20 Church Street  Liberty Corner, NJ 07938  P: (908) 604-9336  F: (908) 604-5951  finpro@finpronj.com  ww

1. Embracing Opportunity in the Current Environment Iowa Bankers Association February 12, 2014 20 Church Street  Liberty Corner, NJ 07938  P: (908) 604-9336  F: (908) 604-5951  finpro@finpronj.com  www.finpronj.com

2. As much as things change, they stay the same . . . • Banking is a heavily regulated industry • The number and cost of which, is growing rapidly • Corporate Governance expectations are also burdensome • Consumer compliance somehow, outweighs practical business sense • The zealots are killing the industry • But value is still easy to measure: • Enhance Tangible Book Value Per Share (TBVS) • Enhance Core Earnings Per Share (CEPS) • Enhance the Franchise Value (Core Deposits, Delivery Channels)

3. In the banking industry, Risk, Governance and Regulation (RGR) drives strategy drives value . . .

4. This FinPro core principal has not changed since developed in 2003 . . . Risk, Corporate Governance and Regulation are necessary, but too much of any of these impede value creation The key is to pro-actively identify the key issues in each, devise mitigation strategies and thus preserve value Once this outer ring is “under control”, we can go re-focus on real strategy and real value creation Hopefully, this makes the industry fun again!

5. Risk • Enterprise Risk Management • Asset Liability Management • Compliance Findings • Allowance for Loan and Lease Loss Methodology • Asset Migration • Liquidity Stress Test • Contingency Funding Planning • Satisfaction of Requirements of 939A of the Dodd-Frank Act • Safety and Soundness Compliance Review • Investment Advisory • Quarterly Economic Update and Webinar

6. Enterprise Risk Management ERM is the integrated umbrella that delineates linkages among various risks currently managed in a SILO environment and provides the foundation for planning . . . Capital Plan + Litigation Mitigation Plan Response to Regulatory Order C Credit Concentration Plan Loan Migration Analysis Loan-to-one-borrower Analysis A + Public Relations Plan Investor Relations Plan Management Succession Plan Compensation Plans M + Internal Audit Internal Controls and Procedures + IT Controls and Testing Plan Budget Business Plan E + Compliance Plan Contingency Funding Plan Wholesale Funding and Funds Management Plan L Interest Rate Risk Analysis S

7. Successful ERM requires a single model, breaking down the SILOs and integrating risk, ALCO, budgeting, planning and stress testing . . . Pre-Phase • Prioritization of Risk • Vertical Risk Assessment • Identify and Quantify Risk • Set Risk Thresholds/ Tolerances • Horizontal Risk Assessment • Setup Risk Committee • Adopt CAMELS+ Approach Stress Test the Base Case Mitigation Strategies/ Policies/ Procedures Model Base Case Scenario Identify Trigger Events Capital Asset Quality Two Approaches: Manage-ment CAMELS+ Assessment Model Alternative Scenarios Pro Forma CAMELS+ Assessment 1. Variable Stress Tests Earnings Liquidity 2. Enterprise Wide Stress Tests Sensitivity +’s

8. Liquidity is still the single risk that can cost you your bank overnight . . . • Deposit growth will return as the key to Balance Sheet growth • follow the 2, 10, and 20 rule • allocate collateral in most efficient manner • update Contingency Funding Plan and incorporate stress tests • Manage Investments • move investment portfolios to HTM • underwrite and document whether investments are “investment grade” • Investment purchases should be pre-planned • buy in bigger chunks and less frequently

9. Governance • FinPro Central Hub • Corporate Governance Management Tool • Board Filing Cabinet • Board Education, Training, and Retreat Moderation • Talent Management and Succession • Management and Board Review • Organization Structure Review and Planning • Compensation Analysis • Vendor Management

10. Boards set strategic direction. As such, they must establish several key principles which will drive strategic decision making. For example . . . Board Principles Minimal TBVS dilution • Grow EPS significantly • 12% compounded annual return on TBVS over next 3 years • Only consider sale today if: • The offer is very strong and is from an acquirer with a strong currency • Market “double dips” • Continue to improve asset quality position • Goal of <3% NPAs/Total Assets • Goal of <50% Classified Asset coverage ratio • Become a “2” rated institution • Eliminate regulatory orders (consent or MOU) • Achieve 8.5% tangible equity capital ratio at the holding company over time • Shift the holding company capital structure away from debt and toward more common • Goal is 33% debt / total capital • Look to replace interest and dividend bearing instruments with new capital after Company is rated a “2” and can raise capital that is accretive to current TBVS

11. Community banks need to improve their Corporate Governance Management Tool (CGMT) to ensure all the processes are being accomplished . . . CGMT List Document Library List List List List

12. CGMT should be able to track and ensure compliance with all the processes required and provide notice reminders . . . Ability to enter dates for deadlines, expirations, and reviews for both processes and documents. Ability to securely store, transfer, and utilize documents critical to proper corporate governance. Ability to provide documents for specific meetings easily and intuitively to board members. A clean and color coded calendar that provides an overview of all processes and meetings. Ability for board members and senior management to audit the completion of processes and proper creation of documents to comply with regulatory requirements. Ability to create custom alerts for each individual process, meeting, or document to ensure users are always on top of due dates.

13. Community bankers are also in desperate need of a Board Education and Training program that works in the real world because . . . Education and Training Modules include: • Role of a Board Member • Banking 101 • Financial Statements and Ratios • Regulations and Exams • Corporate Governance • Capital • Investments • Loans • Funding and Liquidity • Management Compensation • Talent Management • ALCO • Bank Strategy • ERM and CAMELS+ • Value Creation • Bank Specific ERM Review • Bank Specific Corporate Governance • Bank Specific Regulatory Review • Bank Specific Bank Strategy • Bank Specific Value Creation • Bank Specific ALCO Review New rules and regulations are being developed and implemented at a record pace; Boards and executive management continue to age and must focus on talent management; Ongoing education and training is viewed as a must in the industry; FDIC is pursuing legal action against Board members more liberally than ever before; Strategic planning is again focused on value creation, with an expectation of risk management already in place; and Understanding the emerging issues will put the Bank at a competitive advantage over its competition.

14. Standard Board Education and Training Programs for Board Members should include . . . • Note: program combinations are available upon request. FinPro also offers a CEO mentorship program and individual banker training on an as needed basis. Training Programs • Banking 101: Banking Basics • Banking 201: Value Creation • ALCO Committee • Risk Committee • Corporate Governance Committee • Compensation and Nominating Committee • Audit Committee • Loan Committee

15. Regulatory • Regulatory Consulting • Board Resolution, MOU, C&D Mitigation and Compliance • Regulatory Consulting • Negotiate Regulatory Agreements • Expert Witness Testimony • Policy Review • Capital Planning • Community Reinvestment Act Performance Review

16. BASEL III, Dodd-Frank and other new rules Asset Quality Issues: Classifications, Concentrations & Credit Administration Compliance zealots and overreach Qualified Mortgages and Servicing Interest Rate Risk Cyber Security Slow upgrade of CAMELS scores Current Issues . . .

17. Need to know and understand all regulatory ratings Should conduct own internal CAMELS + assessment quarterly Work with the regulators pro-actively, they hate surprises! Know your rights and understand the appeals process Regulatory Keys to success . . .

18. Market • Branch Improvement • Market Ranking Studies • Strategic Market Assessment • Peer Market Composition analysis • Site Studies & Branch Applications

19. Community banks need to be able to identify the most attractive markets based upon there desired strategic goals . . .

20. Customer • Customer Segmentation Analysis • Product Propensity Analysis • New Product Development • Incremental Cost of Funds Analysis

21. There are 58 segments that define the retail customer market. These 58 segments can be further combined into eight major groups based on predictive abilities of financial behavior including income producing assets, household income, age of householder, home-ownership and urbanization . . .

22. The Bank’s commercial customers have the following segment distribution (based on all commercial customers in the US) . . .

23. Franchise • Talent Management and Succession • Holding Company, Exchange Registration and Charter Analysis • Branch network restructuring • Market share acquisitions • Branch network in-fill

24. Talent Management is the most important element of banking . . . • Investors don’t invest in banks, they invest in management teams • A management review is a good thing • True staff planning is essential • Migrate to organizational structure for the future, not today • Which will necessitate organization wide management succession, and • Individual management succession • Must identify training needs and build it in house • We should hire outside the industry, we need new ideas

25. Corporate infrastructure needs to be re-evaluated . . . • Eliminate Holding Company, if not utilizing it • Select appropriate charter • Deregister and delist • Ensure that you have enough authorized but unissued shares for both common stock and preferred stock • Plan to fix your capital structure • 2/3 common • 1/3 in dividend or interest bearing form • Potential adjustment to $10 billion from $500 million cut off

26. Evaluate the cost and effectiveness of the current systems . . . In-house vs. outsourcing The Cloud Data management Contract reviews to avoid astronomical early cancellation fees

27. Ensure the Bank has the appropriate services and sales channels . . . Insurance Mutual Funds Brokerage Trust

28. Value Creation 1. Grow deposits & diversify the mix 2. Grow loan & diversify the mix 3. Grow and diversify noninterest income 4. Control expenses 5. Enhance the branch network and alternative delivery options 6. Increase number of and penetration within customers 7. Utilize capital market tools

29. Grow Deposits & Diversify the Mix • Deposit disintermediation study • Decay analysis • Beta analysis • Deposit concentration analysis 1. Grow deposits & diversify the mix 2. Grow loan & diversify the mix 3. Grow and diversify noninterest income 4. Control expenses 5. Enhance the branch network and alternative delivery options 6. Increase number of and penetration within customers 7. Utilize capital market tools

30. The threat of rising rates has arrived. The last time rates rose quickly was from 2004 to 2007 and bank cost of funds tripled . . . Implied Beta = 55% Source: SNL Financial

31. We need to not only grow deposits and diversify the mix, we need to avoid the rapid rise in funding costs . . . • Minimize non core funding but some, in moderation, is acceptable • Brokered deposits are preferable to wholesale borrowings • Conduct deposit loyalty study • Relationship • Transactions • Tenure • Location • Price • Size

32. Definitions . . . • Beta Value = the change in a given deposit price for each 1.00% change in market price • Measured as a percent • Market price is typically fed funds, LIBOR, or some other short term rate proxy • Decay Rate = the amount of deposit dollars that leaves an individual deposit type over a measured time period • Measured on monthly or annual basis • Utilizes todays rate as a starting point

33. The sensitivity of decays to betas increases and decreases with the Propensity to Renew factor. With a low propensity to renew accounts (unloyal accounts), changes in betas have large impacts on decays . . . Beta Decay ΔD ΔΒ Low Propensity to Renew: ΔΒ < ΔD

34. Utilizing a Sample Bank’s Beta and Decay assumptions and adding the propensity to renew factor, we can model those changes that would help to improve the overall IRR position of the Bank . . .

35. The results of a thorough deposit study are the justification of modeling assumptions, a well developed deposit strategy, and increased value (ability to communicate franchise of deposits to outsiders and potential interest expense savings) . . . To Enhance Value, Managing Deposits Can Not Be Reactive Conduct Deposit Studies NOW! With the adjustments justified from this study the Sample Bank will save $1 million in interest expense in rising rates. That is a BIG number for a $620 million institution.

36. Grow Loans & Diversify the Mix • Loan concentration analysis • Risk vs. Profitability analysis • New product white papers • Prepayment speed analysis 1. Grow deposits & diversify the mix 2. Grow loan & diversify the mix 3. Grow and diversify noninterest income 4. Control expenses 5. Enhance the branch network and alternative delivery options 6. Increase number of and penetration within customers 7. Utilize capital market tools

37. From a Lending perspective, we need to grow loans and diversify the mix . . . • Need expertise, systems, processes and controls • Migrate from investments to loans • Need to hire loan producers • Loan participations are okay only if underwritten by purchaser • Establish solid concentration limits and granularly stratify whenever appropriate • FICO • Geography • LTV (funded and fully drawn) Stress Test: 5%, 10%, 15% • Purchased vs. Refinance • Non owner vs. owner (CRE) • Industry, NAICS code • DSC

38. Select from the 7 Ps of growth . . . • People – Hire Sales People • Price – For small buckets, Price to get loan volume • Place – Establish LPO’s • Product – Look to new products • Promotion - Marketing • Process – Quicker commitments • Purchase – Buy pools but re-underwrite to your credit criteria

39. Grow and diversify noninterest income • Wealth management • Mortgage operation • Alternative fee opportunities • Small Business Investment Companies 1. Grow deposits & diversify the mix 2. Grow loan & diversify the mix 3. Grow and diversify noninterest income 4. Control expenses 5. Enhance the branch network and alternative delivery options 6. Increase number of and penetration within customers 7. Utilize capital market tools

40. Analyze fee income opportunities . . . Target a 50+ basis point non interest income to average assets ratio • Stop waiving fees • Is this a competitive weapon? • Charge fees on single relationship accounts to make them profitable or move them out • Cyclical fee income will receive a lower earnings multiple • Consider purchasing RIA’s • Ultimately, fees may help but they are not the Panacea Source: SNL Securities

41. Control Expenses • GL line item review • Transaction cost savings analysis • Organizational efficiency study • Branch profitability study 1. Grow deposits & diversify the mix 2. Grow loan & diversify the mix 3. Grow and diversify noninterest income 4. Control expenses 5. Enhance the branch network and alternative delivery options 6. Increase number of and penetration within customers 7. Utilize capital market tools

42. Implement expense control measures . . . • Conduct a general ledger line item review • Everyone says they can’t cut and yet when pressed all can and do • Remove sacred cow excuse • Lead by example – Board fees and executive compensation • Sell or close unprofitable branches • Eliminate multiple layers of organization – Flatten organization chart • Conduct branch, account and customer profitability analytics • Recognize pickup from reduced asset quality problems: FDIC insurance, Legal and carry costs, and provision • Ensure your Bank has the appropriate Charter • Determine need, and usage of, Holding Company • If possible, de-register Source: SNL Securities

43. Enhance the branch network and alternative delivery options • Branch Improvement • Market Ranking Studies • Strategic Market Assessment • Peer Market Composition analysis • Site Studies & Branch Applications 1. Grow deposits & diversify the mix 2. Grow loan & diversify the mix 3. Grow and diversify noninterest income 4. Control expenses 5. Enhance the branch network and alternative delivery options 6. Increase number of and penetration within customers 7. Utilize capital market tools

44. Looking at the retail customer segments, the Bank’s markets vary widely but the larger regions tend to have a more affluent customer base . . . Total Households: The vertical axis shows the number of households in the market, from lowest at the bottom to highest at the top. Relative Affluency: The horizontal axis shows the level of affluence in the market, from lowest at the left to highest at the right. Illustration: A market in the top right is a large market with an affluent customer base.

45. The Bank’s markets have a broad range of commercial density, however there is a generally narrow range of relative business density . . . Total Businesses: The vertical axis shows the number of businesses in the market, from lowest at the bottom to highest at the top. Business Density: The horizontal axis shows the concentration of business in the market, from lowest at the left to highest at the right. Illustration: A market in the top right has a lot of businesses in a concentrated area.

46. Increase number of and penetration within customers • Customer Segmentation Analysis • Product Propensity Analysis • New Product Development • Incremental Cost of Funds Analysis 1. Grow deposits & diversify the mix 2. Grow loan & diversify the mix 3. Grow and diversify noninterest income 4. Control expenses 5. Enhance the branch network and alternative delivery options 6. Increase number of and penetration within customers 7. Utilize capital market tools

47. Customer segments should be analyzed to determine the customer base. So let’s look at an example in Jersey City, NJ . . . This immediately says we need to cater to a younger retail customer, if we want to be successful

48. Fiscal Rookies Segment: • Young couples and families. • Relatively high incomes • 25- to 44-year-olds • Not saving a lot of money • Average levels of income-producing assets. • Carry debt from student and auto loans • First home mortgages • Dabbling in investment-style insurance and mutual funds for their 401(k)s. As such we need to understand the following customer segments . . .

49. A checking account with a low minimum or no minimum balance requirement, no fees, free internet banking, unlimited check writing, automatic overdraft protection, and tied to a savings account. Offer some form of custom loan, a term loan secured by real estate for borrowers with good credit but little or no equity to use as an alternative to costly student loans or for other debt consolidation. Consider higher LTV loans with approach of underwriting borrower vs. collateral, when direct payment is made from a bank checking account. Also consider offering interest only periods and some fixed number of options for the customer to convert some or all of the outstanding line into a fixed term loan. The needs profile for the Fiscal Rookies looks like this . . .

50. Product delivery . . . • Technology, Technology, Technology: • Internet and Electronic banking – low usage rate of traditional brick and mortar • Link all accounts together and offer some form of a unified statement as well a free and unlimited electronic access to accounts • These customers have high ATM usage rates (next generation ATMs) • Convenience, Convenience, Convenience: • Direct deposit of payroll checks into a Bank account • Location near retail draws, walking patterns, and stops for the Bergen Hudson Light Rail • Free ATM usage at any Bank locations • A dual credit card/debit/ATM card should be offered • Type of Media: • Radio • Entertainment, Fitness, and Airline Magazines • Affinity relationships • Business Finance section of the newspaper • Search Engine • NO Television