Friday, September 23, 2016

Bankers: Bring On The Change

On the shores of the Ammonoosuc River, alongside the hotel where the famous Bretton Woods conference took place in 1944, I talk about the onslaught of change that has recently occurred, and will continue to occur in our industry.

Change: Is your institution ignoring it, trying to stop it, or adapting to it?


How much grief will I get comparing employees to beavers?


Saturday, September 17, 2016

Politics: Can We All Just Get Along?

I do not venture into politics much, either in this blog or in person. But our environment is so toxic, I would like to take a crack at identifying shared goals by most of us.

1. We all want to reduce the number of impoverished people. We have different ideas on how to do it. I think capitalism is a better solution than socialism, as the latter creates so much more of an underclass. Except for the bureaucrats. They tend to do well in socialism. The more you disperse economic power in a society, the better, in my opinion.

2. Many successful capitalists turn into jerks. I think, by and large, this is because they want to solidify their position, and the by-product is keeping others from achieving it. That is why in large corporations executives might make it difficult for up and comers, fearing they might be unseated by them. This is also why top executives get paid so much. I wouldn't stop companies from paying executives so much, but would insist on transparency and not allow a company to deduct executive comp that is greater than some multiple of company average compensation on their Federal taxes. But better to have many, many successful capitalists, than a few successful bureaucrats. Successful capitalists are the "do-ers" of society. They create jobs. Not government. If you don't trust me on this, study economics. At most colleges. Not all. I also want to encourage a society where capitalists do well, and give their excess to charitable endeavors. Like Warren Buffet is trying to make happen.

3. Our tax system is way too complex. I would make the personal and corporate marginal tax rate the same. Somewhere around 20%. I put a simple tax solution in a post way back in 2012. See it here. This will cause disruption among accountants and tax lawyers. Taxes would be so easy and transparent, these professionals wouldn't be needed by individuals or corporations. Think of all the tax compliance savings!

4. Government spending. Until we reverse the alarming trend of national debt to GDP, we must spend less than revenue growth, and balanced budgets have to be the norm rather than the exception. I wouldn't do a balanced budget amendment, because elevating infrastructure investments and spending during recessionary periods makes sense to me. But until that time, Federal spending growth should be less than GDP growth. Oh, and the last balanced budget under President Clinton was spurred, in part, by Pay-Go. That system where new "programs" would have to be paid for by eliminating other programs that cost the same or more. I would put that structural discipline in place right away.

5. Federal government operation. Our rules are ridiculous. Bills would be cleaner, and more linear. No slapping on stupid amendments for pork. If it has enough support, have the pork get its own bill. And bringing a bill to the floor for vote would be easier. One requirement I would insist on is having a litmus test for programs designed to help society. If they don't meet a pre-agreed upon social objective over a reasonable time period, they automatically die. No vote needed. We tried to fix a social ill. It didn't work. Let's move on. And not worry about those that lose funding sending out press releases that we don't care "for the children".

6. Speaking about lawmaking, there are way too many laws and regulations for society to follow. Nobody, and I mean nobody, knows them all. In fact, most if not all of us break the law every day. This creates a ripe environment for tyranny, that we see playing out in front of our eyes. Don't like someone? Figure out a law they broke and go after 'em. Think about it. If I were in charge, there would be less, and the objective would be far less, rules and regs to follow, reducing the ability of powerful law enforcement and government bureaucrats to move against its citizens. And making it easier to enforce and comply, both individually and economically. Watch the bureaucrats squirm about this one.

7. World relations. We want to influence societies to be free. But our own freedoms are being eroded by the growing body of laws and regs, mentioned above, and political correctness which has curtailed our ability to solve problems. So we should take care of our own problems to show the world that, as our society matures, we make corrections to enhance freedom. And create a worthy example that other countries would like to emulate. But dictators. We have to be active in keeping them in check. If we were isolationist, our world would be a different, and much worse place, in my opinion. But our international forays would be selective, proportional, and  given the resources and the fortitude to win. Isolated cells of terrorists need not worry about a US Army battalion. But they would have to worry if they actively seek to harm our citizens. Their end will not be pleasant. But it may not be all over the news media, either. Oh, and trade. Free trade works. Few economists believe otherwise. The rub is that they must be enforceable and punitive for cheaters, making cheating so unpalatable that parties to the agreements abide by what they signed. There is a lot of angst against free trade now, but as a society we voted for free trade by buying less expensive stuff that must be made by labor that is less expensive than our own. And lets face it, union work rules made us noncompetitive in manufacturing. Shame on us.

8. Elections. Any candidate that wants to run for office, must complete a two-page resume to a non-partisan website. Page one denotes the candidate's experience. Page two has the candidate's answers to five key questions for the office sought (i.e. federal questions for federal office), in 50 words or less for each question. This is so voters like me can review candidate's qualifications and positions before getting into the voting booth. In PA, where I live, there is a tough US Senate race underway, and the ads the candidates run are ridiculously irrelevant and designed to stir up emotion, and not make us better voters. I say ignore that idiocy. Read the two-page, vote smartly.

9. Safety Net. I'm all for a transitional safety net to help our fellow citizens pick themselves up and get on their feet again. I'm all against turning families into lifelong government dependents, which I think is the consequence of a safety net without the transitional philosophy. If someone hurts their elbow and can no longer do the manual job they once did, we don't re-train to do other jobs not dependent on the elbow. We put them on disability for life. C'mon. This makes so much common sense, that the cynic in me thinks those that support lifelong government assistance (either in word or deed) are just bribing people for their vote using other peoples' money. And relegating the lifelong "drawers" to the lower economic rung for life. Sad.

Why doesn't the media cover much of the above? Instead, they assemble a panel of talking heads to discuss a tweet. 

Not sure there would be many that object to the above. Ok, accountants and lawyers, and union leaders. Other than them, why is everyone else shouting at each other?

Who's onboard?

~ Jeff


Monday, September 05, 2016

Board Composition: What Does the Best Bank Board Look Like?

In April 2016, Delaware Place Bank in Chicago was placed under a Consent Order (CO). One article within the order read as follows:

"the Bank shall retain an independent third party acceptable to the Regional Director of the FDIC’s Chicago Regional Office (“Regional Director”) and the Division, who will develop a written analysis and assessment of the Bank’s management needs (“Management Study”) to evaluate the management of the Bank."

This is a common article and my firm performs several of these annually. The CO went on to say:

"As of the effective date of this ORDER, the board of directors shall increase its participation in the affairs of the Bank, assuming full responsibility for the approval of sound policies and objectives and for the supervision of all of the Bank’s activities, consistent with the role and expertise commonly expected for directors of banks of comparable size."

In the same article, the CO compelled the bank to elect an additional director with banking experience. And there lies the rub. By including this provision, the unwritten assumption was that appointing a director with banking experience will make this bank more safe and sound.

Will it? Is there evidence that proves it is so?

What makes an effective banking board? Is there one recipe?

We are often asked this question, either formally (through a Management Study or Board evaluation engagement) or informally, And the answer is, it depends.

It depends on the bank's strategy, geography, risk parameters, and personalities of existing board members. I have seen banks with former regulators on the board fail, and banks with farmers on their board thrive. I do not think there is one answer for all.

To further my point, I evaluated publicly traded, SEC registered banking companies between $500 million to $3 billion in total assets. I searched for the best, and not so much, ROE banks based on their five-year average ROEs. I excluded banks that had negative ROEs, recently converted during that five years from the mutual form (which elevates their "E"), or had standard deviations greater than 4 from their five-year ROE. In other words, they were consistently good, or consistently bad.

Then I reviewed their board composition. The top six results are as follows.



How does this differ from the bottom six? See their board composition below.





































There were retired bankers in three of the six top performing banks. Wait! There were retired bankers in three of the six bottom performers. CPAs, another common piece of expertise desired on a high performing board, were on all six bottom performing banks. CPAs were only on two of the six top performing banks (assuming the CFO was a CPA, which was not mentioned in their bio). Attorneys were on four of six top and bottom performing bank boards.

The prize for most board billable hours goes to Robert Gaughen Jr., and Randy Black, CEOs of Hingham Institute for Savings and Citizens Financial Services, respectively, for having the most attorneys on their board. Perhaps the answer is not only have an attorney on the board, but lots of them.

There were no former regulators on the boards of the above banks. At least they wouldn't admit to it in their bio.

The point of this review is that there is no one answer as to what makes a good functioning board. In my experience, a board that maintains management accountability for business performance and ensures management operates within the risk guidelines established by the board and commemorated in bank policy, is a good performing board. It doesn't matter if that board includes a baker or candle stick maker.

What do you think makes a high performing bank board?

~ Jeff


P.S. I received an e-mail from a banker asking me the insider ownership of the above banks. So here you go! The bottom performing banks have a greater level of insider ownership. And from eye balling it, the bottom performing banks have a greater level of institutional ownership too.



Monday, August 29, 2016

Four Reasons for the 2007-08 Financial Crisis

A recent Bank Think post by ConnectOne Bank CEO Frank Sorrentino regarding restoring Glass-Steagall got me thinking about how far the debate has drifted from the root causes of the 2007-08 financial crisis.

There have been quite a number of research pieces offered as to the root causes (read a good one here by University of North Carolina). In researching this post, I sifted through some interesting, and some not so interesting opinions. Which reminds me that the old axiom "figures don't lie, but liars figure" may be closer to accurate than we would like.

Here is what I think caused the financial crisis based on what I read, what I experienced, common sense, and my interpretation of the facts.

1.  People borrowed more than they could repay if they experienced a modest financial setback.

If you know me personally, I will always put more weight on personal responsibility than the boogeyman. Yes there was some degree of fraud perpetuated on the borrowing public. But, by and large, people knew how much they were borrowing, what their payments were, and that some of their mortgage payments would rise if rates rose. 

In 1974, household debt stood at approximately 60% of annual disposable personal income. In 2007, that number climbed to 127%. It should be noted that in 2006, 40% of purchase mortgages were for investment or vacation property. But you won't see the real estate investor losing his/her shirt on 20/20.

Absolving people of personal responsibility is a problem in our society. As one of my Navy lieutenants once told me: "Be careful pointing the finger, because the other fingers are pointing back at you". Words to live by.

So, in my opinion, number one exceeds all others. It will not get me personal kudos in the news media.

2.  Credit risk was too far removed from the loan closing table.

This is the moral hazard argument, where the people that have the relationship with the customer, that stare the customer in the face and say "yes" or "no" to the loan, were not the same people assuming the risk should the customer default, in most cases. The shoulders where credit risk ultimately came to rest, investors, were placated by insurance and bond ratings. 

Community financial institutions make their debut here, as they purchased bonds, typically highly rated, backed by mortgages that also had insurance applied to them.

3.  There was a lot of money looking for investments, and Wall Street met the demand. Mortgage-Backed Securities (MBS) almost tripled between 1996 and 2007, to $7.3 trillion, as investors lined up to participate in the US housing market. This led to creative means to take a risky mortgage at the closing table, to a perceived "safe" investment in the bond market after it was combined with hundreds of other mortgages, parsed into traunches, insured by a bond insurer, and rated by a ratings agency. What could go wrong?

See the list of top 10 sub prime mortgage lenders from 2007. Note the absence of anything resembling a community bank. BNC was owned by Lehman Bros. EMC-Bear Stearns. First Franklin, a JV between National City Bank (emergency sale to PNC) and Merrill Lynch (emergency sale to BofA). Option One was sold to shark investor Wilbur Ross for its servicing rights. Ameriquest was purchased by Citi, and its origination arm shut down. The table indicates that loans were closed in these banks'/entities' names. A community financial institution that sells its loans in the secondary market would typically close the loan in its own name, and then sell it. So the absence of community financial institutions implies that these loans were originated by mortgage brokers or the listed banks themselves, and not a community FI. This is consistent with my experience. 



The MBS bond-creation engine was a well oiled, end-to-end machine designed to satisfy the appetite of investors.

4.  Government's participation in the mortgage market. Way back to the Great Depression, when mortgages were typically five-year balloons, the Federal Government has intervened in mortgage lending. When the five years were up, the government didn't want people tossed from their homes because they couldn't refinance due to economic hardships. A respectable goal. But this intervention played a role in what we have today, a separation between the borrower and the ultimate lender. 

Note that Presidents Reagan, Bush, Clinton, Bush, and even Obama openly encourage home ownership because it has a causal relationship with household wealth creation.

But the reason why community financial institutions shy from putting 30-year, fixed rate mortgages on their books is because there is no 30-year, fixed rate funding instrument. It creates unpalatable interest rate risk. 

If interest rate risk drives the wedge between borrower (i.e. homeowner), and the desired lender (i.e. local bank that retains the credit on their books), then perhaps a 5/1 mortgage should be the norm. This answers the interest rate risk problem, while allowing borrowers to keep their mortgage and therefore their home if they befall some economic setback after five years.

And note, a local financial institution has more flexibility to alter the terms of the loan if it is on their books, rather than owned by an investor.


Back to my original point regarding re-instating Glass-Steagall. What does this have to do with the four points above? We should ask the same question about every article within Dodd-Frank.

~ Jeff 


Friday, August 12, 2016

Bankers: Give Your Employees a Bucket of Balls

Very few financial institutions commit to the level of employee development found in some of our largest corporations. The fear, aside from the cost of a homegrown development program, is that employees will leave. I have news for you, you should be afraid the untrained will stay.


What banks do you know that have a formal employee development program?

~ Jeff

Saturday, August 06, 2016

Fact or Fiction: Bank Service Is Getting Worse

In my firm's most recent podcast, I editorialized near the end of the episode about declining service levels in banks, particularly the largest banks. I compared service levels to airlines, citing my recent spate of bad luck with air travel.

I should note that I type these words while waiting at the Minneapolis airport for my Southwest Airlines flight, which is delayed for an unknown reason for at least an hour. It's sunny at MSP and I squint as I write so I can see the screen. Perhaps it's delayed due to windshield glare.

Do I have a point? Or is it perception? According to Federal Bureau of Transportation Statistics (yes, this agency does exist, and you are paying for it), US airline flights were on time 83.45% in May 2016, up from 80.48% in May 2015. I went back five years and the trend is similarly positive.

So I'm wrong about airlines, right?

Not so fast. How do they measure those stats? Ever wonder why airlines board planes and push off the gate only to wait on the tarmac? Hmmm. Wonder if they measure "on time" from the time you push from the gate. The devil is in the details.

If airlines were so good, why do we not feel it? Why does strategyand.com, pwc's consulting arm, describe air travel as remaining "for many a disappointing, grumble-worthy experience"?

My theory is that airline mergers have reduced our choices. So our overall experience is "disappointing", simply because our options to economically get from point A to point B might be with one or two airlines for that route.

On to banks. My theory is similar. But the proof, like in airlines, is elusive. According to the J.D. Power 2016 US Retail Banking Satisfaction Study, our satisfaction with big banks rose for the sixth consecutive year. Satisfaction with mid sized banks dropped for the first time since 2010.

Again, I think the devil is in the details. I always wondered when working with community banks how they achieved such high satisfaction numbers, usually high 80's to mid 90's. And it seems like every large bank has a trophy case of J.D. Power hardware. But my experience with large banks points to inflexibility, lack of front line empowerment, and basically an "I don't care about you" attitude.

Similar to airlines, I think it relates to how much of US banking assets are in the comfortable arms of so few banks. Seventy five percent of US bank assets are held by the top 50 banks. Losing individual customers is no big deal. But drop a notch in BSA or CRA, that's a big deal. In other words, they don't necessarily care as much about being flexible with you as they do about rigidly complying with bureaucrats. 

This feels like how socialism begins. Continue to consolidate power into fewer and fewer hands, be it government or large oligopolies, and pretty soon we're giving blood samples for our DNA to open a savings account.

If a bureaucrat reads this, he/she is probably thinking: "Not a bad idea. We'll say we're doing it 'for the children'!"

It could happen! 

~ Jeff


Monday, August 01, 2016

Why No De Novo Banks? Math.

There is increasing chatter about relatively small banks, under $100 million in assets, looking for an exit. Because they are so small, there may not be a line of buyers waiting for a book to come out from the investment banker. So perhaps an investor group would be interested in taking out current shareholders and recapitalizing the bank?

During previous periods of bank consolidation, the net decline in financial institutions was buffered by the number of de novo banks. For example, in 1997, the merger peak in the past 20 years, there were 725 mergers, and 199 de novo banks.

Not so today. Conventional wisdom puts the blame on regulators. They’re not approving charters, or making it extremely difficult to do so. The regulators deny this. But there is truth to it, in my opinion.

If a bank has a business model that is unique, or serves a narrow constituency, regulators push back in the name of concentration risk, or untried business models. I recall an Internet bank that was trying to get off of the ground in Michigan in the late 1990’s. The concept was new, and growth was projected to be robust, albeit not off the charts.

The FDIC required the bank to raise $20 million in capital, a tidy sum back in the 1990’s when banks got started with less than half as much. So because the business model was relatively unique, the regulators required a very high level of capital. The bankers couldn’t raise it, and the de novo never got off of the ground.

Today, regulators still favor plain old business models. Yet they are also requiring high levels of capital. Primary Bank in New Hampshire, started last year, raised around $27 million. Sure more is better from a safety and soundness perspective. But that capital comes from somewhere. And that somewhere, investors, have choices on where to invest their money.

In comes the math problem.

Let’s say an investor group, tired of big banks making decisions about their communities hundreds of miles away, decide to explore starting a bank. They put together an outline of a business plan, project out their financials several years, and go visit the FDIC.

The FDIC looks at the business plan, critiquing any part of it that is outside the norm, serving a particular industry or industries, relying on non-traditional distribution methods, and so on. They suggest that being more plain vanilla will increase their chances of approval. And by the way, it will require $25 million in startup capital.

The investor group puts together a prospectus, and begins soliciting shareholders for commitments. 

Now, Joe Investor has $10,000 to invest. Does he put it with this new bank? Or does he invest in an S&P 500 Index Fund?

The S&P 500 has a compound annual growth rate of 5.0% over the past 10 years, and 13.0% for the past five years. And The 10-year includes the Great Recession, so Joe Investor projects the S&P 500 compound annual growth rate of 9.0% for the next 10 years. For reference, the S&P 500 grew 9.2% annually during all of my adult years since 1984. 

For Startup Bank, the organizers have projected the following over the next 10 years.


A $10,000 investment in a de novo bank pales in comparison to the return Joe Investor could receive by investing in an S&P 500 mutual fund. And if Joe needs his money out of the fund, he places his trade and the money is in his bank account within three days.

Startup Bank, on the other hand, would likely trade very little. For all publicly traded banks between $400-$500 million in assets, the average trading volume is 1,432 shares per day. Joe putting in a sell order on his holdings could move the market and decrease his value. I learned this the hard way, by the way. So take it from my experience.

Lest you think that the dearth of de novo banks is a regulatory problem. I got news for you. It’s a math problem.


~ Jeff