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3 Step Balancing Act – Risk, Strategy, and Financial Performance

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6 minute read – The following blog post was written by c. myers and originally published by CUES on October 12, 2023.

Strategic plans are all about possibilities, but the possibilities for risks to get in the way are also part of the equation.  Knowing that there are risks and knowing that they can impact financial performance means that choices must be made.  Those choices are better made after reaching as much clarity and alignment as possible, especially in a changing or uncertain environment.  Stakeholders who follow a defined process to address the most concerning risks and their effects on financial performance, have more clarity and confidence in how resilient their plans are and whether they need to be adjusted.

Step 1:  Agree on Risk Appetite and Current Level of Risk

This step not only allows decision-makers to articulate their appetite for different types of risk, it also fosters alignment around how much risk is actually present.  Start by identifying your major areas of risk, then determine how much risk various stakeholders are comfortable with in each area and how much risk they perceive the institution has taken on.  This is a targeted way to uncover where risk appetites and perceptions of current risk diverge so they can be brought out for discussion.  The value is in the conversation, which typically leads to better alignment.

In this example, each team member was asked to rate their appetite for and perceived current level of risk on a scale of 0-10 for each category.  Here, we’re showing the average of the team’s rantings.  The team’s appetite for risk to revenue is very close to the perceived current level of risk.  Liquidity risk is a different story.  Conversations can center around why the appetite for this risk is relatively low and why the perceived current level is high.  It’s also helpful to discuss wide variations in individual scores, such as why one person believes the current level is high while another rates it low.  See our blog, Linking Revenue Opportunities with Appetite for Risk, for more ideas.

Step 2:  Ready the Strategic Financial Plan

Many organizations already have a longer-term financial view of the strategic plan, often called a strategic financial plan or financial roadmap.  This is an important tool when balancing risk, strategy, and financial performance.  The plan looks out 3-5 years and provides a high-level financial view that builds upon the current structure and trends, and layers on the financial consequences and timing of the strategy.  This provides a view of the institution’s expectations for a likely scenario.  The fact that none of us can accurately predict the future means that it serves as an excellent starting point but is definitely not set in stone.  Rather, it is a valuable base for alternative outcomes or what-ifs for Step 3.  See our blog, Why a Financial Roadmap is Important, for more information.

Step 3:  Address the Highest Priority Risks

Armed with Steps 1 and 2, stakeholders can begin to address the risks that concern them the most.  Questions for discussion include:

  • What could we do (or what more could we do) to mitigate this risk?
  • What are the costs or downsides of mitigation? How does mitigation impact the strategy?
  • Is the risk already being addressed through the strategy or other means? What is the timeline for resolution?
  • Is the organization on a path that will increase the risk? How much and how quickly?
  • If the risk has not materialized yet but is a concern, how likely is it to materialize and when?

Using the strategic financial plan as a base, what-ifs illustrate what could happen to financial performance if risks are realized or mitigation actions are taken.  Stakeholders can then have more complete information to base discussions and decisions on, which could include adjusting the plan.  For insights on how to connect aggregated risks to strategic net worth, listen to our podcast, Maximizing Net Worth: Insights for Financial Institutions.

Risk evolves over time, so this process is not a “one and done.”  Consider building in regular check-ins – revisiting risk questions periodically is appropriate and can help keep everyone on the same page.

This 3-step process enhances clarity and communication between Board and Management.  It can help stakeholders get more comfortable with the directions the institution is taking and how it’s protecting against the most concerning risks.  By connecting these dots, stakeholders are better able to balance their strategic path, risk tolerance, and financial performance, boosting confidence that they’re making better-informed decisions.

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c. myers live – Expanding Your Team’s Mindset on ALM

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Every day we have timely conversations with leaders on topics such as Interest Rate Risk, Liquidity, and ALM.  Although these are financial topics, the discussions are not limited to the finance team. Involving decision-makers across the organization will help you better approach opportunities and solve problems.  In this c. myers live, we talk about the importance of blending mindset concepts into your conversations to help ask the right questions and achieve alignment in reaching KPIs.  

About the Hosts:

Rob Johnson

Rob, one of five c. myers owners, has a reputation for deep, original thinking on asset/liability management and every conceivable modeling methodology, as well as analysis of investments, liquidity, aggregate risk, concentration risk, and other related topics. While Rob is a familiar face to the managements and boards of many of the largest organizations, he has helped financial institutions of all sizes tackle some of their toughest challenges, such as rebuilding capital and navigating safely and soundly with the smallest of margins. He has become quite familiar to many leaders in the regulatory world, both as an educator and a thought leader.

Learn more about Rob

Brian McHenry

brian mchenry headshotBrian, one of five c. myers owners, has worked closely with financial institution Boards and managements of all sizes in a variety of capacities. As a strategic planning facilitator, CEOs regularly praise Brian’s industry knowledge, calming communication skills, ability to authentically engage anyone with whom he interacts, and ability to keep discussions focused on linking strategy with desired measures of success.

Learn more about Brian

Other ways to listen to c. myers live:

listen on google podcasts listen on spotify listen on apple podcasts

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Add Inspiration to Your Tough Times Playbook

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6 minute read – The following blog post was written by c. myers and originally published by CUES on July 27, 2023.

Many are concerned that the next few years could be financially tough for financial institutions, even if we avoid recession.  Tight liquidity, escalating cost of funds, inflation-driven operating expense increases, and accelerating loan losses are just a few of the challenges the industry faces. 

Raise your hand if you’re tired of disruptive industry events.  OK, noted.  Now, what to do about it?  You’ve survived shocks before, probably some pretty big ones.  Take a moment to remind yourself of the takeaways from those times and how they can be used to adapt to the current environment.  That knowledge can serve as a deep source of optimism, inspiration, and energy, especially through tough times.  Read on for more ideas to add to your “Tough Times Playbook.”  

Should we adjust our strategic plan? 

Depending on your situation, plans may need to be adjusted, which can be incredibly disappointing.  The important thing is to keep strategy as the guiding light as adjustments are made.  Whatever your strategy is – perhaps it’s becoming a leading choice for payments, offering top-notch multi-channel experiences with personal guidance when needed, or building a business banking experience that rivals local competitors – continue to work toward it. 

Envision the cost of delay 

How adjustments to the plan are chosen is also critically important.  Consider these 3 decision drivers: 

  • Strategic and competitive impact in the longer term 
  • Financial position – capital and earnings 
  • Financial impact in the short term 

It’s easy to see how going full speed ahead on strategic initiatives and spending in a tough financial environment could result in an unfavorable financial position.  It’s harder to see the costs of delay.  Picture your competitive environment in 3 years.  Many others will have continued to push their strategies forward.  How do you feel about where you’ll be in comparison to the competition if you pull back or push forward?  A dramatic pullback on operating expense and strategic initiatives to wait out the storm saves money in the short run, but could cost more in the long run if it causes you to fall behind.  But it could be the right decision depending on your capital, interest rate risk (don’t forget rates can go down), and profitability.   

As you work to find the balance, consider whether the measures of success should be revisited.  For example, if continuing with strategic initiatives will result in an ROA under goal because the environment has changed, would the board prefer to accept less-than-stellar financials with great competitive positioning for the future or hit the goal and delay competitive progress?  The answer will depend on many factors, including the capital level. 

Strategic flexibility is not the same as defeat 

Strategic flexibility does not necessarily represent a drastic change in strategy – it means that you need to recalculate the route to get to the same destination.  Assuming that changes to the plan are necessary, how they’re handled is more important than ever.   

We keep hearing that the past few years have left people stressed with more fragile mental health.  Presenting the changes as a failing does not promote engagement or help with stress and mental health, but working together to overcome obstacles does.  The fact that the plan needed to change and the reasons behind it need to be acknowledged.  Stakeholders should understand the brutal facts, then shift the focus to what the organization can do and how it’s making strides toward the strategy while adapting.  Presenting the adjustments as the new battle challenge, rather than a retreat from the battle, helps energize and engage talent.   

Find the opportunities 

Tough times can present unique opportunities, too.  Think about how you can help members with advice, information, products, and services that they need and value during this time.  Brainstorm other opportunities for the organization.  Here are a few ideas to get started: 

  • Gain talent while others are cutting back (they can help the organization become stronger faster) 
  • Market when others are cutting back 
  • Implement automation, process improvements, and other projects in areas with excess capacity (e.g., due to slower mortgage and consumer lending) while those employees aren’t as busy 
  • Take time to think strategically, plan, and brainstorm – even if you can’t execute in this moment 
  • Proactively look for unique ways for your members to save money and tell them how 
  • Think of creative and intentional ways to add fun to the workplace to help offset some of the stressors in employees’ lives 

Throughout it all, report on successes.  Don’t ignore the reality of the situation, but celebrate the good things that are happening.  That’s always good practice and is especially important in tough times. 

Inspiring your team through difficult situations can be a challenge but continue to use strategy as a guiding light.  While it’s important to be realistic and adjust as necessary, find new opportunities and put the emphasis on what can be done rather than what can’t.  Many employees will relish the problem-solving mode and feel that they’re part of the solution can provide a big boost to engagement.  Even if you can’t do everything that you wanted to, highlight the successes of the new plan as you continue to work toward the vision of your future. 

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c. myers live – Make Process Improvement Your Institution’s Superpower

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Business efficiency and consumer expectations are topics we are always discussing with decision-makers.  Making Process Improvement a core competency of your institution will create a competitive advantage.  In this c. myers live, we dive into skills and structures that drive a culture of continuous Process Improvement.  

Beyond reading our Thought Leadership on this topic, many have found value in attending our Process Improvement Education.  Our Experience Improvement methodology was created for and proven in the real world of financial institutions.  For more information about our upcoming May course, click here. 

About the Hosts:

Brian McHenry

brian mchenry headshot

As one of five owners of c. myers corporation, Brian works daily with CEOs and C-Suite teams to help them identify and prioritize necessary changes to continuously adjust their business models and remain highly competitive. When working through the strategic process, CEOs regularly praise Brian’s calm communication style and ability to authentically engage anyone he interacts with.

Learn more about Brian

Lisa Camper

Since joining c. myers in 2014, Lisa has helped propel financial institutions forward to reach their organizational strategic goals.  She regularly takes on key roles in a wide range of engagements with clients as they move their organizations forward through endeavors, such as Process Improvement, Strategic Leadership Development, Strategic Implementation, and Strategic Planning.

Learn more about Lisa

Other ways to listen to c. myers live:

listen on google podcasts listen on spotify listen on apple podcasts

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Pricing Considerations in a Tight Liquidity Environment

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6 minute read – For many C-Suites, discussions around loan and deposit pricing, and funding strategies are now beyond the short-term band-aid.

Leadership teams are expanding their views to grapple with the inevitable – What may the future hold when our shorter-term funding band-aids peel off?

There is no one answer to this question.  That is why there needs to be diligent focus on thinking through options and modeling potential financial results.  This process enables decision-makers to see, in advance, a range of financial outcomes related to the strategic options they are considering.

As leadership teams work through discussions and financial modeling they typically identify and prioritize their options and the actions they will take.  This advanced thinking helps them better articulate what success looks like as they implement their prioritized options.  If forecasted results don’t come to fruition in the desired timeframe, they are prepared with more options to put into play.

As you do your financial modeling:

  • Don’t forget as you simulate potential financial outcomes, to test rates staying about the same, rates going down, and rates going up.  This helps decision-makers see how various options can help or hurt depending on rate movements.
  • It can be helpful to remind decision-makers and Boards that there are very few high-impact decisions that help regardless of what rates do.
  • Keep in mind that even if rates stay the same, it is highly likely that your Cost of Funds will increase.

Many financial institutions have experienced 10% or more decrease in savings accounts.  To make the math easy, let’s assume that the savings accounts had an average rate of 1% and the money moved to CDs paying 5%.  All else equal, this shift in deposits would hurt the current ROA by 40 basis points.

The cost of liquidity has increased dramatically, as evidenced by the chart below that shows the historical Cost of Funds for all U.S. Banks and Credit Unions compared to the 3-Month U.S.  Treasury rates dating back to the last time short term rates hit 5% levels.

Note how Cost of Funds continued to rise after short-term market rates stabilized and began to decline. This may require organizations to consider a variety of changes in lending and deposit pricing as well as investment strategy to support liquidity and cash on hand needs.  In addition, when evaluating your deposit pricing strategy, it is important to consider the potential impact on your relevancy with customers in the short- and long-term.  Liquidity challenges are expected to continue for some time, so it is essential to continue to sharpen your skills in this area.

 

The following questions are designed to help stimulate the discussions.  As always, more questions will be raised as the strategic discussions progress.  Ultimately, there is not one solution or one right answer.

Questions to Consider – Not in priority order as this is a non-linear discussion:

  1. How does your organization define short-, intermediate-, and longer-term?
  • It is important for everyone to base their recommendations and timing of action using the same definitions.
  1. What are your strategic lending objectives and desired positioning in your competitive space?
  • Consider how the answers to this question can result in competing priorities over your defined intermediate- and longer-term horizon.
  • Make sure to agree, and if so how, to factor in potential increasing credit risk and the implications for loan volumes.
  • Have frequent discussions regarding how operational costs to originate loans (including dealer fees) impact loan pricing, and profitability.
  • Once you understand the net yield on loans, consider comparing that to available alternative investments and/or loan pool purchases.  This can help decision-makers better understand the giveback to your customers should your organization’s loan pricing strategy result in lower net yields.
  • If your plan includes selling some of your loan production, be sure to help those involved in pricing decisions to have a clear understanding of the pricing levels necessary to achieve your desired return on sale.
  1. How much and what type of funding do you need to support your lending and growth objectives?
  2. How does your deposit strategy impact your non-interest income, fee income, customer stickiness, and customer growth?
  • This is also a good time to discuss and reconfirm your target markets and your value proposition for them.
  • If your funding needs are lower and your organization can allow some deposits to migrate to other financial institutions’ make sure to have healthy discussions around your level of concern about the potential longer-term implications if those depositors were to never return.
  1. For your strategic options around deposit and funding strategies, how sustainable and affordable are each of the options?  What external forces could severely threaten sustainability and/or affordability?
  • For example, what could be the impact on your Cost of Funds if many of your competitors need liquidity such that their pricing becomes irrational?
  1. What role does your investment portfolio play?
  • Discuss what portion should be allocated to support current and future liquidity needs versus investment return.
  • It is important to view this in light of lending and deposit objectives as well as emerging external forces.

Many of our clients have found that these types of questions, considerations, and discussions, supported by financial modeling, accelerate their leadership teams’ and Boards’ appreciation for the complexity and interdependence of pricing decisions.

The result is a much more cohesive and strategic approach to pricing decisions versus having to make quick reactive decisions, without having time to absorb the potential intermediate- and longer-term implications.