Banking's Execution Imperative

Announcer: Spain had 85% possession against Sweden and did not score.

The strategy drawn up by the Spanish side played out... mostly. What Spain didn't do is execute in their attacking third to put one in the net. It doesn't matter if you had 85% possession. The scoreboard matters.

So it goes with banking. So often management teams put in the work to design a winning strategy. They march out of that planning retreat energized. And when their strategy consultant re-engages next year to see where they are on execution, there is disappointment. The economy, interest rate environment, or their "day job" held them back. And the institution didn't move forward. They didn't execute in the attacking third.

I realize the irony about me writing on execution when one segment of my book, Squared Away-How Can Bankers Succeed as Economic First Responders was "No amount of good execution will help a bad strategy." But if we don't get serious about executing on the well thought out strategies we worked so hard to develop, the scoreboard will reflect it. And we can't expect our competition to put up a zero so we stay level at nil-nil. 

I'm working this soccer analogy to the fullest.

Here is what I mean. Schmidlap National Bank, our hypothetical community bank, researches their markets, customers, competitors, strengths and weaknesses and determine that they can distinguish themselves as the best business bank for businesses between $1 million - $10 million in their markets. So they set out to make it so.

They debate what success would look like. To be the best business bank, they must baseline what their current business customers think of their bank, its products, and its service. So a strategic initiative is to baseline through survey, and repeat at least semi-annually. To align strategy with culture, they make executive and mid-level performance reviews within the departments that serve businesses dependent on continuous improvement in how your business customers view the bank.

Additionally, the strategy team thinks they should be paid for being the "best" in terms of pricing. As such, they identify top-quartile (among market peers) yield on loans to be their aspirational goal. And again, executive performance reviews and/or bonuses are linked to achieving top quartile yield on loans while achieving market average credit quality metrics. In other words, they can't deliver yield by chasing poor credits. 

But there's more. In order to align the organization with this strategic aspiration, lender bonus criteria is changed from volume to continuous improvement in the individual lenders' spread. So now, lenders' incentives are closely linked with strategy. They demonstrate continuous improvement in customer satisfaction scores, and continuous improvement in their portfolio spreads, and they have a good year. 

Each strategic initiative, inextricably tied to strategy, serves to set the table (i.e. culture) for successful strategy execution. And the initiatives are strategic. Not "replace the departing loan assistant" or "upgrade phone system." These are business as usual "to-do's". They are someone's day job.

But for bank executives, strategy execution is your day job.

Don't be Spain.

~ Jeff

And don't forget my book: Squared Away-How Can Bankers Succeed as Economic First Responders. 

Ten percent of author royalties go to K9sForWarriors.org, who work to bring down the suicide rate among our veterans. 

And don't forget my book: Squared Away-How Can Bankers Succeed as Economic First Responders

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Thank you!

Memorial Day: Remember Maurice "Maury" Hukill

In 1975, a bloody civil war erupted in the country of Lebanon between Palestinian and other Muslim guerrillas and Christian groups. During the ensuing years, Syrian, Israeli and United Nations interventions failed to resolve the factional fighting and the resulting instability and bloodshed. 

In August, 1982, a multinational force, including 800 U.S. Marines, were ordered to Beirut to help coordinate a Palestinian withdrawal. They left in early September, but the vacuum that resulted from their departure culminated in a massacre of Palestinians by a Christian militia. So the international peacekeepers returned in force at the request of Lebanon by the end of September at the objection of Syria and Iran. For the next year the peacekeeping force was peppered by snipers, improvised explosive devices, and suicide bombers.

Maurice "Maury" Hukill was born and raised in Elizabethtown, Pennsylvania. A hamlet in the Scots-Irish settled area of western Lancaster County and epicenter for the Mars Chocolate Company's North American production of Dove Chocolate bars. 

Maury attended Virginia Tech, and in 1981 received his degree in forestry and wildlife management at VT's College of Natural Resources and Environment. Although he did not go on to make use of the degree. Instead, he followed his father, Hank Hukill Jr. into military service. Hank was a U.S. Naval Academy graduate, a nuclear engineer and a submariner. After his naval career, Hank went on to serve at the Three Mile Island nuclear power plant, and was part of the team to restart the plant after the 1979 mishap. TMI was near Elizabethtown.

Maury chose the Marines, and went to officer candidate school to earn his commission. A regular suburban kid from my hometown volunteering to serve his country.

He was a 2nd lieutenant in the 24th Marine Amphibious Unit from Camp Lejeune, North Carolina, that was dispatched at the request of Lebanon to Beirut to keep the peace in the midst of factional fighting, religious zealotry, and regional strife.

At 0622, Sunday morning, on October 23, 1983, a non-Lebanese, terrorist driven stake bed truck loaded with explosives equivalent to 21,000 pounds of TNT turned onto an access road leading to the Marine airport compound. It crashed through a barbed-wire fence. The truck passed the sentry post and since the sentries were operating under strict rules of engagement, did not have their firearms magazines loaded, and therefore could not fire upon the truck until it barreled past them. 

The truck, driven by an Iranian national, did not stop until it drove through the front entrance of the BLT building, which was housing 2LT Hukill's unit. Most were still asleep. The blast occurred almost immediately. One survivor said "I don't think there are words in the English language to describe the magnitude of the blast." It was the largest non-nuclear explosion in history. The building collapsed.

The explosion killed 220 Marines including the 25 year-old Hukill, 18 sailors and three soldiers, making it the deadliest single-day death toll the US Marine Corps had seen since the Battle of Iwo Jima during WWII, and the deadliest single-day death toll the Armed Forces had seen since the first day of the Tet Offensive during the Vietnam War. It was also the deadliest terrorist attack on Americans prior to 9-11.

Minutes later, a second suicide bomber drove another truck bomb into the nearby Drakkar building, where French troops were stationed, resulting in the deaths of 58 paratroopers and six civilians. 

A Beirut Monument dedicated to the U.S. service members who lost their lives is located in Jacksonville, North Carolina, where Camp Lejeune is located. 

"Our first duty is to remember..."

While you are enjoying Memorial Day Weekend finally getting together with family and friends, I ask you to remember Maury Hukill and all of his comrades that gave their last full measure of devotion on that terrible day in 1983 in Beirut, Lebanon.

~ Jeff

Research

Beirut Memorial:

8A894694CA09D74F48E5AF790B15DA11.beirut-memorial-program-new-.pdf (beirutveterans.org)

Marines of Beirut video from the Marine Corp Reserve:

https://youtu.be/pqfnJptZEV0

Virginia Tech honors 2nd Lt Maurice Hukill:

University to honor U.S. Marine 2nd Lt. Maurice Hukill at Pylon Dedication Ceremony | Virginia Tech Daily | Virginia Tech (vt.edu)

History "This Day in History":

Beirut barracks blown up - HISTORY

Patriot Connections:

1983 Beirut Bombings – Deadliest day for Marines since Iwo Jima | Patriot Connections

Defense archives listing the fallen:

DefenseLink.mil - Special Report - Beirut Barracks Bombing

Beirut Remembered video:

https://youtu.be/iOqZz_oEdig

Excess Liquidity, Low Rates, and Branching. My Answers to Jeff Davis' Questions

S&P Global Market Intelligence Principal Analyst Nathan Stovall recently interviewed Mercer Capital's Jeff Davis on the Street Talk podcast regarding the thorny banking issues of the liquidity glut, persistently (or perpetually?) low rates, and the branch costs millstone. I highlight Jeff's comments, and offer some solutions in this video blog.

Enjoy!

~ Jeff

Here is the YouTube link to my comments in case the video does not play on your device:

https://youtu.be/8erI7qDMb2g

Street Talk podcast link: 

Excess liquidity, low rates leave banks between a rock and M&A | S&P Global Market Intelligence (spglobal.com)

And don't forget my book: Squared Away-How Can Bankers Succeed as Economic First Responders

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Squared Away- How It Happened

March 11, 2020: The World Health Organization declared a global pandemic. I attended the Pennsylvania Bankers' Association Women in Banking Conference the next day. And I wouldn't attend another for a year and three months. I will be attending the Financial Managers Society FMS Forum this upcoming June.  

The first few months were a haze of helping clients navigate the uncertainties in their business, and the uncertainty in our own.

And then we began settling into a routine. When the U.S. tried to open up in the summer, we actually embarked on a 10-day business trip to Texas to work on a project. And then the second wave hit. Back in the work-from-home (WFH) saddle again.

Do you know how much time a traveling consultant recaptures when they no longer travel? Sure, road warriors try to be productive on phone calls and in hotel rooms. But when all travel is paused, you suddenly have much more time to get things done and be productive.

It was with this newfound time that got me thinking in the summer of 2020.... write a book! 

Annually I would review my most read blog posts for the past year and all time. I've been writing since 2010. Some made sense to me. Others surprised me, such as the amount of views expended on board composition, or on deploying bank capital. And I thought, well, readers know what they want. And viola! Idea! Write a book curated by readers of Jeff For Banks. 

So in the summer I drafted a summary, and an introduction chapter, and solicited the usual publishing suspects for business books. The challenge was that it was a book designed for community financial institutions. Very niche. Not a large audience. No worries though, I could build my own publishing house. So I did, building off what I learned when my then 10 year old daughter published a pre-teen book.

Editors Rule

My first hire was an editor. Here I leaned into my connections. I have written many articles for multiple publications. My best editor, as it turned out, was the ababankmarketing.com editor, Kate Young. She tore up my articles to sometimes unrecognizable levels. Yet they were better, much better, than what I submitted. Could I keep my ego in check by submitting myself to so much red ink again? You betcha.

If you want to write a book, have a great editor. Kate was great, and I think the product shows her skills.

While writing we quickly realized we needed permissions to include references and graphics. Since the book includes blog posts in their original form, I had to ensure every graphic was royalty free or I had to substitute with royalty free graphics. Also, if I included slides from conferences and presentations that I attended, I asked the firm if it was ok to use their material. The last permission was a cartoon on page 57 of the paperback and hardcover, the work of a commercial cartoonist. That one required a royalty payment. Most of the tables and graphs in the book were done by me. I gave myself permission.

My theory behind the book is that serving all stakeholders can be the next best version of my readers' financial institutions. While seventy-five percent done with writing, I read Conscious Capitalism by John Mackey of Whole Foods Market and Raj Sisodia. They put hard numbers behind it in their appendix that shows "Firms of Endearment", i.e. those that serve a higher purpose than solely delivering to shareholders, outperform the general market. That was my theory. Stakeholder primacy is not a zero-sum game. You can deliver value to all stakeholders at the detriment to none. It was good to have confirmation in the form of analysis. I do favor spreadsheets. Oftentimes success is measured by them. 

What's In A Name?

I naturally had a few book names knocking around in my head. And I bounced a few off of Kate, my editor. But for this exercise, I leaned on my family. It was January, and my college daughter was home. It was the pandemic, and my LA daughter's family (fiancée and child) were riding the pandemic out with us. Boom! Naming team.

We sat around the kitchen table and knocked out possible titles. We started with banking specific possibilities, until my daughter's fiancée suggested we link other aspects of my life into the title.  That ended up being the last three titles in the accompanying picture (third from the top offered by my daughter because it's what might have come out of my mouth as a result of teenager hijinks). Obviously we started out less serious. But my wife actually came up with the last one and the winner-Squared Away. It's a typical military term that has widespread civilian adoption. If you're squared away, you got your sh*t together. 

The subtitle came from a virtual conference where Jelena McWilliams, the FDIC Chair, said those words. Actually, I did not attend the virtual conference. You know how I heard of what she said? Several tweets from my Twitter friends. My subtitle came from a tweet. You read it here.

Graphic Artists Drool

Once written and edited, now is the time to bring more professionals onboard. First, a typesetter. Publishing houses and international book standards require certain formats. You'll hear more on this below, but do you know there is not supposed to be any blank pages? That is why some books have This Page Intentionally Left Blank. So it's not blank. Publishers do this to manage where the Table of Contents rest, and each chapter starts on the right side of the book, etc. 

Did you also know that the book title with author and publisher must appear immediately prior to the copyright page. Who knew? At any rate, I hired an experienced typesetter that knew all of these things and promptly formatted the interior of the book for Kindle, Paperback, and Hardcover. She was great, and quick. I had minimal changes.

The cover artist was a bit different. And the cover, as it turns out, is very important to book sales. More important for fiction, but still important. So I researched the most experienced in design and found my Nigerian artist via Fiverr. His design was great, in my opinion (see picture). He gave me a couple mock-ups to choose from but I liked the symbolism of the squares. Each different book format required a different cover (Kindle, Paperback, Hardcover). And for paperback and hardcover, I had different publishers (Amazon and Lulu). Amazon does not do hardcovers. 

As great as the graphic artist was in art, he was a bit challenged in delivering book cover formats correctly. The Kindle version went off without a hitch. The paperback had a couple revisions. The hardcover was a challenge, including putting the wrong barcode on the back. Did you know that each format has a different ISBN number and therefore barcode? Also, did you know, that the barcode on the back of printed books needs to have a white background and be in the exact same spot on every book? 

My graphic artist struggled with this. And ultimately my daughter's fiancée finished the last five yards of the hardcover design. 

Marketing

I'm now in the book marketing business.

Before release, I noticed that two of my social media contacts that served financial institutions and financial technology companies penned their own tomb: Beyond Good. And I worried that much of their thesis was similar to my own. It is similar in that they encourage capitalism's evolution to be more balanced in serving stakeholders. But it is not as targeted towards micro issues facing community financial institutions, as was mine. Phew! I encourage you to read both!

No matter if you use a publisher or create your own, you are ultimately responsible for book sales. My first move was to order author's copies and send pre-release versions to industry insiders. I did so, but only two weeks prior to release. It wasn't like I gave them tremendous time to read, opine, and help promote. But hey, I'm a newbie. 

This led to me being on the Banking Transformed podcast, and be scheduled for a few more. It was a great conversation with Jim Marous. And I look forward to others.

Before going public I e-mailed all of my banking contacts, letting them know before others that I wrote a book specifically designed to bring value to them. And that really started the ball rolling. That was only two weeks ago, so we'll see how it goes. So far the feedback has been positive. But who calls out the author and says "this is crap!" I worked hard to make it valuable, so I'm hoping nobody feels that way. But ya never know.

My LA daughter is helping me with marketing. She works for a marketing agency that specializes in health care and has been in the marketing agency biz her whole professional career. Knows more than me. But don't tell her I said so. If you see an ad on LinkedIn or Amazon, likely done by her. She also guides me in content and pushing out to the world. 

I wonder if she'll like this blog post?

At any rate, that's how my book came to be. I hope you enjoy it. Order by clicking on the below links or go to wherever you get your books:

Kindle

Paperback

Hardcover

Thank you for your consideration!

~ Jeff

Unintended Consequences of Aggressive Regulation

"In case you're looking for some light reading this weekend, FRB-Philadelphia working paper 21-08, Does CFPB Oversight Crimp Credit?" 

~ Robert Morro (@bmorro44)

So went a tweet from one of my Twitter connections. So I listened to him, and dialed up the FRB-Philadelphia WP 21-08. Forty three pages later, with formulas like:

CFPBLoanSharelt = αl + β · Postt + εlt

And a 27 page appendix with subtitles like:

Alternative difference-in-differences model

I got my answer.

Note that the study was limited to Federal Housing Administration (FHA) loans. For the uninitiated, an FHA loan is government-backed mortgage insured by the FHA. It is popular with first-time homebuyers, low to moderate income (LMI) homebuyers, and those with relatively low credit scores... as low as 500. It normally has a low down payment requirement, as low as 3.5%. You can see how it accelerates home ownership, which many economists and policy makers feel is critical to improving net worth.

The study analyzed FHA lenders that were subject to CFPB oversight, which were non-bank FHA lenders and bank FHA lenders with greater than $10 billion in total assets. The period analyzed was immediately prior to the commencement of CFPB oversight in 2011, and afterward. The study also analyzed the impact of the change in oversight intensity brought about by the 2016 election. 

Conclusions

The study revealed intended and unintended consequences. First, the intended consequence was that CFPB oversight is associated with improvement in mortgage servicing practices, leading FHA mortgages from CFPB-supervised banks to become less likely to transition from moderate to serious delinquency. Poor servicing practices were an important driver of the foreclosure crisis during the Great Recession; the study results suggest that tighter regulatory oversight may help reduce inefficient foreclosures during economic downturns. This is good.

There were two unintended consequences. The first was regulator arbitrage, where a bank decides to have an activity regulated by one entity rather than another because of the perception that the chosen regulator will be less risky to them. In this case, bank holding companies (BHC) with mortgage subsidiaries in the holding company had a tendency to put the mortgage sub under the bank where it would be regulated by the bank's primary regulator and not the CFPB so long as the bank was less than $10 billion in assets. If it was in the BHC, it would be a non-bank mortgage lender, and therefore subject to CFPB oversight, even if the bank was under the $10 billion threshold. Meaning: banks chose to avoid CFPB oversight.

The second, and presumably more actionable unintended consequence: Banks subject to CFPB oversight decreased FHA lending and replaced that activity with jumbo mortgage lending. To avoid the reputation and regulatory risk of doing FHA lending, banks chose to do less of it, and therefore reduced the amount of credit advanced to first-time homebuyers and LMI families. Jumbo mortgages are typically for larger homes for wealthier and more credit-established families. There was no conclusive evidence that non-bank FHA lenders and under $10 billion FHA bank lenders increased FHA lending to make up for the shortfall.

Let that sink in a bit.

Further, after the 2016 election, banks subject to CFPB oversight began anew with FHA mortgage lending. They must have perceived lower reputation and regulatory risk in doing so, and therefore came back into the market. 

This is actionable information for both lawmakers and regulators. Particularly given the aggressive rhetoric coming out of the new-teeth CFPB.

Maybe they should read the study. And modify their approach. One can hope. But as Red from Shawshank Redemption said:

"Let me tell you something my friend. Hope is a dangerous thing. Hope can drive a man insane."

Add FRB-Philadelphia WP 21-08 to your night time reading list!

~ Jeff

Fintech Buys Bank. Keeps Stratospheric Valuation.

Imagine a fintech, with off-the-chart valuations such as 2.6x book value and 51x EBITDA, buying a bank. For 1.85x book. 

In today's M&A valuations, 1.85x is pretty lofty. Especially for a community bank. But you don't have to imagine it. Because that was what LendingClub paid for Radius Bank. Since the deal closed, LendingClub has kept its valuations. In fact, since February 17, 2020, one day prior to the Radius Bank deal announcement, LC's share price has risen 58% versus the S&P BMI Software & Services Index increase of 20% (see chart). 

LendingClub bought a bank and didn't trade down to traditional bank valuations. Their valuation grew loftier. Making for even better currency to buy even more banks. And putting them at a strategic advantage over other would-be financial institution buyers mired in the lowly yet more rational bank stock valuations. Truth be told, LC paid mostly cash in the deal. What's cash worth these days? And there are plenty of examples of investors throwing barrelfuls of cash to technology firms.

This is a clear threat to financial institutions. How can we overcome such a hurdle? I wrote that one primary reason banks need scale is to enjoy greater trading multiples. It was one of my most read posts and is a chapter in my upcoming book, Squared Away (soon to be available in your favorite bookstore). 

But we can't pay 2x book for a target when our stock is trading at 1.2x book. Even if we enjoy higher bank-like trading multiples because of scale we may get to 1.5x. Green Dot Corporation is currently trading at 2.6x book and over 6x tangible book. They can easily afford 2x book with that valuation. With more experience acquiring banks in the rearview mirror, fintech's who might have once been worried about bank valuations weighing them down, will be more confident to bid on for-sale banks, to be aggressive, to get deals done. 

Having said that, net interest income is a very small part of  LendingClub's revenue mix, at 22% for 2020, which was prior to the close of the Radius Bank transaction. And they're in the business of lending! Green Dot Corporation showed less than 2% revenue attributed to net interest income. So the continued lofty valuation might be relating to the relative size of the bank within the fintech. 

We were worried that credit unions would be buying banks. Using their ample cash positions, which aren't earning much in the investment portfolio or at other financial institutions, and turning taxable earnings from target banks into non-taxable earnings at credit unions.

What about fintechs that may not be too concerned about profit? I reviewed LendingClub's last five years and see nothing but red ink. Radius Bank had net income of $6.7 million in 2020. On a consolidated basis with the currently bleeding LendingClub, that might revert to tax-free money. Just what we feared with credit unions. 

Should we be worried about more fintechs stepping up to buy banks? (Ref: SoFi and Golden Pacific Bancorp) 

Will these precedents be part of a trend?

~ Jeff

CFPB: Are They Coming to Get You?

A bank trade association CEO asked me a couple of questions while he was researching an op-ed piece. The edited Q&A is below.

Q. Shouldn't the CFPB work to address the impediments to starting a bank in LMI markets rather than punish community banks who scrambled to serve their customers when the economy shut down?

Author's note: This was probably relating to the late January released statement about the acting director of the CFPB's promise to take aggressive action in response to perceived Covid-19 relief violations, including the policy of some banks to only take PPP applications from pre-existing customers, which may have a disproportionate negative impact on minority-owned businesses.

 

A. The problem stems from the spreadsheet, in my opinion. With deposit spreads so low, branch deposit sizes need to be very large for a branch to be profitable. According to my firm's profitability peer group, a branch with $74 million in average deposits made a mere pre-tax profit of three basis points. That is a fully absorbed number, with support center expenses allocated to it. On a direct cost basis, the branch must be at least $38 million in deposits. Knowing this, very large financial institutions operate branches where they can have greater scale to drive greater profitability, which frequently excludes LMI neighborhoods, creating what is termed "bank deserts."

Another challenge is imposed by the very government that tries to assist LMI households: regulation. The average operating cost to originate and maintain an unsecured personal loan is $287 (again, according to my firm's profitability outsourcing service peer group). And the average balance per account is $3,800. The spread needed to cover the cost alone would be 7.5%. That's not the yield... it's the spread. So if the bank's cost of funds was 1% the yield would have to be 8.5%.

But there's more! The provision for loan loss is 1.25% of that balance. A bank would have to charge a 9.75% yield on an unsecured personal loan just to break even. The operating cost is largely attributable to the distribution through the branch network and regulation. Since a bank can't cut regulation, they trim their branch network to lower those costs. And the obvious bullseyes are on branches that lose money.

Similarly, the annual operating cost per account for a retail checking account is $398. With a 1.89% spread and with 0.91% average fees as a percent of balances, the average balance of a retail checking account would have to be over $14,000 to be profitable. A very high hurdle in an LMI neighborhood. Again, much of the cost per account is driven by branch distribution and regulation. Retail banking is heavily regulated. And it's difficult for financial institutions to operate in neighborhoods that have low average balance loans and deposits. Plus, if an institution charges the high yields on loans to be profitable, or assess the high fees it would need to make the retail checking account profitable, think of the reputation risk they would assume. That is why very few of our clients consider retail banking as the driver of future profitability in strategy sessions. 

Q. Should communities today be concerned by the M&A activity taking place? What advantages or disadvantages do they face when institutions consolidate?

A. If we lose 4% of FDIC-insured institutions per year, which was pre-pandemic pace, we will have ~ 3,300 institutions in 10 years. There are people that believe we are over banked, and look to Canada and Europe as case studies for having fewer, larger banks. There are benefits to scale. The most efficient banks in the U.S. tend to be between $5 billion - $10 billion in total assets.

But there are myriads of examples of very efficient $500 million banks, and technology should make it easier for smaller community banks to deliver relevance-sustaining profitability that enables the bank to invest in its future by remaining relevant to its stakeholders. The really small institutions, however, should consider merging, even if one or two engage in a merger of equals to have the resources to remain relevant. Smaller institutions run the risk of nobody wanting to buy them.

As institutions get larger, and their HQ's get farther away, decisions are made that can be sub optimal to the local area, town, and/or borrower. For example, think of the Credit Analyst in Charlotte evaluating a rural Indiana ag loan to an Amish borrower. What does that write-up look like? We will lose that local flavor to allocating capital by centralizing banking. That is what I fear we will lose by continuing the trend that took us from 15,000 banks in 1990 to less than 5,000 today.

~ Jeff