Jeff For Banks

Bank Cost Structures: Mostly Fixed

2012-03-10T09:58:00.000-05:00

I recently taught Bank Profitability to a Washington Bankers' school. As part of the curriculum, we discussed the cost structure of financial institutions and how it impacts decision making.

True to the subject, we discussed using product profitability data to make decisions. For example, if a product is unprofitable, should we make changes to it or cut our losses? The answer is not so easy, in my opinion.

In reviewing the table below, one might conclude that we need to do something about business checking. How can such a core offering be ranked eight of ten in profitability? But, as with everything, there are reasons.

One is how profitability is measured. The method from the table is using funds transfer pricing to determine the spread generated from the product. In such a low interest rate environment, the funding credit is at historic lows. Aside from the interest rate environment, the product's profitability is determined by fully absorbed costing. This begs the question about the variability, or lack thereof, of operating costs.

Community financial institutions don't have much in terms of variable costs. Let's ask the question, what cost would be reduced by discontinuing this product? The answer... very little. Perhaps the core processor charges per account, and the business is on bill pay, also invoiced per account. But will we reduce branches without the product? Probably not and branches represent a significant cost to deposit products.

This is why leveraging your FIs infrastructure is so important to profitability. We have a step variable cost structure. That means we buy resources in bulk. Similar to buying a palate of Hot Pockets at Sam's Club, we add resources and then utilize the resources over time until they are exhausted. If properly utilized, the FIs operating cost ratios should decline over time, until the infrastructure becomes stressed.

How do you tell when your infrastructure is stressed? One CEO uses the parking lot theory. He looks out in the parking lot to see how many cars remain at the Bank after 6pm. I'm sure there are other, more sophisticated methods, but the overall point is that there is a consistent, downward trend in operating cost per account.

In terms of strategic decision making, understanding the FIs cost structure may motivate the FI to increase volumes in business checking, knowing that the marginal cost to add more accounts is minimal, and the revenue per account is significant (3rd greatest in the above menu). Not to mention that the average balance per account tends to be greater than most others. Discontinuing a product based on its fully absorbed profitability simply pushes the costs currently borne by the doomed product to other products.

How do you use your profitability information?

~ Jeff

Job Description: Branch Manager

2012-03-04T06:37:00.000-05:00

I frequently hear lamentations about the gap between the performance expectations of community financial institution (FI) personnel and performance results. A frequent challenge is that performance expectations are not documented in the form of job descriptions. Instead, expectations are often trapped between the ears of the supervisor or senior management.

This post is geared toward drafting a job description of the FI branch manager. Although I am not an HR expert, I am often engaged in discussions with FI senior management teams on what they expect from the person occupying this position. The job description does not include qualifications or compensation, as each FI can assess what is needed based on their own expectations.

Branch Manager

Summary of Responsibilities: Relationship management... Develop relationships with the branch's most profitable customers. Relationships should include knowledge of the customers' banking needs and their service expectations from their FI, evaluation of customer product use to determine optimal product utilization, and routine customer contact. The objective is a level of customer satisfaction that increases customer loyalty based on service and relationship, not price/rate.

Product knowledge and expertise... Develop and maintain significant knowledge of FI product offerings, with an emphasis on products most needed by the branch's target customers as per the demographic profile of the area surrounding the branch and the FI's strategic focus. Develop and maintain financial acumen in customer balance sheet and cash flow management to assist customers achieve financial success. The objective is to establish the branch manager as the subject matter expert of bank products within the branch market.

Community relations... Become the primary community representative by joining a minimum of two community organizations with an emphasis on those where the FI's target customers are likely to participate. Volunteer for a leadership position in at least one. The objective is to promote community involvement consistent with the FI's strategy and to expand the branch manager's relationships for future business development activities.

Business development... Grow branch customers at a pace faster than general market growth that is consistent with the FI's strategy. Manage branch business development efforts that include, but is not limited to, in-branch sales, outbound calling, prospect visitations, direct mail, branch-specific social media activities, etc.

Supervision... Supervise branch staff. Set performance expectations based on job descriptions and capabilities. Coach staff to exceed expectations. Manage staff training to include compliance, operations, and sales/product knowledge. Perform routine performance evaluations. Position subordinates to succeed within the FI. Coordinate with HR for developing optimal staffing levels, modifying job descriptions based on changing expectations, and filling open positions. Address performance deficiencies of subordinates.

Branch operations... Manage branch operations activities such as efficient and compliant transaction processing, correct and compliant account opening and closing, branch/teller cash, etc. Branch manager is not expected to perform these duties. Rather, the branch manager will supervise staff that performs duties and receives regular assessment on the operations of the branch from the branch operations manager and outside sources such as Audit and Compliance departments. Branch manager is responsible for the overall appearance of the branch, ensuring it is consistent with the image the FI wishes to present based on its strategy. Responsibilities include the branch physical plant. Again, the branch manager is not expected to perform these duties, but supervise personnel to ensure that they are satisfactorily discharged. The objective is for the branch to operate smoothly so branch staff has greater availability to deliver service that is noticeably better than the competition, and for sales activities.

Branch profitability... Branch manager is responsible for the overall profitability of the branch, and to establish a positive profit trend that is consistent with the FI's overall strategy.

Other duties as assigned.

What did I miss?

~ Jeff

Common Misperceptions: Community Banks are Beating the Behemoths

2012-02-19T07:10:00.000-05:00

My firm constantly evaluates industry trends and happenings to formulate what we term our Industry Overview. Although a constant process involving hypothesis, research, and re-evaluation, we center our thinking annually to ensure we properly debate, debunk, and determine where our industry is moving.

As part of the process, our staff does a lot of research. Some of the research focuses on themes we hear multiple times over in client strategic planning sessions. One such theme was the right sizing of community banks' funding sources.

Since the dawn of the financial crisis in 2007, loan demand has fallen off of the cliff, and therefore community banks did not need their historically high amount of CD funding. As a result, we dropped rates to such a level that it wasn't attractive to traditional CD customers and they began parking money in liquid savings vehicles, such as the money market account.

Our deposit coffers swelled like a puffer fish. In many strategy sessions, senior management teams began to feel pretty good about their efforts in attracting core deposits, and how they are beating the big banks in deposit gathering.

Not so fast. As the chart below shows, although community FI deposit growth has been quite robust, with an emphasis on core deposit growth, the big banks (defined as top 25 US banks) are outpacing us. This is exemplified by Bank of New York/Mellon charging their largest depositors negative interest for the convenience of parking their cash in BNY's vaults.

Another theme we hear in community FI strategic planning sessions is how much better we are at serving small businesses. We provide access to decision makers, custom loan structures, and better service than our larger brethren, so the discussion goes.

But the chart below from recent Small Business Administration research, although using 2009 data, demonstrates a trend worth noting. In 2005, banks with greater than $50B in total assets accounted for 32% of small business loans, defined as loans less than $1 million. In 2009, that percent rose to 37%, although that is off 1% from the prior year.

All other asset sized FIs either held their market share or slightly declined. Does access to decision makers, custom loan structures, and better service result in more business? Intuitively it should. So why hasn't it?

How do we, as an industry, turn the competitive advantages we have over behemoth banks into real wins in the marketplace? I'd like to hear from you.

~ Jeff

Best Book Ever on Word of Mouth and Direct Mail Marketing

2012-02-11T13:57:00.001-05:00

I hope the title of this post compelled you to read its contents. If so, I suppose you are expecting me to offer my opinion on the most recent thought leadership on word-of-mouth and direct mail marketing. But I will not.

Instead, I will offer you my opinion on a book whose author is not 100% known, but thought to be a Syrian from Antioch named Luke. Recent? No. But would you be interested in a book that describes how to grow raving fans that span the globe from one poor person from a small town? Would you be interested in a book that doesn't only stand the test of decades, or even centuries, but millenia? How about a book that boasts adherents from about one-third of the world's population (see chart)?

Source: http://www.religioustolerance.org/

I'm not talking about Facebook, whose founders are plotting as you read to turn their paper into big money. I'm talking about the biblical book Acts of the Apostles.

Now before you browse away because you may not be religious or not be a Christian, hold on. This is not a post about religion. It has been suggested to not discuss religion or politics in a business blog. But it's my blog! And ignoring how a tiny sect of Judaism, whose apostles feared for their lives and locked themselves in an upper room, grew to a religion followed by 33% of the earth's population is worth discussing.

How did the Apostles do it? The book of Acts tells the tale with a specific focus on two: Peter and Paul. Peter, as many of you know (perhaps a third of you), was appointed by Jesus to build his church after Jesus' death. Indeed, Peter is considered the very first pope.

After Jesus' death, the apostles weren't out canvassing the countryside preaching the faith. As I mentioned, they hid from possible persecution. Jesus had to appear to them several times after death to get them out of the room. Have you ever heard of a doubting Thomas? Biblically based. Jesus had to guide Thomas' hands into his wounds to convince him.

But convince him, and the rest of the apostles he did. They immediately began their ministry, teaching to mostly Jews, healing them, converting them. There was no Internet. No newspaper to take out ads. No postal service to send a direct-mail postcard. No PowerPoint deck. They only had each other and their words, that were inspired by the Holy Spirit, according to the Bible.

They also had a solid foundation of a legend, although it typically takes decades, sometimes longer, for legends to achieve legendary status. In a word-of-mouth world, legends were slow to come. But Jesus' ministry resulted, in part, for the making of a legend that was to attract followers like no other legend before, or since.

The apostles were selected by Jesus not because of their stellar standing within the community. Most were poor and some were in positions not well admired, such as tax collector (not sure their social status has improved much). Nobody knows what Jesus was thinking when he chose such a humble lot. But I surmise he knew what he was doing... such as selecting good men, with good presence, that he could teach/were teachable, and who could preach to the world.

Paul was a different story. Not an original apostle, he enters the picture in Acts as a persecutor of Christians... until his fateful ride to Damascus. According to Acts, he was struck down and blinded by Jesus, and sent off to seek counsel in the faith before his sight was restored. Lesson learned: to knock the cover off the ball in word-of-mouth marketing, convert your biggest critic, and make him/her your raving fan.

Acts ends with Paul's first imprisonment, as it was typical for Christians to be persecuted. Paul's ministry focused on the Gentiles from Asia Minor to Rome. When not spreading the word in person, Paul wrote many letters to various Christian leaders. Much like a political campaign, the lesson learned here is to appoint leadership in key geographies and communicate, teach, and encourage them often.

Lastly, Acts shows the beginnings of the organization of the Christian church (present day Catholic church, as Protestant faiths took root as a result of the Reformation in the 1500's). This organization lives to this day, 2,000 years after its first seeds were planted by a poor carpenter from Nazareth and a few followers that included fishermen and tax collectors.

In summary, my take on the lessons learned from the book of Acts of the Apostles for word-of-mouth and direct mail marketing:

1. Choose your first WOM marketers carefully, make them passionate followers, develop and train them, set them loose;

2. Lay the building blocks to achieve legendary status;

3. Develop an organization that is built to last with leaders in key geographies;

4. Turn your greatest critic into your greatest apostle.

Wouldn't it be shortsighted to ignore these timeless and proven word-of-mouth marketing techniques because they are found in the Bible?

~ Jeff

Note: My fascination with Acts of the Apostles as a quintessential word-of-mouth marketing guide does not make me a Biblical scholar. As one of my favorite comedians, Kathleen Madigan quips, "I'm a Catholic, I don't read the Bible." :)

Bank Super Bowl Ads 2012

2012-02-05T14:12:00.003-05:00

First, check out this creative yet sleepy First Bank ad. If you need to go to the bathroom, feel free to do so:

Amarillo National Bank puts their CSRs through a workout. This, my friends, is a training program:

E*Trade, the gold standard for Super Bowl bank ads... speed dating. Awesome:

Would my marketing readers, being given the keys to the Super Bowl jumbo tron, offer this lack of creativity:

Not a 2012 commercial, but this is my favorite Super Bowl bank ad... E*Trade's milkoholic Lyndsey. This netted Lyndsay Lohan some coin, as she sued E*Trade because it was a little too close to home. May suffer from a broken link because E*Trade and Lyndsay must not like it advertised:

http://youtu.be/5QS9rIZcjaw

Lest we forget, here are the top 10 Super Bowl ads from 2011:

What was your favorite all time? Post the link!

~ Jeff

Let's retake the mortgage market!

2012-01-28T11:48:00.000-05:00

Community financial institutions are grappling with the recent and pending mortgage rules. We fear the Consumer Finance Protection Bureau (CFPB) and government's tendency to fire a bazooka at an ant, causing tremendous collateral damage.

New rules aside, we were not that significant in the mortgage market anyway. Aggressive mortgage brokers hawking products and programs from money center and category killer banks, and government or quasi government agencies such as Fannie and Freddie, were killing us in terms of competition. Lastly and perhaps more importantly, because we collateralize and sell a significant percentage of mortgages into bonds and off of bank balance sheets, the 30-year mortgage became the most prominent. The 30-year carries too much interest rate risk for us.

So we opened the door, let the competition through, and we ceded the mortgage market to brokers, specialists, and the government.

As most FIs are hungry for assets, they are looking for loan volume wherever they can get it. I encourage you to rethink the residential mortgage loan. Two of our clients recently did so, and are finding ways to profitably offer this staple loan product to their customers and communities. With many brokers now out of business, and the government looking for ways to reduce their participation, can we find opportunities to retake what we have previously ceded? I think so.

I recently ran an analysis of all of my firm's product profitability clients to determine exactly how profitable residential mortgages are in the industry. The results were surprising to the client and helped them to peel back the onion further to uncover opportunities to increase production and reduce per-unit costs in their residential lending unit. See the table below for a portion of this analysis.

A note on the data. The profitability of the residential mortgage product is based on fully absorbed costs. So the per-unit cost not only contains direct origination and maintenance costs such as the mortgage originator and the loan servicing department, but also the indirect costs such as a portion of the FIs senior lender, and overhead expenses such as portions of the Finance Department.

What the data shows is that, in an era of needing loans on our books or revenue through our income statement, mortgage loans are doing relatively well. Why shouldn't we do more of it?

One reason may be the variability of volumes. For example, volumes were down in my home state of Pennsylvania from 2009 through 2010, the latest year HMDA data is available. In 2009, there were 374 thousand loans funded for $62 billion. In 2010, 334 thousand loans were funded for $55 billion. This variability is common, and FIs must build their capability with a greater percentage of variable expenses than other lines of business so they can decrease expenses as volumes decrease. But come on people, although down, $55 billion of loans are being funded per year in Pennsylvania alone!

Residential mortgages are critical components of being a community FI. Most of our customers either have them, will need them, or have had them. A fair amount of small business funding can be achieved through residential lending, either through straight mortgages or home equity loans. Big government and aggressive loan brokers made us small players in the market.

I say we should take it back! What do you say?

~ Jeff

Leader Selection: "He's not ready."

2012-01-21T10:48:00.001-05:00

Financial institutions are currently struggling to identify the next generation leaders. Should we fall back on our old playbook, selecting highly "experienced bankers" that have been around and are likely to be the mantle bearers for the good old days, or should we think differently?

The manner at which we choose leaders is not very effective, in my opinion. So often we go with those we personally like, or the safe choices such as elevating longevity to top billing. Been here 20 years... here's the gavel. The resistance to putting young talent in positions of executive leadership is baffling to me. Our industry is changing faster than at any time during any of our lives, and yet we listen to pundits tell us that forward looking, and often young, talent is "not ready".

This mentality reminds me of NFL quarterbacks. Yes... quarterbacks. I write this on Championship Weekend, when the Niners and Giants are set to face off for the NFC Championship while the Ravens and Patriots vie for the AFC crown. Tim Tebow was vanquished last week by the Patriots. Tebow, as many of you know, started the season third on the Broncos depth chart. In my opinion and the Broncos coaching staff, he was the third best QB on the roster. When the Broncos went 1-4 to start the season, Tebow became the first signal caller known to me to win the starting job via popular opinion.

When Tebow's number was called and the starter Kyle Orton was released, Tebow was still only the second best QB on the team. Brady Quinn, in my opinion, was a more talented passer. [Disclosure: I'm a Notre Dame fan, Quinn's alma matar] So Tebow, third string clipboard carrier, goes 8-4 the rest of way. I'm pretty sure FI board members and executive recruiters would have said "he's not ready."

How about the Patriots' Tom Brady? Have you ever heard of The Brady Six? These are the six quarterbacks chosen before Brady was chosen (199th, 6th round) in the 2000 NFL draft. Chosen before him were such inauspicious names as Giovanni Carmazzi (chosen 65th), Chris Redman (75th), and Tee Martin (163rd). The most famous and first QB seclected was Chad Pennington (18th, see photo). FI board members on Brady: "he's not ready."

Lastly, what about Kurt Warner (see photo)? Probably one of the most successful QBs in NFL history, Warner went undrafted and sent to exile in the Arena Football League. In 1998, the St. Louis Rams picked him up as third string clipboard carrier behind such high profile names as Tony Banks and Steve Bono. [Disclosure: I'm a Rams fan]

The next year he was promoted to second string behind Trent Green, who proceeded to get hurt in the pre-season, handing the football to Warner in what was feared to be a lost season for the Rams. What ensued was an MVP season followed up by an MVP Super Bowl performance that sprung a Hall of Fame career. Warner would have never started if Green stayed healthy. FI board members: "he's not ready."

Here's my point: There are professionals that do nothing but evaluate football talent, develop them, opine on them, have reams of data to compare them, and they churn out winners like Jamarcus Russell. Perhaps those that select the next level of FI leadership ought to think about those that can lead people through a difficult and changing industry instead of those that have a good loan book/the safe pick. Or perhaps that person isn't ready.

~ Jeff

Guest Post: 4th Quarter Economic Update by Dorothy Jaworski

2012-01-12T19:07:00.000-05:00

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.

Customer Service... blah, blah, blah

2012-01-07T11:42:00.002-05:00

My family recently shopped around our homeowners and auto insurance to ensure we were getting a fair shake. We used to use an insurance agent for life, auto, and homeowners. I place value in having an agent because they have access to a number of insurance companies (if an independent agent) and should have our best interests in mind. The owner of the agency is a director at a bank, which is a bonus.

But a past "shop" for auto after a dramatic rate increase led me to go to a "direct" insurer. And now, after our most recent shop, we are leaving to a direct insurer for homeowners. When I notified my agent, he asks me if he could have a chance to look around for me, and to try to win back our homeowners and auto.

My e-mail back to him: "I would have appreciated that service prior to me searching on my own." I was irritated. I expect three things from our insurance agent:

1. An analysis of our needs and recommendations to fit those needs;

2. Periodic reviews of our policies versus what is offered by similarly rated insurance companies in the agent's markets; and

3. Good service when I call with questions and problems.

I received one and three from the agent. But I was pretty disappointed when my shopping resulted in a 20% reduction in my homeowners insurance. I am willing to pay a slight premium above discount insurance companies for the service of an agent. But not 20%. This happened with our auto insurance too.

Our agent clearly dropped the ball on two, and scrambled to make up for it after I notified him I had done it on my own. As Donald Trump would say, "you're fired". When I sounded off to my wife about it, she said "I think you have a blog post." Boom!

I suspect financial institutions think they have great customer service too. But in my experience, what FIs mean by great service is "3" above. After my wife planted the seed of this post in my mind, I asked the marketing director of a multi billion FI if they had "service level agreements" (SLAs). She said that they are required to respond to customer inquiries within a certain amount of time, etc. In other words, "3".

But what of one and two? I know it is an insurance list, but don't we have similar demands from our FI? Don't FIs want to be considered for more than a deposit counter or a money machine? Based on my experience, I think they do. In fact, a competitor of my firm did a survey of FI customers that concluded that both businesses and individuals wanted advice from their FI.

Are we giving them what they want? Are we really good at customer service?

What do you think customer service is?

~ Jeff

In Pursuit of Return on Equity

2012-01-03T19:10:00.003-05:00

When performing ratio analysis to determine a company's profitability we should remember that a ratio has at least two data points: a numerator and a denominator. It doesn't matter if it is banking, retailing, or widget making.

In banking, the standard profitability ratio has long been return on equity (ROE). That is... until the financial crisis of 2007-08. It was in the aftermath that capital, the denominator in the return on equity calculation, resumed its place as king.

Where has the pursuit of ROE led us? Yes, it made us focus on profitability, the numerator in the equation. But it also resulted in us looking at bank equity. The smaller the E, the better the ROE, right?

Bond salesman loved the concept. They encouraged their bank clients to borrow from their respective Federal Home Loan Banks (FHLB) or chase high cost deposits to fund the bonds they sold for minuscule spreads. The logic: blow up the balance sheet, eek out incremental profits, and reduce the E. Genius! And equity analysts, who coincidentally worked for the same firms as the bond salesman, loved it too.

During the period 2002-07, when loan growth outpaced the ability to fund it, FIs took on more FHLB borrowings and high cost deposits. This was a higher spread concept, because loans typically had greater yields than bonds. Loans also typically had greater credit risk. FIs did provision for such losses, but accounting rules and how the SEC enforced them did not allow FIs to "over-reserve", whatever that means. This was determined by the high profile case the SEC brought against SunTrust in the Fall of 1998 for managing earnings through the loan loss provision. Read a summary of it from the Atlanta Fed here. The Fed research piece on the subject, written in 2000, is almost comical to read given what has happened.

So, in pursuit of ROE, banks leveraged up their balance sheet. They thinned their capital leaving them more susceptible to distress during economic hard times. This distress was clearly evident when I recently performed some "where are they now" research on the highest performing ROE FIs in 2006, the last normal year prior to the crisis (see table).

A note on the data. I searched all publicly traded banks and thrifts that existed in 2006 and sorted them by the highest ROE. But I also ensured that their prior year ROE was similarly high, in order to weed out one-time gainers. In other words, I wanted consistent, high ROE FIs.

The results are telling. Of the top 10 ROE FIs of 2006, only three are currently profitable. Two are under a regulatory agreement. The remaining five failed. Yes, failed.

How does an FI, sitting atop the ROE chain, fall so far so fast? As mostly always the case, it was bad loans. But many if not most FIs have had loan troubles. What made so many in this group take the perp walk to the FDIC? I already mentioned their inability to put extra away for a rainy day via the loan loss provision. But the pursuit of ROE encouraged levering up the balance sheet to leave little in excess equity to absorb the losses. Inadequate loan loss allowance, relatively low equity. The recipe for disaster in bad times.

I think ROE will re-emerge as ONE important indicator of profitability. But I don't think we will make the same mistake twice. Having the past three years as history in our loan loss allowance calculations, our regulators and the SEC will probably permit us to be more aggressive in provisioning. Needing the federal government to chip in capital because we did not have enough to withstand the storm is resulting in higher capital requirements, and lower ROE expectations. Analysts take note.

What do you think should be the primary measure of FI profitability?

~ Jeff

It's a Wonderful Life

2011-12-21T20:36:00.001-05:00

This 1946 Christmas classic is a story about the impact one man made on his family, his business, and his community. It goes beyond the fate of the Bailey Building and Loan. It teaches us to take stock of our lives, to be helpful instead of hurtful, and be thankful for what we have instead of stressed over what we don't.

But It's a Wonderful Life is also a testament to the importance of community financial institutions (FIs). The classic scene of the run on the Bailey Building and Loan after the 1929 stock market crash depicts the basic principals of community banking, how FIs work, and how important character plays in bank lending and community development.

What you don't see here is the villainous Mr. Potter's diatribe on how the Bailey Building and Loan advanced loans to "riff-raff", and was unwilling to foreclose when the "rabble" ran into difficulty making payments. Instead, the Bailey's modified the terms to help borrowers make it through tough patches.

What you also don't see is the bank examiner showing up to review the bank's books. Note the examiner wasn't plowing through the loan portfolio and criticizing this underwriting anomaly or that. He was there to ensure what the bank reported in its footings was accurate. In the end, Uncle Billy Bailey loses $8,000 when depositing the funds in the correspondent bank; Mr. Potter's bank. It was the mismatch in footings that landed George Bailey in hot water with the examiners. It wasn't lax underwriting, or troubled debt restructurings.

When the Bedford Falls community pulls together to raise the missing $8,000, they toast George as the "richest man in town". The bank examiner actually contributed to the pot of money. My how times have changed.

It's a Wonderful Life portrays the significance a financial institution plays in elevating the socio-economic status of local residents. The working poor increase their wealth by owning cars so they can get to work, to go to college or technical school, and/or to achieve home ownership. The middle class can improve their wealth by upsizing their home, going to grad school, and/or starting a business. Many of these loans don't fit the one-size fits all underwriting criteria of government bureaucrats whose sole objective is to cover their butts should asset quality falter in an institution they examine. "Rabble" need not apply.

In this sense, regulators that examine our financial institutions are the modern day Mr. Potter. But in order to help businesses work through difficult economic times, to help families stay afloat during periods of unemployment, and to help communities re-adjust to remain economically vibrant during changing times, we need more Bailey Building and Loans, not less.

Is anybody listening?

~ Jeff

Note: Since this post, the NY Times wrote an article about a modern day Bailey Building & Loan: Bank of Cattaraugus. Cattaraugus, coincidentally, is in upstate NY, near Buffalo. Perhaps not too far from the fictional Bedford Falls. Although I salute the Bank for its success in helping local people, I do believe community FIs can achieve long-term success through the profit motive, which is consistent with operating in vibrant communities.

http://www.nytimes.com/2011/12/25/nyregion/the-bank-of-cattaraugus-new-york-states-smallest-bank-plays-an-outsize-role.html?_r=1&adxnnl=1&ref=nyregion&pagewanted=all&adxnnlx=1325347237-Q5F/vRUqZwymOgvBcu0zFg

The 17 Fundamental Traits of Organizational Effectiveness

2011-12-17T16:34:00.070-05:00

I recently read Harvard Business Review's 10 Must Reads on Strategy and reviewed it in this blog. One of the "must reads" was The Secrets to Successful Strategy Execution by Gary Neilson, Karla Martin, and Elizabeth Powers from Booz & Co. I dedicated one blog post: naming it Common Sense to Successful Strategy Execution because I didn't think it was a secret. In this post I would like to write further on the subject, focusing on the 17 fundamental traits uncovered during Neilson, Martin, and Powers' research.

The below table was drawn from research from more than 26,000 people in 31 companies. The Booz consultants distilled them in the following order of importance...

A note about the study: The Booz consultants tested organizational effectiveness by having participants fill out online diagnostic that contained 19 questions... 17 traits and two outcomes. The traits were ranked and indexed to a 100-point scale to determine their relative importance to organizational effectiveness.

In the study, 61% of respondents in strong-execution organizations agree that field and line employees understand the bottom-line impact of their decisions. This figure plummets to 28% in weak-execution organizations. For community FIs, this is terrible news, as so many rely on top-level profit reporting to determine success or failure. Does the deposit operations manager know the implications on product costs for adding a software component? Doubtful. Does the lender understand the profit implications to his or her line of business by authorizing the waiving of a fee? Unlikely.

A similar analysis can be performed on your organization as a whole, focusing first on the top traits and working your way down, ensuring your FI moves toward affirmative responses to each trait. Once completed, FIs can then incorporate the 17 traits into executive performance reviews.

Imagine an FIs board of directors using the above table to evaluate the effectiveness of its CEO. Or a CEO to evaluate the effectiveness of his or her direct reports. Simply putting the 17 traits in a spreadsheet, and responding on a five-point scale of "strongly agree" to "strongly disagree" would certainly motivate the person evaluated to create a strong execution culture in his or her organization. For proponents of the 360 review process, subordinates can also respond, giving the Board or CEO insights beyond their own perceptions and bias.

This blog has dedicated countless posts to strategy. If an FI is to promote an execution culture, it begs the question "execute what"? It reminds me of legendary Tampa Bay Buccaneers coach John McKay's response when asked about his team's execution after a lackluster performance: "I'm all in favor of it." My point is, and I do have one, when evaluating the organization and its executives on execution, it should be executing long-term strategy. That implies the FI has a long-term strategy to chart the course to compete and succeed in a rapidly changing industry.

What are your thoughts on developing an execution culture?

~ Jeff

Note: I tried to make the table as large as I could. If you would like a larger version, e-mail me.

Power to the People

2011-12-11T05:29:00.000-05:00

I asked the head of commercial lending how best to turn the tide in business loan growth. His response: people. I asked the head of branches how to elevate the results from low performing branches. Response: people. I asked the head of an insurance subsidiary how he intends to improve margins. Again, it's the people.

My firm moderated a brainstorming session with a client on improving profitability in certain areas. We came up with several credible ideas. But a senior executive spoke up and said something to the effect that the responses that revolved around people were so far ahead of the others, that if the bank got the people issues right then performance will surely improve.

I have opined that bankers come in two general categories: balance sheet managers and customer managers. Since that post over a year and a half ago, financial institutions continue their migration toward the customer aspect. A strategy heavily focused on balance sheet management does not do much to differentiate one FI from another, and therefore does little to improve franchise value.

But strategies that focus on customers require people that are better than the people at the FI across the street. From this perspective, our assets do go up and down the elevator every day. So what are we doing to have the right people in the right positions?

We first attacked this challenge over 10 years ago when we aggressively pursued lenders. The hot pursuit led to wage inflation. The challenge was that we wanted lenders that went after the total client relationship and were surprised when what we got were loans. They were deal people, selling loan transactions usually at attractive pricing and loose covenants. We found it difficult to get the old salts to change their perspective, to build a strong relationship, to achieve trusted advisor status with their clients. They simply wanted to do deals.

Perhaps we can learn from this experience. If FIs seek to supplement their staff with more customer managers, maybe we should focus on attracting motivated, less experienced, but more malleable talent. Or perhaps such talent exists within our franchise.

To succeed at such a strategy, the FI would need a performance measurement process that identifies top performers and hot prospects, develops a training program to teach them the skills to meet performance expectations, and to ingrain your FIs Way (manner in which your FI would ideally like to do business).

If you bring onboard new, yet under-developed talent, perhaps you implement a mentor program with more senior people that have bought into your Way and are performing well. Additionally, ensure your compensation system is consistent with your Way. If you compensate for loan volume, don't be surprised if you get the aforementioned aggressively priced loan transactions and few loyal relationships.

As you populate your employee base with higher quality people your FI will perform better. If you keep in place employees that are millstones around your neck, your FI will struggle to perform better. Your objective should be to maximize the former, and minimize the latter. That's the simplest business strategy ever, don't you think?

~ Jeff

Book Report: HBR's 10 Must Reads on Strategy

2011-11-30T08:30:00.011-05:00

A Written on the cover is a definitive statement made by an entity that has supreme confidence in itself: "If you read nothing else on strategy, read these definitive articles from Harvard Business Review." Wow. And while we're at it, if you read no other blogs on banks, read Jeff For Banks. As much as I would like to believe it's true, I would also have to believe that a higher authority is leading the Denver Broncos on their improbable run. You and I both know that's not true... ???

But if a compendium of essays on vision, strategy, and execution written by luminaries such as Michael Porter, Jim Collins, and Michael Mankins interests you, then this book is for you. I'm pretty much a strategy junkie, and this book gave me fix after fix, every time I powered up the Kindle.

What I liked about the book:

1. Covers, in good detail, disciplines such as strategy development, strategy execution, decision rights, balanced scorecards, and vision;

2. Many essays were in "how to" format, such as how to develop your strategic principle;

3. Summarized key points in Idea in Practice segments.

What I didn't like about the book:

1. Not much. But if I had to pick something, it would be that the essays were penned by academics and/or consultants. It is instructive to hear from practitioners too, although the book is chock full of real world examples of idea implementation.

Do I trust Harvard Business Review to select the appropriate compendium on strategy? Well, no. I'm sure they have their bias and it flows through not only to the essays selected, but also the authors, as many are associated in some way with HBR. But I can't argue with any of their selections, and I am better for having read the book. I think you will be too.

~ Jeff

Book Report note: I will occasionally read books that I believe are relevant to the banking industry. To help you determine if the book is a worthwhile read for your purposes, I will review them here. My mother said if I did not have something nice to say about someone, then don’t say it. In that vein, I will only review books that I perceive to be a “B” grade or better. Disclosure: I will typically have the reviewed book on my Amazon.com bookshelf on the right margin of this blog. If you click on any book on the shelf and buy it, I receive a small commission; typically not enough to buy a Starbucks skinny decaf latte with a sugar-free caramel shot, but perhaps enough to buy a small coffee at Wawa.

The Grand Mishandling of Strategic Projections

2011-11-23T15:42:00.001-05:00

After nineteen years in financial services, I am finally witnessing the tide turn in bank and credit union strategic planning. What once was an annual budgeting exercise, is now beginning to take the more productive path of identifying and paving the way to the financial institution (FI) of the future. The one that makes clear either-or choices to ensure future relevance for their customers, employees, communities, and shareholders (if stock owned).

But the fate of strategic plan projections, for the most part, remains mired in the old-school budgeting process. When asking senior leaders what success would look like if they executed their plan well, the answer is all-too-frequently what leaders reasonably think they can achieve. In other words, success looks like next year's budget.

In February, I proposed that FIs evaluate strategic alternatives as a regular part of the strategic planning process. To use the present value of future earnings streams to determine if the strategy is actually adding value. Developing strategic projections so you have an extremely high likelihood of achieving them may not yield the answer you want. What if your Board expects senior management to increase the value of the FI by 10% per year, and you project a 5% increase in earnings because you feel comfortable you can succeed? You will erode the value of the franchise.

The Board may decide to turn the keys over to someone capable of increasing franchise value. See the chart below for the decrease in the present value of tangible book value per share versus the nominal increase in tangible book. If you were a Board member of this franchise, what would you do?

In my opinion, FI strategic plans should have three scenarios:

Scenario 1: Stretch. These projections should depict "what success should look like" in executing your strategy. I am not proposing creating projections that cannot be achieved, a risk that an investment banker told me often happens when FIs evaluate their strategic alternatives. If I were to handicap these projections, I would give senior leaders at least a 40% likelihood of achieving them. The more strategic leaders gain credibility with the Board and their shareholders (if publicly owned) at achieving stretch goals, the greater the likelihood the FI earns its independence. Creating overly optimistic or "hockey stick" projections only erodes credibility with your constituencies. "Stretch" are the projections that should be discounted to determine the present value of the strategy.

Scenario 2: Base. These projections take more the form of budgets. They are estimates of what senior leaders reasonably believe they can attain. As mentioned, present valuing these projections may not yield the answer you want. But in setting Board and regulator expectations, these projections are likely to be around 70% achievable.

Scenario 3: Stress. These projections serve to identify the things that can go wrong, and their impact on your FIs balance sheet and capital ratios. FIs tend to do this within their ALCO process regarding swings in interest rates. But interest rate risk is only one form of risk that can pose significant challenges. By modeling the most likely stressors, senior leaders can develop contingencies in advance to improve their balance sheet and profitability.

In my experience, FIs tend to use scenario 2. Why? In my opinion it is because they want to manage expectations, and it is how it has always been done via budgets. Another reason may be the uncertainty in projecting out several years. Banking, unlike many other industries, has significant macro issues that are beyond bankers' control which impact their balance sheets and income statements. Because of these uncertainties, we shy away from what our financials will look like in the future.

But if, through strategic planning, we set our sights on the bank we want to become, we should model what that would like like in our financial statements. Not doing so dilutes our credibility and accountability to our Board, our shareholders, and ourselves.

How does your FI use strategic projections?

~ Jeff

Note: The above chart represents the actual tangible book value per share of a Northeast FI from 2005-2010. If the Board of this FI expected a 10% annual return, they were sorely disappointed.

Jeff For Banks 10 Thankful Things

2011-11-20T19:53:00.003-05:00

I should be thankful every day. But I'm not. That internal negativity sometimes wins the day. I blame my internal wiring. Thanks to all of my ancestors for my genetic code. See! I AM thankful.

But if I get better at improving myself, a never ending project mind you, here is where I have some pretty serious thankfulness:

1. I am thankful for my family. And occasionally, I think they are thankful for me. But this may be day-to-day.

2. I am thankful for my coworkers. I enjoy your friendship and working with you.... most of the time.

3. I am thankful for the banking industry. Most colleagues are cordial, humble, smart, and fun to be around. For the ones that don't fit this description, you know who you are.

4. I am thankful for regulators. They keep requiring bankers to hire consultants.

5. I am thankful I am not a turkey.

6. I am thankful somebody at our Thanksgiving Dinner understands the difference between a turnip and a rutabaga.

7. I am thankful for my LinkedIn connections, Facebook friends, and Twitter followers. Even that guy that keeps trying to make me an Internet millionaire. I know in his own way, he really cares about me.

8. I am thankful I don't know what ROFL means. In this regard, ignorance is bliss.

9. I am thankful that I've never seen Jersey Shore, and...

10. I am thankful for my blog readers. Although after reading my 10 Thankful Things you may not be thankful for me.

What are you thankful for?

Have a great Thanksgiving everyone!

~ Jeff

The coming consolidation wave... for bank consultants.

2011-11-16T18:00:00.002-05:00

Last year Millward Consulting merged with my firm. The combination gave Millward greater resources to serve clients, and my firm senior-level expertise to develop our talent, deepen our services, and expand our geography. At the time, I didn't think much about a trend developing in bank consulting.

A couple of months ago two other community bank consulting firms merged, Danielson Associates and Ambassador Financial Group. When I asked Dave Danielson about the combination, he expressed interest in having a mix of transactional business and recurring revenue business. The merger served to accomplish that.

Most recently, Stern Agee expanded its services to financial institutions by making the bold move of buying a bank. The reason: use the bank charter as a platform to offer correspondent banking services to clients. This gives Stern Agee the recurring revenue business Danielson mentioned as important to his combination.

Community bank consulting is highly fragmented, ranging from the larger firms to the one-person shops. Consultants are typically highly specialized, such as asset-liability management, and geographically focused. Indeed, when I attended the North Carolina Bankers' convention for the first time, I hardly knew the other consultants that attended. Last week I attended the New York Bankers' convention and knew most of them.

But the number of banks continues to decline, albeit slower than most investment bankers had hoped and predicted. For community bank consulting firms, this means expanding services or geography, or both, in order to thrive. My firm is doing both.

A logical means to accomplish expansion is through merging with other firms. This makes perfect sense, for the reasons mentioned regarding my firm's combination with Millward. Larger, more robust consulting firms can provide a greater depth of experiences for the benefit of clients.

Combinations can also expand geographic reach. Community bankers (and credit union execs) typically don't hire consultants from an Internet search. They hire consultants because they know them first-hand, through mutual aquaintances that are familiar with their services, or by reading articles, commentary, and/or speeches by them. Consulting rain makers must travel to more distant locales, requiring more rain makers. As the number of community financial institutions continue to shrink, this will become more challenging for the very small consulting shops.

The challenges of combining firms, however, rest in the attitudes of the consultants and investment bankers of the firms themselves. Horizontally integrated firms are commonly designed for thriving lines of business to carry struggling ones until they get back on their feet. Ideally, the once struggling business lines are then in a position to carry others when they struggle. Makes sense.

Except thriving lines of business' full of type-A personalities typically don't WANT to carry struggling ones. They want all the fruits of their labor to accrue to themselves. This attitude permeated one of my past employers. The business model made sense on paper, but was difficult to apply. This challenge must be recognized, but need not stop a consolidation wave.

The decline of community FIs will result in continued consolidation among community FI consulting firms, in my opinion. Some small firms may seek greener pastures in other professions. But the relatively larger firms (large consulting firms for community FIs may be 10 employees or more) have an opportunity to expand services, expertise, and geography to better serve clients. This can be positive for the firms' and the FIs they serve.

What are your experiences with community FI consulting firms or your opinion on their consolidation?

~ Jeff

Community Financial Institutions: Parking Lot for the Benjamins

2011-11-06T19:17:00.003-05:00

The current market volatility has been with us for nearly three years. To resuscitate the economy, the Fed is doing everything possible to keep interest rates low through monetary policy. First dropping the Fed Funds rate to near zero, and most recently with Operation Twist designed to guide long-term rates even lower. The Euro Zone debt crisis and resulting lack of investment alternatives makes US Treasuries, as one economist put it, the "best house in a bad neighborhood".

This has kept investment options for community financial institutions at historic lows. Low loan demand further exasperates the challenge.

While investment options dwindle, FIs find themselves awash in cash. Market volatility and prolonged low bond yields is keeping investors on the sidelines. The sidelines, as it turns out, is in banks. This led to Bank of New York Mellon's decision in August to begin charging very large depositors fees for parking their money. There simply isn't any place for them to lay it off.

Community FIs are experiencing similar activity from their Main Street customers. From December 31, 2009 through June 30, 2011, deposits for all FDIC insured depositories increased 5.84%. But average deposits per money market account, according to my firm's peer database, increased 31% during that same period (see chart). Community FI customers are parking their money waiting for better, more certain times.

At first, senior managers of FIs felt good about the inflow. Loans from 2002 through 2007 generally grew faster than FIs' ability to fund them. This resulted in FIs turning to CD rate promotions, brokered CDs, and FHLB borrowings to bridge the funding gap. Deposit mixes became more expensive and less attractive.

But with loan demand at historic lows, FIs began running off their high-cost CDs and other so-called "hot money" to right-size their funding sources. This may have created a little hubris among senior managements, thinking it was the quality of their service and the value of their brand that attracted the core funding. But looking from a wider lens shows us it has been an industry phenomenon more than what any institution did on their own.

This is creating uncertainty with Treasurers across the landscape. What does the FI do with the money? How long will the money remain in the FI before migrating back to the market or the hottest CD promotion? With historically low re-investment rates, FIs are keeping the money highly liquid. FDIC insurance costs, on average, are 12 basis points on deposit balances. This, and the operating costs for maintaining the accounts, is resulting in some core deposit accounts actually being unprofitable... a highly unusual situation.

But this too shall pass. If FIs are pleased at their current mix of funding, perhaps they should take positive action to maintain it. Initiatives could include a disciplined onboarding program for new customers, and a timely calling program for existing ones. Your customers may certainly be parking their money at your FI, but they probably have money elsewhere too. If you demonstrate service beyond what they experience at their other FIs, perhaps you can win their loyalty, including their core deposit balances.

Alternatively, you could do nothing, stuff your vaults full of cash, and pray that customers stick with you. Hey, it's possible, just not probable.

What do you suggest FIs do to keep core deposit customers?

~ Jeff

Note: I will be part of a panel discussion at the Financial Managers Society (FMS) Philadelphia Chapter on Wednesday, November 9th to discuss liquidity, value, and profitability of core deposits.

Common Sense to Successful Strategy Execution

2011-10-29T10:37:00.000-04:00

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

Tweet Stream: Dick Durbin Staffers on the Durbin Amendment

2011-10-22T12:04:00.000-04:00

Today I had a Twitter conversation about how the Durbin Amendment turned out to be a boon for retailers and a bust for financial institutions and consumers. Senator Dick Durbin from Illinois sponsored the amendment to the Dodd-Frank Act, decrying the unfairness of the debit interchange fees charged by financial institutions to retailers and how it inflated costs to consumers.

The consequences of the amendment are becoming clear; 1) lost revenue to all financial institutions, not just the largest, 2) Increased other fees by financial institutions charged to consumers to make up for the loss, or the decline in "free checking", and 3) no price reductions at the register for consumers. Dick Durbin took to the Senate floor to castigate Bank of America for trying to bridge the revenue gap by charging debit card fees.

What did Senator Durbin think would happen? Frank Sorrentino III, CEO of North Jersey Community Bank, weighed in on this question with an obligatory community bank bias. But the larger question remains, what did Senator Durbin and his staff think would happen?

If Senator Durbin and his staff had a Twitter debate about framing the amendment, here is how I imagine it would have went...

@sendurbin Alright, we gotta do something to get my name on Dodd-Frank. Can't have that weasel from Mass. or the has-been from CT getting all the PR.

@suckupstaffer You are right Sir! Your name somewhere on that bill would be huge!

@lifelongstaffer The perception is that banks are evil. Let's play off of that.

@sendurbin That's a good angle @lifelongstaffer. Tell me more.

@lifelongstaffer Well, we could scour bank income statements and talk to some lobbyists to see where banks make money, and attack there.

@newstaffer Wait. Isn't the bill supposed to stop the abuses in mortgage originations, packaging, and selling by large banks and mortgage brokers?

@suckupstaffer Pipe down @newstaffer, I think the Senator is about to tweet.

@sendurbin Where do banks make money? Hold on, I think I remember Mike Duke of @walmart whining to me about debit cards at a $500/plate fundraiser. Give him a call.

@suckupstaffer Yes Sir! Right away!

@lifelongstaffer @walmart is a big contributor. So if Dukey has an idea, we can pummel banks, get our name on the bill, and throw a bone to a patron. Win-win-win.

@suckupstaffer Mr. Duke suggests we commission a study in the bill with the ultimate goal of reducing what banks charge on debit card transactions.

@sendurbin That sounds like a great idea. We can call it the Durbin Amendment!

@suckupstaffer You're a genius, sir!

@lifelongstaffer We could spin it that we are reducing fees for consumers. We can exempt small banks so we don't look like big, bad government.

@newstaffer But if we reduce interchange fees for big banks, and try to exempt small ones, how would that work?

@lifelongstaffer It doesn't matter newbie. It only matters that it looks like we're helping consumers at the expense of too big to fail banks. Could be huge!

@sendurbin I like it fellas!

@suckupstaffer Then I like it too!

@lifelongstaffer And the windfall to @walmart will keep our campaign coffers full for the foreseeable future!

@newstaffer Wait, isn't the amendment supposed to reduce prices at the register for the consumers, not inflate @walmart's profits?

@sendurbin *laughs* Son, if that's the way it goes down and the banks charge more fees, I'll take to the Senate floor as the champion of the consumer!

@suckupstaffer Another win. Genius!

@newstaffer But the likely result is more fees to the consumer as banks try to make up for decline in interchange fees. We may win in perception, but lose in consequences.

@sendurbin *grins*

@lifelongstaffer @newstaffer Son, you have a lot to learn about politics.

It could've happened!

If you are a Senator Durbin staffer, please forward your cease and desist letter to me via e-mail. I would be happy to post it here, take down this post, for fear of having the full force of the rather sizable federal government coming after me.

~ Jeff

Occupy Wall Street: Occupy This!

2011-10-15T15:03:00.000-04:00

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

2011-10-13T20:03:00.000-04:00

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

Guest Post: Third Quarter Economic Update by Dorothy Jaworski

2011-10-11T19:00:00.001-04:00

Another Volatile Quarter

I know I risk sounding too negative, but we cannot seem to shake the crisis mentality that keeps whipsawing bond and stock markets. The crisis du jour originated in Europe with crushing debt levels in Greece, Italy, Portugal, Spain, Ireland and who knows where else. Germany remains fairly strong but sometimes appears to be coming to the rescue, sometimes not. Rumors of Greek bankruptcy surface every other day. French banks are the largest holders of sovereign debt, but, out of the blue, a Belgian bank, Dexia, has become the first to fall.

Liquidity is becoming a problem for these banks, and with their stocks battered daily, they have no ready sources of capital. There has been a lot of talk about rescues from the European Union, but the markets want action. The US is not of much help as the economic recovery is stalling and the debt ceiling/deficit debate/fight caused a great deal of harm to both consumer and business confidence.

In an environment like this, volatility rules. Stocks have taken the brunt of investor frustration, selling off steeply in the third quarter for the worst quarterly loss since the height of the financial crisis in late 2008 and early 2009. The Dow Jones Industrial Average was down -12.1% to just below 11,000 in the quarter, while the S&P 500 fell -14.3% and the Nasdaq fell almost -13%. And gold had the wildest price action of the quarter—beginning at $1,500 an ounce, soaring 27% to $1,900 on September 5th, and then selling off steeply by -14.5% to end the quarter at $1,624. Oh, the fortunes won and lost!

Enough about gold, and all I will say about stocks, because I always fear being a jinx, is that the forward price earnings ratio is not even 11 and the dividend yield is currently 2.3%, which exceeds the yield on the 10 year Treasury bond. This does not happen often.

Back to Back Historic Moves

The Federal Reserve made two historical easing moves during the quarter and still the markets are not happy. In August, for the first time since the 1940s, the Fed made a two year “promise”—to keep short term rates at their current exceptionally low levels until mid 2013. If you believe the expectations theory of interest rates, that long term rates are simply the compilation of the expected path of short term rates, then you believe that long term rates will stay exceptionally low too. Maybe this will not affect the really long term rates, such as the 10 year to 30 year range, which are so heavily influenced by inflationary expectations and the international flow of funds, but most other longer rates, such as 2 year to 9 year maturities, will be affected. So why were the markets disappointed in the Fed’s forward guidance? Why did the Fed have to act again in September?

Perhaps it is that the Fed did not tie their promise to economic performance, as I thought they should have, but they only chose an arbitrary period of time. By performance, I mean the unemployment rate, number of jobs created, or GDP growth. The Fed could have, and in my opinion should have, promised to keep rates low until unemployment falls to 7% or less, until we are creating 3 million jobs a year or more, or until real GDP grows at and stays above the 3.3% average growth rate of the past 60 years. Only then will inflation even hint at being a permanent risk.

We can only assess the Fed’s performance in terms of their dual mandate—maximum employment and stable prices—and not in terms of a two year waiting period.

So, disappointment in the “promise” to keep short term rates low until 2013 led to another historic action in September. In another easing action dubbed “Operation Twist,” the Fed stated that they will sell $400 billion of their shorter securities (less than 3 year maturities) and buy the same amount of longer securities (6 to 30 year maturities) by June, 2012. They haven’t tried a “twist” since the 1960s. They also added that they will reinvest cash flows from their mortgage backed securities from their Quantitative Easing QE1 Program into more mortgage backed securities, rather than into Treasuries.

Ben Bernanke was quoted as saying that Operation Twist is the equivalent of a 50 basis point cut in the Fed Funds rate. Hey, when Fed Funds is near zero, you have to try something. And don’t forget the cumulative actions they have taken to date—Fed Funds to 0%, QE1’s purchase of $1.5 trillion of Agencies’ bonds and Agency mortgage backed securities, QE2’s purchase of $600 billion of Treasuries, and now the “promise” and the “twist.” These actions someday will push consumers, businesses, and banks out of the liquidity trap.

Don’t Give Up on the Economy

It is not time to give up on the economy. The data has been weaker in recent months and GDP is stubbornly low, at 1.3% in the second quarter of 2011. Many forward looking indicators are showing positive signs, including the index of leading economic indicators, building permits, industrial production and survey measures, such as the ISM series. We have the full support of the Fed until at least 2013.

Companies are sitting on $1.9 trillion of cash on their balance sheets and banks have at least that amount in reserves at the Fed earning next to nothing. It will take time, but eventually, companies and banks will seek higher returns and invest and lend. We probably do not have much in the way of fiscal support from the government as high debt and the deficit make that unlikely. All companies lack the confidence to invest, to hire, or to move forward.

What is on the horizon to shake up the economy? For one, the original culprit of the economic weakness, in my mind, was the spike in oil prices to $115 per barrel and in gasoline prices to near $4.00 per gallon. Oil prices have slipped back by -30% to $80, while gasoline prices have only fallen by -15% to $3.39. Gas prices clearly have room to move downward. This will act like a tax cut at just the time when it seems Washington DC will not provide one.

Another positive is the beginning of another refinancing wave by consumers as the Fed has pushed down long term rates, including mortgage rates. Companies can take advantage by issuing debt at lower interest costs. Stay tuned!

Thank You, Steve

As I was writing this, I saw the announcement by Apple that Steve Jobs had died, after battling illness for eight years. He had a profound influence on so much of the technology that we use in our daily lives. He made computers easy to use and gave us the iPod, the iPhone, and the iPad. Fifteen years ago, these were products we did not even know that we wanted and needed. I have the iPhone and iPad and cannot imagine life without them. He will leave a huge legacy in the company he co-founded and the products he helped invent. I will miss his brilliance. Thank you, Steve!

Thanks for reading! DJ 10/05/11

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.

Brand Leadership: What does it mean? What should it mean?

2011-10-04T20:34:00.002-04:00

I am a student of my industry: consulting and banking. If bankers tell me their institution has a superior brand, I want to know what that means. Too often I am told that the FI has a superior brand because customers come up to senior executives and board members on the street and tell them so.

I am no statistician or expert on human behavior, but I have to believe that people willing to approach senior executives or board members of the local financial institution are probably going to say something positive by an overwhelming majority. A polite neighbor does not make for a statistically significant study.

What I do find in many FIs that claim the throne of brand leadership is higher cost deposits, and lower yielding loans. I hear how the FI keeps deposit prices high so customers don't leave, or runs deposit pricing specials to bring new deposits in the door. I find lenders loosening covenants, waiving fees, and lowering rates to "get the deal done".

Is this our perception of brand leadership? I say no.

Mike Schultz and John Doerr, in their 2009 book Professional Services Marketing, identified traits of brand leaders in the consulting industry. Here is what they found:

"Brand leaders:

Priced their services at a higher level than their competitors in the market; and
Realized higher actual hourly rates compared to the lesser-known firms in all categories of professionals."

In other words, according to Schultz and Doerr, brand leadership translates to real money as buyers of consulting services are willing to pay more. See the chart below:

I frequently cite such studies, plus life experiences we see everyday of how brand equates to either 1) getting more customers faster than competitors; 2) keeping customers longer than competitors; and/or 3) charging more than competitors. Take Mac users versus PC users. Mac has clearly created a brand that evokes loyalty, even at higher price points. How about Marriott customers, citing Marriott Rewards and the superior quality of the hotels? Remember the old axiom, "you will never be fired for hiring IBM" when it comes to hiring a technology solutions firm? Brand, brand, and brand.

My firm recently lost a small strategic planning engagement because of our price. The price was not particularly high, but it wasn't Wal-Mart low either. We work hard to build an environment for robust dialogue that results in a well thought-out strategy. Background work to bring together the data and prepare to create that environment takes time. This FI was not willing to pay for that time and shame on me for not building a brand that this CEO was willing to pay for. I will work harder to do so in the future.

But my colleagues and I should not be alone in building brand. If community FIs believe they bring greater talent, faster responsiveness, and tailored solutions to their customers, then customers should be willing to pay for it. If not, we run the risk of building Four Seasons expenses that we give away at Econo Lodge prices.

Your brand should mean more than that. What do you think brand leadership should result in?

~ Jeff

Link to the Fees and Pricing Benchmarking Report: Consulting Industry 2008

http://www.raintoday.com/product/52_fees_and_pricing_benchmark_report_consulting_industry_2008.cfm

Note: I have no relationship with the authors of the report or the firm(s) that conducted the study. I cite it hear because it demonstrates, in clear terms, the value of brand.

Our Finest Hour

2011-09-24T15:32:00.000-04:00

Things look grim for us: community financial institutions (collectively, "banks") and those that serve those august institutions.

We lost the mortgage business a generation ago to category killers like Countrywide, Golden West, Fannie Mae, and Freddie Mac and the mortgage brokers that fed the beast. When the beast collapsed, we inexplicably donned the bullseye of blame.

But we faltered in our own right. We bought the bonds that kept that mortgage machine running. Those bonds cost us dearly. We lent to one another in the form of Trust Preferred Securities, and our investment portfolios choked as these banks faltered under the weight of poor decisions.

When the economy took its nosedive, we found ourselves over-invested in construction and investment property commercial real estate that were one or two bits of bad news away from disaster. The result: a rapid need to recapitalize. With no investor appetite to invest in us, the government stepped in.

We immediately regretted it. We were encouraged to take government capital, only to have the government change the rules on us afterward, and the public decry "government bailout". Even though the government made a significant return on its investment in us, the public thinks they gave us the money. Yet, the only losses the government suffered from TARP is because of AIG Insurance and General Motors. We still bear the badge of shame.

Now our politicians are doing everything in their power to get us to lend, while their examiner surrogates are doing everything in their power to criticize our loans. Regulations are nipping at our revenue, and piling on our expenses. The Fed, under the guise of helping the economy, is doing what it can to keep long and short term rates low, wreaking interest rate risk havoc on our balance sheets. Much is working against us these days.

But in our darkest hour, I envision tremendous opportunity. Our industry is changing. Excess regulation and costs are driving weak competitors such as mortgage brokers out of the market. Can we re-ascend as the place our customers get a mortgage? I think so.

Large banks, that own a significant part of the banking market, move farther and farther from the customers... turning them to self-service delivery channels to chart their own path in a complex financial world. Can we help our customers navigate turbulent and complex times? I think so.

We don't have the resources to make large technology investments to develop efficient processes, comply with the myriads of regulations, and deliver products and services to today's tech-savvy customer. But community FIs have access to robust, vendor-driven solutions that are on par with our larger brethren. Can we have competitive products and delivery channels delivered with similar efficiency to the large banks? I think so.

In times of great strain, opportunity rises from the ashes like a phoenix. We are closer to our communities, our customers, and our employees. Decisions are made in the office down the street, or the next town over. We don't have to navigate a bureaucracy in a different state or across the country to get to the closing table. Local depositors provide the capital to local borrowers and businesses.

Can we be different, more local, faster, friendlier, better?

We are a community bank. What we do next, is up to us. This can be our finest hour.

~ Jeff

Top 5 Total Return to Shareholders: #1 BofI Holdings Inc.

2011-09-22T22:05:00.000-04:00

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 have reviewed my top five in descending order. Last post was dedicated to the #2 Signature Bank of New York, New York (see post here). The rest of this post goes to our number 1 bank and winner:

#1: BofI Holdings Inc. (Nasdaq: BOFI) of San Diego, California

Old school bankers are rapping their fists on mahogany desks, mumbling under their breath, and turning over in their graves at the notion that the best performing FI based on five-year total return to shareholders is an Internet bank. Yet here we are.

Bank of the Internet was formed in 2000 and went public in 2005. Over the past five years, it has returned over 80%, compared to -4% for the S&P and -66% for SNL Bank & Thrift Index (see chart). As Mel Allen would say, "how about that".

In spite of the stellar five-year performance, the stock currently trades around book value, and a 9x earnings multiple... low by industry standards. The trading multiples are in spite of a 1.26% ROA and 14.83% ROE year-to-date. Why such low multiples for such high performance? I'm not sure, but I have to think some high-brow snobbery regarding Internet banks is involved, much like fine wine drinkers' attitudes while quaffing a Sam Adams.

Not sure why you would have a high-brow attitude towards this bank, since its management team is made up of investment bankers, blue-chip consultants, and engineers (see here for management bios).

BofI prides itself on process discipline, delivering the best technology at the lowest cost, without the millstone of branches dragging down performance. Their efficiency ratio was 40% for their fiscal year 2011 (ended June 30, 2011).

They collect deposits primarily through three online brands, and are seeking affinity relationships to expand their brands. At June 30, 2011, the online bank had 32,000 accounts being served by nine CSRs (see below). BofI has also launched BofI Advisors, giving financial planning firms the ability to offer banking to their clients through a self-branded portal. In other words, the financial advisory firms serve as the point of entry to the bank, with BofI providing the back end banking services.

Vietnam, a communist country, did not develop the infrastructure for a nationwide telephone system. When cellular technology advanced to the point that telephone lines, poles, and in-home wiring wasn't required, they embraced it. The result: Vietnamese can talk to one another as easily as we can in the U.S., but don't have telephone poles delivering outdated technology. BofI is Vietnam, without the beef noodles. Bankers should take note.

Congratulations to BofI Holdings Inc.. They are the best performing financial institution nationwide in total return to shareholders over the past five years. Here is our list of winners:

#1 BofI Holdings Inc.
#2 Signature Bank
#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. FINRA makes people take a test to ensure they know what they are doing before recommending securities. I'm sure that strategy works out.

Top 5 Total Return to Shareholders: #2 Signature Bank

2011-09-19T19:15:00.000-04:00

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 #3 ESB Financial Corporation of Ellwood City, Pennsylvania (see post here). The rest of this post goes to our number 2 bank:

#2: Signature Bank (Nasdaq: SBNY) of New York, New York

Signature Bank is a very interesting story. Started in 2001 with a significant investment from Bank Hapoalim, Israel's largest bank, it has been on an upward trajectory ever since. Signature has been so successful that it's growth was beginning to put strains on Bank Hapoalim's capital. So in 2004, Signature went public and in 2005 Bank Hapoalim divested its controlling interest.

From 2006 through the second quarter of 2011, the bank's assets grew from $5.4 billion to $13.1 billion. It made no acquisitions. During that period return on average assets went from 0.72% in 2006 to 1.15% year to date. It did not lose money during the financial crisis. This superior performance led to superior total return to shareholders (see chart).

How did Signature do it? As stated, they did not do it through whole bank, branch, or asset acquisitions. Instead, they do it by attracting high performing private banking teams. This strategy started from the very beginning by wooing former Republic National Bank of New York bankers. Republic was acquired by HSBC in 1999. Apparently, HSBC's treatment of key bankers created fertile ground for their recruitment by Signature.

But it is not the disenfranchisement of HSBC bankers that is fueling their current success. It is their commitment to building a bank designed to support private bankers serve their clients extraordinarily well. Read their vision statement, which is different than any I have ever read or helped design:

"Signature Bank was created to provide talented, passionate, and dedicated financial professionals a supportive environment in which they can conduct their practice to the maximum benefit of their clients.

The result is a special feeling clients associate with Signature Bank professionals and, ultimately, the Signature Bank brand: the experience of being financially well cared for."

How many vision statements have we read that takes great strains to offend no one, and commit to nothing? In this alone, Signature stands tall.

If you roll your eyes at the thought of a vision, don't lose track of Signature because they may roll over you.

Another key differentiator of Signature's strategy is their single point of contact delivery system. Banks that try to deliver multiple products and services to customers often have different customer touch points. For cash management, call John, for a loan, call Jane, etc. But Signature simplifies for their clients, and lets their relationship manager find the resources necessary to serve client needs. In fact, in an era where it's difficult to tell one bank from another, Signature prides itself in how it is different. See the below slide from their investor presentation.

Congratulations to Signature Bank. They rank #2 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 bank stock broker chuckles when I phone in trades. Get the picture?

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

2011-09-13T20:06:00.001-04:00

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?

Top 5 Total Return to Shareholders: #4 Bank of the Ozarks

2011-09-10T11:47:00.000-04:00

But I'm always looking for support. This blog has dug deep into the numbers to support the notion that bigger is better. I spoke of 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.

I will review my top five in descending order. Last post was dedicated to the #5 Bank, German American Bancorp of Jasper, Indiana (see post here). The rest of this post goes to our number 4 bank:

#4: Bank of the Ozarks, Inc. (Nasdaq: OZRK) of Little Rock, Arkansas

Over a 100-year banking history, Bank of the Ozarks expanded from its headquarters in Little Rock, Arkansas, to more than 100 locations throughout the Southeast and is consistently ranked among the top performing banks in America (see chart).

Bank of the Ozarks began in 1903 as a small community bank in Jasper, Arkansas, and by 1937, included an additional bank in Ozark, Arkansas. In 1979, George Gleason, a 25-year-old attorney, purchased controlling interest and assumed active management of the bank as Chairman of the Board and Chief Executive Officer. At the time, the bank had a couple dozen employees and total assets of $28 million.

What is interesting about the success of Bank of the Ozarks and its CEO is the fact that he wasn't the "experienced banker" regulators almost insist upon when approving the appointment of bank leadership. There are plenty of sad stories of bank demise at the hands of experienced bankers. Bank of the Ozarks and their regulators were not so myopic in their view. If our industry is to change, then who should be change agents?

In 1994, with a total of five banking offices in rural Arkansas markets, Bank of the Ozarks launched an aggressive growth strategy to expand the number of banking offices and product and service offerings. Collectively, the management team built an Arkansas franchise rivaling the largest banks in the state. The company moved its headquarters to Little Rock in 1995. The company held its initial public offering of stock in 1997. Since that time, the company has grown to more than 100 locations throughout Arkansas, Texas, Georgia, North Carolina, South Carolina, Alabama and Florida.

How did they grow so quickly? They acquired seven failed institutions in Georgia, Florida, and South Carolina from the FDIC, adding over $2 billion of acquired assets since March 2010. Such aggressive growth has led to positive operating leverage as net income and EPS has grown faster than assets (see table from their investor presentation).

Bank of the Ozarks has historically been a very good performer as they grew and prior to their recent FDIC deal binge. Their ROA in 2006 when their assets were $2.5 billion was 1.24%. Aided by the FDIC transactions and as a result of disciplined execution of those deals and the accounting of those transactions, OZRK is now a $4.0 billion bank with a 3.60% ROA year to date.

The eye-popping ROA is partially a result of the increased net interest margin, presently 5.67%, due to the accounting of the acquired loans from the FDIC. This margin will drop off as the discounted loans accrete, but if past is prologue OZRK will be well positioned to continue its historic superior performance.

So to summarize, Bank of the Ozarks Inc. achieved superior financial performance by embracing a young, forward looking CEO that clearly has a bent for successful execution. FDIC assisted transactions doubled the size of the institution, and the challenge for the next five years is how well the management team can run a much larger, and geographically sprawling franchise.

Congratulations to Bank of the Ozarks. They rank #4 in total return to shareholders over the past five years. So far, our list is:

#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 wife won't let me buy bank stocks without her permission, so why would you buy based on what I write?

Top 5 Total Return to Shareholders: #5 - German American Bancorp

2011-09-04T12:52:00.000-04:00

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. The rest of this post goes to our number 5 bank:

#5: German American Bancorp, Inc. (Nasdaq: GABC) of Jasper, Indiana

German American is a 100-year old, $1.8 billion in assets bank servicing the businesses, citizens, and communities of Southern Indiana. Upon reviewing their investor presentations, annual reports, and financials, it is clear they are a conservatively managed, geographically focused financial institution. There is no discernible niche strategy to differentiate them from competitors. The chart below demonstrates total return versus an industry and general market index.

However, the past three years have proven to be the best three in their 100-year history. Not only did they survive the financial crisis, they found a way to thrive. Net interest income grew over $10 billion when comparing 2007 to 2010, while non-interest expense grew less than $5 billion. That is positive operating leverage driven by core banking during a period when FI earnings growth is driven more by a lower loan loss provision and not top line growth.

GABC continues to look for opportunities for growth. According to their investor presentation, growth opportunities were greater in nearby markets than their legacy markets (see chart below). To thrive into the future, the bank is executing on a three-pronged strategy in addition to maintaining their market share in legacy markets.

First was a strategy where management exercises the greatest control... de novo expansion. Second was a branch acquisition that added $50 million in deposits and $44 million in loans in markets where the bank desired to grow. Lastly, they acquired a $300 million financial institution, giving them strong market share in Evansville and surrounding communities.

Upon reviewing the pricing of that transaction, their first since 2005 and the largest in their history, I thought they overpaid. But in reading the summary to the issued proxy statement from that transaction, it was clear that the structure of the transaction was designed to 1) get the prize, and 2) make it as accretive as possible given the competition (or the perceived competition) for the target. Two years from now, nobody is going to remember the price-to-book GABC paid compared to other M&A deals of the day.

Indeed, the transaction closed this year on New Year's Day, and GABC's EPS annual run rate of $1.52 is 26% higher than 2010 EPS. Non-interest expense to average assets is lower for the first six months of 2011 compared to the 2010 year. The bank has achieved positive operating leverage as a result of their acquisition strategy and has positioned themselves for further expansion into new markets.

The result: yes they are bigger. No they are not big. And yes their shareholders should be pleased.

~ 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 401(k) year to date return is -5.56%. Need I say more?

Does your strategy drive your structure? I doubt it.

2011-08-27T10:40:00.001-04:00

A few weeks ago I taught Bank Organizational Structure at the North Carolina Bankers Association School of Banking. The School is divided into four classes: Freshman, Sophomore, etc. My course was to the Freshman class.

But the class was very diverse, ranging from junior level people to Senior Vice Presidents. This presents a challenge. Part of my task was to demonstrate “how it is” in organizational structure. This part of the class may not have been very interesting to the more seasoned bankers.

As part of the “how it is” discussion, I outlined org structures evolved to where we are today by:

1. Past experience of Board members and/or Management;

2. Legacy structure… the way it has always been;

3. Entitlement structure… making management positions and reporting lines to promote key managers; and

4. Regulatory requirements… maintaining certain Board and management committees, processes, and policies.

These key drivers resulted in most financial institutions being organized by product group, in my experience. For example, there would be a Senior Lender that has commercial, consumer, and residential loans reporting to them. This puts staff serving very diverse customer groups with different needs reporting to one executive, who is charged with serving only a portion of their need.

The second part of my topic revolved around the evolution of org structures. What if, I posited, a bank were to organize around customers instead of products? See my post a few months back relating to this topic and a Forrester Research study here. Shouldn’t the FIs strategy drive its structure? How would such a structure look? This was probably more interesting to the seasoned bankers, because it challenged how we are typically organized.

We did an exercise regarding a bank, called “Blue Collar Bank (BCB)”, that wanted to focus on working class families. How would such a bank be organized around the needs of its niche customer base, I asked the class?

The results were interesting. The two students that presented their org structure to the class separated support and line functions. This is not atypical to how we do it today. But neither student separated out lending from deposit gathering. Credit, as I recall, was separated out by one student but not the other.

It was interesting that the responsibility for serving all of the niche customers’ needs channeled up to one executive. There were specialties within that line of reporting, but there was no passing the ball across the organizational continuum, as is typical today. This passing of the ball leads to holes in customers being served. In countless strategy sessions FIs struggle with who is going to serve small businesses… the branches or the lenders?

For example: a long time ago I was a branch manager for a commercial bank. Any commercial loan referrals were passed across the org structure to the commercial lending line of business. One customer wanted to expand his car wash by one bay and was seeking financing. I phoned into the commercial department, where the loan officer told me to “not bother him with this sh**.” My guess is he was busy working million dollar deals and didn’t want to be bothered with a $50,000 one. Because I continue to hear this in FI strategy sessions, I don’t think this is unusual, even today.

But would such a reaction be unusual if the bank was organized by customer? After the class, a student from Newbridge Bancorp in Greensboro approached me to proudly hand me her bank’s quarterly financial report. It had the bank’s org structure (see photo below and link here). This bank is organized differently than most, and is more closely aligned around customers versus products.

Could aligning structure with strategy be the next step in changing the culture in community FIs? What do you think?

~ Jeff

Bank Shorts: Sales Culture Gone Wild

2011-08-24T11:19:00.000-04:00

When I was a branch manager, I fondly recall competing with a friend and fellow branch manager for the quarterly sales title. My bank, First National Bank of Maryland, had a very transparent incentive compensation system. I could calculate my own and my team's quarterly bonuses to the penny. It was called RAISE... Recognizing Achievement In Sales Excellence.

The challenge was that it was a sales incentive system. So we sold. This may have motivated us to focus on the product de jour rather than customer needs. I think my friend and I were conscientious enough leaders to mitigate this risk. But it did cause us to focus on the types of customers likely to "buy" promoted products and not focus on the bank's strategy.

Enjoy the Bank Short below. If your incentive system revolves around sales versus profitability, then don't be surprised if this is going on in your branches.

Bank Shorts: Sales culture gone wild.
by: jeffmarsico

Cars: A Lesson in Brand Identity

2011-08-13T12:23:00.000-04:00

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

2011-08-04T18:31:00.000-04:00

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

V-blog: From the desk of jfb. How should FIs use social media?

2011-08-01T20:57:00.000-04:00

Financial Brand August 2010 Survey of Banks Social Media Presence
http://thefinancialbrand.com/13111/2010-bank-credit-union-online-marketing-study/

Frank Sorrentino’s (Twitter: @franksiii) Blog
http://www.bankingonmainstreet.com/

Susquehanna Bank’s blog
http://blog.susquehanna.net/

Chase’s Community Giving Facebook page
http://www.facebook.com/ChaseCommunityGiving

Banker Quotes: As Told to Me v2

2011-07-27T19:07:00.006-04:00

I learn a lot from bankers as I visit their offices, speak to them on the phone or at industry events. Occasionally they will offer an insight that I think my Twitter followers would find interesting. Below are selected quotes that I tweeted this year along with my brief insights or background regarding the comment.

Note that if the quotes exceeded 140 characters, I would have abbreviated or substituted some words to make them fit. So if you are a CPA and want to count, a few of the quotes may exceed the 140 here, but not on Twitter. I quote bankers anonymously to protect the innocent.

@JeffMarsico Bank attorney to me: "The only thing worse than training an employee and having them leave, is not training them and having them stay."

jfb note: I'm not sure if this was original, and I find it odd that an attorney said it. But this attorney is also an ordained minister... an interesting fellow to say the least. The context was a discussion surrounding how community banks used to pilfer previously trained employees of large banks. Once those training programs went away, community banks never filled the void.

@JeffMarsico Bank COO to me: "We must install headphones on our ATMs so visually impaired people can drive up and use them."

jfb note: Think about that for a moment. There should be a common sense-o-meter that sounds the alarm in every office where banking laws and regulations are made.

@JeffMarsico Community bank head of retail: "The transitional branch model will be to acquire consolidated branch buildings and get them open cheaply."

jfb note: This was said in a strategic planning retreat. The transition is from current branches and future branches. Much is being debated about the future role of branches. I think the guiding principle should be: nobody knows and be skeptical of those that claim to.

@JeffMarsico Bank fund manager to me: "Our investment criteria is great management teams, in great markets, with great core deposit franchises."

jfb note: This fund focuses on under $10B in assets community banks. This is his opinion of value creation. It may not agree with yours. But he has hundreds of millions to invest.

@JeffMarsico Bank COO: "We've stopped playing 'let's make a deal' with CD-only customers."

jfb note: Transitioning funding sources into core deposits hasn't been particularly difficult in this low interest rate environment. The true test of this COO's philosophy will happen when rates rise.

@JeffMarsico Behavioral psychologist: "When you pay people enough, they are motivated by autonomy, mastery & purpose."

jfb note: I would agree with the statement. But I doubt there is agreement on the definition of "enough".

@JeffMarsico Bank Chief Risk Officer: "Regulators focus is slowly moving from credit to data security."

jfb note: Data security may very well be the next great banking crisis. I can't help but wonder if those evil geniuses intent on hacking financial systems would dedicate themselves to doing good, they can make a pretty good living. They still can sit at home without showering.

@JeffMarsico CU CFO to me: "We installed a remote teller in one of our branches and customers refused to use it. We had to uninstall it."

jfb note: Remote teller stations, where the actual person is on a screen and transactions are accomplished through ATM-like or suction tubes, are getting a lot of buzz. I think I've been around banking enough to be skeptical of buzz. How about you?

@JeffMarsico TD Bank CEO: "Americans get almost as much pleasure out of crushing an opponent as winning."

jfb note: Ok, this one wasn't told to me in person but I read it. I think the Canadians might be on to something. I wish he got the message to Osama bin Laden earlier.

@JeffMarsico CU CFO to me: "Because we have low balance accounts and a no fee culture, we need to leverage technology to lower costs."

jfb note: Common sense that, occasionally, needs to be said, and tweeted.

@JeffMarsico Bank director: "A loan participation transfers risk from one who lacks courage to one who lacks knowledge."

jfb note: Said in a board meeting where the bank's senior lender was proposing plugging a budget gap in loan production with participations. Ever try to collect on a loan gone sour that was originated by the bank in the next town over?

@JeffMarsico Bank CEO: "Our examiners were simultaneously examining us and interviewing for OCC jobs, which can't be a good thing."

jfb note: Wonder what agency examined this bank? Hmmm?

What interesting things are you hearing out there?

~ Jeff

Guest Post: Second Quarter Economic Update by Dorothy Jaworski

2011-07-21T16:32:00.000-04:00

2011 started with so much economic promise. Jobs were being created, stock markets were rising. Interest rates were rising quickly too, in anticipation of strong economic growth. Then, oil and gas prices spiked over the unrest in Egypt and Libya. Gas prices reached $4.00 per gallon in May and everyone’s tipping point was reached. Enough!

Consumers cut back spending and continue to pay down or shun debt. The economy was creating jobs at a half decent pace in the first quarter and then job growth hit a wall in May. The unemployment rate ticked back up above 9%. Housing, so very important to consumer confidence, resumed its downward trend after seeming to have stabilized in late 2010.

Japan’s earthquakes, tsunami, and nuclear accidents caused severe disruptions in the supply chain for manufacturers of automobiles and electronics; these disruptions are expected to ease in the coming quarters. Bad weather, including tornados and river flooding, also hurt the economy in the second quarter.

Debt problems in Greece and other European countries reared up again and caused a flight to quality as investors bought Treasury bonds and sold stocks in the second quarter. Forward price-earnings multiples are down to 12 times, versus a historical norm of 15.5 times. Weakening economic data did not help either and led to further rate declines, albeit only halfway to the “crazy” low levels of last October and November.

Some of the factors that are causing this economic “soft patch” are temporary (including bad weather, Japan woes, and high oil prices) and some of the factors will linger, most notably stubbornly high unemployment rates and weak housing markets. Some of the forward looking indicators, such as unemployment claims, construction spending, and especially backlogs, have weakened in the last couple of months, signaling slowing growth.

Economists keep ratcheting down their projections for GDP for 2011 and 2012, probably as a result of the weaker forward looking indicators. The latest Wall Street Journal Survey of Economists shows projections of 2.7% and 3.0%, respectively. The Federal Reserve is a little more optimistic, at an average of 2.8% and 3.5%, respectively. These growth rates imply slow, steady recovery and relatively low interest rates as unemployment will be slow to fall from its lofty levels above 9%.

Last quarter, I wrote that I was surprised by the employment data. The total labor force kept dropping this year through April and the numbers of persons “not in the labor force” kept rising. People don’t exit the labor force during a recovery, at least not in any recovery since World War II, according to Chris Low of FTN. Well, finally in May, the situation reversed and people reentered the labor force, so, at least for now, we have found some of the MIA.

But we still have work to do. Since the Great Recession began in December, 2007, until May, 2011, we are still down a net of 6.5 million to 6.9 million jobs, based on household surveys and payroll surveys of employment, respectively.

Anonymous

It is one of the most frightening stories that I have seen recently, with the exception of the Casey Anthony trial’s not guilty verdicts. There is a group of computer hackers calling themselves “Anonymous” and who are referring to themselves as “hacktivists.” They are attacking Internet websites, while encouraging others to do so too, of companies and governments that they simply don’t like or don’t agree with. The hacking began last year with denial of service, or “DOS,” attacks on Visa, MasterCard, and PayPal for rejecting Wikileaks payments. They have hacked the government sites of Iran, Egypt, and Turkey and even the public sites of the CIA and the FBI. They recently attacked Sony PlayStation’s site, which was down for one month. The group left a file on Sony’s networks, called “Anonymous.” Inside the file, it simply said “We are Legion.” Sony spent the entire month and over $170 million getting its site reopened. The costs of protecting Internet data are escalating.

In early June, the group declared war on the Federal Reserve. I guess they don’t like Ben Bernanke. They are apparently moving from DOS attacks to stealing data to disclosing data online. Will they be able to hack the networks of the largest owner/creator of pure money? This has to be one of corporate America’s biggest fears and potentially one of our economy’s biggest expenditures in protecting online networks. For our economy’s sake, let’s hope the Fed can win this war.

Putting It All Together

In the understatement of the year so far, Ben Bernanke stated that short term rates will be lower for longer than we think. So the Fed has just told us that they are keeping rates low for an extended (really extended) period of time. I have contended for some time that the Fed will not raise rates until the unemployment rate is substantially lower. Government stimulus, for all intents and purposes, is over. The ongoing arguments over the debt ceiling and the likelihood of large reductions in government spending to reduce massive deficits mean that there will be no more fiscal stimulus.

Burdensome overregulation is all we will “get” from government. No extended tax cuts and business credits are in our future. The Federal Reserve’s stimulus is ending too. The $600 billion quantitative easing, or “QE2,” program, which injected those funds into the economy, ended on June 30th. Lower gas prices, lower being a relative term from the high of $4.00 in May, will be the only tax cut we will get. Slow growth will be the result.

Low short term rates are also supported by one of Keynes’ favorites – the “liquidity trap” – which is alive and well. Fear of investing in an uncertain economy and unknown market conditions is mostly to blame. Businesses have $1.9 trillion in cash on their balance sheets at the end of the first quarter. Banks currently have $2 trillion in excess reserves, or cash. At the end of May, money market mutual funds totaled $2.75 trillion. All of this money earns next to nothing, so critical is the desire to avoid risk and preserve principal. As long as this money remains parked in cash, short term rates will remain near zero.

You may notice that I have not mentioned the word “inflation” up to this point. That is intentional. The higher inflation rates caused by high energy and food prices will be proven to be “transitory.” Not until we have truly defeated the evil of deflation – ask anyone trying to sell a house – will we have an inflation problem. It is a problem for another day. QE3 anyone? Stay tuned.

Thanks for reading! DJ 07/06/11

How do you feel about a 30% capital ratio?

2011-07-16T11:23:00.000-04:00

I try to keep myself abreast of the significant changes within the banking industry so I can perform research, form a reasonable opinion, and advise my clients. But some industry luminaries are throwing out some far reaching opinions that I think need refuting.

Take Simon Johnson, former chief economist of the International Monetary Fund, co-author of 13 Bankers, and commentator on the NY Times Economix blog (see photo). In his most recent blog post titled "Are Bank Examiners to Blame for Slow Job Growth" he refutes bankers assertions that regulators are unnecessarily forcing banks to put loans that are paying as agreed on non-accrual. There is a bill currently circulating around Congress that allows banks to classify these loans as performing. Mr. Johnson testified against the bill.

But in his post (see link below), he makes two comments that bears refutation:

1. Bank equity is the primary buffer against loan losses.

In the post, Mr. Johnson states "The problem is that some community banks do not have big enough loss-absorbing buffers — the role that bank equity plays." Certainly equity plays the role. But Mr. Johnson's implication is that it is the primary or sole buffer. In fact, against loan losses, the main subject of the post, the bank has a loan loss allowance.

The loan loss allowance has received little attention in the financial crisis. Banks are supposed to set aside a certain amount of reserves for loans to go sour in bad times. But the Financial Accounting Standards Board (FASB) allows banks to reserve for losses only after there is evidence of loss. FASB is now considering allowing banks to reserve on expected losses. This would put them in sync with regulators, that are requiring banks to write down loans on expected losses. But this difference in the treatment of loan loss reserves left banks under-reserved and therefore elevated the need for capital to ascend to greater prominence in absorbing losses from loans. I understand that putting greater amounts in reserve, or provisioning, reduces profits and therefore equity, so the two are linked. But lets use the loan loss reserve for its intended purpose, shall we?

2. Banks should have a 30% equity to asset ratio.

You read that correctly. In the post, Mr. Johnson says, "If we had any kind of free market in banking, you would expect banks to have equity funding of at least 30 percent of total assets." The context was bank failure risk is mitigated by FDIC insurance. True for depositors, not shareholders. But requiring $30 million of equity for every $100 million of assets would not yield equity investment returns. If a bank earned $1 million on $100 million of assets, or 1% ROA, that would yield a 3.33% return on equity. That is investment grade corporate bond returns. How many new banks would we see if we require a 30% equity to asset ratio? What rates would we have to charge on loans to achieve a reasonable return?

Mr. Johnson has an excellent resume. But the things he wrote rather nonchalantly are disturbing. I'm not sure they were thought through to their rightful conclusions.

While making fundamental changes that will dramatically affect how we finance families and small businesses in this country, we must stop elevating lifelong bureaucrats to industry sage status and beating down bankers in the trenches as self-serving idiots. In the end, we are all self-serving, and we have to ask ourselves how do bureaucrats serve themselves.

What are your thoughts on a 30% equity ratio?

~ Jeff

Economix: Are Bank Examiners to Blame for Slow Job Growth
http://economix.blogs.nytimes.com/2011/07/14/are-bank-examiners-to-blame-for-slow-job-growth/

Article on FASB consideration of loan loss reserve guidelines:
http://www.bloomberg.com/news/2011-02-16/fasb-proposes-change-to-loan-loss-reserves-may-pinch-payouts.html

Brain Science Anyone?

2011-07-07T19:22:00.002-04:00

I recently attended a client's all day strategy session. My firm had a small presentation, and were available for Q&A throughout the day. But most of the day we were in the audience, listening to presentations by the executives of the bank and other consultants.

Part of the program was a continuation of the leadership program for bank executives. The program was led by the consulting firm Dorrier Underwood of Charlotte, North Carolina (see link below). This particular presentation revolved around brain science. Now think of an audience full of no-nonsense bankers. I thought the consultants were in for a tough time.

But the presentation intrigued me. Part of it was based on research by David Rock, a doctor of neuroscience, author, and co founder of the NeuroLeadership Institute (see link below). Based on Rock's research on how a brain reacts, he identified the Five Domains of Social Experience as follows (with explanatory bullets provided in the Dorrier Underwood handout):

1. Status

Status is about relative importance, pecking order, and seniority.
A reduction in status resulting from being left out of an activity lit up the same regions of the brain as physical pain. (Eisenberger 2003)

2. Certainty

The brain is a pattern recognition machine that is constantly trying to predict the near future.
Without prediction, the brain must use dramatically more resources to process moment to moment experience.
The act of creating a sense of certainty is rewarding.

3. Autonomy

The perception of exerting control over one's environment-a sensation of having choices.
Working in a team necessitates a reduction in autonomy.
Sound policy establishes boundaries within which individuals can exercise their creativity and autonomy.

4. Relatedness

Relatedness involves deciding whether others are in our out of a social group.
Whether someone is a friend or foe.
When someone is perceived as a foe, different circuits are used in the brain.

5. Fairness

Unfair exchanges generate a strong threat response similar to disgust.
A threat response from a sense of unfairness can be triggered easily.
A sense of unfairness can result from a lack of clear ground rules, expectations, or objectives.

Sum the five up and we have the convenient acronym "SCARF", developed by Dr. Rock.

The context of the SCARF portion of the presentation was to help bank executives become better leaders. To understand how their own and their employees' minds work.

But I began to think that SCARF is also powerful in a sales or relationship building context. For example, it is important that the seller has status in the mind of the buyer, and also conveys status to the buyer to create a positive selling experience.

Buyers want to have relative certainty about what they will receive. This is the basis for people selecting chain hotels or fast food restaurants. The buyer is relatively certain about what they will get.

Buyers do not like to have products or services shoved down their throat. They would like to maintain control, or autonomy, over their buying decisions.

People buy from those that they like, or relate to. And finally, buyers like to walk away feeling they have received a fair shake from sellers, and vice versa.

It would seem that in financial services sales and marketing, we need to create an environment where customers are ready to buy from us. The SCARF model provides a road map to creating that environment, in my opinion.

What do you think is the proper environment to maximize sales in financial services?

~ Jeff

Dorrier Underwood

http://dorrierunderwood.com/index.html

David Rock

http://blog.davidrock.net/

Don't let perfect be the enemy of very good in bank profitability.

2011-06-26T09:28:00.000-04:00

When I began my journey as a bank consultant, my firm's top-notch cost accountant repeated this post title to me often. He was teaching me the mechanics of cost allocations from support centers to profit centers in FIs, and further down to products. The key, he told me, was to develop a rational allocation method that is understandable to those being measured and apply it consistently.

As FIs drill down to relationship and customer profitability, cost allocations become ever more complex and subject to greater challenges by those that disagree with the results. Usually those that disagree are responsible for relationships they once thought were profitable to the FI, but the data shows they fall short. It is easier to challenge the results than to ask "why?", and develop an action plan to improve profitability.

Even though the American Management Information in Financial Services (AMIfs) considers me a certified cost accountant, I put to you that I am not. I come from the line. I am on the line of my firm. I think more like a profit center than a management accountant. So I will not bore you with a discussion of standard versus fully absorbed costs, as I would find it incredibly boring to type, let alone ask you to read.

But there is a rational, middle ground method to drill fully absorbed costs to get an individual operating cost per account. My firm's current profitability software calculates fully-absorbed average costs per account. This means that if I have a checking account, and visit the teller 20 times in a month, I am charged the same cost for my account as someone that solely does 10 Internet banking transactions per month. Those responsible for customer relationship management (CRM) or other account-level profitability software cry foul. And they are right.

But to get to the most exact data takes a tremendous amount of effort that will yield results that are as near to 100% accurate as possible on the day the measurements were taken, and veer from the ideal thereafter. So how can we measure cost per account that rewards low transactions or usage of low-cost distribution channels? I propose developing an easily explainable and defensible fully-absorbed cost per account that differentiates based on account usage.

To do so, you must first determine the fully absorbed cost per account. For example, the average annual cost per retail non-interest bearing checking accounts for my firm's profitability customers was $396 during the fourth quarter 2010. Adding that cost times the number of accounts yields the aggregate operating expenses used to originate and maintain those accounts.

If we divide the number of accounts into quintiles based on number of transactions, we develop pools of accounts to assign different costs. We then can take the "moderate" accounts, and assign the average cost per account, and increase costs for those with greater than moderate transactions and less costs for those with fewer (or cheaper) transactions (see table).

Transaction counts can be weighted to differentiate between high-cost transactions, such as a teller transaction, to low cost, such as an Internet banking transaction. Your FI might estimate that one takes 3 times the amount of resources as the other, so one teller transaction counts as three, whereas the Internet transaction remains at one. In this way, the customer that does 25 Internet transactions is not charged the same cost as the one that does 25 teller transactions.

The results will not be exactly correct. But there is no management information that is exactly correct. It will, however, be what one CEO termed "directionally correct". It will tell the relationship manager what customers are profitable and need to be paid attention to, and what customers are unprofitable and action must be taken to gain more business from that customer or pay attention elsewhere.

This behavior, multiplied by every relationship manager and account service representative in your FI, will improve retention of profitable customers, generate positive action toward borderline customers, and focus attention on the right locations, products, and distribution channels to serve your most profitable customers. In short, it will improve your FIs profitability.

How do you measure profitability or how should you measure it?

~ Jeff

V-blog: Speaking of economies of scale to NY Bankers

2011-06-21T08:31:00.000-04:00

I recently spoke at a New York Bankers Association senior management conference regarding the quest for economies of scale to improve earnings through positive operating leverage. I was the leadoff hitter for a tandem that included a JPMorgan Chase banker. I brought my 21 year-old daughter with me, and thought it might be a good idea for her to use our family camera to video and edit my remarks. See below.

Bottom Line:

Banks and thrifts have not reduced efficiency or expense ratios as they have grown... i.e. they have not achieved economies of scale.

I cited three possibilities why this is so:

1. Culture/Bureaucratic Attitude;

2. Fragmented Responsibilities; and

3. Technology Utilization and We Have Always Done It That Way

The session was based on a white paper I recently wrote for the Financial Managers' Society. See link to the white paper below.

This is my first V-blog and I will get better at it, especially if my daughter provides me guidance.

~ Jeff

Lesson learned: We have to get better at camera positioning!

Link to FMS White Paper on economies of scale and positive operating leverage:
http://www.kafafiangroup.com/PDF/Marsico-Economies-of-Scale.pdf

How I use Twitter

2011-06-05T13:42:00.001-04:00

I am no social media expert. The media is so relatively new, I'm skeptical of those that make the claim. But I was making a half hour presentation to a bank board of directors regarding their strategic plan two weeks ago. The plan called for the bank to evolve its marketing capabilities to include social media. When I mentioned I had a Twitter account, half of my allotted time was spent in a Q&A on how I used it.

I was surprised by this turn, but impressed that a relatively older Board was so interested and had detailed questions about social media. In my mind, I thought "oh no, they must think I'm a social media expert". But I pressed on to tell them how I, not knowing the right way from the wrong way, used Twitter. Here is the gist of what I said.

I signed up for Twitter about two years ago (@jeffmarsico), and have tweeted nearly 3,500 times. That is about five per day. Probably light compared to some, and moderate compared to others. I have no target regarding how many times I tweet. The reason I signed up was two-fold: 1) curiosity about the hype, and 2) as a replacement for a journal.

I have always thought of keeping a journal to remember things that occurred in my life. But I'm not one to sit down at night and jot down events and certainly not my feelings. So, at only 140 characters per tweet, I thought Twitter a decent substitute. So off I went with no strategy other than that.

I searched for people to follow using three themes: 1) local to my hometown; 2) banking-related; and 3) sports-related. Most that I follow have followed me back, either as a courtesy or judging that my tweets may interest them. I hope the latter, but am not foolish to believe this is always true. If you looked at the lists I have compiled on Twitter, you will note these three themes.

I am somewhat bipolar in how I use Twitter. Right or wrong, I typically tweet banking by day, and Yankees by night. This is an oversimplification, as I also like interacting with those that I have never met via Twitter, tweeting things happening in my personal life, and other sports teams that I follow.

Some may criticize how I use Twitter because while some tweets may be interesting to a segment of my followers, they may be irrelevant to others. For example, tweeting an interesting statistic I heard at a banking conference may interest @bankmarketing, but be a snore to @lennysyankees.

Although I still use Twitter with similar objectives to when I started, I have evolved in my thinking. Since joining, I started this blog. I use Twitter to update my tweeps (slang for your Twitter followers) that I just put up a new post. This week, the second-highest traffic source into the blog was from Twitter.

I now use Twitter as an education source. There is a whole universe of blogs and news sources that were unknown to me (see below for a couple good examples of very fine banking blogs). For example, my banking tweeps keep me updated via news links of what is happening in our universe. If I am working in the office, I read Twitter-fed articles that are of interest to me, in addition to my regular reading. When traveling and I see an interesting article or blog post in my Twitter stream, I "favorite" it for later reading.

I also follow sports via Twitter. For example, yesterday I kept apprised of how my favorite MLS soccer club, @philaunion was doing in their match as I was unable to watch it. Watching a Yankees game while following an #yankees hashtag stream and interacting with my tweeps is a whole different experience than watching alone. I would miss the snarky comments from @huntforringsnyy when AJ Burnett bumbles through a start.

I have made my Tweets private, which seems to be counter-intuitive to expanding a tweep-base. But I noticed that Twitter receives a pretty high ranking in search engines. For example, when searching "Jeff Marsico", my Twitter account appeared fifth on Bing and third on Google. If somebody Googles me, I'm not sure I want their first impression to be "The barber chopped off my sideburns, again" (actual tweet that showed up in a Google search). To follow me, a potential tweep need only send a follower request, 95% of which I accept (unless you are a porn site or serial marketer). Most of those I follow back. But I suppose I probably lose potential followers and therefore relationships by making tweets private. I accept the trade off.

I don't know much about establishing brand. For evidence look no further than my Twitter avatar (thumbnail picture, logo, or animation that comes up next to your tweets). I first started with a cartoon (see pictures), then moved to an image of myself after reading some blog posts on the subject, and I now use a simple photo. I suppose the evolution is because I would like to be viewed as a human being like everybody else, and not Shaggy from Scooby-Doo. See the @inking_media link below regarding avatars. Inkling Media is local to Central PA and I would not have known the owner, Ken, other than through Twitter.

This segways to the most important benefit I received from Twitter: meeting people I otherwise would have never met. I'm not saying that I know my tweeps in any material way (although some I do because @shannon_marsico is a tweep). But I never would have known @sharistorm, a credit union marketing executive, mom, blogger, and author from Washington state if I did not follow her. Just this past week I spoke on the phone with @mbartoo about possibly putting on an industry event. I first met Mike via Twitter.

Could Twitter be a short-term fad that goes the way of the Betamax? Possibly. Is it the answer to our industry challenges? Doubtful. But an industry marketing consultant told me last week that financial institutions must learn how to leverage the spheres of influence of their business development officers. If you believe what he said to be true, then social media, and yes Twitter, can be part of that conversation. See Susquehanna Bank link below to a well-done bank blog positioning BDOs as experts. But I do not know many other FIs that are doing this well or have received material benefit from their Twitter or social media efforts yet. We are still in the experimental phase.

But my experimental efforts have given me things that were unknown to me when I first signed up for Twitter... i.e. knowledge, interactions during sporting events, and relationships (if only limited relationships). Perhaps your experimentation can result in lessons learned, brand advancement, and relationship building success. I don't know, but in my experience it's worth a try.

How do you use Twitter?

~ Jeff

Banking blog links:

Marketing Tea Party by Ron Shevlin

http://marketingteaparty.com/

The Financial Brand

http://www.financialbrand.com/

Blog post on Twitter Avatars by Inkling Media:

http://inklingmedia.net/2010/10/25/branding-engagement-pt-1-whats-in-a-name-or-face/

Susquehanna Bank blog:

http://blog.susquehanna.net/

Is your strategy and organization built around the customer?

2011-05-29T16:25:00.001-04:00

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

The coming bank consolidation... but not why you might think.

2011-05-21T09:32:00.003-04:00

If I had a nickel for every time an investment banker predicted the mass consolidation of our industry I could buy a free round to all attendees at next month's Financial Managers' Society Forum. Financial Institutions need greater scale to offset the rising regulatory burden imposed by Dodd-Frank and soon to be imposed by the Consumer Finance Protection Bureau (CFPB) is the most often cited reason.

But I have noticed a couple of trends that may be a better leading indicator of coming FI consolidations, one old and one new.

Old

The old reason is that our CEOs are old... pun intended. Prior to the 2007 financial crisis, we prognosticators used to look at CEOs age as an indication of whether a financial institution would sell. See the table for the average age of FI leadership for publicly traded banks and thrifts. It tells a challenging story... one quarter of FI CEO's are two years from retirement. Half are seven years away. Are there successors in the wings?

I have not read one press release announcing a merger that stated: "Our CEO is old, we have nobody to replace him, so we sold." But the cynic in me says this reason stands tall in prominence in the Board meeting when the sale decision is made.

This could be because the CEO does a good job, and neither the CEO or the Board thinks there is another potential CEO candidate that can do as well. If this is the case, then I put to you that neither the CEO nor the Board has done a very good job of developing leadership in the organization making successful next- generation passing of the baton doubtful. The cynic in me suspects there may be no opportunity for the retiring CEO to unlock the value of his investment in the FI without a sale.

But there are exceptions, such as how Wayne Bank in Honesdale, Pennsylvania implemented a leadership change flawlessly. Bill Davis, a great banker who never thought the success of the bank was all about him, moved out of the executive suite on retirement day and passed leadership to his second in command, who had been groomed from within. See the link below for the jfb post on Bill Davis.

New

The newfangled reason for the coming consolidation wave, in my opinion, is the change in our shareholder base (see chart). Community FIs used to have very predictable shareholders. They were typically within our communities, liked the dividend, and were proud to own a piece of their local bank.

Having gone through a few consolidation waves, our shareholders have become more diverse. They're also becoming older, and many have already passed shares to the next generation that lacks that same connection to the bank.

Lastly and possibly more importantly, FIs have needed capital during the past few years as loan problems and operating losses have reduced industry capital ratios. We turned to the most prominent underwriters of community FI stock, Sandler O'Neill, KBW, and Stifel to replenish our capital coffers. Where do these underwriters place the community bank issues? With institutional shareholders such as asset managers, hedge funds, and the like.

These institutional shareholders have little interest in what you think you mean to your communities or employees. They plug in the number they bought into your shares, and expect a certain return. If you can't deliver the return via profitability, then you better sell to give it to them. These shareholders at times own a relatively large percentage of a stock that doesn't trade heavily. In these instances, it would be difficult for the institutional shareholder to exit the stock through any other means than a sale.

Yes, those that successfully raised capital in the past two years are proud that they have done so. But I wonder if, while basking in the glow of that success, they understand that they may have sealed their fate far in advance?

Do you think there will be an increase in FI consolidations? Why or why not?

~ Jeff

Ode to Bill Davis:

http://jeff-for-banks.blogspot.com/2010/02/ode-to-bill-davis.html

Four Not-So-Serious Don'ts for Financial Institutions

2011-05-14T06:34:00.001-04:00

Movies tell great stories. Most times they exaggerate real life. So I am pouncing on the opportunity to over-dramatize four things I don't think FI's should do.

1. Don't ignore your CEOs age. Prognosticators are predicting incredible shrinkage in community FIs because of regulatory burden. I think it is equally likely that boards throw in the towel because their CEO is far closer to the grave than the cradle, like Aunt Edna from National Lampoon's Vacation. Don't prop your CEO on top of your family truckster.

Note: I wanted to use the "You're my boy, Blue" clip from Old School. But in the movie Blue passed while wrestling sorority girls in a tub of KY Jelly, and I thought it may be a wee-bit inappropriate. But I really, really wanted to use that clip.

2. Don't implement a sales culture that results in no more than product pushing. There are many variants of sales culture. Many FIs went for the worst, the used car salesman variety. If your customers visit your website or branch, and the best you have to say is "yeah, she's a beauty, I can see you behind the wheel, wind blowing in your hair", you better revisit your strategy. We don't want product pushers like Kathy Bates selling squirrels in Rat Race, do we?

3. Don't let Bloomberg radio or the New York Times build your brand. We're taking it on the chin by mass media and it's time to stop the madness. Letting others define who you are may lead to tremendous misunderstandings, such as how Jon Lovitz's family was portrayed in Rat Race to a gathering of World War II vets.

4. Don't "pants" your regulators. I, myself, have peaked into clients' conference rooms at the young-gun examiners and wanted to give them a Three Stooges slap or two. There are some distasteful things we must do in business, and treating our exam team like industry professionals during a time when they seem to be out to get us is one of them. Don't "pants" them as in this Meatballs clip.

Three Banking Lessons Learned from Girls Lacrosse

2011-05-08T04:56:00.000-04:00

Several months ago I was enlisted to coach middle school girls lacrosse. It is a relatively new sport to our area, so my learning curve was steep. We are nearing the end of our season, and yesterday we completed our first double header sweep. As I reflected on how far the girls have come, I thought of the lessons we learned along the way. These lessons apply to many areas of life, including the banking profession. I would like to share them with you.

1. Stack the D

Easter weekend we played a game with a thin roster as many of our players had family commitments. Lacrosse is often referred to as the fastest sport on two feet, correctly implying a great amount of running. With limited substitutes, this puts pressure on the players on the field to perform while being gassed. Midfielders run coast to coast, so I had to be creative in substituting and switching player positions on the field. In so doing, I weakened our defensive unit by moving key defensive players to midfield and middies back to D so they can rest. What I learned was that not adequately protecting our goal can lead to terrible results.

Most financial institutions are not lacking for customers. If we tallied up all customers that do business with us, a likely conclusion may be what one bank CEO stated as "there is enough 'there' there". I have been in countless meetings that the head of retail wonders why their total number of checking accounts remained stagnant while their monthly production reports show great progress in new account acquisition. The reason... customers walking out the back door while the FI tracks new customers coming in the front. A classic tale of not stacking the D and defending your goal. Pay attention to the customers you have, and you will get more business from them.

2. Win in Practice

How you practice drives your game performance. Lacrosse is a sport won in the trenches. If you win the draws, be first to pick up the ground balls (see photo), and disrupt opponent passes you will be successful. But having better skills than your opponent is not bestowed upon you by a higher power, as some may think. To consistently put passes on your teammates stick requires that you do so hundreds of times in practice.

The same goes for serving FI customers. If you are to tailor a solution to a business customer, it is critical you understand his or her needs, their industry, and general economic conditions. Having done your homework allows you to bring a greater amount of value to customers, an imperative in a competitive industry where one FI's money is as green as the bank down the street. If you want to solidify existing customers and win new ones, you better get serious about practice.

3. Find the Hidden Gems

I found it difficult not to make quick judgments about my players. This girl is slow, that one is athletic, etc. To deny that we judge people with minimal information is to ignore human nature. During the course of the season, some of my early judgments proved wrong... dead wrong. Some girls worked hard in practice, improved their skills quickly, and began making significant game contributions. This reminded me that Chase Utley and Michael Jordan were each cut from their high school teams.

Within your employee base there are unpolished gems waiting to shine. It is incumbent on us to identify them, encourage (yes, coach) them, train them, and let them show their brilliance. Most companies have varied levels of employees from stars to, well, not-so-much stars. Often, potential stars are kept under wraps by supervisors that want to keep them for themselves, co-workers that are paranoid about a star's brilliance, and general mediocrity that tends to keep people down. Do you reward mediocrity or protect so-so employees? Do stars receive a 4% raise while not-so-much stars get a 3% raise? Does longevity count more than performance? These are some common ways that FIs keep potential hidden gems from shining.

Summary

In a rapidly changing industry, we frequently look outside of our organization to transform our FI for a sustainable future. But the lessons I learned by coaching youth lacrosse can be applied to your FI... there are opportunities to transform ourselves by looking within. First, by defending our market share and customer base we can reduce attrition and increase the amount of business we do with current customers... Stacking the D. Secondly, in a highly commoditized industry we can differentiate ourselves by being better prepared than competitors... Winning in Practice. Lastly, when product differentiation and cost leadership is difficult, as it is in our industry, then we must find and develop our best employees to elevate our game... Finding the Hidden Gems.

~ Jeff

Does your bank achieve positive operating leverage?

2011-05-01T13:50:00.002-04:00

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

2011-04-16T13:41:00.000-04:00

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

Product Profitability Anyone? The JFB Pro-Growth Matrix

2011-04-09T08:53:00.002-04:00

A bank attorney spoke at a recent Financial Managers' Society (FMS) meeting that I attended. His topic: Leadership. His thesis: Analytics should be the basis for strategic decision making. He offered an interesting fact: 40% of critical decisions in U.S. companies are made from the gut. This style of decision making was romanticized by Jack Welch in his popular 2001 book: Jack Straight from the Gut.

But in reading Welch's tome regarding his successful years at the helm of GE, it is clear that he was far more analytical than the book's title indicates.

Community FI's are similar to other companies in their strategic decision making. Often, critical decisions are made from the gut or based on past experience that becomes more irrelevant as industries, such as ours, rapidly transform. Such disruption gave rise to strategic advisory firms that break down strategic decisions to the facts important to increasing the likelihood of positive outcomes.

One such firm is the Boston Consulting Group (BCG), creator of the Growth-Share Matrix that depicts the potential for a company's products based on growth prospects and market share. Intrigued by BCG's concept and the ability to illustrate facts to improve decision making in FI's, I created the jeff for banks (jfb) pro-growth matrix.

Instead of using market share, as in the BCG model, I utilized net revenue per product. For loans, this was calculated as a percent of the product portfolio as follows: coterminous spread - provision + fee income. For deposit products the formula was: coterminous spread + fee income. This data was pulled from my firm's profitability database for all FI's that subscribe(d) to our profitability outsourcing service.

I chose to use net revenue instead of product profits because of the step-variable nature of an FI's cost structure. Most costs are fixed until a certain level where employees struggle to get the work done and the FI must invest in people and/or technology to increase capacity. If revenues decline, it is not typical for expenses to decline, as banks don't often let people go or scale down operations like a mortgage origination shop or a brokerage firm. Therefore, focusing on the products that drive the greatest revenue through a relatively fixed expense base would be closer to a realistic alternative for FIs.

I measured for both the fourth quarter of 2000 and 2010 to look at how our industry has changed. Change it has! Gone are the days that core deposit products generate net revenue between 4%-9%, as depicted by the "Stars" from 2000. That is because the re-investment rate, or credit for funds, for deposit products has dropped dramatically as a result of the interest rate environment today, particularly at the low end of the yield curve. Many readers may have experienced their treasurer lamenting they don't want any more deposits because they have no place to put them. That phenomenon is represented in the pullback of deposit products from 2000 to today.

But even in our historically low rate environment, core deposit products linger near the "Stars" box. Because revenues are low, some have drifted into the question marks. Interest rates are beyond our control, but if the net revenues per product decline, and much of the decline is outside of our control, then to move "Question Marks" to "Stars" may require an analysis of our expense base and the processes in place to support those products. Are we using technology to its fullest capacity? Do we still engage in outdated processes to protect from a risk that is negligible today?

Another interesting point from the jfb pro-growth matrix was that commercial real estate (CRE), much maligned since the recent crisis, remained in the Question Marks camp, albeit knocked down a notch because of the decline in the 3-year compound annual growth rate (CAGR) used to calculate the Market Growth portion of the chart. With today's elevated loan loss provisioning, CRE continues to contribute to an FIs profitability with above average net revenue generation.

Time deposits have declined on a CAGR basis since 2007, as noted in its position on the chart. In 2000, time deposits had a CAGR of 4.65% and net revenue of 0.53%. Today, CDs CAGR is -8.69% as FIs backed away from this expensive funding source because there is no loan demand. Why book a CD when its current coterminous spread is negative, which is where it stands today? But even when CDs had a positive spread, this product remained unprofitable.

Lastly, the sheer gaggle of products in the "Question Marks" quadrant indicates an opportunity for FIs. Using analytics, product managers have the opportunity to migrate marginally profitable products into either "Stars" or "Cash Cows". Knowing where you do and don't make money is a critical starting point, and positive action based on analytics can improve your FIs financial performance.

How do you use analytics for critical decision making?

~ Jeff

Guest Post: First Quarter Economic Update by Dorothy Jaworski

2011-04-02T08:44:00.005-04:00

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

Book Report: The Lords of Strategy by Walter Kiechel III

2011-03-26T13:01:00.003-04:00

B+ This book, written by a journalist and former editor of Fortune magazine and editorial director of Harvard Business Publishing, tracks the growth and philosophical evolution of strategy. It focuses on three strategy firms in particular: Boston Consulting Group ("BCG"), Bain & Company, and McKinsey & Company. In its entirety, I would suggest that it would be a very beneficial read for banking industry consultants, and a beneficial read for executives at community FIs.

How business is done is often, if not mostly, evolutionary. Understanding how we moved from the days when small businesses in small towns dominated the landscape, to how merchants operated in our large pre-industrial revolution cities, the emergence of large industrial firms, the birth of the corporate man, to where we are today is important to understanding today's business climate.

Management "fads" came and went. These fads were often touted by strategy firms and their army of elite business school educated consultants. This book tracks the evolution of strategy from its early days in the 1960's at BCG to where we are today. Strategy's emergence, and its evolution, being driven by what the author terms the "fiercing of capitalism", i.e. the escalation of competition beyond a few firms and the shortening of competitive advantage driven by technology.

This created fertile ground for strategy's ascendancy and the firms that touted its virtues. Understanding the genesis of strategy and its evolution is an important step in its development and implementation at community FIs and is the basis for my recommendation for the book.

From my perspective, it was interesting to note how strategy became in vogue and how our pre-eminent strategy firms differed in their approach. Creating teams to ponder in a conference room, ruminating how strategy should be formulated and executed is foreign to relatively small consulting firms like mine. We don't develop techniques in our firm's interior. Instead, we develop it across the table from clients, while on the phone with colleagues, or at conferences listening to experts and gauging bankers' opinions.

My world is foreign to BCG's, but it was instructive for me to learn of their methods. Knowing how they do it can only help me do it better. I think it can help you too.

Here is what I liked about the book:

1. Gave detailed descriptions of how strategy came about at BCG, and how it grew and flourished not only at that august firm but also Bain and McKinsey;

2. Introduced the key players in strategy's development, not only at the above firms but also at Harvard Business School;

3. Described strategy through each stage of its evolution, and used interviews with key players in the evolution.

Here is what I didn't like:

1. Focused only on three strategy firms and Harvard Business School. Did other B-schools or consulting firms participate in a material way?

2. The author gave me several vocabulary lessons, such as when he said an author "continued to sound the tocsin" (sound the alarm). Fortunately, I read it on a Kindle and could highlight and get definitions for the difficult words. This is probably a pet peeve of mine, and I should be more thankful that I can now use "tocsin" in a sentence.

But the book is very well put together and thorough in its review of how strategy came to be. I found it a very worthwhile read and recommend it to you.

~ Jeff

Banking: Data hungry and decision challenged?

2011-03-24T19:31:00.000-04:00

I had lunch today with a client's regional manager. We discussed many things, but one thing he told me stuck... they used average balances to determine their highest priority customers. Many of my comrades in the community FI blogosphere feed on data, some good, some bad. But using average customer balances to determine your best customers is unfortunately very common... bad use of data.

Similar to the above, a client of ours requested that my firm identify their top 100 customers by coterminous spread. We distributed the list. They reviewed it quizzically. The senior management team did not know half of the customers on the list. Their perception of their best customers also revolved around balances.

Financial institutions have in their possession more information about their customers than any other industry, with the possible exception of medical. How do we collect it, parse it, and use it? My guess is we don't do a very good job of harnessing this information to identify top customers, profitable products, or strategic opportunities.

I teach at the ABA School of Bank Marketing Management. One of my courses is Profitability & Strategic Issues. I distribute a questionnaire to determine what information students' FIs use to make strategic decisions. The below chart identifies their response to one of the questions.

Forty three percent of respondents reported that their institution did not use marketing data for strategic planning. Another 11% reported using it sometimes. This is astounding but consistent with past years' responses. Marketing data about customers, products, and markets should be critical to strategic decisions. Yet frequently, this data remains within the confines of the Marketing Department. Trapped as bits and bytes in the FIs MCIF or similar system, only to be busted loose to help with the next product promotion.

Aside from information trapped within our core processing and ancillary systems, there is ample data available for strategic decision making in the public domain and primary research conducted by industry professionals. Are we identifying the necessary data points to make important decisions?

For example, if considering branching, one would think the key data points are as follows: Are their enough of the types of customers within a certain community that we typically target and have success with? How many competitors are in the community and what is their branch size? Are branch deposits growing or declining in the community? Are businesses growing and in what industries? Are new housing developments on the horizon and are average home prices increasing? Are branch sites available in locations with adequate traffic?

Most if not all of the data mentioned above is either publicly available or can be obtained from private sources such as local realtors and from the FIs own marketing databases. But if your experience is similar to mine, you understand many branch decisions are made based on anecdotal data or because somebody we know owns the prospective branch property.

As succeeding in financial services becomes more challenging, making informed strategic decisions will be critical to our success. The days of throwing grass into the air to determine wind direction is no longer adequate. Important information need not be out of our reach. Much can be obtained freely via public sources, or can be mined from our own systems. When making decisions with long-term impact, FIs must identify the information needed to make informed decisions and collect and analyze it. Successful execution of the strategies to lead us into a successful future depend on it.

How does your FI use data to make strategic decisions?

~ Jeff

Core Deposits Drive Value

2011-03-13T18:03:00.000-04:00

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.

Experienced Bankers Wanted for Mediocre Bank

2011-03-06T07:26:00.003-05:00

"He's not ready" is the response I often hear when I ask why a sharp banker is not part of the FIs senior leadership team. I hear it from senior leaders, industry executive recruiters, and industry consultants. But when I hear this, let me share with you what my internal voice is saying: "I want to make myself feel better by diminishing your perception of the value this clear up-and-comer can bring to our team."

If the talented individual we are speaking of is not yet good enough to serve in a similar role to me, then, ipso facto, I must be more talented than him. That is one reason I was so impressed with a southeast bank president that said to me "look around, you don't see many executives over the age of 45 because they don't get it [the new way of doing business]." This CEO must not have bought the "he/she's not ready" line.

This attitude is not exclusive to executive ranks. I recently recommended an acquaintance of mine to a regional business banking executive who agreed to take a look at his resume. The result: doesn't have business banking experience. This was true, but knowing the "type A" nature of this individual, I had little doubt he would be successful learning "credit", knocking on doors, and building relationships. Instead, this bank wanted an experienced banker. To which my internal voice said: "experienced at doing commercial real estate transactions and scoffing at directives asking him to build a full relationship."

Another version of the above is when I hear "he doesn't understand credit." I have heard this from FIs currently experiencing credit problems. Apparently it is worse to hire someone that must learn credit than to hire one that has already proven challenged in the endeavor.

Dave Martin, an industry consultant with NCBS, recently wrote in an American Banker opinion piece (see link below, may require subscription) "when we put the wrong person in a job or allow the wrong person to stay in a job, we undermine our businesses." But personnel issues are frequently cited by FI executives as to why they are not succeeding in this strategic initiative or that. And they are not willing to make the necessary changes to move their business forward. Instead, they are in search of "experienced bankers."

Arkadi Kuhlmann, founder and CEO of ING Direct USA, was quoted in a recent Harvard Business Review piece on hiring practices by Fast Company cofounder William Taylor (see link below), "if you want to renew and re-energize an industry, don't hire people from that industry. You've got to untrain them and then retrain them. I'd rather hire a jazz musician, a dancer, or a captain in the Israeli army (see link below to my post on hiring a vet). They can learn about banking. It's much harder for bankers to unlearn their bad habits." If you believe the concept of hire for attitude and train for skill is true, how do you remake your employee base?

First, the FI should clarify the strategy. Understanding where you are going is a critical yet under appreciated step in identifying the people needed to get you there. It requires vision and a roadmap to achieve the vision. Do you know where your FI is going?

Second, you must identify key positions that are important cogs in the wheel to executing strategy. I already made reference to banks that want full relationships with their business customers yet their lending team is chock full of commercial real estate transaction folks with little interest beyond their current pipeline. But if relationship building is the strategy, are your branch personnel up to it?

I have witnessed FIs build confusing and inefficient workarounds to the shortcomings in branches. One reason is that experienced branch managers tend to come from the old school, where taking care of customers once they come in the door is job 1, followed closely by ensuring the branch balances and branch cash is not off. Well, last I checked, not nearly as many customers are coming into branches anymore.

FIs pursing the "relationship" strategy fail to recognize that a relationship occurs between two people. If you hire for attitude in the branches, and get a good go-getter with a positive outlook as branch manager, but proceed to pay her minimally with little upside, she will seek promotions out of the branch. This recently happened at the branch where I bank.

Branch manager is often a destination position for those that were promoted through the teller ranks and have no need to be the bread winner. For those type A people we may want in the branches, branch manager is frequently a waypoint position until something better comes up. Not a particularly effective way to execute on a relationship strategy. But branch managers are critical to our strategy.

The manner at which we hire and fire in FIs reminds me of the different styles of George Steinbrenner and the Pittsburgh Steelers' Rooney family. Steinbrenner would make key hires relatively quickly, and would fire them if they didn't work out. The Rooneys, on the other hand, invest significant time into hiring the right people and stick by their decisions (see link below). In banking, I have witnessed us hiring like Steinbrenner, and firing like Rooney. I suspect we should choose one method or the other, and use execution of our strategy as the measurement of whether a person will work out for us.

For community FIs to remain relevant to customers and prospective customers, we must choose a strategy that delivers either a competitive advantage through differentiation or cost leadership. Fortunately, there are still opportunities to deliver cost leadership for some of us, although I would deem it to be a difficult slog to have lower costs than the very large FIs. If we want to differentiate, then how? Most strategy sessions I attend require that the community FIs people be superior in the manner at which we execute strategy. So I ask you, who is executing your strategy?

Do you believe in the "hire for attitude" philosophy or the "hire experienced bankers" one?

~ Jeff

Dave Martin's American Banker piece, "If he hollars 'bad fit', let him go."
http://www.americanbanker.com/issues/176_42/if-he-hollers-let-him-go-1033869-1.html?zkPrintable=true

William C. Taylor's Harvard Business Review piece, "Hire for Attitude, Train for Skill"
http://blogs.hbr.org/taylor/2011/02/hire_for_attitude_train_for_sk.html

My blog post "Be all that you can be"
http://jeff-for-banks.blogspot.com/2010/05/be-all-that-you-can-be.html

New York Times piece "Rooney Method: Build Methodically and Await Rings"
http://www.nytimes.com/2011/02/03/sports/football/03rooney.html?_r=1&nl=todaysheadlines&adxnnl=1&emc=tha27&adxnnlx=1299413029-4gsue0vxqubNBTcVprKO+Q

Bank Shorts: Schmidlap National Bank Exit Interview

2011-03-02T08:32:00.000-05:00

A client lost his temper with his regulator after one of the more youthful examiners threatened to force the bank to write down the entire consumer loan portfolio based on the information that was given to him. The result, an informal enforcement action. There is a lot of tension between examiners and the examined these days, and I thought this would make an appropriate time to launch an animated series, Bank Shorts.

We shouldn't lose our temper with regulators. Below is my perception of how a difficult exit interview between a fictitious banker and examiner in charge would go. Notice the composure maintained by the banker. I was impressed with his performance. Also note who is sitting in the desk chair versus the visitors chair.

Hats off to Bryan Allain, at http://www.bryanallain.com/ for giving me the idea regarding these shorts. He has created movies at his blog. He is a witty guy and you should visit his blog, in spite of him being a Red Sox fan.

Enjoy.

~ Jeff

Does "Evaluate Strategic Alternatives" mean the end of your bank?

2011-02-26T13:38:00.002-05:00

There is a lot of soul searching happening in the executive suites and boardrooms of community financial institutions (FIs). Nearly three years of economic malaise, political activism, media vilification, and regulatory over-reach have made us weary of continuing as an independent FI.

When Boards or CEOs reach this point, they determine to undertake a review of their "strategic alternatives". I recently spoke at a Financial Managers Society meeting packed with FI CFOs and controllers and asked the crowd what they thought "evaluate strategic alternatives" meant. In unison, they responded "sell". But should a board, in exercising their fiduciary duties, perform this analysis routinely without determining to sell the FI first?

A rhetorical question because the answer is obvious. But what should such an analysis entail if it is to contain an assessment of the FI's strategy, the value of successfully executing such a strategy, the possibility of acquiring, or in the absence of opportunity the value that can be received in a sale?

The first step, not often taken, is to develop a present value analysis of the FI's strategic plan. What do you compare the value in a sale to if you do not perform this analysis? See below for a version that we often use in determining the present value per share of an FI. In the chart, I projected out five years. Why five? Many executives think it involves too much guesswork when projecting so far into the future. True about the guesswork, but you must assess the amount of time your strategy will take to fully realize its value. Strategy execution typically lends itself to a long-term view.

The above analysis places a present value per share on Schmidlap's strategic plan at $23.95 using a 13x earnings multiple and a 9% discount rate. These two factors are important and the FI should use empirical data to determine the earnings multiple and discount rate. For example, in a strategic planning retreat I performed such an analysis on a client using a 12x earnings multiple, to which the CFO took exception. Upon reviewing 10 years of trading history I discovered he was correct, and the appropriate multiple was 14x. This had a meaningful impact on value.

The discount rate is often a point of contention among executives, board members, and industry analysts. I will not pull out my business school textbook and go through a Cap-M exercise (because I would have to find my textbook to accurately do so). In its simplest form, the discount rate in the above sample should be the shareholders' expected capital appreciation of the FIs stock. If shareholders expect a 10% total return from holding this FIs stock, and the FI pays a 2% dividend yield, then the discount rate should be 8%.

Once the FI performs a present value analysis of its business plan, it should assess the M&A market and the value it can receive in a sale. But there should be an additional step: assessing the potential stock price appreciation of a would-be acquirer's stock after the acquisition. In many if not most cases, the selling FI shareholders will be invested in the acquirer.

A textbook case for celebrating the "pop", or premium price received by a seller to celebrating the blues post-transaction because the buyer's prospects and stock tanked was First Union's (now owned by Wells Fargo) acquisition of CoreStates in Philadelphia. Had CoreStates assessed the potential for a post acquisition First Union, perhaps disaster could have been averted. Don't put your FI in the same situation.

But evaluating strategic alternatives should not only be about a sale or remaining independent and executing your plan. What about a "buy"? Your FI should identify potential targets for their ability to propel your strategy, build economies of scale, and accelerate earnings growth.

It is less complex to execute strategy without having to negotiate and integrate an acquisition. So acquiring should accomplish the above objectives, particularly if the present value of your business plan is trumped by your takeout value. Then you have what I term a "strategy gap" that must be filled by either/or: faster organic revenue growth, cost savings, and/or acquisitions. All should be part of your regularly scheduled strategic alternatives meeting.

I recently heard a respected investment banker predict that the 8,000 banks/thrifts in the United States will decline to 5,000. Bold prediction, to say the least. If we are to take faith in it, then there will be a lot of "reviewing strategic alternatives" happening in upcoming board meetings. But in performing such an analysis, the FI should assess the present value of its strategy, determine the reasonable value it can receive in a sale and the prospects of would-be buyers, and the opportunities to acquire to fill "strategy gaps". Looking at only one aspect of the above will only shortchange your employees, customers, and shareholders.

How does your FI perform a "strategic alternative" review or what do you think should be included in such an undertaking?

~ Jeff

Note: The above present value analysis was performed on an actual FI, using actual historical numbers from 2001 (base year) through 2006 (five year projected years). The FI was trading at $39.57/share on 12/31/01, the base period. Therefore, the strategy eroded value over time, primarily because earnings grew at a 3.23% compound annual growth rate. To be fair, the FI made an acquisition in 2005 which may have resulted in a temporary downtick in earnings.