Notes from This Month in Banking Podcast

I was rustling through papers on my desk to clean it up and not look like a candidate for the Hoarders TV show. In the clutter I found my sloppy copy notes from two podcast interviews. I put them in the shred pile.

Then I read them. And rethought about shredding them. There were some valuable nuggets in there. They were uttered in some form by our guests and I thought them so insightful that I wrote them down. So I wondered if my Jeff4Banks.com readers would appreciate them. 

Not knowing for sure, here they are. Why not, right?

Episode: Managing Through Change (or in other words, getting stuff done).

Release: November 2023

Guest: Mike Butler, CEO of Grasshopper Bank

Link: Managing Through Change (or in other words, Getting Stuff Done!!) - The Kafafian Group, Inc.

JPM Notes

- Mistakes are often silo issues.

- Despise bureaucracy.

- Our bank does not want to be a software company.

- We have a partnership strategy with technology companies.

- Successful companies that get stuff done push decision making down.

- Fail fast and fix it.

- Commercial banking is ripe for disruption.

- Build an environment where people can thrive personally and professionally. 

- Culture: When hiring people, the candidate has three decisions to make: 1) is it exciting for the candidate, 2) is it not for them, and 3) do they believe or call BS on what the CEO is trying to create. 

Episode: Ingredients to a Successful Management Team

Release: March 2024

Guest: Bartow Morgan, Jr., CEO of Geogia Banking Company

Link: Ingredients to a Successful Management Team - The Kafafian Group, Inc.

JPM Notes

- We changed how we attracted talent. Didn't necessarily need the banking experience.

- We run each line of business in a more entrepreneurial way.

- Only one person drives culture (CEO).

- Put people at the top. Successful people are usually successful. Passionate people usually win.

- Break down silos by creating cross-functional teams.

- What to look for in leaders: driven, accountable, self-aware, collaborative and ethical.

~ Jeff

What #Banking Trend Will Have the Greatest Impact on Your Bank?

This was the question posed to Bank Profitability students as part of the Oregon Bankers' Association's Executive Development Program (EDP). These were up-and-coming bankers, the future leaders of our industry, identifying industry trends that will have the greatest impact on their bank, in no particular order. 

1. Interest Rates

So many financial institutions had a positive GAP (assets that are maturing or repricing within one year minus liabilities that are maturing or repricing within one year) during the Fed's ambitions five quarter rate hike from zero to 5.25%, meaning that they were asset sensitive and their net interest margins should have expanded. And then what happened in 2004-06 happened again. Depositors woke up and thought "what is my bank paying me?" And our cost of funds chart looked like the trail lift at Breckenridge. The Fed has paused for nearly a year now, and it was our experience in 2006-07 that bank cost of funds continued to increase as the market closed the delta between what someone could earn in a money market mutual fund and a bank account. Cost of funds is leveling off now. But not until $1 trillion went from banking to money markets. Will NIM compression continue, as it did last year (see chart from American Banker)? Will bankers reposition their balance sheet to be liability sensitive so NIMs will improve with falling rates? And will their ALCO reports accurately predict what will happen? Time will tell and it is weighing heavily on bankers' minds as the most impactful to their banks' success. And with our industry still heavily dependent on net interest income for revenue, I think they are right.

2. Consumer Demographics and Changing Customer Demands

Remember all the pre-pandemic talk about millennials? You couldn't go to a conference without every presenter having millennial this or millennial that on their slide decks. They are digital native, meaning they never knew life without the Internet. We've been able to ignore them because, well, they didn't have big borrowing needs nor did they have any money in their deposit accounts. Besides what was needed to buy some Keystone Light and Vlad for this weekend's party. Now the oldest millennial is 43 (see table by Statista). They have cars, houses, and are nearing their peak earning years. They are starting businesses and inheriting money from The Greatest Generation and Baby Boomers. In other words, great bank clients with high lifetime values. In fact, there are segments of millennials that have always had high lifetime values. That's why Sofi went after them at the end of college, focusing on the engineering majors and leaving the English majors to others. High lifetime value. Now we have to tailor what we do, how we do it, and how we differentiate to these young whippersnappers that never had to scroll through library microfilm when researching a college paper. Our tortoise approach worked when Baby Boomers controlled the wealth. EDP students fear it will work no longer. 

3. Shadow Banking

This trend seemed very specific to current commercial lender anxiety today. Because of our current liquidity situation, where depositors now carry lower average balances per account, the aforementioned trillion that went to money market accounts, and our bond portfolios being underwater, nearly every banker is hunting for deposits. As part of that full-court press, commercial lenders are being asked for higher and stricter compensating balances from borrowers. Experienced borrowers are feeling the pinch from the multiple banks they deal with. And, according to some EDP students that are lenders, are turning to the shadow banking market that do not have deposit demands. Such as direct lending funds, and insurance companies. Shadow Banking refers to banking-like operations that take place outside of the mainstream banking industry. Shadow bank lending is similar to bank lending but is not subject to the same regulations, and compensating deposit balace requirements. Typical shadow banking entities are bond funds, money market funds, finance companies, and special purpose entities. Business Research Insights estimates the worldwide shadow banking system to be over $53 trillion in 2021 and believes it will grow to $85 trillion by 2031, a 5% compound annual growth rate (see table). Although shadow banking mostly serves larger corporations, think money market funds buying commercial paper, bankers fear the trend will continue going downstream to more traditional community bank customers.

4. Commercial Real Estate Uncertainty/Vacancy Rates

Nineteen point six percent of office space is vacant at year end 2023, according to Axios.com (see chart). Vacancy reached a record high in the fourth quarter and surpassed previous peaks last reached in 1992. Office buildings are emptying around the U.S., as companies continue to adapt to the new norms of remote and hybrid work by shrinking their real estate footprint. Although large office towers in big cities are not usually part of a community financial institution loan portfolio, smaller commercial real estate in urban areas and throughout suburbia and rural markets are. Commercial rents are projected to decrease by a small amount this year, while borrowing costs will escalate as those that borrowed in the low interest rate environment of 2017-19 have their loans coming due, some at twice the rates of their maturing loan, putting pressure on debt service coverage ratios. Rents are lower, borrowing costs are higher. Do bankers make exceptions to policy, ask borrowers to kick in more equity, or push borrowers out of their bank? There's better news for multi-family and warehouse lenders, as these sectors of CRE are doing just fine. But bankers should be preparing for a devaluation of the collateral used by their borrowers to determine how best to manage this emerging situation.

5. Regulation and the Political Environment

"Last month, the CFPB reported how banks have become more dependent on these fees to feed their profit model on checking accounts. In 2019, bank revenue from overdraft and non-sufficient funds fees surpassed $15 billion with the average cost of each charge between $30 to $35. But that's not the only product where large financial institutions feast on their customers through fees. In 2019, the major credit card companies charged over $14 billion each year in late fees with an average charge of around $35. And when buying a home, there's a whole host of fees tacked on at closing where borrowers feel gouged."

~ Rohit Chopra, CFPB Director, January 26, 2022

"I am pleased to support this adoption (of required climate disclosures) because it benefits investors and issuers alike. It would provide investors with consistent, comparable, decision-useful information, and issuers with clear reporting requirements."

~ Gary Genslar, SEC Chairman, March 6, 2024

"The CFPB and other regulatory bodies will use the disclosures required by Rule 1071 of the Dodd-Frank Act as a cudgel to pressure bankers to lend to politically favored small businesses or to not lend to politically disfavored small businesses."

~ Jeff Marsico

6. Technology Advancement and Generative Artificial Intelligence

In the third quarter of 2023, the total operating expense to operate a branch was 47% direct cost: branch salaries and benefits, lease expense, etc. and 53% indirect costs: operations, IT, human resources, etc. This is a hefty burden to put on a branch that is competing with branchless banks that don't incur the direct costs and can pass that on to depositors in the form of higher interest rates. Bankers must get serious about driving down the cost of the pistons, carburetors, and batteries of running a bank. Technology offers opportunities to do just that. Additionally, customer acquisition is another significant cost to financial institutions. Technology and Generative AI could dramatically lower those costs. As well as compliance, fraud, credit, reconciliations, reporting, and other risk mitigation that is currently performed in a resource intensive way. The opportunity to lower costs without escalating risks, in fact likely lowering risks, is near. EDP students think this could have a significant impact on their banks. 

7. Branch Consolidation

Community financial institutions are caught in this place where they want to demonstrate commitment to the communities where they operate yet can't figure out how to do it profitably in certain locations. Large financial institutions simply consolidate their branches. Community bankers still consider this as a sign of weakness to the market, lack of commitment to its leaders and residents, and admission to a mistake to enter the market in the first place. This, of course, was a Bank Profitability course, and when staring in the face of hard data, namely a branch's income statement showing perpetual red ink, it becomes more difficult to justify keeping the branch open with those soft reasons such as not supporting the community. I got news for you, if you can't operate a branch profitably and you are satisfied that the reason is not because of poor execution by your bank, perhaps the community doesn't support you.

~ Jeff

Guest Post: Financial Markets and Economic Update - First Quarter 2024

Four Years Ago

It was on March 11^th, four years ago in 2020, that the WHO declared a global pandemic due to the Covid virus threat that originated in China.  Our lives changed forever from this whole experience of the government’s declaration of a national emergency, leading to forced shutdowns of businesses and schools, mandated mask wearing, forcing 6-foot distances between people, travel restrictions, fear mongering with case and death counts, and forced vaccines/boosters.  No one who lived through this will ever forget what this time was like. 

In the markets, we watched helplessly as real GDP plummeted -5% in 1Q20 and -31% in 2Q20 before rebounding by +33% in 3Q20.  No one will forget how quickly stocks plunged and recovered.  Interest rates fell to incredible lows, forced there by the Federal Reserve’s rate and bond buying policies.  No one will forget the inflation that followed in 2021 to 2023, started first by supply chain issues, but then fueled by the Fed’s purchases and the obscene amount of cash handed out by the federal government.  M2 growth was out of control at over 20%.  Initially individuals and businesses saved their cash, but then as the pandemic eased, they spent with abandon, pushing up demand on everything from food, autos, clothing, travel, and entertainment to home goods and service-related businesses, such as restaurants.  It was not until May 11, 2023, that the US national emergency was lifted, but sadly, the free cash handouts continue.

The Fed and Inflation

The Fed raised rates by 5.25% between March of 2022 and July of 2023 to try to crush inflation.  I’m sure they are surprised that we did not get a recession yet, but more on that later.  The Fed Funds rate stands at 5.50%, compared to its starting point of .25% in 1Q22.  Although they are willing to admit that they will lower rates, they are not willing to admit that they are too high.  When Fed Funds exceeds inflation, the positive spread between the two creates a “real” rate and indicates tight policy.  Fed Funds minus CPI (3.2%) is 2.30%, Fed Funds minus PCE (1.8% 4Q) is 3.70%, and Fed Funds minus core PCE (2.1% 4Q) is 3.40%.  Are they tight enough?  Yes, absolutely!

Inflation relief may come from an unlikely source- China.  I’ve previously theorized that China would try to reclaim its global market share lost during the pandemic by flooding the markets with cheaper goods.  According to a Wall Street Journal article on March 3^rd, this time has come.  This development could give us good news on inflation.  China, however, is struggling with their economy, too much debt, $4 trillion in real estate losses, and a shaky stock market, so these goods may be slow to arrive.  By the way, China is about to get an inverted yield curve.

Since tight policy has a detrimental effect on GDP growth, the Fed usually lowers rates when nominal GDP falls below Fed Funds.  Since Volcker’s reign, 14 of 18 easing campaigns started with Fed Funds above nominal GDP.  Nominal GDP for 4Q23 was +4.8% (real was +3.2%) and nominal GDP for 3Q23 was +8.2% (real was +4.9%); the latter was clearly too high to start easing, but the 4Q23 nominal rate fell substantially, creating a spread below Fed Funds of .70%. 

Nominal GDP is not the only consideration, but it’s a pretty important one.  Other factors include PCE inflation, M2 growth (or lack of it), consumer spending levels, the dollar, employment, and the real Fed Funds rate.  If the Atlanta Fed’s current GDPNow projection for 1Q24 GDP of +2.1% comes true and the implicit price deflator is 2%, the Fed Funds minus nominal GDP spread will be 1.0% or more.   It’s my thought that the Fed is waiting for 1Q24 GDP to check the spread.  Then they can have more confidence to lower rates in May or June, given that the unemployment rate has been rising slightly recently.  Should they lower rates at that point?  Yes!

I say “yes” for two reasons.  M2 year-over-year growth continues its unprecedented decline that began in December, 2022.  We have not seen a contraction in M2 since the 1930s.  January’s M2 y-o-y was -2.0%, December was -2.4%, and November was -3.0%.  Declining M2 is pulling inflation down.  Paired with a velocity of money that is low, at 1.35 in 4Q23, and projected to fall, there will be downward pressure on GDP.  Look at this equation and think.  GDP= M * V.

The second reason is something I always harp on- the lags in monetary policy- generally 6 to 9 months but they can obviously be longer.  Fed Chairman Powell even acknowledged, as did several of his Governors, that the Fed should begin to ease when inflation is headed to their target, NOT when inflation hits the target due to the risk of overshooting and inflation that turns into deflation.  And don’t forget QT; the Fed continues to let $100 billion per month mature off its balance sheet, further contributing to tighter conditions.  So, why not lower rates now?  Mark Zandi of Moody’s just discussed that a major risk to the markets and the economy is the Fed holding rates too high for too long.

Government Debt

Our government’s debt is now over $34.5 trillion, or 124% of GDP.  Weakness in GDP is a general rule after extended periods of the debt/GDP ratio exceeding 90%.  High debt levels continue to harm GDP as the US Treasury issues new debt with abandon and the politicians hand out money like candy.  It is mismanagement of the worst kind as budget deficits explode; the fiscal year 2023 deficit was -$1.7 trillion, following 2022’s deficit of -$1.4 trillion.  2024 could exceed -$2.0 trillion.

The cash continues to fuel the economy temporarily and then it’s gone.  Some of the infrastructure projects are admittedly investments but many are not.  Real GDP was +3.2% in 4Q23, of which .73% was government spending; the 3Q23 real GDP was +4.9%, of which government was 1.0% of that.  Trillions of dollars of subsidies on “green” BS projects, electric vehicles no one wants, tax credits, debt forgiveness, and free money all fuel demand and contribute to inflation.  I’m surprised no one ever talks about maybe the Fed is keeping rates too high to fight the inflation caused by our own federal government crowding out the private sector. 

Where is the Recession?

I have spoken continuously about a recession coming, so where is it?  Why can’t we see it?  I was taught to watch specific indicators that are extremely efficient in forewarning about recession.  The inverted yield curve persists and is at record times- 10s to 2s since July, 2022 and 10s to 3 months since October, 2022.  Most recessions occur within 14 to 18 months following inversion, especially of both yield curve measures.   

ISMs and regional Fed surveys have been mostly negative for months on end.  Inventory has been building in the second half of 2023, with +$63 billion in 3Q23 and +$5 billion in 4Q23.  GDP shows up as weak every other quarter.  Stocks had their big selloff in 2022 and no recession followed.  In fact, stocks are now at new highs this quarter, led mostly by the Magnificent 7- MSFT, AMZN, NVDA, TSLA, AAPL, GOOG, and META- so there is no recession signal from stocks.  I think stocks are up on the potential of AI to massively increase productivity.

Leading economic indicators, or “LEI,” continues its long stretch of negative readings with January at -.4% and December at -.2% and is now down -3.0% for the past six months annualized.  The LEI index has now fallen 23 months in a row and is the lowest since April, 2020.  Even with the continued dire condition of this index and its trend, the Conference Board gleefully announced that they do not see a recession.  Oh, brother!  It sounds like 2007 all over again, when people got tired of looking at LEI and then in 2008, all hell broke loose.  Remember, hope does not stop recession.

CBS News just released a report saying that the average family is spending $11,434 more per year today than at the end of 2020 to maintain their standard of living.  Tell me that that’s not a bad sign.  JP Morgan Chase estimates that 80% of consumers have depleted their Covid savings, so they have no real extra cash.  Credit card and auto delinquencies have risen above pre-pandemic levels.  Insurance costs have been soaring.  CRE and its depleted value are a problem for many banks, not just NYCB, as vacancy rates for offices top 19% and 190 million square feet of office space is available for sale, lease, or sublease.  These are all signs of recession.

The Fed is holding interest rates too high, creating real spreads to inflation and to nominal GDP.  At this point, I can only say that I believe that recession will come, but I hope there will not be a major shock to cause it.  Of course, if the Fed eases enough soon, we can avoid bad outcomes.

The Employment Report

In my mind, I find that the monthly BLS report has lost some of its credibility.  February’s report showed payroll growth of +275,000 but restated growth in December and January by -167,000.  Challenger layoffs ran above 80,000 for both January and February, but they never seemed to show up in the numbers.  Unemployed persons rose by 300,000 to 6,488,000.  Household employment fell by -184,000, exactly the opposite of payroll growth once again.  The unemployment rate, which has been below 4% for 2 years now, rose by .2% to 3.9%.  The household report and resultant rise in the unemployment rate contrast with the sweet story of ever growing, then constantly restated downward, payrolls making headlines every month.

Here's a rant.  Every time the JOLTs report is issued, headlines say how “tight” the labor market is.  The JOLTS report for January showed 8,863,000 job openings and unemployed persons were 6,488,000 in February.  That’s 1.4 jobs for everyone looking for a job, right?  NO!  Maestro Greenspan taught me many things, including that the supply of labor is measured as the pool of available workers, which is the sum of unemployed persons AND those not in the labor force but want a job.  That number has been rising and is now at 12,130,000.  There are not enough job openings, or .7, for the supply of labor.  Why does everyone ignore the pool of available workers?  One ratio they do follow is the quits rate, which is a leading indicator of the jobs market; the rate was 2.1% in January, which is getting low, as people hold onto their jobs, at which they have to work longer and harder to beat inflation.

Wage growth was 4.3% year-over-year in February, which is not that far above Fed “targets.”  Their inflation target of 2.0% can be added to average historical productivity of 1.5%, which creates a “target” of 3.5%.  Productivity in 4Q23 was twice the historical average at +3.2% and very helpful to offset wage costs.  Greenspan also taught me this.  And a word about Fed targets.  Chairman Powell testified last week to Congress for two days and stated that their 2% target is based on PCE.  So let’s clear up any misconception that they target CPI, which traditionally runs higher based on its different construction.  CPI can be acceptable at 2.5% when PCE is at 2.0%.

 

In the past 18 years, I’ve written over 70 quarterly newsletters and plan to keep them going, as long as I have the energy and desire to rant and to try to make sense of things that just don’t make sense.  I retired in November of 2023, after 49 years in banking and I can tell you it is hard to walk away from something you loved.  When Jason Kelce announced his retirement from the Eagles on March 4^th after 13 years, I truly understood why it was so emotional for him.  And yes, I cried every time he did.  So soon I’ll be off to watch the solar eclipse in totality in NY and I’ll be tending to tulips soon thereafter.  Retirement does have its benefits.

Thanks for reading!  DLJ 03/15/24

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 recently retired from Penn Community Bank where she worked since 2004. She is the author of Just Another Good Soldier, and Honoring Stephen Jaworski, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure of devotion.

President's Day: The Great Refrainer

Why not Calvin Coolidge? In a time when we administer clarion calls to the government that "SOMETHING MUST BE DONE!", Coolidge would likely respond, "no it doesn't."

It is with this admiration of our 30th president, the Great Refrainer, the one that presided over the Roaring Twenties when life improved significantly for all Americans, that I read the official results of the 2024 Presidential Greatness Project Expert Survey administered by professors from the University of Houston and Coastal Carolina University.

The survey was issued to members of the American Political Science Association and asked them to rate each president on a greatness scale of 0-100 with 100 being the greatest. Where did Calvin Coolidge rank of the 46 presidents measured... 34th of 46, between Richard Nixon and Chester Arthur.

I disagree. I full-throated disagree. And Silent Cal signed the Immigration Act of 1924 that was designed to reduce immigrants from, among other countries, Italy. Note my last name. By that measure, I should dislike Coolidge. But I don't.

Because Coolidge's philosophy about the United States is in his probably best-known quotes: "the chief business of the American people is business." He was pro-business, and anti-government intervention in economic affairs. Some criticize that this laissez faire attitude led to the stock market crash of 1929 and the subsequent Great Depression. And non-existent regulation likely played a role in the crash. But there is credible evidence that the actions of Coolidge successors likely caused and extended the Great Depression.

The dramatic stock market crash was probably fueled by wild speculation because of the economic expansion that happened under Coolidge's watch. Coolidge ascended to the presidency from vice president in 1923, when Warren Harding passed away suddenly. In 1923, the GDP was $803 billion, and in 1929 when Coolidge departed for Herbert Hoover, GDP was $977 billion, a 22% increase.

What was Coolidge's greatest attribute: restraint. In a letter to his father when he was Governor of Massachusetts he said "It is much more important to kill bad bills than to pass good ones." Where are you today Calvin!

The truth is, he wouldn't make it in today's politics. Doing nothing is not considered a good attribute. I would agree with that to this extent: doing nothing to reduce the myriads of laws and regulations imposed on us by an ever-expanding government bureaucracy would be bad. And I think Coolidge-like leadership would set about righting this listing ship. Restraint in advancing government. Action in reversing its advance.

Silent Cal was his nickname, but truth be told he had two press conferences per week and used the newfangled radio to speak directly to Americans. It takes explanation why he would do nothing, such as when post WWI veterans lobbied for a pension, or when farmers lobbied for aid. No and no. And Coolidge was a farmer!

After he won the presidency in his own right in 1924, and as a result of unprecedented prosperity and human advancement while he was president, he was poised for a landslide victory in 1928. Except he chose not to run. That's what he said to the press: "I choose not to run in nineteen twenty-eight." How many president's today would bask in such popularity, stare in the face of sure victory, and say, "no thank you, it's time for someone new"? 

Coolidge might very well have been our humblest president. He didn't seek the limelight, spent most of his time in office reducing taxes and the government. He balanced every budget. And the Federal budget was lower when he left office than when he came in. He didn't need big spending resume bullet bills that were not absolutely necessary. And at the height of his popularity, he walked away.

No, the American Political Science Association got it wrong. They clearly do not value government restraint, humility, and freedom. Coolidge, however, took seriously our Constitution and the context from which it was written. 

Some other notable quotes that made Coolidge such a great president courtesy of AZ Quotes:

"Nothing in this world can take the place of persistence. Talent will not; nothing is more common than unsuccessful men with talent. Genius will not; unrewarded genius is almost a proverb. Education will not; the world is full of educated derelicts. Persistence and determination alone are omnipotent."

"Unless the people, through unified action, arise and take charge of their government, they will find that their government has taken charge of them. Independence and liberty will be gone, and the general public will find itself in a condition of servitude to an aggregation of organized and selfish interest."

"Don't expect to build up the weak by pulling down the strong."

"You can't increase prosperity by taxing success."

"Wherever despotism abounds, the sources of public information are the first to be brought under its control."

"You can't know too much. But you can say too much."

"A government which lays taxes on the people not required by urgent public necessity and sound public policy is not a protector of liberty, but an instrument of tyranny. It condemns the citizen to servitude."

"Silence can never be misquoted."

"Doubters do not achieve; skeptics do not contribute; cynics do not create."

"Collecting more taxes than is absolutely necessary is legalized robbery."

"It is difficult for men in high office to avoid the malady of self-delusion. They are always surrounded by worshipers."

Analyst Insights: Two Banks that Deliver to Shareholders

Be curious. That's how I approach Twitter ("X"). Yes, there are some dumpster fire opinions. But then again, there are some real valuable insights that I and we can learn from. And this most recent string by bank analyst Perry Weinstein is one of them that I thought should not be lost to a tweet stream. 

Perry's perspective is clearly focused on shareholder value and may be viewed as shareholder primacy, a sometimes derogatory term because pursuing shareholder value could be done at the expense of other stakeholders, such as employees, customers, and communities.

But the pursuit of shareholder value need not be a zero-sum game, if executed correctly... i.e. not at the expense of stakeholders. In that context, his observations on QCR Holdings, Inc. ($QCRH), an $8.5 billion bank from Moline, IL, and CF Bancshares, Inc. ($CFBK) a $2.1 billion bank from Columbus, OH are very valuable. To the curious.

I offer the string without edits. References to "I" means Perry.

1/25 I like to touch on a topic that can get overlooked, decision making, and how past decisions or lack thereof, can give an investor a better understanding of what will occur in the future. I will highlight $QCRH and $CFBK.

2/25 Past actions/decisions give the best insights into a management team's acumen, capabilities, willpower, and its pursuit of excellence...effort lol.

3/25 Before we start, a summary of a quote by Einstein that perfectly captures the concepts being discussed; doing the exact same think and expecting a different result is the definition of insanity.

4/25 Look how much $CFBK accomplished in just over 4 years. (1/2)

1. Raised capital in late 2019.

2. Launched its equipment finance group - 11/2020

3. Agreed to sell 2 branches in weak markets - 12/2020

5/25 Look how much $CFBK accomplished in just over 4 years. (2/2)

4. Entered Indianapolis on 5/2021, a top 2 Midwest market with Columbus, another market $CFBK is in.

5. Shuttered large parts of its mortgage operations in stages, first in 7/2021 and later in early 2023

6/25 Selling branches is not easy, but it was best for shareholders. Management did not prioritize how things were or what certain people "might like". This management team clearly continues to question how things were/are and are relentlessly trying to improve.

7/25 These actions make it clear what $CFBK's management team will prioritize in the future... shareholder value.

8/25 Due to these decisive decisions/actions, $CFBK has positioned itself to be a very desirable target, with a market presence in the two fastest growing markets in the Midwest, Indianapolis and Columbus.

9/25 $QCRH is another great example of a management team prioritizing long-term shareholder value, not how things are or what certain individuals might like.

10/25 Past actions taken by $QCRH:

1. In 2018, started its LIHTC lending line.

2. Instead of doing what was "easy" and raising capital, $QCRH decided to sell its least profitable charter, Rockford Bank and Trust, to bring in the capital to support its robust growth.

11/25 These two decisions are what first prompted me to closely follow this organization. This management team, led by Larry and Todd, demonstrated its focus on long-term shareholder value, rather than what other banks do or prioritizing how things were.

12/25 Now let's discuss what we can learn from the actions that $QCRH's management team DID NOT take that maximized shareholder value. $QCRH did not raise capital and despite earnings skyrocketing, $QCRH has resisted raising its dividend...interesting, what does this tell us?

13/25 Not raising its dividend clearly demonstrates to me that $QCRH's management team understands the key principles of Deploying Capital Most Profitably.

14/25 Capital priorities for banks:

1. Balance sheet growth-regulatory must

2. Use excess capital for acquisitions, business or bank, and share repurchases.

3. Dividends: If a bank always trades at a high premium to earnings, like CBU, increasing the dividend is more appropriate.

15/25 Great banks ALWAYS have excess capital in order to take advantage of unforeseen opportunities. Understanding the value of time, not having to use excess capital immediately, is another quality I look for in a management team.

16/25 To summarize, topflight management teams continuously find more profitable ways to deploy excess capital than simply increasing the dividend.

Now let's discuss what we can learn from inaction that harms shareholder value.

17/25 A few blatant examples come to mind:

1. A bank that continues to be over-branched

2. A bank that has core fee businesses, wealth management, trust, insurance, that continue to be subscale and these businesses are more like "Hobbies" than businesses.

18/25 These examples are telltale signs that a management team is content, not willing to make tough decisions to cut expenses, and lacks motivation to find ways to scale fee income businesses.

19/25 With the new proposal for higher capital requirements for certain banks, do you think capital light businesses are less valuable or more valuable? Do higher capital requirements increase or decrease the profitability of loans, a capital-intensive business?

20/25 Another example is when a management team waits for a merger to close because "it will be easier to make changes." A merger announcement is no excuse to postpone actions that can be taken TODAY to improve shareholder value.

21/25 If I see a bank that possesses one or more of these "telltale signs", it is evident to me that this franchise is run like a bank not a business. So, what does this tell you about management?

22/25 Management is not asking the question "what can we do to increase profitability?" Great management teams always ask "can we do this better?" A curious mindset is vital. Often, in this type of organization, there are too many layers of management.

23/25 An overcrowded exec team results in a slow acting bank, causing any positive changes to take forever, if at all.

A noncentralized management team can produce a lack of proper information flow to the very top. The CEO could very well not know, but that is no excuse.

24/25 A CEO needs to have an "I can attitude" and do it yourself mind set. If not, the cycle continues. The best CEO's take responsibility for everything and don't say "well it's not my job."

25/25 In summary, understanding "the why and how" a management team both thinks and makes its decisions can be incredibly helpful in better predicting future returns. Actions or lack thereof, are clear signs of the capabilities and motivations of a given management team.

//Note: This post or this blog does not offer investment advice.//

Perry is currently the CEO of PCW Advisors, a financial consulting firm focused on the community banking industry. PCW Advisors looks to serve community bank focused investment funds by providing unique and customized analysis that is significantly different than traditional research. Perry combines a deep understanding of the fundamentals of bank investing with a more specialized emphasis geared towards understanding decision making, to provide clients with actionable ideas. Before launching PCW Advisorsin December 2021, Perry worked as an analyst at Hovde Group, Ares Management, MJC Partners, and BDO. Perry’s work has earned high praise from many prominent investors in the financial sector. More recently, Perry’s work on the strategic side has received positive reviews from community bank management teams.

Perry graduated from the University of Southern California with a Business Administration degree. He holds licenses Series 7, 63, 79, 86 and 87.

Contact Information:
Email: Perry@pcwadvisors.com

Phone: 310-384-6153