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.

Why This 17-Year-Old Investor Prefers Community Banks

Maya Peterson graduates from high school at the end of summer. She’s also the author of two books: “Early Bird: The Power of Investing Young” — which she wrote when she was just 13 years old — and “Lighthouse: Women Leading the Way in Finance,” which published in April.

To call her precocious may be an understatement: Peterson started investing when she was just 9 years old. At 10, most kids just want to play video games; instead, Peterson attended Berkshire Hathaway’s annual shareholders’ meeting to hear Warren Buffett speak and meet personal heroes like Lauren Templeton, the founder and president of Templeton & Phillips Capital Management. Templeton is one of the 20 women featured in “Lighthouse.”

Peterson researches every investment she makes, from the company’s financials to its competitive position in the marketplace and the state of its industry. “Investing is simple to understand: You put in your work, try to understand the business, and do your best to pick stocks; however, the world is unpredictable, and things do not always go as planned,” she writes in “Lighthouse.”

“Over the past seven years, I have developed an investing mindset of patience, frugality, nerdiness, humility and discipline.”  

In August, I interviewed Peterson about why she’s fascinated by women in finance and what she values in an investment. The transcript that follows has been edited for brevity and flow.

BD: As an investor, how do you view the banking sector?
MP: I stick to investing in what I know, so I started out buying [The] Procter & Gamble [Co.] and Johnson & Johnson. The big banks are complicated for outside investors, and I try to keep it simple. For smaller banks, I think new investors have a better chance to be able to analyze them, but there is still a lot of banking jargon to wade through. Overall, seeing how banks adapt to accommodate their customers over the long haul, the quality of their loans and how they serve their community is something that I look for. I find this much easier to see in smaller banks.

BD: You spent time with Robert and Patrick Gaughen of Hingham Institution for Savings, who explained to you how they built their bank. You own shares in Hingham. What did you learn from them?
MP: The biggest key to Hingham’s success has been its culture. They are really customer focused, and they do not overcomplicate their business model with growth for growth’s sake. Their loan quality over many years shows a clear focus on risk quality. There was a quote in [their] 2014 Annual Report, where Robert Gaughen summed it up as, “Balance sheet growth at Hingham must be safe and it must be profitable, in that order.”

[Editor’s Note: Bank Director also spoke with the Gaughens for our report on the Six Tenets of Extraordinary Banks.]

BD: You’re an experienced investor, particularly given your age. What do you value when you look at a company?
MP: I value social responsibility. I invest for the long haul, so the companies I am a shareholder of are ones I think will be around and successful in 20 years. These businesses realize that it is their future too. It is easy to fall into the trap of thinking that capitalism is a short-term game, but most great businesses are built by long-term thinkers. Our thinking has to grow beyond thoughts of, “What is cheapest now?”

[Investor] Jeremy Grantham said [at a 2018 MorningStar conference] that, “Capitalism also has a severe problem with the very long term … anything that happens to a corporation over 25 years out doesn’t [exist for] them. Therefore, grandchildren, I like to say, have no value. … We deforest the land, we degrade our soils, we pollute and overuse our water, and treat air like an open sewer. [We do it] all off balance sheet and off the income statement.”

Investing works over the long run, whether that is competitive advantage, fair prices or good management, and social responsibility is a long-term mindset as well. It focuses on how the business benefits society through diversity within the workplace, their environmental impact and so on.

[Socially responsible investing] brings these two long-term perspectives together.

BD: I decorated my room as a teenager with rock band posters, but you write in the introduction to “Lighthouse” that you wallpapered your room with the photos of 58 female CFOs to inspire you. As a young woman, why does finance appeal to you? Based on what you’ve learned, what are your thoughts now about possibly entering a male-dominated field?
MP: Hearing stories about Lauren Templeton’s childhood full of investing, I was excited to become a young shareholder, too. Those stories launched me into researching and discovering other women in investing and in finance, which was where I began seeking out stories of female CFOs. I think similar to other kids’ posters, these women were larger-than-life figures that taught me the importance of drive. They became my daily reminders to keep learning and asking questions. Once I ventured into investing, I saw the limitless potential to learn, and that is what made finance [appealing] to me. If I ran out of questions, then I couldn’t be thinking hard enough.

 

As a young woman, investing gave me the opportunity to make adult decisions at a young age without being judged by my age or gender. I had control over something in a way I had not yet had at such a young age. Investing felt like my window into the real, adult world.

 

BD: Finally, you’re in school now, but you’re obviously thinking ahead about your career. You come from a unique perspective compared to your peers, in that you really dug into companies and what makes them tick. And a lot of companies struggle to attract younger, skilled talent. With that in mind, what do you hope to see from a future employer?
MP: Emphasis on community. Right now, it is so critical that those who can give are giving to others in many ways. To me, this means having coworkers and employees that represent the customers they are serving, incentivizing and encouraging donating and volunteer work, companies allocating money to give to a good cause and being socially responsible from the inside out.

I think employers who want to attract the younger generation should have a longer-term outlook and ideas on how to make a positive impact on the future. There is no one size fits all — it is different for different types of businesses — but working to make a difference definitely matters in attracting younger employees.

Five Ways to Challenge Digital Banks

Over the past several years, financial institutions have experimented with and implemented new technologies to improve efficiency, security and customer experience. Although online banking is currently challenging traditional banking practices in several aspects, there are ways that traditional banks can fight back. Here are a few key offerings of digital banking, along with ways traditional banks can beat them at their own game.

1. Improved service
Digital banks offer customers 24-hour service and the ability to conduct a variety of transactions in their own time. AI-powered chatbots allows customers to ask questions, perform transactions and create accounts through one platform, at any time. This on-demand service appeals to customers as saving time and effort in their banking experience.

However, one of the key missing components of an online banking platform is human interaction, which can be easier and more rewarding than filling out a checklist on a website. Customers can easily convey any special requests or needs. By providing excellent customer service with genuine and knowledgeable human interaction, traditional banks can offer a more complete service than online banks.

2. Heightened security
To keep up with innovative offerings like video chat and digital account operations, online banks can utilize SD-WAN solutions to maintain reliable connectivity and efficiency for their security needs. Solutions such as antivirus and anti-malware programming, firewalls and biometric and/or facial recognition technology provide additional levels of security to protect customer information.

Traditional banks may less susceptible to cybersecurity threats. Despite online banks’ level of security, their fully-digital presence makes them more vulnerable to cyberattacks compared to traditional banks. It may also be much more difficult to regain what has been lost in the event of a data breach, due to the ways cybercriminals can hide.

3. Streamlined services
Digital transformation is all about streamlining and improving operations; the concept of a digital banking solution is no different. Digital bank users can achieve their banking needs through a single platform. In one “visit,” customers can view their balance and recent transactions, transfer money between accounts and pay bills. Some digital banks also have the option to sync accounts with budgeting apps to further manage budgets and spending.

This streamlining allows digital banks to significantly reduce the number of different products and services they offer. By comparison, traditional banks can provide many more services and options to better fit the individual needs of their customers, and make sure they feel important and well looked after.

Moreover, traditional banks should not feel the need to provide all these services in-house. There are plenty of fintech partners they can lean on, with very specialized capabilities in these services, to help diversify their products and services.

4. Cost-effectiveness
There are often various costs associated with banking, both for the institution and the customer. The low overhead of digital banking allows for a significant reduction in cost and fees and may offer lower-cost options for individuals interested in opening multiple accounts.

Reducing costs may also mean reducing services and, at times, customer experiences. There’s no such thing as a free lunch; the less a customer pays, the less they may get. Many community banks offer more products and services, as well as helpful staff and peace of mind for small financial cost.

5. Environmental consciousness
Working to become more environmentally friendly is becoming an important step for all institutions. Digital banks are succeeding in reducing their carbon footprint and overall waste.

Many traditional banks are making great headway in becoming more environmentally friendly, and have the added benefit of making these changes optional. Many of the customer-facing changes can be approved or rejected by the customer, such as electing paperless statements, giving them more control over their banking experience. Digital banks are challenging traditional community banks in many ways. But community banks can leverage the substantial competitive advantages they already possess to continue providing a greater and more comprehensive experience than digital banks.

Five Considerations for Stronger Digital Communications Adoption

Digital banking services and capabilities are increasingly one of the most important areas of investment for community banks.

Community bank customers appreciate the personal service they receive from their local bank but desire the technology capabilities offered at national banks. Community banks are challenged to deliver seamless, robust digital banking services in a cost-effective manner. These challenges create some compromised digital banking experiences, particularly around digital communications.

Community banks consistently have much lower adoption rates of digital statement compared to large national banks. Bank leaders often cite demographics as the leading factor in the lack of migration to digital communication, with many banks assuming that only younger, wealthier customers adopt digital banking solutions. In reality, adoption rates are fairly consistent across age, income and location. 

Instead, many regional and community bank customers do not adopt digital solutions because they do not trust their bank’s offerings. The network of third-party vendors a bank uses creates a patchwork of solutions that may not communicate effectively, resulting in a negative user experience. This friction results in abandonment, as customers decide to just continue accepting the traditional printed communications.

The good news is that this area can be fixed — but it requires community bankers to fully understand what is needed to create a well-designed digital communications experience.

Crafting A User Interface, Appearance
A customer’s experiences must be consistent across the bank. Banks thrive at managing a customer’s in-person interactions; its digital presence, online and mobile offerings should offer the same experience. When electronic statements on the digital platform look unsophisticated and lack consistency in design, it leaves a bad impression with the customer. The online site must be responsive and mobile-friendly, enabling the customer to bank on-the-go.

Fully Functional Entitlement Management
Passwords, authorizations and verifications can easily become one of the frustrating components of digital adoption for customers. Most often, customers are unaware that numerous third-party vendors are involved in making their digital experience a reality. When they change or update their settings, they expect these changes to occur across their account in real-time. Any delay or latency results in an inconsistent experience for the customer.

Centralizing Preferences, Settings
Bank customers encounter digital experiences that consist of digital banking preference settings in one place on the website or mobile app and settings for digital communications in another area. This can create confusion among customers. Since they may not be aware that the digital communications may be held by one vendor, and other account functions are held by others, it seems to make little sense why all settings are not centralized in one place. It is worth exploring the options to unite these components in one place, further eliminating potential friction.

Longer Retention Period
Communications archival is one of the most beneficial — yet overlooked advantages — for digital adoption. Customers may or may not refer to previous communications such as notices and statements regularly, but when they need them, they will appreciate the capability. Community banks do not often like to pay for the server space needed to store these past communications, but it is an area executive should consider when trying to increase digital adoption. Customers cite short retention periods as a reason for electing to continue to receive paper statements.

Innovative Notification Options
Most legacy digital communication integrations use email as the primary method of notifying customers. Today’s bank customer is inundated with emails from work, personal matters and retailers. They are also cautious about opening emails due to hackers often masking themselves as financial institutions in phishing and other fraud-related schemes. The best way to get around this is through real-time integrations between digital banking and digital communication systems, offering the use of SMS or push notifications when possible.

Achieving greater digital adoption is possible. The status quo not only leaves most banks spending more per customer to deliver documents than their large, national bank competitors, but it gives customers the impression that they cannot manage their digital experience effectively.

The good news for regional and community banks is that it is possible to improve on the efforts already in place to build a strong digital presence by choose vendors that are truly committed to the open banking concept. Once the ecosystem of vendors works together, community banks will be in a much better position to market and grow their digital adoption efforts.

Turning Goals from Wishes to Outcomes

Community banks should measure their goals and objectives against four tests in order to craft sustainable approaches and outcomes.

Community banks set goals: growth targets for loans or deposits, an earnings target for the security portfolio, an return on equity target for the year. But aggressive loan growth may not be a prudent idea if loan-to-asset levels are already high entering a credit downturn. Earnings targets can be dangerous if they are pursued at any cost, regardless of risk. However, in the right context, each of these can lead to good outcomes.

The first test of any useful goal is answering whether it’s a good idea.

One personal example is that about a year ago I set a new goal to lose 100 pounds. I consulted with my doctor and we agreed that it was a good idea. So then we moved to the second test of a useful goal: Is it sustainable?

As “Atomic Habits: An Easy & Proven Way to Build Good Habits & Break Bad Ones” author James Clear puts it: “You do not rise to the level of your goals, you fall to the level of your process and systems.”

What good would my weight loss goal be if it wasn’t sustainable? If the approach I took did not change my habits and instead put me through a shock program, there would be little reason to doubt that the approaches and habits that led me to create this goal would bring me back there again. The only way to pursue my goal in a sustainable fashion would changing my habits — my personal processes and systems.

Banks often pursue goals in unstainable ways as well.

Consider a bank that set a goal in June 2018 of earning $3 million annually from its $100 million securities portfolio with no more than 5 years’ duration (sometimes called a “yield bogey”). Given a choice between a 5-year bullet agency at 2.86% and a 5-year, non-call 2-year agency at 3.10%, only the latter meets or beats the goal. A 3.10% yield earns $310,000 for this portfolio.

In June 2020, the callable bond got called and was replaced by a similar length bond yielding only 40 basis points, or $40,000, for the remaining three years. The sustainable plan would have earned us $286,000 for the past two years — but also $286,000 for the next three. To make earnings sustainable, banks always need to consider multiple scenarios, a longer timeframe and potentially relaxing their rigid “bogey” that may cost them future performance.

 The third test of a useful goal is specifying action.

The late New York Governor Mario Cuomo once said, “There are only two rules for being successful: One, figure out what exactly you want to do, and two, do it.”

In my case, I didn’t do anything unsustainable. In fact, I did not do anything at all to work toward my long-term goal. When I checked my weight six months later, it should not have surprised me to see I had lost zero pounds. A goal that you do not change your habits for is not an authentic goal; it is at best a wish.

My wish had gotten exactly what you would expect: nothing. Upon realizing this, I took two material steps. It was not a matter of degree, but of specific, detailed plans. I changed my diet, joined a gym and spent $100 to fix my bicycle.

The fourth test of a useful goal is if it is based on positive changes to habits.

Banks must often do something similar to transform their objectives from wishes to authentic goals. Habits — or as we call them organizationally, processes and systems — must be elevated. A process of setting an earnings or yield bogey for the bond portfolio relied on the hope that other considerations, such as call protection and rate changes, wouldn’t come into play.

An elevated process would plan for earnings needs in multiple scenarios over a reasonable time period. Like repairing my bike, it may have required “spending” a little bit in current yield to actually reach a worthy outcome, no matter which scenario actually played out.

If your management team does not intentionally pursue positive changes to processes and systems (habits), its goals may plod along as mere wishes. As for me, six months after making changes to my habits, I have lost 50 pounds with 50 more to go. Everything changed the day I finally took the action to turn a wish into a useful goal.

Capital, Digital Initiatives Set De Novos Up for Success

In 2018, Matt Pollock and a group of business leaders and experienced bankers organized a new bank to fill a gap they saw in the Oklahoma City market. And he believes their tech-forward approach sets them apart from competing financial institutions.

“A lot of [banks] fall into the same traps in how they approach client services and products and relationships, and they just don’t do a very good job,” says Pollock, the CEO of $110 million Watermark Bank, which opened its doors in January 2019. “So, we really focused on [building] the right team, with the right model that really drives the business community.”

Few de novo banks have formed since the 2008-09 financial crisis. Of the 1,042 community banks chartered in the eight years preceding that crisis, 13% failed and another 20% were acquired or liquidated, according to a 2016 Federal Deposit Insurance Corp. study. Overall, de novo banks accounted for 27% of all failures from 2008 to 2015, and exited at double the rate of small, established banks.

De novo institutions are particularly fragile: They don’t tend to be profitable in their early years as they invest in building their business and reputation in their markets. In today’s environment, low rates pressure net interest margins, exacerbating these challenges.

With that in mind, Bank Director used FDIC data to analyze the 24 de novo banks formed from January 2017 through December 2019 to understand how they’re performing today and how they might weather the current economic downturn. We examined efficiency, through the overhead and efficiency ratios, and profitability, through return on assets and return on equity, as of Dec. 31, 2019. We also included equity capital to assets and net interest margin in the analysis. Watermark came in fifth in our ranking.  

Today’s batch of de novo banks features higher capital levels, a requirement that has dampened new bank formation. (The FDIC doesn’t set a minimum capital threshold for de novo banks; expectations vary based on the bank’s market, size, complexity, activities and business model.)

If the recession deepens, those high capital levels could come in handy as banks find it trickier to raise more capital, says Nicholas Graham, senior managing director at FinPro. “Many of the de novos that formed over the past several years, in a very general statement, have not fully leveraged their capital to date,” he says. “Therefore, they have more capital right now, all else being equal, to potentially weather this storm.”

Stringent capital requirements led some bank organizers to acquire rather than start a bank from scratch. Not so for Watermark Bank. Acquiring a charter was too expensive due to high bank valuations toward the end of the cycle, says Pollock, and an acquisition would have bogged the founders down with legacy cultural and technological issues.

So, they decided to start fresh. “Let’s build our systems and our workflows exactly how we want to do it; we’ll have to roll up our sleeves, it will take a little bit longer, probably a little bit more work but in the end, it would be a benefit,” says Pollock. “We ran a very lean operation, opened with 12 people, got up and running, and we quickly got to a break-even faster than many others.”

Prioritizing technology sets Watermark and many of its de novo peers apart from those chartered before the 2008-09 crisis. And it allowed Watermark to rise to the occasion in issuing Paycheck Protection Program loans, despite high demand and a spare staff.

“We did as many PPP loans in 10 days as we did loan transactions in our first year of operation,” says Pollock. “There was some stress, but at the end of the day we walked away and said, ‘We have good processes and procedures, we have extremely talented people, and we’re capable of leveraging our platform and our operational capabilities that we have today to a much higher level,’” he says.

Flexibility and nimbleness give de novo banks an advantage. “They’re more quickly able to adapt and add new products and services that may be more beneficial in this time of uncertainty,” says Graham.

Savvy de novos are investing in the digital infrastructure needed for modern banking, says Rick Childs, a partner at Crowe LLP. But there’s one more attribute he believes strengthens a de novo: extensive banking experience on the board and management team.

“You can skin the cat a lot of different ways in banking, but if you don’t have a lot of capital to help you weather the lean years, and if you don’t have strong management and [directors] to make sure you’re not taking unnecessary risk,” it will be hard to survive, he says. “[If] you know how to react when a difficult time comes around, then the rest will follow.”

Top Performing De Novo Banks

Rank Bank Name Asset Size (000s) NIM (3/31/2020) Overall Score
#1 The Bank of Austin $202,738 3.36% 5.8
#2 CommerceOneBank $258,590 3.34% 6.2
#3 Winter Park National Bank $418,816 2.89% 7.0
#4 Tennessee Bank & Trust $272,173 3.25% 7.7
#5 Watermark Bank $110,423 3.40% 8.0
#6 Infinity Bank $110,145 4.41% 8.6
#7 Ohio State Bank $130,519 2.22% 9.5
#8 Gulfside Bank $97,154 3.14% 10.6
#9 The Millyard Bank $23,524 1.41% 11.2
#10 Beacon Community Bank $161,029 3.05% 12.1

Source: Federal Deposit Insurance Corp.
Each bank was ranked based on profitability, efficiency, NIM and capital as of Dec. 31, 2019. The overall score reflects the average of these ranks.

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.

Leverage Tech to Release HELOC Demand

Even though bank may still have limitations on physical operations due to the Covid-19 pandemic, they can still leverage technology to prepare for what a potential boom in home equity line of credit (HELOC) lending.

Inflation will happen and rates will once again rise, making the market ripe for HELOCs. Community and regional banks need to be savvy enough to compete against larger banks and rising fintech nonbank lenders for this growing market share, and they can do this by using technology to properly harness the data. Data is new currency.

According to a J.D. Power study on HELOC satisfaction, 88% of consumers say they started the HELOC process without being prompted by a bank employee. That percentage is even greater for millennials: 94%. This a trend that is likely to continue.

Fast-paced technology allows consumers online options to do their banking from their smartphone, and many don’t want to speak to a banker unless they cannot get the answer online. They are signing up for loans, transferring funds to another account or opening new accounts — all transactional services that can be done with a few keystrokes and mouse clicks, without having to visit a local branch.

This same technology can be applied to the HELOC application process, which banks can use to greatly improve interactions with consumers. So why aren’t more banks embracing this technology? Why do we keep seeing phone numbers or “email us” prompts under the HELOC section of a bank website? It seems home equity lending is stuck in the 1990s.

This has to change to capture customers’ attention. The rise in home prices means millennials have more equity in their homes, and 59% gather their information online — 50% through smartphones only, according to the J.D. Power study. Banks have not been actively marketing to this group, making it a crucial area for improvement with the use of technology.

For any technology to be successful, banks need to change their approach or mindset regarding their HELOC application process. There are many options that can be used on the front-end of the HELOC experience as more banks streamline their digital processes. Others are using their loan origination system as a robust starting point in this process; one that should be easy, fast and intuitive.

Technology can automatically order the necessary data, like credit, income, flood and instant title reports. If the title data is not readily available, it can use intelligence logic to select the best data property report provider, based on turn time and price. That information is then delivered in one report that is custom-tailored to each lender’s unique loan fulfillment requirements.

Other technology can help with the front end, digital marketing and other aspects of the business, from the top of the funnel to eClosing. The constant change means that systems put in place three years ago were probably more expensive than some banks were willing to invest. Those systems might not have featured all the functionality a bank needed; now, they are outdated. Even if banks previously considered and decided against possible systems for whatever reason, it is paramount that they take another careful look today.

Some banks may be content with their current level of home equity loans; however, as the market starts to ramp up, they risk leaving significant business on the table or losing a customer to a non-bank fintech. Recent advancements mean there are innovative and inexpensive systems available that do not require a total retooling of a bank’s existing technology stack. What is the price on shaving 25 days off the process? What price can your bank can put on saving 25 days in the process? With the right approach, these new tools can help banks be cost neutral, or even save money.

Practical AI Considerations for Community Banks

A common misconception among many community bankers is that it isn’t necessary to evaluate (or re-evaluate for some) their use of artificial intelligence – especially in the current market climate.

In reality, these technologies absolutely need a closer look. While the Covid-19 crisis and Paycheck Protection Program difficulties put a recent spotlight on outdated financial technology, slow technology adoption is a long-standing issue that is exacerbating many concerning industry trends.

Over the last decade, community banks have faced massive disruption and consolidation — a progression that is likely to continue. It’s imperative that bank executives take a clear-eyed look at how advanced technologies such as AI can support their business objectives and make them more competitive, while gaining a better understanding of the requirements and risks at play.

Incorporating AI to Elevate Existing Business Processes
This may seem like a contrarian view, but banks do not need a specific, stand-alone AI strategy. The value of AI is its ability to improve upon existing structures and processes. Leadership teams need to be involved in the development process to identify opportunities where AI can tangibly drive business objectives, and manage expectations around the resources necessary to get the project up and running.

For example, community banks should review how AI can automate efficiencies into their existing compliance processes — particularly in the areas of anti-money laundering and Bank Secrecy Act compliance. This application of AI can free up manpower, reduces error rates and help banks make informed decisions while better serving their customers.

It’s necessary to have a strong link between a bank’s digital transformation program and AI program. When properly incorporated, AI helps community financial institutions better meet rising customer expectations and close the gap with large financial institutions that have heavily invested in their digital experiences.

Practical Steps for Incorporating AI
Once a bank decides the best path forward for implementing AI, there are a few technical and organizational steps to keep in mind:

Minimizing Technical Debt and “Dirty Data”: AI requires vast amounts of data to function. “Dirty data,” or information containing errors, is a real possibility. Additionally, developers regularly make trade-offs between speed and quality to keep projects moving, which can result in greater vulnerability to crashes. Managing these deficiencies, “or technical debt,” is crucial to the success of any AI solution. One way to minimize technical debt is to ensure that both the quantity and quality of data taken in by an AI system are carefully monitored. Organizations should also be highly intentional about the data they collect.More isn’t always better.

Minimizing technical debt and dirty data is also key to a smooth digital transformation process. Engineers can add value through new and competitive features rather than spending time and energy addressing errors — or worse, scrapping the existing infrastructure altogether.

Security & Risk Management: Security and risk management needs to be top-of-mind for community bankers any time they are looking to deploy new technologies, including leveraging AI. Most AI technologies are built by third-party vendors rather than in-house. Integrations can and likely will create vulnerabilities. To ensure security and risk management are built into your bank’s operating processes and remain of the highest priority, chief security officers should report directly to the CEO.

Managing risks that arise within AI systems is also crucial to avoid any interruptions. Effective risk management ties back to knowing exactly how and why changes affect the bank’s system. One common challenge is the accidental misuse of sensitive data or data being mistakenly revealed. Access to data should be tightly controlled by your organization.

Ongoing communication with employees is important since they are the front line when it comes to spotting potential issues. The root cause of any errors detected should be clearly tracked and understood so banks can make adjustments to the model and retrain the team as needed.

Resource Management: An O’Reilly Media survey from 2018 found that company culture was the leading impediment to AI adoption in the financial services sector. To address this, leaders should listen to and educate employees within each department as the company explores new applications. Having a robust change management program — not just for AI but for any digital transformation journey — is absolutely critical to success. Ongoing education around AI efforts will help garner support for future initiatives and empower employees to take a proactive role in the success of current projects.

At a glance, implementing AI technologies may seem daunting, but adopting a wait-and-see approach could prove detrimental — particularly for community banks. Smaller banks need to use every tool in their toolkit to survive in a consolidating market. AI poses a huge opportunity for community banks to become more innovative, competitive and prosperous.