Ideas You Can Bank On
Opinions on Improving Performance in Financial Services

Looking in the Mirror of the “5 C’s”

March 3rd, 2009

by Vicki Martell (guest credit blogger)

Most of us who have spent any time in the credit world are familiar with the “5 C’s” of credit: Capacity, Capital, Collateral, Conditions, and Character. As we forge our way through the fire and ice of change, it may be beneficial to turn a mirror of the 5 C’s on ourselves. What you see may surprise you.

 

We can look at Capacity as the ability to lend, the willingness to accept credit risk in exchange for a commensurate return. Capacity for a lending institution is a measure of whether it is able to generate profit (and ultimately cash flow) through engaging in its core business—making loans. From that viewpoint, how would you assess your institution’s capacity?

 

For many financial institutions today, capacity to lend is constrained by the limitations of Capital. High financial leverage (gearing) is and will continue to be an industry characteristic that cuts both ways—allowing higher returns when times are good and increasing vulnerability and risk when times are bad. The perception that many institutions now hold assets of undeterminable value compounds this problem significantly. While it remains to be seen how the governmental recapitalization of the industry will work out, institutions around the world are now challenged to assess more openly their own capital adequacy.

 

The most direct parallel of Collateral for a borrower is the quality of assets on your institution’s balance sheet. An honest and accurate determination of risk asset quality is the first step in assessing the reality of your situation. Sooner or later, everything in your credit portfolio must see daylight—and for most institutions the sooner this happens, the better. What has your institution done to assure customers, investors and employees that risks have been identified and are being properly managed?

 

If situational awareness is a requirement for survival, then you must certainly be aware of Conditions—within your institution, as well as on the local and macro-economic levels. While you may not be able to directly influence the broader market trends, you can certainly impact the conditions within your organization by changing practices and behaviors to improve risk management and seize opportunities. What conditions currently impact your firm? How are you addressing those conditions that you can control?

 

Arguably the most important of the 5 C’s, Character deals with the more subjective issue of people—which for a financial institution is its management and leadership. As a lender, you would not make a loan if the character test is failed, regardless of how you felt about the other criteria. We all know that character assessment is inherently subjective and intangible, but it is a critical factor in any prudent credit analysis. We want to deal with borrowers that we can trust to act in good faith at all times, both good and bad, and who have a record of honoring commitments by being forthright and proactive even when there are problems. Well, there are certainly problems in the financial industry right now, and make no mistake—your character is being judged by customers, investors, staff, and even your peers. As you hold up the mirror, see if you can honestly answer one simple question: Do you pass the character test?

 

Today’s challenges and the changes financial institutions must make to survive and thrive are discussed Omega’s newest eBook, What Now? Critical Changes Financial Institutions Must Make in the New Credit Risk World. The concluding installment is now available for download. Visit www.omega-performance.com to get your copy. 

 

Survival and Success are in the Balance

February 23rd, 2009

by Vicki Martell (guest credit blogger)

 

From the 15th century Medici bankers to the Great Depression to our current credit crisis, the history of financial institutions is filled with examples of dramatic shifts from excess to contraction, from unrestrained deal-making to financial calamity and risk aversion. Our industry, it seems, has found it difficult to learn from history.

 

How did we get here?

 

Much has already been written about the escalation of sub-prime mortgage debt supported by an impossibly complex system of credit derivative instruments, securitization structures, and credit default obligations. Much has also been said about the subsequent free-fall as this system collapsed. I won’t get into that here. The point I’m trying to make is that the financial industry reached this precipice not only because of greed and mismanagement, but also because of systemic excess at a more fundamental level: lending institutions have lost focus on risk and have concentrated too heavily on growth.

 

As naturally Newtonian as it may be for the financial system to now be swept into an “equal and opposite reaction” of risk aversion, I don’t think this is a desirable permanent state. Your short- and long-term survival and success in the new world of credit risk will be determined by balance—not just by being more aggressive in selling your institution’s products and services, nor by being more conservative in managing credit risk, but by achieving and sustaining a viable balance between risk and opportunity.

 

Let me be clear: balance is not the same as moderation or compromise. I have long advocated bold action as a means of gaining competitive advantage in the midst of sweeping change. That being said, I see four strategic areas that institutions must address now to optimize both risk management and opportunity:

 

  • Bridging silos within the organization
  • Building consistent credit practices
  • Optimizing process and technology
  • Maintaining balance

 

The essence of survival and success in an uncertain credit world is your institution’s ability to achieve balance. The traditional tension between credit risk and sales functions in a financial organization can lead to pendulum swings from one extreme to the other. Breaking down and bridging traditional silos by building collaborative workflows is critical to gaining balance.

 

Another requirement for successfully balancing discordant forces is a stable platform of credit culture and standardized practices and procedures is. Alignment of skills and knowledge between groups and with management can and should be accomplished through targeted training initiatives.

 

Furthermore, improving process control and information flows can yield substantial benefits to a lending institution in a time of tumultuous change. Balancing technology with people skills and judgment is the most critical success factor.

 

Lastly, maintaining balance is made more difficult when the ground keeps moving, as it does in today’s credit world. The keys to sustaining success are balancing short- and long-term endeavors, balancing the interests of customers, staff, and shareholders, and most importantly, embracing principles that can guide and keep you upright when things get shaky.

 

These four strategies are discussed in greater detail in Chapter 4 of the newest Omega eBook, What Now? Critical Changes Financial Institutions Must Make in the New Credit Risk World. Your institution’s survival in a rapidly changing credit environment depends on how well you address these strategic areas. Chapter 4 is now available for download. Visit www.omega-performance.com to get your copy.

 

 

Winning in the New Commercial Credit World

February 11th, 2009

by Vicki Martell (guest credit blogger)

 

Although the current credit crisis may have started with consumer mortgage practices, there’s no question that it has deeply impacted the levels of risk and competitiveness in the commercial credit market. The imperative to rapidly build and execute winning strategies in the new world of commercial credit is now just as great as in consumer lending. At the same time, the pool of good quality commercial credit risks grows smaller by the day.

 

So how do lending institutions effectively manage in this new commercial credit world? Omega believes there are four critical success factors:

 

·        Embracing proven practices to preserve order amidst change;

·        Approaching commercial credit with the perspective of holding the risk asset to maturity;

·        Building and retaining strong commercial relationships; and

·        Developing skills and traits that will enable success.

 

During this time of great uncertainty, reliance on proven practices for credit risk assessment provides much needed stability. This means applying a consistent, disciplined approach to commercial credit analysis, understanding the underlying causes for borrowing and focusing on the risks and appropriate sources of repayment, and foreseeing risks that others might overlook. Think about it. Can you afford to have analysts, lenders, underwriters, and managers using even moderately different approaches to assessing risk and making loan decisions? It also means returning to more conservative loan structures while preserving the ability to innovate as necessary. What trends in loan structure are you experiencing in your organization? Are you reacting to competitive actions or is your institution driving the terms of competition?

 

Winning in the new commercial credit world means approaching lending from the perspective of holding the risk asset to maturity and holding relationships even longer. For institutions that have actively engaged in buying and selling commercial credit risks in the old credit world, leadership now needs to refocus on core skills needed to assess and accept risk onto the balance sheet. This means clarifying and communicating the institution’s risk criteria for retaining commercial credit relationships as well as screening existing relationships for additional opportunities. What is your organization doing to prevent foreseeable risks in your commercial portfolio?

 

Along the same lines, winning organizations understand that sustaining viable commercial relationships is not just a competitive advantage—it’s a survival imperative. According to a survey by Greenwich Associates (http://www.cfo.com/article.cfm/12896069), almost half of small and middle-market companies are actively seeking a new bank or would consider switching banks if given a reason to do so. So if your institution is well prepared, you can solidify existing relationships and aggressively pursue many relationships that are currently with competitors. What are you and your institution doing to expand existing commercial relationships and build new ones?

 

The critical changes your institution must make to survive and thrive in today’s commercial credit environment depend on how well these initiatives are executed by people. Strategies to reinforce consistent approaches to commercial credit risk management and enhance business relationships can’t be achieved without the best-prepared people performing these crucial tasks. What are you and your organization doing now to address it?

 

Ongoing economic instability and the lingering credit crisis have combined to cause an upheaval in the commercial credit world. Your challenge is to preserve order amid the chaos. Take a good look within your institution and examine what you are doing to survive and succeed.

 

The changes within and in response to each of these fronts is examined from the perspective of a lending institution in chapter 3 of the newest Omega eBook, What Now? Critical Changes Financial Institutions Must Make in the New Credit Risk World.  Your institution’s survival in a rapidly changing credit environment depends on whether your leadership exhibits these traits. Chapter 3 is now available for download. Visit www.omega-performance.com to get your copy.

 

 

 

 

Winning in the New Consumer Credit World

February 2nd, 2009

by Vicki Martell (guest credit blogger)

 

The consumer credit world has been radically reshaped by the US sub-prime debacle, exacerbated by the plummeting value of personal assets and the adverse impact of the global economic downturn on household incomes. Distrust between lenders and consumers has escalated on both sides. The result is a tidal shift in the way lending institutions segment customers, manage individual and portfolio risks, and handle increasing regulatory requirements for disclosure and fair lending practices.

 

Consumer credit encompasses a broad range of financial products including personal unsecured loans and lines of credit, home mortgages, home equity financing, credit card obligations, installment loans, private banking credit facilities, and small business credits where the business and the owner are virtually interchangeable, And for all of these types of credit the conditions have changed.

 

Conditions have changed with regard to the availability of consumer credit in virtually every part of the world. Where institutions have been hardest hit by the collapse of sub-prime and derivative instruments, the availability of consumer credit has been curtailed. Even as credit remains available in many localities, tighter standards are being applied to those who seek to qualify.

 

Conditions have changed with regard to compliance with the regulatory requirements imposed on lending institutions, regardless of a particular institution’s involvement in risky lending practices. Governments and supervisory agencies are reacting forcefully to protect consumers and national economies by requiring greater transparency and accountability from financial institutions.

 

Conditions have changed from the consumer’s perspective. Many who were lured by easy credit in the past seem to have come to their senses and are beginning to borrow less and save more. Systemic de-leveraging threatens traditional consumer credit markets in unforeseen ways.

 

The bottom line is this: consumer credit has changed and continues to change rapidly and dramatically. To survive and thrive during this period of upheaval and uncertainty, organizations must act quickly with respect to the following four fronts:

 

  1. Consumer segmentation
  2. Risk management
  3. Regulatory environment
  4. Staff development

The changes within and in response to each of these fronts is examined from the perspective of a lending institution in chapter 2 of the newest Omega eBook, What Now? Critical Changes Financial Institutions Must Make in the New Credit Risk World.  Your institution’s survival in a rapidly changing credit environment depends on whether your leadership exhibits these traits. Chapter 2 is now available for download. Visit www.omega-performance.com to get your copy. 

Survival Toolkit for the New Credit World

January 23rd, 2009

by Vicki Martell (guest credit blogger)

 

On the morning of April 18, 1906, Amadeo Peter Giannini was thrown out of bed by a massive and violent shaking that toppled buildings and ignited fires in San Francisco, seventeen miles to the north of his home. As the president of the Bank of Italy located in the city, A.P. Giannini eventually made his way there on foot and by horse cart to find his bank relatively undamaged.

 

He acted quickly.

 

Securing the cash from the bank’s vaults, he and several workers loaded it on wagons. Fearing robbers, they hid the cash under produce crates, then trekked back to his home where the cash was boarded up in the fireplace and guarded overnight.

 

In the weeks following the great San Francisco earthquake and fire, most banks were unable to open and those that did limited withdrawals from accounts. Within days, an undaunted Giannini placed an ad in the San Francisco Chronicle, announcing that his bank was open for business. He set up shop on the waterfront, at a makeshift desk consisting of planks placed on barrels, and personally made home loans to customers who needed help to get through the crisis and rebuild.

 

Giannini knew that many of his customers kept cash buried in tin cans on their property. He loaned them only half of what they needed and insisted that they raise the remaining funds themselves. The result was limited risk exposure for the bank and a flood of new deposits. His action was at once creative, bold and decisive.

 

The story is true and is now the stuff of legend. Within a year after the quake, the North Beach area of San Francisco, predominantly populated by Italian immigrants, was the first to rebuild. Giannini went on to pioneer branch banking in California, the Bank of Italy later became Transamerica Corp., and in 1928 it acquired (and was renamed) Bank of America, then one of New York’s most prominent banking establishments…

 

Our industry has been hit by an “earthquake” and the global financial system is severely damaged. The damage extends beyond the availability of money and structural malfunctions. The viability of the global financial system depends on the pillars of trust and confidence, and these supports now lie fractured like massive marble columns in the aftermath of the 1906 earthquake. Amid this grim scene there is good news and bad news. The good news is that the damage can be repaired. The bad news is that we are the ones who must repair it. Only those of us in the industry can repair that broken trust and confidence.

We could all learn a thing or two from A.P. Giannini.  Through his actions following the devastating earthquake and fire, Giannini exhibited the traits and characteristics that are critical for any business leader to survive and thrive in a time of crisis and change:

  1. Situational awareness
  2. Agility
  3. Communication
  4. Commitment to act

 Each of these critical success factors is examined from the perspective of a lending institution in chapter 1 of the newest Omega eBook, What Now? Critical Changes Financial Institutions Must Make in the New Credit Risk World.  Your institution’s survival in a rapidly changing credit environment depends on whether your leadership exhibits these traits. Chapter 1 is now available for download. Visit www.omega-performance.com to get your copy. 

How Low Can We Go? (…and how the heck do we pull ourselves back up?)

January 21st, 2009

by Mark Faircloth

This holiday season brought many greetings from professional contacts which contained phrases like “I hope we are still around next year” and “peace, no matter what lies ahead.”  Yikes, what a difference a year makes.

So, I’m looking around to see what has really changed and I came across these examples:

Banking: The New Evil Empire

In the about-to-be-released blockbuster movie The International, Clive Owen and Naomi Watts try to bring one of the world’s most powerful banks to justice after discovering a plethora of illegal activities including arms trading and the destabilization of governments.  Think about it — our industry’s reputation has fallen so low that we are now stereotype villains in movies.  (Actually, maybe being portrayed as villains is better than buffoons.)

Glad I’m Not You

Recently on an airplane, I had a casual conversation with my seatmate who was an attorney.  He asked me what line of work I was in and upon hearing that I was connected with the financial services industry, remarked, “Man, thanks to you guys, lawyers are finally off the hook.” 

It’s Not About You, It’s About Me

One of my banking school students called to ask for some advice on approaching a commercial customer to rewrite his loan.  The agreement had been in place for two years and the client was meeting all the terms; in fact, this client was one of the most valuable to the organization, according to the banker.  The bank, fearing rate erosion in a falling market, was directing its bankers to contact clients in mid-term and ask them to agree to a rate floor.  Not a bad idea, but the bank was offering nothing in return, except the explanation, “We need to protect our position.”

Two images and one anecdote.  Are they accurate?  Have we become the new bad guys in cinema and the new lawyers in jokes?  Have we really become that self-centered?

In an earlier blog post, I wrote about three levels of integrity:

  • Industry
  • Institution
  • Individual

The point at the time was that “Industry” was shot (and now is worse), “Institutional” was shaky (as companies continue to disappear), and “Individual” was presented as an absolute last bastion of trust.  (As I think more about it, it seems logical that if we had more “Individual” integrity, the other two would take care of themselves.) We need to get this part right, or we’re never going to recover our image. 

Déjà’ Vu + Amnesia (Haven’t we forgotten this before?)

In 1988 the bank I was working for at the time experienced a significant workforce reduction.  I remember that Monday morning, sitting in my office as the people on both sides and across the hall were laid off; it felt like I was the only car on the freeway that survived the crash.  In talking to my boss later, he had simple advice for surviving.  “Work very hard, do what’s right for the company and the customer, and be nice to everyone.” 

I keep thinking about the middle phrase, “…what’s right for the company and the customer.”  If we as an industry had just kept our balance….. 

It’s not too late — yet.  We can get that balance back.

Surviving and Winning in a New Credit Risk World

January 15th, 2009

by Vicki Martell (guest credit blogger)

Years from now, when our current economic crisis is safely in the past, bank executives who are currently piloting their institutions through the credit crunch will either be lauded as visionary or criticized as incompetent.  Some will have built up the legacies of their institutions and themselves.  Many institutions, unfortunately, will not survive. 

Which one will you be?

Many, if not most, lending institutions have gone into a defensive mode, retreating from aggressive dealmaking on the margins and tightening credit standards.  Unfortunately, that is not enough.  The magnitude of change that is occurring in the credit world extends far beyond that of a mere cyclical arrhythmia.

There are many causes, including inadequate systemic mechanisms and greed, neglect, and incompetence by a multitude of participants.  It’s important for all of us to understand the causes, but even more critical to recognize the consequences of change and be willing to change ourselves how we fundamentally do business.  Here are three critical consequences to consider:

Expanded Role of Governments

When the credit markets stopped functioning, governments and central banks around the world moved quickly to intervene by infusing liquidity and capital, enacting legislation, and in many instances, nationalizing financial institutions.   While these and other remedies may have been necessary, the consequences for all financial firms are tighter controls, potentially higher capital requirements, and restricted areas of operation that may constrain innovation and profitability. 

How are you planning to compete and win in this new environment?

Constricted Access to Global Capital

The erosion of trust and confidence precipitated by the U.S. sub-prime crisis and related financing vehicles has wreaked havoc in the global credit markets.  Sources of capital once available from every corner of the world are now frozen.  Institutions and investors around the world have taken enormous write-downs for their part in the unraveling of this tapestry.  Beyond the massive hits to shareholder value, the threat to all financial institutions, regardless of their involvement in the sub-prime mess, is daunting.  Constrained capital markets result in higher costs of funding, which in turn impact profitability and firm valuations; lower profitability and firm valuations make it more difficult to attract capital; and so on. 

What is your institution doing to succeed under these conditions? 

De-leveraging

In large measure, the household consumption and corporate growth and profitability of the last decade were built on cheap, readily available credit.  We can now be certain that these conditions will not return for a long time.  The effect is constricting growth and profitability expectations for consumers and businesses.  Businesses may be forced to consolidate or deconstruct their balance sheets in order to survive.  This in turn will impact lending institutions. 

Which of your consumer and business borrowing customers are most likely to succeed in a deleveraging scenario? 

How will you determine this? 

What is your institution doing today to identify the winners and the vulnerabilities in your loan portfolio?

These factors are not a cause for panic, but they are a call to urgent action.  There are strategies and actions your institution must take now to survive and more importantly, to emerge from this crisis stronger and healthier than your competitors.  These issues are the subject of an Omega Performance eBook that is being released over the course of the next several weeks.  The Introduction is available now, and you can visit http://www.omega-performance.com/offers/ebook-whatnow.asp?VIPCode=8802 to download a free copy.

But before you do, I want to get your thoughts on the three major effects on the credit and financial industry that I identified in this post. Do you agree or disagree?  How is your institution responding to them?  What is your measure of success? 

I look forward to hearing from you and sharing additional insights on how your institution can survive and win in our new credit risk world.

 

EBITDA & EBITDoesn’t

January 13th, 2009

by Dr. Jerry Crigger

EBITDA is an abbreviation that just seems to roll off of the tongue when pronounced.  Maybe that is why we tend to love it so.  Whether you are in the camp that pronounces it “E-Bit-Da” or “E-Bit-D-A”, it is a powerful sounding abbreviation.

However, what is most important is what EBITDA means. 

For purposes of example consider the following characteristics for a firm:

 

EBITDA

$250,000

CPLTD (prior period)

$100,000

Interest Expense

$30,000

CAPEX (capital expenditures)

$90,000

Depreciation

$75,000

Tax Expense (35%)

$50,750

 

Many commercial lenders and commercial loan analysts utilize the concept of Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) as a measure of cash flow.  Often, EBITDA is compared to the current portion of long-term debt (CPLTD) from the prior period plus interest from the current operating period as a measure of debt service capacity — i.e. EBITDA / CPLTD + Interest Expense. 

This measure has material limitations related to debt service capacity for a firm.

EBITDA is a pre-tax measure, the primary component being operating profit.  Contractually-obligated principal payments for a firm are paid with post-tax cash flow.  Thus, to compare pre-tax EBITDA to post-tax CPLTD, principal payments should be adjusted by dividing the payment by 1-Tax rate.  For example, assume a tax rate of 35%, a principal payment of $100,000, and an annual interest payment is $30,000.  The necessary pre-tax operating profit necessary to meet a debt service test (assuming the covenant is written requiring only EBITDA / CPLT + Int.) of 1.2x would be: [($100,000 / (1 - .65)) + $30,000] = $183,846 * 1.2 = $220,615.  Without this adjustment, a firm could meet the debt service covenant of 1.2x with only $156,000 of EBITDA.

EBITDA is also compared to various other cash use variables to measure different degrees of cash flow “coverage.”  Often the coverage calculations are performed by systematically adding components to the denominator of the ratio in an effort to “build” various cash use layers in an effort to measure a firm’s ability to fully provide operating-style cash flow to cover all primary cash needs.

Let’s look at a few additional coverage measures utilizing EBITDA:

EBITDA / CPLTD + Interest + Taxes

This ratio is designed to resolve two issues: 1) by incorporating taxes into the denominator, the ratio theoretically eliminates the problem noted above by converting EBITDA to a post-tax number, thus allowing CPLTD to be used without tax consideration adjustments, and 2) the inclusion of Taxes in the denominator accepts the reality that taxes must be paid in order for a firm to remain in business.

In this case, the coverage ratio is calculated as follows: $250,000 / ($100,000 + $30,000 + $50,750) = 1.38x.  If one believes that taxes must be considered an operating expense, the question becomes, “Why not include taxes in the numerator?”

This is a logical question, and the calculation is often changed to be: EBITDA - Taxes / CPLTD + Interest Expense. This will yield a different result than including taxes in the denominator as follows: $250,000 - $50,750 / $100,000 + $30,000 = $199,250 / $130,000 = 1.53x.

What then, is the correct conclusion? Does this firm have $1.38 in “cash flow” for every dollar in debt obligation and taxes, or $1.53 in “cash flow” for every dollar in debt obligation and taxes?

EBITDA / CPLTD + Interest Expense + Taxes + CAPEX

This ratio is designed to resolve the dilemma of considering depreciation as a cash flow source perpetually available to service debt. All firms must replace the portion of productive capacity that is depleted by operating activities, or the firm will eventually be unable to produce goods or services. Including CAPEX in the cash needs of the denominator resolves this issue. However, as with taxes, an argument may be made that CAPEX should be considered an operating expense rather than a “coverage” expense. Thus, CAPEX is often included in the numerator. But what is the correct value to include in CAPEX?

Should CAPEX be actual capital expenditures for the period? If so, what about the fact that most often a major portion of the expenditures are financed? If that is the case, the cash flows of an operating nature from the firm were not needed to fully fund that period’s CAPEX, and one solution would be to include only the “funded” portion of CAPEX (i.e. the portion funded by the firm as its equity in the expenditures).

Should CAPEX be “smoothed” to reflect trend spending and thus be averaged for inclusion in the calculation? This intuitively works well. However, to the extent that any amount other than actual CAPEX is used, the calculation relative to cash “coverage” becomes diluted.

Lastly, some analysts utilize “maintenance” CAPEX. Maintenance CAPEX is that level of capital expenditures necessary to maintain the productive capacity of the firm. The problem with accurate identification of this amount is that the financial statements of the firm do not provide any direct measure of this amount. Thus, an approximation is often chosen. The approximation may take the form of direct questioning of the financial officer of the subject firm. Many times, the approximation selected is simply an arbitrary percentage of current depreciation levels (e.g. 75%). As is evident with these approximations, the calculation is moving further and further away from accuracy as more estimations are included in the calculation.

As with the calculation above including Taxes, CAPEX may be considered a “necessary” operating-style expenditure that should be deducted from EBITDA rather than accounted for as a “coverage” need (and therefore included in the denominator). Both calculations are shown below to demonstrate the difference in conclusions: (For these calculations, actual CAPEX will be utilized)

  • EBITDA / CPLTD + Int. Exp. + Taxes + CAPEX = $250,000 / $100,000 + $30,000 + $50,750 + $90,000 = 0.923x
  • EBITDA - Taxes - CAPEX / CPLTD + Int. Exp. = $109,250 / $130,000 = 0.84x

Again, the question is: Did the firm generated operating-style cash flows equal to 92 cents for every dollar of debt service (principal + interest), capital expenditures, and taxes; or did it generate 84 cents for the same needs?

The calculations above highlight some of the insights that may be gained from utilizing EBITDA.  They also serve to highlight some of the limitations of its use.  EBITDA is strictly an income statement depiction of cash flows available to pay for the many needs of a firm.  Notably absent from the calculations above are cash uses or sources provided by balance sheet changes, which may be significant.  Changes in the level of trading assets (primarily Accounts Receivable and Inventory) relative to the support provided by trading liabilities (primarily Accounts Payable) are not considered when focusing on EBITDA.  Thus, EBITDA is valid only when used with a “steady state” firm.  (It could also be adjusted in the numerator for changes in working investment, although that adjustment is not traditional.)

EBITDA is an excellent analytical tool as part of a more robust analytical regimen.  However, it is clearly a relative measure of cash flow available for various cash needs of a firm.  As long as the analyst understands both its uses and limitations, the concept will be valid when taken in context with other analytical measures that combine to provide a clear impression of the credit-worthiness of a firm.

Navigating Through the Storm: The Role of Management

December 8th, 2008

by Mark Faircloth

“Be the change you wish to see.”

Gandhi

With two decades of financial services experience and over 10 years with Omega Performance, I have been around some very high-performing and not-so-high-performing organizations. In many instances, both the high-performing and the not-so-high-performing organizations boasted similar goals and strategies. In my opinion, committed, involved management was the single most important ingredient of success.  So in preparing to write the closing chapter of the eBook, Revealed: Top Deposit Growth Techniques, I asked my co-author Cindi Campana for her thoughts on the role of managers in performance success.  As you will see from her response, Cindi points to the basics, which underscores the theme throughout the entire eBook.  Cindi said:

My best managers always kept their eye on the target.  They brainstormed ideas with different team members and built action plans accordingly. All goals were broken down to the individual level and everyone knew where they stood as an individual and as a team.  These managers understood that changing behavior was the best way to change results.

Put succinctly, the following key phrases stand out:

- Results oriented

- Input from all sides

- Behavior-based individual goals

The more I considered these comments, the more simple and applicable they became.  I remember the research I did while writing the Omega eBook, Coaching: Taking Your Business to the Next Level.  I found hundreds of books on “effective management,” many listing dozens of “important things” to do every day.  I was horrified.  How can anyone do dozens of anything in a day, much less important things? 

Henry David Thoreau once wrote to Ralph Waldo Emerson, “Simplify, simplify.”  In chapter four of Revealed: Top Deposit Growth Techniques, I offer three approaches that are designed to simplify your task as a manager in gathering deposits or in any other leadership task.  They will take you from the may be successful to the will be successful category of performance.  Here is a brief introduction to the approaches:

  • Be Results Oriented — never launch an initiative without a top-down view of what you want to accomplish.
  • Seek Input from All Sides — in thinking through how to manage your deposit acquisition, or any other strategy, consider the importance of getting as many perspectives as possible before you make a decision.
  • Divide Accountable Goals to the Individual Level — do so, and you’ll gain three advantages:
  1. people have a better understanding of their responsibility and stake in performance,
  2. it’s easier to assess success factors, and
  3. knowing how each person performs is a major step in managing more effectively.

Cindi and I have enjoyed sharing our insights on deposit growth with you these last few weeks. We hope you’ll take our ideas, fit them to your organization, and make them successful.  We know they will work, but only if they are aligned with your existing culture.  The process doesn’t have to be difficult.  As Emerson responded to Thoreau, “One ‘simplify’ should be sufficient.”

Resolving the Credit Crunch: Why is it Taking So Long?

December 5th, 2008

by Dr. Jerry Crigger

It’s that old “you can lead a horse to water” issue.  Banks may be given capital, but cannot be forced to lend — especially in this environment.

Why is it taking so long?

When the TARP program was announced, the general population was given the impression that “now everything is going to be OK.”  My belief is that, in time everything will be OK.  What the economy needs today is “patient money” in the form of investments.  The most patient money available is money from the government.  This does not mean that free markets do not work.  As an economist, I believe wholeheartedly in free markets — as a concept.  What we are witnessing is that markets often take time to adjust.  This is true even with government assistance.  Governments cannot “will” markets into functioning.  Governments cannot “pay” a market to adjust in a certain timeframe.  What the TARP program can, and will over time, do is to provide a base of capital that will supply the needed liquidity for the loan market to restart and grow, given a sense of stabilization on the supply side (i.e. bankers’ perceptions of future risks) and demand from firms and consumers that are creditworthy.

When a financial institution receives TARP funds, it must make a series of decisions before simply expanding lending in a wholesale fashion.  After all, that is to a large degree what created much of the current problem (e.g. limited or no-doc mortgages, etc.).  Financial institutions must contend with current loan portfolios that, in many cases, have substantial difficulties.  Managerial emphasis is currently most focused on preserving existing capital by stabilizing earnings.  In many organizations this includes a complete review of the existing loan portfolio by product type, concentration, risk rating, and geographic distribution.  It also may include a complete review of the financial institution’s expense structure and its perceived appropriateness for today, and tomorrow’s environment.  Lastly, financial institution management must determine how best to utilize the additional liquidity provided by the TARP funds.  The funds come with a cumulative preferred dividend coupon and potentially create dilution for current shareholders. 

Thus, the last thing that financial institution management wants to do is to use the funds in an imprudent fashion.  Financial institutions are generally structured to be “really good” at a few, to several, types of lending.  The existing structures are most often a result of location, culture, and lending heritage.  Providing additional liquidity to financial institutions that have limited, profitable new lending opportunities is only half of the issue.  The second half relates to finding profitable uses for the liquidity.  This will take time.  TARP addresses the first critical step in recovery for the credit markets; i.e. restoring liquidity and thus creating the opportunity for a future recovery.  The next steps will take longer.  How much longer is a guess on everyone’s part.

I chafe when I am continually bombarded by the media that we are in the worst economic situation since “The Great Depression.”  It may be true that we are experiencing the largest decline in stock values over a given period of time since The Great Depression.  However, the rest of the impression left by the media is patently false.  By any other measure, we are experiencing difficult economic times — but not catastrophic!  Financial institutions have the ability to earn significant profits with stabilized loan portfolios and managed expenses.  The housing market will take time to bottom out and for significant excess inventory to be absorbed.  Unemployment will continue to rise, unfortunately, until well into 2009 before having the opportunity to improve.  Significant sectors of the economy will continue to operate under significant stress (such as automakers).

However, what I believe is that market adjustments will occur over time.  Our society has come to expect a “quick fix” for all problems.  It took years for the U.S. economy to find its way to this point in time.  It will most likely take at least two to three years to return to a rich complement of healthy economic measures.  If it takes only two or three years with the assistance of our government, I would say that has been a job well done.  With a $13 trillion economy, we simply cannot expect that it can be fine tuned to within a six to 12 month timeframe.

We need to focus on what is being done right by the government and by financial institutions at this point in time.  We need to focus on what is being done right by our clients and prospects.  We need to focus on minimizing losses for those components of our loan portfolios that are distressed.  If we focus on the right “things” every day, we will find that before we know it, we are in a much better place than we have been.  As an industry, we need to accept, and appreciate, the role that government has agreed to play — and then stop looking outside the industry for answers.  The rest of the answers reside with our ability to assess and accept risk.  That is what we do.  That is what we are good at.