How Credit Unions Pursue Growth

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

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

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

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?

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

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

How Nonbank Lenders’ Small Business Encroachment Threatens Community Banks

A new trend has emerged as small businesses across the U.S. seek capital to ensure their survival through the Covid-19 pandemic: a significantly more crowded and competitive market for small business lending. 

Community banks are best-equipped to meet the capital needs of small businesses due to existing relationships and the ability to offer lower interest rates. However, many banks lack the ability to deliver that capital efficiently, meaning:

  • Application approval rates are low; 
  • Customer satisfaction suffers;  
  • Both the bank and small business waste time and resources; 
  • Small businesses seek capital elsewhere — often at higher rates. 

When community banks do approve small credit requests, they almost always lose money due to the high cost of underwriting and servicing them. But the real risk to community banks is that large players like Amazon.com and Goldman Sachs Group are threatening to edge them out of the market for small business lending. At stake is nothing less than their entire small business relationships.

Over the past few years, nonbank fintechs have infiltrated both consumer and business banking, bringing convenience and digital delivery to the forefront. Owners of small businesses can easily apply for capital online and manage their finances digitally.

Yet in 2018, only 11% of small banks had a digital origination channel for small business lending. In an age of smartphones, community banks still heavily rely on manual, paper-based processes for originating, underwriting and servicing small business loans. 

It was no surprise, then, when Amazon and Goldman Sachs announced a lending partnership geared toward third-party merchants using the retail giant’s platform. Soon, invited businesses can apply for a revolving line of credit with a fixed APR. Other major companies like Apple and Alphabet’s Google have also debuted innovative fintech products for consumers —it’s only a matter of time before they make headway into the small business space.

A 2016 Well Fargo survey found that small business owners are willing to pay more for products and services that make their lives easier. It makes sense that an independent retailer that already sells on Amazon would be more inclined to work with a lender that integrates directly into the platform. If your small business lending program isn’t fully online, customers will take the path of least resistance and work with institutions that make the process easier and more seamless.

Serving small business borrowers better
The issue isn’t that small businesses lack creditworthiness as prospective customers. Rather, it’s that the process is stacked against them. Small businesses aren’t large corporations, but many banks apply the same process and requirements for small credit requests as they do for commercial loans, including collecting and reviewing sophisticated financials. This eliminates any chance of profit on small credit requests. The problem is with the bank’s process — not its borrowers.

The solution is clear cut:

  • Digitize the lending process so customers don’t have to take time out of their busy day to visit a branch or speak with a loan officer. Note that this includes more than just an online application. The ability to collect/manage documents, present loans offers, provide e-contracts and manage payments are all part of a digitally-enabled lending process.
  • Incorporate SMB-specific credit criteria that accurately assess creditworthiness more effectively, like real-time cash flow and consumer sentiment.
  • Take advantage of automation without giving up control or increasing risk. For example, client notifications, scoring and application workflow management are all easy ways to save time and cut costs.
  • Free up lending officers to spend more time with your most-profitable commercial customers.

These changes can help turn small business customers into an important, profitable part of your bank. After all, 99% of all U.S. businesses are considered “small” — so the ability to turn a profit on small business lending represents significant upside for your bank. 

With better technology and data, along with a more flexible process, community banks can sufficiently reduce the cost of extending capital to small businesses and turn a profit on every loan funded. Next, banks can market their small business loan products to existing business customers in the form of pre-approved loan offers, and even gain new business customers from competitors that push small business borrowers away. 

Think about it: small business customers already have a deposit relationship at your bank. Community banks have this advantage over the likes of Amazon, Goldman Sachs, Apple and others. But when time is limited, small businesses won’t see it that way. By rethinking your small business lending process, it’s a win for your bank’s bottom line as well as a win in customer loyalty.

The Opportunistic Upside of New Capital Rules

Looming new capital rules are an opportunity for banks to improve strategic planning and data management as they strengthen their compliance and reporting processes.

The coronavirus pandemic has delayed deadlines for complying with the latest round of capital guidelines dictated by Basel IV. Still, financial institutions should not lose sight of the importance of preparing for Basel IV, the difficulties it will create along the way and the ways they can leverage it as a potential asset. Compliance and implementation may be a significant expenditure for your bank. Starting now will lengthen your institution’s path to greater productivity and profitability to become a better bank, not just a more compliant one.

At Wolters Kluwer, we broke down the task — and opportunity — at hand for banks as they approach Basel IV compliance in our new whitepaper “Basel IV – Your Path to a more Profitable Business.” Here are some of the highlights for your bank:

Making Basel IV For Business
Where there is a will — along with the right tools — there’s a way to leverage the work required to comply with Basel IV for other commercial objectives. The new capital rules emphasize using forward-looking analysis, a holistic, collaborative organizational structure and data management capabilities for compliance and reporting purposes. These tools can all be leveraged for strategic planning and other commercial objectives, reducing or controlling long-term expenses while enhancing efficiency.

Central to this approach, however, is adopting the right attitude and approach. Executives should view Basel IV compliance as a potential asset, not just a liability, and be willing to make changes to the structure of operations and supporting data management systems.

A Familiar Approach
Basel IV is not a monolithic set of edicts; instead, it’s a package of regulatory regimens through which the Basel Committee on Banking Supervision’s guidelines will be put into practice. These measures are actually the final version of the Basel III guidelines issued in 2010 but were seen as such an expansion of what came before as to be thought of as an entirely new program. It contains elements that encourage and even require banks to act in ways that enhance business practices, not just compliance.

One element is the mandate for a holistic, collaborative approach to compliance. All functions within an institution must work in concert with one another, to create a data-driven, dynamic, three-dimensional view of the world. Another point of emphasis is the importance of prospective thinking: anticipating events from a range of alternatives, instead of accumulating and analyzing data that shows only the present state of play.

“What now?” to “What if?”
Banks can use Basel’s compliance and reporting data for business intelligence and strategic planning. Compliance efforts that have been satisfactorily implemented and disseminated allow  executives to create dynamic simulations displaying prospective outcomes under a range of scenarios.

The possibilities of leveraging Basel IV for business extends to the individual deal level. Calculations and analysis used for compliance can be easily repurposed to forecast the rewards and risks of a deal under a range of financial and economic scenarios whose probabilities themselves can be approximated. And because a firm’s risk models already will have been vetted in meeting Basel IV compliance standards, bankers can be confident that the results produced in the deal evaluation will be robust and reliable.

Another big-picture use of Basel IV for business is balance sheet optimization: forecasting the best balance sheet size for a given risk appetite. This can show the board opportunities that increase risk slightly but obtain far more profit, or sacrifice a bit of income to substantially reduce risk.

To turn Basel IV’s potential for business into practice requires openness and communication from senior executives to the key personnel who will have to work together to bring the plan to fruition. It will mean adopting a mindset that considers each decision, from the details of individual deals to strategic planning, along with its likely impact. Staff must also be supported by similarly structured data management architecture.

The emphasis on forward-looking analysis and a holistic, collaborative organizational structure for compliance and reporting purposes, supported by data management capabilities designed along the same lines, can be leveraged for strategic planning and other commercial objectives. Success in streamlining operations and maximizing productivity and profit potential, and any edge gained over the competition, can reap especially great long-term rewards when achieved at times like these. Leaders of financial institutions have a lot on their minds these days, but there is a persuasive case to be made right now for seizing the opportunity presented by Basel IV for business.

Opportunity Emerges from Coronavirus Crisis

The banking industry has experienced shocks and recessions before, but this one is different.

Never has the economy been shut so quickly, has unemployment risen so fast or the recovery been so uncertain. The individual health risks that consumers are willing to take to create demand for goods and services will drive the recovery. As we weigh personal health and economic health, banking communities and their customers hang in the balance.

Ongoing economic distress will vary by market but the impact will be felt nationwide. Credit quality will vary by industry; certain industries will recover more quickly, while others like hotels, restaurants, airlines and anything involving the gathering of large crowds will likely need the release of a coronavirus vaccine to fully recover. As more employees work from home, commercial office property may never be the same. While this pandemic is different from other crises, some principles from prior experience are worth consideration as bankers manage through this environment.

Balance sheet over income statement. In a crisis, returns, margins and operating efficiency — which often indicate performance and compensation in a strong economy — should take a back seat to balance sheet strength and stability. A strong allowance, good credit quality, ample liquidity and prudent asset-liability management must take priority.

Quality over quantity. Growth can wait until the storm has passed. Focus on the quality of new business. In a flat yield curve and shrinking margin environment, resist the thinking that more volume can compensate for tighter spread. Great loans to great customers are being made at lower and lower rates; if the pie’s not growing, banks will need to steal business from each other via price in a race to the bottom. Value strong relationships and ask for pricing that compensates for risk. Resist marginal business on suspect terms and keep dry powder for core investments in the community.

Capital is king. It’s a simple concept, but important in a crisis. Allocate capital to the most productive assets, hold more capital rather than less and build capital early. A mistake banks made in prior crises was underestimating their capital need and waiting too long to build or raise capital. Repurchasing shares seems tempting at current valuations, but the capital may be more valuable internally. Some banks may consider cutting or suspend common stock dividends, but are fearful of condemnation in the market. The cost of carrying too much capital right now is modest compared to the cost of not having enough — for credit losses but equally for growth opportunity during the recovery.

The market here serves as the eye of the storm. The front edge of the storm saw the closure of the economy, concern for family, friends and staff and community outreach with the Paycheck Protection Program (PPP), not once but twice. Now settles in the calm. Banks have deployed capital, the infection rate is slowing and small businesses are trying to open up. But don’t mistake this period for the storm being over. There is a back edge of the storm that may occur in the fall: the end of enhanced unemployment insurance benefits, the exhaustion (and hopefully forgiveness) of PPP funds and the expiration of forbearance. Industries that require a strong summer travel and vacation season will either recover or struggle further. And any new government stimulus will prolong the inevitable as a bandage on a larger wound. Banks may see credit losses that rival the highest levels recorded during the Great Recession. Unemployment that hits Great Depression-era levels will take years to fully recover.

But from crisis comes opportunity. Anecdotal evidence suggests that business may shift back to community banks. When markets are strong, pricing power, broad distribution and leading edge technology attract consumers to larger institutions. In periods of distress, however, customers are reminded of the strength of human relationships. Some small businesses found it difficult to access the PPP because they were a number in a queue at a larger bank or were unbanked without a relationship at all. Consumers that may have found it easy to originate their mortgage online had difficulty figuring out who was looking out for them when they couldn’t make their payment. In contrast, those that had a banking relationship and someone specific to call for help generally had a positive experience.

This devastating crisis will be a defining moment for community banks, as businesses and consumers have new appreciation for the value of the personal banking relationship. Having the strength, capital, brand and momentum to take advantage of the opportunity will depend on the prudence and risk management that these same banks navigate the pandemic-driven downturn today.

Texas Strong: Banks Contend With Dual Threats

“Texas has four seasons: drought, flood, blizzard and twister.” – Anonymous

To that list of afflictions you can add two more — the Covid-19 pandemic and a catastrophic collapse in global oil prices, creating double trouble for the Lone Star State.

There were over 50,500 coronavirus cases in Texas through May 20, an average of 174 per 100,000 people, according to the Center for Systems Science and Engineering at Johns Hopkins University. There were nearly 1,400 coronavirus-related deaths in the state.

In mid-March, Texas Gov. Greg Abbott imposed restrictions that limited social gatherings to 10 people or less, and effectively closed close-proximity businesses like restaurants and bars, health clubs and tattoo parlors. Even as Abbott reopens the state’s economy, many of its small businesses have already been hurt, along with many lodging and entertainment concerns.

Shutting down the economy was probably a good health decision,” says F. Scott Dueser, chairman and CEO at $9.7 billion First Financial Bankshares in Abilene, Texas. “It wasn’t a good economic decision.”

And then there’s oil situation. An oil price war between two major producers — Russia and Saudi Arabia — helped drive down the price of West Texas Intermediate crude from over $60 per barrel in January to less than $12 in late April, before rebounding to approximately $32 currently.

Texas still runs on oil; while it is less dependent on the energy sector than in past cycles, its importance “permeates” the state’s economy, according to Dueser. “It is a major industry and is of great concern for all of us,” he says.

The 65-year-old Dueser has been First Financial’s CEO since 2008, and guided the bank successfully through the Great Recession. “I thought I’d be retired by the next recession but unfortunately, we weren’t planning on a pandemic and it has come faster than I thought,” Dueser says.

This downturn could be as bad or worse as the last one. But so far, damage to First Financial’s profitability from the combined effects of the pandemic and cheap oil has been minor. The bank’s first quarter earnings were off just 2.6% year over year, to $37 million. Like most banks, First Financial has negotiated loan modifications with many of its commercial borrowers that defer repayment of principal and/or interest for 90 days.

Dueser won’t know until the expiration of those agreements how many borrowers can begin making payments, and for how much — clouding the bank’s risk exposure for now. But with a Tier 1 capital ratio over 19%, Dueser has the comfort of a fortress balance sheet.

“We unfortunately have been down this road before … and capital is king because it’s what gets you through these times,” he says.

Dueser made a decision early in the pandemic that as much as possible, the bank would remain open for business. It encouraged customers to use branch drive-thru lanes, but lobbies have remained open as well.

“So far we have been very successful here at the bank in staying open, not locking our doors, not limiting hours, keeping our people safe and at the same time serving more customers than we ever have in the history of the bank,” Dueser says.     

The bank has followed Covid-19 safety requirements from the Center for Disease Control. “The most important things are don’t let your people come to work sick and social distancing,” Dueser says. “We split every department, such as technology, phone center, treasury management and so on with having half the department work from home or from another one of our locations. That way we had only half the people here, which allowed us to put people in every other desk or cubicle.”

To date, the bank has had only four Covid-19 cases among its employees. “Thankfully, all four of those individuals are healthy and back at work,” Dueser says. “With each situation we learn more on how to protect our employees and customers.”

Dueser is one of 39 people on a task force appointed by Abbott to advise him on reopening the state’s economy. “I am very supportive of what he is doing, in the fact that we are getting the state back open,” he says. “The virus is not winning the war, which is good. We have a lot to learn so that we can live with the virus without having to go home and hide in a closet.”

One of Dueser’s biggest priorities through the economic hardship was to make sure retail and commercial customers knew that it would stand by them, come what may. That led to a recent marketing campaign designed around the phrase “Texas Strong,” a slogan used throughout the state that traces back to Hurricane Harvey, which devastated Houston in 2017.

“We want our customers to know that we’re safe, sound and strong,” says Will Christoferson, the bank’s senior vice president for advertising and marketing. “What’s stronger than Texas? We couldn’t think of anything.”