Bank Board Letter October 2015 : Page 1

The BANK BOARD Letter Edited exclusively for directors of financial institutions and their holding companies october 2015 Strategic PlanS Shift from minimizing riSk to building value By RoBERt FEhn T oday’s banking and economic environment is changing rapidly and strategic planning must stay ahead of this evo-lution. Regulatory burden continues to increase, the inter-est rate environment remains at historic lows for the sixth consecutive year, and technological advances have allowed new competition into the banking space. This technology has forced a complete change in how markets are defined; mobile technol-ogy is rapidly reducing the geographic competitive advantage of a branch network. For example, Google Wallet utilizes technology to target the millennial generation and provide an FDIC-insured convenient alternative to the established banking system. Due to this rapidly changing environment, many institutions’ strategic plans fall into the same pitfall, omitting the fundamental com-ponent in bank planning. How is the bank going to build value? The approach to strategic planning should not be some sort of academic exercise or something to accomplish for the regula-tors. Rather, top-performing financial institutions in the coun-try utilize planning to: 1. Define success over a specific time horizon. 2. Delineate alternative paths to achieve these goals. 3. Determine trigger points along the way. 4. Examine the execution risks and conduct stress tests. 5. Focus the bank on executing the stated goal. Many banks build their strategic plans by starting with their current position and overlay assumptions to determine where the bank will be over the next three to five years. However, the top-performing banks start with a realistic goal in three to five years and then figure out how to accomplish the task. The key is to identify the top realistic, exciting and “value-add” goals over a given time horizon. For example, your board’s goal in five years may be for the company’s stock price to be worth more than $30 per share on a take-out basis, which equates to an EPS of $1.50 per share and a TBVS of $20 per share. To reach these goals, it may be determined the bank must grow total assets to $1 billion, im-prove earnings to at least a 10 percent ROAE, maintain a mini-mum Tier I leverage ratio of 8 percent, and maintain at least a composite “2” rating with the regulators (to achieve desired multiples). By establishing specific goals, both the board and management team have tangible benchmarks to monitor the success of the plan. Many banks continue to model the institution under one sce-nario. However, effective bankers understand that rapidly chang-ing external factors can impact execution of the strategic plan. As such, banks should be modeling multiple potential strategic op-tions and scenarios. The use of a decision tree helps management and board proactively manage potential risks and weigh the best strategies to build value. For example, by modeling alternative scenarios, a bank is worth $27 in a sale today but could be worth $32.50 in five years by raising capital and growing organically. Bank management and boards, as well as their regulators, have found this process extremely helpful in identifying opportunities and describing the true challenges of running a good bank and building value in a safe and sound manner. As part of the planning process, establishing appropriate trigger points allows bankers to proactively adjust to a rapidly changing environment. These trigger points result in new de-cision tree branches with specific action steps to prepare for future possibilities. As an example, a FinPro client sets trig-ger points if the 10-year treasury reaches 3.25 percent or falls to 1.5 percent. These triggers were put into place for interest rate risk purposes to ensure that the bank was prepared for Premium Digital content: 1. one-Fourth of u.S. Debit cards expected to be emV-enabled by Dec. 31 2. real-time Payments — anyone, anywhere, anytime 3. Project management for the Financial industry 4. banks earned record Second-Quarter income of $43 billion 5. FDic Settles With comenity for credit card ‘add-ons’ 6. FFiec Proposals Would Streamline banks’ call reports

The BANK BOARD Letter

Robert Fehn

Edited exclusively for directors of financial institutions and their holding companies

STRATEGIC PLANS SHIFT FROM MINIMIZING RISK TO BUILDING VALUE

Today’s banking and economic environment is changing rapidly and strategic planning must stay ahead of this evolution. Regulatory burden continues to increase, the interest rate environment remains at historic lows for the sixth consecutive year, and technological advances have allowed new competition into the banking space. This technology has forced a complete change in how markets are defined; mobile technology is rapidly reducing the geographic competitive advantage of a branch network. For example, Google Wallet utilizes technology to target the millennial generation and provide an FDIC-insured convenient alternative to the established banking system. Due to this rapidly changing environment, many institutions’ strategic plans fall into the same pitfall, omitting the fundamental component in bank planning. How is the bank going to build value?

The approach to strategic planning should not be some sort of academic exercise or something to accomplish for the regulators. Rather, top-performing financial institutions in the country utilize planning to:


Define success over a specific time horizon.
Delineate alternative paths to achieve these goals.
Determine trigger points along the way.
Examine the execution risks and conduct stress tests.
Focus the bank on executing the stated goal.

Many banks build their strategic plans by starting with their current position and overlay assumptions to determine where the bank will be over the next three to five years. However, the top-performing banks start with a realistic goal in three to five years and then figure out how to accomplish the task. The key is to identify the top realistic, exciting and “value-add” goals over a given time horizon.

For example, your board’s goal in five years may be for the company’s stock price to be worth more than $30 per share on a take-out basis, which equates to an EPS of $1.50 per share and a TBVS of $20 per share. To reach these goals, it may be determined the bank must grow total assets to $1 billion, improve earnings to at least a 10 percent ROAE, maintain a minimum Tier I leverage ratio of 8 percent, and maintain at least a composite “2” rating with the regulators (to achieve desired multiples). By establishing specific goals, both the board and management team have tangible benchmarks to monitor the success of the plan.

Many banks continue to model the institution under one scenario. However, effective bankers understand that rapidly changing external factors can impact execution of the strategic plan. As such, banks should be modeling multiple potential strategic options and scenarios. The use of a decision tree helps management and board proactively manage potential risks and weigh the best strategies to build value. For example, by modeling alternative scenarios, a bank is worth $27 in a sale today but could be worth $32.50 in five years by raising capital and growing organically. Bank management and boards, as well as their regulators, have found this process extremely helpful in identifying opportunities and describing the true challenges of running a good bank and building value in a safe and sound manner.

As part of the planning process, establishing appropriate trigger points allows bankers to proactively adjust to a rapidly changing environment. These trigger points result in new decision tree branches with specific action steps to prepare for future possibilities. As an example, a FinPro client sets trigger points if the 10-year treasury reaches 3.25 percent or falls to 1.5 percent. These triggers were put into place for interest rate risk purposes to ensure that the bank was prepared for unanticipated events. The triggers effectively protect current earnings (i.e. do not result in the bank extending liabilities today in a potentially long-term, low-rate environment) in an excessively volatile rate environment.

The next step to an effective strategic plan is to ensure that all current and projected risks are identified under each path of the decision tree. An enterprise risk management assessment of each path will allow management and the board to understand the feasibility of and risks associated with each path as well as the overall impact on a CAMELS+ assessment. A single engine for planning, ERM, asset liability management and stress testing is the key to conducting scenario modeling and single/ multi-variable stress tests. Understanding the impacts of these scenarios and stress tests allows the bank to weigh the business risk/reward trade-offs and determine the appropriate course of action along the decision tree.

The final step is to ensure success by assigning accountability and responsibility throughout the entire bank. Key stake holders are assigned specific responsibilities, authority to execute and are held accountable for execution of the plan. Compensation plans should be aligned with the successful execution of the strategic plan. The most successful banks focus on value, break down any obstacles and identify solutions to problems Ð all while managing risk!

Robert Fehn is a managing director in FinPro’s Consulting Division. For more information about FinPro’s regulatory, planning and strategic modeling services contact him at 908-604-9336 or rfehn@finpro.us.

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