The end of an eight-year infatuation with community banking, and suggestions for restoring the relationship
Dear Jane,
I’m leaving you. We’ve had a great time together—eight adventurous years. But it’s time for me to end to this relationship. Maybe it’s all my fault, but I just can’t do this anymore.
My past eight years in banking has taken me on a roller-coaster ride of ‘project jobs’ in which I have opened, closed and done turn-around work at several community banks. I’ve come to describe community banking as an industry of highly-regulated, beat-up small businesses—because that’s exactly what it is. Far from the gargantuan and impersonal image most consumers have of the banking industry, the median U.S. community bank employs fewer than 30 people, operates out of two or three branch locations and generates less than $6 million in annual revenue (‘median’ means that half of all banks are smaller than the one in the middle).
And after eight years of working with good people and helping several companies get back on their feet….I left the industry earlier this year and took a job in the property tax management business (see comment at the end of this article). While I’m grateful for the experiences I’ve earned, I am afraid that all I have to offer as I exit is this: I am a terribly bad example.
I am an example of someone who enjoys helping people, loves a good challenge and has a knack for fostering shared success across a team of dedicated employees. While I don’t offer up my success as any sort of role model or character illustration, my career change is a bad example to anyone looking for affirmation in the business of community banking.
I know you won’t cry for me Jane. You’ll probably just say ‘good riddance’. In many ways I know we found each other to be high-maintenance. Please don’t think I’m angry with you. I just need more.
Mine is not a sour grapes story. Far from it. I am a fan of the community banking business. Community banks serve at once as financial intermediaries, family counselors, small business advocates, neighborhood organizers and coveted local employers. The industry plays a respectable role in society where employees can get good stuff done for the benefit of people and businesses.
So then why did I leave? Three reasons: a lack of strategic understanding in the business, an outdated independent director model and an irrevocable expansion of regulatory governance.
I feel like you don’t want to understand me. You’re so controlling…and I just can’t be myself with you.
It is not the competitive environment in financial services that has driven me away. It is not the opportunity for business success, and it is genuinely not the FDIC that has soured this love affair. Instead, it is a lack of understanding for what banking has become (Gates: “banking is necessary, banks are not”), it’s a government-mandated board structure that has sorely outlived its effectiveness…and it’s the Consumer Financial Protection Bureau.
#1: A lack of strategic understanding in the business
There will always be community bank success stories in the same way that there will always be a Warren Buffet. If there wasn’t a Warren Buffett, the market would have invented one, because somebody always gets to be on top. But as chartered institutions have lost control of financial delivery channels, it is the likelihood of career and financial success that has diminished---because too many banking executives have lost the understanding of what their business really is. Not that many years ago, what constituted banking was far more defined and themarkets were far more regulated. Security was afforded with vaults and armored cars. In-branch banking was necessary for all but the most enthusiastic adopters of technology. But in 2015, ‘security’ is most important for financial transactions that take place outside the walls of a bank, and physical branches are increasingly irrelevant in an ever-broadening array of delivery channels. The modern community bank is a collection of third-party technology contracts with service reps and lenders stacked on top. Banks no longer own any of their delivery channels outside of the branch—and we all know what’s happening to the trend of in-branch transactions. From internet security to check clearing, loan-loss models and lending platforms, bank CEOs have really become vendor managers, but few approach their jobs as purveyors of outside technology. Community bank CEOs---and their boards, rely too often on outside companies to tell them how their businesses work, where the risks are, and what it really costs to run their operations. For decades, community banks prospered by taking on all comers and building up a base of stable deposits in lucrative lending environments. In today’s market though, if your bank does not have a defined customer strategy, a disciplined direction and a demonstrated market niche, then the business is really just a high-cost vending and lending convenience store…with nofranchise value and no long term investment case to offer its stakeholders.
What is my point in making this criticism? It’s not that bank executive boards have suddenly become incompetent—it’s that bankers used to run their businesses, but now third party companies run them instead---and evaluate the risks. What I’ve experienced at community banks is a continued exercise of strategic control without a strategic purpose. Industry commentators frequently note that the average age of a bank CEO is now 66, and the average age of a bank director is something around 73. While CEOs and their directing boards no longer understand the technology that runs their business, much of their net worth---and all of their self-worth, is still wrapped up in positions that they hold. It is hard to value something you don’t understand, and it’s even harder to evaluate the people who manage technology that you don’t understand. That’s an awkward combination for a group whose mission is to steward investor capital. It’s hard to get any group of bank directors to agree on what ‘success’ looks like. It’s even harder to put it on paper and require accountability to the mission.
This paradox of directorship is nothing new, but the margin of error sure feels thinner than ever before. Note the publishing date in the footnote of this quote:
In today’s world, commercial banks are fighting hard to maintain their historic role as leaders of the financial community. They are faced with increasing pressures from competitive institutions which are eager to offer services that have heretofore been restricted to banks; ... A bank director, particularly a non-management director, has a greater opportunity and a greater responsibility today than at any period in recent history ...1
1Theodore Brown, “The Director and the Banking System,” The Bank Director, ed. Richard B. Johnson, (Dallas: SMU Press, 1974), p. 3.
A CEO’s job is to set direction, recommend strategy and establish the tone of leadership. A bank board’s appropriate roles involve policy, strategy and referrals. It is a sad truth that many independent bank directors don’t know how to evaluate and strategize with executive management. As capable practitioners of all stripes and abbreviations (CEO, CFO, CCO, CRO) come to realize that they’ve chained their career wagons to a group that doesn’t understand their value, that the group doesn’t know how to compensate them and doesn’t feel compelled to seek their input, those practitioners will ultimately seek elsewhere for employment and opportunity. Choice is the greatest of privileges, especially as we get older and the game of musical chairs moves along. When I was in my 30’s and early 40’s I was willing to cede control in order to get management experience. Now in my 50’s, I need to have confidence that my board can drive franchise value---and that I will be rewarded appropriately when I create it. It is unlikely that any company can be successful in business unless producers and executives are proud of their leadership.
#2: Irrelevance of the (inexperienced) independent director
Independent directors—defined as members with no employment, family ties or material vendor relationships, comprise nearly 2/3’s of the typical bank board. As noted in policy statement FIL 87-92 issued in 1992, “an outside director usually has no connection to the bank other than his directorship and, perhaps, is a small or nominal shareholder. Outside directors generally do not participate in the conduct of the day to day business operations of the institution.”
While this “independence” may have been valued in 1992, FDIC in recent years has surely stepped up its expectation for director involvement—and culpability. Every FDIC-chartered director in America now knows that “ultimate responsibility for performance, regulatory compliance and adherence to policy rests with the board of directors”. And every director and bank manager in America is also sick of hearing about the risk of “civil money penalties” should they trip a regulatory wire in some unfortunate fashion.
Richard Parsons contributed an article to American Banker in 2012 that first got me thinking about the relevance of the independent director:
Is it reasonable to expect someone with "basic knowledge" of banking and "experience in business or another discipline" to set bank risk limits, monitor exposure and judge management's risk controls? Having spent 31 years in banking, my professional opinion is that it is unreasonable and unfair to expect someone with basic knowledge of banking to meet the FDIC's standard for director qualifications.
I have reviewed board data for 430 U.S. banks of all sizes. My conclusion: The director selection model for too many U.S. banks does not reflect the industry's risk profile realities of 2012.
Despite our nation's history of high bank failure rates, we see little evidence that director selection has evolved from the 1950s era of "paint-by-number" banking. Back then, interest rates were regulated, net interest margins were guaranteed and lending policies were overseen by bankers who survived the Great Depression. None of that is true today.
You can read the full article by clicking here.
#2a: Inexperienced boards are running off talent
Of course it’s important for boards to include independent directors. But in my experience, bank directors with no industry know-how are rarely equipped to evaluate risk and direct executive management. Further, bank boards—including the CEO, are often too self-interested to appropriately reward employees capable of driving value and profits. Employees who demonstrate an ability to create value will migrate to companies that compensate for results. I believe that talent drain is one of the biggest risks faced by community bank franchises. When “A” level players are lured away to better opportunities, what caliber of prospects will replace them? What’s worse, when lenders leave, they typically work to take favorite relationships with them. Small businesses have got to show employees a confident, long term trajectory. If not, they’ll find themselves serving as farm teams for their best employees.
As the drivers and dynamics of banking have changed, I’ve found that independent directors as a group are ill-equipped to understand the risks that they manage. That’s why regulators are now placing such a strong emphasis on enterprise risk management---yet another measurement process that boards have enthusiastically outsourced. ERM and vendor management practices are hardly new concepts in non-regulated industry. The likes of Peter Drucker and Jack Welch were championing such practices decades ago. Unfortunately, my experience has been that independent directors are behaving more like self-interested investors than directors these days. Their opinions, priorities, attitudes and agendas are changing as the prospects for the industry change. In critiquing the capacity of independent directors, though, know that I surely am familiar with the weaknesses of an “internal” board that’s beholden to an imperious chairman. That’s why I’m equally suspicious of board structures where the CEO also serves as board chairman.
A caveat for content bank managers: I believe that community banking will provide a comfortable paycheck to a majority of the industry for at least a few more years. I think that banking offers some of the better white collar jobs ever invented. The benefits are comparatively outstanding, the work environment is pleasant, and as Ogden Nash once quipped, “people who work standing up make less money than people who work sitting down”. It’s not a bad job. The distinction I’m making is that, as an executive, it’s an increasingly perilous career choice. Many bank executives are pained with the realization that they will earn far more from their paychecks and benefit packages over time than they will ever realize from their stock options and bank shares. That means they’ll want to hold on to those jobs for as long as they can, regardless of what’s best for the shareholder. That’s not wrong—but it is self-serving. Directors of all stripes would be wise to take notice.
#3: Enter: a non-supportive regulator with an unlimited public budget
I am as enthusiastic as ever about the ability of an ambitious, entrepreneurially-minded banker to build a successful franchise. In spite of new competitors and distribution channels, banks are still where the customers are. Focus, drive and strategy are required—but that’s nothing new (though perhaps one needs more ofthem…). As revolutionary as it may seem, I believe that 95% of all bank regulation represents generally good business practice—or at least that which existed up until 2011. It’s just that bankers need to use regulation as a tactical guidepost rather than cower behind it as cover in preparation for their next exam. Banks are for-profitbusinesses, funded by investor capital and they need to be run for maximum benefit of shareholders. Bankers whose chief priority in life is to manage for an adequate exam grade are chiefly concerned with a paycheck and not with maximizing shareholder return.
The FDIC has historically served as a supportive regulator…though recently it’s been showing a punitive side (that’s a tip of the hat to those in the Atlanta district). The Consumer Financial Protection Bureau, however, is a dangerous new animal. Since 1933, the FDIC has funded itself by assessing its customer base—chartered financial institutions. As such, the banking industry has been self-insured for the past 82 years, with all banking regulations founded upon the safety of the depositor.
On July 21st 2011, the game changed with establishment of the CFPB. Suddenly a new and powerful regulator elbowed its way onto the scene. With support from the Justice Department, the CFPB has authority to compel the banking industry to conform to politicized opinions of “fairness” and “equity” as defined by career bureaucrats. Not just depositors, but customers of any and all sorts. If required, why couldn’t the executive branch work through an already duplicitous regulatory environment to refocus existing controls? On what basis was it determined that the American taxpayer should shoulder a huge new regulatory burden on top of what banker’s already pay for regulation? In a day and age when so many choices are available to the American consumer, why do we need an agency that struts its ability to “take aim” at any facet of financial commerce it doesn’t like? Too many bankers can attest to so-called “compliance exams” that go on for months, with exasperating cycles of interrogatories that are followed by additional requests…that result in no conclusion. The CFPB is a regulatory authority in pursuit of submission rather than compliance and no for-profit business can stand for long against this onslaught of distraction. Sadly, this is one force that is unlikely to be overcome in the arena of business propositions and career choice. As an entrepreneur in search of an industry in which to build up a free-market business, what hill do you want to die on?
It’s not your money, Jane, it’s your prospects. And you just don’t understand me.
Over the 2014 Thanksgiving break, I read a book that helped to set me on a path for the exits. Bob Buford wrote Halftime in 1994, in large part as a tribute to his good friend and mentor, Peter Drucker. While I can offer many great extracts from this compelling mid-life read, the essence of Drucker is communicated in 3 simple admonitions:
- Build on islands of health and strength. This is counterintuitive for philanthropy, which tends to seek to help the helpless. Building on health and strength, however, is a better idea in that it builds independence rather than dependence.
- Work only with those who are receptive to what you are trying to do. You have but a limited amount of time. Trying to convince people to do what they really don’t want to do requires four times the amount of energy required to help others conceive or implement their own ideas.
- Work only on things that will make a great deal of difference if you succeed. This is a mission, not a hobby. Why invest all your time and energy in something that will only bring incremental change. Aim high!
You can read more about Halftime here.
We both need to get on with our lives, Jane, but we can certainly still be friends. To be honest, I’ve found somebody new. It’s not that she’s more exciting or prettier than you. It’s just that she gets what I need. Is it possible that we’ll ever get back together? Sure—and who knows? If we happen to find an opportunity to spend some time together again someday….well, that could certainly be nice.
Goodbye Jane. I hope you find what you’re looking for…and I hope that you recognize it when you see it. And one last word of advice: do something soon about diversifying that stock portfolio. It’s awful risky to keep all of your eggs in that one bank basket.
All the best,
Bob
So how can you make my example an exception to the rule rather than an industry trend? How can you make good use of my cautionary example?
Manage your bank like any business that seeks to drive shareholder return and create franchise value. Know how you make money, know where the risks are and know how to evaluate and reward performers responsible for executing a business plan.
As for that third problem—the CFPB: I am sorry there are so many question marks in those paragraphs—but I’m afraid that I don’t have any good answers. I believe the CFPB represents a profound intrusion into chartered corporate businesses, and I believe that it can only change with the resolve of a new political administration and exertion of political will. In that regard, I’m afraid Drucker was right: I don’t have that kind of time.
Your comments and feedback are welcomed atRDK@BankForwardConsulting.com. My consulting website, now stale, will be active until the end of this year. I don’t plan to renew my hosting subscription.
And about my new company: I’m excited to be serving as president of Cold River Tax, which offers a unique and compelling property tax management solution for banks, REITs, builders and capital funds. If you’ve ever been frustrated by the complexities of researching, managing and paying property taxes, you havegot to check us out at www.ColdRiverTax.com.