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Dave Volk finally came home last weekend (appropriately, Memorial Day weekend). We cooked a small dinner for his thirty best friends, the menu of which isposted on the website (www.anatbird.com). In addition to the usual six desserts, we had a Chicken Provencale dish you might enjoy preparing yourself, so the recipe is posted on the website. Last, we have pictures, and those, too, are posted on the website slide show.

Thanks to all of you who kept inquiriing after Dav'e health, who prayed for him and who shared with me your own experiences with the horrors of war. your friendship and caring helped all of us get through this time. While Dave has months of Physical therapy ahead of him, the worst is clearly over. Thank you all again for giving us all heart!

Quality of Earnings

Our industry is moving further and further into the "every dollar counts" zone. Banks are leveraging their balance sheets to eke out every dollar of earnings, and not enough analysts are saying: "What's the quality of the next marginal net income dollar you generate?".

Let us pause a moment from our quarterly earnings chase to give the matter serious consideration.

First, what is "quality" when it comes to earnings? Durability, persistency, predictability and granularity of earnings come to mind. Repeated earnings are more valuable than one-timers; hard-to-create earnings (e.g. checking account income) is more valuable than easy-to-create earnings (FHLB advances); predictable earnings are more valuable than volatile earnings (which is why mortgage banks trade generally at lower P/Es than commercial banks). Further, businesses with predictable earnings require less capital than businesses with volatile earnings, another attribute to the "quality" component.

Making quarterly earnings, or any period earnings, is a noble and worthwhile goal. Analysts and shareholders appreciate RPS growth exceeding 10%, and ever-growing dividend payouts. The real question is, though: what's behind the earnings? Is a dollar of income from a trust account (arguably an annuity) worth the same as a dollar of fixed annuity sales (a one-timer, which occasionally cannibalizes the bank's core deposit base)? I posit that the two are vastly different, and that more analysis and attention should be given to the quality of earnings, not just the amount and the simplistic separation of one-timers from on-going income.

For example, franchise income, say core margin income, is worth so much more than wholesale earnings, since it will take so much longer to duplicate the more stable and predictable franchise income vs. the fickle wholesale markets. Case in point is the securitization and flow sales of sub-prime loans, a vibrant and ever-expanding market that literally shut down in a week. Buyers accepted a deal in the morning and declined it in the afternoon. Income generated from that business is much less desirable than income from a small business loan that is fully funded by the same business interest-free demand deposits.

Similarly, making a risk-based capital intensive loan is worth less than making the very same loan amount with lower risk-based capital requirements, so long as the yield is the same (which DOES happen). Yet in most relationship managers' goals that difference in income quality goes unnoticed. They more often get paid the same whether they make an unsecured loan or a fully secured loan, whether the LTV is 80% or 50%, etc. etc. Yet, the quality of the income from each loan varies greatly.

Similarly, fee income, particularly annuity fee income (such as trust revenues, insurance etc.), is more valued than margin income, since it is reliable, repetitive, not capital intensive, typically bears lower risk (but not always) and is much mor eunder the bank's control tahn margin income.

What I'm saying is no news; I know you know this. But I do question how many banks segregate internally their income by source and quality, and plan to grow net income from those various sources in a way that will improve the quality of their earnings.