Banking Is Not Small Business Saturday

The holidays are upon us and the public relations blitz is on so we patronize small businesses for Christmas shopping. Why? Do small businesses have a unique value proposition that larger stores do not? Or are we relying on nostalgia and some David versus Goliath goodwill to drive us into the arms of local shops?

I have news for you. The latter is a failed business idea. For example, in my town, we have two relatively small lumber yards only because the NIMBY's kept Lowes out. If Lowes secured the necessary permits to open shop, bye bye small lumberyards. So the local owners think they perpetuated their business model by keeping out a competitor. How about offering something customers value greater than price, Mr. Lumberyard Owner?

Walk into a Lowes, and you are overwhelmed with the selection, and probably have difficulty finding somebody knowledgeable to help you with what you need for your project. If somebody does help you, there is often a line of people waiting for that worker's attention. Why doesn't the local owner differentiate there? But no. My wife refuses to go to one of the lumberyards because the workers' treat her like she doesn't know what she's talking about. In other words, they chose not to deliver something valued by customers. 

Are we that much different in community banking? Do we rely on some "feel-good" marketing message to drive customers to us instead of Wells Fargo? Do we hope that George Bailey will deliver us from irrelevance? Why should customers bank with you instead of the omni-present Bank of America? Because I got news for you... they haven't. The top 50 banks in the USA, less than 1% of all banks, boast 76% of all banking assets. 

The people have voted, and community banks are losing.

Why? Because we have difficulty answering the question "why bank with us"? Sure, we'll come up with some answer that says "service" or something intangible and, apparently based on the facts, unnoticeable. But have we really identified what differentiates or can differentiate us from the big boys, and built the systems, processes, and people around delivering on that promise?

Or do we keep telling ourselves in management meetings that we have better service than them, and then break into a loan committee meeting to lower our price or terms on a commercial real estate deal we're trying to win from PNC?

Don't rely on your own Small Business Saturday so customers bank with you because they are sympathetic for you.

So I ask you: why bank with you?

~ Jeff


Note: After penning this post I read an article about Small Business Saturday that said $68 of every $100 spent in local small businesses was re-spent in the community. For chain stores and online stores, that stat was $48 and $0, respectively. So there's a good part of the story to build on, in addition to creating a value proposition that customers care about. Also a good lesson for community financial institutions. How much deposit money is re-invested locally compared to the big boys? Don't forget about the in addition to...

Bankers: Are We Accountable?

Twenty years ago there were 14,000 FDIC-insured financial institutions. Today that number is cut in half. The reasons are many. And yes, some are beyond our control such as population mobility, technology, and the need for some scale to invest enough to remain relevant. But, as my one-time Division Officer, Lieutenant Proper, once told me: "Be careful pointing your finger, because the other three are pointing at you."

I recently made a presentation to staffers and advisers to the Pacific Coast Banking School (PCBS) regarding what I would change in the curriculum. My theme was that if we keep teaching bankers the same things, and expect different results (i.e. not cutting our industry by half), then we are insane. I don't think I'll be invited back.

Banking is an industry that is particularly susceptible to external forces such as interest rates, business and consumer confidence, and the economy (both local and national). So if things go wrong, there is plausible deniability as to what or who is responsible. Strange that when things go right, it's difficult to find plausible deniers. But I digress.

Because of the external forces that impact results, it is typical to gravitate to holding ourselves accountable to things under our direct control... i.e. our expense budget. Volumes and balances... not my fault, there's no loan demand. Margins... not my fault, the irrational competitor down the street is being too aggressive. Profits in fee based businesses... not my fault, soft insurance market.

I find this when analyzing client profitability reports. Nobody wants to absorb the costs of support centers, such as HR, IT, and Marketing, or overhead centers such as Finance or Executive. Hold them accountable for their direct profits, because that is what they can control. It reminds me of Louisiana Senator Russell Long's quip in the 1950's... "don't tax you, don't tax me, tax that fella behind the tree." I suppose if nobody finds value in support centers to the point they agree to pay for it, we should eliminate those costs.

I think the answer to move our industry forward by establishing an accountability culture is to identify a few, transparent metrics that are consistent with strategy that hold managers accountable for continuous improvement. To overcome macro-economic factors, use trends and comparatives. For example, if you hold branch managers accountable to continuously improve their deposit spreads, compare them to the average and top quartile deposit spreads of all of your branches. The result of this accountability should be continuous improvement in your bank's cost of funds compared to peers. But instead of managing at the "top of the house" (i.e. bank's total cost of funds), we burrow down to the managers responsible for generating funding.

But since there is some art and science that goes into developing management information to establish accountability at the ground level, those managers that don't shine will frequently lob darts onto the results. But bankers that are committed to identifying and executing on a strategy that differentiates them from the remaining 7,000 FIs, should identify the metrics that correlate to successful strategy execution. 

And when managers challenge the message to dilute their accountability, senior leaders must be exactly that...

Leaders.

~ Jeff

Bankers: What is the value of your strategy?

A colleague and I recently had a healthy discussion about what agenda items to include at strategic planning retreats. He was strongly in favor of showing summary level financial projections for "business as usual" at the financial institution. Showing value creation, or erosion, from doing the same things you have been doing will highlight the need for staying the course or strategic change, in his opinion.

He is right. So often we get bogged down in philosophical debates on what to do about branches, technology, loan growth, expense control, and yes, vision, that we forget that whatever strategic direction the group decides should find its way, long term, to the FIs bottom line to increase the value of the franchise.

It does not matter if you are a stock held bank, mutual bank, or credit union. Your strategic direction should increase the value of the franchise, whether you measure aggregate value (mutual, credit union), or shareholder value (stock bank). Why would you initiate strategic change if it doesn't result in increased value? Even the non-stock bank/CU wants to live another day. Perhaps their Boards of Trustees have a lower capital appreciation hurdle. But doing nothing and eroding the value of the franchise is a sure sign that you will not have the resources or relevance to continue serving your other, non-shareholder constituencies into the future.

So what is enhanced franchise value? Since I have been involved in banking, investors focus on two metrics: price/earnings and price/book. The market places a multiple on these metrics. For example, I used Tompkins Financial Corporation's core earnings per share in the below table. The market currently values TMP at 14.8x earnings. Assuming the market continues to value TMP at 14.8x, you can arrive at the per-share valuation of the stock. For you non-shareholder owned institutions, use an industry p/e and apply it to your aggregate earnings to come up with your franchise value.

The projected business as usual eps grew at a compound annual growth rate (CAGR) of 5.4%. The Board may have determined that this was not enough. So strategic change must take place. After debating strategy and what success would look like in executing strategy, the bank was projected to increase earnings at a 10.4% CAGR. The Board's expectations on capital appreciation was 8%, because the bank's dividend yield was 3.32%. This would equate to a shareholder total return of 11.32% (8% capital appreciation plus a 3.32% dividend yield). The strategy, therefore, is projected to increase the value of the franchise.

Now, my firm does not serve TMP so the above numbers are only hypothetical. Except that I used actual core eps from 2007-12 for the business as usual row. I also have no inside information on what the Board of TMP expects in capital appreciation or total shareholder return. I only use the above as an example.

But in the throes of developing strategic direction, and the future of your bank, is it not important to demonstrate, in financial terms, what success would look like and how it adds value to business as usual?

What are your thoughts?

~ Jeff

Note: Even though my bank stock portfolio is currently making me look like an investment genius, mostly because of industry-wide price performance, I make no investment recommendations in this blog, or anywhere for that matter. You should not invest in any security based on what I type on these pages.

Bank M&A: The Concept of Relative Valuation

It depends. How often do advisers such as doctors, lawyers, accountants, and yes, investment bankers say that? Asking if an offer to buy your bank is a good one depends on numerous factors, as investment bankers' fairness opinions state in excruciating detail.

What value a buyer ascribes to your institution does depend on many things. One key factor, though, is the buyer's currency. More specifically, where the buyer's stock is trading on a price/book or price/earnings basis.

Let's look at two deals.

Deal 1: FNB Corporation (NYSE: FNB) of Hermitage, PA, buying BCSB Bancorp (Nasdaq: BCSB). 

Deal 2: 1st Constitution Bancorp (Nasdaq: FCCY) of Cranbury, NJ buying Rumson-Fair Haven Bank and Trust (OTCQB: RFHB) of Rumson, NJ.

According to the table, BCSB received a higher valuation. Or did it? 

At this writing, FNB trades at 255% of tangible book value per share, and 14.6x earnings. 1st Constitution, on the other hand, trades at 101% of tangible book, and 10.5x earnings. So, although the nominal value paid for Rumson-Fair Haven by 1st Constitution is less than what FNB paid for BCSB, it appears from the table that Rumson-Fair Haven shareholders got the better deal, all other things being equal.

Assuming there is not tangible book dilution or earnings accretion (which we know is probably not true, but most of the assumptions to show dilution/accretion are unknown to us), Rumson Fair-Haven shareholders are set to receive a 37% pickup in tangible book value and 224% pickup in EPS. BCSB shareholders are set to increase EPS 252% but will also incur tangible book dilution of 33%.

The valuation differences between the buyers probably explains why FNB is paying the transaction consideration in stock, and 1st Constitution is trying to use as much cash as possible while still qualifying for a tax free exchange for selling shareholders that elect to take 1st Connie stock. 

So, when evaluating what buyers would be willing to pay for your institution in a merger, you should also consider the value of the consideration received. Just because a buyer can pay a higher nominal value, doesn't make it a better deal.

~ Jeff

Bank Shareholders Are Only One Seventh of the Equation

I am guilty. Guilty of elevating increasing shareholder value to Napoleonic heights. I annually rank the top five financial institutions by total return to shareholders. I write about developing a strategic plan that results in financial returns that satisfy shareholders. I confess, I contributed to the notion that the shareholder matters above all else.

But many, if not most state business corporation laws don't agree. Take my home state, Pennsylvania, Title 15, Subchapter B Fiduciary Duty, Section 515 Exercise of Powers Generally...

"In discharging the duties of their respective positions, the board of directors, committees of the board and individual directors of a domestic corporation may, in considering the best interests of the corporation, consider to the extent they deem appropriate:

(1)  The effects of any action upon any or all groups affected by such action, including shareholders, members, employees, suppliers, customers and creditors of the corporation, and upon communities in which offices or other establishments of the corporation are located.

(2)  The short-term and long-term interests of the corporation, including benefits that may accrue to the corporation from its long-term plans and the possibility that these interests may be best served by the continued independence of the corporation.

(3)  The resources, intent and conduct (past, stated and potential) of any person seeking to acquire control of the corporation.

(4)  All other pertinent factors."

So, as I read (1) above, shareholders are certainly in the mix of parties impacted by a board decision. But so are members, employees, suppliers, customers, creditors, and communities of a corporation. I don't think the order in which the law was written constitutes a ranking. As I read it, and mind you I've never passed the bar, all constituencies have equal weighting.

Shareholder held banks are not not-for-profits. They make money to grow, be safe and sound, invest in personnel and technology, give back to their communities, and yes increase the value of their franchise for shareholders. Boards should be mindful that profits are as much for other interested constituencies as the shareholders. In other words, to a board member, hearing an employee say "I love working here", a customer say "I love banking here", should resound similarly to a shareholder saying "this is a great investment".

Banks used to be owned primarily by retail investors. As the industry consolidated, banks became larger, and retail investors became weary due to the financial crisis, institutional owners filled the breach. These investors care little about the employee that loves to work there, or the customer that raves about extraordinary service. Well, they do care if it ends up dropping more money to the bottom line that can be returned to shareholders in some fashion.

Institutional shareholders are much stronger, and more concentrated and vocal advocates for shareholder returns than the retail shareholder, who once took pride in investing in the local bank. Just because they are louder, should they be at the front of the line? Or should we all read our respective state's business corporation law on fiduciary duty of directors?

~ Jeff