There are a lot of banks in the United States. As of the end of 2017, there were 5,670 FDIC insured depositary institutions. While most of those are privately held and pretty small, there are also a lot of publicly traded banks. Within the Russell 3000, there are 298 companies with an ICB Sector classification of “Bank.” There are more “Banks” in the Russell 3000 than any other ICB Sector and that does not include companies like Bank of New York, Northern Trust, Morgan Stanley, Goldman Sachs or CIT, which are classified as “Financial Services.”
Given how many banks there are, it should come as no surprise that there is a pretty wide discrepancy in performance. There are some high performers, there are some real dogs and there are a lot in between. Given that most banks more or less produce the same product (loans) from the same materials (deposits), my view is that variance in performance basically comes down to the quality of the management team. Again, it should come as no surprise that there are some real rock star management teams and some total duds. After years of study, one conclusion that I have come to is that while the duds might not be great at running a bank, they seem to excel at the art of mushroom management when it comes to their boards.
One surprising thing (at least to me) about the banking industry is that there is so little activism relative to the amount that occurs in the rest of corporate America. Given the size of the industry, how comparable all banks are, the wealth of data that is available on each bank and the wide variance of performance, I would have expected that more activists would appear to hold underperforming banks (particularly where the underperformance is chronic or there are obvious governance issues), their management teams and boards accountable. I understand that activists might have concerns about the regulatory overlay and might not have the industry knowledge, but there are some pretty clear examples of activism working (even if it doesn’t quite work until the second time), so it feels like there should be more activism.
Between the absence of activism and excellence at mushroom management, the natural state for banks that are chronic underperformers, have governance issues or are otherwise generally blind to obvious problems is that of inertia. Absent some external force, the existing state continues. Occasionally, however, no external force is needed and those boards that had been treated like mushrooms by their CEOs (usually for far too long) take matters in to their own hands and demand accountability.
Two great recent examples of this are American River Bankshares (NASDAQ—AMRB) and MidSouth Bancorp (NYSE—MSL). I had followed both these banks for a number of years and, candidly, had viewed the boards of each as in thrall to their CEOs. I also had strong suspicions that, in each case, the CEO was not giving his board and accurate assessment of the bank, its prospects and the issues facing it. I was, therefore, (very pleasantly) shocked when each fired their CEO, evidencing, to my mind, a vigorous embrace of their fiduciary duties and responsibilities.
In the case of American River, it is a pretty simple story: they just didn’t make enough loans. I also think they made some serious mistakes in terms of capital deployment/return, but that was just the insult--the real injury to performance and stockholder value was a chronic inability to make enough loans. Just as simple and obvious as the problem, was the solution: fire the CEO and bring in a new CEO who will do things differently. I can’t link to it, but I will quote the new CEO, David Ritchie, from his first earnings call in January:
"My plan for American River Bank is growth. We are very well positioned with our
capital and liquidity. Now, we need to start deploying that capital. We need to build
upon our 34 years of excellent reputation, expanding existing relationships and
bringing new relationships to the bank."
Again, pretty simple—fire the guy who couldn’t make loans and bring in someone who at least understands that is the priority—and great work by the American River board. I assume and hope that they will give the new CEO the time and resources that he needs to be successful while remaining open to all opportunities to maximize stockholder value.
With MidSouth, it is all a little more complicated and dramatic. In the first instance, it wasn’t just the CEO that was fired, it was the founder, single largest individual stockholder and, basically, personification of the bank. Also, it wasn’t just the CEO who got the axe, his son, the bank’s president, also got chopped. Adding to the drama is the fact that the guy who seemed to be swinging the axe was a football star who had only recently been appointed chairman of the board. In addition, as far as I can tell from published reports, Jake Delhomme, the football star, and Troy Cloutier, the CEO’s son, were close personal friends. Taking all that into consideration, I have tremendous respect for the MidSouth board, since it must have taken enormous fortitude to do what they did, even if it was sorely needed (and maybe prompted by regulators).
As to the reasons for this drastic action, my view is that it basically comes down blindness on the part of the CEO. One obvious blind spot was the impact of having a large concentration of oil field service loans. I don’t necessarily think that was a bad business decision given the market that MidSouth operates in, but it was a bad decision not to acknowledge the issues caused in that portfolio by declining oil prices and address those issues aggressively. Another was the impact of appointing your son to a senior management role when the bank was under duress. Troy Cloutier may be a great bank executive (I don’t really know either way) but it wasn’t the time to do it. A third was the need for additional capital. Less obvious are other blind spots, like being too fond of a branch network that cost too much.
Finally, unlike with American River, the fix is not so easy or obvious. My gut instinct is that Rusty Cloutier was probably a pretty good banker, all things considered, even if firing him was the right thing to do. However, one obvious question is how much business was he responsible for and what happens to that business now that he is not there? Raising additional capital, aggressively dealing with problem energy loans and scaling back the energy business are also all good things, but how to replace the earnings that previously came from energy loans and any deposits that came from those relationships? Similarly, rationalizing their branch network makes sense, but can they actually get their cost base to the right level on their own?
Just as with American River, I assume and hope that the MidSouth board gives its management team the time and resources that they need to be successful while remaining open to all opportunities to maximize stockholder value. However, for MidSouth, the path forward might be better with a partner.