Much Maligned Banking Business Model: Lean and Mean

Does your financial institution pursue a relationship driven strategy? If so, you would be in the majority for community FIs. If not, you are much maligned.

In my last post I identified five things I don't understand. One was "Our Money Is No Different Than the Bank Down the Street". I discussed my confusion as to how bankers could believe this and still pursue a more expensive relationship driven strategy. Instead, why don't you get lean and mean?.

I discussed this with bankers I met at the Pacific Coast Bankers School, where I am currently serving as a Faculty Fellow. As an aside, I'm still not sure what that means, except I go to class to form an opinion about the school and its subject matter. But I digress.

The bankers here did not have an appreciation for the business model of a California bank, who shall remain nameless, that sports a near 1.50% ROA, and trades at over 3x tangible book and 18x earnings. The model, is designed to be highly efficient, having an efficiency ratio in the mid 40's and an expense ratio (non-interest expense/AA) at about 2.3%. In other words, this bank is cheap.

If my experience is any gauge, most community FIs choose a more expensive business model, the relationship driven model. This strategy typically delivers a higher net interest margin, because customers won't dump you at the slightest price variation, and is more expensive as the FI invests heavily in relationship managers and high touch service.

But what does the market think of the two models?

I took a look at publicly traded FIs between $1B-$10B in assets, that had ROA's greater than 1%. I controlled for fee income businesses, as high fee income FIs skew the ratios significantly. So the FIs had to generate less than 30% of total revenue in fees. The criteria delivered 61 FIs. I then split them up into top and bottom quartiles based on the expense ratio. The results are in the table below.

Although community FIs choose the higher expense ratio, higher net interest margin strategy, the markets currently reward the more efficient FIs with higher trading multiples. 

This does not make Porter's "low-cost" model superior, as it calls into question the sustainability versus the "differentiation" strategy, especially for community FIs that lack the scale of our largest banks. But I think it's time to get off of our high horse and recognize, as Michael Porter did, that the low cost model is an option.

Any thoughts on low cost versus differentiation?

~ Jeff 

Book Report: HBR's 10 Must Reads on Strategy

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.