Tuesday, June 18, 2013

Banking Runs on Talent, and the Industry’s Running Low

A surge in new bank formations dilutes talent 


In this final installment of my response to the St. Louis Fed's study of "thriving" banks, I want to make two common-sense points:
  1. The banking industry needs higher barriers of entry
  2. Bankers need to protect themselves from bad bankers
States experiencing a rapid growth in new banks risks face several risks. Common sense suggests that a surge in new bank formation requires a commensurate growth in the number of skilled bankers, directors and regulators to manage, govern and supervise these banks. In the absence of a reliable pipeline of new, skilled talent, states that allow rapid new bank formation experience a serious dilution of talent.

My book, "Broke: America's Banking System – Common Sense Ideas to FixBanking in America," has a table of data showing new bank formation rates for the states from 1996-2010. The 10 states with the lowest new bank formation rates – a group, by the way, that closely resembles the Fed's list of states with the most thriving banks – experienced a modest growth in new banks from 1996 to 2010: 132 banks, which equaled 11% of the total number of banks doing business in those states as of 1995.

In contrast, the 10 states with the highest percentage of new bank formation from 1996 to 2010 – a list that nearly mirrors the Fed's list of states with the lowest percentage of thriving banks – added 781 new banks for the time period, a total equal to 70% of the banks doing business in those states in 1995.

Returning to a point made in my previous post, the NFL and Major League Baseball clearly understand the potential new teams have to dilute the overall talent in their businesses. Not everyone loves sports analogies, but this one is too good to pass up.

Go back to 1960. Since then the NFL added 10 new teams and Major League Baseball added 14. In the case of the NFL, the new teams won a total of only 19% of their games during the teams' first three years in existence. For baseball, the record is better at 38%, but to give some perspective, these teams collectively lost 1,632 more games than they won in their first three years.

Professional baseball and football teams are highly unlikely to win a lot of games in their start-up years. In contrast, in U.S. banking, until the crisis hit full-blast, it appeared that the start-up banks were all the 1927 New York Yankees starring the Babe Ruths of banking. The states that allowed the most new banks to form experienced far and away greater growth in statewide loans and, for a while, growth in profits, than the states that did not experience rapid expansion. Yet consider the tragic annihilation of Georgia banks over the past five years.

Just to be clear, the banks that suffer when new banks are formed too rapidly are not just the new ones. My heart breaks for the stakeholders in banks like Community Bank and Trust and the Bank of Hiawassee, two Georgia banks each over 100 years of age that failed during the recent debacle.

The real crisis in American banking today is a severe talent shortage that will only get worse as the industry's most experienced practitioners retire. The Fed study missed the forest through the trees. Yes, our nation's best bankers are top-notch. But, contrary to the Fed's findings, these great bankers are not only located in states like Texas and Iowa.

Our reality is that even great bankers cannot succeed when forced to compete in markets where rapid new bank formation rates dilute the pool of skilled bankers, wise directors and experienced regulators.

Written by Richard J. Parsons
This post was originally published by the American Banker website on June 18, 2013.
Broke: America's Banking System

Richard J. Parsons is an Author, Speaker, Educator and Business Advisor in the Financial Services industry.  After a 31 year career at Bank of America, Rick founded the RJ Parsons Group in 2012. Rick published his first book in 2013, "Broke: America's Banking System - Common Sense Ideas to Fix Banking in America." He can be reached through his website rjparsonsgroup.com or via social media including @RJParsonsGroup and LinkedIn.

Thursday, June 13, 2013

Why Some Banks Thrived and Others Failed After the Crisis

What the NFL Knows that Banks Do Not


Yes, bankers should read "The Future of Community Banks: Lessons Learned from Banks That Thrived during the Recent Financial Crisis," written by researchers from the Federal Reserve Bank of St. Louis. But bankers may be even better served by asking the commissioners of Major League Baseball and the National Football League why they are so reluctant to grant new franchises.

What do baseball and football have to do with banking? You’ll see.

Like the St. Louis Fed, I have been studying banks and banking in this country. After a 31-year career in the industry, I retired to spend time examining why more than 3,400 banks failed during my career. However, unlike the Fed, my research considered both bank failures and successes.

Not surprising to me, the Fed study revealed that banking in the U.S. is lopsided. Ten states are host to the vast majority of "thriving" banks (i.e., great banks with Camels composite ratings of 1) while another 10 states have hardly any thriving banks. According to the Fed researchers, the states with great banks tend to be states that are heavily linked to the agricultural and energy businesses. Of the top 10 states, only Massachusetts would not be considered as a state connected to either business. (West Virginia is an energy state by virtue of its coal interests.)

However, where the Fed study breaks down is its failure to explain why some states with heavy agricultural interests, most notably California (the leading Ag state in the country), North Carolina (No. 8), Florida (No. 10), Georgia (No. 12) and Washington (No. 14), have virtually no thriving banks. If ag and rural markets are truly the key to being a great bank, would it not stand to reason that a representative sample of banks in these states would have qualified for a top Camels rating in the Fed study? The Fed did not answer this critical question in its study.

Though bank size, location, and asset mix may be of some importance to bank performance, my research shows another factor to be the most critical determinant of why some banks failed while others succeeded from 2008 to 2012.

The answer is one that the NFL and MLB understand better than bankers and regulators: New franchises and banks can weaken the system.

Here are a few highlights from my research.

The Fed identified 10 states as the top homes for thriving banks. When I compared those 10 to data in my research, seven were among the eight states that had the lowest new-bank formation rates in the country from 2000 to 2007. And the three others – Massachusetts, Texas, and West Virginia – were not far behind. In fact, my data shows that not one of these 10 states experienced a growth rate in new-bank formation from 2000 to 2007 greater than 9% of the number of banks in the state in the year 2000.

How about the states identified as laggards in the Fed study? The story is just the opposite: The states that experienced the highest rates of growth in new bank formation between 2000 and 2007 were the worst performing states in bank performance from 2008 to 2012. Arizona, Nevada, North Carolina, Utah, Florida, California, Connecticut, New Jersey, Oregon, Washington, Georgia, and Idaho all had growth rates in new bank formation at a minimum of four times, and in some cases ten times, the rate of the best performing states in the country.

As detailed in the appendix to my book "Broke: America’s Banking System – Common Sense Ideas to Fix Banking in America," the profitability of the banks in a state in 2009 was inversely correlated to new bank formation rates from 2000 to 2007, the years leading to the crisis. The strength of the correlation is remarkably strong.

When new bank formation rates from 2000 to 2007 are compared to bank failures and problem banks by state as of 2011, the correlation rates are meaningful. These findings should have profound implications for how U.S. banking is practiced in the future.

Is it possible that U.S. and state bank regulators do not understand the influence new bank formation played on bank failures during the past five years? Is it possible that bankers and regulators need to study the barriers of entry into banking just as seriously as the NFL and Major League Baseball consider new franchises for football and baseball?



Written by Richard J. Parsons
This post was originally published by the American Banker website on June 13, 2013.
Broke: America's Banking System

Richard J. Parsons is an Author, Speaker, Educator and Business Advisor in the Financial Services industry.  After a 31 year career at Bank of America, Rick founded the RJ Parsons Group in 2012. Rick published his first book in 2013, "Broke: America's Banking System - Common Sense Ideas to Fix Banking in America." He can be reached through his website rjparsonsgroup.com or via social media including @RJParsonsGroup and LinkedIn.

Wednesday, June 12, 2013

Tough Questions for the St. Louis Fed

Secrets of a Successful Bank.


As author of a recent book about the failure of more than 3,400 banks since the 1980s, I read with great anticipation the May 24, 2013 American Banker article entitled "Fed Reveals Secret Lessons Learned of Successful Banks."

In a nutshell, here are the "secrets" discovered by the Federal Reserve Bank of St. Louis in its study of "thriving" banks:
  • Be smaller than $100 million in assets
  • Locate in a rural market
  • Hold more securities and fewer loans on the balance sheet
  • Avoid commercial real estate and construction and development loans
  • Hold more consumer, mortgage, and especially agricultural loans
  • Have a lot of core deposits
When the bankers of the top banks were asked by the St. Louis Fed why their banks were so successful, here is what the bankers said:
  • Strong management
  • Conservative lending
  • Directors who don't try to "run the bank"
  • Business plans customized to the market
  • C-corporation structure
Perhaps the most intriguing comment in the American Banker article is this quote from one of the authors of the paper: "The guys that we talked to could run a good bank just about anywhere."

Although the Fed's paper may add new insights into the debate about why banks in the U.S. succeed, I find the paper actually raises more questions than answers.

Here are four questions for the Federal Reserve Bank of St. Louis.

How sure are you that local ag and energy economies are really the key to the success for thriving banks?

The corollary questions are: Since California, Florida, and North Carolina are among the top ten states in the country in ag production as well as the number of community banks located in rural markets, doesn't it stand to reason that they should have top banks too if the Fed's conclusions are correct? Two other states – Washington and Georgia – are the 12th and 14th highest producing ag states in the nation, so why did more than 100 banks fail in those two states over the past five years?

Is the Fed researcher right when he says that the great bankers he interviewed could run a bank successfully anywhere, anytime?

The corollary questions are: Are you really sure about that? Do you have evidence that shows any examples of great bankers moving from Iowa, Massachusetts, or Texas to less benign markets like Florida, Georgia, or California? If it is true that the nation's best bankers are concentrated in a few states, should directors of banks in low-performing states like Georgia start recruiting CEOs en masse from places like Iowa? Do the skills needed to run a rural bank in Iowa translate into running midsized banks in urban markets like Atlanta or Los Angeles?

What is the role of a bank director?

The corollary questions are: Is the Federal Reserve Bank of St. Louis implicitly endorsing a low profile role for bank directors? How do bank regulators, including the Federal Reserve Bank of St. Louis, know when the CEO has too much power and the board is basically just in place to rubber-stamp? If great banks' directors do not and should not "run the bank," why then does the FDIC sue directors of failed banks for basically failing to run the bank?

Since the Fed used highly confidential Camels ratings to compile their research (which no one can replicate, since the Camels ratings are confidential), what lessons did the Fed learn about the usefulness and accuracy of Camels ratings?

The corollary questions are: Based on your research, how confident are you that the Camels rating system produces accurate, reliable scores? What was the exact number of banks in 2006 with Camels composite ratings of 1? How did the number change over the next five years? How many banks that failed between 2008 and 2013 had a composite rating of 1 in 2006? If the Camels ratings are useful, why is it not a more effective early-warning system as evidenced by the more than 3,400 bank failures that have taken place since U.S. regulators introduced Camels in 1979?


Like the Fed's research, my analysis of U.S. banking explores the wide variability that existed in bank performance from 2008 to 2012. Unlike the Fed, however, my study considers failed banks in addition to top-performing banks. My findings, as a result, are different from the Fed's. This will be the subject of my next post.

Written by Richard J. Parsons
This post was originally published by the American Banker website on June 12, 2013.

Broke: America's Banking System
Richard J. Parsons is an Author, Speaker, Educator and Business Advisor in the Financial Services industry.  After a 31 year career at Bank of America, Rick founded the RJ Parsons Group in 2012. Rick published his first book in 2013, "Broke: America's Banking System - Common Sense Ideas to Fix Banking in America." He can be reached through his website rjparsonsgroup.com or via social media including @RJParsonsGroup and LinkedIn.

Monday, June 03, 2013

It's Time to Kill CAMELS

Capital, Assets, Management, Earnings, Liquidity and Sensitivity
assessments need to die.

When a bank fails and the resulting loss to the Deposit Insurance Fund crosses a certain threshold, regulators are required to write a material loss report explaining why the bank in fact failed. Well over 100 such MLRs have been written in the past few years.

Each report includes a recent history of the CAMELS ratings - the supervisory regulator's assessment of Capital adequacy, Assets, Management capability, Earnings, Liquidity and Sensitivity to market riskthat had been assigned to the bank.

Examine the MLRs and you'll notice two interesting things about these failed banks. First, they share the common problem of having grown too fast, typically in markets where competitors also grew too fast. Second, the banks' examiners almost without exception gave these institutions good to excellent Camels ratings nearly right up until the point of failure.

Start all the way back at 1979 - the year the Camels system was developed - and the total number of bank and savings and loan failures is now north of 3,400 institutions, including more than 470 that have failed just since 2008.

It is time to kill Camels. Unreliable, unpredictable, and outright misleading, this system must be replaced by something that is more than a clever acronym.

A good example of the uselessness of Camels ratings is a case study of Bank of Clark County in Washington State. Closed in January 2009 with a shade under half a billion dollars in assets, the bank had grown an average of 17% a year since its founding in 1999. A big slug of the growth occurred from 2004 to 2007, when Bank of Clark County's balance sheet ballooned 73%.

What were the bank's Camels ratings during that time? Answer: straight 2s, on a scale of 1 to 5 for each category covered by the Camels system, with 1 being great and 5 being brain dead. These were strong ratings, and they included a full-scope examination conducted by the Federal Deposit Insurance Corp. in June 2007.

By the time the state reported the bank's Camels ratings in November 2008, the scores had deteriorated to 5,5,5,5,5,4/5. Two months later the bank was closed, leading to a $131 million loss to the insurance fund.

Sadly, the pattern of scores seen at Bank of Clark County is typical of findings in virtually all the other failed banks for which MLRs are written.

This isn't a matter of implementation or execution. The problem is the system itself. The evidence of more than 3,400 failed banks in 25 years—and the ratings these institutions received shortly before folding—simply overwhelms any defense of the usefulness of Camels.

The United States needs a new, 21st century model for identifying, monitoring and reporting risk at banks. The model must be forward-looking, not backward-looking as the Camels ratings are; it must consider a bank's momentum as well as the emerging risks. It also should be transparent to bankers, depositors, and investors in bank equity and debt. Finally, the new model should be based on objective measures.

My analysis of failed banks shows that there are several factors worth focusing on. There's loan and asset concentration risk, of course. But two other important areas relate to "velocity," i.e. how fast a bank's loans are growing and how fast loans are growing overall in the bank's geographic market. A good rule of thumb: banks and markets with fast loan growth are more risky than banks and markets where loans are growing at a more constrained pace.

Though requiring great judgment on the part of regulators, perhaps the most important factor of all is the need to evaluate the skill and experience of a bank's board of directors to oversee strategy, management selection, risk appetite and controls. Banks that plan to take on strategic risk and grow through acquisitions should have superior board ratings.

We clearly need a process that takes all of this into account, to replace what we have now in Camels, and bankers and regulators should take the initiative and collaborate in designing it.


Written by Richard J. Parsons
This post originally appeared in the June 2013 issue of American Banker Magazine.

Broke: America's Banking System


Richard J. Parsons is an Author, Speaker, Educator and Business Advisor in the Financial Services industry.  After a 31 year career at Bank of America, Rick founded the RJ Parsons Group in 2012. Rick published his first book in 2013, "Broke: America's Banking System - Common Sense Ideas to Fix Banking in America." He can be reached through his website rjparsonsgroup.com or via social media including @RJParsonsGroup and LinkedIn.