Expense Reduction - The Sequel

In a previous posting we questioned the industry’s focus on expense reduction.  It appears some in the industry are looking at top-line revenue.   The American Banker reported that community banks are taking a serious look at the affluent.  The article states that as revenue growth has diminished, more community banks are looking to expand their wealth management and trust operations – now that is encouraging. 

I have included a link to the story should you wish to read it.  Community Banks Take a Serious Look at the Affluent -

I would encourage all of you to begin to look at your existing portfolio for the optimization of risk-adjusted revenue.  Contact Bearmoor if you would like an analysis done on the results for your institution.

Expense Reduction – An Exercise in Insanity

We all recall Albert Einstein’s definition of insanity - "Insanity is doing the same thing over and over again and expecting a different result."   

In April  Bearmoor had both the honor and pleasure of speaking at an industry trust conference, some of you were in attendance.  One item that we discussed is the level of attention being given to the area of expense reduction and/or management within banking organizations.  We continue to be amazed and after reading a story in the American Banker, we are even more baffled by the lack of attention given to the top-line revenue optimization.   The American Banker article titled - Bankers Swinging a BiggerAxe to Cut Expenses, discusses how smaller banks are struggling to keep efficiency ratios down, forcing many executives to look harder at closing branches and laying off employees.  The continued focus on expense reduction is analogous to the war on drugs here in the US – spending a tremendous amount of money to control the problem has only made it worse.  Perhaps it is time we try something different.  How about looking towards the optimization of top-line revenue within your fiduciary activities?

Below are a couple of graphs depicting the industry results  for income and expense associated with fiduciary activities.  The first graph shows the dollar amount of trust activity expenses trend line for the past eleven years – in 2011 the expenses associate with fiduciary activities reached a historical high, increasing 25% over year-end 2010.  The second graph compares income growth rates to expense growth rates for the same eleven year period.  You will see that expense outpaced income for six of the last nine years, and three of the last three.  I am not sure the focus on expense reduction is working here. 

Graph 1

Graph 2

I would enjoy hearing your thoughts on topic.

2011 Planning and Budgeting Opportunities

As the summer vacation season winds down and the “the back to school” ritual commences, your opportunity during the 2011 planning and budgeting process is just around the corner. The components of non-interest income will continue to take center stage as the lending activities and net interest margins continue to be volatile. It appears as though one of the major contributors to non-interest income, overdraft fees, has taken yet another hit. The August 12, 2010 issue of the American Banker highlighted this in one of their articles:

Beyond Opt-In: Fresh Attacks on Overdraft Fees – Outdoing Fed, FDIC Targets Checks, ACH Overdrafts: The Federal Deposit Insurance Corp. ramped up pressure Wednesday on the banking industry to curb overdraft fees, releasing proposed guidelines that would go beyond recent Federal Reserve Board rules.

Outlined below is a graph showing the non-interest income component (year-end 2001 thru year-end 2009) for all institutions reporting fiduciary income on either the Call Report or the Thrift Financial Report (TFR). You can clearly see the sharp decline over the past few years.

Now, more than ever the Wealth Management arena, specifically income from fiduciary activities will be viewed as an area where optimum risk-adjusted revenue will need to be achieved. Bearmoor has assisted several organizations realize increased revenue lifts from their asset management and fiduciary operations. As you prepare for 2011 perhaps exploring the benefits of a Bearmoor Profit Enhancement process is in order.

No Good Revenue Opportunity Goes Unpunished - SEC Proposal

On July 21, 2010 the Securities and Exchange Commission voted unanimously to propose measures aimed to improve the regulation of mutual fund distribution fees and provide better disclosure for investors. The marketing and selling costs involved with running a mutual fund are commonly referred to as a fund's distribution costs. To cover these costs, the companies that run mutual funds are permitted to charge fees known as 12b-1 fees. These fees are deducted from a mutual fund to compensate securities professionals for sales efforts and services provided to the fund's investors. 12b-1 fees were developed in the late 1970s when funds were losing investor assets faster than they were attracting new assets, and self-distributed funds were emerging in search of ways to pay for necessary marketing expenses. These fees amounted to an aggregate of just a few million dollars in 1980 when they were first permitted, but that total has ballooned as the use of 12b-1 fees has evolved. These fees amounted to $9.5 billion in 2009.

The SEC's proposal would:

• Protect Investors by Limiting Fund Sales Charges

• Improve Transparency of Fees for Investors

• Encourage Retail Price Competition

• Revise Fund Directors Oversight Rules

The SEC proposal will provide a transition period for the new rules.

With Additional Regulation Comes Increased Enforcement Actions

One of the results of the global financial crisis has been an increase in both new regulation as well as a closer look at existing regulation. The compliance and risk management functions of financial institutions are operating at full throttle in an effort to address the additional interest being shown by all regulatory agencies. While the efforts of these risk mitigation divisions within the financial institutions is to be commended, the volume of regulation and the interest of the regulatory agencies requires a greater effort to ensure that both the spirit and intent of the regulation is being complied with.

Based upon the number of public enforcement actions issued by federal regulators since the start of 2008; it appears as though additional attention is needed in the area of compliance and risk management. Nearly 1,200 banks have been hit with an enforcement action, and that number is expected to climb at an accelerated rate. Enforcement actions are on pace to increase 64% this year, making bankers increasingly wary of further obstacles to their recovery.

One of the many challenges in developing a strong risk mitigation program is finding qualified and experienced individuals. The current situation provides for a “free agency” environment among the compliance and risk management profession. Some organizations have the ability to attract and retain qualified individuals, while others struggle to maintain the necessary talent. The use of third party providers is no longer scene as a luxury, it is almost a necessity.

The “up and to the right” trend in enforcement actions is a trend you should make every effort to avoid. Enforcement actions can limit an institutions ability to succeed and achieve both quantitative and qualitative goals.

I.R.A. Custodian Responsibilities - A Refresher

The old adage of “follow the money” appears to be the case for many individual retirement account (I.R.A.) owners; especially when a Ponzi scheme is involved. Events over the past twelve months have shined a brighter light on the responsibilities of I.R.A. custodians. These events include recent lawsuits against custodians, the Madoff scandal, and increased media attention. I.R.A. owners are interested in getting some, if not all of their monies returned to them and they are looking at entities that have the deep pockets to share this responsibility.

The types of assets held within I.R.A. accounts vary greatly. Many of the unique assets within an I.R.A. can be complex and difficult to price. Even though regulation exists that requires fair value pricing to be obtained on all I.R.A. assets, the practice of doing so may not always be adequately implemented. Recent lawsuits claim that I.R.A. custodians failed to perform both their contractual and fiduciary duties, and as a result failed to protect the account. The claims further state that I.R.A. custodians aided and abetted the breach of fiduciary duty.

The establishment and administration of I.R.A. accounts is governed by the Internal Revenue Code and accompanying Treasury regulations. The custodian has responsibility for several areas regarding I.R.A. accounts. One area that is being scrutinized and reviewed is asset pricing. The regulation states the following: The custodian will determine the value of the assets held by it in trust at least once in each calendar year and no more than 18 months after the preceding valuation. The assets will be valued at their fair market value.

In light of recent events, now might be an opportune time to review your asset pricing policies and practices pertaining to I.R.A. accounts. Custodians should pay special attention to those assets that are hard to value. In addition, I.R.A. account acceptance standards should be reviewed to determine if some of the risk can be mitigated prior to acceptance for new accounts. The fee for providing custodian services should also be reviewed to determine if optimum risk adjusted revenue is being obtained.

Regulatory Focus - The Changing of the Guard

The financial services industry is one of the most highly regulated industries in America. Therefore; it is of little surprise that the regulatory agencies overseeing the activities of the financial institutions have come under increased scrutiny from Congress. On March 18, 2009 several of the agencies testified before the Subcommittee on Securities, Insurance, and Investment of the Committee on Banking, Housing, and Urban Affairs. The primary purpose of this testimony was to outline what has been learned from the most recent financial crisis as well as what action that the agencies will take to strengthen their supervision and examination processes in the area of risk management activities.

The OCC was one of the agencies that provided testimony to the Subcommittee. Senior Deputy Comptroller Timothy Long presented the OCC’s view on the industry and outlined the role of risk management for within banks. SDC Long’s comments provide insight into the focus and temperature of the regulatory agencies attention to effective risk mitigation functions at financial institutions. Below is an excerpt of SDC Long’s testimony.

The first step in risk-based supervision is to identify the most significant risks and then to determine whether a bank has systems and controls to identify and manage those risks. Next, we assess the integrity and effectiveness of risk management systems, with appropriate validation through transaction testing. This is accomplished through our supervisory process which involves a combination of ongoing monitoring and targeted examinations. The purpose of our targeted examinations is to validate that risk management systems and processes are functioning as expected and do not present any significant supervisory concerns. Our supervisory conclusions, including any risk management deficiencies, are communicated directly to bank senior management. Thus, not only is there ongoing evaluation, but there is also a process for timely and effective corrective action when needed. To the extent we identify concerns; we “drill down” to test additional transactions.

These concerns are then highlighted for management and the Board as “Matters Requiring Attention” (“MRAs”) in supervisory communications. Often these MRAs are line of business specific, and can be corrected relatively easily in the normal course of business. However, a few MRAs address more global concerns such as enterprise risk management or company-wide information security. We also have a consolidated electronic system to monitor and report outstanding MRAs. Each MRA is assigned a due date and is followed-up by on-site staff at each bank. If these concerns are not appropriately addressed within a reasonable period, we have a variety of tools with which to respond, ranging from informal supervisory actions directing corrective measures, to formal enforcement actions, to referrals to other regulators or law enforcement.

Our supervision program includes targeted and on-going analysis of corporate governance at our national banks. This area encompasses a wide variety of supervisory activities including:

· Analysis and critique of materials presented to directors;

· Review of board activities and organization;

· Risk management and audit structures within the organization, including the independence of these structures;

· Reviews of the charters, structure and minutes of significant decision making committees in the bank;

· Review of the vetting process for new and complex products and the robustness of new product controls; and

· Analysis of the appropriateness and adequacy of management information packages used to measure and control risk.

It is not uncommon to find weaknesses in structure, organization, or management information, which we address through MRAs and other supervisory processes described above. But more significantly, at some of our institutions what appeared to be an appropriate governance structure was made less effective by a weak corporate culture, which discouraged credible challenge from risk managers and did not hold lines of business accountable for inappropriate actions.

We all can agree that effective risk mitigation functions within banks will provide for a strong and stable financial system. Therefore the current process needs to be strengthened and improved. It appears as though the regulatory agencies will be increasing their efforts to ensure that such improvements are developed and implemented across each business line. Organizations the fail to do so will be identified and given “special” supervisory oversight.

For the complete testimony of SDC Long please visit: http://www.occ.gov/ftp/release/2009-23b.pdf