5 Principles to Improve Financial Benchmarking

In financial analysis, the question of “How are we doing?” should almost always be answered with “Compared to what?”

As directors prepare for year-end meetings, there are a number of key ways executives and directors can improve the bank’s approach to benchmarking. A focused program can decrease workload, reduce information overload and yield strategic insight. Here are five ways banks can start.

1. Reconsider Your Peers
Most bank directors are familiar with the national asset-based peer groups featured in Federal Deposit Insurance Corp.’s Uniform Bank Performance Report, or UBPRs. These peer groups can serve an important purpose when it comes to macro-prudential purposes (such as regulatory monitoring for safety and soundness within the entire banking system). But for bankers trying to extract value from this data, we recommend looking beyond asset sizes toward more relevant factors such as geography, funding strategy and lending portfolio.

2. Look Toward Leaders, Not Averages
Being above average is not the same thing as being a leader. Rather than compare themselves against the mean or median, banks should be more focused on how they stack up to the best of their peers. If they want to set realistic goals for high performance, boards should first understand what excellence looks like across a relevant set of bank peers.

3. Use Multiple Peer Groups
It’s rare that a bank can be purely labeled as an agricultural or commercial or industrial lender, or something similar. By design, most community banks have a balanced and diversified portfolio of loans and services. The same can be said for funding sources, risk tolerances, investments and fiduciary activities, among others. Despite these complexities, many banks tend to benchmark themselves against a single, universal peer group. Executives may find it more productive and insightful to use multiple, targeted peer groups, depending on the context of the analysis.

4. Add Context to Trends
Trend charts are a powerful way to monitor for constant improvement — but they only tell half of the story. Many bankers will close out 2021 celebrating a much deserved “record year;” a smaller group of insightful executives will pause to consider their stellar results in the context of the entire sector’s stellar results. Nearly every bank has been excelling at growing the portfolio, capturing fee income and improving efficiency ratios. Prudent directors should ask for additional context.

5. Limit the Scope
Since Qaravan’s inception in 2014, we have helped hundreds of banks pull together board packs, dashboards, decks, report cards and all sorts of other financial reports. The biggest challenge our clients encounter in this process is the information overload they inflict on the report recipients. In a sincere attempt to arm directors with as much information as possible, bank management ends up sending the board an overwhelming amount of data. Pulling these “kitchen sink” reports together is not easy, and it takes bank staff away from more important things. Directors can help minimize the inefficiencies associated with these data calls by encouraging a more focused review of key performance benchmarks.

To learn more, visit https://www.qaravan.com/.

Can Boards Be a Technology Resource for Their Bank?

Just 29% of chief executives, and 17% of chief information and chief technology officers, say they rely on members of their board for information about technology’s impact on their institution, according to Bank Director’s 2021 Technology Survey. But what if a bank could leverage their board as a resource on this issue, helping to connect the dots between technology and its overall strategy?

Coastal Financial Corp., based in Everett, Washington, has brought on board members over the past three years with experience working in and supporting the digital sector: Sadhana Akella-Mishra, chief risk officer at the core provider Finxact; Stephan Klee, chief financial officer at the venture capital firm Portage Ventures and former CFO of Zenbanx, a fintech acquired by SoFi in 2017; Rilla Delorier, a retired bank executive who until last year led digital transformation at Umpqua Bank; and Pamela Unger, a certified public accountant who created software to support her work with venture capital firms. That deep bench of technology expertise helps the bank evolve, according to CEO Eric Sprink, by better understanding opportunities and risks. The board can even help $2 billion Coastal identify and bring on staff.

“The board has always been entrepreneurial at its basis, and some of the core values that we developed as a board were, be flexible, be unbankey and live in the gray — and those are [our] board values,” Sprink says. “We’ve really worked hard to continually ask people to join our board that continue that evolution and entrepreneurial spirit with some specialty that they bring.”

Bank Director’s recent Technology Survey finds that roughly half of bank boards discuss technology at every board meeting; another 30% make sure it’s a quarterly agenda item. That’s been the picture for several years in our survey, given technology’s importance in an increasingly digital economy.

But for many community bank boards, the expertise reflected in the boardroom hasn’t caught up to today’s reality — just 49% of board members and executives representing a bank smaller than $10 billion in assets report that their board has a director with a background or expertise in technology. And these skills are even rarer for discrete areas affecting bank strategies and operations, from cybersecurity (25% say they have such an expert on their board) to digital transformation (20%) and data analytics (16%).

Bank boards would benefit greatly from this expertise — and many of them know it, says J. Scott Petty, a partner at the executive search firm Chartwell Partners. “When I interview boards and we go through an assessment process, it’s always the No. 1 thing they talk about,” he says. “There’s no one there [who] can really understand what their head of technology is talking about. So, whatever they say, they go, ‘OK, well, you’re the tech expert.’”

In Bank Director’s 2021 Governance Best Practices Survey conducted earlier this year, board members identify their two most vital functions: holding management accountable for achieving strategic goals in a safe and sound manner, and meeting the board’s fiduciary responsibilities to shareholders.

If board members can’t pose a credible challenge to management when it comes to discussions on technology — asking pointed questions about a rising budget item for the majority of banks, as our recent research finds — then they can’t effectively fulfill their two most important duties. And boards also will find themselves unable to contribute to the bank’s strategy in the way they could or should.

Directors with technology expertise can help boards provide effective oversight and link technology and strategy, says Petty. “That’s the No. 1 [thing] — that fiduciary responsibility to really understand how the bank [aligns] its business strategy with its technology strategy.”

Petty shares a comprehensive list that identifies how technology expertise in the boardroom can contribute to the board’s oversight and strategic functions. These include:

  • Linking technology to the overall business strategy
  • Asking incisive questions of the bank’s CIO and/or CTO, and holding them accountable for goals, deadlines and budgets
  • Providing effective oversight of information security as well as Bank Secrecy Act/anti-money laundering (BSA/AML) compliance
  • Offering input and guidance on the bank’s technology initiatives
  • Giving feedback on innovation, customer experience and acquisition, product development, digital integration, cross-selling opportunities and similar areas

Asking pointed questions and deliberating about these technology matters isn’t just a fiduciary responsibility — it makes banks better, points out Jeff Marsico, president of The Kafafian Group, a consulting firm. Technology use by the industry isn’t new, he notes, but community bank boardrooms are typically composed of older members who will be inherently less tapped into what’s going on in the digital banking space. As a result, “they don’t have enough base knowledge to be challenging to management and therefore management knows, ‘I’m not going to be particularly challenged here,’” Marsico says. “[Boards] need somebody with enough knowledge to be able to challenge management — because then management gets better.”

Marsico sees flaws in most boards’ often-informal nomination processes. Performance evaluations, he notes, aren’t adequately used by the industry to identify gaps in board composition, and board members are often reticent to leave. Bank Director’s governance research backs this up, finding that roughly half of boards representing banks between $1 billion and $10 billion in assets conduct an annual performance assessment; that drops to 23% of boards below $1 billion in assets. Fewer than 20% overall use that assessment to modify the board’s composition.

Finding technology skill sets may challenge community bank boards, but Petty recommends a few ways that nominating committees can expand their search. Banks aren’t alone in the digital evolution, which affects practically every sector of the economy. With that in mind, he suggests looking at other industries for prospective board members. “Take an industry-agnostic look to find technology experts from organizations that are larger than the current institution,” Petty says.

Colleges, universities or vocational schools may also provide a resource to tap into technology expertise. “They typically are also at the forefront of talking about digitization across industries,” Petty adds.

While boardrooms should benefit from recruiting members with expertise for the digital age, that doesn’t excuse directors from enhancing their own understanding of the topic.

The 2021 Technology Survey finds board members highly reliant on bank executives and staff (87%) for information about the technologies that could affect their institution — right behind articles and publications (96%) as directors’ top resources.

While input from the bank’s executive team is critical, it’s important that directors leverage their own backgrounds, in addition to taking advantage of ongoing training and informational resources, to ask the right questions of these executives.

Marsico recommends that boards focus on strategy in every board meeting, with regular quarterly updates on the bank’s progress on executing the strategy. Other sessions should provide opportunities to educate board members on what’s going on in the banking environment — and should include external points of view. These could include technology vendors or representatives from the various associations serving the banking community. Petty suggests bringing in a former technology executive of another, larger bank who could brief members on what they’re seeing in the marketplace.

[Boards] can get an outsider’s perspective that breathes fresh air into what is the possible — because I don’t think they know what is the possible,” says Marsico.

Petty also points to increasing interest in forming board-level technology committees. Bank Director’s 2021 Compensation Survey, conducted earlier this year, found that 23% of banks use such a committee.

“Even the smaller banks will have a technology committee, because it’s such a major focus for any institution to drive the digitization of how they go to market, how they leverage the digital experience for the customer, how they leverage the digital product offerings, [and] how they use digital to acquire new customers and onboard new customers,” says Petty.

To understand the responsibilities of the technology committee, access our Board Structure Guideline on that topic. Recent Bank Director research reports examine “The Road Ahead for Digital Banking” and “Meeting Customer Demand for Bitcoin.” Bank Director’s membership program includes a board assessment tool and access to the FinXTech Connect platform, which helps bank leaders identify potential technology providers and solutions.

Bank Director’s 2021 Technology Survey, sponsored by CDW, surveyed more than 100 independent directors, CEOs, COOs and senior technology executives of U.S. banks below $100 billion in assets to understand how these institutions leverage technology in response to the competitive landscape. The survey was conducted in June and July 2021.

Bank Director’s 2021 Compensation Survey, sponsored by Newcleus Compensation Advisors, surveyed 282 independent directors, chief executive officers, human resources officers and other senior executives of U.S. banks below $50 billion in assets to understand talent trends, cultural shifts, CEO performance and pay, and director compensation. The survey was conducted in March and April 2021.

Bank Director’s 2021 Governance Best Practices Survey, sponsored by Bryan Cave Leighton Paisner LLP, surveyed 217 independent directors, chairs and chief executives of U.S. banks below $50 billion in assets. The survey was conducted in February and March 2021, and explores the fundamentals of board performance, including strategic planning, working with the management team and enhancing the board’s composition.

How Two Community Banks Added Remote Directors, and Why More Should

Increasingly, community banks are considering remote or hybrid work arrangements as a way to bring on hard-to-find and in-demand talent at the employee level. They may want to consider doing something similar for their boards, as well.

Many community banks define “community” as a geographic market and draw director talent from that pool. But increasingly, boards require skills, experiences and perspectives that may be difficult to find in-market. These institutions may want to expand their search to include out-of-market or remote directors with relevant, needed skills, but will need to tailor their assessment and interview process to ensure the remote director meshes well with the local directors.

“A board seat is a rare and precious thing,” says Alan Kaplan, founder and CEO of Kaplan Partners, which helps banks with board advisory and executive searches. “Boards need to be thinking about always having fresh and current skills on the board, and being proactive, thoughtful and deliberate about board succession and repopulation.”

Kaplan says about 20% to 25% of director searches he’s done have considered a remote or out-of-market candidate, but he believes more banks should consider it. Community banks of all sizes are seeking directors with expertise or backgrounds in cybersecurity and technology. As they grow, they’re also looking for financial experts or people who have experience with strategic human capital and management at large companies — which boards may struggle to find in their market. Other institutions may lack qualified candidates that are considered diverse in their racial or gender identity. To combat this, boards can leverage the experience they gained operating remotely during the coronavirus pandemic, which could make it easier to accommodate a director who is outside an institution’s markets.

Citizens & Northern Corp., a $2.3 billion bank in Wellsboro, Pennsylvania, added its first out-of-market director in 2016 as it searched for a financial expert to join the board. Through networking, CEO Brad Scovill was referred to Terry Lehman, a retired CPA who had more than two decades of experience at national and regional accounting firms and had served as the leader of the financial services team. There was a catch, however: Although Lehman lived in Pennsylvania, he was more than 150 miles away from the bank’s headquarters.

“He’s not flying in from Hawaii, but he’s not next door either,” Scovill says.

Citizens & Northern’s board balanced Lehman’s unfamiliarity with the bank’s market area against his expertise in bank auditing and risk. In the interview process, they discussed his ability to connect with the bank’s culture and found it helpful that he had worked with dozens of different community banks over his career. They decided to add him; in May, he was appointed chairman.

Banks may hesitate to add a director who doesn’t live in the bank’s market or is familiar with its culture. But Kaplan points out that most banks would still maintain a majority of directors in-market if they appoint one or two remote directors.

Across the country, Everett, Washington-based Coastal Financial Corp. began adding remote directors after making the strategic decision in 2017 to remain independent and pursue the then-unusual business line of providing financial technology partners with back-end banking services, known as banking as a service, or BaaS. Its customer base would now include tech companies across the country, and the board needed the expertise to better network and serve them, along with compliance, governance and risk expertise, says board Chairman Christopher Adams.

“Our footprint would be into different communities and fintechs, which meant that we were going to have customers across the country,” he says. “Our board needed to represent that.”

Since that time, the $2 billion bank added Stephan Klee, who is based on the East Coast, because of his experience investing in fintechs, and Sadhana Akella-Mishra, who lives in California and serves as chief risk officer at a fintech core provider. There’s a director in Portland, one in Chicago and another on the East Coast. While there are still local directors, Adams says that having board members spread out across the country has brought a variety of perspectives and conversations, especially around technology, to the bank.

Both Scovill and Adams say it’s essential that banks approach the board appointment and interview process thoughtfully and with a sense of formality. Coastal decided to add remote directors after conducting a skills-matrix assessment and continues to question what expertise the board needs. Adams says that keeping the bank’s values at the core of conversations have helped the existing board figure out if a new remote director would be a good fit. And Kaplan recommends that banks look for remote directors who have a strong sense of community and ask about their affinity for community engagement during the interview.

Scovill credits Citizens & Northern’s process for identifying, interviewing and onboarding new board members as the driver behind the board’s willingness to consider a remote director. This assessment process evaluates a prospective directors’ talents and experience and guides the current board through the interview process so they can have meaningful, productive conversations. It also lays out expectations for director performance and participation.

Both Scovill and Adams believe most community banks would be well served by adding one or two remote directors with essential, sought-after skills to their boards. They also added that a search doesn’t have to involve a headhunter or executive search firm; instead, community banks can tap their existing network of attorneys, investment bankers and auditors for recommendations.

“It’s not just ‘Someone knows somebody, he seems a good person that the other seven directors know well so let’s put him on the board,’” Citizens & Northern’s Scovill says. “The old boy network has gone away, but the network hasn’t gone away.”

Scovill acknowledges that adding a new director to a board can change the group dynamic, and an out-of-town director could be an additional wrinkle in that consideration.

“Quality people with good experiences are quality people with good experiences,” he says. “If we get to know them and build those relationships, they seem to work out fine, as long as we commit to that effort.”

What Does Today’s Community Banker Look Like?

After more than a year of great uncertainty due to the coronavirus pandemic, the biggest driver of change for community banks now will likely come from customer behavior.

The shift towards digital banking that took off during the pandemic is expected to become permanent to some degree. Customers are most likely to use online or mobile channels to transact and they are becoming more involved in fraud prevention, with measures such as two-step verification. They are also performing an increasing number of routine administrative tasks remotely, like activating cards or managing limits. Branches are likely to endure but will need to rethink how to humanize digital delivery: The Financial Brand reports that 81% of bankers believe that banks will seek to differentiate on customer experience rather than products and location.

Digitalization is good news for community banks. It reduces pressure on the branch network and increases opportunities to develop the brand digitally to reach new customers. But it also creates an obligation to deliver a good digital experience that reduces customer effort and friction. In the digital age, customers face less costs of switching banks.

Banks that assume they will be the sole supplier of a customer’s financial services or that a relationship will endure for a lifetime do so at their own risk. President Joseph Biden’s administration is promoting greater competition in the bank space through an executive order asking the Consumer Financial Protection Bureau (CFPB) to issue rules that give consumers full control of their financial data, making it easier for customers to switch banks. Several countries have already implemented account switching services that guarantee a safe transfer. How should community banks respond so they are winners, not losers, with these changes?

With their familiar brands, community banks are well positioned for success, but there are things they must do to increase customer engagement and build loyalty. Continuing to invest in digital remains crucial to delivering a digital brand experience that’s aligns with the branch. Such investment will be well rewarded — not only in retaining customers but also attracting new ones, particularly the younger generation of “digital natives” who expect a digital-first approach to banking. The challenge will be migrating the trust that customers have in the branch to the app, offering customers choice while maintaining a similar look and feel.

The branch will continue being a mainstay of community banking. Customers are returning to their branches, but its use is changing and transactions are declining. Customers tend to visit a branch to receive financial advice or to discuss specific financial products, such as loans, mortgages or retirement products. Some banks already acknowledge this shift and are repurposing branches as advice centers, with coffee shops where customers can meet bankers in a relaxed atmosphere. In turn, bankers can go paperless and use tablets to guide the conversation and demonstrate financial tools, using technology augmented by a personal touch.

Community banks can play a crucial role in promoting financial literacy and wellness among the unbanked. As many as 6% of Americans are unbanked and rely on alternative financial services, such as payday loans, pawnshops or check cashing services to take care of their finances. According to a 2019 report by the Federal Reserve, being unbanked costs an individual an average of $3,000 annually. By increasing financial inclusion, community banks can cultivate the customers of tomorrow and benefit the wider community.

Cryptocurrencies are the next stage of the digital revolution and are becoming more mainstream. Although community banks are unlikely to lose many customers in the short term over cryptocurrency functionality, these digital assets appeal to younger customers and may become more widely accepted as a payment type in a decade. Every bank needs a strategy for digital assets.

The shift to digital banking means bank customers expect the same experience they get from non-financial services. Application program interfaces (APIs) have ushered in a new era of collaboration and integration for banks, their partners and customers. APIs empower banks to do more with data to help customers reduce effort, from automating onboarding to access to funds and loans immediately. At a time when community banks and their customers are getting more involved with technology, every bank needs an API strategy that is clearly communicated to all stakeholders, including partners and customers. Although APIs cannot mitigate uncertainty, they do empower a bank to embrace change and harness the power of data. Banks without an APIs strategy should speak to their technology partners and discover how to find out how APIs can boost innovation and increase customer engagement.

Three Steps to Building a Post-Pandemic Payments Strategy

The Covid-19 pandemic spotlighted contactless payments. To stay competitive with the future of payments, community banks must offer multifaceted options, like virtual cards, P2P payments and digital wallets.

But building a digital and contactless payments strategy goes beyond just offering digital wallets — though that can be a key tool. To become their customers’ primary transactional relationship, community banks need a strategy to make credit and debit payments easy in any digital channel.

Digital banking and contactless payment adoption accelerated during the coronavirus pandemic. A Mastercard survey conducted last year found that contactless transactions grew twice as fast as traditional checkout methods at grocery and drug stores between February and March. Additionally, Juniper Research found that spend in digital wallets is projected to increase 83% by 2025 due to adoption of digital payments during the pandemic. Three key steps for community banks looking to construct a card strategy are to audit your payments capabilities and gaps, use digital to become the passive provider of choice and diversify your card and payment portfolio.

Audit Payments Capabilities, Gaps
Before bank leaders can roll out new card programs, they must evaluate where their bank’s existing programs are and if any service gaps exist. Common questions every manager should evaluate are:

  • How much revenue is the current card program driving, and is it increasing or decreasing?
  • What is the wallet share of the bank’s current cards and is it increasing or decreasing?
  • Who are customers using to make payments outside your network?
  • What payment options can you support? Options should encompass virtual cards, P2P payments, purpose-driven cards that are targeted to specific audiences and needs and digital wallets.

From here, bank leaders can figure out where their greatest opportunities lie. It might be in building a set of niche card programs to meet a specific need, such as teen card accounts, gig worker cards or a virtual card offering. It could also be expanding card options to include prepaid programs, bringing debit cards in-house or adding card controls to enhance the customer experience.

Become the “Passive Payment” Provider of Choice
Once bank leaders understand their opportunities, they need to build strategies that help their cards become the “passive payment” provider of choice. Taking security as a given, customers care most about convenience. They will use the payment option that is the easiest for their chosen channel of commerce.

Digital wallets and contactless are becoming table stakes for banks; they are no longer “nice-to-have” products that will differentiate your institution from your competitors. The rise in e-commerce means that banks must make it easy for their customers to fulfill those purchases with their preferred payment option virtually.

Additionally, customers are increasingly demanding instant access to new accounts. Instant digital card issuance enables customers to issue or reissue a credit or debit card digitally and on demand for immediate use.

Banks should also work to ensure that their cards are able to integrate with existing digital wallets, allowing customers to “push-provision” their cards into their preferred wallet or app, rather than manually entering their card information.

Diversify the Card, Payment Portfolio
A diverse payments strategy is more than just offering a general-purpose debit or credit card. People increasingly want purpose-driven cards that meet their specific needs and situations. Families love accounts that provide the parents control over funds while giving their teens the ability to learn how to manage their money and spend with some autonomy. A dedicated business card can make paying vendors and other bills easy to manage without staff in the office to run a traditional accounts payable team. In addition, many businesses want “team” or “disbursement” cards they can issue to employees and monitor the transactions in real-time while retaining some control over how the funds are spent. The combinations are endless — elderly care accounts, affiliations with membership organizations and gig worker cards are other popular options.

To determine which products a community bank should focus on, leaders need to analyze customers’ spending behaviors by channel, using transaction data to look for trends. Then, they can build campaigns to target the most profitable or most engaged customers.

The additional revenue sources will be vital to community banks’ survival, given continually low interest rates. By building a comprehensive digital, contactless and physical card payments strategy, institutions can positioned themselves to remain the bank of choice for their communities.

The Issue Plaguing Banks These Days

Net interest margin lies at the very core of banking and is under substantial and unusual pressures that threaten to erode profitability and interest income for quarters to come. Community banks that can’t grow loans or defend their margins will face a number of complicated and difficult choices as they decide how to respond.

I chatted recently with Curtis Carpenter, senior managing director at the investment bank Hovde Group, ahead of his main stage session at Bank Director’s in-person Bank Board Training Forum today at the JW Marriott Nashville. He struck a concerned tone for the industry in our call. He says he has numerous questions about the long-term outlook of the industry, but most of them boil down to one fundamental one: How can banks defend their margins in this low rate, low loan growth environment?

Defending the margin will dominate boardroom and C-suite discussions for at least eight quarters, he predicts, and may drive a number of banks to consider deals to offset the decline. That fundamental challenge to bank profitability joins a number of persistent challenges that boards face, including attracting and retaining talent, finding the right fintech partners, defending customers from competitors and increasing shareholder value.

The trend of compressing margins has been a concern for banks even before the Federal Open Market Committee dropped rates to near zero in March 2020 as a response to the coronavirus pandemic, but it has become an increasingly urgent issue, Carpenter says. That’s because for more than a year, bank profitability was buffeted by mitigating factors like the rapid build-up in loan loss provisions and the subsequent drawdowns, noise from the Paycheck Protection Program, high demand for mortgages and refinancing, stimulus funds and enhanced unemployment benefits. Those have slowly ebbed away, leaving banks to face the reality: interest rates are at historic lows, their balance sheets are swollen with deposits and loan demand is tepid at best.

Complicating that further is that the Covid-19 pandemic, aided by the delta variant, stubbornly persists and could make a future economic rebound considerably lumpier. The Sept. 8 Beige Book from the Federal Reserve Board found that economic growth “downshifted slightly to a moderate pace” between early July and August. Growth slowed because of supply chain disruption, labor shortages and consumers pulling back on “dining out, travel, and tourism…  reflecting safety concerns due to the rise of the Delta variant.”

“It’s true that the net interest margin is always a focus, but this is an unusual interest rate environment,” Carpenter says. “For banks that are in rural areas that have lower loan demand, it’s an especially big threat. They have fewer options compared to banks in a more robust growth area.”

The cracks are already starting to form, according to the Quarterly Banking Profile of the second quarter from the Federal Deposit Insurance Corp. The average net interest margin for the nearly 5,000 insured banks shrank to 2.5% — the lowest level on record, according to the regulator, and down 31 basis points from a year ago. At community banks, as defined by the FDIC, net interest margin fell 26 basis points, to 3.25%. Net interest income fell by 1.7%, which totaled $2.2 billion in the second quarter, driven by the largest banks; three-fifths of all banks reported higher net interest income compared to a year ago. Carpenter believes that when it comes to net interest margin compression, the worst is yet to come.

“The full effect of the net interest margin squeeze is going to be seen in coming quarters,” he says, calling the pressure “profound.”

On the asset side, intense competition for scarce loan demand is driving down yields. Total loans grew only 0.3% from the first quarter, due to an increase in credit card balances and auto loans. Community banks saw a 0.5% decrease in loan balances from the first quarter, driven by PPP loan forgiveness and payoffs in commercial and industrial loans.

On the funding side, banks are hitting the floors on their cost of funds, no longer able to keep pace with the decline on earning assets. The continued pace of earning asset yield declines means that net interest margin compression may actually accelerate, Carpenter says.

Directors know that margin compression will define strategic planning and bank profitability over the next eight quarters, he says. They also know that without a rate increase, they have only a few options to combat those pressures outside of finding and growing loans organically.

Perhaps it’s not surprising that Carpenter, a long-time investment banker, sees mergers and acquisitions as an answer to the fundamental question of how to handle net interest margin compression. Of course, the choice to engage in M&A or decide to sell an institution is a major decision for boards, but some may find it the only way to meaningfully combat the forces facing their bank.

Banks in growth markets or that have built niche lending or fee business lines enjoy “real premiums” when it comes to potential partners, he adds. And conversations around mergers-of-equals, or MOEs, at larger banks are especially fluid and active — even more so than traditional buyer-seller discussions. So far, there have been 132 deals announced year-to-date through August, compared to 103 for all of 2020, according to a new analysis by S&P Global Market Intelligence.

For the time being, Carpenter recommends directors keep abreast of trends that could impact bank profitability and watch the value of their bank, especially if their prospects are dimmed over the next eight quarters.

“It seems like everybody’s talking to everybody these days,” he says.

The Evolving, Post-Pandemic Role of Management and Directors

Many community bankers and their boards are entering the post-pandemic world blindfolded. The pandemic had an uneven impact on industries within their geographic footprints, and there is no historical precedent for how recovery will take shape. Government intervention propped up many small businesses, disguising their paths forward.

Federal Reserve monetary policies have hindered the pro forma clarity that bank management and boards require to create and evaluate strategic plans. Yet these plans are more vital than ever, especially as M&A activity increases.

“The pandemic and challenging economic conditions could contribute to renewed consolidation and merger activity in the near term, particularly for banks already facing significant earnings pressure from low interest rates and a potential increase in credit losses,” the Federal Deposit Insurance Corp. warned in its 2021 risk review.

Bank management and boards must be able to understand shareholder value in the expected bearish economy, along with the financial markets that will accompany increased M&A activity. They need to understand how much their bank is worth at any time, and what market trends and economic scenarios will affect that valuation.

As the Office of the Comptroller of the Currency noted in its November 2020 Director’s Book, “information requirements should evolve as the bank grows in size and complexity and as the bank’s environment or strategic goals change.”

Clearly, the economic environment has changed. Legacy financial statements that rely on loan categories instead of industries will not serve bank management or boards of directors well in assessing risks and opportunities. Forecasting loan growth and credit quality will depend on industry behavior.

This is an extraordinary opportunity for bank management to exploit the knowledge of their directors and get them truly involved in the strategic direction of their banks. Most community bank directors are not bankers, but local industry leaders. Their expertise can be vital to directly and accurately link historical and pro forma information to industry segments.

Innovation is essential when it comes to providing boards with the critical information they need to fulfill their fiduciary duties. Bank CEOs must reinvent their strategic planning processes, finding ways to give their boards an ever-changing snapshot of the bank, its earnings potential, its risks and its opportunities. If bank management teams do not change how they view strategic planning, and what kind of data to provide the board, directors will remain in the dark and miss unique opportunities for growth that the bank’s competitors will seize.

The OCC recommends that boards consider these types of questions as part of their oversight of strategic planning:

  • Where are we now? Where do we want to be, and how do we get there? And how do we measure our progress along the way?
  • Is our plan consistent with the bank’s risk appetite, capital plan and liquidity requirements? The OCC advises banks to use stress testing to “adjust strategies, and appropriately plan for and maintain adequate capital levels.” Done right, stress testing can show banks the real-word risk as certain industries contract due to pandemic shifts and Fed actions.
  • Has management performed a “retrospective review” of M&A deals to see if they actually performed as predicted? A recent McKinsey & Co. review found that 70% of recentbank acquisitions failed to create value for the buyer.

Linking loan-level data to industry performance within a bank’s footprint allows banks to increase their forecasting capability, especially if they incorporate national and regional growth scenarios. This can provide a blueprint of how, when and where to grow — answering the key questions that regulators expect in a strategic plan. Such information is also vital to ensure that any merger or acquisition is successful.

2021 Technology Survey Results: Tracking Spending and Strategy at America’s Banks

JPMorgan Chase & Co. Chairman and CEO Jamie Dimon recognizes the enormous competitive pressures facing the banking industry, particularly from big technology companies and emerging startups.

“The landscape is changing dramatically,” Dimon said at a June 2021 conference, where he described the bank’s growth strategy as “three yards and a cloud of dust” —  a phrase that described football coach Woody Hayes’ penchant for calling running plays that gain just a few yards at a time. Adding technology, along with bankers and branches, will drive revenues at Chase — and also costs. The megabank spends around $11 billion a year on technology. Products recently launched include a digital investing app in 2019, and a buy now, pay later installment loan called “My Chase Plan” in November 2020. It’s also invested in more than 100 fintech companies.

“We think we have [a] huge competitive advantage,” Dimon said, “and huge competition … way beyond anything the banks have seen in the last 50 [to] 75 years.”

Community banks’ spending on technology won’t get within field-goal distance of JPMorgan Chase’s technology spend, but budgets are rising. More than three-quarters of the executives and board members responding to Bank Director’s 2021 Technology Survey, sponsored by CDW, say their technology budget for fiscal year 2021 increased from 2020, at a median of 10%. The survey, conducted in June and July, explores how banks with less than $100 billion in assets leverage their technology investment to respond to competitive threats, along with the adoption of specific technologies.

Those surveyed budgeted an overall median of almost $1.7 million in FY 2021 for technology, which works out to 1% of assets, according to respondents. A median 40% of that budget goes to core systems.

However, smaller banks with less than $500 million in assets are spending more, at a median of 3% of assets. Further, larger banks with more than $1 billion in assets spend more on expertise, in the form of internal staffing and managed services — indicating a widening expertise gap for community banks.

Key Findings

Competitive Concerns
Despite rising competition outside the traditional banking sphere — including digital payment providers such as Square, which launched a small business banking suite shortly after the survey closed in July — respondents say they consider local banks and credit unions (54%), and/or large and superregional banks (45%), to be the greatest competitive threats to their bank.

Digital Evolution Continues
Fifty-four percent of respondents believe their customers prefer to interact through digital channels, compared to 41% who believe their clients prefer face-to-face interactions. Banks continued to ramp up their digital capabilities in the third and fourth quarters of last year and into the first half of 2021, with 41% upgrading or implementing digital deposit account opening, and 30% already offering this capability. More than a third upgraded or implemented digital loan applications, and 27% already had this option in place.

Data Dilemma
One-third upgraded or implemented data analytics capabilities at their bank over the past four quarters, and another third say these capabilities were already in place. However, when asked about their bank’s internal technology expertise, more than half say they’re concerned the bank isn’t effectively using and/or aggregating its data. Less than 20% have a chief data officer on staff, and just 13% employ data scientists.

Cryptocurrency
More than 40% say their bank’s leadership team has discussed cryptocurrency and are weighing the potential opportunities and risks. A quarter don’t expect cryptocurrency to affect their bank; a third haven’t discussed it.

Behind the Times
Thirty-six percent of respondents worry that bank leaders have an inadequate understanding of how emerging technologies could impact their institution. Further, 31% express concern about their reliance on outdated technology.

Serving Digital Natives
Are banks ready to serve younger generations? Just 43% believe their bank effectively serves millennial customers, who are between 25 and 40 years old. But most (57%) believe their banks are taking the right steps with the next generation — Gen Z, the oldest of whom are 24 years old. It’s important that financial institutions start getting this right: More than half of Americans are millennials or younger.

To view the full results of the survey, click here.

Meeting Customer Demand for Bitcoin

NYDIG-Report.pngCommunity banks across the country play a critical role in advancing the American dream, helping everyday Americans purchase assets and pursue financial freedom.

Today, that role includes helping consumers safely purchase and custody bitcoin. An estimated 46 million Americans over the age of 18 have acquired bitcoin since it was first created more than a decade ago, according to research from New York Digital Investment Group (NYDIG). But as ownership rates have risen, banks have struggled to provide bitcoin services to their customers. Concerns about safety, along with regulatory and institutional unfamiliarity, have created a gap now occupied by third-party digital asset exchanges and financial applications.

Fintech competitors are increasingly luring deposits away from traditional banks, with customers moving their money from traditional bank accounts to digital wallets on third-party sites. The experience is cumbersome because users can’t manage and view their holdings alongside other investments and credit accounts, says Patrick Sells, head of bank and fintech solutions at NYDIG. A customer’s primary financial institution can still become be the natural nexus for bitcoin solutions — if bank leaders are willing to take advantage of this opportunity.

Banks interested in adding bitcoin products will have to answer the same crucial questions that arise when evaluating any new offering or technology: How difficult will this be to implement, and how much will it cost? What will the bank need to do from a risk assessment perspective?

Partnering with companies that have the requisite expertise and investments in this space can help banks quickly address those gaps — and potentially generate new sources of revenues.

For a downloadable version of this report, click here.

Community Banks and the Adoption of Real-Time Payments

The Covid-19 pandemic dramatically reshaped how community banks approach digital transformation.

This is largely in response to the shift in fundamental consumer behaviors and new technology, as Americans adapted to the realities of the pandemic. According to a report from Mojo, 44% of consumers who wait to adopt new technology have shifted to an “early adopter” stance. Additionally, 41% of “later adopters” stated they were likely to adopt new technology at a faster pace, even after the pandemic subsides.

Digital innovation is no longer an option for banks. Financial institutions must evaluate their digital products against consumer expectations. Leading the list of customer demands is access to more convenient and immediate payments. The pandemic’s remoteness made receiving and making immediate payments a necessity, accelerating the movement to real-time payments (RTP).

RTP are not a new concept; many countries have transitioned from paper-based payments and directly to real time. The U.S. has successfully worked with electronic payments, but is now behind in the global shift to real time. The Clearing House launched RTP in 2017; it experienced slow but steady growth initially but has been propelled by the pandemic more recently.

Addressing the growing need for immediate payments, the Federal Reserve announced plans for FedNow to streamline the clearing and settlement process. FedNow will enable customers to move funds instantly between accounts, pay bills and transfer between family and friends. Though FedNow garnered strong support from banks, it is not expected to launch until 2023 at the earliest.

No Time to Wait
Financial institutions are finding it difficult to wait for FedNow. Although vaccinations have blunted most of the impacts from the pandemic, the changes in consumer habits engendered by the pandemic persist — including demand for innovation in real-time payments. Consumers looked to technology for shopping, entertainment, paying bills and banking in general. A recent PYMNTS survey found that 24% of consumers would switch to financial institutions that offered RTP capabilities. It’s critical that banks recognize and react to this paradigm shift in payment by prioritizing RTP solutions.

Popular P2P payments apps like Venmo, PayPal Holdings, and other solutions from big tech companies underline that consumers are willing to adopt new technologies to meet a need. Now, these firms are offering credit cards, loans and even demand deposit accounts. (I even received an invitation to open a checking account from my cell phone company!) This should be a wake-up call to banks. In the same PYMNTS survey, researchers found 35% of consumers consider access to real-time payments as “extremely” important. These survey results reflect a growing trend and reality that financial institutions must recognize and address.

The race is now on to compete with non-traditional providers and megabanks to attract and retain tech-interested customers. Real-time payments are where consumers and businesses are headed. Financial institutions need to be fully engaged to connect to RTP or FedNow.

This is not an easy path for financial institutions that are used to making project decisions based on calculating the return on investment of the project alone. Strategic technology initiatives should be evaluated broadly, including the cost of doing business in banking. Large financial institutions have already moved forward to deliver top-notch digital services and experiences. To level the playing field, smaller institutions should look to technology savvy leaders and fintech partners to help deliver innovative solutions. Unheralded sources for fintech solutions are the bankers’ banks, which play a vital role for technology and as funding agents in RTP/FedNow and are offering innovative solutions to help community banks connect to real-time payments.

Changes in customer behavior and heightened demand for immediate payments driven by Covid-19 are here to stay; adoption of RTP will only continue to grow. In just the last year, real-time payments in the United States grew 69% year-over-year, according to Deloitte.

To act now, financial institutions should consider fintech partnerships to remain relevant in a dynamic financial and regulatory landscape. Financial institutions that tap into technology companies’ speed to market and access to a broader audience can approach RTP as a competitive advantage that distinguishes them in their local markets and attract new customers. Those taking a “wait and see approach” are already behind.