Grow or Die. Really?
Grow or die. Acquire or be acquired. Build it or kill it. And so go the banking platitudes. Now, perhaps those that invoke these phrases have strategies that compel them to grow. Shareholder value, so the logic goes, is created if I grow my balance sheet 10% per year and my earnings, because I’m realizing economies of scale, grow faster.
But what if you adopt the strategy of the tortoise? Go slow. Be methodical. Right size your cost structure as you go. Prune the tree frequently. Or what if the markets where you exist can’t support 10%+ growth? You are pushing the proverbial rock up hill expecting your employees to beat a plodding market, year in, year out.
Calamity say the consultants, the investment bankers, the rock star banks. You must grow or die! In this environment, how could you possibly face the industry headwinds without doubling your size?
But wait a minute. If we are a public financial institution, what do our shareholders expect? Would a 10% total return be sufficient? It certainly is greater than our industry has been delivering, regardless of the size. In fact, as a disgruntled Citi shareholder, I put to you that their size worked against them. The risk on their balance sheet was (is) incomprehensible, even to them. I bought in at $50, which is now the equivalent of $500 due to a reverse stock split so they can increase their embarrassingly low share price. Today they trade at $25. Their clarion call should have been grow AND die.
What if, in the board room of a community financial institution, your strategy team decided to go slowly? What would your shareholders say to 5% earnings growth that translated to 5% stock price appreciation? Not too sexy. But what if your strong profitability allowed you to pay a 5% dividend yield. Now we have a 10% total return to shareholders delivered by a steady hand. Such was the strategy of City Holding Company, a $2.8 billion West Virginia bank. Its 10-year growth rates, represented in the accompanying table, doesn’t exactly wow analysts.
But look at their 10-year total return to shareholders compared to the industry. Slow growth, combined with a 50%+ dividend payout ratio resulting in a 4.5% dividend yield delivered impressive returns. Compared to the rest of our industry, off the chart returns.
How do those that sound the growth siren square City Holding Company, and the many slow growth, highly profitable financial institutions like them?
I would like to hear from you.
Note: I make no investment recommendations in my blog. Please do not claim to invest in any security based on what you read here. You should make your own decisions in that regard. FINRA makes people take a test to ensure they know what they are doing before recommending securities. I’m sure that strategy works out. You read that I invested in Citi, right?
4 thoughts on “Grow or Die. Really?”
If we are talking pure investment, what choice would you make, assuming these two options
– a 10% total return (which is a dream for the vast majority of Community Banks in the country) on a high Beta investment in a Bank, or
– municipal bonds which yield nearly the same with essentially zero risk
On a pure risk-return basis, the decision is very simple… no rational investor would choose to invest in a Bank stock.
The chorus of 'grow or perish' is directly primarily and directly toward Community Banks — the 90% of Bank institutions with assets less than $1 billion. Why? Because their size encumbers them with inefficiencies (read: http://bankblog.optirate.com/do-smaller-banks-perform-as-well-as-larger-banks) which can only be shed via growth.
Moreover, customers… and particularly customers that have multiple bank accounts on both sides of the ledger tend to prefer larger banks (read more: http://bankblog.optirate.com/self-imposed-strategic-disadvantage-marginalizes-community-banks-credit-unions/).
Diversification is not a bad strategy. In fact, it can be argued that by concentrating 100% of Bank's activities in a very small geographic footprint is a breach of fiduciary duty to diversify risk. It makes no sense for a Community Bank to exclude 99.9% of potential customers & business opportunities by focusing on a tiny geographic footprint. It is bad for business, and it significantly increases the Bank's risk profile.
Yes, there are plenty of big banks that have not performed well. But using these examples as an excuse to stand-still is neither rational nor profitable. There is no question that Community Banks that fail to execute on growth strategies will eventually fail… either through an outright failure or a take-out that will most likely come at below-par P/B.
Need examples of big(ger) successful Banks — there are many… start with Wells Fargo, Umpqua, and First Republic. Much of the success enjoyed by these banks resulted from growth strategies.
I'm not sure I understood your response to why CHCO achieved a 274% total return to shareholders while the SNL Bank & Thrift index returned -36%.
I do not disagree with a growth strategy. I disagree that a high growth strategy is the only strategy. Your examples delivered a total return of 67% (WFC), 20% (FRC), and 13% (UMPQ) during the last ten years. Not CHCO big, but better than the industry as a whole.
Jeff – you make a good point, growth strategy is the the only option for Banks, especially Regional Banks like CHCO (a nearly $3bilion asset bank). Yet, I contend that a high growth, high profitability strategy is the best option for Community Banks (those with assets < $1 billion).
By the way, CHCO's M&A history (http://www.snl.com/irweblinkx/mna.aspx?iid=100199) indicates a total of
– 13 Bank acquisitions, two of which were completed in the past 10 years adding more than $500 million in assets
– 3 Insurance Agencies in the past 10 years
Indeed, it looks like CHCO has pursued a growth strategy with a fair volume of in-organic growth.
I think there will always be people—including bank executives and bank investors—who see the hare's strategy as being more exciting and more attractive than the turtle's. Over the past 5 years or so, I suspect the stats in banking favor the turtles, though. The more you grew in the go-go days—whether making construction loans, mortgages, or acquisitions—the more likely you were to have sudden and potentially fatal trouble as the economy tanked.
Consider this excerpt from a 2008 "year in review" story from the American Banker:
Companies once viewed as laggards became stars.
Though they were hardly poor performers, First Niagara and Community Bank System had produced only average returns over the years, in large part because they operate in relatively slow-growing markets.
But as more and more companies in once high-flying Sun Belt markets flamed out, some slow-and-steady performers in parts of the Middle Atlantic and Northeast emerged as darlings of the investment community.
I am inclined to agree with your point, Jeff. Slow and steady often wins the race.
But I also wonder whether we can draw this corollary from recent history and apply it to the future. Given the excessive expense pressure on banks following the financial crisis—higher capital requirements, increased regulatory compliance costs, shrinking revenue from overdrafts, interchange, etc.—I'm not so sure that slow and steady won't be just as troublesome a strategy in the next few years as overzealous growth proved to be for so many in the past few years.
That said, I want you to be right, Jeff. For the sake of a lot of community banks, I hope slow and steady works in the future as well as it did in the past.
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