BID® Daily Newsletter
Mar 9, 2012

BID® Daily Newsletter

Mar 9, 2012

BE BACK IN A JIF


Back in the 1800's, thieves & other ne'er- do-wells used to have their own slang to confuse the police and anyone else trying to listen in on their plans. The term "jiffy" reportedly emerged from that. Back then, "jiffy" referred to something that would happen quickly, like a bolt of lightning. As time progressed, scientists adopted the term to refer to a short period of measurable time, such as the amount of time it takes light to travel one centimeter, or the time between alternating currents. These days, "jiffy" is probably best known as it relates to everyday things we see and use, such as Jiffy Lube oil changes, Jiffy Pop popcorn, corn muffin mix, pots and yarn. No matter how you use the term, here are some jiffy thoughts around diversification in banking to get you thinking this morning. In the investment world, diversification has been proven over time to be a decent strategy to protect against risk in a given portfolio. Whether that portfolio is made up of loans, securities, deposits or something else; diversification can make good sense. Diversification is a strategy that has been summed up over the years as not putting all of your eggs in one basket. By diversifying your asset classes, types and subtypes for example, if market movement or another issue surface that negatively impacts one, the others more than make up for the losses. Over time, diversifying allows your bank to reduce the risk of losing a large amount of money and protects the portfolio's overall returns and smoothes performance. A diversified portfolio of anything needs to be diversified between asset categories and within asset categories. To diversify, your bank needs to have a good balance of cash, securities, loans, etc. and within loans, for example, exposures need to be spread out across various segments or sectors that may perform differently under different market conditions. One way banks diversify loan risk is to spend time identifying and lending to a wide range of companies and industry sectors. To reach decent levels of diversification, you not only need to diversify by subsector, but also need to lend to at least a dozen carefully selected individual companies to reach diversification. Originating a single loan in multifamily, for instance, does not add much diversification at all, but adding 12 loans to the book does. Achieving and maintaining diversification can be challenging, particularly when you have geographical and other limitations as most community banks do, but it is a good objective. Even when diversification seems to fail, as it did during the worst of the crisis when many asset classes moved downward at the same time, it still helps over longer periods of time. As with anything, it is not perfect and human selection is inherently biased, but it can help. One key is to be careful when you seek to diversify when you lend to unrelated industries or companies where you may not have the resident corporate skills to manage the risk. Be sure you have reviewed lending policies, ALLL methodologies, employee experience and have robust monitoring processes when you get into new lending sectors to avoid issues. The key to diversifying properly is to stay active. As time horizons change, goals shift and the portfolio mix drifts away from original targets, you should rebalance. Only by aggressively managing each portfolio and rebalancing as needed, can you remain truly diversified. Doing that over time can help improve performance, as each portfolio's performance is monitored and management keeps a close eye on the potential for growth, risk profile and return on capital expected. We will be back in a jiffy sometime soon with more tips and ideas in this area for sure, but in the meantime, taking a look at areas where you have concentrations and working on strategies to diversify those can be a good place to start a decent program.
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