Transcript
Coming up on this episode of Cornerstone Advisors’ Plugged In, a conversation with some of our industry’s longtime investors.
Get ready, because we’re talking about the business of banking and what smarter banks might look like in the coming years with the heads of Patriot Financial Partners, a private equity firm led by our guests.
I’m going to say hello first to Kirk Wycoff so he can bring Tom into the picture.
They’re holding it down in the tough town of Philadelphia, whereas my friend Steve Williams is enjoying balmier air temperatures than we have on the East Coast in our Scottsdale, Arizona headquarters.
We’re going to have some fun as we welcome Kirk and Tom to Plugged In.
Over the summer, Steve and I started talking about the characteristics of so-called smarter banks.
We did this against what are known as smart banks today, those that have good performance that people appreciate.
But we’re looking at what smarter banks might show in the coming years as they focus on outcomes and not just certain activities.
As a cheat sheet, we’re looking at banks that become known for being hyper-efficient, nimble, data-driven, differentiated, and opportunistic.
Given Kirk and Tom’s experience in this space, we thought we could pick their brains by weaving those themes into a conversation around moving even faster than you feel you’re able to, gauging a leadership team’s strengths in tech and on the digital front, and really exploring business models that guys like these would gladly open up their checkbooks for.
We’ve got some good stuff coming at you.
In our last episode of Plugged In, we unpacked Steve Williams’ Spotify playlist to keep things both focused and fun.
We figured, why wouldn’t we do the same thing for this one?
I went into the vault, picked out some songs that I think would lend themselves to a fun conversation.
We started this whole thing back with Tom Michaud way back when, and we’ve just continued to use it for these episodes, where we try to take a song and tie a lyric or two that can easily be applied to the state of banking.
So that’s my tee-up for this new episode of Plugged In.
You guys ready to roll?
All set.
All set here.
Here we go.
I am going to start with a guy who helped keep himself alive, Freddie Mercury.
We thought we could borrow from Queen’s song “Keep Yourself Alive” because he talks about being told a million times of all the troubles in his way.
As I think about the state of banking at the moment, it’s an industry that’s getting smaller.
But if you’re a community bank, you have to think about how you can get bigger, play bigger, and run even faster.
I really wanted to toss this one out to Kirk and Tom and get their thoughts on how that’s possible, given all the things that are impacting the industry at the moment.
Thanks, Al. I appreciate it.
Happy to have Tom here with me today.
How do you get bigger and run faster?
It’s a tough one, given the problems of the last year and the regulatory environment we’re in.
But shortly after we make an investment, or as we’re making an investment, we really assess the ability of the company to grow its loan book with customers.
Everybody today has just finished up their year-end budgets, and I would suspect that three-fourths of them came up with not enough asset growth to generate the EPS that they were looking for.
So we do see loan purchases as part of budgets this year and plans.
Credit quality has been good, so it’s a good environment for that.
But at the heart of core banking are deposits and loans.
On the loan side, we try to invest in markets where there’s a fair amount of growth and with CEOs who can recruit the teams that know the customers.
You can be in a great market like D.C., where you’re sitting, and if you can’t recruit the right team and the right leadership on the business-banking or real-estate-banking side, then you’re not going to win.
If you have the best team there is in Memphis, Tennessee, you’ll probably be fine growing your loan book.
But the answer to the question, with moving rates over the last year and a half, is: How many 8% floating-rate loans can your team deliver in 2024?
That would be the answer to the question.
Steve, you’ve had some thoughts about recruiting teams.
You want to chime in and maybe build on what Kirk just shared?
Yeah, because Kirk, you said 8% floating-rate.
How do you see the selection of teams changing from maybe more commercial property and CRE to more C&I, owner-occupied?
How do you get that right mix?
Are you seeing your banks change the character of their recruitment from those relationship managers?
Look, CRE was always the way to grow size because you make bigger, chunkier loans.
Customers in the development or hotel business are always coming back for another one.
They pay off, but they reload.
The C&I business tends to be more stable.
Companies don’t grow their C&I borrowing needs 100% a year.
So we would see the C&I team being two to three times the size of the CRE team, particularly with the 300% guideline on CRE.
They’re hard to recruit.
Most of the recruitment we see, which we have some hesitation about, comes from BofA or Wells Fargo, or other larger banks.
A lot of those people don’t fit in a smaller-bank, get-it-done-now environment.
But that’s where we see the recruiting.
Tom, anything to add to that?
No.
I think that’s definitely the key.
Where we see people having success, they’ve been in markets for a long time.
They’ve established networks.
They know the small-business community.
They’re able to bring the right people into the bank to drive growth.
Where you can do that, you can be pretty successful in terms of carving out a niche in the marketplace and doing pretty well financially.
I do agree.
Sometimes taking those big-bankers and turning them into entrepreneurial bankers can work.
But the ones that can mint those kinds of players over time, I think, are where you see the entrepreneurial banks thriving.
Yeah.
We have an investment in one bank that has a team of eight C&I lenders that produces $250 million a year.
The good news is that they do it.
The bad news is every one of them has gotten an offer from the competition in the last 90 days.
We just had a board meeting this week and put in a retention plan that had a three-year cliff vest at one-time salary, in addition to any stock-incentive plan or annual bonus.
So the other thing is, let’s not start with recruiting.
If, when we invest, we interview the team that’s there and they can get it done, let’s keep them.
Yeah, absolutely.
And thank God we don’t have a transfer portal in banking.
Right.
Oh gosh.
The fact that we are even having to use the transfer portal at this point.
Well, on the conversation around boards, let me switch over a little bit.
It strikes me that this has been a year where boards have been asking their leadership teams just how resilient and efficient their balance sheet really is.
I want to borrow on that theme.
Technology is such a major driver of potential opportunity.
The tools that are available are pretty compelling, but they’re just that.
They’re just tools.
I’m curious, how do you gauge how resilient your banks’ leadership teams are when it comes to technologies that are available, their digital positioning at the moment, and where they want to go?
That’s a mouthful.
Your digital positioning has to do with your customer experience and how efficient the bank is.
We’ve already talked about being efficient.
One of the ways you get to be a 50% efficiency-ratio financial institution is deploying technology in account opening, loan opening, and loan underwriting, credit algorithms, et cetera.
The management team, the tech team, has to be efficient at that.
They have to be good at that.
Their tech-development plan has to look out three years and be constantly implementing the solutions that are driving cost down.
That’s the resiliency or the plan on the tech side.
The resiliency of the balance sheet really goes to how good management is at managing interest-rate risk and credit.
Two years ago, I would have said credit and interest-rate risk.
Five years ago, I would have said credit and interest-rate risk.
If you go back into the ’90s, unfortunately when I was running banks, we had the interest-rate-risk management tools then, and we used them in ’90, ’91, ’92, and ’03, ’04, ’05.
We got a little complacent as an industry in actually reading, not the tea leaves, but reading the data in 2021 and 2022.
You see only about 20% of the industry today, in the size we focus on, banks under $10 billion, have resilient balance sheets.
You’ve seen the ones that are public, their stocks move dramatically over the last 60 days.
The ones that aren’t so resilient and have a hole in their balance sheet, not only in AOCI but in their loan book, those stocks are not getting the market acceptance.
A resilient balance sheet today means that you don’t have a mark on the asset side of your balance sheet of 40% or 50% of your capital.
I think half of our target universe does have that big mark.
Yeah.
And on the loan side, Kirk, it’s showing up in that they’re just not getting the asset-yield pickup they should be getting, given all the rate increases.
It’s showing the implied economic losses of the loan book, not just the bond book.
I agree with that.
And the ability to grow loans.
If you think about a bank with a $2 billion loan portfolio, normally, in static interest-rate times, it would have $500 million or $600 million in payoffs a year and grow 10%.
So they’d have to make $700 million in loans.
That means your loan book turns over pretty much in two and a half to three years.
I was looking at budgets yesterday where I’m seeing a 10- or 20-basis-point change in overall loan yield from December 2023 to December 2024.
That’s not enough.
That means you haven’t done your work on your interest-rate risk.
The only thing I wanted to add to that with respect to resiliency of the balance sheet really goes to the funding side.
I think we really saw this back in the spring and the summer, where those franchises that had low-cost deposits, non-interest-bearing deposits, they fared pretty well throughout the crisis versus people that were wholesale-funded, that saw those costs go up dramatically right away.
Managing the fixed side of the asset part of their balance sheet, they really got squeezed.
Their balance sheets were not efficient or resilient, and they got the most pressure during the summer.
The good, solid franchises and the deposit bases that we talked about earlier, those balance sheets were pretty resilient.
Yeah.
A lot of people have that regret, like, “I wish I had the capacity to be getting those 8% floaters, but I just don’t have the room in the balance sheet right now because of the marks and because of the fixed rates.”
It’s worth noting, when we size a bank that needs capital for whatever reason, in 2008, ’09, ’10, ’11, it was credit.
Now it’s because of interest-rate risk and balance-sheet holes.
We size that bank based on their non-interest-bearing deposits.
If you don’t have 20% non-interest-bearing deposits, either you had them and you’ve overleveraged, or you brought in more money markets or more CDs.
You have to grow your non-interest-bearing deposits essentially at the same rate or faster than you grow your balance sheet to have what you call resiliency.
I would call it profitability.
One leads to double-digit return on equity.
I’ll move my language over the years, Kirk.
No problem.
Actually, what I find interesting, I had pulled a song by Fitz and the Tantrums, “Head Up High,” because the lyric is, “I got a headache and a heartache. I’m running circles, trying to find another finish line.”
What you just described is basically why we picked that song.
Now I’m going to give Steve a little toast from across the country with our Plugged In mugs, which I know we sometimes like to give the virtual clink.
This song is a Steve Williams song if ever there was one.
It’s by Mötley Crüe.
It’s “Dr. Feelgood.”
Kirk, we’re going to have you be Dr. Feelgood because we want you to make us feel all right.
We really want to get a sense of your vision on the future of regional and community banks, vis-à-vis their business models.
What are you willing to write checks for looking ahead?
People should know we didn’t script this question, but I’m going to do better than make you feel good.
I’m going to make you feel great.
The worst environment for community banking that could exist, and for Patriot, for two of our four funds, has existed over the last decade with very low rates.
In April and May of this year, when the proverbial stuff was hitting the fan, we went back and revisited our core business model of what a $2 billion bank looks like and how fast we can compound capital in a $2 billion bank with normal interest rates, which I would call today normal levels, even though the curve’s not sloped.
The answer is that a bank with an 85% loan-to-deposit ratio, a 3.5% margin, and a 60% efficiency ratio, and normal charge-offs, earns 15% on equity and 1.2% on assets.
It always will and always has.
That means you’re going to compound your equity for your shareholders about every six years, maybe five and a half, which is our investment period.
The takeaway from that is, once your balance sheet is normalized to today’s rates, which could be today, could be a year or two from now, the next 10 years in this business, where we’re never going to see zero interest rates again, we’re going to make multiples of the money at Patriot and at your banks that we made over the last decade.
This will be the golden era of community banking.
Add some M&A onto that.
We’re going back to three times book for exit models.
Wow.
There you go.
That makes me feel good.
We’re going back to three times book for exit.
There we go.
Dr. Feelgood is playing through the speakers right now.
I love it.
I think you must disagree with Steve Eisman saying banks are uninvestable at this point.
It sounds like you’re saying it was the shock of the rate increases that wounded the balance sheets.
They’ve got to heal to today’s rates, and that’s at different paces depending on how well they were positioned.
Right.
I think there are two parts to that.
We like Warren Buffett’s quote on that.
The time to run into the burning building is when it’s burning.
We’ve been investing all year in equities.
The other part of that comment that’s partially true, and this is now my fifth decade in the banking business, is whenever there’s a banking crisis, and there’s one about every decade if you haven’t noticed, the regulators show up about six months after the crisis and make it three times worse.
We’re in that period now.
October was six months after March.
The exams we were privileged to see as directors of various banks that concluded in April, May, June, and even into July were fine.
They were based on the original parameters for examining banks for 2023.
Then the exams that started after that and concluded in August, September, October, November had a totally different tone around liquidity, interest-rate risk, capital.
All for no good reason, lots for banks that had 90% insured deposits and plenty of liquidity.
But the playbook changed and it made it worse.
To the extent banks are uninvestable, that’s a phenomenon that’ll correct itself over the next year.
Hopefully, it’ll get some accelerated correction in the election in November.
But balance sheets, by the end of 2024, I think we’ll be all clear for a really good period coming up in banking.
Kirk, another follow-up on Dr. Feelgood.
I look at Fund Four at Patriot, and I’ve seen names like Ampersand, CorServ, Finxact.
It’s not just traditional banking where you see an opportunity to write a check, but also some of the tech-enabled platforms and companies that are surrounding your community banks.
Can you comment on that?
Fintech’s been a little spotty the last 18 months.
Where do you guys see the opportunity there?
Boy, spotty would make me feel good.
It hasn’t been spotty.
The answer is, we carve out a small portion of each of our funds to invest in companies, not fintech, bank-tech companies, that can really accelerate the earnings of the 25 or 30 banks we have investments in at any one time.
We get those people introduced to our bank management teams so that they can have an early advantage, if they like the technology, in terms of moving forward with Numerated, or with loan automation, with Narmi on account opening and business-account opening.
We’re obviously not investors in the big side of fintech.
It’s a small part of our dollars.
But the same analysis applies.
Are the management teams really knowledgeable in their industry?
Can they accelerate their revenue?
But for us, can they accelerate bank earnings if our banks that we invest in deploy that technology?
Gotcha.
It’s a smarter-bank portfolio play for your partners.
Yeah.
We would say it adds alpha to our portfolios, or at least we hope it does over time.
It did in Fund Two, where we built Laurel Road, which was the large student-lending company up in Connecticut, and sold that to KeyBank.
We built a large foreign-exchange trading company based on a tech platform.
So it’s added some alpha to our funds, which are pretty consistent performers.
The investors like that.
Kirk, you talked about running into a fire, and you reminded me of a conversation that Steve and I had with Gene Ludwig, who most people remember being the head of the OCC.
He was on an episode of Plugged In with us, and he talked about being a firefighter.
Really, you don’t form a committee to decide if you’re going to go fight a fire when the alarm bell goes off.
You just get after it.
If I swap out the role of a firefighter for that of a bank CEO, I’m curious.
Sometimes you just have to hop into things.
I’d like to understand how you see bank CEOs striking a balance between the stability of rules against the rewards of risk.
How many bank CEOs do we have on this podcast?
I need to know how many people I’m going to offend when I answer this question.
Well, we can do the math.
It’s every one of them.
They all listen religiously.
It’s like going to church.
You’re there every Sunday.
We have, rightfully so in the banking industry, to continue your analogy, dispatchers and planners and county officials who fund fire departments.
As I say, rightfully so, because it is a rule-based economy.
I could name five bank CEOs who were firefighters over my career.
Unless you’re as old as I am, you wouldn’t recognize their names because they didn’t last very long.
The shareholders generally aren’t rewarded by it, and the regulators really don’t like abnormal risk-taking.
What I think firefighters do is take risks that you or I probably wouldn’t want to take in a burning building.
That said, I think about a third of the industry’s CEOs are very proactive and thoughtful when they see opportunities and take advantage of them.
I think those banks tend to be the higher-ROE banks.
The status quo in the banking business isn’t working very well right now because it’s harder and harder to bring on a zero-cost checking account that costs less than $300 in account acquisition.
It’s more and more expensive to acquire that team or acquire that C&I borrower.
We like CEOs who can make things happen, and we invest in those people.
We have plenty of examples of those people in our portfolio.
I think they play a big role there.
Al, talent follows CEOs that people see as opportunistic, not just the status quo.
I think that’s when I’ve seen some of those entrepreneurial banks get those ROEs, because they brought in the relationship talent who believed in chasing that opportunity.
Look at Tony Labozzetta.
Look at Frank Sorrentino.
Look at guys like that who have really built banks.
Look at Jack Kopnisky, who retires at the end of this year as executive chairman of Webster.
We invested in Jack when Provident was $2.5 billion, and Webster is $60 billion.
He believes, if he was on this call, he’d tell you that if you’re not running your bank at a 45% efficiency ratio, you’re not doing a good job.
If you want to call them firefighters, we love guys like that.
But taking too much risk has never been a formula for success in banking.
We’ll try to dub a little “Ring of Fire” by Johnny Cash over this part of the conversation.
I think that would be an appropriate song.
Steve, to your point, I totally agree.
I don’t think people follow a title as much as they follow the person.
Kirk, you just raised some great names in the recent history of banking that have done some great things and continue to do great things.
I think that lets me take us all home.
The industry as a whole gets described in a lot of different financial terms.
We’ll be at Acquire or Be Acquired in January, and I expect we’re going to see some charts that show the sweet spot for banks in terms of asset size.
I remember when $1 billion to $5 billion was considered just where you wanted to be.
It’s moved up.
Five to 10 now.
I think you and I would agree there are some folks that think it’s maybe closer to $35 billion to $50 billion.
How do you think about size in this industry and the proverbial sweet spot that gets investors like you thinking there are still some really interesting opportunities in front of everyone?
The first thing I would say, as I said to you before we got on the podcast, is don’t fall for the investment-banking model of the year, which we’ll all see at AOBA from all the investment bankers.
I would like to focus on ROE.
The reason we’re in the size banks that we’re in is we see the efficiency curve being dramatic between $2 billion and $8 billion.
But the whole goal is to be a 12% to 15% earner.
When I started in banking, because 6% or 4% was adequately capitalized, we had enough leverage that that was normal.
You see the biggest competitors getting back to double-digit ROEs.
Certainly, certain debt products on the sub-debt side have helped with that.
But whatever size you are, you’re going to compound your shareholders’ capital if you’re making 12% to 15% on ROE.
We can’t invest in $20 billion and $30 billion banks because our check size is less than $50 million and we wouldn’t make a difference there.
But we think, with 18 people, the heart of Patriot is we can make a difference in balance-sheet diversity, interest-rate-risk management, product differentiation, digital development, because we see it every day.
Yeah.
If you look at the numbers in banking, at the 4,500 banks left, there’s a lot that will become some of those two-to-eights.
Meaning, they’re $300 million or $600 million right now.
Wells Fargo is not going to go acquire them.
It’s part of the consolidation into that sweet spot, I think.
Yeah.
It’s been interesting to us over 17 years.
When we started in 2007, there were 1,100 banks in our size range that we targeted.
Today, there’d be 1,300.
Some get acquired, but to your point, Steve, more come in.
That’s where we want to be the provider of choice for capital in that $10 million to $50 million range.
Makes perfect sense.
I’m going to look forward to seeing you guys out in Arizona in January for Acquire or Be Acquired.
Because my friend Steve is not able to join us, I’m going to ask him to take us home today.
You want to wrap up this episode, Steve?
Well, thank you guys.
Kirk and Tom, always great to see you.
I’m a little sad we didn’t get horse racing in.
That’s got to be something we do the next time.
I know that’s like a three- or four-day podcast, Steve.
That’s not a 30-minute conversation.
I want a beautiful bow tie and my gorgeous wife with a big hat in Kentucky.
The first day of AOBA is January 27 this year.
That’s a Saturday.
I was at AOBA last year and missed our horse Atone win the million-dollar Pegasus World Cup.
He will be back this year.
Al, I won’t be there until Sunday.
I’m not going to miss it again.
I can’t give you the official dispensation since I’m no longer in charge of Bank Director, but I know my friends there will at least give me slight permission to say you’re always welcome to join us.
We want to hear some winning stories when you do step foot in the desert.
I’ll take it home, Al, by saying it’s fun to talk to Kirk and Tom because they’re not only looking at this thesis of the sweet spot of banking and a new golden age.
We’ve had people like Tom Brown agree with Kirk’s thesis that this is going to be fun.
Buckle in.
But also the tech side of things.
We gave a GonzoBanker Award to Kelly Brown for some of her work and what she’s doing with you guys.
The collision of bank tech with the community-banking model that’s based on talent, I think this conversation says to me it’s alive and well.
We’re building smarter, nimble banks, and it’ll be fun to watch the journey.
Well, thanks, guys.
Thank you, Steve.
Appreciate it.
Thank you, Tom.
Thanks for getting Plugged In with Cornerstone.
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