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Capital Market Commentary – February 2016

Written by admin on February 18, 2016. Posted in Management & Planning.

By: Steve Clinton, President, Capital Market Securities, Inc.

We are now approaching seven years since the Great Recession. While the economic recovery has been slow, it has lasted much longer than a typical recovery. The average recovery, since the end of World War II, had been 58 months. The longest recovery on record was the 10-year period that spanned the 1990s. The length of the current recovery has been aided by the Fed’s maintenance of historically low interest rates. The Fed ended its “zero” rate posture and raised a key interest rate in December. This was the first increase in interest rates in almost a decade. How quickly the Fed is able to move interest rates higher will depend upon the continued strength of the economy.

Job creation continues to occur and unemployment has trended downward. Inflation remains in check. Business profitability may have reached a near-term plateau. Fourth-quarter earnings for the S&P 500 are expected to slide 5.3 percent, according to data provider FactSet. That would represent the third straight quarterly drop in profits, and the first time the S&P 500 has experienced such a decline since the first three quarters of 2009. Steady consumer spending has enabled the U.S. economy to continue to grow despite broad economic weakness globally.

As we enter 2016, there are a number of items worth monitoring:

Presidential Election – The Obama era enters its final year. The presidential campaigns have already begun in earnest. The primaries began February 1st. The future direction of the country will be decided in the next election.
Economic Growth – Last year, we predicted that “U.S. economic growth in 2015 will be hard-pressed to continue its strong pace.” Our prediction was correct in that the economy likely expanded 2 percent last year. The results reflect weak global trade and severe cutbacks by energy companies due to the slide in oil markets. Also, business investment has been limited. Our prediction for 2016 – a 2 percent growth comparable to 2015.
Housing – Home price values steadily accelerated throughout 2015, underscoring that the housing market is returning to normal as the economy improves. The S&P/Case-Shiller Home Price Index rose 5.2 percent in the 12 months ending in October. The index is up 36 percent from its low recorded in March 2012, and is only 11.5 percent below the high recorded in July 2006. We anticipate that real estate values will continue to increase at a moderate pace in 2016.
Oil Prices – In early 2015, we noted that oil prices had declined to $50 a barrel. Oil prices continued to decline in 2015 as supply outstripped demand. In early 2016, oil prices fell below $30 a barrel reaching a 12-year low. The prospect of up to 500,000 barrels a day of Iranian crude flooding an already oversupplied market is the main reason for oil price declines. We expect oil prices to fall to a level of around $25 a barrel and that will force major suppliers to restrict oil production which will drive oil prices higher in the second half of 2016.
Industrial Production – The industrial sector remains soft. Capacity utilization fell to 76.5 percent in December. Before the recession, capacity use typically hovered above 80 percent. U.S. car sales were a bright spot in 2015. Auto sales were a record, passing a total last reached 15 years ago as cheap gasoline, employment gains, and low interest rates spurred Americans to snap up new vehicles. In all, auto makers sold 17.5 million cars and light trucks in the U.S. last year, a 5.7 percent increase. We anticipate slowing auto sales in 2016. Rising rates will make auto financing more expensive.
Imports/Exports – Europe and Japan, the U.S.’s major trading partners are at risk economically. China’s problems have been well discussed in the press. However, U.S. exports account for only about 13 percent of gross domestic product. If the rest of the world falters, a relatively small share of U.S. production will be exporting into the weakness. We do expect the strong dollar and continued economic struggles of our trading partners to cause exports to trail 2015 levels.
Consumers – Consumer confidence is being tested as we enter 2016. For the six-year period beginning January 2009 until the end of 2014, the S&P 500 more than doubled. This increased wealth added to consumer confidence and consumer spending. In 2015, the S&P 500 was essentially flat for the year. 2016 has begun with a market correction of nearly 10 percent. It is likely the recent stock market results will weigh on household finances. Offsetting the negative of lowered net worth will be lower gas prices that will serve to increase consumers’ incomes. Overall, we anticipate consumer spending to hold steady.
Fed – We mentioned last year that we expected modest rising rates in the second half of 2015. We also predicted that the Fed would be patient. We only got one rate increase in 2015. With the state of the economy, we would expect the Fed to continue to move slowly in 2016 in its effort to move interest rates upward.

Market Update
The overall stock market ended lower in 2015. The U.S. stock market encountered its first correction (a drop of at least 10 percent) in four years in August. The Dow declined 2.23 percent in 2015 while the S&P 500 Index was down 0.73 percent. Short-term interest rates ended 2015 with the 3-month T-Bill at 0.16 percent. Longer-term interest rates increased modestly in 2015. The 10-year T-Note ended the year at 2.27 percent, compared to 2.17 percent at December 31, 2014.

Bank pricing followed the overall market decline in 2015. The KBW Bank Index declined 1.59 percent for the year. Bank prices, as measured by the KBW Bank Index, remain nearly 40 percent below the highs recorded in 2006.

Merger and Acquisition Activity
Merger activity in 2015 was comparable to the level of activity in 2014. Pricing on 2015 bank sales was comparable to 2014’s pricing, recording a median price to book multiple of 141 percent and a price to earnings multiple of 22.4 times.

Interesting Tidbits
As has been our custom from time to time, we like to pass along various items that we have seen that you might enjoy reading:

The number of Americans seeking first-time jobless benefits is lower this year than any since 1973. (Note: The labor force has nearly doubled since 1973.) This indicates that the number of workers involuntarily losing their jobs is trending near historical lows.
The U.S. bull market is now more than 6½ years old, the fourth longest on record.
JPMorgan Chase expects to spend about $500 million on cybersecurity in 2016. Bank of America Chairman Brian Moynihan has said that the bank’s cybersecurity budget is unlimited. John Stumpf, Chairman of Wells Fargo, said the bank spends “an ocean of money” on cybersecurity. Says Stumpf, “it’s the only expense where I ask if it’s enough.”
U.S. merchants are said to have paid $61 billion in interchange fees last year.
High-yield bond assets held by U.S. mutual funds total over $300 billion, triple their level in 2009.

Young & Associates, Inc. has a successful track record of working with our bank clients in the development and implementation of capital strategies. Through our affiliate, Capital Market Securities, Inc., we have assisted clients in a variety of capital market transactions. For more information on our capital market services, please contact Stephen Clinton at 1.800.376.8662 or click here to send an email.

A Capital Plan That Addresses Enterprise Risk Management

Written by admin on February 18, 2016. Posted in Management & Planning.

By: Gary J. Young, President and CEO

The need for community banks to complete a Capital Plan has intensified since the Office of the Comptroller of the Currency issued guidance which closely corresponds with the manner in which the FDIC and Federal Reserve assess capital adequacy according to information in their examiner’s handbook. The concept is that the bank (1) assess capital adequacy in relation to its unique overall risks, and (2) plan for maintaining appropriate capital levels in all economic environments. A bank should maintain a sufficient level of capital based on the associated risk at the bank and within the economic environment comprised within the bank’s market. This sounds a lot like Enterprise Risk Management. In fact, I believe that Enterprise Risk Management is morphing into Capital Planning based on risk.

This article outlines the methodology that Young & Associates. Inc. recommends in meeting this guidance.

Step 1 – Developing a Base Case
A five-year projection of asset generation and capital formation (earnings less dividends) would be used to project the future tier-1 leverage ratio and risk-based capital ratios. This is the base case scenario. Within this scenario, minimum capital adequacy standards will be established. At this point, there will be no additional capital for risk. As an example, for the tier-1 leverage ratio, the bank might establish a 5.0 percent minimum plus a 1.5 percent additional for unknown risk. This approach would be similar to the Basil III calculation. This would establish a 6.5 percent leverage ratio minimum. This example is for the leverage ratio only. A separate calculation would be needed to examine risk-based capital.

Step 2 – Identification and Evaluation of Risk
The focus here will be in identifying and evaluating all risk within the Enterprise:

Credit risk
Operational risk
Interest rate risk
Liquidity risk
Strategic risk
Reputation risk
Price risk
Compliance risk

The risk would be assigned a level (i.e., extreme, high, moderate, and low) and a trend (i.e., decreasing, stable, or increasing). Based on these assignments, additional capital may be added to the base. In the analysis of risk you should examine the current position, as well as potential risk in a stressed environment. You should also look closely at regulatory examinations, audit reports, and observation of current systems. Consider assigning additional capital for each position within the risk levels. It is acceptable and advisable that differing risk areas would have differing impacts on capital need. As an example, credit risk might have a greater capital contribution than price risk. Let’s assume that an additional 1.25 percent in capital is required based on the bank’s risk profile. This is similar to the use of Qualitative Factors in the Allowance for Loans and Lease Losses. Added to the 6.5 percent from above, the new capital adequacy level based on risk would be 7.75 percent.

It is possible that your directors would want the leverage ratio to exceed 7.75 percent. Let’s assume that percentage is 9.0 percent. While directors want 9.0 percent, those directors could also state that based on our risk compared with others, 7.75 percent is the measure for regulatory capital adequacy. This is not inconsistent.

Step 3 – Capital after Lending Stress
Both the FDIC and the OCC have suggested models for banks to stress capital based on stress from loan losses by loan classification. Young & Associates, Inc. strongly recommends that the appropriate model should be included in your bank’s planning process. The goal is for the model to indicate that the bank could survive a significant stress. This will also help in formulating your capital contingency which is discussed as Step 4.

Step 4 – Contingency Planning for Stressed Events
If development of the base case and identification of risk is perfect with no internal or external errors, there would be no need for a contingency plan. However, as we all know, plans don’t work perfectly. Therefore, it is critical to stress all assumptions in the development of the base case and in the identification and evaluation of risk. The stress or worst-case scenario in these areas will determine the amount of capital needed to be raised. The analysis would then examine all realistic possibilities for increasing capital including, but not limited to:

Reducing assets from the base case
Asset diversification (impacts risk-based capital)
All profitability enhancement measures
Dividend reduction, if applicable
Branch sale, if applicable
Downstream cash from holding company
Capital raise from existing shareholders
Capital raise from new shareholders
Additional holding company debt
Sale of the bank

A brief word for mutual companies that are now regulated by the OCC: Many of the capital raising opportunities do not exist for a mutual. We would suggest that this is an additional risk for these banks. We would suggest that an additional 0.5 percent, or so, of additional capital is necessary for mutual banks compared with stock banks.

Step 5 – Policy
All of the preceding will be placed in policy and would include:

Assignment of roles and responsibilities
Process for monitoring risk tolerance levels, capital adequacy, and status of capital planning
Key planning assumptions and methodologies, as well as limitations and uncertainties
Risk exposures and concentrations that could impair or influence capital
Measures that will be taken based on differing stress events
Actions that will be taken based on stress testing

Young & Associates, Inc. has been working with banks to develop capital adequacy standards, a capital contingency, and the related policies. In addition, we have developed a product that will help you complete this risk assessment on your own in as little as one day. You can find this product by clicking here, or you can call our office. If you have any questions about this article or would like to discuss having Young & Associates assist your bank, please call Gary J. Young, President and CEO, at 330.283.4121, or click here to send an email.

How to Staff Branches in the Digital Age

Written by admin on November 10, 2015. Posted in Management & Planning.

By: Mike Lehr, Human Resources Consultant

The digital age has hit branches hard. Lines out the door no longer exist. Patterns of activity flatten with each passing day. Activity spikes can occur anytime. How should banks staff their branches in the digital age?

In the past, banks relied on transaction-based staffing models to answer these questions. In the digital age, these models show staff reductions year after year. Transactions are going down. From our studies and experience, community banks staff to peak demand for the week. That means for rest of the week excess capacity exists. Staff is idle. Now, the busiest time of day is when employees open and close branches. It is not when customers transact.

Still, customers need help. It is a different kind of help. It is not about transactions. It is about sales. The digital age has blown the doors off product and service offerings. It is no longer just accounts and loans. It is no longer about what kind of accounts and loans. It is about the many ways to access them. The ways to do business with banks have spread like weeds.

Customers still need help from a person. It is not help with transactions though. It is help with understanding what banks can do for them. It is advising. It is consulting. It is selling. Traditional transaction models do not deal with selling. They are about transactions. Reducing staff can reduce selling. The question becomes, “What are your people really doing?”

The digital age is turning branches into sales offices. Staffing models need to account for sales. It is about new accounts. It is about referrals. It is about cross selling. How much time does it take to do these things? How much time does it take to do them well?

Selling is more complicated than transacting. It is a team effort. Tellers could act as assistants for sales personnel. They could research customer data. They could identify customers who might need additional help. They could make up the call lists for customer service representatives, loan officers, and branch managers. Still, it boils down to what your people are doing. How much time is it taking? How much downtime is there? How much time are they selling? The answers will most likely surprise.

If you would like to learn more how Young & Associates, Inc. can help you answer these questions for your bank and your people, contact Mike Lehr at 1.800.525.9775 or click here to send an email.

The Community Bank Capital Problem – Too Much

Written by admin on November 10, 2015. Posted in Management & Planning.

By: Gary J. Young, President & CEO

The Mantra
As community bankers, we have all heard the mantra to increase capital. This is heard by the banker who has an 8% leverage ratio and needs to increase capital to 9%, by the banker who has a 9% leverage ratio and needs to increase capital to 10%, and by the banker who has a 10% leverage ratio and needs to increase capital to 11%. Based on this view regarding capital, more is always better. I disagree.

Capital Adequacy
I agree with the OCC. Capital adequacy at each bank is uniquely based on the current and planned risk within the bank. And, it is the responsibility of the bank board to determine capital adequacy with the input from executive management. Capital adequacy is the point at which a capital contingency plan is implemented if actual capital falls below that point. In other words, let’s assume capital adequacy has been defined as a 7.5% leverage ratio, or a 11.25% total risk-based ratio. If actual capital falls below either measure, the bank should implement the methodology for improving capital as described in the capital contingency plan.

Capital Target
A bank’s target or goal for capital is higher than capital adequacy. It is an estimate of the amount the board of directors has decided is desired to take advantage of opportunities such as additional organic growth, branch expansion, purchase of a bank or branch, stock repurchase, etc.; or to use as additional insurance or protection against negative events that could hurt profitability and capital. As an example, a 7.5% leverage ratio could be defined as capital adequacy, but the target level of capital is 9.0%.

Cost
Excess capital has a cost. Let’s assume you had to eliminate $1 million of excess capital. To balance that transaction, you would also eliminate $1 million in assets which would be investments. Let’s assume that the investments had an average yield of 1.5%. After taxes, that would be approximately 1.0%. Based on this example, the return on equity of the $1 million of excess capital is 1.0%. We must agree that 1.0% is unacceptable. Well, it is unacceptable unless that is your return for opportunity capital or insurance capital as described above.

Another example of the cost of excess capital can be seen here. There are four banks with a 1% ROA. However, the equity/asset ratio at each is different, ranging from an 8.0% leverage ratio to a 12.0% leverage ratio. By dividing the ROA by the leverage ratio, you get the ROE. By multiplying the ROE by an assumed PE, you get the multiple of book. In this example, the bank with an 8.0% leverage ratio has a value of $30 million while the bank with a 12.0% leverage ratio has a value of $20 million. This is a simplified example that provides information on the cost of excess capital.

The Right Amount
There is no right amount. The average less than $1 billion bank has a 10.8% leverage ratio and a 16.6% total risk-based capital ratio. Most everyone would agree that banks do not need that level of capital. But, every bank is unique with different levels of risk and different levels of risk appetite. The important thing is that executive management and the board of directors understand that there is a shareholder cost to holding excess capital.
That doesn’t make it wrong. The board of directors has multiple responsibilities and at times they can be conflicting. From the shareholder perspective, you want to maximize the return on equity and shareholder value which assumes leveraging capital, but you must also oversee the operation of a safe and sound bank. And, at the heart of safety is capital adequacy. It takes balance and awareness of both to determine the right level of capital for the bank. My concern is that through the Great Recession and after, the capital mantra has been “more is better.” Well frankly, more is not necessarily better. I am suggesting that it is time to balance the capital need for risk management with the capital need for improving shareholder value.

Best Practices
The question for executive management is what should I do? It is my opinion that best practices would indicate that every bank develop a definition of capital adequacy based on inherent risk. Furthermore, a capital contingency plan should be part of that plan that indicates the steps the bank might take if capital falls below or is projected to fall below your definition of capital adequacy. You should then have a frank discussion at the board level on the amount of capital that is your goal or comfort level. If you then find that your capital is above that, consider the following:

Focus on additional organic growth, if possible.
Expansion opportunities. I would suggest looking for opportunities that begin turning a profit in two years or less.
A stock repurchase plan. This is a win for the shareholders that want to sell and the shareholders that want to hold. Everyone wins and shareholder value should increase.
A slow, steady increase in dividends to shareholders.

Consider how all of these items might impact your capital adequacy, return on equity, and shareholder value over a 3-5 year period. Remember, the goal of executive management is to maximize profitability and shareholder value within capital guidelines approved by your board of directors.

For More Information
If you would like to discuss this article with me, you can contact me 1.800.525.9775 or click here to send an email.

Employee Retirement Income Security Act (ERISA) Compliance — Recent Changes

Written by admin on September 1, 2015. Posted in Management & Planning.

By: Sharon Jeffries, Human Resources Manager

Did you know?

Recent changes to the health and welfare side of the federal Employee Retirement Income Security Act (ERISA) now mandates that all employers/plan administrators provide a Summary Plan Description (SPD) to each plan participant and that ERISA-covered plans be maintained in accordance with a written Wrap Plan Document.

The SPD is an important document that tells participants what the plan provides and how it operates. If a plan is changed, participants must be informed, either through a revised summary plan description, or in a separate document, called a summary of material modification, which also must be given to participants free of charge.

A Wrap Plan Document is designed to meet plan documentation requirements under ERISA and other federal laws and to incorporate all other welfare plans, insurance contracts and other relevant documents into a single plan. These materials can be kept together for administrative ease. The Wrap Plan Document provides additional legal protection for the employer and plan fiduciaries and can simplify plan administration.

What does that mean?

In the past, much of the regulatory focus was on the retirement side of the ERISA legislation. However, with the implementation of the Patient Protection and Affordable Care Act (PPACA) that has changed. Much of the current government monitoring, oversight, and auditing relates to the health and welfare side of the ERISA regulation.

ERISA now requires employers who are plan administrators of their group health plans to comply with two (2) critical requirements or they will risk potential penalties and possible government audits.

Those requirements are:

Maintain and distribute SPD’s to plan participants which accurately reflect the contents of the plan and which include specific information as required under federal law.
Group health plans must be administered in accordance with a written Plan Document which must be made available to plan participants and beneficiaries upon request.

Are you at risk?

Yes, and the reason is this: Many banks will mistakenly assume that insurance contracts, certificates of insurance and benefit summaries fulfill the ERISA requirements for an SPD and Plan Document, but they do not. And, the primary reason is they do not include the required or recommended provisions that protect the plan and the employer.

What should you do?

Recognize that:

Failure to provide an SPD or Plan Document within 30 days of receiving a request from a plan participant or beneficiary will result in a penalty of up to $110/day for each violation
Lack of an SPD could trigger a plan audit by the United States Department of Labor (DOL)
The United States DOL has increased its audit staff and national enforcement initiatives to investigate employers’ compliance with Health Care Reform, resulting in companies of all sizes being audited and being required to provide an SPD and Plan Document

The Solution

Do not try to create these in house. Allow experts in the areas of benefits and benefits regulations assist you with this monumental effort. Young & Associates, Inc. has partnered with The Alpha Group Agency, Inc. to offer our clients this unique service. The Alpha Group Agency, Inc. is a highly skilled, reputable organization involved in the management of health insurance services as well as other related subjects.

The Alpha Group Agency, Inc. has been an advisor to Young & Associates, Inc. for almost fifteen (15) years in the management of its group health insurance plans. For additional information on how you can become compliant with these critical ERISA regulations and also lower the risk of a DOL audit, contact Sean Nehlsen, The Alpha Group Agency at 800-886-3315 or snehlsen@thealphaga.com.

Executive Search and Interim Management Services

Written by admin on June 22, 2015. Posted in Management & Planning.

By: Sharon Jeffries, Human Resources Manager

All banks face changes in management and other key positions from time to time. These changes can be due to retirements, relocations, unsatisfactory work performance, as well as other factors. All of these situations can put your bank in difficult and unique situations that generally cannot be quickly resolved.

Don’t rush to fill the vacancy by placing a candidate/current employee in a position that may provide temporary support, but results in a poor fit for the long-term, lacking the skills and experience needed to meet the ever changing regulatory banking climate.

What should you do?
If you find yourself in this situation, Young & Associates, Inc. can help by becoming an extension of your Human Resources Department. We will work with management and discuss options for your bank to meet both its short-term and long-term staffing needs.

If we find that the skill set/experience level desired is such that it will take additional time to source the “right” candidate for the position, we will present “interim” solutions, while beginning to search for a candidate that will be a more long-term solution for your organization.

One “interim” solution may be contracting with Young & Associates to put one of our accomplished consultants on-site at your bank to assist in covering those critical areas while continuing the search for a more permanent option. Another option would be for Young & Associates to provide you with a seasoned individual who may be looking for project and/or short-term work. Through years of experience in the financial services industry, we have developed an extensive network of contacts and resumes of individuals with a broad knowledge base in critical areas that are needed in banking today.

We can customize the services we offer to meet the ever-changing workforce needs of your bank. Although some of what we offer is similar to traditional search firms, several differences set us apart from other firms. Our knowledge of the skills necessary to be successful in banking today, along with the ability to utilize our in-house experts throughout the process, are key differences. Also, our professional fee structure is generally lower than traditional placement firms. However, most importantly, our reputation is proven effective. Young & Associates is reliable with more than 35 years successfully serving banking clients.

To learn more about these unique staffing services, contact Sharon Jeffries, Young & Associates, Inc.’s Manager of Human Resources. Sharon has over 25 years of experience in Human Resources Management and can be contacted at 800.525.9775 or you can click here to send her an email.