Asset Based Lending
Chief Investment Officer
Commercial Loan Automation
BirdsEye Viewadding value to shareholders
All banks were not created equal. Even the most profitable banks aren’t competing for capital appreciation and market valuations on the same footing. Shareholders look for consistency, stability, profitability, growth and no surprises. Here are the main elements they look for as they evaluate whether they should add a bank to their portfolio.
· Organic growth. Shareholders look for future earnings potential as they evaluate investment opportunities. It’s less about the current performance and more about the realistic expectations for future performance that drive their decision. Organic growth if the first quality they look for. Can the bank grow faster than inflation and with solid pricing and credit metrics with current resources? Do their markets support such growth? If quality organic growth is in the cards, the first hurdle on the road to investment attractiveness has been passed.
· M&A effective growth and reasonable future opportunities Organic growth is critical, but growth through acquisition is also an attractive way to build scale and leverage fixed asset investments. Not all banks have such opportunities. Acquisitions opportunities are largely driven by market availability, and not all markets have banks that are available for sale. Banks located in markets where acquisition opportunities are abound are in a better position to grow effectively. Further, banks that developed core competencies in acquisition attraction, negotiation, integration and look-backs also enjoy a competitive advantage for scarce investment dollars relative to those who lack those skills.
· C&I lending. Markets like C&I lending better than CRE lending. Many Chief Credit Officers disagree. “At least we have the dirt”, they say. Sadly, dirt is occasionally worth just that – dirt. C&I lending is typically accompanied by strong demand deposits, Treasury Management needs, and, on occasion, the personal business of the borrower’s owners. Further, some believe that cash-flow lending is more credit-worthy than collateral-based. Many investors share that view.
· Core deposit mix and growth ability. I have made this pint many times before – core deposits are golden. Deposits that are less price sensitive (which often include small business and C&I borrowers’ deposits) reflect the true franchise value of the organization. Raising deposits through CDs, the broker market and FHLB is certainly an option, but it takes far less effort to create than checking accounts. Such deposits are also more volatile and price sensitive, making them less valuable for shareholders.
· Profitable and additive ancillary business lines. Most high-performing banks have at least one specialty line of business that generates revenues beyond the core bank. Often the revenue comes in the form of fee income, which, in itself, is a more attractive form of revenue. Any well-run ancillary business that operates within the overall risk appetite of the organization can be perceived as a net gain for shareholders. Examples range from the more typical trust company and RIAs and leasing to unusual businesses such as ATM cash and information management. The key is to build a business that stands on its own and adds non-margin-dependent revenue to the bottom line.
· Strong expense management ingrained in the culture. The key word here is “culture”. We’ve all seen the expense management projects come and go. They typically achieve their savings objective, but often witness expense growth almost as soon as the project is completed and the dollar target realized. Strong banks incorporate expense management info their fabric. It is places where employees turn off the lights before they go and think twice before subscribing to the next magazine or requesting the next non-actionable report. Those places typically do not engage in cost reduction projects, and their efficiency ratio outperforms the industry.
· Efficient delivery systems. Banks have branches. They will continue to have branches. The size, staffing, density and productivity of these branches varies widely. Banks that put much thought and intestinal fortitude into their branch network configuration and modification attract investors more than those who settle into their network and do not trim some places while investing in others. The world is changing and we must change with it. Efficient delivery isn’t only relevant for today’s financial performance but also for tomorrow’s. It is also relevant to our customers who look for technological innovation from their financial institutions. This makes the organization’s delivery system important on several fronts.
· Fee income generators. Investors like banks that enjoy a significant percentage of non-interest income of total income. There are some excellent high-performing banks with fee income ratios as low as 85%. Those banks have different business models and they excel in their execution. Fee income helps mitigate the impact of adverse net interest margin developments, as we have seen in the last decade. It is more easily controlled by the bank than other income streams. Last, it sometimes requires less capital than margin-based income.
· Metropolitan franchise focus. Banks serve a critical function in the velocity of money throughout our financial system by moving money from money-producing markets to those who need money to grow. This important function typically means that rural markets fund metro market growth. Investors understand that and look at metro market as more attractive because of their growth opportunities. Note that capital allocation in our system isn’t based on societal considerations but on profit motives alone. Hence, metro markets are more welcome than rural markets – for their density, average branch size, efficiency across many variables and growth opportunities.
· Management team depth. Strong banks are typically high-performing due to an excellent management team in addition to their strategy. Strategic commitment and clarity are important, but execution is everything. Execution depends heavily on the people who lead it and perform it, which is why management depth is so important. In addition, management must be capable of achieving growth while driving profitability, something that is difficult to accomplish and is often inherently conflicted. The quality of management and its next two or three tiers of staff is critical to any organization’s future success.
· Culture strength. Culture and management are two closely related items. Culture is the decision-making fabric of the organization. The right management is critical to success, and so is the culture that spells out how success is to be achieved. Culture is a “gushy” words, especially for investors who are so numeric. Nevertheless, it is critical to future performance.
· Balance sheet capacity for growth. Even when all the qualitative elements are in place for organizational growth and performance, numerous quantitative realities must be present to facilitate profitable growth.
o Strong capital position – the bank must have enough capital or access to additional capital to enable growth in the first place.
o Clean credit metrics – credit issues drain a bank’s resources and distract management from growth. A bank becomes inevitably inwardly focused when credit is broken.
o Strong compliance oversight functions – the greatest strategic risk a bank has is regulatory risk. Nothing can stop you dead on your tracks faster than regulatory digressions. Therefore, a growth-oriented organization must put in place a strong compliance function and culture to ensure that its compliance infrastructure is consistent with its growing size.
o Solid technology with growth capacity – First Niagara is the textbook example of a bank that grew fast, acquiring banks in the northeast, without catching their technology up to their growing size. The ultimate bill for this problem was so high that the bank couldn’t credibly fund it within an acceptable time frame. Growth must be supported by appropriate technology investment much like the compliance function.
o Strong business development teams – there is no organic growth without effective sales. Ensuring the presence and loyalty of strong sales people is essential to quality organic growth.
· Well-positioned with the regulators. Strong risk and compliance structure aren’t enough if the regulators do not trust management to do the right thing. A positive relationship with the regulators is another prerequisite to growth of which investors are keenly aware.
As I reflect upon these elements, they are no different than the criteria by which I, and many of you, assess banks and their future. Combined, they will be assembled into a strong and sustainable company which is focused on achieving shareholder value the right way and over the long-run. This is the ideal many of us strive for, and it serves all constituents well – shareholders, customers, communities and associates.