Pub. 13 2018-2019 Issue 2

WWW.NEBANKERS.ORG 26 ARE YOU DECIDING TO MAKE LESS MONEY? Phil Nussbaum and Eric Brown, Performance Trust T ODAY, YOU OPERATE IN AN INDUSTRY CAPTURING, ON AVERAGE, 450 BPS LESS IN return on equity than it did a decade ago. Can you afford to leave any money on the table? As a banker, you make decisions of many kinds – credit, operational, mar- keting, and financial. In all of these areas, analyzing your options is important; suboptimal decisions can cost youmoney in expense, foregone earnings, or both. You can improve your decisions and capture better potential returns by adhering more closely to eight analytical principles of sound financial decision-making. 1. Multiple Scenarios are Required There is little value in attempting to predict the future – interest rates, credit cycle timing, political outcomes – for a very simple reason: we are no good at it. World-class economists cannot successfully predict the 10-year Treasury rate six months from now, pollsters cannot predict election results, and you don’t know which of your borrowers is going to disappoint you. Yet, thinking about the future is critical. A loan or security yield represents a single scenario for the future. So does a loan classifica- tion. What if a different future actually occurs? Would all assets and liabilities experience that difference in the same way? The principle here is to consider multiple scenarios for every decision and compare al- ternatives across this same set of scenarios to determine when and where one choice will turn out more favorably, and by how much. This goes a long way towards eliminating surprises. Once you have your choices laid out across multiple scenarios, resist the very natural de- sire to “average” these outcomes into a single ranking “number.” This common misstep elimi- nates nearly all the value you’ve gained with multiple scenarios. 2. Net Future Value isWhat Matters Time’s passage is inevitable and the key in- gredient of net interest income. For this reason, net future value is far more important than net present value. Yield, internal rate of return, and duration are all calculations for the present, not the future. Do you realize that if a 30-year mortgage’s duration is 5.5 years today, in twelve months, it is likely to be 5.5 years? Isn’t that a future value you want to be alert to? Assets earn money over time, and they can also evolve through time. Looking to what that asset will provide in accumulated earnings and residual value at some reasonable future date would bemore telling than its nature today, which is, after all, something you already know. 3. Finding a Common Denominator is Essential Longer cash flow instruments offer more reward, and carry more risk, than shorter cash flows. But how does one compare the risk versus reward trade-off of two unlike things?