Fintechs Offer Many Opportunities for Banks. But How Do You Decide?

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Another version of this article was originally published on April 3, 2023, as part of a special report called “Finding Fintechs.” 

As part of his job, Clayton Mitchell once bought a list of global financial technology companies from a data provider. It had 7,000 names on it. 

“I can’t do anything with this,” says the managing principal in the risk consulting practice of Crowe LLP, who advises banks on partnering with fintech companies. “Figuring out the winners and losers is a bit of a needle in a haystack approach.” 

Banks that want to partner with technology companies or buy software from a vendor face the same sort of tsunami of options. On the one hand, fintechs offer real promise for community banks struggling to keep up with bigger institutions, credit unions and other competitors — a chance to cut costs and increase efficiencies, grow deposits and loans, and give customers quicker and easier ways to do business with the bank. 

But in the midst of economic uncertainty, banks face real risks in doing business with early-stage fintechs that might consolidate or even go out of business. So how do you choose? 

The problems banks face making a digital transformation are legion. In Bank Director’s 2022 Technology Survey, 45% of responding CEOs, directors, chief operating officers and senior technology executives said they worried about reliance on outdated technology. Forty-eight percent worried their bank had an inadequate understanding of the impact of emerging technologies. And 35% believed their bank was unable to identify the solutions it needs.

Historically, small and midsized banks have relied on their core processor to identify and vet companies for them. About half of Mitchell’s customers continue to rely on the bank’s core processor exclusively to find and vet technology companies for them. Cornerstone Advisors’ annual “What’s Going On In Banking” survey of community banks found this year that 55% of respondents didn’t partner with a fintech startup in 2022; 20% had partnered with one fintech; 16% with two and the rest with three or more. But Mitchell thinks the opportunities to go beyond the core are better and more feasible for small and community banks than ever, if the bank follows due diligence. “Sometimes you have to solve problems quicker than the core will get it to you,” he says. “There’s a growing appetite to go outside the core.” 

The big three core processors — Fiserv, FIS and Jack Henry & Associates — have started offering newer, cloud-based cores to connect with a greater variety of technology companies, plus there are ways to add additional layers to core systems to connect useful technological tools, using what’s known as application programming interfaces. “There are different layers of technology that you can put in place to relegate the core platform more into the background and let it become less of a focus for your technology stack than it has historically been,” says Neil Hartman, senior partner at the consulting firm West Monroe. 

In combination with technological change, leadership among banks is changing, too. The last three years of the pandemic taught banks and their customers that digital transformation was possible and even desirable. “We’re seeing more progressive bank leadership. Younger generations have grown up in digital environments and with the experiences of Amazon and Apple, those technology behemoths, and are starting to think about their technology partnerships a little more aggressively,” Hartman says. He adds that banks are beginning to reckon with the competition coming from the biggest banks in terms of digital services. “That’s trickling down into the regional and community bank space,” he says. 

Fintechs, likewise, are adjusting to banks’ sizable regulatory compliance obligations, and they’re maturing, too, says Susan Sabo, the managing principal of the financial institutions group for the professional services firm CliftonLarsonAllen LLP. Many fintechs have upgraded their structure around risk management and controls to ensure they’ll get bank customers. “With the onset of the pandemic, I do think it allowed many fintechs to reset and reinvest, and they did start to build some traction with banks,” Sabo says. 

Still, many banks hesitate to use an alternative to the big three core processors or switch the bulk of their lending and deposit gathering capabilities to a fintech, she says. They’re sticking to fintechs that offer what she calls ancillary solutions — treasury management, credit loss modeling and other types of platforms. But even that has been changing, as evidenced by the success of the fintech nCino, which sells a cloud-based operating system and had its initial public offering in 2020. Sabo recommends using proper due diligence to vet fintech companies. It’s also important to consider cybersecurity, data privacy and contractual issues. And last but not least, consider what can go wrong.

One big hurdle for smaller banks is the cost of using third-party solutions. “Nothing about technology is ever cheap,” Sabo says. “Even things as simple as, ‘We need to refresh all of our hardware,’ becomes a massive investment for a [community] bank. And if you’re held to your earnings per share each quarter, or you’re held to your return to your investors each quarter … you may keep putting it off. Many banks are in a situation where they’re anxious about their technology because they haven’t invested along the way.”

Talent is another large obstacle banks face. Small banks, especially those in rural areas, may struggle to find the staff to make the technology a success. Information technology departments often aren’t equipped with strategic decision-making skills to ensure a fintech partner will meet the bank’s big-picture goals.

And banks that want to leverage data analytics to improve their business will have to hire data scientists and data engineers, says Corey Coscioni, director of strategic alliance and business development at West Monroe. “You’re going to need to build some level of internal capabilities,” he says.

Considerations for Post-CECL Adoption

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Over the last 10 years, banks have discussed and debated the current expected credit loss, or CECL, accounting standard. Many of the larger banks adopted the standard in 2020, with the majority of smaller banks adopting on Jan. 1, 2023.

While the industry has adopted CECL, here are some items to consider in 2023 to position your institution for success in your next regulatory exam or external audit.

Prepare a CECL Adoption “Package”
When your regulators and auditors arrive in 2023, they will likely ask about your CECL implementation process. One way to address their questions is to prepare a package that  includes:

  • Board-approved allowance for credit losses, or ACL, policy.
  • The initial adoption calculation.
  • The consideration of unfunded commitments, which are recorded as a liability on the bank’s balance sheet, and debt securities, both available-for-sale and held-to-maturity.
  • The bank’s narrative that supports its CECL calculation, which should include a summary of the selected model and methodology, assessment of qualitative factors and forecasting and a summary of any individually evaluated loans.
  • The initial adoption journal entry, a reconciliation to your CECL calculation and documentation of a review and approval of the journal entry.
  • Third-party vendor management documentation and CECL model validation.

Third-Party Vendor Management
If your bank is using a third-party vendor for its CECL calculation, be sure to document the vendor management considerations over this calculation annually in accordance with your bank’s vendor management policies and your primary regulator’s guidance.

Make sure this documentation includes procedures the bank has taken to gain comfort over the third party’s calculation, obtaining a service organization controls (SOC) report for the calculation and a CECL model validation for the third-party calculation. Your institution may need to get support from the vendor to assist with articulating the math behind the calculation and a recalculation of the ACL on an individual loan basis.

Perform Back Testing in 2023
As the bank’s CECL model “ages” in 2023, management should document back testing of the model to verify it is functioning as expected. Back testing can aid the bank in understanding the model and how estimates and varying economic results impact it.

As your bank develops its back testing procedures, consider comparing estimated data points to actual results, including prepayment speeds, loan charge-offs and recoveries, economic data points and loan balances. Additionally, management should consider sensitivity or stress testing of the model, including analysis of various scenarios or assumptions and their impact on loss estimates.

Add CECL to the 2023 Internal Audit Plan
The CECL model, like the historic incurred loss model, should be subject to the bank’s internal audit plan. This internal audit program can include reviewing the policies and procedures, gaining an understanding of the model, reviewing the assumptions in the model for reasonableness and consistency with other assumptions and reviewing the model access. It should also include procedures to verify calculations are appropriately reviewed by management and governance.

CECL Model Validation
As bank regulators discussed in the 2020 interagency policy statement on the allowances for credit losses, model validation is an essential element to a properly functioning process for a bank, and should be completed annually. Validation activities for a bank include evaluating and concluding on the conceptual soundness of the model, including developmental evidence, performing ongoing monitoring activities, including process verification and benchmarking and analyzing model output, according to the interagency statement.

The CECL model validation, which is a frequently overlooked part of CECL implementation, should be performed by an individual or firm that is independent from the model’s design, implementation, operations and ownership. Additionally, the interagency statement states the external auditor of the bank may impair independence if they also perform the CECL model validation.

The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, investment, or tax advice or opinion provided by CliftonLarsonAllen LLP (CliftonLarsonAllen) to the reader.

CLA exists to create opportunities for our clients, our people, and our communities through our industry-focused wealth advisory, digital, audit, tax, consulting, and outsourcing services. CLA (CliftonLarsonAllen LLP) is an independent network member of CLA Global. See CLAglobal.com/disclaimer. Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC-registered investment advisor.

Building the Board’s Ethical Backbone

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An ethical foundation is vital to a healthy, successful financial institution, and it starts with the board of directors.

“Ethics is something that you carry with you every day,” says Samuel Combs III, CEO of the management consulting firm COMSTAR Advisors and the governance committee chair at $2.7 billion First Fidelity Bancorp, based in Oklahoma City. “It begins with the leadership team, of course, [and] boards.”

As a guiding principle for the organization, a code of ethics provides a pathway to govern. And the rise of environmental, social and governance (ESG) initiatives, with their emphasis on customers, employees and communities, puts additional pressure on corporate behaviors. While a bank’s regulators require a certain level of ethical standards, some organizations have taken the lead in driving an ethical approach to banking to garner consumer trust. The board should be at the forefront of these discussions, yet, incorporating an ethical approach to banking does not come with a paint-by-numbers guide. Instead, it’s driven by management, and shaped by the questions and insights boards can bring to the conversation.

Organizations often go wrong with their ethical duty not on the personal level, but due to a systemic breach, says Steve Williams, the president and co-founder of Cornerstone Advisors. “When people get caught up in something, it’s seen as normal when it shouldn’t be,” he adds. “Systemic pressure, that can happen in any place; you have to believe it can happen here, in order to protect against it.”

Board members have a limited opportunity to peer into the day-to-day of the organization and understand how it’s operating from an ethical standpoint. Combs advises directors to look for “signals,” and ask questions about the gray areas of finance and the business’s success.

“To mutually arrive at a standard, the board must set the expectations,” says Combs. “It’s up to the management to live up to those standards.”

When financial reports are produced, if results prove far better than expected or end up very true to estimates quarter after quarter, it’s important to inquire as to how the bank achieved the numbers. It doesn’t mean something has gone awry, but you should ask to ensure liberal accounting tools or untoward sales practices are not being used. Another sign? Maybe there’s a sense that employees’ engagement has dropped significantly. Boards must seek to answer why. It requires asking further questions about sales processes, deposit efforts and the management of the institution. “It’s a signal that you should look further,” adds Combs.

This doesn’t mean that the board needs a separate ethics committee to manage this process. “I believe it should be engrained in all committees,” says Williams. Ethics should be the backbone for all deliberations in the audit, governance, compensation, risk and other committees of the board, informing how members analyze, question and provide guidance.

This thread should also trickle down to how the board makes decisions and evaluates performance. Reevaluating the code of ethics, whistleblower policies and other internal documents should be conducted once a year, and should be done with some “degree of visibility,” says Williams.

What Should a Code of Ethics Address?

Sources: Office of the Comptroller of the Currency, Federal Deposit Insurance Corp.

  • Prohibitions and monitoring relative to conflicts of interest, insider activities and self-dealing
  • Confidentiality of bank, customer and employee information
  • Maintaining accurate and reliable records
  • Compliance with applicable laws and regulations
  • Fair dealing, including the use of privileged information and misrepresentation of facts
  • Protection and use of bank assets
  • Expectations that employees, executives and directors deal honestly with the bank’s auditors, regulators and legal counsel
  • Screening the backgrounds of potential employees
  • Whistleblower policy, which allows employees to safely report concerns about bank practices
  • Periodic ethics training
  • Updating ethics policies to reflect new business activities
  • Consequences that could occur if executives, employees or directors breach the code of ethics or otherwise participate illegal behaviors Process.”

When looking at these documents, hold them up to the board’s actions and performance. How did the board make decisions, based on the code of ethics? When tough issues arose, did the board make the easy decision or take a tougher route that was more in line with the code of ethics? Did the board, in its decision making, represent the bank’s core values? Consider incorporating these questions into the board’s performance evaluation. You may not have a perfect score, but regularly revisiting the board’s deliberating process will ensure that living to the bank’s values becomes second nature, says Williams.

Failing to have this ethical background can lead to a significant backlash against the company, both from a legal perspective as well as harm to its reputation. The board at Wells Fargo & Co., for instance, received significant criticism for not questioning gray areas in its results and sales processes, which led to more than $3.7 billion in fines levied by the Consumer Financial Protection Bureau. Damage to its culture and reputation promises to be longer lasting.

An emphasis on ethics should also be found in how the board evaluates management, and how management evaluates the rank-and-file. Williams says it should even bleed into how a director may compliment an executive on a social site like LinkedIn. Has the director complimented the manager based on reaching some sales target? Or does the compliment reflect that the person lived up to the ethical core of the organization? It’s often telling when ethics isn’t emphasized in what directors publicly acknowledge.

That said, it’s important for potential directors to consider avoiding certain opportunities, even if the challenge of reshaping a poorly run organization may be an initial draw. Combs says he once considered joining the board of a non-bank entity that had some questionable ethics, which had become public. At the time, he felt he could have the opportunity to change what the organization would look like moving forward.

However, he eventually passed on the role because he wouldn’t have the levers to make change from the board position. “If you like a challenge, it’s fun to do the work,” says Combs. “You have to know [the organization] is willing to do the hard work.”

The same diligence and decision making must occur when the board is presented with possibilities, some that could improve the bank’s bottom line but would be counter to the institution’s ethical framework. It’s in those moments where the decisions made by the board could determine whether the bank experiences an ethical failure down the line.

Sometimes the right decision will be the hard one, even if the easy one is technically legal.

“Regulatory compliance does not cover all our needs for ethics,” says Williams. “Be much broader and active in that reflection.”

Don’t Let Fear of Missing Out Guide Tech Due Diligence

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In September 2021, JPMorgan Chase & Co. purchased the college financial planning platform Frank for a cool $175 million. For that price, the big bank expected to gain a purported five million potential new customers — students, parents and low-to-moderate income households. The bank kept Frank CEO Charlie Javice as head of student solutions as part of the deal, paying her a $20 million retention fee, according to The New York Times.

But JPMorgan said it didn’t get what it was promised. In a lawsuit filed in December 2022, the bank alleged Frank had fewer than 300,000 customers — roughly four million had been faked. JPMorgan shut down Frank’s website in early 2023.

Jamie Dimon, JPMorgan’s CEO, called the acquisition “a huge mistake” in the bank’s fourth quarter 2022 earnings call, and indicated that more details would be disclosed after the litigation has been resolved. JPMorgan didn’t respond to Bank Director’s request for information. Javice is suing JPMorgan; her lawyer told The New York Times that the bank realized it couldn’t work around student privacy laws and tried to “retrade” the deal.

The cost of the Frank acquisition seems eye-popping, but it’s a mere drop in the bucket for the big bank. JPMorgan reported $34.5 billion in net revenue in the fourth quarter 2022; that’s around $375 million earned daily. It’s an experienced fintech acquirer, with seemingly endless resources it can dedicate to vetting these deals. If a fintech company managed to trick the largest of the big banks, what does that mean for other banks looking to acquire tech companies in 2023? 

The number of financial institutions acquiring technology companies remained few in 2021-22, according to an analysis from information from Piper Sandler & Co. using compiled for Bank Director with data from S&P Global Market Intelligence. Those buyers are primarily above $50 billion in assets. Crispin Love, senior research analyst at Piper Sandler, says those deals tend to complement the bank’s strategy, via deposit, lending or payments platforms, or niche services. “It tends to be the larger players buying some of these smaller fintech players to enhance solutions at the bank, rather than being [a] big transformational deal,” he says.

Sixteen percent of the bank executives and directors responding to Bank Director’s 2023 Bank M&A Survey, sponsored by Crowe LLP, say their institution is likely to acquire a technology firm in 2023. Due to last year’s drop in fintech valuations, it could be a great time to buy, says Crowe Partner Rick Childs. But price isn’t the only factor in an acquisition, and acquiring a technology company requires additional due diligence.

Dion Lisle, director of corporate ventures at $183 billion Huntington Bancshares, has more than 100 items on his due diligence checklist for any fintech the Columbus, Ohio-based bank may choose to invest in or acquire. At a high level, he and his team want to know:

  • Who are the founders, and what are their backgrounds? Who are the investors?
  • Is the tech stack modern, and will it fit with the bank?
  • How much technology has been outsourced?
  • Does the company own its intellectual property?
  • Have there been lawsuits against the company?
  • What about the company’s books? How much money do they have, and how have they spent it?

Lisle also seeks customer references. This was easy with Huntington’s recent acquisition of Digital Payments Torana, which worked with two of the bank’s customers. “We had assurance from that,” says Lisle. “We knew the people that said, ‘Yeah, this product uniquely solves this business case.’”

Code review is also part of Lisle’s checklist and is among the few items he’s willing to outsource. Most is covered by the bank’s ventures unit. “We’re a team of 10 folks with expertise around banking, venture investing, due diligence [and] compliance, so we’re able to do a pretty good job in house,” says Lisle.

Clayton Mitchell, a principal at Crowe, says banks should examine controls, processes and potential compliance gaps, particularly where the technology could pose significant regulatory, legal, financial or reputational risk, including potential fair lending or Unfair, Deceptive, or Abusive Acts or Practices (UDAAP) violations. And he advises banks to build a team that includes the CFO and finance staff, relevant business leaders, technology and information security, and risk and compliance. “Don’t get enamored with the tech,” he cautions. “[Fintechs have] been pitching for money since the day they were born. It’s the only way they’ve existed. So, they’re really good at sales.”

Banks should also take time with due diligence, and shouldn’t cave in to FOMO, or fear of missing out. “That’s never a good way to do deals,” says Lisle. “You never skip basic DD [due diligence].”

Earlier in his career, Lisle worked for Citigroup, which sent him to Brazil to check out a payments company that boasted a million signups. The company even paid soccer star Ronadinho Gaúcho $5 million to be its spokesperson. But Lisle dug deeper and uncovered just $10,000 in transactions — a low figure given the large user base the fintech claimed to have. Citi pulled the plug on the deal.

Lisle says it took 24 hours to pull the plug on the multi-million-dollar transaction. Problems aren’t always hard to spot, he explains. At JPMorgan, a few thousand emails would have quickly revealed the authenticity of Frank’s user base. “[It’s] literally two days of due diligence.”

3 M&A Risks to Consider

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One crucial component of the merger and acquisitions process is due diligence, which needs to be performed efficiently within a limited amount of time as opportunities arise. Senior management is primarily responsible for this task, but may need assistance from key areas such as compliance, and often uses third-party support. If your bank is considering an acquisition, consider these three risks and document them as part of your due diligence.

1. Credit Risk
Potential acquirers must perform rigorous due diligence on the target bank’s credit portfolio — it’s imperative to the success of any merger. Executives at the acquiring bank need to understand the loan portfolio, including the types of credits offered, underwriting practices and problem loan management. This includes reviewing sample credits, including the top borrowers, adversely classified loans, watch list loans, loans to insiders and a sample of loans of each collateral type, if possible.

While there is no required portfolio coverage for due diligence, executives should have a flavor for the lending practices at the target bank.

2. Financial Risk
As part of due diligence, executives need to gain an understanding of the balance sheet and income statement at the target bank. Consider:

As 2022 unfolds, the Federal Reserve indicated it will continue increasing rates in an attempt to reduce inflation, which has created significant unrealized losses in many bond portfolios. This is after many banks invested the flux of cash generated by pandemic-era programs into their bond portfolios in an effort to achieve some return throughout 2021.

Consider the impact this could have on bond portfolios in acquisitions, including the value in a sale of the full portfolio, the long-term market rate forecast or even hedging strategies.

Review significant on- and off-balance sheet liabilities, including major contracts such as the core system contract, employment contracts, equity plans or stock options. These contracts could result in additional liabilities for the acquiring bank.

Acquirers will need an independent valuation of the target bank, including an estimate of the goodwill, core deposit intangibles, fair value adjustments to loans and other fair value adjustments that will be considered as part of the transaction. This valuation should be fluid, starting with the preliminary stages of the merger discussions, and evolving and refining as the merger proceeds.

Executives should prepare pro forma and projected financial statements to depict what the combined organization will look like at the merger date and going forward. In addition, those financial statements should determine the rate of return on the acquisition and the earn-back period.

3. Reputational Risk
Many banks are heavily involved and invested in their local communities, including deep and long-standing relationships with many bank customers. The art of combining two institutions and selling the “new” institution to the existing customers takes planning and care.

In addition, the employees and branches of the target bank are part of that same community. If the transaction includes retaining all employees and branches, communicate that as part of the press releases. If necessary, consider stay bonuses to retain the talent of the target bank. The new combined entity will want to uphold a positive and strong reputation throughout the community.

Bonus: Cyber Risk
Here’s a bonus tip to consider during your due diligence process: Cyber risk continues to be top of mind for advisors and regulators alike. As part of the transaction, assess the target bank’s information technology environment. That includes reviewing any external reports or assessments, and understanding any findings and the related remediation. In addition, identify material gaps or issues in due diligence so the bank is not surprised by additional costs at merger consummation.

If mergers and acquisitions are part of your bank’s strategic plan, having a proper plan in place to direct due diligence can help you execute the transaction seamlessly and with success. Put together an internal team that can help you review those risks or explore external options to assist.

The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, investment, or tax advice or opinion provided by CliftonLarsonAllen LLP (CliftonLarsonAllen) to the reader.

Three Tips to Manage Third-Party Cybersecurity Risk

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Third-party vendors enable community banks to deliver essential products and services to consumers, but they can also be a weak link in their cybersecurity strategy.

The events of 2020 have made it imperative for banks to focus on protecting their employees, consumers and valuable assets — making cybersecurity a persistent priority for executive management. Ransomware has escalated at an alarming rate, leading community banks to engage even more with managed security service providers to strengthen their cybersecurity strategies. Given the critical nature of omnipresent cybersecurity and the continuous dependency on third-party providers, here are some practical tips for managing third-party risk in your cybersecurity strategy.

1. Collaborate Across Your Institution
It’s common to have a dedicated vendor management team or department at community banks, but it’s important to avoid a silo mentality when dealing with risk. Know your bank’s risk appetite and make sure everyone involved in risk management knows it as well.

Evaluate third parties against that appetite. Vendor assessments are critical to ensure your business will reap the benefits of the services you expect to receive.

Document third-party products and services in your environment. Update operational, IT and cybersecurity policies, as well as business continuity plans to include your vendors, outlining their roles and responsibilities — especially in the event of an outage, incident, or disaster.

2. Due Diligence is Key
Ensure your bank has a detailed process for evaluating third parties prior to signing contracts. One good way to prevent a third-party cyber incident is to ensure third parties have strong cybersecurity programs. The Federal Financial Institutions Examination Council states, “Financial institutions must understand the complex nature of arrangements with outside parties and ensure adequate due diligence for the engagement of the relationships and ongoing monitoring.”

Establish how your bank’s data is handled to protect the privacy of your employees and customers. Who owns the data and who has access to it? How long will data be retained? What happens to data if you terminate your contract? Make sure the bank documents data ownership and management in its third-party contracts. A data breach caused by a third party can endanger customer privacy and violate data privacy laws, including the General Data Protection Regulation and California Consumer Privacy Act.

3. Trust but Verify
It’s important to ensure that services continue to perform as expected after determining the need for third-party services and conducting due diligence to ensure the best fit. The phrase “trust but verify,” while originally used in a political context, is often used to describe this practice in vendor management.

Periodically review the bank’s vendors to ensure they’re meeting the obligations set in the Service Level Agreements (SLAs), which can help address issues before an incident can occur. If appropriate, the board should consider engaging an independent provider to audit, monitor or alert of any issues that could impact the vendor’s ability to meet their SLA.

Banks should consider supporting their vendor management strategy with technology solutions that can:

  1. Track vendors, subsidiaries, relationship owners, documentation and contacts.
  2. Perform vendor due diligence and analyze criticality, usage and spend.
  3. Deliver surveys and risk assessments to external third-party contacts.
  4. Manage contract review and renewals.
  5. Coordinate with legal, procurement, compliance and other functions.
  6. Monitor key vendor metrics via personalized dashboards and dynamic reports.

Third-party risk is an important component of any bank’s cybersecurity strategy and should align with its enterprise risk management and information security programs. Using a common risk framework that includes vendor management will promote collaboration, integration and visibility across the bank. Ultimately, the result is a reliable and consistent process that can help you protect and service your customers.

Tactical Pillars for Quick Wins in the Challenging Operating Environment

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The challenges of 2020 included a landslide of changes in financial services, and the sheer effort by banking professionals to keep operations running was nothing short of historic.

Although there will be some reversion to prior habits, consumers in 2021 have new expectations of their banks that will require more heavy lifting. This comes at a time when many banks in the U.S. are engaging in highly complex projects to redesign their branches, operations and organizational charts. Fortunately, there are some quick win tactics that can support these efforts. Consider the following three “pillar” strategies that offer short-term cost savings and guidelines to set a foundation for operational excellence.

Portfolio Rationalization
Portfolio rationalization need not involve product introductions or retirements. But, given the changing consumer landscape, executives should consider taking a fresh look at their bank’s product portfolios. Due to the many changes in accountholder behavior, certain cost/benefit dynamics have changed since the pandemic began. This fact alone makes re-evaluating and recalibrating existing portfolio strategies a matter of proper due diligence. Rationalizing the portfolio should include revising priorities, adding new features and reassessing risk profiles and existing project scopes.

Process Re-Engineering
Banking executives have been under tremendous pressure recently to quickly implement non-standard procedures, all in the name of uninterrupted service during socially distanced times.

Though many working models will see permanent change, it is critical to optimize these processes early for long-term efficiency, security and customer experience. As the digital curve steepens, banks will need to map out the customer journey across all digital channels to remain competitive. Some process re-engineering methods include eliminating workarounds, streamlining processes and updating legacy policies that are no longer relevant.

Intelligent Automation
Banks are increasingly leveraging technologies classified under the umbrella of intelligent automation. These include machine learning, robotic process automation and artificial intelligence — all of which have become especially relevant to deal with multiple types of high-volume, low-value transactions. Automated workflows remove the clerical aspects of the process from the experts’ plates, allowing them to focus time and energy on more high-value activities. When executed well, intelligent automation works alongside humans, supplementing their expertise rather than replacing it. For example, areas like fraud and underwriting are becoming increasingly automated in repetitive and known scenarios, while more complicated cases are escalated to personnel for further analysis.

Supplier Contracts
Auditing invoices for errors and evaluating vendor contracts might be the last place a banker would look to establish a quick win. However, our benchmarks suggest they can be a critical stepping-stone to bottom-line opportunities. Existing vendor contracts often include inconsistent clauses and undetected errors (such as applications of new pricing tiers missed, etc.). Eventually, minor errors can creep into the run rate that adds up over the years to significant dollar discrepancies. With extensive due diligence or someone in the know, it’s possible to find a six to seven figure lift, simply by collecting intelligence on the prevailing market rates, the available range of functionality and reasonable expectations for performance levels.

While the financial services industry has been keeping operations running uninterrupted, there is no time like the present to optimize operating processes. Accomplishing a few results early  on can free up resources and support long-term gains. Executives should take the time now to optimize operating model structures in order to brace for what comes next. Looking into the increasingly digital future, consumers will continue to expect banks to reinvent and build up their operating models to greater heights.

Dual Deal Accounting Challenges During a Pandemic

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Bank mergers and acquisitions are not easy: balancing the standard process of due diligence to verify financial and credit information, adapting processing methods and measuring fair value assets and liabilities. The ongoing pandemic coinciding with the implementation of the current expected credit loss model, or CECL, by larger financial institutions has made bank mergers even more complex. As your financial institution weighs the benefits of a merger or acquisition, here are two important accounting impacts to consider.

Fair Value Accounting During a Pandemic

When two banks merge, the acquiring bank will categorize the loans as performing or purchase credit impaired/deteriorated and mark the assets and liabilities of the target bank to fair value.

This categorization of loans is difficult — the performance of these loans is currently masked due to the large number of loan modifications made in the second quarter. With many customers requesting loan modifications to defer payments for several months until the economy improves, it is difficult for the acquiring bank to accurately evaluate the current financial position of the target bank’s customers. Many of these customers could be struggling in the current environment; without additional information, it may be very difficult to determine how to classify them on the day of the merger. 

One of the more complex areas to assess for fair value is the loan portfolio, due to limited availability of market data for seasoned loans. As a result, banks are forced to calculate the fair value of assets while relying on subjective inputs, such as assumptions about credit quality. Pandemic-response government programs and significant bank-sponsored modification programs make it difficult to fully estimate the true impact of Covid-19 on the loan portfolio. Modifications have obscured the credit performance data that management teams will base their assumptions, complicating the process even further.  

U.S. Generally Accepted Accounting Principles (GAAP) allows for true-up adjustments to Day 1 valuations for facts that were not available at the time of the valuation to correct the fair value accounting. These adjustments are typically for a few isolated items. However, the lagging indicators of Covid-19 have added more complexity to this process. There may be more-pervasive adjustments in the coming year related to current acquisitions as facts and circumstances become available. It is critical for management teams to differentiate between the facts that existed the day the merger closed versus events that occurred subsequent to the merger, which should generally be accounted for in current operations.  

CECL Implementation

For large banks that implemented CECL in the first quarter of 2020, a significant change in the accounting for acquired loans can create a new hurdle. Under the incurred loss model, no allowance is recorded on acquired loans, as it is incorporated in the fair value of the loans. Under the new CECL accounting standard, the acquirer is required to record an allowance on the day of acquisition — in addition to the fair value accounting adjustments. While this allowance for purchase deteriorated credits is a grossing-up of the balance sheet, the performing loan portfolio allowance is recorded through the provision for loan losses in the income statement.

This so-called “double-dip” of accounting for credit risk on acquired performing loans is significant. It may also be an unexpected change for many users of the financial statements. Although CECL guidance has been available for years, this particular accounting treatment for acquired performing loans was often overlooked and may surprise investors and board members. The immediate impact on earnings can be significant, and the time period for recapturing merger costs may lengthen. As a result, bank management teams are spending more time on investor calls and expanding financial statement disclosures to educate users on the new accounting standards and its impact on their transactions.  

The two-fold accounting challenges of implementing CECL during a global pandemic can feel insurmountable. While the CECL standard was announced prior to Covid-19, management teams should take a fresh look at their financial statements as they prepare for earnings announcements. Similarly, if your bank is preparing to close an acquisition, plan on additional time and effort to determine the fair value accounting. By maintaining strong and effective communication, financial institutions will emerge stronger and prepared for future growth opportunities.

Five Questions to Ask When Weighing Banking Software

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A contract for banking software should be the start of a working relationship.

When your bank purchases a new banking system, you should get more than a piece of software. From training to ongoing support, there’s a tremendous difference between a vendor who sells a system and a true partner who will work to enhance your banking operations.

But how do you know which is which? Here are some questions that could help you determine if a vendor is just a vendor — or if they could become a more-meaningful resource for your bank.

Do they have real banking expertise?
A software vendor that lacks real-world banking experience will never have the institutional knowledge necessary to serve as a true partner. The company may have been founded by a banker and their salespeople may have some cursory knowledge of how their solution works in a banking environment. However, that is not enough. You need a vendor that can offer expert insights based on experience. Ask salespeople or other contacts about their banking background and what they can do to help improve your bank.

Do they want to understand your issues?
A vendor won’t be able to help solve your problems if they aren’t interested in learning what they are. You should be able to get a sense of this early in the process, especially if you go through a software demonstration. Does the salesperson spend more time talking about features and system capabilities, or do they ask you about your needs first and foremost? A vendor looking to make a sale will focus on their program, while a true partner will take time to find out what your challenges are and what you really want to know. Look for a vendor who puts your needs above their own and you’ll likely find one who is truly invested in your success.

How quickly do they respond?
Vendors will show you how much they care by their turnaround speed when you have a question or need to troubleshoot a problem with your banking system. Any delay could prove costly, and a good partner acts on that immediate need and moves quickly because they care about your business. It can take some companies weeks to fully resolve customer issues, while others respond and actively work to solve the problem in only a few hours. Go with the software provider who is there for you when you need them most.

Do they go above and beyond?
Sometimes the only way to address an issue is to go beyond the immediate problem to the underlying causes. For example, you might think you have a process problem when onboarding treasury management customers, but it could actually be an issue that requires system automation to fully resolve.

A vendor that can identify those issues and give you insights on how to fix them, instead of bandaging the problem with a quick workaround, is one worth keeping around. This may mean your vendor proposes a solution that isn’t the easiest or the cheapest one, but this is a good thing. A vendor that is willing to tell you something you may not want to hear is one that truly wants what’s best for your organization.

Do they continue to be there for you?
Some software companies consider the engagement over once they’ve made the sale. Their helpline will be open if you have a problem, but your contact person there will have moved on to new targets as you struggle with implementation and the best way to utilize the software.

Find a vendor that plans to stick with your institution long after agreements have been signed. They should not only provide training to help facilitate a smooth transition to the new system, but they should remain accessible down the road. When a new software update becomes available or they release a new version of the system, they should proactively reach out and educate you on the new features — not try to sell you the latest development. Although you won’t know how those interactions will go until after you’ve made your purchase, it pays to evaluate the service you’re getting from your vendors at every stage of your engagement.

Finding a software vendor that you trust enough to consider a partner isn’t always easy. But by looking for some of the characteristics discussed above, you can identify the most trustworthy vendors. From there, you can start building a relationship that will pay dividends now and into the future.