Jim Kleinfelter, President and Senior Consultant
No need to sell if you don’t want to—that’s what I often tell banks during strategic planning sessions. There are still a variety of reasons banks have chosen to sell. In some cases, the sale of the bank was planned, but in many cases the reasons for the sale were not due to planning. Reasons for un-planned sales include: profitability problems, management concerns, regulatory difficulties and concerns over new regulations, technology issues, and competition. Regulatory fatigue or persistent poor earnings don’t have to be a reason to “give up the good fight” and sell your bank.
Keys for Survival
We believe that the four key actions that community banks can take to plan for their survival remain unchanged. These actions are:
- Maintain a focused strategic plan.
- Provide a great place to work.
- Focus on shareholders.
- Practice broad and specific risk management.
These actions are not in conflict with each other; in fact, they are very complementary. Every day, successful bank managements and boards of directors work to address these areas and the various factors associated with each. The following summarizes our thoughts on what factors require attention to assure that banks are in the position to control their own destiny.
Maintain an Effective Strategic Plan
Assess products and services
- Develop a clearly-defined mission
- Conduct a thorough and unbiased assessment of financial performance, focusing on both strengths and weaknesses
- Conduct a thorough and unbiased assessment of management and staff strengths and weaknesses
- Use this information (above) to understand risks and opportunities.
- Develop realistic financial projections (but don’t be afraid to set some stretch goals)
- Evaluate capital management strategies
- Plan for employee training and development
- Consider growth opportunities
- Expansion, acquisition, or partnering
- Measurement of profit contribution
- New product offerings
By steadily executing your strategic plan and communicating your vision with all stakeholders (especially employees and shareholders) on a regular basis, the resistance to any needed change will be lessened.
Focus on Shareholders
The focus on shareholders, in broad terms, should include:
Management of Risk
- Addressing fiduciary duty to shareholders
- Comprehending shareholder expectations
- Understanding market value factors
While effective risk management can seem expensive, it is our opinion that long-term effective risk management will serve all stakeholders well and provide the overall return. While the relative importance of each of the following areas of risk change from time to time, they must all be managed effectively:
- Regulatory risk
- Operations risk
- Interest rate risk
- Credit risk
- Liquidity risk
Our analysis of strong, independent banks shows that those who have the most consistent earnings and consistently manageable classified assets avoid overreaching and lead, not follow, and have fewer issues over time than those banks that react to the latest crisis or trend. The question becomes, while the liquidity concerns of a few years ago seem to have abated and most banks have gotten a handle on asset quality issues, are community banks prepared for life after high provisions for loan and lease losses and the end of banks being awash in deposits? In recent years, the community banking industry has been preoccupied with asset quality and regulatory compliance (as it should be), but what additional steps do we need to take now to ensure a return to strong and sustainable earnings in a soft economy?
What if the situation in which we find ourselves is the new normal? We find ourselves being in the position of almost wanting to turn away low-cost deposits, because investment yields offer virtually no prudent option for putting even the lowest-cost deposits to use. We will admit that loan demand is certainly not robust; but even at the current level of economic activity; there are still opportunities to originate earning assets at rates and risk that are acceptable to almost any community bank. For many community banks, it will involve a somewhat different way of thinking, additional training, or partnerships with non-competitors. With the “think local” movement gaining strength, and the terrible public perception of large financial service providers, there has seldom been a better time to take market share from our larger competitors while lessening interest rate risk. We have gained market share on the deposit side of the balance sheet; now is the time to seize the initiative and do the same thing on the earning asset side of the balance sheet. While the following ideas may not work for all community banks, we suggest considering all or some of the following:
- Retaining or gaining larger loan customers by selling loan participations to other community banks while still managing credit risk
- Using SBA or USDA credit enhancements to increase in-house lending limits while lowering credit or interest rate risk
- Participating in the National Shared Credit Program on credits that you can analyze and understand
- Smart pricing of commercial and Ag ARMs to balance interest rate risk against earnings (only after fully understanding your bank’s appetite for less rate-sensitive assets)
- Acquiring expertise in lending areas that you currently lack
As many banks painfully learned over the last few years, no one type of lending is a panacea for long-term higher yields and high asset quality. As we all know, a more balanced loan portfolio can improve both risk management and long-term earnings. Obviously, you must have the expertise to understand and manage any loan made in your bank, but acquiring this expertise may be more feasible than you think. Conversations with your regulator before embarking on any strategy is always smart.
In many cases, community banks may lack the resources or expertise to address all of the factors we have noted. Young & Associates, Inc. was formed over 33 years ago specifically to serve as a resource to community banks to supplement their internal capabilities. We have worked with many community banks over the years to assist them in planning and implementing strategies not only for survival, but for long-term success. Even if we can’t always help you directly in one of the areas mentioned, we can direct you to someone whom you can trust to do so.
There are reasons causing some banks to sell and for others to be buyers. We do think, however, that community banks have the choice to remain independent and to be successful. Those who focus on the factors noted have greater control over their future than those who do not.
For more information on our Strategic Planning services, please contact Jim Kleinfelter at 1.800.376.8662 or click here
to send Jim an Email.
Gary J. Young, CEO; John Fahrendorf, Executive VP, Western Region
Everyone knows of the need to stress the loan portfolio, and the need to stress the interest-rate risk. Recently a third stress test was added with a Financial Institution Letter regarding stressing liquidity. This article relates to a fourth stress test that most banks should perform in this uncertain economic environment – stressing capital. This should be done even though it is not a requirement.
The definition of a well-capitalized bank is clear for most banks – 5% tier-1 capital, and 10% total risk-based capital. There are other factors, but this fits the definition for the average under $1 billion bank. Confusion can occur since the regulators can demand a higher level based on their opinion of bank risk. This brings to mind the real definition of FDIC – Forever Demanding Increased Capital
. But, we must understand that as the economy improves, the pressure is on increasing capital ratios not decreasing them. Chairman Bernanke added to this opinion when he mentioned that banks need to increase capital in good times so that they have it for the bad times. While I don’t believe the definition for well-capitalized will change, I do think regulators will push banks to increase capital levels.
Projecting future capital and its implications are a critical component of strategic planning. If a bank has too much capital, shareholder value is reduced. If a bank has too little capital, the bank takes on undue risk. The strategic part of the discussion is to decide the appropriate amount of capital at your bank, or how you define capital adequacy.
It is relatively easy to project the future tier-1 capital ratio. It is a function of profitability, asset growth, dividends, and other one-time events on capital such as a stock repurchase. When you have the projections completed, it is suggested that you stress capital by assuming a drop in income. It doesn’t matter what the cause. How does your bank look with respect to capital adequacy under a stress to capital? Further, what are contingencies that will be implemented if the bank does not maintain capital adequacy? It is always best to consider these issues prior to an event that causes the problem. This should become a part of your strategic plan.
In the relatively simple case below, Community Bank is in relatively good shape with capital in the Base Case scenario. Capital remains above 7.5 percent, and earnings are positive, although weak. However, when capital is stressed with an additional $4.0 drop in net profit in 2011, a $3.0 drop in 2012, and a $2.0 drop in 2013, the tier-1 leverage ratio drops quickly. If Community Bank defined capital adequacy as a 7.5% tier-1 capital ratio, the stress creates a problem. The contingency would be implemented if the stress condition becomes reality. While Community Bank is in no danger of a catastrophe, the bank would realize heightened regulatory oversight. The capital component would be downgraded; the earnings component would be downgraded; if the loss was due to asset quality, that component would be downgraded; and the management and liquidity component could also be downgraded. It is best to establish an effective contingency prior to this possible event.
You are encouraged to add capital stress and a capital contingency to your next strategic plan. It will provide increased oversight for the board, a plan for management, and positive points from regulators. We recently completed a strategic plan for a smaller community bank in the Midwest that included a capital stress. That bank received a positive comment from the regulators for being proactive in exploring future capital needs. While banks will receive positive comments now, it will soon be a requirement.
Stressing capital provides a look at the bank in a worst-case scenario. When a capital contingency is built around this capital stress, your bank will have a realistic plan for dealing with the unknown.
For more information, contact Gary J. Young at 330.283.4121 (cell) or click here
to send Gary an Email.
James E. Kleinfelter, President
I sincerely believe that every bank could improve performance with an effective strategic plan. But, the cost to smaller banks makes it very difficult to engage a professional facilitator.
Young & Associates, Inc. has solved this problem.
We have developed a planning process for under $100 million banks that significantly reduces our cost, which we can then pass on to the client. This reduces the professional fee to approximately $5,450, and also significantly reduces or nearly eliminates out-of-pocket expenses. With this approach, the smallest bank can afford to have the leaders in strategic planning assistance, Young & Associates, Inc., assist in developing an effective strategic plan that will meet the needs of the bank and regulators.
While we will use a methodology that focuses on the unique needs of your bank, the process will include the following steps:
- The lead facilitator will have a discussion with the president to develop a detailed situational analysis.
- We will request current balance sheet, income statement, budget, and other pertinent data from the bank.
- Our bank analysts will analyze bank data and pertinent peer data from the Uniform Bank Performance Report and other material from our database.
- The analysts will then develop a Peer Analysis with historical graphs. In addition, a five-year projection will be made that reflects future net profit, capital, ratios, and most importantly, shareholder value. This program also provides the ability to project the impact of expansion, stock repurchase, debt, or new stock issues.
- After a thorough review, your facilitator will develop an outline of primary talking points.
- These talking points will then be discussed with the bank president or a small planning committee from the bank. This could be done at the bank or via telephone conference. If done by telephone, out-of-pocket expenses can be nearly eliminated.
- The facilitator will then write the plan as a draft, which will be E-mailed to the bank. After bank input, corrections or changes will be made, and a second draft will be E-mailed. This process will continue until the finished project is approved.
- The strategic plan is then bound and sent to the bank.
We are very excited about this new program and pleased that we can offer professional strategic planning assistance to smaller banks in a cost-effective manner.
If you would like to discuss this service, please contact me at 1.800.525.9775 or click here
to send an Email.
Gary J. Young, Chief Executive Officer
I have had the pleasure of working with numerous community banks across the country in developing a strategic plan. In almost every case, I have found that bankers have established goals that (1) realize a reasonable return for their shareholders, (2) serve the banking needs of customers in a friendly and efficient manner, and (3) provide employees with a comfortable and rewarding place to work. While the objectives, strategies, and/or tactics are often different, the three points mentioned above, in varying degrees, are always present.
It has become clear that there are certain principles that often determine the success of the strategic plan, and more importantly, the bank.
The 10 principles of strategic planning are:
1. There is no value in a strategic plan. Value is achieved when the plan is implemented to the benefit of the bank. Therefore, value is in the implementation not in the plan itself. Too many planning retreats focus on the wish list of what the bank would like to accomplish. However, without a clear plan regarding who is going to do each item, with what resources, and when it will be accomplished, most items on the list won’t be completed. You will have a good strategic plan that has no value. Furthermore, participants lose confidence in the process, which of course is a negative. By focusing on implementation, you will develop a plan that adds to profit and shareholder value (see point 2).
2. Shareholder value is king. I sincerely believe this. I know that taking care of customers, employees, and the community is important. But in many, if not most, situations, without shareholder value, it is a matter of time until the bank is sold. If shareholders are well cared for, you have the opportunity to continue the good work of serving customers, employees, and community. I have yet to see a bank sell because it couldn’t meet the needs of customers. When planning, examine the impact of decisions on value. Remember that an increase of $100,000 in net income improves shareholder value by $1,300,000 assuming a 13 price-earnings multiple; that core deposits have more shareholder value than Federal Home Loan Bank borrowing; that a diversified loan portfolio has more value than a heavy concentration in the portfolio; that branches provide value in addition to the net income generated, etc.
3. A strategic plan is not about predicting the future, but making the future. If you believe that you must be able to predict the future to complete an effective strategic plan, forget it. It can’t be done, at least not effectively. A strategic plan assists you in making the future. That’s why I like to ask plan participants, “If you could plan the perfect future for your bank, what would it look like or be like in five years?” The goal is to then build strategies and tactics to deliver the consensus of that perfect future. Of course, there will be deviations from which a change in course will be made. We call that good management, and it is why the plan needs to be a living document, and a plan that is reviewed regularly.
4. There is no one best plan for every bank. I have seen successful banks run in an extremely conservative manner and in an extremely aggressive manner. There is never one best way. Whatever the strategy, I can give you an example of a successful bank that took a different position. The key is to have a consensus in strategy that exists between the board of directors and senior management. I don’t mean that there needs to always be agreement on issues, but there should be agreement on the basic core values that lead to direction. If you read in a banking publication something that infers that all good banks are doing this, but it is opposed to your core values, don’t do it.
5. Goals must match infrastructure. This seems very basic, but it is often overlooked. Simply stated, do you have the operating systems, physical space, capital, and people to achieve your goals without adding an inordinate amount of risk? If not, you should add to the infrastructure prior to focusing on the goal.
6. Corporate culture is a powerful thing. I know that during a planning retreat it is helpful to remove the blinders and think creatively. Occasionally, everyone must adapt to change. However, be mindful of the bank’s culture. It is a powerful thing. I can give you numerous examples of a new president, chief lending officer, operations officer, etc., who brought good ideas that didn’t fit the culture of the bank. The disastrous results are not because the idea was bad, nor because people would not change, but because there was a clash of culture. I often see this when banks decide to buy a related business, or recently when a bank and thrift completed a merger-of-equals. It seems so similar, but cultures are very different. And, the results are so predictable and bad. Do not avoid these ventures, but understand the difficulty and plan accordingly.
7. Don’t overlook the easy options. We spend so much time on ventures that can add to profit and shareholder value. This time is needed because these ventures add a significant amount of risk. But, we often overlook the easy choices that add to profit and shareholder value without adding significantly to risk. As an example, for many banks that have more capital than needed, a stock repurchase plan can provide a significant increase in shareholder value without a significant increase in risk. Plus, shareholders that want or need to sell at a fair value have a ready buyer. Take advantage of this type of activity.
8. Be cautious about this year’s “thing that every good bank should be doing.” Since the late
60s, I have seen periods in which the consensus was that only in-store branches made sense, and that in-store branches made no sense. I read a banking article in a Chicago publication stating that regional banks have found a new approach to growth – branching. I’m sorry, but community banks have been using that concept for – well forever. Finally, wasn’t it in the late 90s that we read that the majority of banking would be completed on the home computer? Obviously, it is important to stay current. But, consider products in terms of the above, especially that shareholder value is king. If the new product will add to shareholder value, that product has value. If it doesn’t add to shareholder value, postpone the product.
9. Asset quality can kill you. Discussing asset quality is not as exciting as many other issues. But, nothing will derail a bank’s plans more quickly and more completely than asset quality problems. Even though loan growth drives asset growth, which is a key component of bank success, we must remember to aggressively seek and conservatively underwrite. If you lower underwriting standards to achieve the desired growth, it is a matter of time until you get hurt.
10. It is not imperative for a good bank to have a strategic plan. I was once asked by a regulator, “Don’t you think to be a good bank, a bank must have a strategic plan?” To that I answered, “No.” I have seen many well-run banks without a strategic plan. I’m sure that you have to. However, I do believe that every bank could improve even further with a strategic plan. That is the key – to continue to improve for the benefit of shareholders, customers, and employees.
And with that, we have come full circle. The strategic plan should assist the bank in reaching the goals of: (1) realizing a reasonable return for their shareholders, (2) serving the banking needs of customers in a friendly and efficient manner, and (3) providing employees with a comfortable and rewarding place to work. I hope that you will consider these concepts as you complete your next strategic plan. Also, if you are considering a facilitator, I hope you consider Young & Associates. If you would like to discuss this article or the strategic planning process, please call Gary Young or Jim Kleinfelter at 1.800.525.9775.