Today is like a capitalist holiday. Not only did we get Warren Buffet’s seminal shareholder letter over the weekend, but given that it is Leap Day, we get an extra day of production that is not in most bank’s budget (if it is, that is some expert-level budgeting). To celebrate, we will save you extra time by breaking down the 7 main takeaways from Berkshire Hathaway annual letter written by the CEO of capitalism itself, Warren Buffet, that will add value to your bank.
Trying to sell more loans and deposits is a different strategy than trying to add value to the customer’s life. Jim, a commercial bank customer has a company that produces high-end drum equipment. Back in 2014, Jim drew 95% of his availability in anticipation of the holiday season. In early 2015, Jim got a note from his banker that the line was being increased due to the increase in sales volume.
It is normal for stock markets to fluctuate, interest rates to vacillate, oil priced to decline and China’s economic growth forecasts to be adjusted (those numbers are mostly made up anyway). However, the recent behavior in the above mentioned markets is much more volatile than anything experienced over the last few years, and this turmoil is going to change lending and borrowing behavior. Loan terms, floors, rate resets and debt levels have already been chanced.
There are a variety of attributes that signify a profitable customer in banking. Age, industry, loan balance, deposits, number of products used and fee income generation are all well understood as it relates to finding a more profitable customer. However, in this age of big data, there are a variety of other attributes that, when assembled, resemble, in some way, your existing group of profitable customers.
A common narrative with community bankers is this view that their options are limited. A challenge is often presented with just two options – make the loan or lose the loan, agree to the customer demands or not or comply with the regulators or not. When viewed this way, bankers set themselves up for a sub-optimal outcome as they turn a tactical decision into a self-created conundrum. To increase performance, banks need to realize that there are always more than two choices.
Introduced in 1937 in an Oklahoma Humpty Dumpty supermarket, the shopping cart has proven to increase per person sales and extend shopping time. A boost to many retail establishments, it is often said to be a predictor of retail health. More shopping cart sales equals more store openings. The problem is that sales are slowing. This is germane to banks as commercial real estate exposure related to retail property financing composes an estimated 22% of community bank commercial real estate (to also include mixed use).
If you handle deposits or look to issue a certificates of deposit special in the near-term, then you should read this because most banks get their callable certificates of deposit (CD) valuation completely wrong and, as a result, underutilize the product to help lower the funding cost of the bank. For the record, we are not advocates of any CD that markets on rate, as a majority of time a customer’s predilection for rate is highly correlated to low or negative lifetime value.
If there is one thing your bank needs to be successful it is not more technology, a more profitable loan product or new fee income services. What your bank needs is culture and specifically, the ability to adapt. While that sounds like a trite business book topic and can easily be dismissed as pabulum, it is critical to success and only a few banks have it. CEO’s may talk about it, management teams think they are adaptable, but when you look at the actions of a bank, it is extremely rare that a bank demonstrates it - Umpqua does, as does Chase and Wells.
Last week we discussed the strategy of offering 10-year fixed rate loans that adjust after the first 5 years. We considered why historically this strategy worked for some banks and why it may not work as well for banks in the future. If interest rates rise as currently expected by the market, 5-year adjustable loans expose banks to interest rate risk, prepayment risk and sales risk. Credit risk is the subject of our discussion in this blog.
An old strategy in commercial banking when faced with a borrower that wants a 10-year fixed rate loan is to offer a 10-year loan that adjusted in five years. This has historically worked with some customers and has paid off well for banks over the last 35 years as 5-year rates have fallen. The graph below shows 5-year Treasury rates for the last 35 years. As interest rates have generally fallen over the entire period shown, 5-year loans generated wider net interest margins for lenders (as cost of funding decreased over the period) and the borrower also benefit
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