Three Things You Missed at Experience FinXTech


technology-9-11-19.pngThe rapid and ongoing digital evolution of banking has made partnerships between banks and fintech companies more important than ever. But cultivating fruitful, not frustrating, relationships is a central challenge faced by companies on both sides of the relationship.

The 2019 Experience FinXTech event, hosted by Bank Director and its FinXTech division this week at the JW Marriott in Chicago, was designed to help address this challenge and award solutions that work for today’s banks. Over the course of two days, I observed three key emerging trends.

Deposit displacement
The competition for deposits has been a central, ongoing theme for the banking industry, and it was a hot topic of conversation at this year’s Experience FinXTech event.

In a presentation on Monday, Ron Shevlin, director of research at Cornerstone Advisors, talked about a phenomenon he calls “deposit displacement.” Consumers keep billions of dollars in health savings accounts. They also keep billions of dollars in balances on Starbucks gift cards and within Venmo accounts. These aren’t technically considered deposits, but they do act as an alternative to them.

Shevlin’s point is that the competition for funding in the banking industry doesn’t come exclusively from traditional financial institutions — and particularly, the biggest institutions with multibillion-dollar technology budgets. It also comes from the cumulative impact of these products offered by nondepository institutions.

Interestingly, not all banks struggle with funding. One banker from a smaller, rural community bank talked about how his institution has more funding than it knows what to do with. Another institution in a similar situation is offloading them using Promontory Interfinancial Network’s reciprocal deposit platform.

Capital allocation versus expenses
A lot of things that seem academic and inconsequential can have major implications for the short- and long-term prospects of financial institutions. One example is whether banks perceive investments in new technologies to be simply expenses with no residual long-term benefit, or whether they view these investments as capital allocation.

Fairly or unfairly, there’s a sense among technology providers that many banks see investments in digital banking enhancements merely as expenses. This mindset matters in a highly commoditized industry like banking, in which one of the primary sources of competitive advantage is to be a low-cost producer.

The industry’s justifiable focus on the efficiency ratio — the percent of a bank’s net revenue that’s spent on noninterest expenses — reflects this. A bank that views investments in new technologies as an expense, which may have a detrimental impact on efficiency, will be less inclined to stay atop of the digital wave washing over the industry.

But banks that adopt a more-philosophical approach to technology investments, and see them as an exercise in capital allocation, seem less inclined to fall into this trap. Their focus is on the long-term return on investment, not the short-term impact on efficiency.

Of course, in the real world, things are never this simple. Banks that approach this decision in a way that keeps the short-term implications on efficiency in mind, with an eye on the long-term implications of remaining competitive in an increasingly digitized world, are likely to be the ones that perform best over the long run.

Cultural impacts
One of the most challenging aspects of banking’s ongoing digital transformation also happens to be its least tangible: tailoring bank cultures to incorporate new ways of doing old things. At the event, conversations about cultural evolution proceeded along multiple lines.

In the first case, banks are almost uniformly focused on recruiting members of younger generations who are, by habit, more digitally inclined.

On the flipside, banks have to make hard decisions about the friction that stems from existing employees who have worked for them for years, sometimes decades, and are proving to be resistant to change. For instance, several bankers talked about implementing new technologies, like Salesforce.com’s customer relationship management solutions, yet their employees continue to use spreadsheets and word-processing documents to track customer engagements.

But there’s a legitimate question about how far this should go, and some banks take it to the logical extreme. They talk about transitioning their cultures from traditional banking cultures to something more akin to the culture of a technology company. Other banks are adopting a more-tempered approach, thinking about technology as less of an end in itself, and rather as a means to an end — the end being the enhanced delivery of traditional banking products.

A Common Trait Shared by Elite Bankers


investment-8-2-19.pngIf you talk to enough executives at top-performing banks, one thing you may notice is that not all of them see themselves as bankers. Many of them identify instead as investors who run banks.

It’s a subtle nuance. But it’s an important one that may help explain the extraordinary success of their institutions.

This came up in a conversation I had last week with the president and chief operating officer of a $2.6 billion asset bank based in New England. (I’d share the bank’s name, but they prefer to keep a low profile.)

His bank is among the most profitable in the country and is a regular fixture atop industry rankings, including our latest Bank Performance Scorecard.

Its profitability and earnings growth are consistently at the top of its peer group each year. More importantly, its total shareholder return (dividends plus share price appreciation) ranks in the top 3% of all publicly traded banks since the current leadership team gained control in 1993.

The distinction between investors and bankers seems to lay in how they prioritize operations and capital allocation.

For many bankers, capital allocation plays a supporting role to operations. It’s a pressure release valve that purges a bank’s balance sheet of the excess capital generated by operations. As capital builds up on the balance sheet, it impairs return on equity, which can foster the illusion that a bank isn’t earning its cost of capital.

To investors, the relationship between operating a bank and allocating its capital is inverted: The operations are the source of capital, while the efficient allocation of that capital is the ultimate objective.

Bankers who identify as investors also tend to be agnostic about banking. If a different industry offered better returns on their capital, they’d go elsewhere. They’ve gravitated to banking only because it’s a peculiarly profitable endeavor. In no other industry are businesses leveraged by a factor of 10 to 1 and financed with government-insured funds.

There are plenty of other bankers that fall into this categorization. The recently retired chairman of Citigroup, Michael O’Neill, is one of them. He said this when I interviewed him recently for a profile to be published in the upcoming issue of Bank Director magazine.

O’Neill’s time as chairman and CEO of Bank of Hawaii bears this out. A major objective of his, after refocusing its geographic footprint, was reducing the bank’s outstanding share count.

Bank of Hawaii had 80 million shares outstanding when O’Neill became CEO in 2000. When he left 4 years later, that had declined by 38% to only 55 million outstanding shares. This helped the bank’s stock price more than triple over the same stretch.

Another example is the Turner family, which has run Great Southern Bancorp for almost half a century. Since going public in 1991, Great Southern has repurchased nearly 40% of its original outstanding share count. A $2 million investment during the initial public offering would have been worth $140 million last year.

The Turners never said this when I talked with them last year, but it seems safe to infer that they view banking in a similar way. They’re not trying to build a banking empire for the sake of running a big bank. Instead, they’re focused on creating superior long-term value.

This philosophical approach coupled with meaningful skin in the game insulates a bank’s executives from external pressures to chase short-term growth and profitability at the expense of long-term solvency and performance.

“Having a big investment in the company … gives you credibility with institutional investors,” Great Southern CEO Joe Turner told me last year. “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.”

M&T Bank Corp. offers yet another textbook example of this. Of the largest 100 banks operating in 1983, when its current leadership team took over, only 23 remain today. Among those, M&T ranks first when it comes to stock price growth

I once asked its chairman and CEO René Jones what has enabled the bank to create so much value. One of the main reasons, he told me, was that they could gather 60% of the voting interests in the bank around the coffee table in his predecessor’s office.

And the bank in New England that I mentioned at the top of this article is the same way. The family that runs it, along with its directors, collectively hold 40% of the bank’s stock.

The moral of the story is that it’s tempting to think that capital allocation should play second fiddle to a bank’s operations. But many of the country’s best bankers see things the other way around.

An Easy Way to Lose Sight of Critical Risks


audit-6-7-19.pngLet me ask you a question…

How does the executive team at your biggest competitor think about their future? Are they fixated on asset growth or loan quality? Gathering low-cost deposits? Improving their technology to accelerate the digital delivery of new products? Finding and training new talent?

The answers don’t need to be immediate or precise. But we tend to fixate on the issues in front of us and ignore what’s happening right outside our door, even if the latter issues are just as important.

Yet, any leader worth their weight in stock certificates will say that taking the time to dig into and learn about other businesses, even those in unrelated industries, is time well spent.

Regular readers of Bank Director know that executives and experienced outside directors prize efficiency, prudence and smart capital allocation in their bank’s dealings.

But here’s the thing: Your biggest—and most formidable—competitors strive for the same objectives.

So when we talk about trending topics at this year’s Bank Audit and Risk Committees Conference, hosted by Bank Director in Chicago from June 10-12, we do so with an eye not just to the internal challenges faced by your institution but on the external pressures as well.

As we prepare to host 317 women and men from banks across the country, let me state the obvious: Risk is no stranger to a bank’s officers or directors. Indeed, the core business of banking revolves around risk management—interest rate risk, credit risk, operational risk.

Given this, few would dispute the importance of the audit committee to appraise a bank’s business practices, or of the risk committee to identify potential hazards that could imperil an institution.

Banks must stay vigilant, even as they struggle to respond to the demands of the digital revolution and heightened customer expectations. I can’t overstate the importance of audit and risk committees keeping pace with the disruptive technological transformation of the industry.

That transformation is creating an emergent banking model, according to Frank Rotman, a founding partner of venture capital firm QED Investors. This new model focuses banks on increasing engagement, collecting data and offering precisely targeted solutions to their customers.

If that’s the case—given the current state of innovation, digital transformation and the re-imagination of business processes—is it any wonder that boards are struggling to focus on risk management and the bank’s internal control environment?

When was the last time the audit committee at your bank revisited the list of items that appeared on the meeting agenda or evaluated how the committee spends its time? From my vantage point, now might be an ideal time for audit committees to sharpen the focus of their institutions on the cultures they prize, the ethics they value and the processes they need to ensure compliance.

And for risk committee members, national economic uncertainty—given the political rhetoric from Washington and trade tensions with U.S. global economic partners, especially China—has to be on your radar. Many economists expect an economic recession by June 2020. Is your bank prepared for that?

Bank leadership teams must monitor technological advances, cybersecurity concerns and an ever-evolving set of customer and investor expectations. But other issues can’t be ignored either.

At our upcoming event in Chicago, the Bank Audit and Risk Committees Conference, I encourage everyone to remember that minds are like parachutes. In the immortal words of musician Frank Zappa: “It doesn’t work if it is not open.”

Exclusive: The Inside Story of Colorado’s Leading Bank


bank-4-25-19.pngGreat leaders are eager to learn from others, even their competitors. That’s why Bank Director is making available—exclusively to members of our Bank Services program—the unabridged transcripts of in-depth conversations our writers have with the executives of top-performing banks.

One such bank is FirstBank Holding Co.

With $18.5 billion in assets, FirstBank is the third-largest privately-held bank in the United States and the biggest bank based in Colorado, where its headquarters sits 10 miles west of downtown Denver. It’s among the most efficient institutions in the industry, with an efficiency ratio often dipping below 50 percent. It has an abundance of risk-based capital. And its return on equity has ranked in the top 10 percent of large bank holding companies in all but one of the past 12 years.

Bank Director’s executive editor, John J. Maxfield, interviewed FirstBank’s CEO Jim Reuter and Chief Operating Officer Emily Robinson for the second quarter 2019 issue of Bank Director magazine. (You can read that story, “How FirstBank Profits from Being Private,” by clicking here.)

In the interview, Reuter and Robinson shed light on:

  • The benefits of being a privately-held bank
  • How FirstBank became a leader in the digital evolution of banking
  • Strategies to stay disciplined at the top of the cycle
  • The advantage of having three former FirstBank CEOs serving on the board
  • Their philosophy on capital management and allocation

The interview has been edited for brevity, clarity and flow.

download.png Download transcript for the full exclusive interview

A Timely Reminder About the Importance of Capital Allocation


capital-7-6-18.pngCapital allocation may not be something bank executives and directors spend a lot of time thinking about—but they should. To fully maximize performance, a bank must both earn big profits and allocate those profits wisely.

This is why the annual stress tests administered each year by the Federal Reserve are important, even for the 5,570 banks and savings institutions that don’t qualify as systemically important financial institutions, or SIFIs, and are spared the ritual. The widely publicized release of the results is an opportunity for all banks to reassess whether their capital allocation strategies are creating value.

There are two phases to the stress tests. In the first phase, the results of which were released on June 21, the Fed projects the impact of an acute economic downturn on the participating banks’ balance sheets. This is known as the Dodd-Frank Act stress test, or DFAST. So long as a bank’s capital ratios remain above the regulatory minimum through the nine-quarter scenario, then it passes this phase, as was the case with all 35 banks that completed DFAST this year.

The second phase is the Comprehensive Capital Analysis and Review, or CCAR. In this phase, banks request permission from the Fed to increase the amount of capital they return to shareholders by way of dividends and share buybacks. So long as a bank’s proposed capital actions don’t cause its capital ratios from the first phase to dip below the regulatory minimum, and assuming no other deficiencies in the capital-planning process are uncovered by the Fed during CCAR, then the bank’s request will, presumably, be approved.

There’s reason to believe the participating banks in this year’s stress tests will seek permission to release an increasingly large wave of capital. Banks have more capital than they know what to do with right now, which causes consternation because it suppresses return on equity—a ratio of earnings over equity. And last year’s corporate income tax cut will only further fuel the buildup going forward, as profits throughout the industry are expected to climb by as much as 20 percent.

We probably won’t know exactly how much capital the SIFIs as a group plan to return over the next 12 months until, at the soonest, second-quarter earnings are reported in July. But early indications suggest a windfall from most banks. Immediately after CCAR results were released on June 28, for example, Bank of America Corp. said it will increase its dividend by 25 percent and repurchase $20.6 billion worth of stock over the next four quarters, nearly double its repurchase request over last year.

The importance of capital allocation can’t be overstated. It’s one of the most effective ways for a bank to differentiate its performance. Running a prudent and efficient operation is necessary to maximize profits, but if a bank wants to maximize total shareholder return as well, it must also allocate those profits in a way that creates shareholder value.

One way to do so is to repurchase stock at no more than a modest premium to book value. This is easier said than done, however. The only time banks tend to trade for sufficiently low multiples to book value is when the industry is experiencing a crisis, which also happens to be when banks prefer to hoard capital instead of return it to shareholders.

As a result, the best way to add value through capital allocation is generally to use excess capital to make acquisitions. And not just any ole’ acquisition will do. For an acquisition to create value, it must be accretive to a bank’s earnings per share, book value per share or both, either immediately or over a relatively brief period of time.

If you look at the two best-performing publicly traded banks since 1980, measured by total shareholder return, this is the strategy they have followed. M&T Bank, a $119 billion asset bank based in Buffalo, New York, has made 23 acquisitions since then, typically doing so at a discount to prevailing valuations. And Glacier Bancorp, a $12 billion asset bank based in Kalispell, Montana, has bolstered its returns with two dozen bank acquisitions throughout the Rocky Mountain region.

The point is that capital allocation shouldn’t be an afterthought. If you want to earn superior returns, the process of allocating capital must be approached with the same seriousness as the two other pillars of extraordinary performance—prudence and efficiency.