Window of Opportunity for Sub Debt

Bankers who have not done so recently may want to revisit their subordinated debt playbooks so they can successfully navigate an emerging window of opportunity.

Market activity is up significantly due to interest rate trends, regulatory developments and other factors. Bank management teams who are prepared to act quickly can capitalize on the opportunity.

Sub debt is a long-term debt obligation with a maturity typically ranging from 10 to 15 years, a fixed (or fixed-to-floating) interest rate and the ability for the issuer to redeem the notes under certain circumstances. It has become a staple of bank capital planning, because it can qualify as Tier 2 capital if properly structured. Most banks can even use it to generate Tier 1 capital at the bank level, a strategy even more banks can employ following the 2018 changes to the Federal Reserve’s Small Bank Holding Company Policy Statement.

However, executives must be mindful of certain limitations of sub debt. In particular, its treatment as Tier 2 capital is phased out by 20% per year, beginning five years before maturity. Additionally, the interest rate typically flips from a fixed rate to a floating rate during the last five years, which is often higher than the fixed rate. Accordingly, banks that issued sub debt in 2014 and 2015 — when they were preparing for Basel III capital rules and, in some cases, repaying comparatively expensive Troubled Asset Relief Program funding — may now have the opportunity to refinance that sub debt.

New Issuances
Banks considering a new sub debt offering need to consider several matters in planning the transaction. These include many familiar decision points, such as selecting a placement agent or underwriter, deciding whether to seek a credit rating, consulting with regulators and determining the proposed offering terms, including offering size, maturity, interest rate structure, use of proceeds and other matters. In addition, banks will need to be mindful of federal securities laws that govern the offering.

There are also new issues for management teams to consider, like selecting a benchmark rate for the floating rate component. Historically, sub debt floating rates have been calculated based on the London Interbank Offered Rate, or LIBOR. Given LIBOR’s likely disappearance after 2021, issuers will need to evaluate whether to preserve the flexibility to select an alternate benchmark rate at the beginning of the floating rate period or to preemptively commit to an alternate benchmark.

Directors will want to make sure they have a clear understanding of how the offering complies with the company’s long-term capital plan and review the pro forma effects of the offering on capital ratios. From a fiduciary perspective, they also need to understand how the sub debt fits into the capital structure and how the organization will use the proceeds.

Given the significant planning needed ahead of a sub debt issuance, banks should begin the process at least two to three months before they need the capital.

Redeeming Existing Sub Debt
The mechanics of redeeming existing sub debt are relatively straightforward, and are governed by the terms of the notes and any applicable indenture. The terms can limit the dates on which a redemption can be completed, require some notice period to holders and dictate that partial redemptions be allocated pro rata among noteholders.

But before taking any steps, it is critical that issuers consult with their regulators and be mindful of related issues, including compliance with the Federal Reserve’s SR letter 09-4, which prescribes certain actions and considerations in connection with return of capital transactions. Depending on an institution’s size and other characteristics, it may need to obtain prior regulatory approval. Directors will need to understand the effects of the redemption on the organization’s capital structure and pro forma capital ratios.

Public Company Considerations
Banks with publicly listed holding companies will also want to evaluate whether to conduct a public offering through their shelf registration statement. This generally requires an indenture, clearinghouse eligibility, prospectus supplements, a free writing prospectus, limitations on credit rating disclosure and other actions. However, it can improve execution by making it easier for purchasers to resell their notes. Public companies also need to comply with their Exchange Act reporting obligations.

While there are several other issues to be considered in connection with any sub debt issuance or redemption transaction, management teams and boards of directors who have a basic understanding of the considerations outlined above will be well positioned to develop and maintain a strong capital foundation to execute their strategic growth initiatives.

Weighing the Value of a Bank Holding Company


governance-6-24-19.pngIn May, Northeast Bank became the fourth banking organization in two years to eliminate its holding company. Northeast joins Zions Bancorporation, N.A., BancorpSouth Bank and Bank OZK in forgoing their holding companies.

All of the restructurings were motivated in part by improved efficiencies that eliminated redundant corporate infrastructure and activities. The moves also removed a second level of supervision by the Federal Reserve Board. Bank specific reasons may also drive the decision to eliminate a holding company.

Zions successfully petitioned to be de-designated as a systemically important financial institution in connection with its holding company elimination. In its announcement, Northeast replaced commitments it made to the Fed with policies and procedures relating to its capital levels and loan composition that should allow for more loan growth in the long run.

Banks are weighing the role their holding companies play in daily operations. Some maintain the structure in order to engage in activities that are not permissible at the bank level. Others may not have considered the issue. Now may be a good time to ask: Is the holding company worth it?

Defined Corporate Governance
Holding companies are typically organized as business corporations under state corporate law, which often provides more clarity than banking law for matters such as indemnification, anti-takeover protections and shareholder rights.

Transaction Flexibility
Holding companies provide flexibility in structuring strategic transactions because they can operate acquired banks as separate subsidiaries. This setup might be desirable for potential partners because it keeps the target’s legal and corporate identity, board and management structure. But even without a holding company, banks can still preserve the identity of a strategic partner by operating it as a division of the surviving bank.

Additional Governance Requirements
A holding company’s status as a separate legal entity subjects it to additional corporate governance and recordkeeping requirements. A holding company must hold separate board of directors and committee meetings with separate minutes, enter into expense-sharing and tax-sharing agreements with its bank subsidiary and observe other corporate formalities to maintain separate corporate identities. In addition, the relationship between the holding company and its subsidiary bank is subject to Section 23A and Section 23B of the Federal Reserve Act, an additional regulatory compliance burden.

Additional Regulatory Oversight
Holding companies are also subject to the Fed’s supervision, examination and reporting requirements, which carry additional compliance costs and consume significant management attention. The Fed also expects bank holding companies to serve as a source of financial strength to their subsidiary banks, an expectation that was formalized in the Dodd-Frank Act.

Diminished Capital Advantages
Historically, holding companies could issue Tier 1 capital instruments that were not feasible or permissible for their bank subsidiaries, such as trust preferred securities and cumulative perpetual preferred stock. They also enjoyed additional flexibility to redeem capital, an advantage that has largely been eliminated by the Basel III rulemaking and Fed supervisory requirements. A holding company with existing grandfathered trust preferred securities or with registered DRIPs may find them useful capital management tools. Holding companies with less than $3 billion in consolidated assets that qualify under the Small Bank Holding Company and Savings and Loan Holding Company Policy Statement are not subject to the Fed’s risk-based capital rules. These companies are permitted to have higher levels of debt than other holding companies and banks.

Broader Activities, Investments
Bank holding companies, especially those that elect to be financial holding companies, can engage in non-banking activities and activities that are financial in nature through non-bank subsidiaries that are bank affiliates. In some cases, these activities may not be bank permissible, such as insurance underwriting and merchant banking. The Fed also has authority to approve additional activities that are financial in nature or incidental or complementary to a financial activity on a case-by-case basis.

Bank holding companies can also make passive, non-controlling minority investments that do not exceed 5 percent of any class of voting securities in any company, regardless of that company’s activities. By comparison, banks are limited to making investments in companies that are engaged solely in bank-permissible activities or must rely on authorities such as community development or public welfare authority to make investments. Banks may also have limited leeway authority to invest in specific securities or types of securities designated under the applicable state banking law or by the applicable state banking regulator.

Banks that are not interested in activities or investment opportunities available to holding companies may be less concerned about eliminating the structure. But an organization that engages in activities at the holding company level that are not permissible for banks or that desires to maintain its grandfathered rights as a unitary savings and loan holding company may not wish to eliminate its holding company.

Operating without a holding company would result in more streamlined regulatory oversight, corporate governance and recordkeeping processes. But a holding company provides the flexibility to engage in activities, to make investments and to create structures that a bank may not. Bank boards should weigh these costs and benefits carefully against their strategic and capital management plans.

Rodge Cohen: Are We Preparing to Fight the Last War?


risk-3-1-19.pngHis name might not command the same recognition on the world stage as the mononymous Irish singer and song-writer known simply as Bono, but in banking and financial services just about everyone knows who “Rodge” is.

H. Rodgin Cohen–referred to simply as Rodge—is the unrivaled dean of U.S. bank attorneys. At 75, Cohen, who is the senior chairman at the New York City law firm Sullivan & Cromwell, is still actively involved in the industry, having recently advised SunTrust Banks on its pending merger with BB&T Corp.

Cohen has long been considered a valued advisor within the industry.

In the financial crisis a decade ago, he represented corporate clients like Lehman Brothers and worked closely with the federal government’s principal players, including Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke. His character even made an appearance in the movie “Too Big To Fail,” based on a popular book about the crisis by Andrew Ross Sorkin.

Eleven years later, Cohen says the risk to the banking industry is no longer excessive leverage or insufficient liquidity—major contributing factors to the last crisis.

The Dodd-Frank Act of 2010, passed nearly a decade ago, raised bank capitalization levels substantially compared to pre-crisis levels. In fact, bank capitalization levels have been rising for 40 years, going back to the thrift crisis in the late 1980s. Dodd-Frank also requires large banks to hold a higher percentage of their assets in cash to insure they have enough liquidity to weather another financial storm.

The lesson from the last crisis, says Cohen, revolves around the importance of having a fortress balance sheet. “I think that was the lesson which has been thoroughly learned not merely by the regulators, but by the banks themselves, so that banks today have exponentially more capital, and the differential is even greater in terms of having more liquidity,” says Cohen.

But does anyone know if these changes will be enough to help banks survive the next crisis?

“I don’t think it is possible to calculate this precisely, but if you look at the banks that did get into trouble, none of them had anywhere near the level of capital and liquidity that is required now,” says Cohen. “Although you can’t say with certainty that this is enough, because it’s almost unprovable, there’s enough evidence that suggests that we are at levels where no more is required.”

It is often said that generals have a tendency to fight the last war even though advances in weaponry—driven by technology—can render that war’s tactics and strategies obsolete. Think of the English cavalry on horseback in World War I charging into German machine guns.

It can be argued that regulators, policymakers and even customers in the United States still bear the emotional scars of the last financial crisis, so we all find comfort in the fact that banks are less leveraged today than they have been in recent history, particularly in the lead up to the last crisis.

But what if a strong balance sheet isn’t enough to fight the next war?

“I think the biggest risk in the [financial] system today is a successful cyberattack,” says Cohen. While a lot of attention is paid to the dangers of a broad attack on critical infrastructure that poses a systemic risk, Cohen worries about something different.

“That is a very serious risk, but I think the more likely [danger] is that a single bank—or a group of banks—are hit with a massive denial of service for a period of time, or a massive scrambling of records,” he says. This contagion could destabilize the financial system if depositors begin to worry about the safety of their money.

Cohen believes that financial contagion, where risk spreads from one bank to another like an infectious disease, played a bigger role in the financial crisis than most people appreciate. And he worries that the same scenario could play out in a crippling cyberattack on a major bank.

“Until we really understand what role contagion played in 2008, I don’t think we’re going to appreciate fully the risk of contagion with cyber,” he says. “But to me, that is clearly the principal risk.”

And herein lays the irony of the industry’s higher capital and liquidity requirements. They were designed to protect against the risk of credit bubbles, such as the one that precipitated the last crisis, but they will do little to protect against the bigger risk faced by banks today: a crippling cyberattack.

“That’s why I regard [cyber] as the greatest threat,” says Cohen, “because a fortress balance sheet won’t necessarily help.”

Understanding Your Bank’s Capital Alternatives


capital-10-18-17.pngIt is crucial for executive management to engage their boards in practical conversations surrounding the raising of capital. Important questions include what form of capital is best from a strategic perspective, how much dilution to earnings per share (EPS) is acceptable and how soon can the dilution be earned back. To answer these questions, management must first have a solid understanding of each type of capital.

Common Equity
Common equity tends to receive the most favorable treatment from a regulatory perspective and is fully included in Tier 1 capital. This, however, comes at a cost beyond the 5 to 7 percent fee paid to your investment banker. A common equity raise increases the number of shares outstanding. This translates to dilution of earnings per share and existing ownership until the new capital is leveraged, or put to work.

When a bank undergoes a common equity raise, it also gives up ownership and voting rights. If the bank is unable to raise common equity at or above current tangible book value per share (TBVS), or is concerned with existing ownership dilution, it should seriously consider an alternative source of capital. Banks must have clearly defined parameters in place for raising capital, particularly its impact on TBVS and EPS.

When evaluating a common offering, two key considerations are: (1) whether to conduct a private offering or undergo an IPO, and (2) whether to raise capital internally or externally. Having a strategic plan in place is critical to ensure that the bank can execute on deploying capital and earning back the initial shareholder dilution.

IPO or No?
Not everyone needs to conduct an initial public offering (IPO), but for larger institutions or institutions seeking liquidity, it is an excellent option. An IPO provides liquidity for stockholders, generates capital to accelerate growth, and depending on trading volume establishes currency that can be utilized in acquisitions. Once an institution undergoes an IPO it has also created access to capital markets for follow-on offerings to continue to raise capital as needed. While IPOs provide a faster vehicle to raise capital, they also require more time from key management, detracting from their role in day-to-day operations.

Subchapter-S corporations must consider ramifications of increasing their shareholder base before triggering a requirement to convert to a stock corporation. Once an S-corporation exceeds 100 stockholders, it must convert to a C-corporation, which has immediate tax implications and changes in reporting requirements.

Private Placements
For smaller banks or institutions that are closely held, private placements may be preferable to an IPO. Although the timeframe for a private placement may be longer, less time is required from management. Private placements are limited to existing stockholders, accredited investors and qualified institutional buyers. While private placements are generally smaller and less dilutive to EPS, it can also may be difficult to raise larger amounts of capital using this vehicle. The bank will be able to remain private with less pressure to immediately leverage capital, allowing greater autonomy in strategic decisions.

Alternative Sources of Capital
Noncumulative perpetual preferred stock can be counted towards Tier 1 capital and can be used to increase tangible equity. Banks with a clean risk profile may be willing to operate with lower levels of tangible common equity and focus on bolstering tangible equity. Preferred stock is generally less expensive to raise, although there is a post-tax dividend that can range from 5 to 9 percent.

For banks with a holding company, another form of capital—debt—can be down-streamed in its entirety to common equity at the bank level. Debt is the least expensive form of capital, costing approximately 3 percent to raise with no dividends and tax-exempt interest expense.

Regardless of the approach used to raise capital, be realistic in how much you can effectively leverage. Excess capital may be viewed favorably from a regulatory perspective but can become a value detractor if not effectively deployed. This is particularly true for banks entertaining the possibility of a sale. Over-capitalized targets are likely to be priced on a leveraged capital approach, meaning that tangible common equity in excess of a certain percentage of average assets will be priced at 100 percent TBVS and only the leveraged portion of capital will receive a premium.

When raising capital in any form, proactively communicate with regulators and stockholders remembering that neither party likes surprises. Work with your financial advisor to run pro forma analyses on multiple scenarios and establish parameters for EPS and ownership dilution to maximize the impact of your capital raise.

Banks May Get Capital Relief


regulation-10-6-17.pngFederal banking regulators are trying to make life easier for regional and community banks by making changes to Basel III capital rules, particularly in areas that have been subject to banker complaints. Whether the changes provide real relief may be up to the bank.

Last week, the Federal Reserve Board, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency issued a proposal to “reduce regulatory burden” by simplifying regulatory capital rules that dictate how much capital banks must maintain. The rules mostly apply to banks subject to what’s known as “standardized approaches,” so it will generally impact banks and thrifts with less than $250 billion in total consolidated assets or less than $10 billion in total foreign exposure. Comments on the proposal are due within 60 days of publication in the Federal Register, which hadn’t occurred as of Thursday morning.

“This is an effort to make lives for community banks a little bit easier,’’ says Luigi De Ghenghi, a partner in Davis Polk’s Financial Institutions Group. The big picture on all of this is that as the industry approached the 10-year mark for the start of the financial crisis, regulators are looking at ways to update rules as the health of the industry has improved. Still, regulators are sensitive to accusations that they may be exposing the industry to another financial crisis by rolling back rules too enthusiastically, industry observers say.

The U.S banking agencies are walking a bit of a tight rope because on the one hand they want to be seen as simplifying the capital rules and giving an appropriate level of capital relief,’’ De Ghenghi says. “On the other hand, they don’t want to be seen as substantively weakening capital standards,” especially since lack of capital and risky loans were a factor in the failure of hundreds of community banks during and after the crisis.

It would be wrong to assume that this is coming out of the new Trump administration’s drive to provide financial regulatory relief, as detailed in the Treasury Department report in June. Although politics is always a factor, the latest proposal comes out of an Economic Growth and Regulatory Paperwork Reduction Act, which requires banking agencies to review regulations every 10 years and to get rid of “unduly burdensome regulations” while ensuring the safety and soundness of the financial system. The review kicked off in 2014 and concluded earlier this year.

One of the most important of the proposed changes deals with the definition and risk weighting of high volatility commercial real estate (HVCRE) loans, which are considered among the higher risk loans that banks make to developers and builders, such as non-recourse loans. But community bankers had complained that the HVCRE loan definition and exemptions were too complex to apply and that the risk weightings were too high for the risks these loans posed.

“The banks were pushing the trade associations to push members of Congress to say, ‘We need a fix here,’’’ says Dennis Hild, managing director at Crowe Horwath and former bank examiner and supervisory analyst with the Federal Reserve. “’We think we know what falls under the purview of a high volatility real estate loan and the regulators come in [for an exam] and there is a disagreement on certain sets of loans.’”

To respond to the need for clarification, the proposal creates a new high volatility loan category for loans going forward that focuses less on underwriting criteria and more on the use of the proceeds, according to De Ghenghi. It potentially includes a wider array of commercial real estate loans, but lowers the risk weight from 150 percent to 130 percent, meaning banks have to hold slightly less capital against these loans. Also, banks will be able to include higher amounts of mortgage servicing assets and certain deferred tax assets as common equity Tier 1 capital, a new tier of regulatory capital that was created after the financial crisis as part of the global agreement known as Basel III.

This will help “the institutions that have substantial amounts of mortgage servicing assets or deferred tax assets,” says Hild.

The agencies have summed up the proposal’s impact on community banks here. The 10-year review details several other changes already made or in the works to reduce the regulatory burden. Among them, the agencies made changes to provide institutions with up to $1 billion in assets, instead of the $500 million limit, with the opportunity for an 18-month exam cycle instead of a 12-month exam cycle, if they score highly on their exams. The agencies also proposed this summer to increase the threshold for requiring an appraisal on a commercial real estate loan from $250,000 to $400,000.

Nine Strategic Areas Critical to Your Bank’s Future


strategy-6-30-17.pngHow should banks determine the best way to proceed over the upcoming quarters? While no one can predict the future, there are several critical developments that anyone can keep an eye on. These are the areas that are most impactful to banks and for which they need to strategize and position themselves.

Rising Rates: Obviously, rates are rising but by how much? Banks should position for moderate hikes and a slower pace of hikes than the Fed predicts. The Fed predictions on rate hikes have been overstated for several years running. The yield curve for the 10-year Treasury is flattening as of late, which also indicates fewer hikes are needed. A reduced duration for assets and reduced call risk makes the most sense; but practice moderation and don’t overdo it. Too many banks had their net interest margin crushed by being too asset sensitive and waiting for rates to increase while we had eight years of low rates. Check your bond portfolio against a well-defined national peer group of banks with similar growth rates, loan deposit rates and liquidity needs. Very few banks perform this comparison. They just use uniform bank performance reports or a local peer group. Every basis point matters, and there is no reason to not be a top quartile performer.

Deposits: Buy and/or gather core deposits now. Branches provide the best value. Most banks overestimate what deposits are core deposits, meaning they won’t leave your bank when rates rise. Like capital, gathering core deposits is best done when it is least needed.

Mergers and Acquisitions: If you are planning on selling in the next three years, sell right now, as optimism and confidence are at 10-year highs. If you are a long-term player, go buy core deposits, as they are historically cheap and you are going to need them. They are worth more now than perhaps ever before.

Get Capital While You Still Can: Solve your capital issues now. Investors are probably overconfident, but banks have done well the last seven years and finally, they aren’t taboo anymore. Investors want to invest in banks. That always happens before something bad in the economy occurs, so get it while you can.

Real Estate Carries Risk: With regulators mindful of capital exposure and real estate deal availability being spotty, it’s best that banks be wary of deals in this area. Commercial real estate linked to retail is more and more being viewed as extremely risky. There is an all-out war being waged on store retailers by online retailers. Since retail is a huge sector of the U.S. economy, investment will follow the online trend. Industrial real estate has become “retail extended” with the least amount of real estate risk.

Beware of Relying on Credit Scores: Banks need to be careful of the credit cycle. Consumers are loaded full of debt. Cars and homes are too expensive relative to wages and affordability. Credit scores probably don’t capture the downside risk to the consumer.

Get Ahead of Your Risks: Cyber-risk is a major and very real risk. Get ahead of the curve. Two other areas bearing risk are 401(k) plans and wealth management areas as they are especially exposed to litigation and are a nightmarish mess to be addressed. 401(k)s are overloaded with too many choices, fiduciary risk, performance issues, excessive fees and conflicts of interest. Get help now or you may be painfully surprised.

Marketing: Your bank had better get creative with digital marketing opportunities for your website as well as mobile devices. Why? Billions are being invested into financial technology companies and it’s easier for fintech to learn about banking than it is for bankers to learn about fintech.

Millennials: Surveys from The Intelligence Group and others show that finding young, motivated workers, and then retaining them, may be a challenge.

  • 45 percent of millennials believe a decent paying job is a right, not a privilege.
  • 64 percent would rather make $40,000 at a job they love versus $100,000 at a boring job.
  • 71 percent don’t obey social media work policies.
  • Millennials are proving to be more loyal to employers than previous generations, and are better at multi-tasking than previous generations.

Hopefully, some of these items provide bankers strategic ideas to incorporate over the next two or three years.

Now is the time to chart your course.

Fifth Third CEO Says Pace of Bank Industry Change Is Fastest He’s Ever Seen


growth-6-14-17.pngWhile the audience was largely optimistic at Bank Director’s Bank Audit & Risk Committees Conference in Chicago yesterday, many of the speakers, including Fifth Third Bancorp President and CEO Greg Carmichael, hit a note of caution in a sea of smiles.

During an audience poll, 51 percent said the nation will see a period of economic growth ahead but 28 percent said the nation has hit a high point economically. Bank stock prices soared following the presidential election. Credit metrics are in good shape and profitability is up. Capital levels are higher than they’ve been in decades. And political power in Washington has turned against bank regulation, as evidenced by the U.S. Treasury Department’s recent report on rolling back the Dodd-Frank Act.

“It’s unlikely we will have increasing regulatory burdens and instead, we’ll go regulatory light,” said Steve Hovde, an investment banker and chairman and CEO of Hovde Group.

Although there’s a sense that bank stocks may be overvalued at this point, or “cantilevered over a pillar of hope,’’ as Comerica Chief Economist Robert Dye put it, the economy itself is resilient. “We’ll have another recession and we’ll get through it fine,” he said.

But financial technology is transforming the industry and creating entirely new business models, said Carmichael. That won’t be a problem for banks as long as they adapt to the change. “The volume and pace of what’s emerging is amazing,’’ he said. “I’ve never seen it before in our industry.”

Carmichael, who has an unusual background as a bank CEO—he was originally hired by the bank in 2003 to serve as its chief information officer—is working hard to transform Fifth Third.

Sixty percent of the bank’s transactions are now processed through digital channels, such as mobile banking. Forty-six percent of all deposits are handled digitally. And the bank has seen an increase of 17 percent in mobile banking usage year-over-year.

To meet the needs of its customers, Fifth Third recently announced it had joined the person-to-person payments network Zelle, an initiative of several large banks. It has a partnership with GreenSky, which will quickly qualify consumers for small dollar loans, and which Fifth Third invested $50 million into last year. Consumers can walk into a retailer such as Home Depot, order $17,000 worth of windows, and find out on the spot if they qualify for a loan.

Fifth Third is gradually reducing its branch count, and new branches are smaller, with fewer staff that can handle more tasks. Carmichael is trying to make the organization more agile, with less bureaucracy, and less cumbersome documentation.

Automation will allow the bank to automate processes “and allow us to better service our customers instead of focusing on processes that don’t add value,” he said.

Banks that are going to do better are those that can use the data they have on their customers to better serve them, he said. But when it comes to housing enormous amounts of personal and financial data on their customers, the biggest worry for bank CEOs is cybersecurity risk, Carmichael said–not the traditional commercial banking risk, which is credit.

When he was a chief information officer, executives often asked how the bank could make its network secure, and his completely honest response was, “when you turn it off.”

Adding to the cybersecurity challenge, returns on capital are low for the industry compared to other, more profitable sectors, and measures of reputation are middling for banks compared to more popular companies such as Apple, Nordstrom, Netflix and Netflix.

Carmichael encouraged banks not to get mired in pessimism.

“There’s a lot of change but we can step up and embrace it and leverage it to better serve our customers and create more value for our shareholders and contribute to the success of our communities,” he said.

Franklin Synergy Bank Partners with Built Technologies to Streamline Construction Lending


Built-Franklin-Synergy-Bank.png

For banks that finance construction projects, managing their loan portfolio—and particularly the draw disbursement process—can be an especially burdensome undertaking.

Most construction projects financed by a bank contain a draw schedule, which is a timeline of intervals for which funds will be disbursed to borrowers and contractors for use. The goal for banks is to make progressive payments as work is completed. Disbursing funds before work is completed or materials have been delivered puts the bank’s capital at risk. Late disbursement often entails delayed projects and poor client satisfaction.

The problem is, many banks have an arduous, time consuming—and ultimately costly—process for fulfilling draw requests. Which is exactly the challenge that Franklin Synergy Bank (FSB) had been facing for quite some time. Headquartered in Franklin, Tennessee, FSB operates with 12 branches, servicing over $400 million in construction and development (C&D) loans. FSB’s loan administration and draw disbursement processes were fraught with administrative headaches: large staffing overhead, heavy phone call volume, duplicate data entry into multiple systems, use of multiple spreadsheets, unmanageable email communications and antiquated fax and paper usage.

In short, FSB’s loan administration approach was not only costing the bank time and money, but it wasn’t allowing it to deliver a top-notch customer experience for their clients. Seeing technology as the most plausible solution to these issues, FSB decided to partner with Nashville-based enterprise software company Built Technologies. A web-based application with mobile functionality, Built’s application is designed to simplify draw management and disbursement for construction lenders like FSB. Built also allows clients and borrowers to manage the loan from their end, delivering a more seamless customer experience. In addition, borrowers and contractors gain more visibility into the draw management process, increasing confidence in their lending institution.

Prior to partnering with Built and implementing the firm’s platform, FSB had to handle most of the draw process manually. A single residential construction loan draw might involve an average of eight back-and-forth emails prior to approval, in addition to significant manual data entry. As a result, FSB’s loan portfolio had grown more expensive to manage, harder to report against and more prone to human error.

After the Built implementation, FSB no longer needs to receive emails to manage construction draws. Upon closing, the bank loads a new loan into the Built platform and grants the borrow, builder and inspector access based on specific user-based permission levels. The borrower or builder can then simply log into the platform and request a draw, triggering an automated series of events within a pre-defined workflow that facilitated only a single approval touchpoint at the end of the process on FSB’s end. Built then releases funds in an automated and fully documented fashion that saves time and energy across all user groups—including builders, borrowers, loan officers and inspectors. The result is providing construction borrowers the same level of access, visibility and convenience that retail customers experience when they bank online.

Adopting the Built platform has allowed FSB to streamline its construction loan administration team from four employees to two full-time and one part-time staff members. And the team went from managing roughly 750 loans at any given time to an increased capacity of over 1,000 loans. FSB was also able to reduce its draw processing time from 24 hours to a mere 30 seconds, resulting in both an increase in interest income and client satisfaction. Human error has been substantially decreased, and Built’s reporting capabilities have provided FSB greater insight into its construction lending portfolio. FSB can now easily identify, and proactively address, overfunded draw requests and stalled construction projects. In fact, this might be the most innovative aspect of the Built and FSB partnership, because it enables the bank to manage its construction loan risk better than its competitors.

The partnership between FSB and Built is a fitting example of a regional partnership setting the pace for what’s likely to be a national trend. Manual and paper processes are a productivity drain on businesses in any industry in terms of time, money and customer satisfaction. And with the enormous amounts of capital invested in building projects, nowhere is this more evident than the construction lending sector. Once other lenders realize the return on investment that merging technology with their loan management and draw disbursement processes can result in, similar partnerships are sure to follow.

This is one of 10 case studies that focus on examples of successful innovation between banks and financial technology companies working in partnership. The participants featured in this article were finalists at the 2017 Best of FinXTech Awards.

M&A Alert for Banks: Preparing to Be a Buyer


strategy-1-27-17.pngBefore a board and management of a bank pursue an acquisition, they should realistically assess their bank, the characteristics of the board and the shareholders, and the alternatives available.

The board and senior management should develop a strategic plan for the bank. The Federal Deposit Insurance Corporation has cited an increasing number of banks for lack of strategic planning in matters requiring board attention. The Office of the Comptroller of the Currency also has focused on strategic planning in the last few years. 

All board members must share a commitment to the strategic plan. Divisiveness in the boardroom often jeopardizes a bank’s ability to achieve its objectives.

The board has a fiduciary duty to make fully informed business decisions as to what is in the best interests of the hypothetical shareholder who is not seeking current liquidity. Management must assume the responsibility of educating the board (or bringing in consultants to do so) regarding the bank’s strengths and weaknesses, its inherent value, and the market(s) for targets. The board and senior management should meet regularly to discuss the bank’s strategic direction.

Debate in the planning process is healthy, but once the board agrees on a course of action, the board and management should speak with a united voice.

The board and management should communicate the bank’s strategic direction to shareholders. If key shareholders disagree with the direction, the board and management should arrange for such shareholders to be bought out or be comfortable that the bank need not do so. It is difficult to achieve strategic objectives if the board and key shareholders are working at cross purposes.

Evaluate Alternatives
The prospective buyer has a number of alternatives for enhancing shareholder value or multiple paths to be pursued at the same time. The board should evaluate such alternatives to identify the most attractive transaction.

Evaluate Your Prospects for Success
In embarking on bank M&A in the current environment, sellers will demand assurances that buyers can close. Here are some of the factors purchasers should consider:

  • Community Reinvestment Act and compliance ratings: Purchasers need to understand the “hot button” issues driving regulatory reviews and stay up to date. Yesterday’s focus on asset quality, anti-money laundering and Bank Secrecy Act compliance and third-party relationships have been joined by redlining, incentive compensation, concentration risk and cybersecurity, among others.
  • Capital levels: Determine whether the bank’s capital is sufficient to support an acquisition. If not, where will your bank obtain the needed funding?
  • Management: Does the purchasing bank have sufficient senior management capacity to staff the acquired bank or will target management be needed to implement the acquisition?
  • Systems and facilities: The purchasing bank’s board should evaluate whether the bank has compliance management systems and an enterprise risk management program that can scale for the acquisition.

Coming up with a good strategic plan while considering the bank’s alternatives is important for the board to discuss before embarking on an acquisition.

Negotiating the Transaction
There still may be a problem: What if there are very few targets that the bank has identified as “fits,” and none of them are in the market to sell?

Increasingly would-be buyers are willing to consider offering stock as part or all of the merger consideration. There are several drivers of this newfound willingness. First, buyers must meet increasingly challenging capital requirements. The exchange ratio in the merger may offer more attractive pricing to the buyer than issuing common equity to the market. Second, sellers have become more willing to accept private or illiquid stock as merger consideration. This may be a function of sellers’ understanding that economies of scale offer potential for greater returns on investment while enabling sellers to refrain from taking their “chips off the table” as would be the case in a cash sale. The recent run up in the stock market indexes has not yet translated into a general increase in M&A pricing. Third, a transaction that provides for a significant stock component allows for more one-on-one negotiations. Lastly, a strategic combination allows for mutuality of negotiation.

Just offering the selling shareholders stock may not be enough to convince a reluctant seller to consider a transaction. Would-be community bank buyers must recognize that there are social issues in any transaction (even when the merger consideration is cash). Accordingly, the buyer must evaluate in advance the roles of senior management of the seller, retention arrangements to proffer, severance to provide as well as bigger picture social issues such as board representation, combined institution name and headquarters.

A focus on the social issues and a willingness to put stock on the table may allow community bank buyers to continue to compete for acquisitions despite the rebounding stock market. Other competitors may be able to offer nominally more attractive pricing, but such an offer may not have better intrinsic value.

Could a Republican President Mean More M&A Activity?


Banking-Industry-8-12-15.pngWith the first prime time Republican primary debate of the 2016 election cycle in the rear view mirror, we have all gotten an inkling of what the candidates think about the banking industry. I did take particular note of Senator Marco Rubio when he stressed the importance of repealing the Dodd-Frank Act. As Commerce Street Holdings’ CEO shared in an article on BankDirector.com, “many bankers feel that given the legislative and regulatory environment coupled with low rates, low margins, low loan demand and high competition, growth is very difficult.”  So repealing Dodd-Frank is a dream for many officers and directors, and Rubio is echoing their concerns.

Senator Rubio’s comments build on those of former Texas Governor Rick Perry, who recently laid out a sweeping financial reform agenda earlier. He believes the biggest banks need to hold even more capital—or Congress should possibly reinstitute elements of the Glass-Steagall Act. While his campaign appears to be winding down, I do agree with his call for government to work harder to “level the playing field” between Wall Street banks and community institutions.

With so much political scrutiny already placed on banks, it is interesting to think of the pressures being placed on institutions to grow today. On one side, you have politicians weighing in on how banking should operate. On the other, regulatory and investor expectations are higher now than in recent years. Buckle up, because I believe the coming election will only further encourage politicians with opinions, but little in the way of detailed plans, about “revitalizing” the economy.

Against this political backdrop, today’s business environment offers promising opportunity for bold, innovative and disciplined executives to transform their franchises. But I believe regulatory hurdles are making it tougher to do deals. Indeed, the recently approved merger of CIT Group and OneWest Bank creates a SIFI [Systemically Important Financial Institution] which will have to submit to increased regulation and scrutiny. However, when the deal was first announced, CIT’s CEO, John Thain, suggested that his purchase of OneWest could spur other big banks to become buyers. A year later and such activity has yet to be seen.

I see the absence of bigger deals reflecting a reality where any transaction comes with increased compliance and regulatory hurdles. For CIT, going over the $50 billion hurdle meant annual stress tests will now be dictated by the government, as opposed to run by the bank. The institution will have to maintain higher capital levels. Thain seems to think that those added costs and burdens are worth it. By the lack of action, other banks haven’t yet agreed.

Without a doubt, regulatory focus has impacted strategic options within our industry. For instance, we learn about CRA [Community Reinvestment Act] impacting deals and also find fair lending concerns and/or the Bank Secrecy Act delaying or ending potential mergers. Consequently, deals are more difficult to complete. As much as a bank like CIT can add cost savings with scalability to become more efficient, you can understand why banks in certain parts of the country need to debate whether it is better to sell today or to grow the bank’s earnings and sell in three to five years.

The evidence is clear that big banks are not doing deals. Maybe a GOP victory in the next election will thaw certain icebergs, creating a regulatory environment more friendly to banks. While regulators have to comply with existing laws, the leadership of regulatory institutions is appointed by the president and the tone at the top is critical in interpreting those laws. Until we see real action replace cheap talk, I’m looking at CIT as an outlier and simply hoping that political rhetoric doesn’t give false hope to those looking to grow through M&A.