You wouldn’t think Jill Castilla would have trouble getting a bank loan. After all, she’s the CEO of Citizens Bank of Edmond, a $354 million institution in Edmond, Oklahoma. But as a veteran of the U.S. Army married to retired lieutenant colonel Marcus Castilla, she figured they would qualify to get a VA home loan from a bank other than Citizens, which doesn’t offer VA loans.
After 60 days stretched to more than 90 days, the big bank still hadn’t said yes or no, and the seller was getting increasingly anxious. To get the house they wanted, the couple switched gears and got a loan from Citizens instead.
After abandoning the attempt to get a VA loan, Castilla vowed to help other veterans. Her bank has partnered with several technology companies, including Jack Henry Banking, Teslar Software and ICE Mortgage Technology to start a lending platform on a national basis called Roger.
Bank of Edmond hit on a problem the market hadn’t solved: How to make the process of getting a VA loan quicker and easier, especially in a hot real estate market where veterans are more likely to lose bids if they can’t be competitive with other buyers. As Managing Director Sam Kilmer of Cornerstone Advisors put it at Bank Director’s FinXTech Experience conference recently, borrowing from Netflix co-founder Marc Randolph, “the no. 1 trait of an innovator is recognizing what causes other people pain.” Many banks like Castilla’s are trying to solve customer problems and remake themselves with the help of technology, particularly from more nimble financial technology, or “fintech” partners.
In fact, investors already view banks differently based on their approaches to technology, said William “Wally” Wallace IV, a managing director and equity analyst at Raymond James Financial, who spoke at the conference. Wallace categorized banks in three groups: the legacy banks, the growth banks and the tech-enabled banks.
The legacy banks aren’t growing and trade close to book value or 1.5 times book, Wallace said. The growth banks emphasize relationships and are technologically competent. They trade at 1.5 to 2.5 times book. But the tech-enabled banks use technology offensively, rather than defensively. Tech-enabled banks look to create opportunities through technology. Their stocks command a median tangible to book value of 2.5 times. They have more volatile stock prices but they have outperformed other indexes since 2020, with an average return of 104%, he said. Wallace predicts such banks will out-earn other banks, even growth banks, in the years ahead. He estimates their earnings per share will enjoy average compound annual growth rates of about 24% over a five-year period starting next year, compared to 7% for small-cap banks on average.
Take the example of banking as a service, where a bank provides financial services on the back end for a fintech or another company that serves the customer directly. Wallace said those banks have a fixed cost in building up their risk management capabilities. But once they do that, growth is strong and expenses don’t rise at the same rate as deposits or revenue, generating positive operating leverage.
But, as banks try to remake themselves in more entrepreneurial and tech-forward ways, they’re still not tech companies. Not really. Technology companies can afford to chase rabbits to find a solution that may or may not take off. Banks can’t, said Wallace. “You have to be thoughtful about how you approach it,” he added. But, he suggested that tech-enabled banks that invest in risk management will have large payoffs later. “If you guys prove you can manage the risks, and not blow up the bank, investors will start to pay for that growth,” he said.
Customers Bancorp is positioning itself as one of those tech-forward banks but it’s already seeing results. The West Reading, Pennsylvania-based bank reported a core return on common equity of 24% and a return on average assets of 1.63% in the first quarter of 2022.
Jennifer Frost, executive vice president and chief administrative officer at $19.2 billion Customers Bank, spoke at the conference. “We had some pretty sophisticated platforms, but we didn’t have a way to unlock the power with the people who knew how to use them,” she said. Since the Paycheck Protection Program proved the bank could pivot to providing digital loans quickly, the bank began ramping up its capabilities in small business and commercial lending. Instead of limiting itself to buying off-the-shelf platforms from technology providers, its strategy is to carefully pick configurable programs and then hire one or two developers who can make those programs a success.
“Take what you’ve learned here and start a strategy,” she warned the crowd of some 300 bankers and fintech company representatives at the conference. “If you’re not starting now, it’s going to be a dangerous season.”