What’s Your Bank’s Agenda?
By Douglas V. Austin
Wandering through myriad state and national banking and thrift conventions and seminars, I’ve been listening to bank and thrift directors as to what is on their hot lists for the coming year versus what doesn’t seem to be of much importance.
In this commentary, I offer you a nonscientific sampling of what the directors have been talking about. I am not naming the directors individually, so as to protect the guilty.
The most important thing directors are talking about is corporate governance. They’re aware of Sarbanes-Oxley and all the pronouncements sent out by the Federal Deposit Insurance Corp., the Federal Reserve, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the state banking departments, plus articles published in trade association newsletters and magazines, and of course seminars covering the subject nationwide.
Even though 7,000 of the almost 8,000 commercial banks in this country aren’t covered by Sarbanes-Oxley, you couldn’t convince the directors of any bank or thrift that they’re not. They know that best practices at the board level will be reviewed as another element of the M in CAMELS (capital, asset quality, management, earnings, liquidity, sensitivity) in the years to come, and they are preparing to improve their director internal controls.
I haven’t run across any directors who are panicked on the subject, but they are aware that they must review – in a prudent, timely manner – their corporate governance practices and must improve them by eliminating the weaknesses revealed by the analysis. Most directors are utilizing their bank legal counsel to document exactly what they have done so that next time the examiners come in, there will be written documentation and proof of what the board has done to improve itself and to foster best practices at the board level.
However, corporate governance is not the only topic being discussed. There are a couple of old standbys. Boards are concerned about asset quality, as exhibited through credit underwriting standards and the performance of past-due non-accrual, nonperforming and restructured loans within the portfolios.
The federal banking regulators have been concerned about credit underwriting and asset quality since 2000, especially driven by the Federal Reserve and the FDIC, and almost all directors I have talked to are concerned at the local level to make sure that their banks’ financial quality has not suffered. In many ways it hasn’t, since there were only 136 commercial banks in this country out of 7,800 that were on the FDIC’s problem list as of the end of 2002. There is a concentrated effort on behalf of board members to ensure that asset quality remains high and that there is ample professional training to make sure loan officers and the directors keep it that way.
The same kind of concern is expressed on the subject of capital adequacy. The adequacy of capital at the bank or thrift is a constant, decade-in/decade-out area of concern. Most directors believe that their banks currently are over-capitalized, but asset quality and the level of capital adequacy are intertwined.
The only problem that the directors I talked to expressed is that they do not understand how they are going to perform at outstanding rates of return on average equity levels (i.e. 16 percent to 20 percent) when they are proud possessors of 12 percent to 15 percent capital-to-asset ratios. Community banks and thrifts are over-capitalized and operate with a low return on average equity (ROAE), and they’re being judged unfavorably vis-à-vis the big boys who operate with high levels of rate of return on average equity, but not necessarily high levels of capital. Add to the equation Basel 2, which most people haven’t figured out yet (we have at least two years before it applies to the large financial institutions, and it may never apply to most of the community banks), and you have a degree of uncertainty concerning the levels of capital adequacy.
In essence, the directors believe that if 8 percent is the standard for the primary capital-to-asset ratio, then 9 percent is above average and will keep the doctor away. Ten percent would be even better, and almost 50 percent of all community banks today have 10 percent or more capital. Thus capital adequacy may not be a problem, except in the marketplace when someone wants to know how much the bank or bank holding company stock is worth.
Interestingly, the most conversation outside of corporate governance is on profitability. After 20 years of the pundits telling bankers that smaller community banks ($50 million to $500 million) would be performing less well than the international and national money center operations, guess what? They are! During the last half-decade, the smaller community banks and thrifts are now operating with lower return on average assets and ROAEs than the super-regionals, or even at times the CitiGroups and the J.P. Morgan Chases.
Individual community banks and thrifts are still profitable, but there are alarming trends of decreasing rates of return on average assets, occasioned by narrowing net interest margins and increased competition from the multi-state, 800-number, money center banking institutions. Competition is now more national than international in scope (the international banks have been muted somewhat over the past decade by bad loans at home), but at the same time there has been increased competition from the major money center banks in this country in local banking markets, which has adversely impacted rates of return on assets and total profitability at these institutions.
Boards of directors are concerned about the long-term viability of their local banks and thrifts, especially as the younger consumers participate in banking by mail, by phone, by Internet or automated teller machine … and don’t seem to care about personal, one-on-one service. This is why we see a lot of customer relationship management articles floating around, so as to understand who your best customers are and how to compete for them with the toll-free number banks which are constantly calling on the 10 percent of the customers who have 90 percent of the profitability inherent in the business.
There is a strong subcurrent at the community bank and thrift level addressing how to increase profitability in direct competition with the major money center banks. The directors and senior management of the community banks and thrifts know full well that these banks are increasing market penetration and creating competitive disadvantages for the smaller financial institutions. Concentration is increasing, and competitive pressures are exacerbating the ability of the community banks and thrifts to compete.
Finally, there is still strong interest in improving the marketing and sales culture at the local community bank and thrift. In spite of more than a decade of attention to “sales, sales, sales,” most of the directors I have talked to think that their banks still perform “transactions, transactions, transactions” and don’t sell or cross-sell very well.
Directors do not believe that the management and staff of their financial institutions are sales-oriented enough, and that they are simply waiting for the customers to come in the door or call them on the phone. This concern is most evident among directors who must market and sell in order to survive as businesspeople. They have a hard time understanding how a financial institution can be profitable while sitting on its duff waiting for everybody to come and pound on the door.
It looks like this year will be a year of consolidation, financial performance with little interest in mergers and acquisitions and very little interest in expansion beyond the local marketplace. As the economy improves, the outlook for the coming year might be a little more aggressive and a little more acquisitive in nature – but I said that two years ago, and we still haven’t come out of this secular stagnation that we’re in.
Good luck on meeting your financial and nonfinancial goals and objectives. Keep your quality up and your capital high.
Douglas V. Austin is chairman and CEO of Austin Financial Services Inc., based in Toledo, Ohio.