Like other companies, banks have different outfits to wear in public. As a retired CFO once confided, We had three suits: one to impress regulators, another to attract investors, and the last--most important of all--to deceive ourselves."
Banks' most frequent raiment--usually in shades of gray--is woven from GAAP-based financials. This is, of course, required dress when confronting regulators, investors, creditors, and big customers. And if one listens to the high priests of accountancy, this is the only one required.
But to one trained as an equity analyst, this definition doesn't hunt. Bank analysts like the late Harry Keefe, founder of Keefe, Bruyette and Woods, began persuading banks to disclose the "net interest margin"--and other investor-useful metrics--decades before the AICPA added such ideas to their audit guides.
Even among accountants, the GAAP-based vision of bank performance was also criticized. Here's the thinking of Lee G. Irving, then KeyCorp's chief accountant. He wrote me:
"Any management that restricts itself to GAAP financial reporting will be out of touch with the indicators needed in adapting a business to a changing strategic environment. GAAP-based information is limited to customer (and other) interactions resulting in a transaction. Seeking out, managing and retaining customers in a high-volume, commodity-like business like banking, however, requires a grasp of how all customer events proceed, not just those that get booked."
The gray dress of accountancy, in other words, is hardly all-weather gear. Is there a sturdier garment a bank might don to display its financial coloration? Yes! But to describe it we must enter a field of economics called "productivity."
I hit upon this insight when a banker friend who owns and chairs his $150 million Midwest bank asked me to attend a board meeting. The issue that day was cost control, especially its largest item, workforce compensation. The group reflex was how to "cut" that cost, not knowing by how much, nor why. Did the challenge run deeper than to show earnings improvement? They didn't see costs as an asset, in the sense that costs fund the bank's strategies, to say nothing of their execution.
I suggested another way of addressing the challenge. Let's start, I said, with a trend line showing revenue per employee. This simple metric--the higher the better--serves as the unique 'signature' of any bank, accurately reflecting the benefits arising from innovation and efficiency. Then layer in compensation per employee and, finally, the ratio of the two. In a workforce-healthy bank all three productivity trend lines will be gradually rising, the top line leading the others upwards. And if you're interested in morale, this 'ratio cluster' conveys important information.
It's when revenue per employee is much lower, as at community banks, that these productivity trend lines become urgent. To whom? To the owner of a bank looking to sell, or to buy another, such metrics could help turn the key to a successful deal.
The directors I met that day liked the decision-support texture of this cluster for the light it sheds on wage policy. But the chairman dissented, since he, like his dad before him, felt more comfortable with the simpler tactic of "cutting."
Productivity metrics as a diagnostic "lens" go way beyond compensation issues. The strength of productivity modeling stems from the fact that people serve as accountable agents within the model. Compare this to the people-empty model of mere profitability, from which goals, style, and rewards are absent.
So let's define productivity more fully. The factors driving it include--in addition to raw materials like funding and products--an entrepreneur and a workforce. This inclusiveness leads to a rich menu of insights useful to managers and investors alike.
Say our hypothetical entrepreneur wants to make a name for herself. …