Two Distinct Duties: Holding Company vs. Bank Boards

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It wasn’t too long ago that banks were restricted from conducting business outside their home state.  But some institutions found a workaround: Bank holding companies offered a way to operate in multiple states, leading Congress to pass the Bank Holding Company Act of 1956. Regulators also wanted to limit banks’ ability to own nonbank firms like a manufacturing company or retailer, which could have allowed them to influence borrowers to patronize those subsidiaries or use deposits to make loans to those businesses, according to Joe Mahon of the Federal Reserve Bank of Minneapolis. 

Interstate banking has been the norm since the 1980s, and the Bank Holding Company Act has been modified several times since its 1956 passage. But generally, the law clarifies the purpose of a bank holding company and gives the Federal Reserve broad powers to supervise these companies. 

Recently, with the failure of Silicon Valley Bank, questions have been raised about a holding company’s role as a source of financial strength. The Santa Clara, California-based bank’s holding company, SVB Financial Group, remained in operation as of Sept. 7, 2023. 

But even in normal circumstances, a holding company presents distinct governance considerations for boards. 

Why Have a Bank Holding Company?
A bank holding company’s primary purpose is to hold stock, or ownership, in a bank. 

Banks don’t have to be held by a holding company — notable examples of banks without holding companies include Little Rock, Arkansas-based Bank OZK, with $31 billion in assets, and $87 billion Zions Bancorp., in Salt Lake City, which merged its holding company into its bank in 2018. Zions said at the time that the consolidation would improve efficiency and cut down on duplicative regulatory examinations. 

A holding company structure eases an organization’s ability to borrow or raise money, and “inject it down into the bank,” says Andrew Gibbs, a senior vice president at Mercer Capital who leads the advisory firm’s deposit institutions group. Equity plans, including employee stock ownership programs, could be easier to manage via a holding company. For smaller banks below $15 billion in assets, it also changes what counts as regulatory capital.

“One of the benefits of bank holding company status is the ability to count securities like trust preferred securities as regulatory capital,” says Gibbs. Zions and Bank OZK didn’t receive those capital advantages due to their size.

A holding company structure also allows a bank to engage in a broader array of activities. “A bank holding company can invest in any kind of company, so long as it holds less than 5% of voting stock of that company,” says Samantha Kirby, partner and co-chair of the banking and consumer financial services practice at Goodwin Procter. Those investments can include fintechs. In Bank Director’s 2023 Bank M&A Survey, conducted last fall, 9% of bank executives and board members reported that their organization had directly invested in fintech companies in 2021-22. 

If a bank holding company wants to offer a broader selection of financial services, such as investment banking or insurance, the board can elect to become a financial holding company, a separate designation created in 1999 via the Gramm–Leach–Bliley Act. 

A bank holding company can also serve as a financial source of strength for the bank, referencing a doctrine that was reinforced in Section 616 of the Dodd-Frank Act, which amended the Bank Holding Company Act. Put simply, the holding company should provide financial support to its insured bank subsidiary “in the event of the financial distress” of that institution. 

James Stevens, a Georgia-based partner at Troutman Pepper, witnessed a number of bank failures in that state during the 2008 financial crisis. Bank holding companies were expected to ensure their subsidiary bank had enough capital to survive. “If a subsidiary bank needs capital, and the bank holding company has additional capital that could be injected into the bank, it is supposed to push that capital into the bank under the source of strength doctrine,” he says. “If a bank holding company doesn’t do that, its board could be subject to criticism from regulators.”

Investors often prefer that capital be held at the holding company rather than at the bank. Gibbs explains that pulling capital out of the bank generally requires regulatory approval, so large capital activities — like dividends — are best handled at the holding company level. “It’s generally easier to keep [capital] at the holding company, and then you don’t need to deal with [the] regulatory process to extract it from the bank, if the bank has too much capital.”

Know Your Role
Both holding company and bank boards have the same fiduciary duties to shareholders, says Kirby, meaning the directors of both boards have a legal and ethical responsibility to act in the best interests of the company’s owners. That said, bank and holding company boards have distinct responsibilities, and directors should have a “clear understanding of whether they are serving on the bank board or on the holding company board, or both,” she says. It sounds basic, but sometimes that line isn’t clear.

Often, the boards mirror one another, but it’s not uncommon for a member or two to serve on just one of the boards. For example, it’s fairly routine for a private equity investor to only serve on the holding company board where they can focus on the overall direction of the company. And sometimes, the holding company and bank boards could be two entirely different groups. 

According to Bank Director’s 2023 Compensation Survey, holding companies and banks tend to have the same number of members, at a median of 10. Bank boards meet a little more frequently, at a median 12 times a year versus 10 meetings for the holding company board.

The bank board should focus on the bank’s activities — put simply, strategies, policies and risks related to the bank’s business of making loans and taking deposits. “Bank regulators will not find it acceptable if the bank holding company is the one that’s managing the risk,” says Stevens. “Same thing with audit and compliance management, and the scope of internal audit. … They want the bank board to be focused on those things.”  

Stevens describes the structure as one that’s “bottom up,” as the bank board makes important decisions about the business, and the holding company makes higher level decisions about strategy — capital allocation and deployment, or prospective M&A activity. “What’s the risk management framework? What’s our internal audit going to look like? Who has lending authority?” says Stevens. “That stuff has got to be at the bank.” 

The holding company typically can add or remove directors from the bank board. “The process and authority depend on the articles and bylaws of the bank,” says Stevens, “but generally the bank holding company, as the sole shareholder of the bank, has the power to change the composition of the bank board.”

Separate Agendas, Minutes
No matter the makeup of the holding company and bank boards, both Kirby and Stevens say it’s important that deliberations — which board is taking action on what — are clearly documented. 

Ideally, the bank board and the holding company board would have two distinct agendas, and two sets of minutes. 

Stevens sometimes sees mirrored boards make joint resolutions. But he says it can get complicated when the two boards aren’t composed of the same directors. “You have to be thoughtful, if you have separate groups, that you’ve got the right people in the room to make the decisions that impact those fundamental banking decisions.”

That isn’t to say that members of the holding company board won’t sit in on the bank board meeting, or vice versa, says Kirby. But, when it comes time for formal action, that should be taken by the appropriate board.

Revisit Your Structure
Choosing to adopt a bank or financial holding company structure — or not — should be a decision informed by the bank’s strategy. Kirby recommends that this be part of the board’s annual strategic discussions. Consider whether the bank has the right structure to pursue its strategic goals and facilitate its growth. 

While the difference between the two boards, holding company and bank, may appear trivial, getting governance right makes a difference on regulatory examinations. The board’s effectiveness factors into a bank’s CAMELS rating, short for capital adequacy, asset quality, management, earnings, liquidity and sensitivity to market risk. The board falls under the management pillar. 

“You want to have this buttoned up, and [you] don’t want to get criticized for it,” says Stevens. “If you’re being examined, and you’re on the cusp of being a three or a four, you don’t want the corporate governance issue to move you from a three to a four CAMELS rating. … It’s not a place for boards to be creative and make mistakes.”  

Additional Resources
Bank Director’s 2023 Compensation Survey, sponsored by Chartwell Partners, surveyed 289 independent directors, CEOs, human resources officers and other executives of U.S. banks below $100 billion in assets to understand how they’re addressing talent challenges, succession planning and CEO performance. Compensation data for directors, non-executive chairs and CEOs for fiscal year 2022 was also collected from the proxy statements of 102 public banks. Members of the Bank Services Program have exclusive access to the complete results of the survey, which was conducted in March and April 2023.

Bank Director’s 2023 Bank M&A Survey, sponsored by Crowe LLP, surveyed 250 independent directors, CEOs, chief financial officers and other senior executives of U.S. banks below $100 billion in assets to examine current growth strategies, particularly M&A. Members of the Bank Services Program can access the complete results of the survey, which was conducted in September 2022.

What 2022’s M&A Market Practice Can Teach Banks

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Nelson Mullins reviewed 43 publicly available merger agreements for bank mergers announced in 2022 to identify common market practices. The transactions ranged in deal value from $10.1 million to $13.7 billion, with a median deal value of roughly $136 million. They reflected average pricing of 1.6x tangible book and 16x earnings.

Understanding these market practices can help potential targets understand what might be available in the market, and help potential purchasers understand where they may be able to stand out from the market. Below are some of the highlights and observations of the review.

Adjustments to Merger Consideration Based on Closing Capital
Ten of the 43 transactions included an adjustment to the merger consideration based on the target’s closing capital, with nine including a dollar for dollar decrease in merger consideration based on the target missing a stated closing capital level. Only one merger agreement offered a dollar for dollar increase or decrease based on a stated closing capital level. Transactions varied with respect to whether changes in the value of available-for-sale securities were backed out of closing capital as well as whether transaction expenses were to be included or excluded in such calculations; there was no market consensus. At least one merger agreement also required the held-to-maturity securities portfolio to be marked-to-market for purposes of calculating closing capital. Only eight transactions provided a minimum capital amount as an explicit closing condition.

Closing conditions predicated on minimum capital amounts are more common in years in which financial stress overhangs the industry, such as during the 2008 financial crisis. Given the significant interest rate moves in 2022, these observations are expected. As we look to 2023, we would expect these conditions to become less common if interest rate trends moderate or even stabilize and drop, noting that any asset stress resulting from a possible economic downturn would change our opinion.

Other Adjustments to Merger Consideration
Although there has been discussion of similar provisions, only the TD Bank Group/First Horizon Corp. agreement included additional merger consideration if the transaction was delayed based on delayed regulatory approvals. No other public merger agreements included such a provision. However, there was one agreement that interestingly provided that the parties could mutually agree to reduce the merger consideration by up to $3.5 million if an event caused a material adverse decline in the value of the transaction. One has to wonder: Would a target ever subsequently agree to a discretionary reduction in merger consideration?

Must the Purchaser Act in the Ordinary Course of Business?
In roughly a third of the transactions, the purchaser undertook an affirmative covenant to only act in the ordinary course of business. This would presumably require the purchaser to obtain the target’s consent before engaging in another acquisition. Conversely, in two-thirds of the transactions, the purchaser made no such covenant.

In all transactions, the purchaser did covenant not to undertake any action that would be expected to cause a delay in the immediate transaction. In the two transactions where the target was closest in size to the purchaser — hence more likely a strategic merger or “merger-of-equals” — the purchaser and target agreed to mutual affirmative and negative covenants.

Target’s Ability to Accept Superior Proposals
Virtually all of the transactions permitted the target’s board of directors to respond to unsolicited alternative proposals. This arrangement, commonly referred to as a “fiduciary out,” is common and effectively required under most frameworks of director’s fiduciary duties.

In roughly 75% of the transactions, the target board of directors had the right to terminate the merger agreement if confronted with a superior proposal and conditioned upon paying a termination fee. However, in 25% of the transactions, while the target board of directors could change its recommendation to shareholders in light of a perceived superior proposal, only the purchaser could elect to then terminate the merger agreement and require the target to pay the termination fee. Otherwise, the target remained obligated to seek shareholder approval and likely most of the directors would remain obligated, if subject to voting support agreements, to continue to vote for the transaction. In four transactions, even the target shareholders’ rejection of the merger agreement didn’t immediately give the target the right to terminate the merger agreement; the parties remained obligated to make good faith reasonable best efforts to first negotiate a restructuring that would result in shareholder approval.

Increasingly Common New Provisions
We increasingly saw provisions addressing cooperation on data processing conversions and coordination of dividend timing, with a desire to ensure that each parties’ shareholders received one dividend payment each quarter.

5 Ways to Keep and Attract Commercial Clients

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It’s no longer enough for banks to provide clients with standard products and services. Clients are constantly looking for differentiators when deciding which financial institution to trust with their business. Whether your clients are baby boomers preparing for retirement or millennials interested in purchasing their first home, everyone wants their bank to make them feel special.

When implementing any initiative, strategic marketing is key. Your clients need to be aware of, and excited by, your incentives — one benefit can set your institution apart from competitors. Below are five benefits for banks to consider.

1. Partner With Other Companies
Partnering with other companies like gas stations, grocery stores and retail brands gives you a way to offer rewards to clients when they purchase their essentials. Plus, your bank will enjoy free marketing and awareness as part of the collaboration. Banks can also increase their trust, credibility and relevance when they partner with businesses that clients already know and use. For example, Bank of America Corp. offers a customizable cash back credit card that offers 2% back at grocery stores and wholesale clubs.

2. Connect Clients to Capital
Often, clients are unaware of programs that can net them working capital, like the Employee Retention Credit (ERC). ERC providers are highly qualified professionals that help clients navigate the ERC process and can work with banks to help their commercial clients collect an average of $400,000. This is another example of an alliance that’s mutually beneficial: Clients gain back money they’re owed, while the bank receives referral commissions from its agreement with a trusted ERC provider. Banks can also benefit from the goodwill built between the institution and the client.

3. Offer a Loyalty Program
A loyalty program can provide clients with compelling, ongoing reasons to continue banking with your institution. Going a step further, your institution can add different tiers of rewards that incentivize clients to take advantage of each initiative. One great aspect of a loyalty program is that banks can customize it according to clients’ unique needs, creating a personalized offering that resonates with them. As an example, Kasasa Cash and Kasasa Cash Back function as a checking account, plus include monthly rewards like exclusive savings at different stores and restaurants.

4. Provide Enrollment Incentives
To encourage potential clients to sign up with your bank, consider offering exclusive rewards only available for new clients. From exclusive discounts to no sign-up fees, there are many ways banks can provide value up front to people deciding between institutions. For example, Citigroup’s Citibank is giving new clients up to $2,000 when they open a checking account by Jan. 9, 2023.

5. Implement Digital Banking
For banks with ample resources, a digital banking app is a great way to further improve your clients’ experience. Providing a more streamlined way for clients to manage their finances allows your bank to create greater value that other institutions may not be able to offer. Digital banking allows clients to interact with your bank wherever they are, at any time. Some features your bank may want to include are:

● Disposable virtual card.
● Credit card transaction disputes.
● Recurring bills.
● Chatbot support.
● Digital account opening.

Earnings Are High but Bank Stock Prices Are Low

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Banks are doing very well, if you look at credit quality and profitability. But tell that to investors.

Last week, the Federal Open Market Committee raised the target federal funds rate by 75 basis points, the third hike of that magnitude in a row, to combat inflation.

The market has punished equities lately in response, but even more so, bank stocks, probably in anticipation of a recession that may have arrived. The S&P 500 fell 21.61% in 2022 as of Friday, Sept. 23, but the S&P U.S. large cap bank index was down 25.19% in that same time frame, according to Mercer Capital using S&P Global Market Intelligence data. By asset size, large banks have seen the biggest declines so far this year.

Going back further in time, the cumulative return for U.S. bank stocks in general, as measured by the S&P U.S. BMI Banks index, was down 5.30% as of Sept. 22 from the start of 2020, compared to a gain of 21.55% for the S&P 500.

Investors’ dim view of bank stocks belies the underlying strengths of many of these banks. Bank net income of $64.4 billion in the second quarter was higher than it had been in the same quarter of 2018 and 2019, according to the Federal Deposit Insurance Corp. Since 2019, in fact, bank profitability has been going gangbusters. Rising interest rates improved net interest margins, a key profitability statistic for many banks. Plus, loan growth has been good.

And credit quality remains high, as measured by the noncurrent loan and quarterly net charge-off rates at banks, important bank metrics tracked by the FDIC. Despite weaknesses in mortgage and wealth management, this combination of variables has made many banks more profitable than they were in 2018 or 2019.

“Earnings are excellent right now, and they’re going to be even better in the third and fourth quarter as these margins expand,” says Jeff Davis, managing director of Mercer Capital’s financial institutions group.

Investors don’t seem to care. “It’s been a real frustration and a real incongruity between stock prices and what’s going on with fundamentals,” says R. Scott Siefers, managing director and senior research analyst at Piper Sandler & Co. “You’ve had a year of really great revenue growth, and really great profitability, and at least for the time being, that should continue. So that’s the good news. The bad news is, of course, that investors aren’t really as concerned with what’s going on today.”

Worries about a possible recession are sending investors away from bank stocks, even as analysts join Davis in his prediction of a pretty good third and fourth quarter for earnings this year. The reason is that investors view banks as sensitive to the broader economy, Siefers says, and think asset quality will deteriorate and the costs of deposits will rise eventually.

The place to see this play out is in two ratios: price to earnings and price to tangible book value. Interestingly, price to tangible book value ratios have remained strong — probably a function of deteriorating bond values in bank securities’ portfolios, which is bringing down tangible book values in line with falling stock prices. As a result, the average price to tangible book value as of Sept. 23 was 1.86x for large regional bank stocks and 1.7x for banks in the $10 billion to $50 billion asset range, according to Mercer Capital.

Meanwhile, price to earnings ratios are falling. The average price to earnings ratio for the last four quarters was 10.3x for large regional banks, and 11.4x for mid-sized bank stocks. (By way of comparison, the 10-year average for large cap bank stocks was 13.4x and 14.6x for mid cap bank stocks, respectively.)

For bank management teams and the boards that oversee them, the industry is entering a difficult time when decisions about capital management will be crucial. Banks still are seeing loan growth, and for the most part, higher earnings are generating a fair amount of capital, says Rick Childs, a partner at the tax and consulting firm Crowe LLP. But what to do with that capital?

This might be the perfect time to buy back stock, when prices are low, but that depletes capital that might be needed in a recession and such action might be viewed poorly by markets, Childs says. Davis agrees. A lot of companies can’t or won’t buy back their own stock when it’s gotten cheap, he says. “If we don’t have a nasty recession next year, a lot of these stocks are probably pretty good or very good purchases,” he says. “If we have a nasty recession, you’ll wish you had the capital.”

It’s tricky to raise dividends for the same reason. Most banks shy away from cutting dividends, because that would hurt investors, and try to manage to keep the dividend rate consistent, Childs says.

And in terms of lending, banks most certainly will want to continue lending to borrowers with good credit, but may exercise caution when it comes to riskier categories, Davis says. Capital management going forward won’t be easy. “If next year’s nasty, there’s nothing they can do because they’re stuck with what’s on the balance sheet,” he says. The next year or two may prove which bank management teams made the right decisions.

How Credit Unions Pursue Growth

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The nationwide pandemic and persistent economic uncertainty hasn’t slowed the growth of Idaho Central Credit Union.

The credit union is located in Chubbuck, Idaho, a town of 15,600 near the southeast corner, and is one of the fastest growing in the nation. It has nearly tripled in size over the last five years, mostly from organic growth, according to an analysis by CEO Advisory Group of the 50 fastest growing credit unions. It also has some of the highest earnings among credit unions — with a return on average assets of 1.6% last year — an enviable figure, even among banks.

“This is an example of a credit union that is large enough, [say] $6 billion in assets, that they can be dominant in their state and in a lot of small- and medium-sized markets,” says Glenn Christensen, president of CEO Advisory Group, which advises credit unions.

Unsurprisingly, growth and earnings often go hand in hand. Many of the nation’s fastest growing credit unions are also high earners. Size and strength matter in the world of credit unions, as larger credit unions are able to afford the technology that attract and keep members, just like banks need technology to keep customers. These institutions also are able to offer competitive rates and convenience over smaller or less-efficient institutions.

“Economies of scale are real in our industry, and required for credit unions to continue to compete,” says Christensen.

The largest credit unions, indeed, have been taking an ever-larger share of the industry. Deposits at the top 20 credit unions increased 9.5% over the last five years; institutions with below $1 billion in assets grew deposits at 2.4% on average,” says Peter Duffy, managing director at Piper Sandler & Co. who focuses on credit unions.

As of the end of 2019, only 6% of credit unions had more than $1 billion in assets, or 332 out of about 5,200. That 6% represented 70% of the industry’s total deposit shares, Duffy says. Members gravitate to these institutions because they offer what members want: digital banking, convenience and better rates on deposits and loans.

“The only ones that can consistently deliver the best rates, as well as the best technology suites, are the ones with scale,” Duffy says.

Duffy doesn’t think there’s a fixed optimal size for all credit unions. It depends on the market: A credit union in Los Angeles might need $5 billion in assets to compete effectively, while one in Nashville, Tennessee, might need $2 billion.

There are a lot of obstacles to building size and scale in the credit union industry, however. Large mergers in the space are relatively rare compared to banks — and they became even rarer during the coronavirus pandemic. Part of it is a lack of urgency around growth.

“For credit unions, since they don’t have shareholders, they aren’t looking to provide liquidity for shareholders or to get a good price,” says Christensen.

Prospective merger partners face a host of sensitive, difficult questions: Who will be in charge? Which board members will remain? What happens to the staff? What are the goals of the combined organization? What kind of change-in-control agreements are there for executives who lose their jobs?

These social issues can make deals fall apart. Perhaps the sheer difficulty of navigating credit union mergers is one contributor to the nascent trend of credit unions buying banks. A full $6.2 billion of the $27.7 billion in merged credit union assets in the last five years came from banks, Christensen says.

Institutions such as Lakeland, Florida-based MIDFLORIDA Credit Union are buying banks. In 2019, MIDFLORIDA purchased Ocala, Florida-based Community Bank & Trust of Florida, with $743 million in assets, and the Florida assets of $675 million First American Bank. The Fort Dodge, Iowa-based bank was later acquired by GreenState Credit Union in early 2020.

The $5 billion asset MIDFLORIDA was interested in an acquisition to gain more branches, as well as Community Bank & Trust’s treasury management department, which provides financial services to commercial customers.

MIDFLORIDA President Steve Moseley says it’s probably easier to buy a healthy bank than a healthy credit union. “The old saying is, ‘Everything is for sale [for the right price],’” he says. “Credit unions are not for sale.”

Still, despite the difficulties of completing mergers, the most-significant trend shaping the credit union landscape is that the nation’s numerous small institutions are going away. About 3% of credit unions disappear every year, mostly as a result of a merger, says Christensen. He projects that the current level of 5,271 credit unions with an average asset size of $335.6 million will drop to 3,903 credit unions by 2030 — with an average asset size of $1.1 billion.

CEO Advisory Credit Union Industry Consolidation Forecast

The pandemic’s economic uncertainty dropped deal-making activity down to 65 in the first half of 2020, compared to 72 during the same period in 2019 and 90 in the first half of 2018, according to S&P Global Market Intelligence. Still, Christensen and Duffy expect that figure to pick up as credit unions become more comfortable figuring out potential partners’ credit risks.

In the last five years, the fastest growing credit unions that have more than $500 million in assets have been acquirers. Based on deposits, Vibe Credit Union in Novi, Michigan, ranked the fastest growing acquirer above $500 million in assets between 2015 and 2020, according to the analysis by CEO Advisory Group. The $1 billion institution merged with Oakland County Credit Union in 2019.

Gurnee, Illinois-based Consumers Cooperative Credit Union ranked second. The $2.6 billion Consumers has done four mergers in that time, including the 2019 marriage to Andigo Credit Union in Schaumberg, Illinois. Still, much of its growth has been organic.

Canyon State Credit Union in Phoenix, which subsequently changed its name to Copper State Credit Union, and Community First Credit Union in Santa Rosa, California, were the third and fourth fastest growing acquirers in the last five years. Copper State, which has $520 million in assets, recorded a deposit growth rate of 225%. Community First , with $622 million in assets, notched 206%. The average deposit growth rate for all credit unions above $500 million in assets was 57.9%.

CEO Advisory Group Top 50 Fastest Growing Credit Unions

“A number of organizations look to build membership to build scale, so they can continue to invest,” says Rick Childs, a partner in the public accounting and consulting firm Crowe LLP.

Idaho Central is trying to do that mostly organically, becoming the sixth-fastest growing credit union above $500 million in assets. Instead of losing business during a pandemic, loans are growing — particularly mortgages and refinances — as well as auto loans.

“It’s almost counterintuitive,” says Mark Willden, the chief information officer. “Are we apprehensive? Of course we are.”

He points out that unemployment remained relatively low in Idaho, at 6.1% in September, compared to 7.9% nationally. The credit union also participated in the Small Business Administration’s Paycheck Protection Program, lending out about $200 million, which helped grow loans.

Idaho Central is also investing in technology to improve customer service. It launched a new digital account opening platform in January 2020, which allows for automated approvals and offers a way for new members to fund their accounts right away. The credit union also purchased the platform from Temenos and customized the software using an in-house team of developers, software architects and user experience designers. It purchased Salesforce.com customer relationship management software, which gives employees a full view of each member they are serving, reducing wait times and providing better service.

But like Idaho Central, many of the fastest growing institutions aren’t growing through mergers, but organically. And boy, are they growing.

Latino Community Credit Union in Durham, North Carolina, grew assets 178% over the last five years by catering to Spanish-language and immigrant communities. It funds much of that growth with grants and subordinated debt, says Christensen.

Currently, only designated low-income credit unions such as the $536.5 million asset Latino Community can raise secondary capital, such as subordinated debt. But the National Credit Union Administration finalized a rule that goes into effect January 1, 2022, permiting non-low income credit unions to issue subordinated debt to comply with another set of rules. NCUA’s impending risk-based capital requirement would require credit unions to hold total capital equal to 10% of their risk-weighted assets, according to Richard Garabedian, an attorney at Hunton Andrews Kurth. He expects that the proposed rule likely will go into effect in 2021.

Unlike banks, credit unions can’t issue stock to investors. Many institutions use earnings to fuel their growth, and the two measures are closely linked. Easing the restrictions will give them a way to raise secondary capital.

A separate analysis by Piper Sandler’s Duffy of the top 263 credit unions based on share growth, membership growth and return on average assets found that the average top performer grew members by 54% in the last six years, while all other credit unions had an average growth rate of less than 1%.

Many of the fastest growing credit unions also happen to be among the top 25 highest earners, according to a list compiled by Piper Sandler. Among them: Burton, Michigan-based ELGA Credit Union, MIDFLORIDA Credit Union, Vibe and Idaho Central. All of them had a return on average assets of more than 1.5%. That’s no accident.

Top 25 High Performing Credit Unions

Credit unions above $1 billion in assets have a median return on average assets of 0.94%, compared to 0.49% for those below $1 billion in assets. Of the top 25 credit unions with the highest return on average assets in 2019, only a handful were below $1 billion in assets, according to Duffy.

Duffy frequently talks about the divide between credit unions that have forward momentum on growth and earnings and those who do not. Those who do not are “not going to be able, and have not been able, to keep up.”

AMERIBOR Benchmark Offers Options for Bank Capital Raises

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Banks that belong to the American Financial Exchange (AFX) are not waiting until 2021 to make the switch away from the troubled London Interbank Offered Rate, or LIBOR, interest rate benchmark for pricing their offerings in the capital markets.

These institutions, which represent $3 trillion in assets and more than 20% of the U.S. banking sector, are using AMERIBOR® to price debt offerings now. They say AMERIBOR®, an unsecured benchmark, better reflects the cost of funds as represented by real transactions in a centralized, regulated and transparent marketplace. The benchmark has been used to price loans, deposits, futures and now debt — a critical step in a new benchmark’s development and financial innovation.

In October, New York-based Signature Bank announced the closing of $375 million aggregate principal amount of fixed-to-floating rate subordinated notes due in 2030 — the first use of AMERIBOR® in a debt deal. The notes will bear interest at 4% per annum, payable semi-annually. For the floating component, interest on the notes will accrue at three-month AMERIBOR® plus 389 basis points. The offering was handled by Keefe Bruyette & Woods and Piper Sandler. The transaction was finalized the first week of October 2020.

Signature Bank Chairman Scott Shay highlighted the $63 billion bank’s involvement as a “founder and supporter” of AFX.
“We are pleased to be the first institution to use AMERIBOR® on a debt issuance. … AMERIBOR is transparent, self-regulated and transaction-based, and we believe that it is already a suitable alternative as banks and other financial institutions transition away from LIBOR,” Shay said.

The inaugural incorporation of AMERIBOR® in a debt offering paves the way for more debt deals and other types of financial products linked to the benchmark. The issuance adds to the list of U.S. banks that have already pegged new loans to the rate, including Birmingham, Alabama-based ServicFirst Bancshares, Boston-based Brookline Bancorp and San Antonio-based Cullen/Frost Bankers. As AFX adds to deposits, loans and fixed income linked to AMERIBOR, the next risk transfer instrument up for issuance will be a swap deal.

Banks of all sizes have options to choose from when it comes to an interest rate benchmark best suited to their specific requirements. AMERIBOR® was developed for member banks and others that borrow and lend on an unsecured basis. Currently, AFX membership across the U.S. includes 162 banks, 1,000 correspondent banks and 43 non-banks, including insurance companies, broker-dealers, private equity firms, hedge funds, futures commission merchants and asset managers.

This article does not constitute an offer to sell or a solicitation of an offer to buy the notes, nor shall there be any offer, solicitation or sale of any notes in any jurisdiction in which such offer, solicitation or sale would be unlawful.

Balance Sheet Opportunities Create Path to Outperformance

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How important is net interest margin (NIM) to your institution?

In 2019, banks nationally were 87% dependent on net interest income. With the lion’s share of earnings coming from NIM, implementing a disciplined approach around margin management will mean the difference between underperforming institutions and outperforming ones. (To see how your institution ranks versus national and in-state peers, click here.)

Anticipating the next steps a bank should take to protect or improve its profitability will become increasingly difficult as they manage balance sheet risks and margin pressure. Cash positions are growing with record deposit inflows, pricing on meager loan demand is ultra-competitive and many institutions are experiencing accelerated cash flows from investment portfolios.

It is also important to remember that stress testing the balance sheet is no longer an academic exercise. Beyond the risk management, stressing the durability of capital and resiliency of liquidity can give your institution the confidence necessary to execute on strategies to improve performance and to stay ahead of peers. It is of heightened importance to maintain focus on the four major balance sheet position discussed below.

Capital Assessment, Position
Capital serves as the cornerstone for all balance sheets, supporting growth, absorbing losses and providing resources to seize opportunities. Most importantly, capital serves as a last line of defense, protecting against risk of the known and the unknown.

The rapid changes occurring within the economy are not wholly cyclical in nature; rather, structural shifts will develop as consumer behavior evolves and business operations adjust to the ‘next normal.’ Knowing the breaking points for your capital base — in terms of growth, credit deterioration and a combination of these factors — will serve your institution well.

Liquidity Assessment, Position
Asset quality deterioration leads to capital erosion, which leads to liquidity evaporation. With institutions reporting record deposit growth and swelling cash balances, understanding how access to a variety of funding sources can change, given asset quality deterioration or capital pressure, is critical to evaluating the adequacy of your comprehensive liquidity position.

Interest Rate Risk Assessment, Position
In today’s ultra-low rate environment, pressure on earning asset yields is compounded by funding costs already nearing historically low levels. Excess cash is expensive; significant asset sensitivity represents an opportunity cost as the central bank forecasts a low-rate environment for the foreseeable future. Focus on adjusting your asset mix — not only to improve your earnings today, but to sustain it with higher, stable-earning asset yields over time.

Additionally, revisit critical model assumptions to ensure that your assumptions are reflective of actual pricing behaviors, including new volume rate floors and deposit betas, as they may be too high for certain categories.

Investment Assessment, Position
Strategies for investment portfolios including cash can make a meaningful contribution to your institution’s overall interest income. Some key considerations to help guide the investment process in today’s challenging environment include:

  • Cost of carrying excess cash has increased: Most institutions are now earning 0.1% or less on their overnight funds, but there are alternatives to increasing income on short-term liquidity.
  • Consider pre-investing: Many institutions have been very busy with Paycheck Protection Program loans, and we anticipate this will have a short-term impact on liquidity and resources. Currently, spreads are still attractive in select sectors of the market.

Taylor Advisors’ Take:
Moving into 2021, liquidity and capital are taking center stage in most community banks’ asset-liability committee discussions. Moving away from regulatory appeasement and towards proactive planning and decision-making are of paramount importance. This can start with upgrading your bank’s tools and policies, improving your ability to interpret and communicate the results and implementing actionable strategies.

Truly understanding your balance sheet positions is critical before implementing balance sheet management strategies. You must know where you are to know where you want to go. Start by studying your latest quarterly data. Dissect your NIM and understand why your earning asset yields are above or below peer. Balance sheet management is about driving unique strategies and tailored risk management practices to outperform; anything less will lead to sub-optimal results.

Finding Opportunities in 2021

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Will deal volume pick up pace in 2021? Despite credit concerns and negotiation hurdles, Stinson LLP Partner Adam Maier predicts a stronger appetite for deals — but adds that potential acquirers will have to be aggressive in pursuing targets that align with their strategic goals.

  • Predictions for 2021
  • Capital Considerations
  • Regulatory Hurdles to Growth

Community Banks Are Buying Back Stock. Should You?

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Banks are making lemonade out of investors’ lemons — in the form of buybacks.

Fears about how the coronavirus will impact financial institutions has depressed bank valuations. A number of community banks have responded by announcing that they’ll buy back stock.

Bank Director reached out to Eric Corrigan, senior managing director at Commerce Street Capital, to talk about why this is happening.

The Community Bank Bidder
Much of the current buyback activity is driven by community banks with small market capitalizations. The median market cap of banks announcing new buybacks now is $64 million, compared to a median of $377 million for 2019, according to an Aug. 27 report from Janney Montgomery Scott.

One reason community banks might be buying back stock now is that their illiquid shares lack a natural bidder — a situation exacerbated by widespread selling pressure, Corrigan says. By stepping in to buy its own stock, a bank can help offset the absence of demand.

“You can help support it or at least mitigate some of the downward pressure, and it doesn’t take a lot of dollars to do that,” he says.

Buybacks Are Accretive to Tangible Book Value
Many bank stocks are still trading below tangible book value. That makes share buybacks immediately accretive in terms of both earnings per share and tangible book value.

“If you can buy your stock below book value, it’s a really attractive financial trade. You are doing the right thing for shareholders, you’re supporting the price of the stock, and financially it’s a good move,” Corrigan says.

Buying Flexibility
Share buyback announcements are a statement of intention, not a promise chiseled in stone. Compared to dividends, buybacks offer executives the flexibility to stop repurchasing stock without raising concerns in the market.

“If you announce a buyback, you can end up two years later with exactly zero shares bought,” Corrigan says. “But you signaled that you’re willing, at a certain price under certain circumstances, to go out there and support the stock.”

Buybacks Follow Balance Sheet Bulk-Up
Many of the nation’s largest banks are under buyback moratoriums intended to preserve capital, following the results of a special stress test run by the Federal Reserve. Banks considering buybacks should first ensure their balance sheets are resilient and loan loss provisions are robust before committing their capital.

“I think a rule around dividends or buybacks that’s tied to some trailing four-quarter performance is not the worst thing in the world,” he says. “The last thing you want to do is buy stock at $40 and have to issue it at $20 because you’re in a pinch and need the equity back.”

Many of the banks announcing repurchase authorizations tend to have higher capital levels than the rest of the industry, Janney found. The median total common equity ratio for banks initiating buybacks in 2020 is about 9.5%, compared to 9.1% for all banks.

Why a Buyback at All?
A stock price that’s below the tangible book value can have wide-ranging implications for a bank, impacting everything from a bank’s ability to participate in mergers and acquisitions to attracting and retaining talent, Corrigan says.

Depressed share prices can make acquisitions more expensive and dilutive, and make potential acquirers less attractive to sellers. A low price can demoralize employees receiving stock compensation who use price as a performance benchmark, and it can make share issuances to fund compensation plans more expensive. It can even result in a bank taking a goodwill impairment charge, which can result in an earnings loss.

Selected Recent Share Repurchase Announcements

Bank Name Location, Size Date, Program Type Allocation Details
Crazy Woman Creek Bancorp Buffalo, Wyoming
$138 million		 Aug. 18, 2020
Authorization		 3,000 outstanding shares,
or ~15% of common stock
PCSB Financial Corp. Yorktown Heights, New York
$1.8 billion		 Aug. 20, 2020
Authorization		 Up to 844,907 shares, or
5% of outstanding common stock
First Interstate BancSystem Billings, Montana
$16.5 billion		 Aug. 21, 2020
Lifted suspended program		 Purchase up to the remaining
~1.45 million shares
Red River Bancshares Alexandria, Louisiana
$2.4 billion		 Aug. 27, 2020
Authorization		 Up to $3 million of outstanding shares
Investar Holding Corp. Baton Rouge, Louisiana
$2.6 billion		 Aug. 27, 2020
Additional allocation		 An additional 300,000 shares,
or ~3% of outstanding stock
Eagle Bancorp Montana Helena, Montana
$9.8 billion		 Aug. 28, 2020
Authorization		 100,000 shares,
~1.47% of outstanding stock
Home Bancorp Lafayette, Louisiana
$2.6 billion		 Aug. 31, 2020
Authorization		 Up to 444,000 shares,
or ~5% of outstanding stock
Mid-Southern Bancorp Salem, Indiana
$217 million		 Aug. 31, 2020
Additional allocation		 Additional 162,000 shares,
~5% of the outstanding stock
Shore Bancshares Eston, Maryland
$1.7 billion		 Sept. 1, 2020
Restatement of program		 Has ~$5.5 million remaining
of original authorization
HarborOne Bancorp Brockton, Massachusetts
$4.5 billion		 Sept. 3, 2020
Authorization		 Up to 2.9 million  shares,
~5% of outstanding shares

Source: Company releases

Banks Tap Capital Markets to Raise Pandemic Capital

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Capital markets are open — for now — and community banks have taken note.

The coronavirus pandemic and recession have created an attractive environment for banks to raise certain types of capital. Executives bracing for a potentially years-long recession are asking themselves how much capital their bank will need to guard against low earnings prospects, higher credit costs and unforeseen strategic opportunities. For a number of banks, their response has been to raise capital.

A number of banks are taking advantage of interested investors and relatively low pricing to pad existing capital levels with new funds. Other banks may want to consider striking the markets with their own offerings while the iron is hot. Most of the raises to-date have been subordinated debt or preferred equity, as executives try to avoid diluting shareholders and tangible book value with common equity raises while they can.

“I think a lot of this capital raising is done because they can: The markets are open, the pricing is attractive and investors are open to the concept, so do it,” says Christopher Marinac, director of research at Janney Montgomery Scott. “Banks are in survival mode right now. Having more capital is preferred over less. Hoarding capital is most likely going to be the norm — even if it’s not stated expressly — that’s de facto what they’re doing.”

Shore Bancshares’ CEO Lloyd “Scott” Beatty, Jr. said the bank is “cautiously optimistic” that credit issues will not be as dire as predicted. But because no one knows how the recession will play out, the bank decided to raise “safety capital” — $25 million in subordinated debt. The raise will grow the bank’s Tier 2 capital and boost overall risk-based capital from 14.1% to about 16%, according to analysts.

“If credit issues do not develop, we will be in a position to use this capital offensively in a number of ways to improve shareholder value,” Beatty said in the Aug. 8 release.

That mindset resonates with Rick Weiss, managing director at PNC’s Financial Institutions Group, who started his career as a regulator at the U.S. Securities and Exchange Commission.

“I’ve never seen capital I haven’t liked,” he says. “I feel safer [when banks have higher] capital — in addition to avoiding any regulatory problems, especially in a bad economy, it gives you more flexibility with M&A, expanding your business, developing new lines, paying dividends, doing buybacks. It allows you to keep the door open.”

Raising capital is especially important for banks with thinner cushions. Republic First Bancorp raised $50 million in convertible preferred equity on Aug. 27 — a move that Frank Schiraldi, managing director at Piper Sandler & Co., called a “positive, and necessary, development.” The bank had capital levels that were “well below peers” and was on a significant growth trajectory prior to the pandemic. This raise boosts tangible common equity and Tier 1 capital by 100 basis points, assuming the conversion.

Banks are also taking advantage of current investor interest to raise capital at attractive interest rates. At least three banks were able to raise $100 million or more in subordinated offers in August at rates under 5%.

Lower pricing can also mean refinancing opportunities for banks carrying higher-cost debt; effortlessly shaving off basis points of interest can translate into crucial cost savings at a time when all institutions are trying to control costs. Atlantic Capital Bancshares stands to recoup an extra $25 million after refinancing existing debt that was about to reset to a more-expensive rate, according to a note from Stephen Scouten, a managing director at Piper Sandler. The bank raised $75 million of sub debt that carried a fixed-to-floating rate of 5.5% on Aug. 20.

Selected Capital Raises in August

Name Location, size Date, Type Amount, Rate
WesBanco Wheeling, West Virginia $16.8 billion Aug. 4, 2020
Preferred equity		 $150 million 6.75%
Crazy Woman Creek  Bancorp Buffalo, Wyoming
$138 million		 Aug. 18, 2020 Subordinated debt $2 million 5% fixed to floating
Republic First Bancorp Philadelphia, Pennsylvania
$4.4 billion		 Aug. 19, 2020 Preferred equity $50 million 7% convertible
Atlantic Capital Bancshares Atlanta, Georgia
$2.9 billion		 Aug. 20, 2020 Subordinated debt $75 million 5.5% fixed to floating
CNB Financial Clearfield, Pennsylvania
$4.5 billion		 Aug. 20, 2020 Preferred equity $60.4 million* 7.125%
Park National Co.       Newark, Ohio
$9.7 billion		 Aug. 20, 2020 Subordinated debt $175 million 4.5% fixed to floating
Southern National Bancorp of Virginia McLean, Virginia
$3.1 billion 		 Aug. 25, 2020** Subordinated debt $60 million 5.4% fixed to floating
Shore Bancshares Easton, Maryland
$1.7 billion		 Aug. 25, 2020 Subordinated debt $25 million 5.375% fixed to floating
Citizens Community Bancorp Eau Claire, Wisconsin $1.6 billion Aug. 27, 2020 Subordinated debt $15 million 6% fixed to floating
FB Financial Nashville, Tennessee $7.3 billion Aug. 31, 2020 Subordinated debt $100 million 4.5% fixed to floating
Renasant Corp. Tupelo, Mississippi
$14.9 billion		 Aug. 31, 2020 Subordinated debt $100 million 4.5% fixed to floating

*Company specified this figure is gross and includes the full allotment exercised by the underwriters.
**Date offering closed
Source: company press releases