My friend Bob Kafafian heads the Kafafian Group of Parsippany, N.J., which advertises itself as a finance, strategy, and operations consulting firm. But having known him for two decades, I think his greatest strength is common sense.
Example: The CEO of a bank asked him to help fix the problems with one of its branches. It was growing only about 1.5% a year, while the bank's leading branch was growing at 8%.
Bob didn't start by looking at the branch's operations. Rather he turned to demographics.
What did he find? The lead branch was in a community growing at 12% a year. The other was actually doing pretty well for a town whose population was shrinking.
Growth can also be a misleading indicator. If it's largely from rate-driven expansion in CDs that does not bring in more profitable corollary business, the apparently good numbers may leave the bank complacent about a real growth and profit problem.
Another Kafafian caveat is about banks that pride themselves on loan volume growth. The self-congratulations should be postponed a few years, to when the loans are paid off, Bob points out.
Joseph G. Blake Sr., a financial analyst at BNK Advisory Group of Bethlehem, Pa., states the same principle a different way:
"Taking on the credit risk others don't want is a guaranteed way to lose money," because no one is smarter than the market, Joe says.
In his advisory work Joe also sees another problem at many banks: They hold their funds liquid and wait for great opportunities that may not arrive, instead of taking modest risk and gaining a good, steady return.
Such banks, he says, "are like Robert E. Lee's daughters, who never married - they were waiting for men to come along who they felt were as good as their dad."
Conversely, some bankers are too aggressive. They think they know all the answers, so they bet the ranch on interest rate expectations that may or may not be realized.
Joe is also skeptical of earnings that result from one-time sales of high-yielding assets and thus provide income that does not grow predictably.
(My own worst horror story in this regard - I like it so much I have told it several times in these pages - is about the executive who sold his bank's high-yielding bonds after rates fell, took the capital gains, paid the taxes on the profits, and reinvested what was left at the much lower yields then available. The reason, of course, was that he was on profit sharing. All he considered was what the bank would earn that particular year, so he could get his cut.)
Good analysts or bank stock investors should be skeptical of numbers. It is a mistake to compare two banks' ROE or ROA without first considering how their loan-loss reserves are structured and whether this year's gains are repeatable.
And don't forget the tale of the CPA looking for business. When asked, "What's two and two?" he answered, "What number did you have in mind?"
Numbers can be a great crutch for a while, but then the bank must stand on its own.
