Case: Lakeside Bank
Lakeside Bank was chartered as a national bank in 1975 in a large Midwestern city. The bank grew rapidly and enjoyed a reasonably high level of profitability until the bank suffered some severe credit losses during the banking crisis in the mid-l 980s. These credit losses put a serious strain on the bank's capital, which required the bank to call upon the shareholders to infuse $4 million in new capital. Shareholders were very upset with losing their capital to bad credit decisions, and as a result brought in a new president who led the bank back to profitability, which it continued to enjoy until 2016. In 2016, the president who led the bank very ably, Frank Smith, retired. Upon Mr. Smith's retirement, he recommended that Tom Pierce, Executive Vice President of the bank, become his successor. The board of directors felt that it needed to go outside the bank to obtain a president. They were impressed with Lawrence Thompson, who had a background of taking risks but still obtaining high levels of profitability.
Mr. Thompson did not get along well with the board of directors and the other members of the bank's management. After three years and a bad report of examination, the board of directors dismissed Mr. Thompson and asked the Chairman of the Board, Mr. William Franklin to assume the chief executive officer role. He promoted the senior lending officer, Mr. John Johnson, to the position as president.
Dealing with the serious problem
At the close of 2019, Lakeside Bank had total resources approximately of
$400 million. Lakeside serves it market area with 18 offices and 320 full-time equivalent officers and employees.
In February 2020, Mr. John Johnson, president of Lakeside Bank, began to review the financial data he had gathered for the asset and liability committee (ALCO). Mr. Johnson, along with Mr. William Franklin, chairman of the board and the chief executive office, joined Lakeside just six months earlier. Soon after the two joined Lakeside, Mr. Franklin instructed Mr. Johnson to act in response to the report of the Office of the Comptroller of the Currency's examination, dated October 15, 2019. This report criticized the bank's policies and procedures for monitoring and controlling its risk position. Mr. Johnson was directed to review the bank's performance. He was then to evaluate the situation and make his recommendations for corrective actions to the asset/liability committee of the bank.
Mr. Johnson soon realized the bank examiners had plenty to criticize. The examiners particularly focused on three main areas. First, Lakeside excessively exposed itself to credit, interest-rate, and liquidity risks relative to its capital strength and earnings performance. Second, Lakeside funded nearly 25% of its assets through large CD's. This was more than twice the peer bank average of about 11%. Lastly, Lakeside's financial reports and written policy statements regarding interest-rate and liquidity risk management did not provide the data and necessary guidelines to make appropriate asset and liability management decisions.
Mr. Johnson proceeded to evaluate Lakeside's operating performance and its financial position. He began designing an information system of financial reports that would aid in the managing of the bank's resources and that would satisfy the criticism of the bank examiners.
The Asset/Liability Committee
Until the bank had problems, there had been very little attention given to having formal asset/liability committee meetings. Most of the decisions relating to the management of interest rate risk were a one or two person decision. Mr. Johnson felt that the risks relating to asset/liability management dictated the involvement of key management members in the decision-making process.
Mr. Johnson recommended the following committee make-up for the asset/liability committee:
1.Mr. Bill White, Executive Vice President
2.Ms. Mary Smith, Senior Vice President and Manager of Investments
3.Mr. John Callis, Senior Vice President and Chief Financial Officer
4.Ms. Jane Moore, Senior Vice President and Manager of Marketing
5.Mr. Bill Gillis, Senior Vice President and Senior Lending Officer
6.Mr. Toby Green, Senior Vice President and Manager of Operations
Mr. Johnson felt that he should serve as Chairman of the Asset/Liability Committee until the major problems facing the bank were resolved.
Comparing Performance To Peers
To analyze Lakeside's performance, Mr. Johnson assembled the financial data of eight banks for 2018 and 2019. None of these banks competed directly with Lakeside, and each was about the same size of $350 million to $650 million. Also, each of the eight banks was in areas of similar economic and demographic conditions. Exhibits 1 and 2 show the balance sheets and income statements respectively for Lakeside and the peer banks. Key financial ratios for Lakeside and the peer banks are in Exhibit 3.
Mr. Johnson produced two financial data sheets to aid in asset and liability management decisions. The first, the interest-rate sensitivity report, can be found in Exhibit 4. The second, the liquidity report can be found in Exhibit 5. Mr. Johnson believes these reports will help management monitor and evaluate Lakeside's risk position. To prepare for the meeting with ALCO, Mr. Johnson talked with each member of the committee to obtain their views on the outlook of both the local and national economy for 2020. The ALCO members seemed to agree that interest rates would remain fairly stable through the end of the first quarter of 2020 and would increase slightly during the rest of the year. The summary of this forecast is in Exhibit 6.
1.Analyze why the earnings performance for Lakeside Bank was somewhat below average.
2.Evaluate the risks Lakeside Bank has taken to obtain these earnings, classifying them into four categories - capital, credit, interest rate, and liquidity.
3.Examine the interest-sensitivity report in Exhibit 4. What are the shortcomings of the report in revealing Lakeside's interest rate risk position at the end of 2019?
4.What future actions would you suggest bank management take to improve overall performance?
5.From the bank's performance as chronicled in the case, what appears to be lacking in the board of directors' oversight of the bank's risk position?