Monday, December 22, 2014

Lessons For Community Bank Investors

In the December 14, 2014 Sunday Edition of the New York Times, there was an article titled, “Population 686 – A Tiny Town in Banking’s Fast Lane.”
The article describes how the couple, Suresh Ramamurthi, a former Google executive and his wife, Suchitra Padmanabhan, a former investment banker, purchased a small bank, Citizens Bank of Weir, in the decaying city of Weir, Kansas in late 2009. Citizens Bank of Weir at the time of the of the purchase had about $6.3 million in assets, $5.7 million in deposits, total equity capital of $0.5 million and three employees. During the next six years, the couple implemented a few innovative approaches using technology, and turned around a bank that over a matter of time, would have ceased operations.
The article, which was given a full page spread in the print edition, was interesting and insightful.  Bank investors, entrepreneurs, venture capital, and private equity including operating managers can take away four critical lessons from this article, which, from my perspective, are: patience; as-is where-is; innovation and risk layering; and capital.
Why are these four lessons important? Return-On-Investment expectations. For any ROI calculation, the key question is: How much is enough and how soon? Investing in a bank is a long-term investment.  Therefore, a bank investor should seek long-term capital appreciation. It is a marathon, not a sprint.  Far too many investors expect unrealistic financial and growth results within a short time frame.
I have encountered entrepreneurs, venture capitalists, and private equity, all of which wanted to start a bank or acquire a bank, especially after the financial crisis. Most expected speedy regulatory approvals, thought that they could acquire a bank on the cheap and provide as little capital as possible, while proposing to layer on significant risk in the quest for the immediate ROI.
Patience. Starting or acquiring a bank in today’s regulatory environment is not impossible but it is a long and arduous process, not for the faint of heart or he impatient. It took Mr. Ramamurthi ten months to get through the regulatory process for the bank acquisition. That was in 2009, at the tail end of the crisis, for a very small bank. Now, it can take 12 to 18 months, even longer, for a bank acquisition and in the case of a start-up bank, it can take 36 months or more to receive regulatory approval. As the article stated, “Getting a bank charter isn’t easy. Start-ups and giants like Walmart have been turned down by regulators.” There are myriad of reasons why applicants get turned down. There are only 8,000 or so banking licenses in the United States and those licenses are dwindling every Friday. Ask yourself, how bad do you want one and how long are you willing to stand in line and answer questions to get one? In addition, investors cannot expect immediate returns on capital.  In short,  bank investors need to have a much longer timeframe. It took Mr. Ramamurthi six years to get the bank from negative earnings to profitability.
As-Is Where-is. One of the most critical components of the Mr. Ramamurthi’s acquisition of the Bank was that he and his wife said they would keep the bank exactly where it was allowing it to continue to service its market…all 686 of them. In my experience, this was probably the most favorable accord in their acquisition application. Regulators are not particularly keen on allowing a bank license to relocate just because an investor doesn’t like the local market. The banking license gives the financial institution a national customer base in addition to the local customers. So, it doesn’t really matter where the main banking office is located. But for most investors, this does not make sense, and who the heck would want to work in a bank in the middle of “sticksville”. Well, Mr. Ramamurthi and his wife did just that. In the first year, they stayed in a hotel in the next town that was a short 20-minute drive to the Bank. As the situation got better, Mr. Ramamurthi was able to extend his commute to two hours, one way, from Lawrence, a more metropolitan town. I worked with a group of investors where the principals were unwilling to make a daily one-hour drive to the bank. Ultimately, the deal did not go forward because the principals couldn’t get over the location of the bank. The drive was way out of their way and the management team, which consisted of some of the principals, did not want to reside in the town where the bank was located. Not for a day, not for a month, not for the opportunity.
Innovation and Risk Layering. Although, the couple set out to work on a big ticket item called payments, they didn’t loose sight of the smaller innovations such as check scanners, a new phone system, computers and a cheaper core processing system because these smaller items were non-existent or outdated. Many small banks across the United States like Citizens Bank of Weir are operating on antiquated systems or none at all. I remember working on a project for a client in 2009 where the bank kept its book on paper financial ledgers. It was a scene right of “It’s a Wonderful Life.” After making small incremental improvements in the operations of the bank, that Mr. Ramamurthi turned his focus to payments, his passion. The payment business is not new, but it is a very significant industry. In 2011, global payments were $1.34 trillion and will increase as we continue to grow as the world becomes a cash-less society. Although Mr. Ramamurthi is doing something innovative for the bank and unique in approach, from the regulators’ perspective, Mr. Ramamurthi is not doing anything significantly new and unknown to them. Rather, by focusing on a small segment of the payments market, international remittances using existing credit/debit card rails, he has layered a small amount of financial and transaction risk in the bank. The true innovation is the software he is developing to assess the transaction risk.
Capital.  There is always a need for additional capital in bank acquisition.  Don’t expect to buy a bank or start a bank without adequate levels of capital to put into bank on top of the purchase price which regulators often require.  In Mr. Ramamurthi’s case, the bank’s equity book value was about $0.5 million. He and his wife probably paid, more or less, a half million dollars for the bank. I venture that he paid a little less than half million because the bank had some issues that probably helped Mr. Ramamurthi achieve a discount on the book value. But what is important and not mentioned in the article, is that there was an additional half million of capital added to the balance sheet after the acquisition which increased the bank’s equity capital from half million to one million. The additional capital that that Mr. Ramamurthi put in the bank was the amount that was needed to execute on his business plan. It gives the bank room to grow it balance sheet and it provides a backstop for risk. But Mr. Ramamurthi invested much more capital that is not reflected in the Bank’s equity accounts. Mr. Ramamurthi’s and his wife incurred other capital costs to win the regulatory approval such as consulting fees, legal fees, and living expenses just outside Weir while the imbedded themselves in the bank in year one. Mr. Ramamurthi has also incurred additional capital outlays such as the engineers in Topeka to build the back-end transaction system and Yantra, his software company, housed in bookstore in Lawrence, KS.
So what does it all mean? According to the article, the bank in the last quarter earned $60,000 in interest income on loans and $720,000 from the rest of the business. So, I looked closely at the financials and this is the full story: Since Mr. Ramamurthi’s acquisition of the bank in late 2009, the bank’s net interest income ratio as percentage of assets (net interest margin) has decreased by 24 percent even though assets has doubled. But that is expected. Every Bank in America has seen net interest margin compression as a result of the current rate environment. But the Bank’s non-interest income has increased by a whopping 4690 percent from $27,000 in 2009 to $2.2 million in 2014. The Bank’s year-to-date net income at the end of the third quarter of 2014 was $819,000 compared to a net loss of $52,000 at the same time period in 2009. Assuming a simple run rate, the bank is on pace for $1 million net by year-end. The question is whether the Bank and Mr. Ramamurthi can sustain and grow the earnings. I certainly think so. With a $1.34 trillion global payments market, just capturing a mere fraction of the market can generate significant returns for the bank and Mr. Ramamurthi.
Ultimately Mr. Ramamurthi is an investor-entrepreneur. He is not doing this for altruistic reasons. A million dollar plus investment is a million dollar plus investment. He has a passion; he found a platform that will help him realize his passion. The platform he chose is highly regulated and subject to scrutiny, which meant he had to show patience, take the platform as-is where is, innovate, and put up capital, direct and indirect. The value of his bank is appreciating. Maybe Google will take a small equity stake in his bank.
These are the learning lessons for any outside investor seeking a bank…big or small!

Thursday, February 4, 2010

Maryland Community Banks Update

Two quarters have passed. Maryland banks have fared very well compared to other states, but the clock is ticking.  The state of Maryland banks has seen a slow and steady decline. Maryland banks had a 284% decrease in net income from a positive $60 million at the end of September 2008 compared to a negative $109 million at the end September 2009.  If the tea leaves are correct, Maryland will lose at least 2 more banks in 2010.  The FDIC is putting all the regulatory agencies (OCC, OTS and State DFIs) under pressure to take action and clean up.  Sheila Bair, FDIC Chairman, wants them be proactive not reactive. 

"We are seeing the next wave of industry consolidation, either in the form of managed consolidation, encouraged by the regulators, or strategic acquisitions of banks with solid core deposits and an established franchise“  - Paul Joegriner, “Chevy Chase Bank, Citi in talks, Sale would boost New York institution's presence in state. The Business Gazette of Politics and Business, 14 Nov 2008.

The insurance fund cannot afford continued claims.  So much so that Sheila Bair wants all U.S banks prepay three years of insurance premiums to replenish the fund. 

A concern for the industry and economic growth is the decline in industry assets of 18% driven by a 22% decline in loans and leases.  Commercial and Industrial (C&I) loans declined 14% and real estate development (C&D) loans declined 38%.  A major reason for the decline in loans is the high charge-off rate of 137% compared to one year ago.   In dollar terms, Maryland Banks have charged-off $127 million. While deposits was up 12% for the state, most of those deposits went to the big banks or non-Maryland banks.  Deposits decreased 15% for Maryland banks compared to one year ago.  Community banks are in a tough position competing for deposits against big banks and larger out-of-state banks.

The credit crisis is dramatically changing the competitive landscape for bank deposit gathering. Three events, in particular, directly affect funding costs. The first is the increase in FDIC deposit insurance from $100,000 to $250,000 per depositor per institution. The second is the FDIC’s Temporary Liquidity Guarantee Program (TLGP) of which one component provides full insurance coverage for non-interest bearing transaction accounts while another guarantees new issues of senior unsecured debt. The third is the Federal Reserve’s apparent willingness to approve nonbank financial firms’ applications to become bank holding companies.  Timothy W. Koch, “The Competition for Deposits Will Pressure Community Banks.” December 1, 2008.

The big banks have benefited by the FDIC actions  more than the community banks thus creating an imbalance between the big balance and community banks.  The four universal banking giants, Bank of America, JPMorgan Chase, Citigroup, and Wells Fargo/Wachovia now control 40% of the U.S. deposits, up 9% from one year ago.

View my SlideShare Presentation:

Saturday, October 24, 2009

U.S. Banking Consumers Not Ready for Mobile?

A recent article in Reuters U.K. indicated that 95% on the U.S. households surveyed said they were so uncomfortable with conducting financial transactions on their phones that they've never used them to make a purchase on a retailer's Web site. About 48 percent of respondents cited security and privacy worries as their main reason for not banking on their cellphones, according to KPMG. "U.S. consumers snub mobile banking on security fears." Reuters UK 8 April 2009

These are staggering statistics. Every American household is uncomfortable with using a mobile phone to conduct financial transactions and 1 out every 2 said that they have security and privacy concerns.

Yet, the mobile phone is now as ubiquitous as mom's apple pie. Most Americans will leave home forgetting their wallet or purse before they forget their mobile phone. Here are some key U.S. mobile phone statistics:

  • 8 in 10 Americans own a mobile phone. This number is expected to increase to 9 in 10 by 2011.
  • 58% percent use mobile phone for other purpose than calls (84% among 18-24 year olds)
  • 6 in 10 of all population group (African American, Caucasian, Asian and Hispanics) own a mobile phone.
  • 90% of Gen Y own a mobile phone.
  • 60% of income earners $25,000 or less own a mobile phone.
  • 60% of income earners $100,000 or above own a mobile phone.
  • $1 out of $10 from Gen Y was spent on mobile products and services.
  • The list goes on...
I mentioned that 58% of mobile phone owners use the phone for a purpose other than a phone call - games, internet, camera, PDA, music, television, navigation, etc. And, now with the iPhone (and its competitors), the mobile phone is almost capable of doing everything (could surpass the Star Trek NG Tricorder).

The market for mobile banking in the United States could be one of the most lucrative banking services for the 21st century. Yet, U.S mobile banking adoption rates are the lowest in the world and the rollout of services among financial institutions has been limited.

The big names of banking, Wells Fargo, Chase, Wachovia, Bank of America, Chase, Citi and PNC, have lunched mobile banking to some degree of success.

According to Javelin Strategy and Research, consumer adoption of mobile banking is lacking due to ineffective mobile banking strategies by financial institutions. 50% of financial institutions are not adequately addressing consumer two primary mobile banking concerns.

In order for mobile banking to become as ubiquitous as the mobile phone itself, the banking industry has to make a paradigm shift about how it approaches and thinks about the mobile banking concept.

Note: To discuss this article or any other banking and financial services topics with Paul Joegriner, please contact at 240.246.5587 or

Tuesday, October 7, 2008

The Current Economy and Opportunity

Two weeks ago, I said that now is the the time to be buying. Some are calling this a recession, others are afraid that it might become a depression. I call it OPPORTUNITY!

Opportunity is an auspicious state of affairs or a suitable time: "If you prepare yourself . . . you will be able to grasp opportunity for broader experience when it appears" Eleanor Roosevelt.

Before I discuss the opportunity that is available, let's backup so that you have a better understanding of where we are economically. Maybe I shouldn't rehash what the media, the financial experts, and the politicians have said over and over again in the last several weeks. Greed, leverage, poor oversight created one of the biggest threats to America's financial system since the great depression. This is not new? Henry Clew wrote a book called, "Fifty Years on Wall Street" in 1908 in which he surmised that in every crisis, the primary cause was a large amount of credit in the market. Sound Familiar? What's really interesting is that he wrote this book before the 1929 crash.

What caused the 1929 crash? The same thing: Too much credit, too much leverage and poor, very poor, oversight.

What happened this time? The absurd amount of credit in the marketplace involved the American home. In 1929, it involved stocks. Creditors assumed that home values would go up in straight line and the borrowers would not default on their home loans. People who should have not been given credit where given credit. Lots of it! And then, the investment banks packaged, repackaged and futher repackaged the loans intermingling the good credit with bad credit to the point where no one could assess the value of these loans anymore. The good was mixed with the bad. These packages were called MBS (mortgage-backed securities) which were then packaged into CDOs (collateralized debt obligations) which were then sold and traded on the stock market.

Then housing market took a downturn. I wrote about the reasons two week ago. The downturn had an adverse impact on the holders (large banks, investment banks, funds, etc) of these MBS assets. Many of these institutions were leveraged to the hilt. Some as much as 50-1. As underlying value of the collateral, residential real estate (aka, the American home) declined, the value of the MBS assets disappeared rather quickly (some would say, "in the blink of an eye"). Confidence eroded and the two oncoming trains, the train from the west called liquidity and the train from the east called credit, collided bringing the system to near collapse.

So where is the opportunity, you ask? First, let's look a some economic indicators:

1. The Consumer Confidence Index, which is an indicator of the degree of confidence Americans have in the economy, for September was 59.8. This is probably the second lowest number in ten years (see graph below):

2. The S&P 500 stock index has declined 35% from circa 1550 to near 1000.

These two leading indicators tell me one thing...we are headed for a recession. The big question is how deep and how long? The average length of a recession in the US has lasted 10 months. The shortest was six month and the longest was 16 months. Bear in mind that this recession is atypical.

So where is the opportunity? Three areas to invest your money: startups, real estate, and other alternative investments. There is still opportunity in the stock market. The opportunities to get the best returns from the stock market requires that the "buy and hold" strategies have to be scrapped. I can prove with a high degree of certainty that the average investor has lost money in the stock market since 2000 using the old mantra buy and hold. The better strategy is Trade.

Stay tuned for more about the three areas to invest your money and my stock market trade strategy.

Sunday, September 28, 2008

The Beginning of a New Real Estate Cycle--

The American Public is up in arms about the financial bailout of Wall Street. The investment banks, large and mid tier Banks, and to a much lesser extent community banks all played a part in this debacle. But do not blame the banks alone, we the borrowers deserve as much blame as the banks. Everyone needs to relax and stop worrying. Its the job of Congress and the financial gurus at Treasury, The Federal Reserve, SEC and FHFA to restore faith in the in American Economy and free up liquidity. This act of socialism may end up causing more pain than pleasure. I just hope that it is less socialism and more capitalism.

Don't blame this on lax lending standards. Don't blame it on Wall Street. Don't blame it on subprime. Blame it on all of these. It was a combination and convergence of market and financial events. The national (and local) real estate market from 2000-mid 2007 had gone wild. Prices were going through the roof and there was unprecedented growth. Those who were smart enough to sell were becoming multi-millionaires. Those who wanted to live like millionaires refinanced the market equity in their homes (more like used their homes as ATM machines) to live lavish lifestyles and buy worthless assets. And finally, those who should have remained renters wanted to join the party. It was crazy.

When the quantity of any commodity which is brought to market falls short of the effectual demand, all those who are willing to pay... cannot be supplied with the quantity which they want... Some of them will be willing to give more. A competition will begin among them, and the market price will rise... When the quantity brought to market exceeds the effectual demand, it cannot be all sold to those who are willing to pay the whole value of the rent, wages and profit, which must be paid in order to bring it thither... The market price will sink...

An Inquiry into the Nature and Causes of the Wealth of Nations, by Adam Smith. Methuen and Co., Ltd., ed. Edwin Cannan, 1904.

The national real estate market is going through a correction. Why? It has to. Our capitalistic system of supply and demand requires it do so! Is it for the good of our economy? Absolutely! It's healthy for the market to go through this cycle. It is necessary so that the market can collect itself, rest, and grow again. What concerns me is that the government intervention will artificially prop up the market.

Why did the real estate market undergo such price appreciation? There are many reasons. The most basic are: speculation and population growth.
When particular real estate markets have properties being traded between buyer and seller at a frenetic pace, particularly for investment, market values will rise quickly. The result is real estate valuations that become suspect because the price increases are occurring faster than the local affordability levels.

For example, a real estate investor buys a home for $150,000, adds $50,000 in improvements, and sell its 90 days later for $300,000. That house gained a 150% price appreciation in the three months. What happens if 25% of the homes that are being sold in any particular area during a period time(say, one year) are growing exponentially while incomes stay flat. It will result in problems. Overtime, this price to affordability effect will impact the market as potential buyers can no longer afford to buy a home.

Also, existing homeowners who saw the market heating up, wanted a piece of the pie. So as prices kept going up, those homeowners started putting their properties on the market. Some where the same people that cashed out their equity (and had blown all the cash on frivolities) now realizing that they had more debt than they could afford to carry, thus forcing them to sell along with those that just wanted a piece of the action. Eventually, the market became flooded with property.

Invariably, as demand slowed, sellers were still trying to sell at the highest prices possible, but it was too late for them. They are usually the ones who fail to see the end of the growth period and eventually, have to adjust their prices and so, the market corrects itself (just like the stock market).

What happens next? Once the market has fully corrected, prices stay flat and growth slows for a period of time,the upward cycle will begin again as demand starts to rise.

Please take a moment to view this video from a conference in California. The speaker, a CEO of a top California Real Estate firm, has an exceptional insight into real estate cycle. While the speech later gets into the California real estate in particular, I think the early part is very informative. Click here to see video

So what does this mean? It's an opportunity for the savvy investor. Now is the time to be buying when everybody is selling.