets on the bank's books, and are 100% risk-weighted for capital calculation purposes. In other words, you have to carry more capital against the branch than a bond in the investment portfolio that might be 20% risk-weighted.

The pictured TD branch is about 100 yards from the Wells Fargo branch pictured below. Sorry for the poor focus but I took the picture with my phone while walking so cut me some slack! If Wells decided to consolidate this branch, it could easily be converted to an office, a hair salon, or a coffee shop. In other words, Wells could sell it and, current real estate market woes aside, can probably sell at a gain. The buyer can convert it to whatever they want. TD, on the other hand, may have to devalue their branch because they can't sell it. Or if they can, it would be for the land and the buyer may have to raze the building to something more functional. Think of all the empty gas stations dotting the landscape.

To be fair, the Wells branch had $52 million in deposits and the TD branch $130 million at June 30th. But the old Commerce was known for large branch deposit sizes because they aggressively pursued municipalities for their banking business. So aggressive, indictments were involved. But I digress. The TD branch does have more deposits, and perhaps this is partially due to the palace.

But as we determine our next step in branching, we can't ignore the trends that are telling us that transaction processing in branches is becoming secondary to something else. As branches decline in prominence, we should plan our next branch with the gas station in mind. We don't want to manage multiple properties of former branches that sit stale on our books eating our capital.

What is your opinion of what the "next" branch should look like?

~ Jeff

Top 5 Total Return to Shareholders: #3 ESB Financial Corporation

I was recently moderating a strategic planning discussion with a multi-billion dollar in assets financial institution. During the discussion, the President of one of the bank's most profitable divisions opined that less than $10 billion in assets was the "dead zone". They had to grow to survive.

I challenged the thinking. But he held firm that the regulatory environment, changing customer preferences, and the pace and expense of technology were driving the market towards bigger is better. In that, I thought, he has a point.

But I'm always looking for support. This blog has dug deep into the numbers to support the notion that bigger is better. I wrote about the best performing FIs in ROA (see link here), and how growth impacted expense and efficiency ratios (see link here). Neither supported this regional president's opinion.

This time, I searched for the top five best performing FIs by total return to shareholders over the past five years. After all, what is the point of becoming big if you cannot deliver value to shareholders? I used two filters: the FI had to trade over 2,000 shares per day so there is some level of efficiency in the stock (this created a larger FI bias in so doing); and the FI could not have a mutual-to-stock conversion during that period, which muddies the waters.

I will review my top five in descending order. Last post was dedicated to the #4 Bank, Bank of the Ozarks of Little Rock, Arkansas (see post here). The rest of this post goes to our number 3 bank:

#3: ESB Financial Corporation (Nasdaq: ESBF) of Ellwood City, Pennsylvania

ESB started in 1915 as the Ellwood Federal Savings and Loan in Ellwood City. It converted to a public company through a Mutual Holding Company conversion in 1990 and performed the second step conversion in 2001. Since its humble beginnings, it has grown to 24 offices and $2.0 billion in assets. Since 2006, it has returned 32% to shareholders as the industry returned -62% (see chart).

How has ESB done it? Upon reviewing their financial performance and reading their annual report and website, it appears as they do it through plain vanilla banking, a style that this blogger has expressed concerns about its future viability.

But you can't argue with results. ESB operates like many other thrifts... i.e. low net interest margins (currently 2.75% at the bank level), accompanied by a low non-interest expense to average assets ratio (currently 1.44%/the "expense ratio"). The expense ratio is extraordinary, as typical commercial banks hover around 3% and thrifts register in the 2.50% range.

ESB does traditional mortgage lending, with some commercial real estate too, funded by retail deposits with a heavy dose of CDs. Whether you like this model or not, it has delivered tangible book value and earnings per share growth that has driven its total return to shareholders (see table).

If you believe traditional thrifts currently trade on book value, as I do, then 12.42% compound annual tangible book value per share growth should deliver superior returns, all things being equal. Add a 3.68% current dividend yield, and the "plain vanilla" thrift is delivering to their shareholders.

Part of the secret sauce may be management longevity, as most senior managers, including CEO Charlotte Zuschlag, have been with ESB for 20 years or more. This gives employees comfort in management consistency, management a deep understanding of bank operations, and customers comfort in seeing familiar faces at the bank and in the community.

The CEO describes their success in the 2010 annual report as follows:

"Throughout our 95-year history, ESB has continually and successfully responded to change. However, we believe that sticking to basics and maintaining our commitment to the strategies that have made us a leading financial service provider remains a solid roadmap for continued growth and success. In this regard our priorities have not changed and remain:

• Focusing on per share results and working diligently to maintain our reputation as a company that creates superior shareholder value;

• Being financially conservative and managing our Company to the highest ethical standards;

• Growing the Company in a controlled and safe manner;

• Maintaining strong credit quality;

• Continuing to strive to exceed our customer expectations for quality products and services;

• Continuing to make investments in human capital, technology and physical infrastructure to ensure our long-term success;

• Continuing to provide a productive work environment that maximizes the alignment of customer and employee objectives and

• Seeking and consummating acquisition opportunities when practical."

She didn't say anything about economies of scale, regulators, or leading edge technology. The first bullet is very telling. Perhaps other bankers should take note.

Congratulations to ESB Financial. They rank #3 in total return to shareholders over the past five years. So far, our list is:

#3: ESB Financial Corporation

#4: Bank of the Ozarks, Inc.

#5: German American Bancorp

~ 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. My year to date return on bank stocks... negative. Need I say more?

Cars: A Lesson in Brand Identity

A few weeks ago I was driving the Pennsylvania Turnpike when I noticed a sweet ride. Deep black, with flecks of blue, tan leather interior, advanced looking dash, and a pretty, well-dressed lady in the passenger seat to boot. I thought to myself, "what a handsome and successful couple". The car, as emblazoned on the trunk, was a "Genesis"... the beginning... awesome name.

I looked up the car later in the week. It is made by Hyundai. I thought "maybe that couple isn't so successful after all". The lightbulb atop my head went off, sirens blaring, slightly embarrassed by my reaction, but I think I had a blog post! My opinion of this couple, a couple I have never met, was significantly influenced by the car they drove. I promised myself I would swim in deeper waters in the future.

Is my reaction unique? When I transitioned from banking to bank consulting in 1997, I drove up to my new office with great anticipation. I was anxious to get started. My car... a Mitsubishi Eclipse. On that day, my boss matter-of-factly informed me that I would have to get another vehicle. He drove a Volvo.

When I coached my daughter's club softball team, I was in charge of finances. Funny how this banking thing bleeds into your personal life. But one family was persistently late making their fee payments. I caucused with the other coaches to see if we should cut them some slack. Cutting slack meant the other families would have to pay a little more to support the family having difficulty. We decided against it when the father pulled up in a Cadillac Escalade.

I don't think cars influencing our opinions of others is unique to me.

This causes some people great difficulty, including me. I grew up in a blue collar family. The first family car I remember was the Dodge Dart Swinger. As I moved through my professional life, my family income has naturally gone up. But my upbringing does not permit me to spend $20,000 more on a car just so people can think well of me. Look at the cars of other consultants, you'll find the Volvo's, BMW's, and Infinity's. I drive a Dodge. But not the famed Dart Swinger!

I witness many friends and colleagues spend suitcases of cash on vehicles. Some are spending cash they do not have. No matter what math you use, it does not make financial sense to drive a "status" car. And yet many do. I think there is a strong lesson here for financial institutions.

There are countless resources for FIs to research how to appropriately position their brand. Maybe we are looking at this the wrong way. Perhaps we should build a brand that enhances the brand of our target customers?

For example, after a bank board of directors meeting a few years ago, a director approached me on a different topic regarding something his Merrill Lynch broker told him. This bank had a significant Trust Department, and one of their directors had his money at Merrill Lynch. It almost felt like he wanted me to know he was a Merrill client. In the eyes of the director, Merrill Lynch elevated HIS brand. Wonder what he thinks of them now!

Getting closer to home, listen to how friends and colleagues discuss coffee. Some go to the break room and pour a free cup. Others go to Starbucks, often saying "I need my Starbucks". Their Starbucks? Again, this could be a case of a company elevating the personal brand of their customers.

The proliferation of Starbucks outlets has made drinking their coffee less exclusive, and therefore lessens their ability to elevate customers' personal brands. CEO Howard Schultz readily admits they diminished their brand by opening too many stores. Fortunately for personal brand builders, they keep their price points high so schleps like me gravitate to Mickey D's.

If the question about brand changes from building the brand of the FI to building the brand of the FIs customers, what changes need to be made? If our target customers are small businesses, how do we position the FI in such a manner that the small business person is proud to proclaim that we are their bank? And if we position ourselves as customer brand builders, do we have the courage to focus on our target customers to the exclusion of other customers that are valuable to us, but not our strategic focus?

It would be writing the obvious to say that banking is at a crossroads. History and culture did not require us to position our FI for anything other than locational convenience and efficient transaction processing. Now, we must be unique, be focused, have purpose. Much like Harley Davidson, our customers should be fiercely loyal to us because we mean something to them. We build their personal brand.

I think my next car will be a muscle car. Beats going to the gym.

What are your thoughts of brand building focusing on customers instead of our institutions?

~ Jeff

Back of the Envelope: Branch Acquisition Math Made Easy

On Sunday, July 31st, First Niagara Financial Group Inc. ($30.89 billion) agreed to buy 195 Northeast branches with approximately $15 billion in deposits from HSBC Holdings Plc for an approximate 6.67% deposit premium. During a conference call the next day, First Niagara President and CEO John Koelmel said the bank will divest 100 of the branches and will likely sell about two-thirds of the divested branches and close the others.

Aside from making the announcement on a Sunday, it is odd to strike a deal only to have to divest over half of the bounty. But the branch divestiture has some upstate New York financial institutions circling branches like hyenas around a wildebeest.

Branch purchases are on the mind of many CEOs these days as a means to accelerate growth to achieve the perceived scale necessary to absorb increasing, non value added costs such as compliance and systems security. Nobody knows how big they have to be, just bigger. Sort of like professional baseball players in the late 90's.

But it is not important enough to just be big. As noted in a prior post regarding how FIs failed to reduce expense and efficiency ratios as they grew (see link below), it is more important to be smart than big. Take this from one who invested some of my daughter's college money in Sovereign Bank, a bank that prayed at the altar of bigger is better, only to have me work harder to fund the money I lost. The lakehouse will have to wait.

Analyzing the impact of a branch purchase is not particularly complicated. I ran a hypothetical analysis on the back of an envelope for Schmidlap National Bank buying a $50 million in deposits branch from First Niagara (see photo).

Counter-intuitive for those not initiated in branch purchase is that the buyer actually receives funds.  For example, if Schmidlap buys $50 million in deposits for a $1 million premium and the value of the fixed assets of the branch (including real estate, tables, desks, everything except the signs) was $2 million, Schmidlap would get a check for $47 million at closing from First Niagara.

Except if you listen to some of my early adopter bank marketing or IT friends, First Niagara would more likely remit payment via a QR code on their smart phone.

Schmidlap would have to pay the interest expense on all $50 million of deposits. They would also have to amortize the premium paid over some period. In this hypothetical case, it amortizes straight line over 10 years. There are limited exceptions to having to amortize the entire premium. And First Niagara may very well be able to put some of their premium paid in goodwill. But when acquiring only one branch, such as what Schmidlap is doing, it is likely the whole premium will be amortized. This is a non-cash charge, but an expense nonetheless.

Since Schmidlap only receives $47 million in net proceeds, that is what they have to invest in either loans or the investment portfolio. Yields on bank qualified investments are so low these days, that for any branch purchase to be anything more than a single at best, the buyer would hope to deploy proceeds in loans. In Schmidlap's case, we assume that they can put the net proceeds to work at 3% and the deposits cost 1%.

When all is said and done, this branch purchase will only drop $385,000 to pre-tax profit. Readers may think that $385k is better than nothing. But this represents only 0.77% pre-tax return on assets. If Schmidlap has a better ratio at time of closing, than this transaction would bring their pre-tax ROA down.  If the bank allocated $4 million of capital (an 8% leverage ratio) to support the branch, that would yield a 9.63% pre-tax return on equity.

Not exactly a home run, would you agree? But Schmidlap would be bigger, just not better. Or am I looking at it wrong? Doesn't bigger equate to better? Barry Bonds thinks so.

~ Jeff

Does your bank achieve positive operating leverage? Post regarding expense & efficiency ratios:
http://jeff-for-banks.blogspot.com/2011/05/does-your-bank-achieve-positive.html

Is your strategy and organization built around the customer?

I was researching videos of positive customer experiences for another potential post when I discovered this gem from Forrester Research done in 2007. Four years in our information driven society may seem like a lifetime but I listened with fascination as Forrester Research Principal Analyst Kerry Bodine described key elements of a customer centric culture.

Customer centric culture is most likely an industry buzz phrase similar to Total Quality Management and may evoke negative connotations. Industry buzzwords are processes built to solve business problems that have existed since time immemorial. Total Quality Management supposed to reduce fail rates and therefore avoid unnecessary processes. Six Sigma was designed to optimize operations and reduce or eliminated wasting time and wasteful spending. These things happened prior to TQM and Six Sigma. Buzzwords are about the packaging. Similarly, the logic behind building your business around your customers is as old as business itself.

Based on Forrester’s research, Bodine identified five key elements of a customer centric culture as follows (see video):

1. View customer experience as critical to meeting business goals;

2. Develop an accurate understanding of customers and their needs;

3. Align company strategy with customer needs;

4. Support customer experience initiatives from the top down;

5. Have common goals across the organization.

These tenets seem so simple that it is difficult to fathom why we needed to research the subject. But apply them to financial institutions, and levels of complexity surrounding simplicity emerge.

Our primary hurdle to implementing the above elements is culture. As George Millward, a colleague of mine at The Kafafian Group, tells me: “strategy drives structure” (most likely a Peter Drucker quote, as told to me by Ron Shevlin of Aite Group in Boston... thanks Ron!). But strategy has only been around corporate America since the 1960’s, and much later in FIs because of repressive regulation. Ask many CEOs about their strategy, and you may get a blank stare or a clear indication that strategy looms solely between their ears, never to descend to those responsible for executing it. According to my experience though, strategy is clearly taking hold in our industry.

So how about a strategy that puts the customer first? Customers are surely one of an FI’s constituencies, along with employees, communities, regulators, and in some cases shareholders. This form of strategy requires some thoughtful deliberations on our organizational structure.

For example, plenty of banks deem small to mid-sized businesses as their primary customer constituency. But their business bankers are typically lenders, leaving the majority of business deposit gathering to branches. To fully align with customer needs, one would think a business relationship manager would be able to advise the business person on all facets of their income statement, cash flow statement and balance sheet... not just their borrowing needs. But lenders like to lend, and talk deposits only if their boss makes them do it.

Again, it’s culture. FIs tend to organize more around product than customer. I often hear from bankers that a significant percentage of businesses do not borrow or only require a small line of credit. If true, why are lenders responsible for calling on them?

If the business person would like to add a 401(k), the lender can make a referral to some other department with separate responsibilities and reporting lines. In fact, I often hear that the lender or other FI “relationship manager” is hesitant to bring in other FI employees for fear they might screw up the relationship. Does this happen at your FI?

I do not deem the above five elements to be impossible for an FI to achieve. But I have not experienced many, if any FIs that implemented them. We talk about customer centricity, for sure. But if we want to design a strategy focused on customers, it’s time to start walking the walk.

What other elements do you believe are critical to a customer-centric strategy?

~ Jeff

Does your bank achieve positive operating leverage?

When a significant portion of your cost structure is fixed, then growing revenues should generate positive operating leverage... the cost of generating the next $100 of revenue should be less expensive than generating the previous $100.  This fundamental logic stands behind the banking industry buzzphrase, economies of scale. The fixed cost of your IT infrastructure is less on a relative basis for a $1 billion in assets financial institution (FI) than a $500 million in assets FI.

Because it is intuitive, doesn't make it so. Over the course of the past 10 years, the number of FDIC-insured FIs decreased by 23% (see chart). The average asset size per institution increased from $753 million to $1.7 billion. Clearly, part of this consolidation wave was attributable to FIs striving for economies of scale and positive operating leverage.

Has this consolidation, partly designed to give surviving institutions scale so they can spread relatively fixed costs over a larger franchise, resulted in positive operating leverage? My research into the subject says no.

One measure of achieving positive operating leverage is the efficiency ratio, defined as operating expense divided by the result of net interest income plus fee income. The lower the efficiency ratio, the greater the profitability. As an institution grows and is able to spread costs over a larger base, the efficiency ratio should go down.

But over the past ten years, efficiency ratios have risen in every asset category in both banks and thrifts with the exception of the very largest (>$10B in assets) banks (see charts).

The efficiency ratio measures how much in operating expense it takes to generate a dollar of revenue. So what if revenues (net interest margin, or fee income) are on the decline? Naturally, the efficiency ratio will go up. To further isolate expenses, I reviewed how expense ratios, defined as operating expenses divided by average assets, fared for our industry (see chart).

For banks, expense ratios have not budged during the period that resulted in a 23% reduction in FIs. Thrift expense ratios rose materially. I reviewed my company's bank and thrift product profitability reports to see if operating expenses per account declined during the 2000-2010 period. The answer: not one spread product group showed a decline in annualized cost per account. Not one.

Let's look at a couple of highly acquisitive FIs to see if they are achieving positive operating leverage by growing their balance sheets through mergers.

Fifth Third Bancorp

Fifth Third Bancorp is a $110 billion in assets financial institution with 1,363 branches and is headquartered in Cincinnati, Ohio. It has made six acquisitions totaling $32.6 billion in acquired assets between 2000 and 2007. The largest acquisition by far was the second quarter 2001 acquisition of Old Kent Financial, a $22.5 billion in assets bank. I chose this period to offset any impact from the 2008-2009 financial crisis. Clearly Fifth Third undertook acquisitions to achieve economies of scale. Relevant statistics during this period include:

While Fifth Third’s assets grew at a compound annual growth rate (CAGR) of 13.5%, earnings per share grew at a 1.1% CAGR and both the efficiency and expense ratios were higher in 2007 than when the bank was $45 billion in assets in 2000. Positive operating leverage should result in EPS growing faster than asset size because adding the next $100 in assets should cost less than the previous $100. Has Fifth Third achieved positive operating leverage by more than doubling the size of the bank during the measurement period?

 

 

BB&T

 

BB&T is a $157 billion in assets financial institution with 1,791 branches headquartered in Winston-Salem, North Carolina. It made 21 acquisitions totaling $44.6 billion in acquired assets from 2000 through 2007.  BB&T acquired more, and often smaller, financial institutions during the measurement period than Fifth Third.  Relevant statistics include:

 

While BB&T’s assets grew at a CAGR of 12.2%, earnings per share grew at 10.8%. But the efficiency ratio remained relatively steady in spite of BB&T’s net interest margin falling from 4.20% in 2000 to 3.46% in 2007. The expense ratio declined, realizing economies of scale from its asset growth. Although EPS did not exceed asset growth, the culprit lies more in revenue generation than on realizing efficiencies from growth.

This analysis is a simple undertaking to determine if your financial institution is getting the results you want when executing a growth strategy to achieve economies of scale and positive operating leverage. If your results more closely resemble Fifth Third’s than BB&T’s, you should ask yourself why.

Economies of scale should result in lower efficiency and expense ratios, and greater profitability… i.e. positive operating leverage. If you are growing to spread relatively fixed costs over a greater revenue base, then you should measure to determine if you are succeeding. Success should result in better results to peer, industry benchmarks, and downward trends in operating costs per account. Growing absent success in these metrics means you are simply managing a more complex organization for no additional benefit. 

   

Do you measure and hold yourself accountable for reducing relative costs as you grow?

 

~ Jeff

 

Note: The above post was excerpted from a soon to be published Financial Managers Society (FMS) white paper drafted by the author.

Enterprise-wide Risk Management (ERM): Yawn

I attended an industry presentation on ERM this past week put on by RSM McGladrey.  The topic highly interested me, not because it is interesting, but because everybody is talking about it and there are differing opinions about what to do about it. What an opportunity for a non-audit, non-compliance, non-IT, and non-credit blogger to write about it!

First I would like to say that the McGladrey speaker really knew his stuff and was balanced. So often I hear commentary on ERM by advocates that think it is the next best thing to, say, online banking. Well, no it isn't. It is not likely to make your FI a lick of money. That said, here is my criteria for an ERM program:

"A successful ERM will result in reduced losses that exceed the investment made in the ERM program."

~ jeff for banks

Why else would an FI embark on ERM? If the investment in ERM exceeds losses foregone, then don't invest in an ERM program. It's not worth the money. As community FIs, regulators force us to throw enough money down a black hole without us volunteering to do so.

But managing risk across organizational silos is highly fragmented in FIs. It makes sense to coordinate the effort into one area. Perhaps, as suggested by one attendee at the presentation, ERM could streamline risk management efforts to make reporting more relevant, less voluminous, and less labor intensive. If this was a by-product of ERM, then I'm in! I think your Board of Directors (Trustees for CUs) would appreciate reducing the size of monthly Board reports for monitoring risk.

An organization's risk profile looks like the bubble chart below from McGladrey's presentation. But not all risks are equal. If we were to quantify risk across the industry, Credit Risk would rank at 10 for greatest risk (on a hypothetical scale of 1 to 10), but other significant risks would be much lower such as Liquidity and Interest Rate Risk (perhaps 4's). How would a non-audit, non-compliance, non-credit person develop a ranking system for risks?

Look at past experience to determine levels of risk. For example, perform a lookback over a meaningful sample period (perhaps 10 years, or at least one economic cycle) to identify where your FI actually lost money. A second criteria could be to query your personnel with the greatest knowledge of the risk to quantify the possible loss and the likely loss from a certain risk. By developing such a discipline, the FI should determine how much resources, if any, should be dedicated to mitigating the risk.

The bubble chart above contains too much in the form of risk categories, as most categories have sub-risks. The McGladrey presenter mentioned having 20-25 risks worth monitoring and mitigating, although he was not married to it. As ERM evolves, we have to guard against monitoring so many risks that the processes that result are inefficient in their application and ineffective at preventing those risks that represent the greatest potential loss.

For example, I was evaluating processes in a client's deposit operations function where one of the ladies in the department sorted through a large stack of checks for two hours each day. I asked why she did it. She said the Bank had a check fraud about seven years ago, and therefore she had to manually review all checks over $5,000. I asked what a fraud might look like. She didn't seem clear. I asked how many she has prevented since the undertaking. She said none.

Here was an FI that allocates two employee hours per day to prevent a fraud that she probably would not prevent. The investment in resources significantly outsized the risk. I put to you that this example will be all too familiar if we implement ERM without evaluating the size and likelihood of risk. And processes, like government programs, last forever.

This past economic cycle made clear that the single greatest risk FIs face is credit risk. I don't see this changing. Even FIs that failed due to liquidity had their woes start with credit risk, including the credit risk in the FIs investment portfolio. So let's not fool ourselves into thinking that somehow "employee fraud", or some other risk, ranks nearly as high.

But there are risks that can have materially negative impacts on our business. So a CEO and Board can efficiently and effectively monitor the greatest risks to the safety and soundness of the FI, consider implementing a well thought out ERM that is focused, efficient, and effective.

Any thoughts on what such an ERM program would look like?

~ Jeff

Guest Post: First Quarter Economic Update by Dorothy Jaworski

The World Around Us

World events are impacting our markets. Unrest in the Middle East has already changed governments in Tunisia and Egypt. Protests and internal fighting in Libya have led to an international coalition bombing the country in order to establish a “no-fly” zone. Saudi Arabia and Bahrain also face protests. Triple tragedies in Japan from the 9.0 magnitude earthquake, the giant tsunami, and the ongoing nuclear emergencies have us all unsettled.

Moody’s Rating Service never sleeps and has downgraded the debt of Spain, Greece, and yes, Japan. Oil prices keep rising and we’ve seen a 15% increase in gas prices since year end 2010. So far, about half of the positive economic impact of the surprise 2% reduction in social security taxes and small business tax cuts are gone because of higher gas prices. It may not take long before the remainder is gone, too.

It is no surprise then that the confluence of these events chipped away at the stock market rally and set into motion the inevitable correction. Stock markets had been rallying nicely since the Federal Reserve unveiled their $600 million quantitative easing program, commonly known as “QE2,” in November. Actually, stock markets are up nearly 100% since the Fed was in the midst of their first quantitative easing program in early 2009. One of the Fed’s QE2 goals, as stated by Chairman Bernanke, was to improve the stock market. In that, it has succeeded.

But the other stated goal was to keep longer term interest rates low or push them lower; this has not been accomplished. The bond markets had other ideas, selling off continuously since November, until three year through ten year Treasury yields had risen by over 100 basis points, peaking at increases of 130 to 140 basis points over November levels. It was not until stocks began to correct in early March that rates began to fall some-what, or about 25 basis points, as investors bought Treasuries and other bonds in a flight to quality because of all the uncertainty in the world.

Fundamentally, stocks should continue to do well in this, the third year of the rally. Corporate profits are strong and companies are sitting on a $2 trillion stockpile of cash. Mergers and acquisitions are continuing at a brisk pace. Prospects for economic growth are gradually improving, with 3% to 3.5% expected this year, and consumer and business confidence has been rising. The S&P 500 forward price-earnings ratio of 13.5 times is well below the historical norm of 15.5 times, so there is room to continue the upward trend, if world events cooperate, that is.

The Missing People

I usually do not obsess over economic data but I have been trying to figure out why the unemployment rate managed to drop from 9.8% to 8.9% in just three months, without a commensurate improvement in the number of jobs created. There has not been a drop of this magnitude in the unemployment rate in so short a time since 1958, when I was an infant. So, let’s look at some of the recent numbers and you will probably join me in asking “Where are the missing people?”

Payroll employment rose by 407,000 in the past three months, or an average of 135,000. Household employment, which incorporates the self-employed, rose by 664,000, or an average of 221,000.

Now, let’s look at the other data: Over the past three months, the number of people reported as unemployed has dropped by 1,028,000, the pool of available workers dropped by 1,206,000, and the total labor force dropped by 704,000. Where are these people, when there were not enough jobs created to account for the drop in unemployed persons? Why are they missing? If they didn’t get jobs, where are they?

We are creating average monthly payroll growth of 135,000 and household growth of 221,000, or barely enough to absorb new entrants into the workplace, and we are supposed to believe that the ranks of the unemployed dropped by over a million and the unemployment rate has miraculously dropped by nearly 1%! Ridiculous!

Growth for 2011

Economists were stampeding over each other to raise their GDP forecasts to 3.5% from 3.0% for 2011 earlier this year after the surprise tax cuts for consumers and businesses. Even the Federal Reserve raised their forecast range to 3.4% to 3.9% from the prior 3.0% to 3.6%. Then they all got another surprise from surging oil prices (currently over $100 per barrel) and gas prices (currently up almost 50 cents from the end of 2010), so the higher growth projections may have been a bit premature. At this point, we will probably see the originally projected 3%, given the still rising oil and gas prices, high unemployment, higher interest rates, and still weak housing markets.

To put this 3% growth rate into perspective, it would be only slightly better than 2010’s rate of 2.7% and equal to the average rate of GDP growth from 2000 to 2004. But 3% is tremendously above the recent average between 2005 and 2009 of 1.0%. We long for the glory days of the 1990s, when the average growth rate for the decade was 3.8%.

But, dream on, because the long term historical average is 3.2% since World War II, so we are close to average. I will note that GDP for 4Q10 was a record $14.86 trillion (annualized basis), which is above the prior record set in 4Q07. Consumers, businesses, and governments – state and local – are improving slowly. Very slowly. Enough to keep the Fed on hold with short term interest rates near zero – until unemployment falls from today’s high levels – from real job creation not just missing people.

Putting It All Together

Since my NCAA bracket did not turn out too well – I had Temple, Pitt, and Syracuse among others – I am forced to focus on the rest of the madness in the world. It really is true that our markets are closely tied to what is happening elsewhere and not always what is happening at home. Other than protests and natural disasters, there is one theme that has been garnering attention – that of soaring food and energy prices.

Some of the Middle East protests are in response to higher food prices, which, according to the IMF, are setting new records. So far, these dramatic price rises have not worked their way permanently into the prices of other goods and services. That is because our economic recovery is still fragile and increases in prices may not be sustainable.

Consumers likely will pull back spending in response to high prices, leading to weakening economic growth. We count on the Federal Reserve to watch inflation developments closely and they are seeing excess capacity, high unemployment, low wage and salary gains, and continued weak housing markets.

Today’s issue is to reduce unemployment; tomorrow’s issue may well be fighting inflation. Expect the Fed to keep short term rates low for an “extended period” of time, just as they promise us each month. Expect the Fed to remain angry over the bond market’s reaction to their QE2 program. For all we know, they may be plotting QE3. Stay tuned!

Thanks for reading! DJ 03/21/11

Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy has been with First Federal of Bucks County since November, 2004.

 

Core Deposits Drive Value

The title of this post is common community FI phraseology. I hear it often, and use it often. My epiphany came when I performed research for a client that subscribed to the Return on Equity school of thinking. This FI had a high percentage of funding coming from CD's and FHLB borrowings, a relatively low loan to deposit ratio, and focused on generating profits within the investment portfolio.

The FI performed very well on an ROE basis. Its relatively low net interest margin, due to high funding costs and low yield on earning assets, was more than offset by very low operating costs. The FIs CEO lamented at his low trading multiples. I decided to dig into why his multiples were so low. It turned out that the best indicator for trading at high multiples was a low cost of deposits. I performed this research about ten years ago.

Dial forward to today and I decided to test again if the cost of deposits as value driver is still true. The results are in the table below. I searched for profitable banks & thrifts with at least 1,000 daily trading volume that had non-performing assets to assets less than 3%. The search yielded 101 banks and 30 thrifts. Not a large number but in order to get reasonable values I had to control for inefficient trading and asset quality.

Banks in the top quartile (best) cost of deposits traded at a 17.4% premium to bottom quartile performers in price to earnings multiples and a 35.5% premium in price to tangible book multiples.

Thrifts top quartile performers traded at an 18.9% and 30.2% premium on price to earnings and price to tangible book, respectively.

But could this be relating to their margin or yield on earning assets? I tested for yield on earning assets and the answer was no, there was no positive correlation between trading multiples and yield on earning assets.

There are imperfections to this analysis, though. Upon review, larger banks with greater trading volume also trade at higher multiples. This is probably the result of a greater pool of institutional investors due to volume requirements. Additionally, although trading multiples are beginning to show signs of improving, the overall trading of the banking sector has not returned to normal.

But ten years ago my analysis demonstrated that FIs with better deposit mixes and therefore lower cost of deposits enjoyed greater valuations. And today, the results are very similar. So why do so many FIs doggedly stick to asset-based business strategies?  Some, such as Sandy Spring Bancorp (see slide below), have been generating value from the liability side of their balance sheet and continue to do so.

According to Sandy Spring's latest investor presentation, the bank pursues a "strategic focus on small business, middle market and affluent retail customer relationships". Anecdotally, most small and mid-sized businesses do not borrow. So serving them, one would think, would require a focus on deposit relationships.

It appears as though Sandy Spring is winning, having 23% of their deposits in non-interest bearing DDAs and a cost of deposits of 0.49% in the fourth quarter. They trade at a 16.2x earnings multiple and at 130% of tangible book. It should be noted that Sandy Spring is headquartered in Maryland, a state that has experienced its fair share of credit challenges, hence the relatively low price to tangible book multiple from other top quartile banks.

Do you believe core deposits drive value? If so, why, and if not, why not?

~ Jeff

Special note: I am not making stock recommendations here. So don't call your broker to make a trade based on what I write. If you saw the performance of my stock portfolio, you would know what I mean.


Disclosure: My company has served as a strategic advisor to Sandy Spring within the past twelve months.