A Valuable Lesson from the Best Bank You’ve Never Heard of


strategy-8-24-18.pngThere are a lot of places you would expect to find one of the highest performing banks in the country, but a place that wouldn’t make most lists is Springfield, Missouri—the third-largest city in the 18th-largest state.

Yet, that’s where you’ll find Great Southern Bancorp, a $4.6 billion regional bank that has produced the fifth best total all-time shareholder return among every publicly traded bank based in the United States.

Since going public in 1989, just two years before hundreds of Missouri banks and thrifts failed in the savings and loan crisis, Great Southern has generated a total shareholder return, the ultimate arbiter of corporate performance, of nearly 15,000 percent.

What has been the secret to Great Southern’s success?

There are a number of them, but one is that the Turner family, which has run Great Southern since 1974, owns a substantial portion of the bank’s outstanding common stock. Between CEO Joe Turner, his father and sister, the family controls more than a quarter of the bank’s shares, according to its latest proxy report, which places most of their net worth in the bank.

The importance of having “skin in the game” can’t be overstated when it comes to corporate performance. This is especially true in banking, where a combination of leverage and the frequent, unforgiving vicissitudes of the credit cycle renders the typical bank, as one of the seminal books on banking written over the past decade is titled, “fragile by design.”

The trick is to implement structural elements that combat this. And one of the most effective is skin in the game—equity ownership among executives—which more closely aligns the interests of executives with those of shareholders.

“Having a big investment in the company…gives you credibility with institutional investors,” says Turner. “When we tell them we’re thinking long-term, they believe us. We never meet with an investor that our family doesn’t own at least twice as much stock in the bank as they do.”

An interesting allegory that speaks to this is the way the Romans and English governed bridge builders many years ago, as Nassim Taleb wrote in his book Antifragile:

For the Romans, engineers needed to spend some time under the bridge they built—something that should be required of financial engineers today. The English went further and had the families of the engineers spend time with them under the bridge after it was built.

To me, every opinion maker needs to have ‘skin in the game’ in the event of harm caused by reliance on his information or opinion. Further, anyone producing a forecast or making an economic analysis needs to have something to lose from it, given that others rely on those forecasts.

The most important thing having skin in the game has done for the executives at Great Southern is the long-term approach to their family business. “Our dad turned a valuable asset [stock in the bank] over to me and my sister [a fellow director at the bank] and my goal, when I’m finished, is to turn that over to my kids and have it be worth a lot more,” says Turner.

This becomes especially evident when the economy is hitting on all cylinders. “When institutional investors and analysts…are rewarding explosive growth, you need to have a longer-term view,” says Turner. “For instance, the explosive growth you can get from acquisitions is great in terms of the short-term boost to your stock price, but over the longer term that type of thing can reduce your shareholder return.”

Having skin in the game also addresses the asymmetry in risk appetite that otherwise exists between management and shareholders, where the potential reward to management in short-term incentives from taking excessive risk outweighs the potential long-term threat to a bank’s solvency, a principal concern of shareholders.

A long-term mindset promoted by skin in the game also causes like-minded, long-term investors to flock to your stock. This is a point Warren Buffett has made in the past by noting that companies tend to “get the investors they deserve.”

“That point is probably right,” says Turner. “We have a much larger proportion of retail investors than a lot of other companies do. I understand where institutional, especially fund, investors are coming from. It’s great for them to say they’re long-term shareholders, but they have investors in their funds that open their statements every quarter and want to see gains. So it’s harder for big money managers to be truly long-term investors.… It’s a different story with retail investors, who, in my opinion, tend to be longer term by nature.”

This cuts to the heart of what Turner identifies as the biggest challenge to running a successful bank.

“The hardest thing is balancing different constituencies,” says Turner. “We have a mission statement that is to build winning relationships with our customers, associates, shareholders, and communities. What we’re talking about is building relationships that are balanced in a way that allow each of those constituencies to win.”

The moral of the story is that, much like bridge builders in ancient Roman and English times, one of the most effective ways to construct an antifragile bank is by putting skin in the game.

How You Can Foster an Entrepreneurial Environment


entrepreneur-8-8-18.pngGone are the days of bank employees repetitively completing their tasks. A productive day in today’s banking environment consists of collaboration and teamwork to solve challenging problems.

Community banks and credit unions need to deliver on two industry trends to succeed: 1) managing interest rate, compliance, and regulatory risks, and 2) adapting with technology and products to compete against a decline in branch visitors, check volume, and cash transactions. The question is, how?

The answer is new ideas. Managers and leaders must cultivate an entrepreneurial environment where employees are not afraid to share them, because they are the future of the banking industry.

1. Refine the team
Leader Bank itself is an entrepreneurial venture started in 2002 with $6 million in assets. After spending the first six years focusing on implementing traditional methods, we began shifting our hiring practices to include employees with little or no banking experience but that had a lot of potential for creative problem solving. Today, almost 40 percent of our employees (excluding loan officers) are new to the banking industry.

By not hiring solely based on education and experience, and focusing more on potential, we have seen some of our most successful periods of growth to date.

2. Listen to customers
New ideas often present themselves as customer issues.

Take this example: A landlord customer encounters legal complications with his tenant’s security deposit, so to avoid future issues he assumes a greater risk by no longer requiring security deposits. Identifying this real-world problem led to the creation of a new security deposit platform that manages compliance headaches for landlords.

3. Pursue lopsided opportunities
All ideas come with upsides and downsides, but as we all know, the best ideas are asymmetrical, meaning the upsides outweigh the downsides.

A great example is when we developed our rewards checking product.

Before developing the product, we knew we not only wanted to grow deposits but also reward our customers for using us as their primary bank. We analyzed the downside versus the potential upside before deciding to move forward.

The downside vs. the upside
A downside is best kept small and finite. It’s something you would be comfortable with if it actually happened.

With our rewards checking product, the only real downside we could foresee was lack of participation. There is always a risk with a new product or process that the client may not fully adopt it.

However, in this particular situation, the upsides significantly outweighed our fear of failure.

To start, we developed Zeugma in-house. We had existing employees working on it, to keep our cost of investment low. It gave us control of the product features, which allowed us to differentiate leading to strong growth in deposits.

Assessing the upside vs. downside
With any new idea, senior management and the board will want to know what the downside is, and if it is limited. That limitation is finite and can be articulated, then odds of approval increase.

When trying to measure the downsides relative to the upsides, there are questions we ask to lean one way or the other:

  • Is the total potential financial loss greater than the cost of the project?
  • Could the project cause significant reputational damage?
  • Does the project require additional resources?
  • Does the project effort need significant interdepartmental coordination?

If the answers are “no,” then the idea likely carries low risk and can move quickly.

There are also additional ways to mitigate risks throughout the launch process of any new idea.

Start a focus group
There is no better way to see how a new idea works before launching full-force than experimenting with beta groups. Testing the product with hand-selected, vested people first helps gives managers an idea how customers will use the product and understand pitfalls before going live.

Conduct weekly meetings
Weekly meetings are great for adapting procedures as necessary throughout the development and launch process. Teams from product development to marketing can share ideas on how to develop and grow the product to its utmost potential.

Maintain strong financial tracking
Tracking every penny will ease the anxiety that comes along with the development and launch process of any new idea. Start a shared spreadsheet among involved employees and enter in the income and expenses along the way. If the financial budget is kept in check, it is easier to plan where to allocate future expenses.

Also don’t forget to track success, including each new customer acquired or deposit gathered.

Moving forward
Banks are inherently risk-management institutions, which is why understanding the downsides of new ideas is so important.

Transitioning a financial institution to an entrepreneurial, spirited workforce takes time, patience and dedication. Every idea, whether a success or a failure, is a stepping stone to the next. Over time, even in a highly regulated industry like banking, a culture of energy and entrepreneurship can be a competitive advantage.

Have MVB and BillGO Reached True Financial Symbiosis?


payments-7-18-18.pngSometimes a fintech partnership doesn’t result in a new product or service for the bank but can still result in new opportunities for both organizations. The relationship between BillGO, a real-time payments provider based in Fort Collins, Colorado, and MVB Financial Corp., a $1.6 billion asset financial holding company headquartered in Fairmont, West Virginia, isn’t your typical partnership story. Instead, it’s an example of true symbiosis between a bank and a fintech firm, with MVB gaining deposits and fee income while helping BillGO scale its real-time payments solution to more than 5,000 banks and credit unions. Less than a year ago, the company worked with just 200 institutions. It plans to go live with another 3,000 in the next few months.

The two companies were recognized as finalists for the Best of FinXTech Partnership at Bank Director’s 2018 Best of FinXTech Awards.

MVB supports BillGO’s growth in a number of ways. The bank processes its payments, resulting in fee income for MVB. The bank also holds deposits for the company and its B2B clients in connection with their transactions. And the bank’s compliance expertise is another key benefit. “We keep them out of trouble, so to speak,” says MVB CEO Larry Mazza.

This growing understanding of the fintech industry’s needs, gained in part due to its relationship with BillGO, is quietly turning MVB into a bank of choice for fintech firms.

“We’re meeting other, more mature fintech companies that allow us to help them in different ways,” Mazza says. “It’s really started to be very positive for us, in learning fintech [and] in profitability, deposits as well as fee income.”

“They don’t really advertise it, but they do have a specialty with fintech because of their compliance [expertise], because of their ability with payments and their ability with partnerships to deliver some unique offerings that fintech companies can’t normally do by themselves,” says BillGO CEO Dan Holt.

Before partnering with MVB, BillGO worked with a larger bank, but Holt says MVB is a Goldilocks-style bank for the company: Big enough to help the company scale, but small enough to make decisions quickly and develop an in-depth relationship with his company. Holt adds that his company has access to MVB’s executive team, unlike his previous banking provider.

And MVB is an investor in BillGO. “I felt this would be a really good [way] for us to start the process of investing in fintech,” says Mazza. “Once you invest money in it, it definitely piques your interest.” He describes the bank as an active investor, and Mazza has served on the company’s board since January 2017.

This expertise has been invaluable for BillGO, given Mazza’s financial background and his ability to shed light on the needs of the banking industry, says Holt.

Just as the BillGO relationship is a strong reputation-builder for MVB with other fintech firms, Holt says that MVB’s investment in BillGO speaks volumes about his company’s reputation to potential bank clients. New customers feel more comfortable knowing a traditional financial institution is an investor and has completed the associated due diligence.

Holt joined the MVB board late last year as an extension of the partnership between the two organizations, and Mazza says his background has been highly beneficial to the bank. “[Holt] has intimate knowledge into the industry and payment processing,” says Mazza, and his expertise enhances board discussions about technology trends and opportunities. “Our board members could see the difference.”

Many bank boards struggle to add tech-savvy directors, with 44 percent of bank directors and executives in Bank Director’s 2018 Compensation Survey citing this as a key challenge.

“Banks are more traditional. They really honor regulation,” says Mazza. “It’s our lifeblood, and we have taken regulation extremely seriously. We see regulation as a competitive advantage, if we do it right.” But partnering with BillGO, and adding Holt to the board, is helping MVB think like a startup as well. “That has changed our lives,” he says. “BillGO has helped us think more innovatively [and be] more forward-thinking.”

Enhancing the Lending Process Through Data



Customers today expect quicker decisions, and data can empower banks to improve the customer experience. Data can also enable growth as banks gain more and better information about their customers. In this video, Steve Brennan of Validis outlines how banks can confront the challenges they face in making the most of their data.

  • How Data Has Transformed Lending
  • The Benefits of Leveraging Data
  • The Challenges Banks Face
  • Addressing Data Deficiencies

The Evolution of Regional Champions



Over the past decade, regional champions have emerged as strong performers in today’s banking environment, entering new markets and gaining market share through acquisitions. In this panel discussion led by Scott Anderson and Joe Berry of Keefe Bruyette & Woods, John Asbury of Union Bankshares, Robert Sarver of Western Alliance Bancorp. and David Zalman of Prosperity Bancshares share their views on strategic growth opportunities in the marketplace, and why culture and talent reign supreme in M&A.

Highlights from this video:

  • Characteristics of Regional Champions
  • Identifying Strategic Opportunities
  • Why Scale Might Be Overrated
  • Lessons Learned in M&A
  • What Makes a Good Acquisition Target

Video length: 41 minutes

 

Investor Pressure Points for the 2018 Proxy Season


proxy-2-9-18.pngInvestors need to stay focused on long-term performance and strategy in 2018. So says Larry Fink, the chief executive of BlackRock, the world’s largest asset manager with $6.3 trillion in assets under management, in a recent and well-circulated letter. “Companies must be able to describe their strategy for long-term growth,” says Fink. “A central reason for the risk of activism—and wasteful proxy fights—is that companies have not been explicit enough about their long-term strategies.”

Focusing on long-term success isn’t controversial, but Fink’s letter underlines the fact that proxy advisors and investment management firms are more frequently looking at broader issues—gender diversity and equality, and other cultural and environment risks—that can serve as indicators of long-term performance.

Board composition will continue to be a growing issue. BlackRock, along with State Street Global Advisors, the asset management subsidiary of State Street Corp., both actively vote against directors where boards lack a female member. “[Institutional investors] are tired of excuses,” says Rusty O’Kelley, global leader of the board consulting and effectiveness practice at Russell Reynolds Associates. “Regional banks [in particular] need to take a very close look at board quality and composition.” Fink, in his letter, said that diverse boards are more attuned to identifying opportunities for growth, and less likely to overlook threats to the business as they’re less prone to groupthink.

The use of board matrices, which help boards examine director expertise, and disclosure within the proxy statement about the use of these matrices, are increasingly common, according to O’Kelley. The varied skill sets found on the board should link to the bank’s overall strategy, and that should be communicated to shareholders. Expertise in cybersecurity is increasingly desired, but that doesn’t necessarily mean the board should seek to add a dedicated cybersecurity expert. “Institutional investors view cybersecurity as a risk the entire board should be paying attention to,” says O’Kelley. “They want all directors to be knowledgeable.”

Some investors are pursuing gender equality outside of the boardroom. On February 5, 2018, Bank of New York Mellon Corp. disclosed the pay gap between men and women—the fourth bank to do so in less than a month, following Citigroup, Bank of America Corp. and Wells Fargo & Co. “Investors are demanding gender pay equity on Wall Street, and we have no intention of easing up,” said Natasha Lamb, managing partner at the investment firm Arjuna Capital, in a release commenting on BNY Mellon’s gender pay disclosure. These banks, along with JPMorgan Chase & Co., Mastercard and American Express, rejected Arjuna’s proposals last year to disclose the pay gap between male and female employees, along with policies and goals to address any gap in compensation.

A domino effect can occur with these types of issues. “[Activist investors will] move on to the next bank,” says Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware.

Shareholders are aware that cultural risks can damage an organization. This includes bad behavior by employees—Wells Fargo’s account opening scandal, for example—as well as an organization’s approach to sexual harassment and assault, an issue that has received considerable attention recently due to the “Me Too” movement. “Shareholders are very focused on whether or not boards and management teams are doing a sufficient job in trying to understand what the tone is throughout the organization, understand what the corporate culture is,” says Paul DeNicola, managing director at PwC’s Governance Insights Center. Metrics such as employee turnover or the level of internal complaints can be used to analyze the organization’s culture, and companies should have a crisis management plan and employee training program in place. Boards are more frequently engaging with employees also, adds DeNicola.

Investors are keenly aware of environmental risks following a year that witnessed a record-setting loss estimate of $306 billion due to natural disasters, according to the National Oceanic and Atmospheric Administration. Institutional investors expect boards to consider the business risk related to environmental change, says O’Kelley, particularly if the bank is at greater risk due to, for example, a high level of real estate loans in coastal areas.

Finally, investors will be looking at how organizations use the expected windfall from tax reform. “What will you do with the increased after-tax cash flow, and how will you use it to create long-term value?” said Fink in his letter. It’s an opportunity for companies to communicate with shareholders regarding how additional earnings will be distributed to shareholders and employees, and investments made to improve the business.

In an appearance on CNBC’s “Squawk Box,” Fink explained that BlackRock votes with the companies it invests in 91 percent of the time due to the engagement that occurs before the proxy statement is released. Fink’s preference is that engagement occurs throughout the year—not just during proxy season—to produce better long-term results for the company’s investors.

Engaging with shareholders—and listening to their concerns—can help companies succeed in a serious proxy battle. “If you have good relations with your investors, you’re apt to, in a contest, fair a bit better,” says Elson.

Are Innovation Labs the Best Way to Innovate?


innovation-1-15-18.pngThese days, companies as diverse as Lowe’s and Blue Cross are touting a shiny new innovation lab—and banks are no different. These special divisions, designed to incubate new ideas and technologies, are on the rise. According to a report from the website Innovation Management, the number of innovation labs jumped 66 percent in a 15-month period from July 2015 through October 2016. But even though some banks like to think of themselves as technology companies, does it really make sense for them to build standalone innovation teams?

Bank innovation labs are unlikely to replicate the secret sauce found in many successful startup companies because they are artificially engineered environments that cannot recreate the parameters that allow the most successful technologies to thrive. As described by Anderee Berengian, CEO of Cie Digital Labs, in-house innovation labs are missing three key ingredients:

  1. A passionate leader: Apple had Steve Jobs, Facebook has Mark Zuckerberg and Amazon has Jeff Bezos. The most successful technology companies in the world have one thing in common: a passionate, obsessive founder. Bank innovation labs miss out on this key ingredient. Even if they’re able to hire a technical wunderkind to run the lab, they simply can’t have that kind of passion. Part of this is because of a lack of ownership. Part of this is that labs are rarely, if ever, founded to pursue a specific idea or product. Bank labs are conjured up to digitize the company, explore new products or pursue any myriad of equally vague directives. These directives do not inspire and, without a visionary founder to lead the way, labs flounder about trying to build something that will meet undefined and unmeasurable objectives.
  2. Room to fail: Banks expect a reasonable ROI when they make a large investment. As Berengian described, “[p]icture Thomas Edison trying 5,000 light bulb filaments before settling on tungsten . . . [t]he reality is, most profit-focused companies would stop after 500 tries. Edison would then go start his own company.” Many of the “innovations” banks expect to come out of labs will not immediately add to the bottom line, or may be difficult to measure in any meaningful capacity for that matter.
  3. Constraints: Bank innovation labs also lack the constraints that force startups to either succeed or burn out. Bank innovation teams have security. So what if they don’t make that iteration deadline? It’s not like they need to ensure another funding round. Without clear objectives and high stakes, it’s hard to push an innovation lab to the lengths necessary to be truly groundbreaking.

Banks are, by nature, the direct opposite of startups; so why are they striving to artificially recreate that environment? That’s not to say that banks are incapable of invention—quite the opposite. To meet the demands of the digital world, banks don’t need innovation labs. They simply need to harness the creativity and ingenuity their teams already possess.

We know that innovation works best when it’s engrained as a corporate cultural value (see the book “Driving Growth Through Innovation,” by Robert Tucker). Too often, responsibility for innovation is limited by organizational silos that relegate the task (typically seen as merely one of many check marks on a CEO’s to-do list) to a small pocket of individuals. Technological advancement shouldn’t be a pet project for an executive team, or a nebulous directive for an innovation lab. It should be a goal that’s shared by every employee—from the retail teller to the CEO—so that ideas can flow freely from those that have a good handle on the way the bank actually works.

Instead of investing in new innovation labs, banks should strive to encourage organic innovation by fostering a culture that prizes critical thinking and new ideas. For example, USAA stays on the cutting edge of technology by utilizing the ideas of its 30,000 employees through events, challenges and its “ideas platform,” which allows any bank employee to post and vote on new ideas. Over 1,000 employee ideas were implemented in 2017. (For more on USAA, read the article “Crowdsourcing Innovation” in the May 2017 issue of Bank Director digital magazine.)

That’s not to say that remaking a bank’s culture is easy. Cultivating culture is hard, especially at a large institution, and can be even more difficult than creating an in-house innovation lab. However, the rewards of culture shift can be more far reaching and long lasting than a lab because new talent—especially tech talent—wants to work in an open, inclusive environment that encourages collaboration.

Innovation is not new; it’s something humans inherently do when faced with a problem. To truly innovate, banks don’t need new office facilities or new branches on their organizational chart (and, really, who needs more of those?) Instead, they need to embrace the natural creativity in their organizations and harness ideas to create specific solutions to real issues.

Tax Certainty in Uncertain Times


innovation-12-13-17.pngWarning: This is NOT another article about how tax reform may or may not affect your bank.

Disappointed? We can still talk tax! Instead, let’s talk about tax incentive and reduction programs that positively affect financial institutions and fintech businesses, and will go unscathed by tax reform.

Domestic innovation, quality jobs and capital investment are beneficial to the economy. To promote these economic benefits, the U.S. government financially supports and entices companies to engage in certain behaviors in exchange for tax credits, deductions and tax abatements. The behaviors that policy makers want to encourage include:

  • Developing new software and technology;
  • Creating and maintaining jobs in the U.S.;
  • And investing in facilities and other capital.

Tax and incentive programs are available to companies planning to incorporate any of the above into a growth strategy, and will offset the cost of such investments by reducing cash taxes and the effective tax rate.

A diverse menu of tax programs—many of which are regionally specific—are designed to incent corporate behavior. The below examples highlight a few of these programs.

The Federal Research Tax Credit
The Federal Research Tax Credit (RTC) is a well-established planning tool utilized by U.S. companies engaged in traditional technology development. It is rapidly becoming a similarly valuable planning tool for financial institutions and fintech companies investing in technology-enabled services.

How does it work? Companies claim an annual tax credit based on the cost of the technology development and process enhancements, regardless of whether the development was outsourced or in-house. The rate of return ranges between 5 and 8 percent of the cost, and there is an increased benefit when the company simultaneously claims a state credit.

If you thought this credit was only for product developers and scientific research companies, you are not alone. Financial institutions and other financial service providers reliant upon software platforms and web-based programs underutilize this tax planning opportunity.

Historically, the guidance as to how the RTC applied to financial service technology was murky, and as a result, financial institutions often opted not to apply the credit due to the inherent audit risk. But in 2016, Department of the Treasury regulations finally caught up to include such activities as eligible for the RTC. Companies that have invested in technology focused on financial modeling and enterprise tools, data security mechanisms, and modules developed to provide improved services may want to strategically reevaluate this credit.

Jobs & Investment Location Incentives
Speak with any state or local economic development group, and they will tell you that job creation and capital investment are top priorities to fuel economic growth. To meet this goal, each state has its own menu of programs designed to incent companies to create and maintain jobs, and invest in facilities and capital.

Recall the huge incentive packages recently lobbed to Amazon in hopes of landing its second headquarters, which promises 50,000 jobs and massive real estate development in the community that Amazon ultimately chooses. Although the Amazon project is truly a white whale for most states, development groups regularly put together similar packages, and the value offered is reflective of the anticipated impact of the project.

How do these incentives work? Companies lock in location incentives prior to engaging in development. The threshold for discussion is generally 20 or more jobs, coupled with capital investment. The program names differ in each state, but the gist is the same. If a company embarks on a strategy to build new facilities or improve current facilities, create jobs, or even maintain its current headcount—which could be relocated elsewhere—the state is motivated to support companies to ensure that growth stays within the state.

The jobs and investment incentives generally take the form of income or withholding tax reductions, refundable tax credits, property tax abatements and even cash grants. Although these incentives often seem like a black box, obtaining financial packages for proposed growth is quite likely. Leverage is gained through strategic discussions prior to initiating the project.

Investments made to improve processes, services and technology, or to add quality jobs and invest in your business’ facilities often give rise to direct and indirect tax savings. Our taxing systems will continue to reward such behaviors. The key to maximizing savings is strategically matching the behavior with the relevant program.

What Directors Can Learn From Stalled M&A Transactions


transaction-4-20-17.pngBank mergers and acquisition (M&A) announcements are no longer a rarity, with more deal announcements coming every month. But for every successful transaction, another 10 transactions have died or stalled. And sometimes these are the deals that can be most educational for community bankers who want to get into the M&A market. For instance, the following five issues are hampering many would-be deals:

1. Many banks have organically grown themselves out of the M&A market due to concentration issues. One of the most overlooked consequences of aggressive organic growth in a low-rate environment is now becoming clear. Most high-growth banks focused on commercial real estate loans (particularly in urban and suburban markets) have maxed out their concentration levels relative to capital, based on regulatory thresholds. In these cases, regulators will hold pending deals hostage unless the acquiring bank agrees to inject more capital. It’s been reported that New York Community Bank’s failed acquisition of Astoria Financial is an example of high concentrations of real estate loans undoing a deal. One thing that helps: Meet with regulators far earlier in the deal process to check their temperature.

2. Buyer beware: the mortgage banks are coming to market. There are many small banks that depend too heavily on their mortgage business to drive earnings. In some cases, the core bank would not even be profitable without its mortgage arm. As a result of the historically low and prolonged rate environment, mortgage companies have been doing well, particularly with refinancings booming in 2011 and 2012, and home purchases picking up in the years since. However, now that we are transitioning to a new environment with rising interest rates, the situation may change.

Most executives and investors in banks with mortgage companies understand this and are looking to exit. The problem is they want their banks to be valued on their recent earnings. But a buyer is not buying a bank’s recent earnings, it is buying its future earnings. In a rising rate environment, refinancing can dry up, and home purchases won’t be able to make up the difference. Smaller banks with mortgage operations tend to be more heavily skewed toward refinancing than other banks, making them even more vulnerable. As a result, their valuations can be grossly overstated, if these issues are not recognized. When negotiating with such a bank, focus on what percentage of a small bank’s business is refinancing versus home purchases, and what percentage of the cost structure is fixed versus variable. Mortgage bankers also are often cut from a different cloth than commercial bankers, so cultural fit should be scrutinized.

3. A deal that appears to be expensive from a price-to-tangible book value perspective is not as expensive as it appears. Most bank acquisitions are structured as a stock purchase of the holding company’s equity. However, in the vast majority of cases, the only true asset acquired is the subsidiary bank. But there is a big difference between the target holding company’s capital structure and the subsidiary’s capital structure, which too many acquirers are ignoring. Acquisitive banks need to educate their investors on the value of such things as inexpensive trust-preferred securities (TruPS) and debt that may be on the holding company’s books. By assuming TruPS and debt, you are essentially purchasing bank capital at tangible book value. Banks must find hidden value by analyzing in detail the differing capital structures between a target’s parent company and its bank subsidiary.

4. Acquiring a bank with equity can introduce control issues. One problem associated with using equity as a currency for the buyer is the selling bank’s shareholders could own a meaningful percentage of the equity in the buyer. This is far less of an issue if the selling bank’s shares are widely held. However, many community banks, particularly on the small side, are controlled by a single shareholder or family. As a result, this single shareholder could become the largest shareholder in the buyer after the deal, especially if he or she is receiving a significant portion of the purchase consideration in stock. The normal playbook is for this shareholder to agree to certain restrictions related to voting, selling of shares in the open market, and other restrictions.

5. Look for more creative transactions that solve problems. Many banks are struggling with financial issues such as concentration issues, high loan-to-deposit ratios and a compressing net interest margin. Acquisition targets that alleviate these problems may not make immediate sense from a strategic perspective. The targets may not be geographically perfect, perhaps they aren’t adjacent to the acquirer’s footprint, or maybe they’re unattractive from a macroeconomic perspective. However, for the reasons previously mentioned, these targets may actually have premium value to the acquirer. It goes without saying that the acquiring bank’s management must come up with an operational plan to manage execution risk, but these outside-the-box deals often create the most value and lead to cutting-edge strategies that fetch higher premiums from investors in the long term.

Need to Grow? Try Data


growth-10-3-16.pngTo survive, a plant at a minimum needs soil, sunlight and water.

Plants that grow better than others have usually received fertilizer on a regular basis. Think of the vegetable garden that produces bushels of produce throughout the summer.

Farms that produce commercial volumes utilize all of these resources, but they also have someone directing strategy based on a big-picture view including weather forecasts, equipment maintenance needs, field reports on pests, research on future risks to the crop, etc.

Banks, too, can subsist on the basics: good staff, products that meet the market’s current needs and essential data about the customer or operations. These financial institutions may be able to get by without analyzing the tons of data in their systems. Other banks may “fertilize” their growth by analyzing some of their data to shape product development or efficiency processes.

However, even at these institutions, a common factor stunting growth is disconnectedness between analysts, teams and departments when it comes to day-to-day operational or regulatory information. Just as the data is siloed, so is the insight and communication, making it challenging to provide either top-down or bottom-up strategy reviews. When people from multiple departments try to piece together data from multiple systems, it can be nearly impossible to glean actionable insight for outpacing current and future competitors. This quandary is magnified at top management levels, where executives must balance strategic objectives and pressures without a data-driven big picture.

Indeed, bank CEOs, directors, chief information officers and chief technology officers responding to Bank Director’s 2016 Technology Survey recently overwhelmingly indicated their institutions are plagued by the inability to effectively use data.

Financial institutions using data over the life of a loan are better able to manage and direct the big picture, shaping institutional strategy for superior growth. They can help determine not only where the institution has been making money, but also where it can expect to make money, how it can maximize profits and how it can minimize risk.

For example, at an ill-equipped institution, loan pricing decisions may be based only on competitive information. While comparability of terms is important to borrowers, it can also lead the institution into a disadvantageous relationship—one that could lose money for the institution. However, at an institution using a life-of-loan system, the loan officer would have an accurate measure of risk and overall profitability of the relationship, providing the loan officer with a range of acceptable terms that still ensure the bank meets its targets. When decisions aren’t made in a vacuum or from a single lender’s spreadsheet, the bank benefits from better decisions, and when better decisions happen across the commercial portfolio, the institution wins.

In addition to pricing, an integrated solution streamlines and automates much of the:

  • loan origination process
  • credit analysis
  • loan approval
  • loan administration and
  • portfolio risk management.

Connecting the data throughout the entire loan process allows bankers, underwriters and risk management professionals to communicate better and more efficiently. These systems also tend to unify employees with diverse skills into a more cohesive unit while building in a layer of awareness and appreciation for the full life of the loan.

All of this enables the financial institution to make better lending decisions based on relationship profitability and strategic goals, and it makes it easier for management to make informed decisions that ensure outperformance—even in an environment where interest rates and loan demand remain low and compliance risks are high.

In short, an integrated solution addresses the three greatest business concerns cited in Bank Director’s Technology Survey: regulatory compliance, becoming more efficient and competition from other banks.

The intersection of insight provided through an integrated solution not only creates more opportunity to develop an effective strategy, it can also guide the strategy. It gives bank management the ability to pivot, and the knowledge of where best to pivot to, so that the institution can focus its investments, development and sales efforts on the right areas for growth. In this way, the financial institution can flourish, rather than simply survive.

Want to learn more about integrated banking solutions? Sageworks has a free guide for bank executives.