The Impact To ROE Of Various Bank Budget Initiatives

Impact of Bank Budget Initiatives

Three years of kicking the can down the road, striking last minute deals for “Super Committees” and pointing fingers obviously wasn’t enough practice for Congress as our esteemed government is finally shut down.  You would think that, when faced with the two options of either cutting down on spending or raising revenues, Congress could have picked one, or at least implemented a combination of the two. Instead, our elected officials (who are still getting paid) decided to go with the age-old strategy of hyperpartisan malfeasance and do nothing.    You know you have issues when Greek newspapers are poking fun at your fiscal position.

 

Luckily banks are more fiscally astute, and while the government is shut down, banks are actively working through next year’s budget.  Our point today is that not all strategic and tactical initiatives are the same.  Some initiatives have a larger impact on bank return on equity (ROE) than others. To help keep things in perspective, we reviewed a dataset from Accenture and added additional data from a group of banks that we work with.   We then compared the before and after the impact of various initiatives. That is, we looked over the last three years of what banks said and did, and have tried to isolate the impact that initiatives, like “cost-cutting,” actually have on the bottom line.

 

Not all bank efforts are the same and some produce a greater impact than others. Unlike last year when most banks were still focused on cost management, this year depicts a trend of increased spending to drive loan growth. Many banks are pushing into new products, with both C&I  and SBA expansion remaining popular.  In areas where loan growth can’t be had, banks are rightfully questioning certain business models in some markets such as mortgage origination. Further, increased regulatory cost, greater capital reserves, and continued loan runoff are leading to new, lower levels of projected profitability. 

 

The bottom line is that banks need to rebuild profitability and reboot shareholder value through a combination of actions.  Here are rough estimates, compiled from variously sized banks, provided just to offer a feel for where resources might be allocated for 2014:

 

Initiative  Potential Impact to ROE
Regulatory compliance initiatives -0.6%
Increasing process efficiencies 0.9%
Cost reduction initiatives   (includes branch reduction) 1.1%
Increasing leverage 1.5%
Adding/expanding fee lines of business 2.2%
Asset quality improvement   3.2%
Adding new loan programs 3.5%

 

The above list is created so that each initiative is additive. The downside is that we may not have the allocation just right as in when we say “Increasing processes efficiencies” we mean going to online account documents for example. However, some of the ROE impact is driven by cost cutting (but we allocated the savings to the former). The good part is that no double counting was had, so if you want to embark on several initiatives you can add them together. The impact of a leverage program and adding and SBA program will likely add a total of 1.5% and 3.2%  to the bottom line for a 4.7% ROE change. This might provide a common sense check of what you want to discuss before you expend a whole lot of energy researching and modeling the data yourself.

 

Hopefully, the above data gets you thinking as you plan for 2014.  As for the government shut down, we last provided commentary on our Federal Government’s shutdown 17 years ago, we ended the column with the comment that we were not sure our politicians can sink any lower. Of course, a week later we got Monica Lewinsky, so this time we will just watch with breathe baited.  

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