This is Part III of a three part series. Click here if you missed Part I
Click here if you missed Part II.
In parts I and II of this three-part white paper, we explored the financial crisis landscape of 2008, and the issues that Community Banks brought on them and those brought to their door steps by all too eager politicians and regulators. [make changes from part 2] Also surveyed was the impact this excessive regulatory environment had on investment in systems and to an already competitive industry grappling with the emergence of “disruptors” such as FinTechs, and with advanced technology that deemphasized “bricks and mortars” service delivery. Part II focused on Organizational Levers, primarily the Board’s role in shaping the bank’s direction; the promotion of a strong Credit and Enterprise Risk Management (“ERM”) cultures, and the shedding of any Bank Holding Company corporate structure. Part III deals with Financial and Operational Levers.
Financial Levers
- Large Fee Revenue Component, and Stable Deposit Stream
Aggressive loan plans and ergo heavy reliance on Net Interest Income (“NII”) to meet earning plans can only lead the bank into a treacherous territory. It’s no different than overeating. This too leads to a stomachache. By skewing the revenue line as close to an even balance between “sticky” fee income and NII, the bank can afford to say “NO” when it is warranted; and avoid decisions that require “over-stretching.” Fee revenue is also more reliable, predictable, and subscription-like. It helps mitigate economic slowdowns, retrenchment by borrowers, and/or swings in interest rate, and deposit costs. More importantly, a heavily weighted fee component is a cheaper and reserve- free cost of capital.
- Assets & Liabilities and “Match Funding”
One of the most remarkable difficulties of the 2008 financial crisis is the seizing of money markets. Institutions that relied heavily on bought deposits, “hot” short-term money, commercial paper, etc. saw their funding sources dry up, and made meeting loan commitment difficult to sustain. “Hot money” does not mean illegal money, as much as it means unreliable, short term non-relationship depositors that flit from bank to depository institution seeking the highest short term rates returns. A bank that “gaps” the balance sheet deposit base with short, medium and long term deposit maturities insures a smoother match funding between assets and liabilities. Meaning, loan commitments’ tenors should closely if not identically match with certificates of deposits maturities funding or interest rate risk exposure
- Razor-Sharp Efficiency Ratios
A bank cost structure is pretty simple. The larger cost is typically personnel and “bricks and mortar” infra-structure. A bank’s efficiency ratio is calculated by dividing its noninterest expenses by the bank’s net income. A low efficiency ratio indicates that the bank is earning more than it is spending. Shareholders and regulators of banks with larger than 50% efficiency ratio should be concerned about the bank’s competitive position, its long term viability and its survivability.
How does a bank maintain a healthy efficiency ratio? A balanced and focused strategy of: (i) a high Relationship to Client ratio; (ii) an ultra-efficient Omni delivery channels; (iii) a low loan loss from a disciplined credit culture as well as a diversified portfolio (CRE and C&I). And yes, a larger fee income base that affords the bank the luxury of turning down “stretch” loans.
Operational Levers
- Customer Focused Relationship Philosophy
The old-fashioned term “Relationship Banking” meant not only intimately knowing the customer’s business, but anticipating the client’s requirements in terms of a balanced credit and non-credit products. The relationship also ran deep to the “top of the house.” where the relationship officer made the “elephant dance,” a quaint term that was defined as “delivering the bank.”
Those banks that serviced and anticipated wholesale clients’ needs with up to date non-credit products and low account officer turnover saw the relationship deepening, the account profitability widening, and a large defensive moat around the client.
- Cordial Relationship with Regulators
A collaborative and cordial relationship with the regulators serves multiple purposes. First, if you/your bank periodically communicate with the regulators, they will not be surprised in case of an unexpected event. Tapping the resident examiner’s or EIC’s knowledge for valuable industry data and trends is not only valuable to the organization, but also helps avoid issues or surprises during the exam. Additionally, regulators could be helpful when a bank is in an M&A mode, since their sign-off will be required. Regulators also reach out to collaborative and well-run banks when a third institution needs to “rescued.” Moreover and if need be, they can make accommodations to bring the transaction to a satisfactory close.
- Up-to-Date Technology, Systems and Relevant Competitive Product Set
Banks that invested in technology and updated systems’ platforms were generally survivors; were able to fend off competitors; had better efficiency ratios, and higher client satisfaction. And while “brick and mortar” service delivery is still important to certain demographics, millennials and others have migrated to mobile, online and electronic banking services offered by FinTech companies’ platforms and better equipped providers. Clients are looking for Omni product delivery channels. These are equally efficient for providers.
- Private Label and Outsourcing
Banking is a cyclical industry that faces head winds every ten years or so. Moreover, community banks’ normal business travails is compounded by two additional factors, a regulatory burden that has shackled them with capital requirements, and was brought on by the 2008 financial crisis. Second, natural inefficiency brought on by their sub-optimal size with banks less than $1Bil in assets shouldering the brunt of these two factors.
The much needed investments in product development and systems require the very capital needed to grow assets and balance sheet footings. A way for the bank to offer existing and prospective clients the latest in technology and products offering is to use private label larger non competing institutions products. Institutions like Vanguard, Fidelity, T. Rowe Price and others are only happy to offer their products to clients in return for non-compete.
Similarly, FiServe, Accenture, IBM offer bank systems outsourcing solutions that not only defrays expensive headcount costs, but heavy CAPEX requirements for state of the arts technology and MIS platforms, to include customer service.
While waiting for regulatory and capital relief, Community Banks’ Boards need to move toward an offensive posture with a process and delivery redesign, and an organizational self-evaluation. Change is unsettling; however, the environment and the ongoing disruption calls for nothing short of “call to action” toward transformational and reenergizing strategies that will ensure the organization will thrive and not merely survive in the face of the current challenges.
Bay Harbor Capital Advisors 