Performance, growth take center stage at BHCA seminar

The economy may be weak but bankers still can drive performance and growth in their franchises, reassured David Kemp, president of Bankers Management Inc. Kemp spoke on the future of community banking at the Bank Holding Company Association's Spring Seminar May 6-7 in Bloomington, Minn. The meeting attracted some 300 attendees..Offering performance benchmarks adjusted for these times of weak loan demand, narrow net interest margin and expanding compliance cost, Kemp said 8 percent to 12 percent return on equity is an acceptable ratio in the current economy. "If your management team is above that, they are doing a darn good job," he said. "Seven years ago, I would have said your return on equity needed to be at 15 percent. If management didn't reach that, I would have said they are not trying hard enough.".For return on assets, Kemp said bank managers should expect a ratio between 0.8 percent and 1.1 percent. "Only the best banks are at 1.5 percent," he said..Community banks wanting to reach these numbers need to increase their prices, said Kemp, adding that the best banks have non-interest income to assets at 0.7 percent. "Community bankers are notoriously bad at charging fees," he observed. "The average American has no idea how much he pays in bank fees. We are under-charging, sometimes not even making the customer pay for services provided," he said..To illustrate his point, Kemp shared the story of an exchange with one of his students. He once asked his banking class how much their bank charged to document a loan. "One young lady raised her hand and said her bank charged $75," Kemp recalled. "I told her to double the fee to $150.".The banker replied that such a high fee wouldn't work in her market. So, Kemp offered her a wager. "Go back and double your fee. If your loan volume has declined in six months, I will write your bank a check for the lost revenue. However, if your loan volume is the same, you write me a check for 50 percent of the increase in your fee income." The banker declined, a move Kemp affirmed as wise..Kemp said bankers should operate on the theory that higher price creates a perception of value. He gave the example of Coach purses. "Twenty years ago, the manufacturer of lady's handbags had a problem: flat sales. If they cut the price they wouldn't make any money. So they branded the bag and increased the price to $400 from $40. Sales sky-rocketed," Kemp said.."This would work in financial services," he advised. "American Express's platinum card costs $400 annually, yet there are two million platinum card holders. Why would anyone pay that amount for a credit card when they could get one for free? They do it because other people see it when they take it out of their wallet," he said..Turning to lackluster loan demand, Kemp said only the best banks in the country have a loan to deposits ratio above 76 percent. "Many of you cannot get to that number with organic loan demand," he said. "You will have to use participations.".Kemp told bankers to forget participations where the loan is collateralized by land development in Arizona. "Your loan officer should be able to drive and see the project before you put your money into it," he explained. "Your lending partner will be a well-known player in your area. They will lead, and you likely will join in because you know all the players.".The bank consultant said analysis has shown there are 1,953 banks in the United States that should consider selling. "Their outlook for future earnings and their continued struggle to meet capital requirements indicates that they ought to sell," he said. .M&A outlook.John Freechack, chairman of the financial institutions group at the Chicago law firm of Barack Ferrazzano, and Allen Laufenberg, managing director of investment banking at Keefe, Bruyette & Woods, also of Chicago, agreed with Kemp. Presenting jointly on coming opportunities in mergers and acquisitions, the duo said all signs point to an uptick in acquisition activity in the months ahead.."There are many publications out there saying an M&A wave is coming," Laufenberg said. "That story has been out there for a while and it will continue to be a theme. The reason for it is that the conditions that drive consolidation are still present.".Laufenberg said the economy is the first of many reasons for coming consolidation. "Uncertainty still prevails from Washington and the number of troubled institutions continues to be sticky," he said. "The industry also is making money generally, and the number of buyers is coming up. There are more buyers and less sellers; when you put the equation together it means better prices for sellers, which only helps M&A.".Banks which have trust preferred debt at the holding company level or which participated in the U.S. Treasury's Troubled Asset Relief Program also could become acquisition targets, Laufenberg said. "The dividend rate on TARP stock goes up to 9 percent in January 2014," he explained. "We believe the regulators will be talking to TARP banks, telling them to get out and raise some capital. That can create opportunity for some banks in this room.".Trust preferred debt has a default feature that kicks in after five years of deferral, Laufenberg said. "It has some real teeth to it," the investment banker said. "Here also, there could be some opportunity.".And then there are those banks that are in year seven of a four-year exit plan, Laufenberg said. "These banks likely have no succession plan, things didn't go as they expected after they chartered in 2005, again offering prospects for M&A.".Prepare the regulator.Banks looking to grow through acquisition should be sure to prepare their regulator, Freechack advised. "The timing on communication with your regulator is very important. Do not surprise them," he said..Bankers shouldn't assume a regulator will always behave the same way, even when the acquisitions are similar, Freechack advised. "Regulators react differently to the same facts and circumstances," he said. "What they do comes from their perception of the buyer's management team, and the relationship they have with them.".To better a regulator's perception of management, Freechack advised bankers to prepare thoroughly. "Show them you know more about your bank than they do," he said..Freechack encouraged bankers to be up front with regulators. Some clients, he explained, make a presentation to their regulator before an examination. The bank's management tells the regulator about the challenges facing the organization; they also present a plan to fix the issues, if there are any. "We've found they appreciate it," he said. "This kind of good regulatory relations increases the likelihood you'll be approved for an acquisition, and you also might get the benefit of the doubt if you make a mistake." .But Laufenberg urged caution. "If you give the regulator a little presentation and the slides contain a footnote which says the bank's plan assumes it will raise $5 million in subordinated debt from friends and family, the regulator will take that as a commitment to raise $5 million," Laufenberg said. "Be very thoughtful about when you bring that sort of thing up.".Focused on operations.During the last few years, managers have focused on efficiency in the bank, according to Paul Danola, group practice manager at Catalyst Consulting Group. He said too many distractions have prevented executives from focusing on franchise growth. .In a recent survey completed by CCG, 19 percent of bank executives said improving operations processes was their top initiative. Another 18 percent said navigating changes in the regulatory environment was most important, closely followed by the 15 percent of bankers who said cost reduction initiatives were at the top of the list. Only 8 percent thought improved risk management processes was a top priority, and only 6 percent thought a change in business model was most important.