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The Nolan Company is pleased
to bring our readers a special series of new articles covering the
surprising opportunities and the risks of these turbulent times.
In each of the coming weeks, we will share our insights and
experiences in managing toward the upside during a time of unique
market dynamics.
Everyone Has a Plan,
Until They Get
Punched in the Mouth
Bob Grasing
President
This was the
most enlightening comment ever spoken by ex-heavyweight boxing
champion Mike Tyson during his reign in the ring. What does it have
to do with our current banking crisis? The economic impact of the
subprime lending crisis, the credit default swaps, the side bets
wagered by financial service industry leaders, the CDOs
(collateralized debt obligations), and the relatively recent
adoption of mark–to–market accounting rules have resulted in the
subsequent deleveraging of the banking industry. And, of course, the
collapse of credit on a world scale has led to the inevitable global
markets' decline. I think we can safely call this a "punch in the
mouth" to the banking industry without overstatement. The question
is, how many banks will get up and what do they need to do to
survive?
In banking, capital is king and those banks that have stable,
secure core deposits have a leg up on being in the surviving
franchise club. Yes, the infusion of $700 billion from the federal
government should eventually free up the credit markets, but
initially we are seeing many banks hoarding cash to ensure their
short-term survival.
The banking industry will need to get some relief from the
federal government on mark–to–market accounting to be sure. It is
illogical for banks holding securities that are performing (and that
they plan to hold to maturity) to be required to write down their
capital. Currently, if a troubled bank is forced to sell securities
in any form at fire sale prices to solve their own capital problems,
then this greatly reduced market price sets the value of similar
products for the entire industry. The current lack of buyers due to
an overly conservative mentality is exacerbating the market price
issue. The sound banks then must sell or write down those
securities, which continue to lower the market price in what seems
like a death spiral. This further reduces the available capital in
the banking system – not due to actual performance of that bank but
due to effect of mark–to–market accounting. If the situation
continues to play out this way, it will make the thrift industry
demise look like a warm up to the "perfect economic storm" in which
we are all currently participating.
Every bank has its own set of conditions and while we have
nearly 8,000 in the banking system, the top nine hold nearly 60
percent of the assets. This is why they were addressed first in the
Treasury Department's bank recapitalization plan. The other 40
percent is just as important to the financial life of the economy.
We need to concentrate on steps those banks must take to reposition
them (or react to the punch).
There are many different scenarios, but we can separate banks
into two basic categories: 1) those banks that are viewing our
economic crisis as the opportunity of their business lifetime (to
add to their footprint and profitability); and 2) those banks that
are seeing the crisis as "a fight for survival." We have already
noted that there is a sub-category of sound, very well-managed and
conservatively run banks being forced to deleverage. Many of these
will initially survive as smaller institutions.
Let's view the banks in the "opportunity" category and
identify what they need to do to survive and/or thrive.
The banks that are clean, have no subprime loans, and have
been based on good credit quality are not immune to the crisis since
instability will likely bleed into the consumer side as well as
commercial real estate in the near future. Credit card delinquencies
are up and banks with a sizable home equity portfolio or auto loan
portfolio should have major concerns right now. We have worked with
client banks to reassess and redesign their collections departments
to assure that they can manage this aspect of the crisis as
adequately as they manage the credit side of their business. As one
Illinois CEO expressed it, "If they are not actively applying the
same management talent and creative focus to this side of their
business they will soon be in harms way." We have seen banks in the
$1 to $5 billion in assets range view the day-to- day activities of
the retail collections as a function and not a strategic strength.
This is the time to make sure that your bank has the capability and
capacity to effectively handle the impending increase in
delinquencies before it commands your attention.
This is also a time to examine every element of revenue and
expense that is required to run the bank effectively. Operating
efficiency can assure survival, as well, for relatively clean banks.
One of our clients got caught in the mark-to-market issues that we
have outlined. They were required to write down $60 million in their
investment portfolio in 2008; however, due to having gone through a
focused bank-wide redesign initiative a few years earlier, they were
off plan by only $5 million year-to-date in October. A well designed
operations improvement initiative should not only properly align
each bank's cost structure but also examine the value of all
services from the stockholders' and the customers' points of view.
It is important to examine all possible revenue sources as we sort
through this crisis. Even well-run organizations that constantly
review revenue should take a closer look. A well-run bank in the
northeast with $1.3 billion in assets was able to identify $1.5
million in increased revenue annually through using a similar
rationalization and redesign methodology this past year. This was
significant as the executive management team expected to find less
than $200,000 in the review but proceeded with an open mind.
All warning signs aside, the banks positioned with strong
capital and a stable portfolio should be thinking about acquisition
in the near future. This should not be a strategy for big banks
only; it should be a strategy for strong banks ready to become
stronger. The Treasury has intimated that the next wave of the
recapitalization process will encourage banks that would use the
capital for acquisition. It will place a value on banks that are
positioned to further their wish to help consolidate the industry.
Therefore, banks need to have a plan for consolidation that would
eliminate cost and leverage their management and administrative
assets. The annual Nolan Efficiency Ratio Benchmarking Study
indicates that the average range of administrative cost in banks is
in excess of 22 percent of operating costs. High performing banks
are between 12 percent and 14 percent, so the gap becomes the
eventual purchase price for banks positioned and capitalized to step
up. Outside assistance is often required in the consolidation
process to realize the expense improvement in a timely manner
without diluting service to customers.
The boxer who survives the blow certainly needs to quickly
reassess his strategy and tactics to get back into the fight. And
like the boxer, there will be many survivors in banking. However,
these questions remain: Which banks will become stronger as a result
of this crisis? Which institutions will actually win the fight by
seizing the opportunity to aggressively take advantage of their
financial competitors' weaknesses? I would be glad to personally
share some of our relevant experiences and advice. Please email me
at bob_grasing@renolan.com
or contact me at 800-653-1941.
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