CFO Bookshelf does not sit in the seat of judgment, nor does it play the role of pundit in the midst of the 2023 banking crisis. We’ll let the regulators and the media handle those duties. Instead, CFO Bookshelf is about old and revolutionary ideas we can test and apply in our organizations. In response to this banking crisis, we share four impactful banking frameworks that can be applied by any senior leadership team in any industry.
I started my career in public accounting, and most of my work was on bank audits and directors’ exams. Because I was just a junior accountant, I never thought much about the CAMELs rating system until the financial meltdown that started in 2007. CAMELs, thanks to great journalistic writing, became a top-of-mind concept that eventually stuck with my daily work with small business owners.
CAMELs vs CAMELS
I tend to write CAMELs with the small letter ‘s’ because that part of the framework came later after the introduction of CAMEL. This is merely a convention of my own choosing. That is because I apply this part of the framework from sensitivity to market risk to something more appropriate to the industry I’m working in.
When I design short and impactful financial reporting for small business owners, I include a page on CAMELs and I never allow it to be deleted.
I never use CAMELs to quantity the health of the business I’m working with. Instead, it’s a leadership construct we employ to ensure that we remain in proactive mode with various aspects of our organization.
But what is it? In short:
- C – Capital Adequacy – this is part of the framework I focus on daily for every business I work with. On the podcast, I explain my reasoning for starting the LOC renewal process six months in advance of the due date – that’s even when I meet with them monthly.
- A – Assets – this part of the framework even applies to service businesses. Asset thinking should be addressed at least annually, and there are creative ways to assess the assets in our organizations. My favorite case study of this concept is when Steve Jobs took over Apple as CEO when he was brought back to his company. Remember one of the first things he did with Apple’s product line?
- M – Management – even if I knew how regulators quantified their assessment of management, I would never use it. Obviously, free cash flow, ROA, and increasing the market value of the business are the result of a strong management team. I still prefer a subjective approach to addressing management. The primary issue I’m looking at is one of the worse impediments to a strong management team – loyalty and familiarity. Management that gets you to $10 million will not be the same management to get you to $50 million. Regrettably, CEOs and founders are usually the last to figure this out because loyalty can cause mental blindness. Don’t marginalize this part of the framework with a raw number.
- E – Earnings – is it even possible for a CFO to not continually monitor earnings? Impossible. I pair the ‘E’ with free cash flow, and I wrote a comprehensive essay about free cash flow on my personal website.
- L – Liquidity – I pair this tightly with ‘adequacy’ above. If you don’t have excess cash on your balance sheet, 13- to 26-week rolling cash flow forecasts are critical. I also like plenty of margin between my LOC collateral value and the LOC limit itself. If you’d like to peek at my liquidity playbook, you can find glimpses of it in another essay I wrote on my personal website.
- S – Sensitivity to Market Risk – I consider this the most complex part of CAMELs. I typically downgrade this to a simple discussion about the potential risks and threats we face in the organization. Every management team member and CEO I serve can rattle these off in their sleep. Still, I want the CEO to discuss these at least annually so that we can build up our Plan B muscle memory.
To learn more about CAMELs, start with this simple article on Investopedia. Again, don’t focus on a number. If you are a CFO or controller, I want you to READ-THINK-WRITE-SHARE your findings after you write one paragraph after each letter as you apply a holistic microscope to the business you are serving.
God Bless Betty
On the show, I mentioned that every professional should consider serving on a non-profit and a credit union (CU) board to improve their management skills. Why a CU board? They are easy to get on if you have an account, and it may take years for you to be asked to join a bank board.
I joined the United Credit Union board in 1997 because of my technical acumen, and the president at the time liked using me as a guinea pig for their new online banking tools. Betty was our CFO, and after she shared the financial report at our quarterly board meetings, she spent about ten minutes talking about her stress testing. If only you could see the glow in her eyes. God bless her little heart because every board member, including me, didn’t understand a word she was saying. But we knew all was well because Betty had a smile on her face.
I’ve had more than one financial modeling software vendor call me an expert behind my back. Accordingly, I cannot think of any financial modeler who doesn’t incorporate what-if analysis in their toolset. Stress testing? I never did, and nor did the vendors I served.
My stress-testing sense of awareness changed forever after 2007 during the financial meltdown. In 2014, Timothy F. Geithner wrote a brilliant book entitled Stress Test. There were parts of the book that were gut-wrenching, and I found that the narrative was pricking my pathos more than my logos.
As I mentioned on the show, this is why I don’t use stress testing as a numbers exercise. Scenario planning is quantitative. Stress testing is about the stories we tell ourselves that could happen and how we’ll respond. While this delineation can be easily argued, I like to save a separate designation for qualitative scenario planning vs quantitative scenario planning.
How do we do this? How do we take a qualitative approach to stress testing our business? We didn’t have time to unpack this question during the show. Instead, let me recommend the history and purpose of OPFOR. Start with this outstanding article at HBR entitled, Learning in the Thick of It.
If you pair the idea with how I’m defining stress testing with OPFOR, you might find yourself sitting on a new framework that becomes commonplace in your business.
The Texas Ratio
I loved Friday Night Lights.
Let me clarify. I loved the audio and Kindle versions written by Buzz Bissinger. I almost love the story behind his book more than the book itself. His editor deserves much of the credit for this project that almost didn’t get completed.
To continue my thought about Friday Night Lights, I loved the television series but not the movie (although Billy Bob Thornton nailed his role).
In the book, I thought the author wrote masterfully on the Texas banking crises of the 1980s that continued the following decade. He cited that more than 400 banks failed, including 9 of the largest bank holding companies in that state.
In the book, a judge referred to one bank as the Titanic, “regarded as unsinkable, said to withstand the formidable forces of natural laws.” He goes on to say, “If one of its parts were weakened or damaged, the other sections were designed to keep it afloat.”
No one saw the crash coming. Not the industry, nor those serving it, and certainly not the banks. Why not?
Maybe it wasn’t the Titanic at all, but just a Ship of Fools turned mad by money and greed.Friday Night Lights, H.G. Bisssinger, page 210
Now that we have some context let’s define The Texas Ratio. Investopedia states it’s “nonperforming assets … divided by the sum of the bank’s tangible common equity … “
Obviously, this is a bank-centric ratio, so I gave it a different definition in this episode with Bruce. I defined it as non-performing assets divided by all assets in question. Assets can be customers, inventory, vendors in our supply chain, or even our human capital.
I work at a macro level, not a micro level. So I’m not a numbers jock to assign metrics to such a modified ratio. But there is no harm in doing that, especially for inventory- or products-centric businesses.
Instead, this is a leadership team mental construct that forces us to continually be focused on what is most important.
On the show, I mentioned small coaching firms. I love working in these organizations that sell invisible and guaranteed promises. My biggest issue with the majority of these coaching practices is that they lack authenticity by focusing on other people’s frameworks vs. their own, or they sell far too many frameworks. That causes confusion for the client/customer.
A Texas Ratio mindset is going to force the CEO of these firms to consider purging the fluff and focusing on the one or two tools that generate the greatest profitability for their customers.
I hope you get the idea; with some creativity, there are many uses for this ratio that was intended as a blunt instrument to assess a bank’s balance sheet.
As I was prepping for this show, I revisited a list of nine categories of risk as defined by the OCC. One of those categories caused me to stop and reread it more than once. It was reputation risk.
The OCC explains this is the risk to earnings or capital arising from negative public opinion.
I have Steve Jobs on my brain, probably because I recently published a show about Return to the Little Kingdom, the origin story of the Apple founders up to the rise and success of the Apple II.
One of Apple’s unknown heroes was Regis McKenna, a PR genius who knew how to work the media. He was also a skilled writer with technical documentation that end users would actually read.
I read a story about Jobs calling McKenna for advice during the iPhone 4 era. The company was facing some negative publicity, and McKenna guided Jobs on how to handle that situation.
I’m not a communications director, and my one class in PR does not qualify me as a beginner in this field.
My best advice related to reputation risk is, “Who will you turn to when your business takes a hit to its reputation?”
On the show, I give a few suggestions on where to find such a person. Will you ever need that person? I hope not, but you need to have the person on your retainer payroll now rather than later.
My other suggestion to build your reputation risk awareness is to scan, read, and study e911. I love that site. The author focuses on the term crisis management because that’s his specialty. In my mind, crisis management fits snugly with reputation risk.
The Banking Crisis Is Not an Excuse to Focus on Negativity
I started with the premise that the SVB closure reminded me of four powerful frameworks that were created inside the banking industry.
A positive and forward-looking CEO/founder might call these mental constructs backward thinking or too focused on the negative.
I would not disagree with that person. But I would offer this gentle retort that I found in an annual report:
Day 2 is stasis. Followed by irrelevance. Followed by excruciating, painful decline. Followed by death. And that is why it is always Day 1.
To be sure, this kind of decline would happen in extreme slow motion. An established company might harvest Day 2 for decades, but the final result would still come.
I’m interested in the question, how do you fend off Day 2? What are the techniques and tactics? How do you keep the vitality of Day 1, even inside a large organization?Jeff Bezos in his 2016 Amazon letter to shareholders
My paraphrase of Day 1 is a relentless customer-focused mentality focused on the long term.
Is Bezos being negative? Or is he being pragmatic? The 2023 banking crisis reminds me of Day 2. Consider any or all of the four frameworks I’ve shared with you to remain on Day 1.
Title Photo Attribution: Source