One of a bank board’s most vital responsibilities is overseeing the plan of succession for the CEO. Whether driven by a looming retirement or change in the incumbent’s personal timeline, a well-orchestrated plan of succession and leadership continuity reassures employees, investors and communities. Unfortunately, too many bank boards still take a passive approach to CEO succession, rather than acknowledging that as directors, they are responsible for the selection and ongoing evaluation of CEO performance.
Good succession planning for any executive role starts with understanding the potential succession timeline and the bank’s strategy. These seven steps will help to guide the board and incumbent CEO in developing a solid succession plan.
Understand the succession timeline. What is the intended horizon for the incumbent leader to remain at the helm? This timeline is often fluid, which can create a challenge for the board. It is natural for many healthy CEOs to struggle with stepping out of a role that has been so closely tied to their personal identity. Yet, boards must insist on some understanding of the timing in order to maximize the development of potential internal contenders and to avoid frustrating executives who are waiting in the wings.
Strategy informs profile. One of the most critical elements of planning for CEO succession is the bank’s strategic plan. The direction of the bank going forward should help to clarify the skills and attributes required in the bank’s next leader. Given the massive transformation of the industry over the past decade, the old maxim—what got you here may not get you there—may truly apply. Directors need to align around the bank’s strategy to develop a profile for the bank’s next CEO.
Identify key skills. There are countless technical and industry skills needed in a bank leader today—so many, in fact, that it is virtually impossible to find an executive with all of the ideal requisite experiences. So, prioritize the specific banking skills that the bank must have versus those the board would like to have. Key experiences such as commercial credit skills, regulatory experience, balance sheet management, board experience and risk management are often considered critical to success as a bank CEO today.
Determine critical attributes. What are the most important elements of a potential leader’s personal style and leadership philosophy that are necessary at this time for the institution? For example, most community banks see a CEO’s community presence and visibility as critical for success, as well as creating and achieving a strategic vision. Strong communication skills, cultural agility and the ability to attract top talent also rank high these days.
Develop a process. Successful succession at the CEO and other executive levels involves a robust and thoughtful process, not just putting together a list of who the board knows or who the incumbent leader suggests. Boards today not only need to select a superior executive as their next leader, but are often called upon to defend their decision—and how they made it—to investors, customers and their communities. This does not mean that an external or formal search is always warranted, but it does mean that there needs to be a genuine effort to source, screen, assess and validate serious contenders, which ultimately adds credibility to the board and the selected leader.
Make your bank attractive to star talent. Despite the declining number of banks in the country today, the crop of qualified bankers available to fill the growing ranks of retiring CEOs is not deep enough. Thus, the market is competitive for top bankers, and relocating someone to a new and potentially smaller market remains a challenge. Star bankers will ask tough questions of the board and will want to understand the bank’s strategy, as well as the level of support, engagement and strategic value they can expect from the bank’s directors.
Prepare for an emergency. As most boards know, the bank should plan for the best and prepare for the worst. Reviewing and updating the bank’s emergency succession plan on a regular basis is a must for good governance and regulatory satisfaction. There have been too many instances where this backup plan has been called into action. Having a scenario ready to keep the train on the tracks during an unexpected situation is critical to keeping the institution moving forward.
There is no greater responsibility for a bank’s board of directors than ensuring that the organization has the right leader in place. While there are many important elements to successful CEO succession, the most important point is to maintain the topic of leadership succession as a regular and ongoing board-level discussion.
If you counted the minutes in a day that you save because of technology, it would add up to quite a bit. With so many issues confronting financial boards, adequate time for strategic planning is a valuable commodity, so time is exactly what busy board members of financial institutions need.
Changes in the economy and the financial markets have complicated matters for boards of all sizes. Larger banks and conglomerates are finding it difficult to adapt to increasing regulations. Community banks are finding it harder to compete with larger banks. At the same time, financial institutions are finding it difficult to provide the level of technology that their customers want and need, in addition to other significant strategic issues.
Board portals help directors focus more of their time on strategic decisions. These portals have all of the features that directors need, and ensure that the information they need is available to them wherever they are, while also remaining secure.
Preparing board handbooks manually with paper copies and binders places a huge burden on the board secretary. Every time a board meeting approaches, the secretary spends countless hours copying and collating documents, and filing them into the proper sections of the handbook. Updating a board portal requires some work on the part of board secretaries, but they only have to upload a document one time. And secretaries can limit access to certain documents only to the people who need to view them.
In addition to the time savings, board portals provide material and environmental savings. Financial institutions save the cost of reams of copy paper, other office supplies and the labor to assemble board books. The savings can net banks upwards of $1,100 per board meeting. Board portals are environmentally friendly as well. Banks and credit unions contribute less paper to the landfills, and they expend less electricity to produce it. According to a recent analysis by Diligent, boards of banks and credit unions can save up to $10,000 a year by using a board portal.
Board Portals Provide Mobility and Improve Security There’s nothing worse than the panic that a director of a bank feels in learning that an important piece of paper is missing from the board book. This could happen easily enough with busy board members who travel often for business and pleasure as they juggle suitcases and briefcases in cars and on airplanes. Board portals let busy directors access their board documents with ease on any electronic device, including laptops, tablets and phones. Directors no longer need to lug heavy board books through busy airports and risk valuable information getting into the wrong hands. Most board portals have a double authentication process with a user ID, password and scrambled PIN code, so even if an electronic device gets lost or stolen, sensitive board information remains safe and secure.
Choosing a Board Portal While board portals are generally intuitive and user-friendly, some directors who are not adept at technology may find that they have a learning curve. But most board directors adapt quickly with a little training and experimentation. Board portals for banks are a single tool that stores meeting materials, communications, bylaws, archived documents and more in neatly arranged files. Many of the features that board portals provide are of great use to directors, particularly board rosters, board biographies, electronic surveys, voting history and shared notations. Many portals also have a built-in time tracker, so directors know how much time they are spending on board business. This feature can help boards evaluate whether directors are dedicating enough time to board service to comply with proper governance principles. Once they get used to the tool, board members appreciate the ease of posting news items, linking documents, sharing agenda items and calendars, and using the chat and email features. Premium products may also include offline capability, which is an important feature for many bank board directors.
Look for a board portal product that is easy to use and that has knowledgeable customer service support that is available around the clock. As with most products that consumers buy, less expensive board portals aren’t necessarily the best value. Board directors will spend a significant amount of time on the portal, so it’s best to conduct a thorough review of the features, usability, speed and functionality before investing in a portal. The right board portal will do all that you need it to do and more.
Hurricanes Harvey and Irma, which struck different locations on the U.S. coastline in August and September, were a tragic reminder that we live in an uncertain world, and natural disasters can cause widespread devastation. The individuals who have been directly affected will always be the first concern, but it’s equally important that businesses and government agencies be able to rebound quickly after a widespread disaster because their ability to function effectively is vital to the recovery of the communities they serve.
Every bank needs a business continuity management plan that the senior executive team and board of directors can activate in the event of a disaster like Harvey or Irma. The plan should be reviewed and tested annually, and updated as needed, suggests Christopher Wilkinson, a principal in Crowe Horwath’s Technology Risk Consulting Group who oversees business continuity planning and penetration assessments for the firm’s cybersecurity team. A common mistake that many organizations make is to see business continuity planning as purely an IT issue, when in fact it is much broader than that. “It’s important to make sure that you focus, first and foremost, on business continuity as a business issue and not just as an IT issue,” he says. In an interview with Bank Director Editor in Chief Jack Milligan, Wilkinson talks about the basic elements of a sound business continuity management program.
BD: What are the primary elements of a good plan? Wilkinson: When you take a look at business continuity management (BCM) programs, there are four key components. The first component starts with a business impact analysis (BIA). Organizations used to look at business continuity as an IT problem when in fact it really is a business issue. IT is a big component of restoring business operations, but business continuity as a whole is not just an IT problem. A lot of organizations have made the shift to say, “When an event happens, I don’t necessarily want to restore [just] my payroll application. I want to make sure that the process of paying my individuals is restored in full.” And the BIA builds the requirements for each one of the organization’s critical business processes.
One of the biggest components, or variables, that is set during the business impact analysis is the recovery time objective, or RTO. This tells an organization how long a specific business process like HR or payroll can be placed on the back burner before it significantly impacts the organization.
You can look at the impact from a variety of different perspectives. The obvious one would be the financial impact to the organization, but there are others, like the ability to attract new customers or the impact on servicing existing customers. There are a variety of factors that you want to measure the impact of for each business process to determine the overall impact on the organization.
The second important variable in BCM is the recovery point objective, or RPO. This one is a little bit more difficult, but what this variable tells us is, if I had to go to a snapshot of data in the past for some of the systems associated with a business process, how far back could I go? Depending on how dynamic the data is, are we talking minutes, hours or days?
Disaster recovery is an IT issue, and basically what it tells the organization is, “How do I strategically prepare my critical applications to meet the RTO and RPO expectations from the process owners?”
For example, when you talk about RTO, do I have a system designed in such a way with data backups and system redundancy, and the ability to recover that system within the required recovery time objective that the business has given me? So in essence, it’s giving you a service-level agreement, or an SLA, for each and every one of your applications. It tells the IT department, “Here’s how long I can go without this system. Now it’s your job to make sure that system is positioned strategically to meet expectations.”
The third component of a BCM program is the business continuity plan. This is, once again, a business issue. When we document business continuity plans for organizations, one of the things that we’re doing is making sure that certain processes can still be performed in the event of a disaster. If it’s payroll, for example, what can I prepare beforehand to ensure that I can pay employees given the absence of either the systems, the people, or the resources and facilities that are available?
The fourth component of BCM is testing. Are we doing our tabletop testing? Are we getting the right people in a room and walking through disaster scenarios on an annual basis? Are we testing the business side and the business continuity plan? Are we testing the disaster recovery plan, and the ability for IT to recover both the systems and the data that support the business function?
BD: What mistakes do companies, including banks, typically make in their business continuity planning? Wilkinson: That is a great question. I think one of the more common mistakes that I mentioned earlier is looking at business continuity as an IT issue, instead of as a business issue.
If we’re dealing with payroll and HR as an example, I very likely could recover the payroll application. But there may be other dependencies within the payroll process that aren’t up and running that aren’t IT related.
So it’s important to make sure that you focus, first and foremost, on business continuity as a business issue and not just as an IT issue.
Another mistake is that some of the smaller banks under $10 billion in assets haven’t done a business continuity risk assessment, where you’re prioritizing your threat based upon the company profile. That could be geographic location, which is probably one of the largest factors for banks. As you can imagine, if I’m a bank in the Florida Keys, I’ll have much different concerns with regards to the types of events or threats that may impact me than a bank in the Midwest.
So I need to make sure that I take a look at those threats, and then take a look at the controls that are in place from a business continuity perspective. Look at the most effective controls that are required for each one of those types of events, and then put those in place, and make sure that they’re effective.
BD: Do banks have any special issues when it comes to business continuity? Wilkinson: Banks are probably a little less challenging than other kinds of organizations. If you think about manufacturing and distribution, you have to worry about supply chain management. The Japanese tsunami in 2011 was a great example of that; it disrupted the supply chain for folks in many industries. It became quite a challenge to be able to find some of the parts and raw materials that companies needed, especially if they were coming from Japan.
Probably the most challenging aspect within the banking world is the number of branches they have and their geographic distribution. Banks need to review their facilities and understand where the critical business processes lie within each one of those facilities, and then strategically design a business continuity plan for each one of those facilities, based upon their geographic footprint. That is probably the most challenging thing that bankers face that other industries may not.
BD: Are there other risks that banks need to worry about from a business continuity standpoint that don’t necessarily relate directly to some kind of natural disaster? Wilkinson: There absolutely is. And that’s why when we talk about more mature organizations and their business continuity management program, what we’re starting to see is the convergence of the business continuity management program and the crisis management plan.
Having a crisis management playbook and a communication strategy for things like an active shooter scenario are starting to converge with business continuity management. The primary area where we see overlap is the management structure that’s going to be leading that organization through one of those events. They are very different situations if you think about a tornado versus an active shooter. But the overall management structure, and who’s leading the organization and making key decisions and putting out public communication—that’s where the primary overlap is for those two different kinds of events. In the past, we’ve looked at them as two different programs. More mature organizations are starting to converge those two into one larger program that speaks to business resiliency.
BD: Any last points you want to make before we close this out? Wilkinson: Today we are a very mobile workforce. How am I to use that mobility strategically to assist my business continuity program?
One of the ways that organizations can take advantage of this mobility is if they have a laptop refresh program. Let’s assume that a certain number of bank employees carry laptops, and those laptops get refreshed on an annual, biannual or every-three-year basis. If you’re not leasing those laptops and you own them, it’s a good opportunity to take those laptops, put them in a secure location and leverage them in case something does happen. It’s a lot easier to pull out 15- or 20-year-old laptops that already have a lot of the software and systems I need loaded on them than it is for me to create new systems from scratch.
Number two, when we see banks or organizations connecting their business continuity programs, in the unfortunate case where there is an event, communication is key. There are a lot of different systems out there that allow me to communicate with my employees and my customers. Pricing varies between the different products that are available, but the ability to send text messages—especially because typically that’s one of the last things that ultimately will go down from an infrastructure perspective in terms of the amount of data that’s used across networks—is changing the way that we as practitioners implement our plans.
Issues like cybersecurity, digital transformation and future business models now require the attention of not just management teams, but also bank boards. As directors engage more deeply in these issues, Bill Fisher of Diligent explains how they can enhance the effectiveness of the board to be a true strategic asset to the bank.
Could Amazon be a threat to banks? The online retailer announced in June that its Amazon Lending program, a small-business loan service that the company began offering in 2011, had surpassed $3 billion in loans globally, to more than 20,000 small businesses. One-third of those loans—$1 billion—were created in the past year, making it larger than most small banks.
Competition from nonbanks in small business lending isn’t new. But while lending startups in the past have often excelled in technology, they struggled to gain customers, and funding was more expensive than for traditional banks. In contrast, banks have had the expertise and relationships, and can fund loans more cheaply.
Amazon’s loan growth may represent a new phase in loan disruption, according to Karen Mills, a senior fellow at Harvard Business School and former head of the U.S. Small Business Administration.
“Having a pipeline into a set of small business owners who are doing business with the platform, knowing a lot of data about their business, could very well be the equivalent of a customer pipeline that’s unparalleled except at some of the most important traditional banks,” Mills says.
Amazon isn’t putting banks out of business, at least not in the foreseeable future. While 20,000 small businesses and $3 billion in loans is nothing to sneeze at, the program is invitation-only and limited to Amazon sellers, with the company leveraging its data on its client businesses to make credit decisions.
“Amazon looks at everything as basically a use case,” says Steve Williams, a partner at Cornerstone Advisors, based in Scottsdale, Arizona. “Is it something that we can do that the customer would want, can we technically deliver it, and can we make a business out of it?”
Banks should prepare for a reality, led by companies such as Amazon, where customers expect rapid credit decisions and an easy loan process. An employee describes the lending process as “three fields and three clicks” in a video published by Amazon in 2014.
“You can’t waste your customer’s time, and Amazon is relentless in trying to make things easier for its partners and customers,” says Dan O’Malley, the chief executive officer at Boston-based Numerated Growth Technologies, which spun off from Eastern Bank’s lab unit in May. That unit developed an express business loan program for the bank, and banks can now license the lending platform through Numerated.
Mills recommends that banks examine whether they want to grow their small business lending portfolio and if so, examine if they can provide the platform in-house or need to use an outside company.
Banks have been increasingly partnering with fintech firms, but Amazon’s suitability as a partner is debatable: O’Malley says Amazon is notoriously difficult to work with. But Amazon seems open to relationships of convenience. JPMorgan Chase & Co. offers an Amazon Prime Rewards Visa credit card, which gives 5 percent cash back to Amazon Prime members on their Amazon.com purchases. BBVA Compass has been testing the Amazon Locker program in its Austin, Texas, branches, so Amazon customers can safely and conveniently pick up their orders. Presumably, this would drive more traffic to BBVA’s branches.
And there’s Alexa, Amazon’s voice-operated digital assistant, which is used in Internet-enabled speakers such as the Echo. So far, Capital One Financial Corp. and American Express are among the few financial institutions whose customers can use Alexa for tasks like making a credit card payment or getting details on spending.
Amazon sees promise in its voice-enabled devices. “We’re doubling down on that investment,” Chief Financial Officer Brian Olsavsky said in Amazon’s first quarter 2017 earnings call. With the Echo, Dot and Tap products, Amazon has about 70 percent of the smart speaker market cornered, according to TechCrunch.
“Voice commerce and having to deal with voice as a channel is an important thing that [banks] are going to have to figure out,” says James Wester, the research director responsible for the global payments practice at IDC Financial Insights.
Amazon likely doesn’t have its sights set on becoming a bank—at least not for now, says Wester. But the company’s customer-first approach to improving processes is setting the tone for commerce, and if Amazon thinks it can make life easier for its customers and make money doing it, it won’t shy away from competing with the banking industry.
The possibilities are endless. Amazon unveiled its Amazon Vehicles webpage as a research tool for consumers in 2016, and the retailer is gearing up to sell cars online in Europe, according to Reuters. “There’s no reason that people won’t say, ‘I’m going to buy my car through Amazon and finance it,’” says Cornerstone’s Williams. Auto loans may very well be the next financial product on Amazon’s radar, and then, what’s next?
As bank executives look to add value through mergers and acquisitions (M&A), a recurring source of frustration is the tendency of investors and analysts to rely on narrow metrics to measure a deal’s value. Simple metrics are inadequate for evaluating the true value of a transaction. One widely used but misleading metric is the dilution of tangible book value (TBV) that occurs as a result of a transaction, coupled with the TBV earn-back period. TBV dilution and earn-back are poor indicators of a transaction’s full effect on the overall value of an organization.
Rather than using a single number to evaluate the success of a transaction, shareholders, boards and analysts should strive toward more comprehensive evaluations. Broader measures, coupled with a more qualitative evaluation of a transaction’s effects on bank strategy and shareholder value, can provide a holistic understanding of the relative worth of a merger or acquisition.
Gaps and Challenges Despite its widespread use, TBV dilution earn-back can produce an incomplete measure of the viability of a bank M&A transaction. Reliance on simple metrics produces gaps and challenges such as the following:
M&A structure: TBV dilution earn-back and other popular metrics are significantly affected by the way an acquisition or merger is structured. An all-cash acquisition will have a different effect on book value and earnings metrics than a deal that involves the issuance of new stock.
External factors: Management actions such as post-deal stock repurchases can influence TBV dilution earn-back and various other earnings-based metrics. These metrics also are shaped by numerous external factors that can affect stock price, such as the run-up in bank stock values in the month after the 2016 election, when the markets began to anticipate regulatory reform.
Regulatory expense: Despite expectations of future regulatory relief, regulatory expense will continue to contribute to banks’ financial pressures in the near term, reinforcing the need for continued growth in order to spread compliance-related costs across a larger base. Moreover, many banks still are likely to find it challenging to price deals fairly, due to the constraints of regulatory capital requirements.
Indirect consequences: The market’s reliance on simple metrics can pose less immediate—but equally serious—indirect consequences. For example, negative perceptions about prior deals can limit a publicly traded bank’s growth opportunities, since its ability to compete in future deals often hinges on the value of its stock. This limitation can be damaging for banks and thrifts whose growth strategies are built around continuing M&A activity.
Measurable Success Serious investors begin their evaluations with an estimate of the deal’s impact on earnings and earnings per share (EPS), but they also consider factors such as projected cost savings, expenses related to the transaction itself, and the speed and costs associated with a successful integration of the two organizations.
Management should lay out meaningful steps with measurable indicators of success. When evaluating cost savings, both the recurring savings and the one-time expenses that will be incurred to achieve them must be considered. An equally stringent standard also should be applied to projected merger-related expenses, such as professional fees and operational costs.
The totality of these various projections should be compared to the actual results achieved in prior transactions. If they vary significantly—or if earlier deals failed to achieve promised results—management should be able to explain the variations and rationale for the current projections.
The financial impact of an M&A transaction also should be compared with its potential return. Management should outline the rationale for the deal compared to alternative uses of capital, and it should be ready to present complete and relatively detailed plans, timetables, and targets. This analysis might be time-consuming, but it produces a clearer picture of a transaction’s true value.
A Comprehensive Approach to Deal Valuation A complete analysis involves studying factors such as a deal’s impact on capital ratios, management’s integration plans and benchmarks, projected cost savings, and the management team’s track record and credibility. Thorough analysis also takes into account unpredictable external factors such as general economic conditions, changing interest rates, new competitive pressures, future technological advances and the changing needs of bank customers.
When management demonstrates a history of competence and a clear and credible rationale for its planned actions, it makes a more compelling case for investor confidence than simple metrics can offer. This more analytic approach can help investors, analysts, and other stakeholders—and ultimately bankers—by encouraging a more disciplined and comprehensive approach to deal valuation.
When a board of directors decides to explore a sale, one of its initial decisions is whether to use a public auction, a soft shop approach, or a negotiated sales process. A negotiated sales process with an individual buyer may be an attractive alternative approach when selling a bank. In a one-on-one negotiation with a buyer, social issues may be more easily navigated, day-to-day operations of the bank are less likely to be disrupted, and post-merger integration may be easier than in other approaches. There are instances where two banks fit so well financially and culturally that it may make sense to bypass a formal bidding process. In any private negotiation, however, the seller is subject to a much higher level of scrutiny relative to a soft-shop approach or a public auction. This is primarily because of a lack of competitive bids. The importance of board participation and proper documentation cannot be overemphasized. Before entering a negotiated sale, you must understand the importance of documenting the decision-making process: if it was not documented, it did not happen.
In order to evaluate whether a negotiated sales process is an appropriate option for a sale, it is first necessary to understand two alternative approaches:
Public auction: A public announcement is made that the bank is for sale. If it decides to terminate the sale, it has publicized itself as a target in the market. This process is not frequently used.
Soft-shop approach: The board identifies a pool of potential buyers to contact. The most important elements of a soft-shop approach are the board’s ability to select who gets invited into the process, and the element of confidentiality, which preserves the bank’s ability to remain independent if it decides to terminate the sale. This approach is generally the most common process encountered in community bank M&A.
The business judgement rule, which places a higher burden on the plaintiff in a lawsuit and takes some of the burden off the board, does not provide assurance that the bank will avoid litigation following announcement of a sale. It only takes one stockholder to initiate legal action against the bank and if the bank cannot produce consistent, formal documentation of its duties, the board has left itself completely unprotected. This is especially the case for publicly traded companies, which often have a larger shareholder base.
It is therefore critical for the board to demonstrate duty of care from start to finish and it is incumbent on the board and its legal and financial advisors to document the process. This means that a third-party fairness opinion at the end of the process is insufficient. The board must be able to demonstrate that prior to entering a negotiated sales process, it has met to evaluate its stand-alone value, discussed other potential buyers in the market, and analyzed all possible strategic paths. A capacity to pay analysis is a useful tool in determining if there are buyers that could, in a soft shop process, pay higher consideration than the buyer engaged in the one-on-one negotiations. In a cash transaction in particular, if there are buyers that could have potentially paid a higher price, the bank may be open to criticism if it cannot demonstrate a sound rationale for not undergoing a soft-shop process.
A pro forma analysis can also be used to ensure that the risk profile of the combined entity is likely clean from a regulatory perspective and can also be used to evaluate future upside potential to shareholders in the combined entity relative to future stand-alone value. Creating long-term value for shareholders should be at the forefront of considerations in any transaction, and is perhaps one of the most compelling reasons to enter a negotiated sale in a deal with a stock component. The combined entity should continue to thrive and build value long after the deal has closed, mitigating the weaknesses and enhancing the strengths of the two stand-alone entities.
Remember to always look at long-term value of the combined entity in a stock transaction. Documented board participation along with quality analytics will protect the board and allow the combined entity to prosper going forward. Above all else, have advisors that you can trust to tell you if a transaction is not in the best interest of your stockholders. Have a disciplined approach and know when to walk away from a deal. Strong corporate governance and sound understanding of value will be your greatest allies in any sales process and will ensure that a negotiated transaction is executed seamlessly and in a manner than unlocks value for your stockholders.
Bank 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.
Not ready to file an IPO? Over-the-counter markets can be an effective solution for community banks, and offer similar benefits with less complexity and cost, explains Jason Paltrowitz of OTC Markets Group.
To set the stage for a successful technology implementation, it takes more than just training your staff or setting up a platform. You also need to understand your firm’s strategy, culture and people—and know how the new technology will enhance all three.
Increased competition, shifting customer expectations and more diligent enforcement of expanding regulation are making the commercial lending space a tougher place to do business.
It’s true that commercial loan growth is expected to hit 11 percent in 2016. That impressive growth belies a challenging market environment. In truth, lower interest rates and higher costs of doing business are squeezing lenders’ margins. To paraphrase an old joke: Financial institutions need to avoid losing money on every loan, while “making it up in volume.”
Financial institutions that want to avoid becoming a punchline are responding strategically, investing in core technologies and leveraging the new analytical capabilities of solutions to drive product-level profitability.
Due to the increased cost of doing business and the need to operate in a leaner environment, most financial institutions do not possess the internal expertise needed to properly plan and execute enterprise-wide process change. This lack of experience leads to longer success rate times and reduced buy-in by end users and management.
According to the technology and consulting firm CEB, a vast portion of business-led technology adoption happens without the input of information technology, with nearly half of originators saying they are willing to forgo quality for speed. This lack of planning is showing up in the final output. Eighty-five percent of the “stall points” in the adoption of new technology result from a lack of planning, with just 15 percent related to issues around the implementation itself.
So, what are the steps that your financial institution needs to take to ensure the success of your implementation?
Identify What Change is Needed: The institution needs to have a clear idea of what needs to change, and the metrics by which the success of the change will be measured. To make this happen, it’s important to have an executive steering committee, to get senior-level buy-in around a common goal.
Organize the Core Team: Next, it’s important for the institution to assemble a wide variety of cross-functional teams to allow free-thought around how paradigms at the firm could change. Effective tech implementations mean new processes, not just swapping one platform for another. To ensure that those paradigms work across the organization, everyone who will interact with the new system needs representation. For a commercial implementation, this means including representatives from the front line, such as relationship managers, all the way to the back-office, such as loan processors.
Choose a Champion: Financial institutions have to make a careful choice of the person who will be the face of change. The final candidate should be a strong communicator who can explain the benefits of the change to everyone in the organization.
Thoroughly Scope Business Requirements: Conduct a full scoping and planning session with your technology provider to understand business rules, as well as the existing systems and processes that need to change as a result of implementation.
Identify Key Implementation Resources: The financial institution needs to allocate the correct resources to maximize productivity and efficiency throughout the implementation. The creation of an implementation steering committee (separate from the executive steering committee we discussed above) can also help minimize design changes that need to occur after the implementation begins. This steering committee should also ensure that the changes have no unintended consequences for the organization.
Create Program/Project Plans: Will the project be an enterprise-wide implementation or focused on a specific area? Is the organization better suited to a waterfall or agile implementation methodology? (A waterfall implementation tends to be linear and sequential, while an agile approach is incremental and iterative, with processes occurring in parallel.) Will the rollout of the new technology be a “big bang” or phased? These issue need to be addressed in advance, along with the standard project timeline.
Most importantly, financial institutions need to work deliberately and efficiently, and avoid hurrying the process. Rushing into a mistake will delay the outcome longer than working slowly and effectively. As they say in the Navy SEALS: “Slow is smooth, and smooth is fast.”
Careful planning can significantly reduce the amount of time that a financial institution requires for the implementation, and speed up the time to realize the benefits. The key is planning right—from the beginning.