The Changing World of Banking

The world is changing with ever-increasing frequency and magnitude for financial institutions. Almost daily we get news that shave a few more cents off our EPS, and the analysts are getting weary of readjusting estimates downward.

Here's a quick summary of our situation:

Other news includes margin deterioration (down another 6bp in 4Q08) and fee income reductions (mostly due to lower ATM fees, lower overdraft fees and mortgage servicing rights impairment). Compliance costs continue to rise, most notably the FDIC premium announcement Friday. All these combine to exacerbate the uncertainty that is a defining characteristic of the business today.

Amidst the chaos, TARP continues to morph. Initially the funds were meant to absorb toxic assets. That quickly changed to funding strong banks so they could absorb their weaker brethren; however, this too was made untenable by the fact that some TARP recipients had one foot in the grave and non performing assets exceeding 5% of total loans. The next iteration showed TARP as a way to inject more liquidity into banks' balance sheets and ease credit. Every change in the expected application of TARP became a contributor to further instability and uncertainty in the system.

Unfortunately, as TARP usage and grants continued to be a moving target, the regulatory "strings" attached to the government funds started unfolding, and they proved to be more onerous than anticipated. Banks which applied and received TARP as a source of capital for acquisitions or simply and insurance policy have quickly re-evaluated their position given the new provisions (e.g. no severance, no cash bonuses, claw backs for '08 bonuses etc.), and many are considering returning the funds already (in some cases, a mere month after receiving the money). Daryl Byrd, the CEO of Iberia Bank, put it best: "We believe recent actions, interpretations, and commentary regarding various aspects of the program places our company at an unacceptable competitive disadvantage," said Byrd. Yet another moving part was introduced into this already unbalanced system, further destabilizing the banking industry.

Chaos rules as the government and its TARP goals zig and zag, and, with it, our industry. This volatility has been particularly challenging for compensation committees, who need to develop CEO performance evaluation criteria before too long, which has been difficult for some time. Old criteria, such as EPS growth, stock price, total shareholder returns and even ROE and ROA, are less relevant or controllable these days. This, coupled with the ever-changing regulatory expectations (which very little clarity attached to them), make the role of board compensation committees more challenging than ever.

My thoughts on the topic: while traditional executive performance measures are eternally relevant, today's environment is more conducive to longer term performance measures that consider the company's safety and soundness as well as franchise value building in addition to core and annual profitability results. Examples:

In times of such uncertainty and volatility, navigating with the longer-term goal in mind should create some predictability and order in our chaos. Keeping strategic goals in mind and aligning short term compensation, incentives and CEO performance assessment criteria with those goals, will have a stabilizing effect on your team and leadership, as well as a long-term benefit to your shareholders.