Sunday, September 17, 2017

An Open Letter Calling For The Establishment Of The Consumer Beverage Protection Bureau (CBPB)

I'm fed up and not going to take it anymore! So I am proposing to my state's Senators to submit legislation to form the Consumer Beverage Protection Bureau (CBPB).

Dear Senators Casey and Toomey:

I am a citizen of your fine state and am writing to strongly encourage you to submit legislation to establish a Consumer Beverage Protection Bureau. The establishment will serve to protect the citizens of our fair land from the aggressive and deceptive practices of the beer industry.

For too long, the beer industry has been praying on our citizens. Luring us into beverage centers with cardboard cutouts of attractive young women or the likes of Kevin Harvick and Dale Earnhardt Jr. Such marketing tactics have had a disparate impact on those that fancy attractive women and NASCAR fans. Note that I made no reference to the identity of those clearly in the beer industry's cross hairs as I now have adopted political correctness in my protest letters. And don't get me started on Busch beer clearly targeting plaid shirt-wearing mountain folk. smh

Once the beverage centers lure you in, past the attractive woman or Earnhardt Jr. cutout, what do they feature? Expensive, high margin craft beer. Not the more reasonably priced Busch. We are bombarded with images and smooth marketing schemes of Troegs, Harpoon, and Flying Dog. The deception gets worse. Anheuser-Busch fools us into believing craft beers such as Elysian, Breckinridge, and Goose Island are brewed in small batches by people with long, scraggly beards. Not so. They are owned by Anheuser-Busch, who is in turn owned by beer conglomerate InBev. From Belgium! 

Gentleman, this is our new Battle of the Bulge!

Here is what I propose. Form the CBPB, that is within the Federal Alcohol Administration, yet is not accountable to the FAA or the President of the United States. In addition to investigating such deceptive practices, the CBPB should have examination authority over large beverage wholesalers to ensure that their practices are "fair", whatever definition they drum up for that term.

Give the CBPB the power to:

- Rescind or reform contracts;
- Demand monetary refunds;
- Disgorgement of violators' assets;
- Return of property;
- Restitution;
- Compensation for unjust enrichment;
- Payment of damages or other monetary relief;
- Public shaming of a beer distributor's violation;
- Limits on the activities or functions of a person;
- Civil monetary penalties

In this way, the CBPB can stop the practice of beer distributors from upselling a Hoppy Ending Pale Ale to the college student that just wants a PBR. The added compliance costs may put the small beverage distributor out of business in favor of their larger brethren, limit beer drinker choices, and raise prices. But let's face it, those small operators are not likely to support lifer politications anyway, and who wants that?

No, creating a government bureaucracy accountable to nobody creates jobs, and is a great gig for smart people like Jeopardy winners that can solve complex problems in the form of a question, such as "What is Fair?"

This madness must end! Support the CBPB!

Sincerely, your faithful servant that believes the government can solve what "ales" us...

~ Jeff Marsico

Sunday, September 10, 2017

Bankers: Five Ways to Use Profitability Data to Move You Forward

Accountability is a dirty word. It evokes images of finger wagging, stern looks, and sheepish floor staring. I'm sure at one point of the word's evolution it wasn't this way. Words and phrases earn their reputation by those that use and receive them. In banking, it is what we made it to be.

On a recent Pennsylvania Institute of CPA podcast, Bob Kafafian from my firm was asked how to use management information. Bob's response resulted in a follow-up question by a Midwest banker friend of mine. 

And since I am scheduled to speak about it at a Financial Managers Society breakfast tomorrow, I'll answer it.

Here are my ideas on how to use Management Information to create a positive accountability culture.

1. Hold branch managers accountable for revenue growth. Revenue growth equals deposit spread (coterminous using funds transfer pricing, or FTP), loan spread less provision (for loans that the branch is responsible for generating), and fee income. Imagine if Wells Fargo branch managers were accountable for this, instead of number of accounts per customer. Fake accounts with little or no balance generate little or no spread. But draws operating expenses from support centers. Imagine if your branch managers were accountable for this instead of deposit dollar growth. Would you be getting that desperate phone call asking for a rate exception to keep the money at the bank?

2.  Hold lenders accountable for their portfolio ROE. You read it right. That's an "E", not an "A".
Lending is a risk business, and aside from the provision expense, and net-charge off rate, those loans require equity to support them. If you allocate equity by product based on your institution's risk experience, then you know how much equity your institution requires. It should be part of your capital plan. Drill that down to the loan level, you can create ROE hurdles when lenders price loans, and measure their pre-tax ROE on their entire portfolio using the coterminous spread, less provision expense, less operating expense per loan type, to calculate the lenders' actual ROE for their portfolio. Imagine!

3. Hold support centers accountable for a decreasing relative cost per balance sheet category. If measuring a deposit operations department, then the operating expense from deposit operations as a
percent of deposit balances should decline long-term in a growing institution. It is the very definition of economies of scale. Notice I say long-term, because you don't want to defer investment in personnel or technology in fear of causing an upward blip in your trend. That's managing by budget that has caused executives to reduce innovation so they can make their budget.

4. Rank. Nothing should be more motivating than ranking branches, lenders, and support managers in achieving their goals as measured by Management Information than seeing where they rank among their peers. Including a ranking report of your twenty branches by revenue growth, and profitability,  in a sales meeting should put smiles on the faces of those at the top, and a look of determination on the faces of those wanting to get there.

5. Reward. Incentivize your personnel for achievement. Let's turn that frown upside down when we talk of accountability. Deposit Operations costing 16 basis points of deposits three years ago, and 12 basis points today, is an achievement that should be recognized by the entire institution. The same for ROE improvement for lenders, or pre-tax profit improvement by branch managers. Let's not foster a culture of fear, recrimination, and public floggings. Let's raise up our achievers!

I frequently speak of financial institutions' over-investment in under performing branches. Those investments of our precious operating expense dollars could be used in more promising areas. Instead, we limit resources to the very things that could lead us to a more sustainable future. Using profitability information to incentivize the right behavior will create a culture of achievement, and help us make more efficient decisions to better serve customers, reward employees, and improve performance. 

How do you use Management Information to run your bank?

~ Jeff

Note: This is my personal blog and I mostly refrain from direct sales pitches. But since I firmly believe 1) every financial institution should do this, and 2) few have the resources to do this, I offer this...

My firm, The Kafafian Group, does profitability reporting on an outsourced basis because we recognize the challenge community financial institutions face in building their own model, and running it quarter after quarter. If interested, call Gregg Wagner, our practice leader, at 973-299-0200 x114 or reach him at 

Tuesday, August 29, 2017

Banks and Bungee Cords

Your relationships, your job, your life comes with baggage. I recently made the analogy that there are bungee cords affixed to your belt. Some hold you back. Some propel you forward.

And it applies to banks too.

In a traditional SWOT analysis, there are things within your control (strengths, weaknesses), and things outside of your control (opportunities, threats). But what are the forces that propel you towards your strengths and opportunities? Or towards your weaknesses and threats?

These forces are mostly within your control. Should you choose to embrace the challenge.

Do you?

Here are the forces I see for bankers that pull them back, toward their weaknesses and threats:

1.  Regulators. OK, I'm playing to the audience. But regulators don't want you to veer off the beaten path. Keep it plain vanilla. Build a bank that thrived in 1963. Ask those bureaucrats this question: "How many businesses have you run?" Because you would swear by their swagger they were Richard Branson or Elon Musk.  

2.  Seargents. If you have hired me, or have read what I have written, you would understand that I believe there are "old-schoolers" in your organization that cause tremendous friction to progress and change. 

3.  "No Mistakes" Culture. The amount of energy that banks commit to being 100% in compliance, find no audit findings, or, gasp, no Matters Requiring Attention on their exam, is monumental, in my opinion. Some operations managers' evaluations and, in some circumstances, variable compensation is dependent on clean audits. What does that get you? Hyper conservatism in compliance. And a whole lot of "we can't do it" from executives. It's killing our industry.

4.  He's/She's Not Ready. This is a common reason I hear why banks don't elevate forward thinkers to the executive suite. They fear those "crazy ideas" they have in management meetings, or the fact that they are willing to accept some risks old school bankers would not. Better to keep them suppressed deep in the bowels of our organization and let others pilfer our future customers than to risk innovation through calculated risk taking.

Here are the forces that I see can propel bankers forward:

1.  Allowing Experimentation. And, 'gasp', failure. I'm not talking "bet the bank" failure. But a failure that may bust your budget is not Armageddon. It is an opportunity to learn, and help you implement the next innovation. Not the reason to look back 10 years and think, 'we tried and failed 10 years ago and, dag nabbit, we are not goin' to try again!'

2.  Fire Seargents. They are not that important to your organization. In fact, they are destroying it. And when you give them their packing papers it sends a message to the masses... "We are a forward looking bank. Backward thinkers take notice."

3.  Continuous Learning. A bank that believes everyone, from the CEO to the newly hired loan operations clerk, should learn, will have a far better chance to being the one bank that survives the non-stop tide of bank consolidation.

4.  Run the bank by strategy, not by budget. Strategy forces banks to look far out into the future. Running by budget forces bankers to look to next year. Where is the puck going, versus where it is. We intuitively know that our industry would not have yielded so much market share to outsiders if we could think outside of our budget. 

So you have bungee cords hooked to your belt. Where are they pulling you?

~ Jeff

Sunday, August 20, 2017

Small Bank-Big Bank: Spending on People, Technology

I was recently slated to speak at an industry conference and I was diligently preparing when the organizer asked if I would be on a panel instead. Fine. But what about my diligent preparation?

I have a blog.

My remarks, should I have made them, were going to revolve around how much large banks spend on strategically significant resources compared to small banks. I took no bias into my search. I ran the data, and here are the results based on bank Call Report data.

The initial news was good. Smaller banks, either under $10 billion in total assets or the smaller group, under $1 billion, dedicate a greater proportion of their total operating expense to salary and benefits. The under $1 billion cohort spends nearly 9% more of their operating expense on employees. This would seem to be crucial, as I frequently hear bank strategy teams identify employees as a strategic advantage smaller banks have over larger ones.

Not so fast. I broke down salary and benefits per employee as well. And in that case, it appears as though the larger financial institutions pay more. The greater than $10 billion banks pay $103,235 per employee versus the under $1 billion banks at $76,411, a 26% difference. That explains why no hands went up at the Pacific Coast Banking School when the director asked how many students went to college to be community bankers.

To further the challenge for small financial institutions, the $1 billion to $10 billion cohort pays 12% more. So if the altruist wants to work for a community bank that is closer to its communities, they can make more with big brother. 

I understand that many, if not most under $1 billion banks are in rural areas, and therefore the salary and benefits disparity may be misleading. But we would be hard pressed to find a college senior that says they'll take a 26% pay haircut and work in Tombstone, Arizona. Although I'm sure there are exceptions.

I'm sure Tombstone is nice. I use as an example recognizable by all. Please refrain from angry comments and e-mails.

My second data search revolved around IT expenditures using the same asset size cohorts. Actually, the Call Report category is Data Processing expense. Although I've been poked for using this 70's-80's phraseology. You know who you are!

A note on the data. It does not include personnel.

The news looks good for smaller banks, spending a relatively larger proportion of their operating expenses on IT. But the larger banks are gaining ground, growing this line item at a compound annual growth rate of 10% over the past 10 years. The banks in the middle cohort spend relatively the least on IT.

What was alarming was how little this expense represented of total operating expenses. Reading industry literature one would think IT would dominate the expense ledger. Not so. 

But it will. 

Were there any surprises in the above tables?

~ Jeff

Saturday, August 12, 2017

Bank Loan Leading Indicators

I recently shared a long ride with a colleague discussing a Capital Plan project we were working on. In Capital Plans, you would typically use baseline projections, usually taken from the strategic plan, and apply adverse events that, based on the bank's balance sheet and strategy, can occur. Even if they are not particularly likely to occur. 

But it's planning. And planning for bad stuff is part of planning. Life isn't all sunshine and rainbows.

As part of our commute discussion, we talked about leading versus lagging indicators of adverse events in order to reduce the impact of such events. Many if not most adverse events are beyond the bank's control. Because risks don't typically come home to roost at the time the Board or Management decide to accept the risk. Lagging indicators are easy, such as the migration from 30-89 days past due, 90+ past due, and non-accrual loans.

But lagging indicators are history. It would've been nice to know that Lee Harvey Oswald was heading to the sixth floor of the Texas School Book Depository. Unless you're Oliver Stone. Then you're wondering who Lyndon Johnson is talking to. I digress. Stopping Oswald or diverting him likely would've ended in a different result.

Can banks identify leading indicators that can reduce risk at the right time?

I was never a lender. And my firm is not in Loan Review or other areas involved with the evaluation of credit. Nor are we an ALCO firm, estimating Interest Rate Risk or Liquidity Risk. But we do Strategic Plans, Capital Plans, Process Reviews and General Advisory that deals with how banks identify and mitigate risk. 

Credit risk remains the greatest risk to a financial institution by far, in my opinion. Not even close. Although examiners and consultants will tick off a laundry list of risks that could put your bank in peril, like reputation risk. The way reputation risk is likely to roost is through liquidity risk. Customers lose confidence in your bank and your liquidity position takes a nosedive. But has many financial institutions suffered as much reputational damage as Wells Fargo recently? And their liquidity ratio is over 40%. They have plenty of liquidity.

No, I'll stand by my credit risk statement. Take the IndyMac domino effect. They had credit problems that came home to roost, Senator Chuck Schumer wrote a letter to the OTS about the bank's problems, and due to the reputation risk customers made a run on the bank. Liquidity is what put them under. Credit is what pushed the first domino.

Identifying leading indicators for credit risk isn't particularly difficult. Finding research that makes the correlation is. But I will list what I think are common-sense leading indicators to credit risk that may very well be effective, and hopefully can be tracked and monitored automatically so we don't have seven risk management analysts on staff hunting and gathering data.

JFB's Credit Risk Leading Indicators
1.  Residential and Commercial Real Estate, and Construction Lending: Trend of days on market (by property type)

2.  Residential and Commercial Real Estate, and Construction Lending: Trend of the difference between initial asking price and actual sale price (by property type)

3.  Commercial and Consumer Lending: Trend of average balance per commercial checking (by NAICS code), and retail checking accounts

4. Residential and Construction Lending: Trend of price index for single family homes under construction

5. Residential, Commercial Real Estate, and Construction Lending: Average checking account balance trends for your customers in the Real Estate Development NAICS

6.  Commercial Real Estate and Multi-family Lending: Trends in occupancy rates.

These are a few that I have seen or make sense to me. Could they be downloaded into a dashboard so bank management could see the trends, and modify risk appetites to curtail new lending in categories that are showing yellow or red? And advise your bank's borrowers on how to navigate difficult times to preserve their business to fight another day?

Do you agree with the above indicators and what others should be considered?

~ Jeff

Monday, July 31, 2017

Are Banks Overvalued?

The S&P 500 Bank Index is up 41% in one year. US Regional Banks' price-earnings multiple was 16.6x and price to tangible book value was over 2x (see chart). So are banks over-valued?

It depends. One way to compare is to look at the p/e ratio compared to the market. The S&P 500 p/e currently stands at 24.6x. So it looks like bank stocks are not overvalued.

But hold on. One ratio that can help us out is the PEG ratio. Remember that in Finance class? It's the p/e ratio divided by the earnings growth rate. According to Peter Lynch's iconic book One Up on Wall Street, a stock is fairly priced if its PEG ratio was 1. Meaning if it's p/e is 16.6x, like the US Regional Banks mentioned above, then the earnings growth rate should be 16.6%. I know I'm comparing a multiple to a growth percent. But, hey, I didn't invent the PEG ratio.

The challenge with banks' PEG ratio, as the chart shows, is that it is way over 1, by a factor of over 5 (5.7). I checked it against other industries in the Financial Services sector. Insurance brokerage has a PEG of 3.4. Specialty Finance: 0.4. The regional banks' PEG ratio, if I do the reverse math, implies that earnings are growing around 3% for the banks in that index. Which is very close to the 3-year annual net income growth for all FDIC insured banks.

So by the PEG ratio, banks would appear to be over-valued. Which may be true. But I want to bring up two mitigating points about banks:

1.  Banks are capital intensive. We must contemplate that implicit in their p/e ratio is some level of their tangible book value.

2.  Banks are not, in general, growth stocks long term. Risk management and the legions of regulators work in tandem to limit growth. 

Relating to 1, I did a data run of all banks and thrifts between $1 billion and $10 billion in total assets that were profitable. I checked their median p/e ratio. I then took their market cap and deducted their tangible common equity to deconstruct their p/e between tangible book and their market cap over tangible book (see chart). 

It is true that other industries can deconstruct p/e in this fashion. But would such an analysis of other industries equate 56% of an industry's p/e to it's tangible book value?

Even if we deducted tangible book from p/e, the industry PEG would still be 2.53 (7.6x / 3% growth), more than double Peter Lynch's prediction of fairly valued.

Which brings me to 2. How long can a company, a sector, and an industry grow faster than its markets? Certainly not forever. And for many, earning their p/e's means stoking growth either through acquisition, or greater risk taking. One is risky, and the other can be deadly. 

For these reasons, bankers may want to consider more moderate growth objectives, maximize earnings, and pay a larger portion of shareholder returns in dividends. 

What is your opinion on bank valuations?

~ Jeff

Note: I make no investment recommendations in my blog. I have a difficult time with my own portfolio. 

Friday, July 21, 2017

Health Insurance: A Bank Problem Too

Bank health insurance premiums have escalated to the point of cutting back benefits. As a nation, our system is not working, whether it be Obamacare or pre-Obamacare. The cost continues to escalate.

An industry publication recently contacted me for some commentary on their "Best Banks to Work For" annual piece. Naturally, I had opinions. When I analyzed their list two years ago, I noted that the financial performance of those banks was similar to banks that didn't make the list. Greater investments in personnel and employee benefits did not result in inferior financial performance.

I also noted that the most cited benefit by employees of banks on the list was gym and health initiatives. And generous benefits was near the top, at fourth. Remember the days that employees would seek banks out for stability, fair pay, and employee benefits? Merger mania has nearly eliminated stability, and the rising cost of healthcare has led to many banks cutting back on generous benefits, removing another competitive advantage in the employee marketplace.

It should be noted that the data in the accompanying charts came from employers. Not premiums in the Affordable Care Act marketplaces so often cited by lawmakers. But the escalation of premiums continues to far exceed inflation and will continue to put pressure on banks' bottom line unless they prune benefits even more.

So I would like to chime in on the healthcare debate, because we can no longer rely on media outlets to provide us with the information to make informed decisions. They cover protests. And protesters are likely to be people that receive free or highly subsidized insurance. I doubt there are net payers to the health care system out there protesting that they should pony up even more for the net takers.

The media covers inflammatory political rhetoric. Like saying one proposal or another will kill people. Not fact-based debate. Too boring. As evidence, look for the oft-quoted CBO stat that one proposal will result in 20 million more uninsured people. The next sentence should say, "the vast majority of which would choose to not participate". Does the media coverage say that? There ya go.

Any health care proposal should be: 1) private, 2) widespread, 3) transparent, 4) favor freedom.

So here are my thoughts:

Health care is a group system. If someone gets sick and consumes more than they contribute, the cost is made up through a pool of people that are paying more than their consumption. That is truth no matter if it's private insurance or government paid. But single payer, or government paid insurance where it's a continual transfer from one group to another is a bad idea. Look at the VA. True competition will come when the payer of services is the consumer of services. Look at auto insurance. We're forced to buy it, and we do so privately. Bad drivers pay more than good drivers. And the Camaro owner pays more than the Camry owner.  

So the JFB health care plan would be private health insurers.

To give small business, the life-blood of our economy, negotiating leverage with private insurers, I propose we allow businesses to affiliate through trade associations, unions, etc. across the country, not state lines. This also applies to an individual market. Allow them to affiliate, through churches, trade associations, etc. 

I propose there be a required minimum basic coverage that keeps families out of bankruptcy should they fall ill and encourages preventative care. Such as a high-deductible Health Savings Account (HSA) plan that has a maximum out of pocket (MOOP) per annum per family of about $10,000, adjusted for inflation. There must be language to limit political influence in this law. One of the failings of Obamacare was putting in political wish-list stuff for social engineering. Such as birth control. To keep teenagers from making babies. Sort of like mandatory parenting. The Basic Plan should be simple and protect families from bankruptcy for extraordinary medical expenses and encourage preventative care. 

I like HSA plans because it puts individual skin in the game. You want to load the shopping cart with Oreos or smoke a pack a day. It will cost you much more than me. Skin in the game. Put behavior and cost of the behavior as close to the individual as possible so there is consequence. I'm an accountability type of guy.

States can have overlays to keep state control. Especially since the Federal mandate will be Basic. But regulation and enforcement of the national law would be national. Regulation of overlays can be state-based. So if California wants to jack up the prices of plans to include medical, recreational, and Cheech and Chong level marijuana use, it's on Californians. We're not going to charge Kentucky for it.

My apologies to the freedom lovers, but we must compel people to buy insurance. In 1985 we required hospitals to treat whoever came to the emergency room, regardless of their ability to pay. That is why you would have to wait so long to get your broken arm fixed. Someone checked in before you with a head cold. Remember those long wait lines in the emergency room? Free health care for those that chose not to buy health insurance. Free riders. No more. This also solves the adverse selection problem in health insurance. People that don't participate in a health insurance plan if they are healthy (i.e. net payers). Many wait until they are likely to be net takers.

Make insurance transparent through a pricing portal run by your insurance company. Insurance companies negotiate different rates for different services by provider, and by insurance plan. It is nearly impossible to make an economic decision. I remember my daughter being at the doctor and was diagnosed with hip dysplasia, a common problem for growing female athletes. The doc said he was 95% sure this was the issue. If we wanted him to be 100% sure, he would need an MRI. I asked how much that would cost. He was taken back by the question, but left the room and asked his admin staff, and they came back with somewhere in the $900 range. That would come out of my HSA. So I decided his 95% was enough. I balanced an economic and medical decision. If a third party paid for it all, I probably would have gotten the MRI. See the problem?

Under the JFB plan, there would be an app that prices out services and service providers so everyone knows the price of their decision, including the prices of local doctors.

Medicaid should be transitory. We are creating a lifelong needy class in our society. It's moving closer towards indentured servitude to the government. Which is dangerous. Check history. However, keeping with the theme of pushing things more local, states can keep ponying up for people that aren't employed, lack the basic plan, and have lots of protest time. Their choice.

Companies can compete for talent based, in part, on their additions to basic coverage. They have the option to make HSA contributions and premium contributions to the basic plan, add benefits, or all of the above. Making it easier for would-be employees to determine which insurance offering is better, and tilt the scales towards those that are more generous, and creating transparent competition for talent. 

That's it. Simple. Transparent.

What do you think?

~ Jeff