Pub. 6 2015 Issue 2

summer 2015 23 West Virginia Banker You face a declining cost curve Processes and technology is increas- ingly driving down the future cost of operating a bank. Just as remote deposit capture reduces the need for a courier or a branch; new loan processing systems, credit stress test models, channel deliv- ery, management systems and hundreds of other items will make the bank more efficient in the future. Banks not only base their profitability decisions on loans using the highest expected credit risk, but they also underwrite loans based on their current cost structure. Wells Fargo, for example, is underwriting loans not on where their cost structure is today, but where it is in the future. If you don’t have initiatives to reduce operating cost in the future, you should and planning for it will ensure it will happen and thus should be considered when booking loans today. You face an inclining fee income curve The opposite of the above, to survive, your bank will also have to add other products such as international services, insurance, treasury management, pay- roll and other products to produce fee income. Adding these future services will increase the overall lifetime value of a large portion of your customers, thus resulting in higher future ROE for many of your customers. If you don’t have the quality businesses that you need, you may never have enough scale to make these fee income lines worth the risk. You have already invested your acquisition cost Most likely you have already spent half your acquisition cost in putting the bank in a position to issue a term sheet on the loan. While not our best argument, making that loan at 9% recoups that investment in obtaining that relationship and enhances the banks overall ROE compared to letting that loan go to a competitor. Speaking of the loans you want to go to a competitor, it is the higher margined, riskier loans that contain a large credit component that you really want to see go to a competitor. These loans may produce a high ROE now, but if you are going to error, we recommended erring on the side of being able to extract future value from a quality relationship than having to bet on future credit fun- damentals. Before you turn down that quality loan at a thin margin consider there is very little correlation between earnings and net interest margin. A bank is faced with a series of investment decisions at any given time and it has to be sure that before you pass up that 9% ROE loan a better loan must come by and come by quickly. If you give up that 9% this year, because of the time value of money, that means you need to book loan with a larger ROE next year and a still larger ROE the year after. If you are already leveraged up, then passing on a low earning loan may be your best move. However, if you have under-deployed capital, funding and infrastructure, mak- ing that 2% margined loan may be your best tactical move. n Reach your target audience a ordably. advertise get results KRIS MONTIONE Advertising Sales 727.475.9827 or 855.747.4003 kris@thenewslinkgroup.com Chris Nichols is Chief Strategy Officer at Centerstate Bank, former CEO of the capital markets armof Pacific Coast Bankers’ Bank and former author of the Banc Investment Daily.