Pandemic Challenges, Strengthens Bank’s Deal Integration

One bank found that the Covid-19 pandemic actually accelerated its deal integration, creating a stronger pro-forma institution to serve clients after overcoming a number of unexpected hurdles.

The coronavirus crisis has thrown a wrench in bank mergers and acquisitions, challenging everything from due diligence to pricing to regulatory and shareholder approvals. Only two bank deals were announced in May, according to S&P Global Market Intelligence; potential buyers and sellers seem to be focusing on assisting customers while they wait for a normalized environment. But Sandy Spring Bancorp found itself with no choice but to adapt its deal integration with Rockville, Maryland-based Revere Bank, even as both banks shifted to a remote work environment.

For us, it’s very important to understand that not just the successful integration, but a successful acquisition is centered around finding the right partner to begin with,” says Sandy Spring President and CEO Daniel Schrider. “And it’s really important … to find an organization that either complements what we do or provides access to a different market that maybe we’re not in, but has a shared vision around client relationships.”

The Revere team was well-known to Sandy Spring, with executives serving on their state bank association as well as competing against each other for local deals. After talking for about 18 months, they announced their merger agreement in September 2019; the deal pushed the Olney, Maryland-based bank above $10 billion in assets.

For months, deal integration proceeded as expected. The banks kicked off internal communication campaigns to keep both groups informed of the timeline, process and upcoming changes, and increase comradery before merger close. They formed 20 cross-functional teams of employees from both companies that tackled specific integration-related tasks or objectives, which met through mid-February.

“Both companies had tremendous first quarters. We were very excited about bringing the two organizations in a new structure and pulling the trigger on a number of things, based upon our ability to be together,” he says. “Then obviously, things came to a screeching halt.”

Once the pandemic closed physical offices, Sandy Spring used video and electronic communication to continue integration work. The pro-forma executive team created welcome videos featuring Schrider, along with digital and virtual orientations, instead of the usual face-to-face interactions.

But the integration encountered yet another unexpected challenge: the Paycheck Protection Program. The Small Business Administration loan program began accepting applications on April 3, two days after the Revere acquisition closed.

All of a sudden, two companies were faced with trying to solve the problems that many of their clients are having,” Schrider says. “That actually accelerated our integration.”

The newly combined teams, which pride themselves on being relationship focused, worked together to fulfill the unsolicited loan demand. They hosted daily PPP calls and involved more than 200 employees to process applications from customers at both banks. The undertaking combatted any inertia they may have felt about actually combining and functioning as one company.

“In a strange way, we’re probably in a better place today than we would have been, absent a pandemic, from the standpoint of being together,” he says. “Even though we’re not physically together.”

Sandy Spring believes picking a bank partner with similar values and staying focused on its strategy helped the pro-forma institution navigate deal-specific challenges. For instance, the all-stock deal for Revere originally carried a price tag of $460.7 million when it was announced in September; at close, it was valued at $287 million based on Sandy Spring’s quarter-end stock price, according to S&P Global Market Intelligence. Schrider says potential buyers and sellers should avoid fixating on absolute deal price, and instead consider the relative value and potential upside of the combined entity’s shares.

So far, the only integration activities that the pandemic has paused are reorganization efforts the bank believes are best done in person, including the planned appointment of Revere co-CEO Ken Cook as executive vice president. The systems conversion and branch consolidation are still on track for the third quarter. Until then, the pro-forma institution will continue to integrate while serving clients during the pandemic.

“It’s been a wild ride but a good one,” Schrider says.

Embracing a Challenging Environment to Evolve

New York University economist Paul Romer once said, “A crisis is a terrible thing to waste.”

With a nod to Dr. Romer, we believe banks have an extraordinary opportunity to embrace the challenging environment created by the Covid-19 pandemic to enhance critical housekeeping matters. Here are five areas where banks may find opportunities to declutter or reengineer policies, procedures and best practices.

Culture
One of the most obvious opportunities for banks is to focus on culture. Employees working from home has eliminated the ability to have typical office parties, barbeques and other events to build comradery. Remote and semi-remote working environments are challenging employees in many difficult ways. Fortunately, banks are finding simple, yet creative, ways to stay in contact with their employees and build culture through additional correspondence and feedback — electronic happy hours, car parades, and socially distant visits, for example. Creatively maintaining high engagement in challenging times will serve to improve communication and culture over the long term. As management consultant Peter Drucker once said, “Culture eats strategy for breakfast.”

Cybersecurity
Cybersecurity risk continues to be top of mind for bankers and regulators given the remote work brought on by Covid. Certainly, most banks’ cybersecurity risk management planning did not contemplate the immediate scale of remote work, but the extreme experience is an opportunity to drill down on underlying policies and procedures. Banking agencies have provided the general blueprint on sound risk management for cybersecurity.

This heightened risk environment provides executives with a perfect opportunity to note where their vulnerabilities may exist or be discovered, where cyberattacks focus and what works—or doesn’t —for your bank. Use the guidance provided to assess your bank’s response and resilience capabilities. Consider the overall map and configuration of your cyber architecture. Consider authentication requirements and permissions to protect against unauthorized access. Take the time to work with information technology experts to clean up access controls and response plans. This is an active situation that provides bankers the unique opportunity to learn and adapt in real time.

Compliance
Banks also face enhanced compliance originating from federal programs aimed at keeping businesses afloat. A worthy endeavor to be sure, but the rollout of some federal programs such as the Small Business Administration’s Paycheck Protection Program has far outpaced the guidance for banks tasked with implementation. The trickle of (often inconsistent) guidance on the documentation, eligibility and certification adds compliance challenges in reporting under the Bank Secrecy Act, fair lending under the Equal Credit Opportunity Act and unfair or deceptive acts and practices under the Federal Trade Commission Act, for example.

Compliance teams have an opportunity to shine at something they are already extraordinarily good at: documentation. They should document the processes and practices they deploy to demonstrate compliance, despite the uncertainty and pace at which they are expected to operate. This documentation can support real-time decision-making that may come up with regulators in the future, and can serve as a basis for improvement on future best practices and training. Compliance teams will discover new questions to ask, novel scenarios to address and gaps to fill.

Operational Planning
The best time to consider the impacts of Covid on your bank’s operations is while events and memories are fresh. Banks all over the country are experiencing what a handful of institutions may go through in the wake of a natural disaster: devastation, uncertainty and a need for banking support. This is the time to review your bank’s disaster recovery and business continuity plans, specifically including pandemic planning, to assess the plans against reality.  

To help, the Federal Financial Institutions Examination Council released an updated statement on pandemic planning suggesting actions that banks can take to potentially minimize a pandemic’s adverse effects. This is an chance to improve business continuity planning for similar future events, understanding that they may not be as deep or prolonged as the coronavirus. Exercising the plans in real time, compared to a scheduled test, can reveal helpful improvements that will only strengthen the bank.

Customer Experience
Coping with remote work and providing banking services outside of a branch provides the opportunity for banks to consider strategies around technology and financial technology partnerships. Customers have been rerouted to electronic avenues, and many seem to have embraced technology to deposit checks, access accounts online and transact business.

This evolution offers banks the opportunity to adapt and recognize the use of financial technologies. Many customers will understandably return to branches to conduct some of their business when they reopen, but may require them less. Banks may want to consider how they can satisfy future customer demand and improve the customer experience more broadly. These are just five areas where we see opportunities for banks of all levels and complexity to enhance their policies, procedures and best practices as they prepare to move forward.

Addressing the Income Inequality Imperative Before It’s Too Late

There’s an unofficial adage in journalism that three similar events make a story. One car wreck at a particular intersection is an accident. Two accidents are an unfortunate coincidence. Three times is a trend — and an issue to discuss and address.

So it was hard not to start worrying when three different guests — an entrepreneur, a former regulator and a longtime financial services consultant — mentioned the same potential fear on Promontory Network’s podcast “Banking with Interest.” They all worried that rising economic inequality, which has been exacerbated by the Covid-19 crisis, could spur widespread social unrest beyond anything we’ve seen to date.  

“Things can go really bad,” entrepreneur and Shark Tank costar Mark Cuban told me in April, well before the brutal police killing of George Floyd in late May sparked nationwide protests in response to racial injustice and inequality. “We’ve seen riots. We’ve seen small businesses burn down.”

One recent warning came from Karen Shaw Petrou, managing partner of Federal Financial Analytics. Petrou is one of the most thoughtful voices in the financial services industry; since 2018, she has been adamant that income inequality is an increasing — and underappreciated — risk to the financial system.

You have empirical and theoretical evidence that the more economically unequal a nation is, the more fragile its financial system,” Petrou told me in June. “I worry… that prolonged economic inequality, combined with the kinds of crises it keeps precipitating, will also lead to rage. History is not inspiring on the topic of what happens to societies with profound inequality.”

John Hope Bryant, the founder, chairman and CEO of Operation Hope, a not-for-profit dedicated to financial literacy and economic inclusion, agreed.

“Societies don’t crater from the top down,” he told me. “They crater from the bottom in. You cannot have 1% doing great, 15% doing pretty good and 80% plus doing pretty crappy and expect that to be sustainable.”

They are hardly alone. Both Citigroup CEO Michael Corbat and JPMorgan Chase & Co. Chairman and CEO Jamie Dimon flagged economic inequality as a growing threat to financial and political stability. And Brian Brooks, Acting Comptroller at the Office of the Comptroller of the Currency, acknowledged to me that systemic inequities need to be addressed.

“People are not actually crying out because the system is a terrible system, right? They’re crying out because the system that has worked for a bunch of people has totally excluded other people for a fairly long period of time,” he told me. “And the banking system can fix that.”

Among other things, Brooks wants to reexamine how credit scores are calculated and how current models shut minority Americans out of the finance system.

Economic inequality predates the spread of the coronavirus. The wealth gap between the richest and poorest families more than doubled from 1989 to 2016, according to the Pew Research Center. The data is particularly grim for African Americans. The average wealth of white households was seven times the average of black households in 2016, according to a recent post by Petrou. White Americans owned 85% of U.S. household wealth at the end of 2019, she wrote, while Black Americans held just 4.2%.

But the coronavirus crisis is set to make the problem far worse.

“Low-income households have experienced, by far, the sharpest drop in employment, while job losses of African-Americans, Hispanics, and women have been greater than that of other groups,” Federal Reserve Chairman Jerome Powell told lawmakers recently. “If not contained and reversed, the downturn could further widen gaps in economic well-being that the long expansion had made some progress in closing.”

There are proposed solutions. Petrou has called for the creation of an “Equality Bank,” controlled by a consortia of banking companies to “rewrite the profit equation to serve low- and moderate-income households.” This bank could offer short-term, low-dollar loans to consumers through the banking system, without the often-onerous rates and terms of existing products like payday loans.

Bryant has called for a new Marshall Plan to combat the problem, including calling for a universal income for workers making less than $60,000 per year,  a national financial literacy mandate, and a redesigned education system that includes a free college education for most students.

“You need a mass of people to be highly educated,” Bryant said. “This is not rocket science. It’s the radical movement of common sense. As you educate more people, and raise credit scores along with it, you get more economic energy. You get more small business startups, you get more job creation. You get higher educational engagement. You get better skilled workers. You get less societal friction. This is an investment, not a giveaway.”

Brooks, meanwhile, has said the OCC is set to launch a pilot project designed to bring together banks, civil rights organizations and academics to tackle wealth creation. Cuban has talked about creating jobs to track and trace the spread of the virus in the short-term and pushed for government investments in low-income housing and companies offering stock to employees so that they have a stake in a firm’s success.

Tackling economic inequality hasn’t been a high priority for many in banking and government. That needs to change — and soon. While people may reasonably disagree on the right solution to this issue, most are of the same mind when it comes to what happens if we don’t try to address it.

We need to lift people “from the bottom-up,” Cuban told me. “We have never thought like that in the past, and we need to. Because if we don’t, oh my goodness … If we screw up, it could get ugly.”

Compensating Employees in a Crisis

It’s an old conflict with new, pandemic-created urgency: How to compensate employees during a crisis.

Compensation is one of the biggest variable expenses a bank has, and many incentive compensation plans may have components or goals that are no longer realistic at this state of the business cycle. At the same time, bank employees have served as first-responders to the economic crisis created by the coronavirus pandemic, putting in long hours to modify or originate loans. Boards are figuring out how to reward employees for these efforts while keeping a lid on expenses overall, balancing the bank’s growth and safety against the short-term operating environment.

The Paycheck Protection Program from the Small Business Administration creates an interesting compensation opportunity for banks, says Flynt Gallagher, president of Compensation Advisors. Many banks had employees who pulled all-nighters while working remotely to fulfill demand for these unsolicited loans. Some institutions may choose to exercise discretion by issuing spot awards, which reward employees for a specific behavior over a limited period of time, to bankers who worked overtime to help customers. Gallagher believes these may be larger than a typical award, citing one client that is setting aside $100,000 of PPP profits to distribute to employees who pitched in.

The pandemic created challenges for Civista Bancshares’ commercial lenders and their incentive compensation program, though it presented opportunities as well. Processing PPP applications took time that the Sandusky, Ohio-based bank’s commercial team may have spent monitoring and administrating their existing portfolios or prospecting for new customers. But after the $2.6 billion bank satiated demand from current customers, it opened its doors for new customers, says Civista Bancshares CEO Dennis Shaffer. Some new customers transferred their accounts and service needs as a result, which counts toward deposit goals that retail bank staff have.

Banks with plans featuring objectives or goals that may no longer be reasonable or prudent may be able to exercise discretion under their plans’ “extraordinary events” clause, Gallagher says. The clause applies to events that materially affect profitability, like selling a branch or implementing a new operating system. Banks electing that approach, he says, will also need to quantify the impact that Covid-19 has had on their performance.

At Civista, goals tend to be set in the first quarter, and Shaffer says that changing course on an incentive plan midstream could compromise its integrity. Gallagher adds that public companies like Civista may face scrutiny from proxy advisory firms if they make changes to a current plan or exercise too much description.

But boards have some options as they evaluate their current incentive compensation plans. Some may break their compensation plans into shorter plan periods. Gallagher predicts that banks may decide to shift or roll up individual goals into team or department objectives to reward the broad efforts of groups that may have gone beyond the four corners of their job descriptions.

“I don’t think you’re going to see any general methodology adopted. It’s going to be all over the board, based on the institution,” he says.

Walden Savings Bank is comparing its compensation plan, which uses a scorecard of 12 metrics evaluated monthly, to its expected financial performance, says Stephen Burger, who has chaired the Montgomery, New York-based bank’s compensation committee for 16 years. He says there is already “no way” to achieve at least four of those metrics, reducing the incentive accrual by 25%. The board and CEO of the $603 million bank also decided to cut their pay, but so far no employees have been laid off or furloughed.

“The scorecard is just a guideline,” he says. “We do have latitude to look at other opportunities and reward or cut in certain areas.”

The bank is already trying to keep a tight lid on expenses. They stayed local for their strategic planning weekend instead of going out of town, implemented a hiring freeze, paused a branch transformation project and are mulling alternations to certain benefits or staff reductions.

“We will find a way to reward our employees,” Burger says. “At the same time, if earnings aren’t there, we’ll also do a very effective job of making sure that they recognize that it’s a unique type of year.

Gallagher cautions against banks making short-term cuts in employment or not rewarding producers. Good employees need to be retained in anticipation of better operating periods. And some banks may actually look to hire new employees right now, given that mass unemployment has flooded the marketplace with talent.

“One banker [I spoke to] said he doesn’t think he is overstaffed, he just doesn’t think he has people in the right places,” Gallagher says. “Companies that are forward-thinking will go hard on people while they’re available, even if they don’t need them. You’ll figure out how to use them to the best of their ability later. Get the talent right now.”

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.

Currency Rates Become Wildly Important

As we’re seeing with the COVID-19 crisis, very little in our economy is purely local.

Currency markets are one example. The markets are reflections of what is happening globally. They serve as the ultimate sentiment indicator, telling us what the future may bring for a country, region or the world at large.

But the sentiment can be costly — changes in currency rates can alter business costs in the blink of an eye. Still, many have no understanding of how currencies work, an opportunity ripe for your bank to offer some education.

While most would assume that the stock market is the biggest asset class on the trade block, it pales in comparison to currency trading volumes. Bloomberg reports that $6.6 trillion USD traded daily in 2019.

Since the 1920s, the U.S. dollar has enjoyed a long period of stability. This has allowed most business owners to go about their lives barely giving currency a fleeting thought, except perhaps when they’re traveling abroad or making a major international purchase.

But here’s another surprising undercurrent to this impression: Much of what we think of as domestic buying is an illusion.

Your business clients may buy a product from a local manufacturer, but where does that manufacturer buy its machinery? Where do they buy supplies to create their goods? Even local businesses tend to have international partners somewhere in their supply chains. Because of this, prices of the local goods are affected by currency rates.

Further, the world of currencies is surprisingly abstract. The U.S. dollar doesn’t have a single price. It has a unique price relative to the 200 or so other currencies in the world.

All of those prices fluctuate moment to moment because currency rates aren’t anchored by specific metrics. Instead, they reflect how buyers feel about the economic outlook of one country compared to another at any given time.

Buyers speculate about a country’s future inflation and interest rates, as well as intangibles like politics and socioeconomics. The pricing of currency is more art than science; more emotion than math. It’s enough to make heads spin.

The speculative nature of currency valuations makes them volatile. They are highly susceptible to world affairs; bad news can easily send them into an overnight tailspin. The global coronavirus crisis is the most recent example of this, sending currencies around the world reeling.

This is why your business clients can no longer be complacent. Outside the pandemic, previously stable countries have become unsettled by climate change. Once developing economies are maturing. It’s no longer the case that any particular currency is the safest bet. More and more, the name of the game is currency diversification.

But the good news is, your bank can help business clients protect themselves from currency fluctuations. The first step is to figure out how they’re at risk.

Advise business owners to figure out what percentage of their costs are in foreign currencies. If rates changed and suddenly those costs were 15% higher, could they absorb it? What about 20%? What is their back-up plan if they can no longer afford these suppliers?

Based on what they discover, your clients should consider diversifying their business costs through currency to help reduce the chances of over-exposure to any particular one.

Finally, advise your clients to increase their awareness of currencies. Suggest that they select a few that most affect their business and track them to see how their movements could affect their company’s well-being over time.

It’s true that uncertainty is always part of life, but preparation creates resilience.

Pandemic Poses Path to Boost Employee Engagement

The coronavirus crisis has temporarily boosted employee engagement, giving companies and managers a chance to implement changes that could make those increases permanent.

Employee engagement has increased since the start of the pandemic, according to the analytics and advisory firm Gallup, even as negative emotions also have risen. One potential reason could be stronger and more-empathetic connections between managers and employees. Companies have an opportunity to continue making changes that could result in long-term employee engagement increases, such as shifting managers from bosses to coaches.

Stay-at-home orders caused many banks to move to remote work environments for their employees, which altered the way managers relate with and oversee their reports, says Andrew Robertson, a managing consultant in retail banking and financial services at Gallup. Those shifts occurred as the firm began to see lower reported levels of well-being and higher levels of emotions like stress and anxiety in its surveys.

Work has really shifted, so the dynamic of … command-and-control literally can’t work right now,” Robertson says. “A boss would be over-the-shoulder task managing or micromanaging. Employees are acutely aware that is no longer applicable.”

The firm has also seen an increase in the percentage of employees who wish to continue working from home in some capacity, as well as an openness from managers and executives to allow that. But adding a work-from-home arrangement can complicate management once employees go off-site. In response, some managers seem to be electing a more empathetic, personal and coach-like approach when it comes to connecting and managing remote workers.

Managers are key to a team’s success, especially in moments of pressure and crisis. Their ability to connect and lead their reports has huge implications for banks seeking top performance. But they can also be a major liability when it comes to preserving, enriching and engaging a bank’s workforce.

Gallup’s research indicates that 70% of a team’s engagement can be attributed to their manager. Bad managers are costly: The firm found that one out of every two people leave a job as a direct response to a manager.

“If you want to boil employee engagement down, it’s essentially the manager,” says Paul Berg, financial services thought leader at Gallup. “Most people are having a mediocre-to-poor experience with their manager.”

But Gallup has found that employee engagement has moved higher during the pandemic, from 34% to 38% — its highest level since it began tracking in 2000. That’s a critical opportunity for banks. Higher employee engagement can translate into higher customer advocacy, productivity and profitability, and lower turnover, absenteeism, safety and theft.

Some of the reasons behind the move include that companies quickly rolled out definitive and detailed plans that kept employees informed of how their jobs would need to change. Managers were empowered to support employees as they moved to remote work, and employees may be especially grateful to have a job right now.

But another reason may be that employees and their managers may be having more meaningful and more frequent conversations — a dynamic that can drive engagement. Managers are figuring out ways to keep their teams connected to their work and to each other, acknowledging their colleagues’ stress and trying to keep morale high.

This creates a natural opening for banks to continue cultivating this increased engagement by training managers to become coaches and not bosses. But not just any type of coach.

Berg says companies that adopt a coaching mentality for managers tend to focus on specific objectives, which winds up being “completely ineffective.” The secret to good coaching is focusing on an employee’s strengths. Just as the best coaches help their players identify and leverage their strengths as part of a team, the best managers “focus on what’s right with a person,” Berg says.

Shifting to a coach mindset may come more naturally for some managers right now, given that remote work has changed the types of conversations they have with employees. Robertson says effective managers during the pandemic are the ones who get to know their employees and their situations in order to help them accomplish what they need to, and can have more-meaningful conversation about their work as a result. He believes the role of managers as a glue connecting workers to their banks has become more, not less, important during the pandemic.

“There have been moments [during the pandemic] where we’ve really understood that these human connections are important at work, and that we’re actually able to accomplish so much together when we make those thoughtful human connections,” he says.

Starting from Scratch: Reassessing Business Loans

Deposits are up, investors have shown signs of optimism and parts of the country are slowly reopening. But amid these positive signals, banks are only just beginning to see the signs of future trouble that Covid-19 may cause for their loans. Prudent banks are working to plan for the long-tail impacts the crisis will have.

One of the banks gazing into its crystal ball is PNC Financial Services Group. The Pittsburgh-based bank made headlines when it sold its 22% stake in BlackRock last month. Chairman and CEO William Demchack, explained in an early June company presentation that the institution was selling while it could, and preparing for the unknown effects that Covid will likely have on the economy.

“[B]ehind the scenes, what hasn’t played out, and will take some period of time to play out, is the deterioration we’ve seen in small business, commercial and real estate,” he said. Once the stimulus payments and deferrals run out,  “the pain shows up.”

That pain may be especially acute for smaller banks which, Demchack pointed out, tend to carry higher concentrations and exposures to small business and commercial real estate  than their larger counterparts. “[I]t’s the smaller end of our economy that’s really getting crushed here.”

With losses looming on the horizon, some banks are leveraging data and analytics solutions to essentially re-underwrite their entire loan portfolios in light of Covid-19.

Just after announcing the BlackRock sale, PNC was again in the news for a brand new partnership it struck with OakNorth, which licenses an AI-based underwriting platform it incubated within the company’s UK-chartered bank. OakNorth recently announced some of its first partnerships with U.S. banks, including Customers Bancorp, a $12 billion asset institution based in Wyomissing, Pennsylvania.

Customers’ Vice Chairman and Chief Operating Officer, Sam Sidhu, is paying close attention to the unknown outcomes of Covid and the effects the economic crisis will have on the bank’s “core” mid-sized commercial loans.

Sidhu explains that in the first 30 to 60 days of the crisis, banks encountered the known, obvious risks that social distancing and stay-at-home orders posed to businesses like restaurants, hotels and hair salons. “But where banks can become a little complacent is the areas that are unknown risks,” says Sidhu. That’s where it’s important to practice discipline in stress-testing the portfolio.

But how can a bank re-evaluate its loans at scale, in a way that doesn’t throw the baby out with the bathwater?

A generalist might point out that restaurants won’t perform well in this environment. But what about a pizza franchise that earned significant portions of its revenue from deliveries pre-Covid? These types of restaurants may be unaffected by the health crisis; in fact, they may be booming because of it.

To complicate the calculation, it’s not just immediate issues like an absence of demand that lenders need to consider. They also need to understand a business’ ability to restock and recover. To do that effectively, context is key. That’s what the technology that PNC and Customers Bank have licensed from OakNorth is designed to provide.

The OakNorth platform categorizes businesses into 1,600 sub-sectors so that they can be segmented into highly specific groupings. Then, the platform can be used to apply any number of OakNorth’s more than 150 stress testing models, including a new Covid Vulnerability Rating framework, to assess business borrowers.

Customers Bank is working with OakNorth on portfolio management and underwriting. Sidhu says a benefit of using the technology is that it’s “allowing a community bank to be able to have investment banking-type access to data” — an important factor in a world where old models have been rendered irrelevant.

“Everything that you thought when you underwrote a loan is no longer true,” says OakNorth Chief Information Officer Sean Hunter. Banks typically use previous years’ financial statements to underwrite a loan, but 2019 financials cannot predict how a business will perform in the 2020 world. Hunter says “you need to underwrite your whole book again, from scratch.”

OakNorth has been offering banks the opportunity to test drive its Covid Vulnerability Rating, running a forward-looking analysis on bank portfolios using 15 to 20 anonymized data points to identify at-risk loans.

No one knows what risks banks will be battling in the coming months. “Hopefully, these unknown risks will never become an issue,” says Sidhu, “but smart banks can’t really rely on hope. [They] need to be focused on trying to proactively address those risks, and get ahead of problems.”

Risk, Business Continuity Planning: Trends and Lessons from Covid-19

The Covid-19 pandemic has introduced unprecedented strains to the economy, enhancing concerns about credit risk and pressuring lenders’ ability to serve their borrowers.

Cybersecurity and other risk environments have also evolved, following government-mandated work from home models. These shifts are prompting bank leaders to evaluate their business continuity plans and pandemic planning initiatives to ensure they’re putting safety and efficiency first.

Bank Director’s 2020 Risk Survey, sponsored by Moss Adams, was conducted in January before the U.S. economy felt the full effect of the coronavirus. Yet, insights derived from this annual survey of bank executives and board members help paint a picture of how the industry will move forward in a challenging operating environment.

Credit Risk
Most community banks have issued loans through the Paycheck Protection Program (PPP), the Small Business Administration’s loan created under the Coronavirus Aid, Relief and Economic Security (CARES) Act passed in late March. These loans, which may be forgiven if borrowers meet specified conditions, allowed small businesses to retain staff, pay rent and cover identified operating expenses.

However, it’s likely that businesses will seek additional credit sources as the economy restarts. The lapse in business revenue generation will pose significant underwriting challenges for banks.

More than half of respondents in the 2020 Risk Survey revealed enhanced concerns around credit risk over the past year, while 67% believed that competing banks and credit unions had eased underwriting standards.

While there’s no way to determine what the future holds, near-term lending decisions will likely occur amid an uncertain economic recovery. There are some important questions institutions should consider when determining their lending approach:

  • How will our organization evaluate lending to businesses that have been closed due to the coronavirus?
  • Should a pandemic-related operational gap be treated as an anomaly, or should lenders consider this as they underwrite commercial loans?
  • What other factors should be considered in the current environment?
  • How much bank capital are we willing to put at risk?

Cybersecurity
Directors and executives who responded to the survey consistently indicate that cybersecurity is a key risk concern. In this year’s survey, 77% revealed their bank had placed significant emphasis on increasing cybersecurity and data privacy in the wake of cyberattacks targeting financial institutions, such as Capital One Financial Corp.

With more bank staff working remotely, cyber risks are even greater now. Employees are also emotionally taxed with concerns about their health, family and jobs, increasing the risk for errors and oversights. Unfortunately, the COVID-19 pandemic presents cybercriminals with a ripe opportunity to prey on individuals.

Business Continuity
In the survey, respondents whose bank had weathered a natural disaster within the last two years were asked if they were satisfied with their institution’s business continuity plan. The majority, or 79%, indicated they were.

However, the Covid-19 pandemic isn’t a typical natural disaster. Although buildings haven’t been destroyed, companies are still experiencing significant disruption to their normal operations — if they’re able to operate at all.

These circumstances, coupled with expanding technology and banks operations increasingly moving to the cloud, will likely lead to further changes in business continuity planning.

Remain Flexible
In an interagency statement released a week before the World Health Organization declared that the Covid-19 outbreak a pandemic, federal regulators reminded depository institutions of their duty to “periodically review related risk management plans, including continuity plans, to ensure their ability to continue to deliver their products and services in a wide range of scenarios and with minimal disruption.”

The Federal Financial Institutions Examination Council also updated its pandemic guidance, noting the need for a preventative program and documented strategy to continue critical operations throughout a pandemic.

Since that time, banks have encouraged customers to broadly adopt digital platforms and, when necessary, serve customers in person through drive-through lines or by appointment to reduce face-to-face contact. Bank employees wear masks and gloves, branches are cleaned frequently and, where possible, staff work remotely.

Gain Insights
The pandemic is a real-world tabletop exercise that can provide important takeaways about the effectiveness of an organization’s business continuity plan. It’s important for organizations to take advantage of this opportunity.

For example, there could be another wave of Covid-19 later this year; alternately, it could be years before we see an event similar to what we’re experiencing. Either way, your bank must to consider the potential consequences of each outcome and have a plan ready. Reviewing your organization’s business continuity plans and initiatives can help reveal opportunities to move forward with confidence, despite challenging operating environments.

Five Reasons to Consider Banking Cannabis

Like nearly every industry, the banking sector is facing major economic disruption caused by the coronavirus pandemic.

Operational strategies designed to capitalize on a booming economy have been rendered obsolete. With the Federal Open Markets Committee slashing interest rates to near zero, financial institutions have needed to redirect their focus from growth to protecting existing customers, defending or increasing earnings and minimizing losses.

While this will likely be the status quo for the time being, bank executives and their boards have a responsibility to plan ahead. What will financial markets look like after absorbing this shock? And, when rates begin to rise again — as they will, eventually — how will you position your financial institution to take advantage of future growth?

The booming legal cannabis industry is one sector banks have been eyeballing as a source for low-cost deposits and non-interest income. While ongoing conflict between state and federal law has kept many financial institutions on the sidelines, others have made serving this industry part of their growth strategy. According to new market research, the U.S. legal cannabis market will be worth $34 billion by 2025. While we don’t claim that sales will be immune to the financial shock caused by the pandemic, they have remained somewhat steady — due in large part to being deemed essential in most states with legal medical cannabis programs. With much of this revenue unbanked, it’s worth taking a closer look at how this industry can be part of your bank’s long-term strategy. Here are five reasons why.

  1. Cannabis banking can provide reliable non-interest income. As net interest margins compress, financial institutions should look to non-interest income business lines to support overall profitability. Cannabis companies are in dire need of quality banking solutions and are willing to pay upwards of 10 times the amount of traditional business service charges. Assessing substantially higher base account charges, often without the benefit of an earnings credit to offset those charges, means there are untapped cash management fee opportunities. Together, these fees can fully offset the operational cost of providing a cannabis banking program.
  2. New compliance technologies can reduce costs and support remote banking. Many banks serving cannabis customers are using valuable human capital to manage their compliance. However, new technologies make it possible to automate these processes, significantly reducing the labor and expense required to conduct the systematic due diligence this industry requires. New cannabis banking technologies can also enable contactless payments, and handle client applications, account underwriting and risk assessment — all via remote, online processes.
  3. Longer-term, cannabis banking can provide a source of low-cost deposits. The pressure to grow and attract low-cost deposits may wane momentarily but will continue to be a driver of bank profitability long-term. Increasing those deposits today will protect future profitability as the economy improves.
  4. Comprehensive federal legalization is on the back burner — for now. While your bank may want to wait for federal legalization before providing financial services to this industry, there’s a significant first-mover advantage for institutions that elect to serve this industry today. The ability to build new customer relationships, earn enhanced fee income and gain access to new sources of low-cost deposits early on could be a game-changer when legalization eventually occurs.
  5. You don’t need to be a pioneer. Having spent most of my career leading retail operations at a community bank, I know financial institutions don’t want to be the first to take on something new. Although it is still a nascent industry, there are financial institutions that have served cannabis businesses for several years and are passing compliance exams. Banks entering the industry now won’t have to write the playbook from scratch.

The coronavirus pandemic requires banks to make many difficult decisions, both around managing the financial impact and the operational changes needed to protect the health of customers and employees. While adapting operating procedures to the current environment, banks should also begin planning for a future recovery and identifying new potential sources of growth. Cannabis banking can provide a lucrative new revenue stream and the opportunity for financial institutions to grow deposits with minimal competition — at least for now.