Thursday, December 18, 2014

Banking's Total Return Top 5: 2014 Edition

For the past three years I searched for the Top 5 financial institutions in five-year total return to shareholders because I grew weary of the "get big or get out" mentality of many bankers and industry pundits. If their platitudes about scale and all that goes with it are correct, then the largest FIs should logically demonstrate better shareholder returns. Right?

Not so over the three years I have been keeping track.

My method was to search for the best banks based on total return to shareholders over the past five years... capital appreciation and dividends. However, to exclude trading inefficiencies associated with illiquidity, I filtered for those FIs that trade over 1,000 shares per day. This, naturally, eliminated many of the smaller, illiquid FIs.

For comparison purposes, here are last year's top five, as measured as of December, 2013:

#1.  BofI Holdings, Inc.
#2.  Marlin Business Services Corp.
#3.  Fidelity Southern Corp.
#4.  Eagle Bancorp, Inc.
#5.  Bancorp, Inc.

This year's list is in the table below:

BofI Holdings celebrates its third straight year on this august list. Congratulations to them. A summary of the banks, their strategies, and links to their website are below. 

#1. Open Bank (OTCQB: OPBK)

Open Bank commenced operations in 2005 as First Standard Bank in the Koreatown section of Los Angeles. They are built as a relationship bank serving the Korean community in LA and surrounding areas. It is a significant SBA 7(a) lender, ranking in the top 100 (#54) in the country in that category, ahead of much larger financial institutions like Bank of America. Year to date through September 30th, Open Bank had $4.5 million gain on sale of loans, representing 24% of its total revenue for that period. The lion's share of their growth, profitability, and capital have come since their re-branding to Open Bank in 2010. In June, the bank raised an additional $30 million of common equity, positioning it to continue its strong growth.

#2. BofI Holding, Inc. (Nasdaq: BOFI)

BofI Holdings Inc. and its subsidiary BofI Federal Bank aspire to be the most innovative branchless bank in the United States providing products and services superior to their competitors, branch-based or otherwise. In its latest investor presentation, BofI claims that its business model is more profitable because its costs are lower. It supports the claim by highlighting its efficiency ratio is in the top 2% of UBPR peers, and its operating expenses as a percent of average assets are in the top 12% of peer banks. So, as a branchless bank, BofI has leveraged its significantly lower operating expenses into profit. That profit led to the top spot in five year total return to shareholders, three years running. Well done!


BNCCORP, Inc., through its subsidiary BNC National Bank, offers community banking and wealth management services in Arizona, Minnesota, and North Dakota from 14 locations. It also conducts mortgage banking from 12 offices in Illinois, Kansas, Nebraska, Missouri, Minnesota, Arizona, and North Dakota. BNC suffered significant credit woes during 2008-09 which led to material losses in '09-10, and the decline in their tangible book value to $5.09/share at the end of 2010. Growth, supported by the oil boom in North Dakota's Bakken formation, and a robust mortgage refinance business resulted in a tangible book value per share at September 30th of $17.18... a significant recovery and turnaround story that landed BNC in our top 5 for the first time.

Western Alliance, through its subsidiary Western Alliance Bank, provides comprehensive business banking and related financial services, operating full service banking divisions in local markets as Alliance Bank of Arizona, Bank of Nevada, First Independent Bank, and Torrey Pines Bank. It also has a national platform of specialized finance units in homeowners' associations, public finance, resort finance, and warehouse lending. Its diversified and primarily commercial loan portfolio and a loan/deposit ratio of 91% resulted in a year to date net interest margin of 4.41%. This margin plus a 2.07% operating expense ratio resulted in a YTD efficiency ratio of 47%. That type of financial performance plus picking yourself up from credit problems leads to top 5 total returns for your shareholders. Well done!

#5. Mercantile Bank Corporation (Nasdaq: MBWM)

In June, Mercantile Bank and Firstbank Corporation closed on a merger of equals to form the fourth largest Michigan-based bank by deposit market share. Firstbank traced its roots back to the 1800's, while Mercantile was founded in 1997. As part of the transaction, Mercantile shareholders received a $2/share special dividend prior to closing, shaving off of tangible book value. But the total return story is similar to others on the list. Mercantile suffered through its share of credit snafus, losing a collective $70 million 2008-10, only to recover and negotiate a franchise changing merger of equals. Best of luck on the integration and congratulations for landing on the JFB top 5 total return to shareholders list! 

There you have it! The JFB all stars in top 5, five-year total return. The largest of the lot is $10 billion in total assets. No SIFI banks on the list. What about that economies of scale crowd? Hmm.

The flavor of this year's winners is recovery, with the exception of our consistent top performer, BofI. Congratulations to all of the above that developed a specific strategy and is clearly executing well. Your shareholders have been rewarded!

Are you noticing themes that led to these banks' performance?

~ 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 well.

Tuesday, December 09, 2014

Why Does Kim Kardashian Kick Your Bank's A**?

I have never heard Kim Kardashian speak. I never watched her show. I don't know the family story. I can't name family members beyond Bruce Jenner. Until today, I never searched on her name.

But I know who she is. I know she's pretty. I have heard her claim to fame is an online sex video. I have seen her butt. But not in person. I saw it on a prime time news program. That's right, her derier was featured on a prime time news story.

How has this person turned nothing into significant brand recognition and revenue stream?

By typing Kim Kardashian, and adding her as a label, I just significantly increased this blog post's SEO, or search engine optimization. According to Yahoo, she was the  sixth most popular search during the year. There were no banks in the top 10. If I add her picture, which I am contemplating doing, I would increase my traffic. This is known as "click bait". Put a pretty girl next to any post... be it about fishing or the Victoria's Secret fashion show, and you'll get more clicks, so they tell me.

In fact, when I searched (via Bing) "Washington Trust Bank", a $4.7 billion in asset community bank based in Spokane and founded in 1902, I had 74,900 hits. I did the same for "Wells Fargo" and got 3.4 million hits. Kim Kardashian: 4.3 million hits.

Strategy teams perform a Situation Analysis prior to developing bank strategy, surveying reams of facts to get an accurate assessment of their operating environment. One particular part of a US bank's environment, sadly, is that we are celebrity obsessed. You want to follow Will and Kate, our crack news coverage has you covered. Wonder how far along Iran is in their nuclear program? Good luck.

This became apparent to me when I was speaking to a Washington state banker about his most famous customer, Sig Hansen, the captain of the F/V Northwestern, a crab fishing vessel. Yes, I hot linked to a crab fishing vessel. They have a website, and a pretty nifty one too. How could this be? Because Sig and the Northwestern are front and center on Discovery Channel's Dangerous Catch. Click over to their website and you can buy the coffee Sig drinks. Clearly, Sig's celebrity has aided the cash flow ups and downs typical of a fishing vessel.

How can banks respond to our celebrity obsessed culture? I don't think it is by hiring a celebrity to pitch your bank. Society has grown accustomed to this, and I'm not convinced it moves the needle much. Honda recognized this by enlisting Stretch Armstrong as spokesman for its line of cars this holiday season.

But perhaps we can make a celebrity or two out of our senior executives. For example, I live in Central Pennsylvania, where a credit union uses its CEO in all of its advertisements, billboards, etc. Forget the fact that he wears tights and a cape in most ads. No, seriously, I'm trying to forget that fact. But you get my point. This credit union has made a celebrity out of their CEO, and he is widely recognized in the community.

If done properly, this strategy could leave you exposed to the new celebrity departing the bank, or demanding higher compensation due to their new found status. There are ways to mitigate this risk. Progressive Insurance did so with Flo.

Do you think turning key employees into celebrities would help execute your strategy?

~ Jeff

P.S. I went with Sig Hansen's photo. Not as pretty as Kim.

Friday, November 28, 2014

Bankers: You spend like drunken sailors.

As a former sailor, I take offense to the post title. As if I spent my family's food money on alcohol while on shore leave. I only spent my food money.

But the phrase is synonymous with spending money without direction or regard to consequence. And sometimes, we bankers fall into the trap of not considering our operating expenses as strategic investments.

On December 8th I am speaking at the Northwest Bank Executives conference in Seattle. My topic: Ten Things Banks Should Do, But Generally Don't. One of the ten is "not considering operating expenses as strategic investments".

As an example, let's take an average $1 billion in assets financial institution. The below table was drawn from a peer group analysis my firm performed for a client. Dollar amounts are annual averages for each expense category of 13 financial institutions with an average asset size of $1.0 billion. 

At a time when so many banks are challenged to grow revenues, marketing expenditures represent 2.1% of all operating expenses. And that includes professional services, such as consultants that have little to do with winning the next customer.

Strategically, this hypothetical bank spends $30.4 million per year. Now let's assume you had this thirty mil to execute a strategy to build your bank for a sustainable future. Whatever that strategy may entail, could you not find the resources to fund it?

But we are often bound by legacy. We have seven people in Deposit Ops, and need a new piece of technology or another person and therefore must increase our budget by 7%. Three percent increase in Loan Servicing, and another 5% in IT, etc. etc. etc.

What if you blew up your budget and started constructing an infrastructure, footprint, and employee base hyper-focused on executing your strategy? Instead of 20 branches staffed with six transaction processing pro's each, you need only 16 branches, strategically located, with four higher paid relationship building go-getters per branch. 

This hypothetical bank spends $1.2 million/year, or 4% of total operating expenses, on data processing (not including personnel). Can we allocate that sizable chunk into core and ancillary systems specifically designed to serve our core customers, as per our strategy, in a superior fashion to the financial institutions that spend wide and far to satisfy every constituency? Perhaps we should recognize the importance of the digital distribution system and appoint the appropriate executive to be its champion. 

As McKinsey director Somesh Khanna states in an interview titled "The Bank of the Future" on who should drive the digital strategy in a bank...

"I actually think that it’s less dependent on the role. It’s much more dependent on the person. If the person is someone that is able to visualize a future, get the organization rallying around a bunch of different objectives, and inspire people to actually pursue that path, it’s their real leadership capabilities that’ll come to bear to pull off digital agendas."

So you build your digital strategy around such a person, allocating an appropriate slice of the budget pie to develop your bank of the future for the benefit of your constituencies. Or is our digital strategy champion hyper-focused on installing ATMs that are ADA compliant?

I am not proposing an academic exercise. I am proposing considering every dollar you spend as an investment. And you should invest in your strategy, not your legacy. 

Can we shake our budget mentality, and view our operating expenses as investments into the bank we want to become? I hope so.

~ Jeff

Wednesday, November 19, 2014

Why are start up businesses not creating jobs?

I posed this question to a Fed economist today. Her answer: lack of capital.

The above chart is from a Federal Reserve Bank of San Francisco Economic Letter: Slow Business Start-ups and the Job Recovery published in July.

But in strategic planning retreats that I moderate, community financial institutions insist that they lend to small businesses. In fact, when I recently spoke to a group of New York bankers, I opined that community FIs would lend to small businesses only if they have three years of operating profit and a building as collateral. Some took offense.

The chart above, taken from a Harvard Business School Working Paper: The State of Small Business Lending written by a former SBA Administrator and also published in July, shows that only 34% of small businesses use a regional or community bank as their primary financial institution. The second chart shows the primary sources of capital. Yes, a loan is the most often cited. But trade credit and credit cards also weigh in heavily.

The above chart, taken from the same HBS working paper, shows the use of proceeds of small business credit. Given a community FIs lending proclivities, one would assume that small businesses borrow to finance a building. But no, the primary use of proceeds is for cash flow. Real estate structuring is pretty low on the list.

I discuss this disparity between how bankers perceive they contribute to small business capital formation, and why businesses need capital. In March 2010, I wrote about the decline in business lending among community financial institutions in a blog post titled: Have we checked out of business banking?

So we limit small business lending to those businesses with three years of operating profit and have real estate as collateral. Not exactly lending into the industries that are projected to grow, such as service firms and professional/technical practices. These businesses are commonly located in an office building that they do not own. 

Another challenge is the number of businesses that do not borrow. According to the HBS working paper, only 40% of small businesses apply for credit. Out of the forty percent, 43% did not receive the credit they requested (see chart). 

So let's extrapolate... eleven percent of small businesses borrow for real estate structuring and another 13% for debt restructuring. But only 40% of small businesses borrow. So 40% of 23% is 9.2%. But only 43% get approved for the amount of loan they requested. So about 4% borrow for real estate or debt restructuring and get the credit they requested. But only 34% of small businesses bank with regional and community banks. 

So for 1.35% of small businesses, community FIs stand ready to lend!

Of course, I exaggerate, because many small business loans used for cash flow, inventory, etc. are collateralized by a commercial or residential building and financed by community FIs. But I think our participation in small business funding is far smaller than we claim.

So if we want our communities to thrive now and into the future, small business formation and growth will be critical. Lack of capital is always a top of the list constraint to small business success.

Are we participating in this critical segment of our economy?

~ Jeff

Sunday, November 09, 2014

Ever test the theory that acquiring banks is good? I did.

Every strategic planning retreat has its own flavor. This one particular retreat included a parade of investment bankers conveying the virtues of deal making while the audience of senior bank executives and board members nodded their heads in unison and solidarity.

One question that was unasked was whether it is better to seek acquisitions or go it alone. The conventional wisdom being that doing deals is better than not doing deals. I didn't know the answer, and figured asking an investment banker the question would be like asking a Beverly Hills plastic surgeon if it was better to do a little nip-and-tuck or let nature have its way. (Disclosure: I am also an investment banker, but don't like to admit it at cocktail parties. I am not a plastic surgeon.)

So I went to the spreadsheets. It always comes down to the spreadsheets. The operative question was does doing deals result in better financial performance and total return than not doing deals?

First I had to create some criteria to control for some variables that impact total return and financial performance greatly, such as bank size and asset quality. So I chose publicly traded financial institutions between $1 billion and $20 billion in total assets, with non-performing assets to assets of less than 2%.

I then divided the group into two, deal makers and non deal makers. Deal makers did two or more merger deals for whole institutions since 2010. Non deal makers did one or no deals. There were 46 deal makers and 173 non deal makers. A decent sample, in my opinion.

Their Return on Average Assets and Average Equity performance, at the average, were as follows from 2011 to present.

Deal makers had a better ROA year-to-date: 0.96% versus 0.90% for the non deal makers. But non deal makers had a better ROE: 8.57% versus 8.47% for the deal makers. This may be why you hear so many deal makers talk about return on tangible equity (ROTE) in their earnings conference calls. Better to ignore that goodwill they keep building on their balance sheets as a result of paying premiums for selling financial institutions. Because for ROE, it looks like non deal makers take the brass ring.

And what about three-year total return? Deal makers delivered 73.97% to their shareholders. Non deal makers did better... 75.56% on average.

Does your FI pursue acquisitions? If so, have you tested the conventional wisdom that doing deals is better than going it alone?

~ Jeff

Friday, October 24, 2014

Guest Post: Third Quarter Economic Commentary by Dorothy Jaworski

The Bond Guru Switches Teams
The surprise of September was the abrupt departure of the Bond Guru, Bill Gross, from PIMCO, the company that he helped found forty years ago.  Shock went through the bond markets, especially at
PIMCO, who found out about Gross’ exit along with the rest of us.  Between the September 26th surprise announcement and October 2nd, investors pulled nearly $24 billion from PIMCO funds and ETFs.  There is no way to know exactly how much money will ultimately move and land with Bill at Janus Capital, his new home.  And he doesn’t even have to stray far from the beautiful beaches and leisurely lifestyle of Newport Beach, California, because Denver-based Janus is opening an office in Newport Beach, California.  How about that?

She’s Getting Better at Press Conferences, But
The Federal Reserve has let the talk of rising interest rates hang over the markets like a fog.  We have seen several restless Fed governors, who keep dissenting to the Fed’s statements on policy to keep rates low for a “considerable time.”   Many in the markets thought that the Fed would drop these words from the September statement because they act like a promise to the markets, but the Fed retained them.  Following the meeting, Janet Yellen gave her press conference.  She was repeatedly asked about the words and their meaning and she kept saying over and over again that the Fed’s moves are “data dependent.”  She was not very convincing.  She could have said that returning to “normal” is taking longer than expected and the market projections that rates will rise in the middle of 2015 is about as good as any right now.  Markets build in assumptions for short term rates and this impacts long term rates, of course along with inflationary expectations.  She could have used some coaching to reassure investors.

Growth and Inflation
One would have to question a Fed that would raise rates when the US economy is the only one of the four largest world economies that is displaying any growth, albeit at a very slow 2%.  China, Japan, and Europe are all struggling.  Remember that we are five years in this recovery and we are only managing 2.2% average growth, compared to 4.6% after the prior ten economic recoveries.  Inflation is falling along with many commodity prices (except for gas prices, but I digress).  In China, consumer price inflation is -2.0%, in Europe, it is +1.0%, and here in the US, it is +1.7%.  It would not be unprecedented for the Fed to raise rates with falling inflation, as happened in 1994, but it would be unusual and fairly shocking.

Geopolitical tensions abound in the Russia-Ukraine conflict, Syria, Iraq and a US led group of allies fighting against the evil that is ISIS, and the Israel-Palestinian fighting.  The threat of the spread of Ebola is increasing tensions as well.  This is not an environment that screams for rates to rise; reality may be quite the contrary.

The Unemployment Rate
Much of the fear of Fed tightening springs from the decline in the unemployment rate to the Fed’s “goal.”  For the month of September, the unemployment rate fell to 5.9%, within the NAIRU band quoted by Fed Chair Yellen in her press conference.  NAIRU, or the non-accelerating inflation rate of unemployment, is the unemployment rate below which inflation will rise.  Oh, Phillips curvers, where have you been?

I have a couple comments when I look at the drop in the unemployment rate over the past two years.  First, the drop has been caused more by workers dropping out of the labor force than from job creation.  Job growth has established itself at an average above 200,000 per month, which is fairly good, but well below the pace of other recoveries when the economy was so much smaller.  The labor force participation rate has dropped to 62.7%, the lowest since 1978.  It is not just retirees lowering the rate, but it is young people, too.  Those Not in the Labor Force now total 92.6 million, which is a record.  Many of the jobs created are lower level or part-time, so wages are not rising dramatically.  I cannot believe that productivity will benefit from the structural shifts that we are seeing in employment and I believe we will continue to see sub-par growth in GDP.  I saw this quote on Bloomberg in September and it resonates:  “The economy always appears stronger if you ignore the weakness.”

Speaking of productivity, we are in the midst of another period where we will pour trillions of dollars of our precious earnings into protecting our computer systems and networks from the scourge of hacking.  I have listed this as a risk to the economy in the past but I didn’t realize the extent to which cybercrime would reach new heights.  The evidence was revealed by JP Morgan in the first week of October.  Hackers got into their bank systems and stole names, addresses, and email addresses (but supposedly not account data) of 76 million households and 7 million businesses.  No system is sacred anymore.   Witness the Acme announcement of a major hack at their stores recently.  We are just getting over Home Depot’s admission of 60 million credit and debit card numbers being stolen over the course of months, eclipsing Target’s data breach.  So, nothing is sacred online.  The complete waste of time and money is an ever-increasing drag on GDP.  Add this to the purported estimates of regulatory costs of $1.86 trillion on our economy, and 2% growth seems like a gift.

Our Bank’s Senior Vice President of Deposit Operations and Information Technology, Karen Shinn, knows all too well the risk and costs of these breaches to banks.  She works continuously with our vendors and has implemented fraud detection tools to protect our customers’ debit cards.  But customers can work closely with the Bank, too, by being vigilant about their personal information and by notifying us right away about any unusual activity.  Hacking prevention and network protection expenses will continue to filter into the costs of every company.  Maybe this will be the inflation that the Fed and ECB so desperately desire.

Last Word
Dr. Charles Plosser, President of the Philadelphia Federal Reserve, recently announced his retirement as of March, 2015.  Thank you for all that you have done for our Philadelphia region over your years here!

Thanks for reading!  10/09/14

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. She is the author of Just Another Good Soldier, 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.

Friday, October 10, 2014

vBlog: How to break down organizational silos in financial institutions

There are a number of challenges that nearly every financial institution faces, in my experience. Regulatory over-reach, check. Compliance woes. Got it. Branch under-utilization. Ditto. 

One such omnipresent challenge is how to blow up thick-walled organizational silos to serve the customer well over several banking and neo-banking disciplines. The below video highlights some of my ideas on how bankers can break down barriers to win more of their customers' business.

What are your ideas?

~ Jeff

Note: Here is the YouTube link of the above video in case you can't view it in the Blogger application.

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