The War for Talent in Banking Is Here to Stay

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It seems that everywhere in the banking world these days, people want to talk about the war for talent. It’s been the subject of many recent presentations at industry conferences and a regular topic of conversation at nearly every roundtable discussion. It’s called many things — the Great Resignation, the Great Reshuffling, quiet quitters or the Great Realignment — but it all comes down to talent management.

There are a number of reasons why this challenge has landed squarely on the shoulders of banks and organizations across the country. In the U.S., the workforce is now primarily comprised of members of Generation X and millennials, cohorts that are smaller than the baby boomers that preceded them. And while the rising Gen Z workforce will eventually be larger, its members have only recently begun graduating from college and entering the workforce.

Even outside of the pandemic disruptions the economy and banking industry has weathered, it is easy to forget that the unemployment rate in this country was 3.5% in December 2019, shortly before the pandemic shutdowns. This was an unprecedented modern era low, which the economy has once again returned to in recent months. Helping to keep this rate in check is a labor force participation rate that remains below historical norms. Add it all up and the demographic trends do not favor employers for the foreseeable future.

It is also well known that most banks have phased out training programs, which now mostly exist in very large banks or stealthily in select community institutions. One of the factors that may motivate a smaller community bank to sell is their inability to locate, attract or competitively compensate the talented bankers needed to ensure continued survival. With these industry headwinds, how should a bank’s board and CEO respond? Some thoughts:

  • Banks must adapt and offer more competitive compensation, whether this is the base hourly rate needed to compete in competition with Amazon.com and Walmart for entry-level workers, or six-figure salaries for commercial lenders. Bank management teams need to come to terms with the competitive pressures that make it more expensive to attract and retain employees, particularly those in revenue-generating roles. Saving a few thousand dollars by hiring a B-player who does not drive an annuity revenue stream is not a long-term strategy for growing earning assets.
  • There has been plentiful discourse supporting the concept that younger workers need to experience engagement and “feel the love” from their institution. They see a clear career path to stick with the bank. Yet most community institutions lack a strategic human resource leader or talent development team that can focus on building a plan for high potential and high-demand employees. Bank can elevate their HR team or partner with an outside resource to manage this need; failing to demonstrate a true commitment to the assertion that “our people are our most important asset” may, over time, erode the retention of your most important people.
  • Many community banks lack robust incentive compensation programs or long-term retention plans. Tying key players’ performance and retention to long-term financial incentives increases the odds that they will feel valued and remain — or at least make it cost-prohibitive for a rival bank to steal your talent.
  • Lastly, every banker says “our culture is unique.” While this may be true, many community banks can do a better job of communicating that story. Use the home page of your website to amplify successful employee growth stories, rather than just your mortgage or CD rates. Focus on what resonates with next generation workers: Your bank is a technology business that gives back to its communities and cares deeply about its customers. Survey employees to see what benefits matter most to them: perhaps a student loan repayment program or pet insurance will resonate more with some workers than your 401(k) match will.

The underlying economic and demographic trend lines that banks are experiencing are unlikely to shift significantly in the near term, barring another catastrophic event. Given the human capital climate, executives and boards should take a hard look at the bank’s employment brand, talent development initiatives and compensation structures. A strategic reevaluation and fresh look at how you are approaching the talent wars will likely be an investment that pays off in the future.

Banking During a Time of Uncertainty

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The following feature appeared in the fourth quarter 2022 edition of Bank Director magazine. It and other stories are available to magazine subscribers and members of Bank Director’s Bank Services Membership Program. Learn more about subscribing here.

For John Asbury, CEO at Atlantic Union Bankshares Corp., a $19.7 billion bank headquartered in Richmond, Virginia, concerns about the direction of the U.S. economy have a familiar feel to them. It was just two years ago that Asbury and the rest of the banking industry were staring into the abyss of an economic catastrophe caused by the Covid-19 pandemic.

The U.S. economy shrank 31.2% in the second quarter of 2020 when the country was put into lockdown mode to fight the pandemic. And while the economy made a dramatic recovery, growing 38% the following quarter, it was a time of great uncertainty for the nation’s banks as they dealt with an unprecedented set of economic and operational challenges.

For bankers like Asbury, it’s déjà vu in 2022.

“Once again we find ourselves in a period of great uncertainty — which is a familiar place to be,” says Asbury. This time the economic challenges come from a sharp rise in inflation, which came in at 8.5% in July — well above the Federal Reserve’s target rate of just 2%. The Fed clearly misread this sudden increase in inflation, thinking it was driven primarily by supply chain disruptions coming out of the pandemic, and now is trying to catch up with a fast-moving train.

Year to date through September, the Fed’s rate setting body — the Federal Open Market Committee — raised the federal funds rate five times, including three successive rate increases of 75 basis points each, bringing the upper limit of the target rate to 3.25%. It’s been a long time since the Fed raised interest rates by such a substantial margin in so short a time. The FOMC was scheduled to meet again in November and December, and Federal Reserve officials indicated in September that rates could reach 4.4% by year-end.

During the early days of the pandemic, the Federal Reserve also pumped money into the economy through a policy tool called quantitative easing, where it bought long-term securities from its member banks. Earlier this year, the Fed began to reverse that policy to reduce liquidity in the economy, which should help boost interest rates.

The result has been a dual economic outlook, with the immediate future looking more promising than it has in years — but with the longer-term prospects clouded by the threat of inflation and the Federal Reserve’s determination to bring it to heel. Rising interest rates are generally a boon to most banks, but there is a threshold point at which higher rates can lead to a prolonged economic downturn — which is not good for banks or most other companies.

“It remains to be seen what [the Fed] will do when push comes to shove but at least for now, it looks like they’re more concerned about reining in inflation than any of the effects — like a slowdown — that such actions could cause,” says R. Scott Siefers, managing director and senior research analyst at the investment bank Piper Sandler & Co.

The challenge for banks is plotting a course through such a confusing landscape. Do they push for loan growth at the beginning of an economic slowdown of unknown depth and duration, or adopt a more conservative posture toward credit? Should they compete for deposits as funding costs inevitably go up, or be content to let some of their excess funding run off? And lurking in the background is the risk that the Federal Reserve ends up tipping the economy into a deep recession as it seeks to choke off inflation.

By a traditional definition, the U.S. economy has already entered a shallow recession. The country’s gross domestic product, which is the monetary value of all goods and services produced in a specific time period, was -1.4% in the first quarter and -0.9% in the second quarter. Recessions are generally thought of as two quarters of economic contraction, but a variety of factors and data are part of that consideration. The Business Cycle Dating Committee, which is part of the National Bureau of Economic Research, is the group that declares when the U.S. is in recession and has yet to declare this current cycle one.

By other measures, however, the economy is doing surprisingly well. The country’s unemployment rate in August was just 3.7% — down from a peak of 13.2% in May 2020 — and the economy added over 500,000 new jobs in July and another 315,000 in August. In another piece of good news, August’s inflation rate was 8.3%, down from 8.5% in July and 9.1% in June, offering a glimmer of hope that the Fed’s rate hikes are beginning to work.

And in many respects, the experience of bankers on the ground is also at odds with the economic data. “What I’ve found myself saying as I speak to our clients and to our teams is that I feel better than I do when I simply read the financial press,” says Asbury. “Despite all the uncertainty, we’re actually in a pretty good place at the moment. Asset quality remains very benign. We see no end in sight to that, which is one of the more astonishing aspects of the whole pandemic, continuing even to now. Liquidity is still very good. We would have expected to see more deposit runoff than we have. It’s really all about business and consumer sentiment, which seems to be going up and down … The reality is that we’re in a pretty good spot.”

Ira Robbins, chairman and CEO at Valley National Bancorp, a $54.4 billion regional bank headquartered in Wayne, New Jersey, offers a similar assessment. In addition to New Jersey, the bank also does business in New York, Alabama and Florida. And a bank’s experience during an economic downturn may depend on its geographic location, because not all regions of the country are affected equally. “I’m sitting in Florida today, and it doesn’t feel like a recession here at all,” says Robbins in a recent interview. The economy might fit the traditional definition of a mild recession, but that doesn’t seem to bother him very much.

“I really don’t think it’s all that relevant to be honest with you,” he says. “When I look at the behavior of our consumers and commercial customers, we would say we’re not in a recession based on activity, based on spending habits, based on the desire to still have capital investments. When it comes to commercial endeavors, the economy still feels very, very strong.”

Valley National is a large residential lender, and Robbins says that the rise in interest rates has chilled the mortgage refinancing market and made it more difficult for first-time home buyers looking for an entry-level home. “But general activity in the purchase market is still very strong,” he says. “The Florida market is still on fire for us. Prices really haven’t abated yet. And the demand is still very strong in the market from a residential perspective.” Commercial real estate activity, including multi-family housing, is also booming in Florida thanks to the continued influx of people from out of state, according to Robbins. “We still have many of our borrowers — developers — looking to this footprint to grow,” he says. “And the rise in interest rates really hasn’t impacted their desire to be in this market.”

Valley National is also seeing a lot of multi-family development in the Jersey City, New Jersey market, where the bank is an active lender. “We have an environment where the supply hasn’t kept up with demand for a long time,” Robbins says. “Irrespective of what’s going on in the interest rate environment, there’s still a lot of people demanding newer product that just isn’t available to them today.”

If Asbury and Robbins see the current economic situation from a glass-half-full perspective, Tim Spence, CEO at $207 billion Fifth Third Bancorp in Cincinnati, Ohio, sees it as half empty. Spence has chosen to position the bank more conservatively given the economy’s uncertain outlook going into 2023. “We’ve elected to be more cautious as it relates to the outlook than many others have been,” he says. That caution has manifested itself in tougher expense control, “paring around the margins in terms of the lending activity” and using swaps to protect the bank’s net interest margin should the Fed end up cutting interest rates in the future, Spence explains.

While the U.S. economy may be slowing down, there are other factors that should buoy the industry’s profitability through the remainder of 2022. Most banks benefit from a rising rate environment because they can reprice their commercial loans faster than market competition forces them to reprice their deposits.

Deposit costs have yet to increase upward even as interest rates have shot up dramatically, and there is still a lot of liquidity in the country’s banking system. Siefers points to Fed data that deposits grew 0.6% in the first half of the year and remarks in an email exchange that he’s “been surprised at how resilient the deposit balances were. The conventional wisdom is that commercial balances have been looking for other homes, while consumer [deposits] have [gone] higher. Net/net, very little movement in total balances.”

One of the dichotomies in the economy is the industry’s strong loan growth despite the evidence of a slowdown. Citing Federal Reserve data, Siefers points out that loans excluding Paycheck Protection Program loans grew 5.5% in the first half of the year. While it might seem counter-intuitive that loans would grow while the economy is cooling off, Tom Michaud, CEO of investment bank Keefe, Bruyette & Woods, says that many commercial borrowers have been returning to the loan market after staying out during the early days of the pandemic. “The government took much of the role of lending out of the industry’s hands with the Paycheck Protection Program and other support elements,” he says. “And then after Covid started, most middle market corporations didn’t see any reason to increase borrowing a lot until they had a better feeling about the economy.”

The industry’s asset quality has also remained at historically low levels and along with the Fed’s interest rate hikes, has created what Siefers calls a “Goldilocks environment” with rising margins, strong loan growth and benign credit trends.

This will likely lead to higher profitability in the latter half of the year. “You’re going to see a significant expansion in bank net interest margins in the third and fourth quarters — the likes of which we’ve probably not seen in a couple of decades, because you’re going to have the cumulative impact of the May, June and July rate hikes flowing into the third and fourth quarters,” says Ebrahim Poonawala, who heads up North American bank research at Bank of America Securities.

The dichotomy between low deposit costs and higher rates won’t last forever, of course. David Fanger, a senior vice president at Moody’s Investors Service, says that deposit rates typically move very little during the first 100 basis points in rate hikes when the Federal Reserve begins to tighten its monetary policy. And even when they do begin to move upward, it’s never on a one-to-one basis. “Even at the end of the [last] rate hike cycle, deposit rates increased only 30% of the increase in [the federal funds rate],” says Fanger. Once deposit rates do begin to rise — certainly in 2023 if not later this year as the Fed continues its tight monetary policy — that will probably cut into the expanding net interest margin that most banks are currently enjoying, although Fanger does not expect the industry’s margin to contract unless loan growth drops significantly.

What probably will change, however, is a decline in the industry’s liquidity level as banks decide not to compete for excess funds that seek out higher rates than they are willing to pay. Through a combination of federal stimulus legislation like the CARES Act, passed in March 2020 during the Trump administration, and the American Rescue Plan Act, passed in March 2021 during the Biden administration, along with $800 billion in PPP loans that banks originated and the Fed’s quantitative easing policy, trillions of dollars were pumped into the economy during the pandemic. Much of this money ended up on banks’ balance sheets at historically low interest rates. (The federal funds rate in May 2020 was 0.05%.) As rates rise, some of the money will start looking for a higher return.

“I don’t think banks are going to manage their companies just for the absolute level of deposits,” says Michaud. “I believe they’re going to manage their deposits as the market becomes more competitive for deposits relative to the size of their loan portfolio or what they believe is the size of their core bank. Some banks even started doing that in the second quarter. They were happy to let deposits run out of the bank, and they were more willing to focus on their core deposits.”

While it’s possible that the inflation rate peaked in June, Michaud doesn’t expect the central bank to begin lowering the fed funds rate anytime soon. “I think, if anything, the Fed is going to wait to see the outcome from their policy actions to ensure that inflation has gone back down to the level that they wish to see,” he says.

Asbury is of the same mind. “There have been lots of studies that suggest that if the Fed backs off too quickly, that will be a bad thing,” he says. “So, I don’t think rates are coming down anytime too soon.”

In fact, in late summer, there was a disconnect between the fed funds futures market and information coming out of the Federal Reserve. Activity in the futures market implied that the Fed would cut rates next year, even though messaging coming out of the central bank strongly suggested otherwise. The Fed’s summary of economic projections, which includes its dot plot chart that reflects each Fed official’s estimate of where the fed funds rate will be at the end of each calendar year three years into the future, suggests that the median rate will be 4.4% at the end of this year and 4.6% at the end of 2023.

And in a speech at the Federal Reserve Bank of Kansas City’s annual policy symposium in Jackson Hole, Wyoming, in late August, Federal Reserve Chairman Jerome Powell warned that “[r]educing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions. While higher interest rates, slower growth and softer labor conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation.”

Translation: If it takes a recession to bring the inflation rate back down to 2%, so be it.

Inflation has several direct effects on bank profitability. Like most other industry sectors, banks have seen their employment costs rise in a tight job market. “We’ve had to make adjustments, and we continue to look at what needs to be done to remain competitive for front line, client-facing teammates,” says Asbury. “The war for talent is raging.” Valley National also gave raises that went into effect in June, 5% to those making less than $65,000 a year, and 3.5% for those earning between $65,000 and $75,000 a year. “Those are permanent raises,” says Robbins. “It’s going to cost us almost $5 million a year in increased salary expense. So, we have to do a much better job on the revenue side to make sure we’re generating enough to support those expenses.”

The sharp rise in interest rates has also led to an increase in bond yields, which has impacted those banks that over the last two years used their excess deposits to invest in lower yielding securities. This has resulted in unrealized losses in their accumulated other comphrensive income — or AOCI — line. While these losses are not charged against a bank’s net income or its regulatory capital if the securities are being held for investment rather than trading purposes, they still impact its tangible common equity capital ratios “and industry observers watch that,” says Michaud.

But the biggest impact of inflation is how it drives the Federal Reserve’s monetary policy. Rising interest rates help fatten the industry’s net interest margin, but they also hike the debt service costs for corporate borrowers as their loans reprice higher. And some of those companies may end up defaulting on their loans in a longer, deeper recession.

As bankers look at the uncertainty hanging over the economy going into 2023, it’s important to give increased attention to customer communication and credit risk analysis. “Banks that have underwriting processes that have survived through multiple economic cycles and that are extremely client-centric will do better,” predicts Poonawala at Bank of America Securities.

“This is an appropriate time to step up communication with the client base, and we are doing that,” says Asbury. “You also have to run sensitivity analyses in terms of the impact of higher borrowing costs. We do this in the normal course of underwriting. Even when rates were at absolute historic lows, we still made credit decisions [by] running scenarios of higher rates and their capacity to service debt and repay in a higher rate environment. That’s just good banking.”

For his part, Robbins sees no need to pull Valley National back from its core commercial borrowers, even with the economy cooling off. “Seventy percent of our commercial origination comes from recurring customers,” he says. “Many of them have been through interest rate environments that have historically been much higher. Their ability to operate in this type of environment isn’t something that really concerns us.” Interest rates would have to go much higher before many of the bank’s core borrowers, particularly in an asset class like multi-family housing, where the demand for new product is high, would pull back from the market, Robbins says.

The larger risk occurs when banks stray beyond their comfort zone in search of yield or volume.

“Because we’ve been in a declining net interest margin environment, banks have been stretching to get into new geographies or asset classes they don’t have any real experience with,” Robbins says. And in an economic downturn, “banks that have done that but haven’t done it in the proper way are going to have real challenges,” he adds.

The difference in perspective may be more nuanced than truly material, but Spence at Fifth Third takes a more cautious view of the future beyond 2022. “From our point of view, it is a challenging environment to understand because the Fed has never had to move at the pace it has,” he says. “We’re coming off 15 years of zero or near-zero interest rates, and an environment where central banks were the largest bond buyers in the world. Now all of a sudden, they’re bond sellers.” Factor in the continued supply chain challenges that were initially driven by the pandemic but are now being accentuated by the war in Ukraine, along with a tight labor market, and it’s a very uncertain time.

Spence outlines three steps that Fifth Third has taken to address this uncertainty. First, the bank is spending even more time thinking about concentration risk. “Are we lending to sectors of the economy … that are going to be more resilient in any environment?” he says. On the consumer side, that has meant more emphasis on super prime customers and homeowners, and less on subprime borrowers even though they pay higher rates. And on the commercial side, that translates into greater focus on commercial and industrial loans to provide inventory financing, equipment purchases and working capital, and less emphasis on commercial real estate and leveraged lending.

Second, Fifth Third has used various hedging strategies to protect its balance sheet for a time when the Fed eventually loosens its monetary policy and begins to lower rates. Spence says the bank has added $10 billion in fixed-rate swaps to build a floor under its net interest margin for the next 10 years.

And finally, the bank is prepared for a scenario in which the Fed has to drive interest rates much higher to finally curb inflation. “In that case, nothing is more important than the quality of your deposit book,” says Spence, who believes that Fifth Third has a strong core deposit franchise.

Spence worries much less about the consequences of being too conservative than being too reckless. “In a business like ours that’s susceptible to economic cycles, the single most important thing that you can do is ask yourself what happens if I’m wrong,” he says. “From my point of view, if we are wrong, then we gave up a couple of points of loan growth in a given year that we can just get back later.”

Safeguarding Credit Portfolios in Today’s Uncertain Economic Landscape

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Rising interest rates are impacting borrowers across the nation. The Federal Open Market Committee decided to raise the federal funds rate by 75 basis points in its June, July and September meetings, the largest increases in three decades. Additional increases are expected to come later this year in an attempt to slow demand.

These market conditions present significant potential challenges for community institutions and their commercial borrowers. To weather themselves against the looming storm, community bankers should take proactive steps to safeguard their portfolios and support their borrowers before issues arise.

During uncertain market conditions, it’s even more critical for banks to keep a close pulse on borrower relationships. Begin monitoring loans that may be at risk; this includes loans in construction, upcoming renewals, loans without annual caps on rate increases and past due loans. Initiating more frequent check-ins to evaluate each borrower’s unique situation and anticipated trajectory can go a long way.

Increased monitoring and borrower communication can be strenuous on lenders who are already stretched thin; strategically using technology can help ease this burden. Consider leveraging relationship aggregation tools that can provide more transparency into borrower relationships, or workflow tools that can send automatic reminders of which borrower to check in with and when. Banks can also use automated systems to conduct annual reviews of customers whose loans are at risk. Technology can support lenders by organizing borrower information and making it more accessible. This allows lenders to be more proactive and better support borrowers who are struggling.

Technology is also a valuable tool once loans is classified as special assets. Many banks still use manual, paper-based processes to accomplish time consuming tasks like running queries, filling out spreadsheets and writing monthly narratives.

While necessary for managing special assets, these processes can be cumbersome, inefficient and prone to error even during the best of times — let alone during a potential downturn, a period with little room for error. Banks can use technology to implement workflows that leverage reliable data and automate processes based directly on metrics, policies and configurations to help make downgraded loan management more efficient and accurate.

Fluctuating economic conditions can impact a borrower’s ability to maintain solid credit quality. Every institution has their own criteria for determining what classifies a loan as a special asset, like risk ratings, dollar amounts, days past due and accrual versus nonaccrual. Executives should make time to carefully consider evaluating their current criteria and determine if these rules should be modified to catch red flags sooner. Early action can make a world of difference.

Community banks have long been known for their dependability; in today’s uncertain economic landscape, customers will look to them for support more than ever. Through strategically leveraging technology to make processes more accurate and prioritizing the management of special assets, banks can keep a closer pulse on borrowers’ loans and remain resilient during tough times. While bankers can’t stop a recession, they can better insulate themselves and their customers against one.

3 Ways to Help Businesses Manage Market Uncertainty

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Amid mounting regulatory scrutiny, heightened competition and rising interest rates, senior bank executives are increasingly looking to replace income from Paycheck Protection Program loans, overdrafts and ATM fees, and mortgage originations with other sources of revenue. The right capital markets solutions can enable banks of all sizes to better serve their business customers in times of financial uncertainty, while growing noninterest income.

Economic and geopolitical conditions have created significant market volatility. According to Nasdaq Market Link, since the beginning of the year through June 30, the Federal Reserve lifted rates 150 basis points, and the 10-year Treasury yielded between 1.63% and 3.49%. Wholesale gasoline prices traded between $2.26 and $4.28 per gallon during the same time span. Corn prices rose by as much as 39% from the start of the year, and aluminum prices increased 31% from January 1 but finished down 9% by the end of June. Meanwhile, as of June 30, the U.S. dollar index has strengthened 11% against major currencies from the start of the year.

Instead of worrying about interest rate changes, commodity-based input price adjustments or the changing value of the U.S. dollar, your customers want to focus on their core business competencies. By mitigating these risks with capital market solutions, banks can balance their business customers’ needs for certainty with their own desire to grow noninterest income. Here are three examples:

Interest Rate Hedging
With expectations for future rate hikes, many commercial borrowers prefer fixed rate financing for interest rate certainty. Yet many banks prefer floating rate payments that benefit from rising rates. Both can achieve the institution’s goals. A bank can provide a floating rate loan to its borrower, coupled with an interest rate hedge to mitigate risk. The bank can offset the hedge with a swap dealer and potentially book noninterest income.

Commodity Price Hedging
Many commercial customers — including manufacturers, distributors and retailers — have exposure to various price risks related to energy, agriculture or metals. These companies may work with a commodities futures broker to hedge these risks but could be subject to minimum contract sizes and inflexible contract maturity dates. Today, there are swap dealers willing to provide customized, over-the-counter commodity hedges to banks that they can pass down to their customers. The business mitigates its specific commodity price risk, while the bank generates noninterest income on the offsetting transaction.

International Payments and Foreign Exchange Hedging
Since 76% of companies that conduct business overseas have fewer than 20 employees, according to the U.S. Census Bureau, there is a good chance your business customers engage in international trade. While some choose to hedge the risk of adverse foreign exchange movements, all have international payment needs. Banks can better serve these companies by offering access to competitive exchange rates along with foreign exchange hedging tools. In turn, banks can potentially book noninterest income by leveraging a swap dealer for offsetting trades.

Successful banks meet the needs of their customers in any market environment. During periods of significant market volatility, businesses often prefer interest rate, commodity price or foreign exchange rate certainty. Banks of all sizes can offer these capital markets solutions to their clients, offset risks with swap dealers and potentially generate additional income.

How Technology Fosters Economic Opportunity and Success

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Is your bank promoting financial literacy and wellness within the communities you serve?

The answer to that question may be the key to your bank’s future. For many community financial institutions, promoting financial wellness among historically underserved populations is directly linked to fostering resilience for individuals, institutions and communities.

Consider this: 7 million households in the United States didn’t have a bank account in 2019, according to the Federal Deposit Insurance Corp.; and up to 20 million others are underserved by the current financial system. Inequities persist along racial, geographical and urban lines, indicating an opportunity for local institutions to make an impact.

Many have already stepped up. According to the Banking Impact Report, which was conducted by Wakefield Research and commissioned by MANTL, 55% of consumers said that community financial institutions are more adept at providing access to underrepresented communities than neobanks, regional banks or megabanks. In the same study, nearly all executives at community institutions reported providing a loan to a small business owner who had been denied by a larger bank. And 90% said that their institution either implemented or planned to implement a formal program for financial inclusion of underserved groups.

Technology like online account origination can play a critical role in bringing these initiatives to life. Many forward-thinking institutions are actively creating tools and programs to turn access into opportunity — helping even their most vulnerable customers participate more meaningfully in the local economy.

One institution, 115-year-old Midwest BankCentre based in St. Louis, is all-in when it comes to inclusion. The bank partnered with MANTL to launch online deposit origination and provide customers with convenient access to market-leading financial products at competitive rates.

Midwest BankCentre has also committed $200 million to fostering community and economic development through 2025, with a focus on nonprofits, faith-based institutions, community development projects and small businesses for the benefit ofr historically disinvested communities. The bank offers free online financial education to teach customers about money basics, loans and payments, buying a home and paying for college, among others.

Midwest BankCentre executives estimate that $95 out of every $100 deposited locally stays in the St. Louis region; these dollars circulate six times throughout the regional economy.

In a study conducted in partnership with Washington University in St. Louis, researchers found that Midwest Bank Centre’s financial education classes created an additional $7.1 million in accumulated wealth in local communities while providing critical knowledge for household financial stability.

“When you work with a community banker, you are working with a neighbor, friend, or the person sitting next to you at your place of worship,” says Danielle Bateman Girondo, executive vice president of marketing at Midwest BankCentre. “Our customers often become our friends, and there’s a genuine sense of trust and mutual respect. Put simply, it’s difficult to have that type of relationship, flexibility, or vested interest at a big national bank.”

What about first-time entrepreneurs? According to the U.S. Bureau of Labor Statistics, approximately 33% of small businesses fail within 2 years. By year 10, 66.3% have failed.

Helping first-time entrepreneurs benefits everyone. Banks would gather more deposits and make more loans. Communities would flourish as more dollars circulate in the local economy. And individuals with more paths to economic independence would prosper.

For Midwest BankCentre, one part of the solution was to launch a Small Business Academy in March 2021, which provides practical education to help small businesses access capital to grow and scale.

The program was initially launched with 19 small businesses participating in the bank’s partnership with Ameren Corp., the region’s energy utility, with a particular focus on the utility’s diverse suppliers. And 14 small business owners and influencers participated in the bank’s partnership with the Hispanic Chamber of Commerce of Metro St. Louis. Midwest BankCentre teaches small businesses how to “think like a banker” to gain easier access to capital by understanding their financial statements and the key ratios.

Efforts like these might explain why, according to the Banking Impact Report, 69% of Hispanic small business owners and 77% of non-white small business owners believe it’s important that their bank supports underserved communities. Accordingly, non-white small businesses are significantly more likely to open a new account at a community bank or credit union: 70%, compared to 47% of white small businesses.

This can be a clear differentiator for a community bank: a competitive advantage in a crowded marketplace.

For today’s community banks, economic empowerment isn’t a zero-sum game; it’s a force multiplier. With the right strategies in place, it can be a winning proposition for the communities and markets within your institution’s sphere of influence.

The Opposite of Blissfully Unaware

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There’s been an increasingly common refrain from bank executives as the United States moves into the second half of 2022: Risk and uncertainty are increasing.

For now, things are good: Credit quality is strong, consumer spending is robust and loan pipelines are healthy. But all that could change.

The president and chief operating officer of The Goldman Sachs Group, John Waldron, called it “among — if not the most —complex, dynamic environments” he’s seen in his career. And Jamie Dimon, chair and CEO of JPMorgan Chase & Co., changed his economic forecast from “big storm clouds” on the horizon to “a hurricane” in remarks he gave on June 1. While he doesn’t know if the impact will be a “minor one or Superstorm Sandy,” the bank is “bracing” itself and planning to be “very conservative” with its balance sheet.

Bankers are also pulling forward their expectations of when the next recession will come, according to a sentiment survey conducted at the end of May by the investment bank Hovde Group. In the first survey, conducted at the end of March, about 9% of executives expected a recession by the end of 2022 and 26.6% expected a recession by the end of June 2023. Sixty days later, nearly 23% of expect a recession by the end of 2022 and almost 51% expect one by the end of June 2023.

“More than 75% of the [regional and community bank management teams] we surveyed [believe] we will be in a recession in the next 12 months,” wrote lead analyst Brett Rabatin.

“[B]anks face downside risks from inflation or slower-than-expected economic growth,” the Federal Deposit Insurance Corp. wrote in its 2022 Risk Review. Higher inflation could squeeze borrowers and compromise credit quality; it could also increase interest rate risk in bank security portfolios.

Risk is everywhere, and it is rising. This only adds to the urgency surrounding the topics that we’ll discuss at Bank Director’s Bank Audit & Risk Committees Conference, taking place June 13 through 15 at the Marriott Magnificent Mile in Chicago. We’ll explore issues such as the top risks facing banks over the next 18 months, how institutions can take advantage of opportunities while leveraging an environmental, social and governance framework, and how executives can balance loan growth and credit quality. We’ll also look at strategic and operational risk and opportunities for boards.

In that way, the uncertainty we are experiencing now is really a gift of foresight. Already, there are signs that executives are responding to the darkening outlook. Despite improved credit quality across the industry, provision expenses in the first quarter of 2022 swung more than $19.7 billion year over year, from a negative $14.5 billion during last year’s first quarter to a positive $5.2 billion this quarter, according to the Federal Deposit Insurance Corp.’s quarterly banking profile. It is impossible to know if, and when, the economy will tip into a recession, but it is possible to prepare for a bad outcome by increasing provisions and allowances.

“It’s the opposite of ‘blissfully unaware,’” writes Morgan Housel, a partner at the investment firm The Collaborative Fund, in a May 25 essay. “Uncertainty hasn’t gone up this year; complacency has come down. People are more aware that the future could go [in any direction], that what’s prosperous today can evaporate tomorrow, and that predictions that seemed assured a few months ago can look crazy today. That’s always been the case. But now we’re keenly aware of it.”

How to Capitalize on Sustainability Growth

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The automotive sector is a vital part of the US economy, accounting for 3% of the country’s gross domestic product. But the increasing demand for electric vehicles (EVs) and evolving battery and fuel cell technology means it is experiencing incredible disruption. These ripple effects will be felt across the entire automotive value chain.

Three years ago, EVs represented just 2% of all new car sales in the U.S. A year later, it doubled to 4%. In 2021, it doubled again to 8%; this year, it’s forecast to double yet again to 16%. We can only expect this trend to continue. For example, California regulators unveiled a proposal in April to ban the sale of all new vehicles powered by gasoline by 2035, as the state pushes for more EV sales in the next four years.

How will these transition risks — which includes changing consumer demand, policy and technological disruption — impact the creditworthiness of the 18,000 new-car dealerships, 140,000 used-car dealerships and 234,700 auto repair and maintenance centers across the country? What are the implications for the banks that lend to them?

Some of the world’s largest automotive brands have published bold commitments that will hasten their transformation and the industry’s shift. Last year, Ford Motor Co. announced that it expects 40% to 50% of its global vehicle volume to be fully electric by 2030, while General Motors Co. plans to exclusively offer electric vehicles by 2035.

But these commitments won’t just impact the Fortune 500 companies that are making them – businesses of all sizes, across the automotive value chain, will be affected. To stay in business, these firms will need to update their supply chains and distribution models, invest in new technologies, processes, people and products. In some cases, they may even potentially need to build an entirely new brand.

Banks will have an important role to play in funding much of this transition.

The pool of potential borrowers is getting bigger. Opportunities for banks don’t just exist in being a partner for helping automotive businesses transition — there is also a growing number of new automotive businesses and business models designed for the net-zero future that will require funding as they scale. Tesla isn’t even two decades old but last year, it produced more than 75% of U.S. all-electric cars. With growing consumer demand for EVs, the need for more EV charging stations is also rising. The global market for EV charging stations is estimated to grow from $17.6 billion in 2021 to $111.9 billion in 2028, according to Fortune Business Insights.

Electrify America, ChargePoint, and EVgo are brands that didn’t exist 15 years ago because they didn’t need to. How many more businesses will be born in the next five, 10 or 15 years, which will need loans and investments to help them scale? This is an opportunity worth billions a year for banks — if they have the foresight to anticipate what’s coming and take a forward-looking view.

The Smaller the Detail, the Greater the Value
Currently, most climate analyses work at a broad sector level, looking no deeper than the sub-sector level. This provides some indication of a bank’s exposure, but such a broad view lacks the insight needed to really understand the impact and trends at the individual borrower level.

To get a true grasp on this opportunity, banks should look for solutions that include financial forecasts and credit metrics at the borrower level across several climate scenarios and time horizons. Institutions can directly input these outputs into their existing risk rating models to drive a climate-adjusted risk rating and apply them across the full credit lifecycle, from origination and ongoing monitoring to conducting portfolio level scenario analysis.

Throughout the pandemic, banks enjoyed a unique opportunity to rebuild public trust and goodwill that was lost during the financial crisis 12 years earlier. Climate change is another chance, given that sustainability will be the growth story of the 21st century. With the right technological investments, strategic partnerships and data, banks have an opportunity to be one of the protagonists.

OakNorth will be diving deep into the challenges and issues facing the automotive value chain in an upcoming industry webinar on June 16, 2022, at 1 p.m. EST. Register now at https://hubs.li/Q01bPN1v0.

Reconsidering Pay Strategy in the Wake of Inflation

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Say goodbye to the Goldilocks economy, where moderate growth and low inflation sustained us for years. Our global economy and social norms have careened from crisis to crisis over the last 24 months. The world has faced down a pandemic, unprecedented restriction of interpersonal interactions, and disruption of worldwide supply chains. And yet the world economy is booming.

Opinions vary about the reality, root cause, and associated solutions for inflation and low unemployment. But what’s critical is that the growing expectation of future inflation is a self-fulfilling prophecy, and that it stresses the systems for retaining and motivating employees.

Inflation simply is another type of disruption, albeit one that impacts companies and employees at nearly every level. Higher input costs lead to lower corporate margins. Higher costs of goods lead to lower individual savings rates (i.e., margins).

People costs are rising, too. Thinking about people cost as in investment allows strategic discussion about maximizing return. The good thing about people investments relative to say, commodity costs, is that cost levers are largely in corporate control and the tradeoffs can be managed. We view it as an imperative to consider changing pay strategy to reflect the reality of a world where the dollar does not go as far.

Companies and boards should think about how well pay strategy addresses four needs:

Need 1: Is our pay/reward strategy about more than dollars and cents?
Employees have far more choices for employment at this time and can command dollars from multiple places and roles. It is worthwhile to think hard about culture — what makes your culture unique, what people value in their roles, and what might be missing — and then build incentives and reward systems that support those activities in balance with financial performance.

Need 2: Does the pay strategy create the right balance of stability and risk?
Adapting pay programs to be more “risk-off” in the face of a highly uncertain external environment may be appropriate. Think about employees as managing to a “total risk” equation. When the expectation was that corporate growth was close to a given, then the risk meter could accommodate taking more risks to earn potentially more money.

Need 3: Are we making the best possible bets on our top talent?
Paradoxically, it might be a time to take more talent risk by digging deep to find your best people and providing them with differentiated rewards, visibility and responsibility. This is the heart of performance management, and it can always improve. The increased risk comes from investing more in fewer people. What if the assessment turns out to be incorrect or if someone leaves? Managing this risk versus avoiding it is the path to success.

Need 4: How are we sure performance in the face of a more volatile outside world is being rewarded?
This is the most “structural” of the needs. Elements to consider would include:

  • Higher merit budgets
  • More modest annual incentive upside and downside
  • Incorporation of relative measurement into incentive programs
  • Rationalization of equity participation and limitations to a smaller group as needed
  • Designation of equity awards based on overall dilution or shares awarded versus dollar amounts

Each of these needs has material tactical considerations that require much discussion about implementing, communicating and managing change. But unlike other major costs, rising people costs present an investment opportunity for increased returns rather than just a hit to the bottom line.

Complacency Becomes a Major Risk

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One word seems to encapsulate concerns about banker attitudes’ toward risk in 2022: complacency.

As the economy slowly — and haltingly — normalizes from the impact of the coronavirus pandemic, bankers must ensure they hew to risk management fundamentals as they navigate the next part of the business cycle. Boards and executives must remain vigilant against embedded and emerging credit risks, and carefully consider how they will respond to slow loan growth, according to prepared remarks from presenters at Bank Director’s Bank Audit & Risk Committees Conference, which opens this week at the Swissotel Chicago. Regulators, too, want executives and directors to shift out of crisis mode back to the essentials of risk management. In other words, complacency might be the biggest danger facing bank boards and executives going into 2022.

The combination of government stimulus and bailouts, coupled with the regulatory respite during the worst of the pandemic, is “a formula for complacency” as the industry enters the next phase of the business cycle, says David Ruffin, principal at IntelliCredit, a division of QwickRate that helps financial institutions with credit risk management and loan review. Credit losses remained stable throughout the pandemic, but bankers must stay vigilant, as that could change.

“There is an inevitability that more shakeouts occur,” Ruffin says. A number of service and hospitality industries are still struggling with labor shortages and inconsistent demand. The retail sector is grappling with the accelerated shift to online purchasing and it is too soon to say how office and commercial real estate will perform long term. It’s paramount that bankers use rigorous assessments of loan performance and borrower viability to stay abreast of any changes.

Bankers that remain complacent may encounter heightened scrutiny from regulators. Guarding against complacency was the first bullet point and a new item on the Office of the Comptroller of the Currency’s supervisory operating plan for fiscal year 2022, which was released in mid-October. Examiners are instructed to focus on “strategic and operational planning” for bank safety and soundness, especially as it concerns capital, the allowance, net interest margins and earnings.

“Examiners should ensure banks remain vigilant when considering growth and new profit opportunities and will assess management’s and the board’s understanding of the impact of new activities on the bank’s financial performance, strategic planning process, and risk profile,” the OCC wrote.

“Frankly, I’m delighted that the regulators are using the term ‘complacency,’” Ruffin says. “That’s exactly where I think some of the traps are being set: Being too complacent.”

Gary Bronstein, a partner at the law firm Kilpatrick Townsend & Stockton, also connected the risk of banker complacency to credit — but in underwriting new loans. Banks are under immense pressure to grow loans, as the Paycheck Protection Program winds down and margins suffer under a mountain of deposits. Tepid demand has led to competition, which could lead bankers to lower credit underwriting standards or take other risks, he says.

“It may not be apparent today — it may be later that it becomes more apparent — but those kinds of risks ought to be carefully looked at by the board, as part of their oversight process,” he says.

For their part, OCC examiners will be evaluating how banks are managing credit risk in light of “changes in market condition, termination of pandemic-related forbearance, uncertainties in the economy, and the lasting impacts of the Covid-19 pandemic,” along with underwriting for signs of easing structure or terms.

The good news for banks is that loan loss allowances remain high compared to historical levels and that could mitigate the impact of increasing charge-offs, points out David Heneke, principal at the audit, tax and consulting firm CliftonLarsonAllen. Banks could even grow into their allowances if they find quality borrowers. And just because they didn’t book massive losses during the earliest days of the pandemic doesn’t mean there aren’t lessons for banks to learn, he adds. Financial institutions will want to carefully consider their ongoing concentration risk in certain industries, explore data analytics capabilities to glean greater insights about customer profitability and bank performance and continue investing in digital capabilities to reflect customers’ changed transaction habits.

Low Interest Rates Threaten Banks — But Not the Way You Think

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The coronavirus pandemic laid bare the struggles of average Americans — middle class and lower-income individuals and families. But these struggles are an ongoing trend that Karen Petrou, managing partner of the consulting firm Federal Financial Analytics, tracks back to monetary policy set by the Federal Reserve since the financial crisis of 2008-09.

In short, she says, the Fed bears some of the blame for the widening wealth gap, which sees the rich getting richer, the poor getting poorer and the middle class slowly disappearing. And that’s an existential threat to most financial institutions.

“The bread and butter of community banks — urban, rural, suburban — is the middle class and the upper-middle class, as well as the health of the communities [banks] serve,” Petrou explains to me in a recent interview. Even for banks focused on more affluent populations, the health of their communities derives from everyone living and working in it. “When you have a customer base that is really living hand to mouth,” she says, “that’s not a growth scenario for stable communities, or of course, [a bank’s] customer base.”

A lot of digital ink has been spilled on inequality, but Petrou’s analysis — which you’ll find in her book, “Engine of Inequality: The Fed and the Future of Wealth in America,” is unique. She explores how misguided Fed policy fuels inequality, why it matters, and how she’d recraft monetary policy and regulation. And she believes the future is bleak for banks and their communities if changes don’t occur.

Her ideas have the attention of industry leaders like Richard Hunt, CEO of the Consumer Bankers Association. “She’s not what I’d consider an activist or someone who has an agenda,” he says. “She is purely facts-driven.”

Central to the inequality challenge is the ongoing low-rate environment. We often talk about the Fed’s dual mandates — promoting maximum employment and price stability — but Petrou points out in her book that setting moderate rates also falls under its purview.

Low rates have pressured banks’ net interest margins for over a decade, but they’ve squeezed the average American household, too. Petrou writes that these ultra-low rates have failed to stimulate growth. They’ve also “made most Americans even worse off because trillions of dollars in savings were sacrificed in favor of ever higher stock markets.”

The Fed’s preoccupation with markets over households, she says, benefits the most affluent.

Low interest rates, as we all know, lower the returns one earns on safer investments, like money market accounts or certificates of deposit. That drives investors to the stock market, driving up valuations. Excepting a brief blip early in the pandemic, the S&P 500, Dow Jones Industrial Average and Nasdaq have all performed well over the past year, despite high unemployment and economic closures.

However, stock ownership is concentrated in the hands of a few. As of the fourth quarter 2020, the top 1% hold 53% of corporate equity and mutual fund shares, according to the Federal Reserve; the bottom 90% own 11% of those shares. Most of us would be better off, Petrou concludes, earning a safe, living return off the money we manage to sock away.

More than 60% of middle-class wealth is tied up in their homes; pension funds account for another 17%. Those have been underfunded, “but even underfunded pensions have a hope of paying claims when interest rates are enough above the rate of inflation to ensure a meaningful return on investment,” she writes.

And while homes account for a huge portion of middle-class wealth, home ownership has actually declined over the past two decades among adults below the age of 65, according to a Harvard University study. The supply of lower-cost homes has dwindled, and banks are reticent to make small mortgage loans, which are costly to underwrite. And for those who already own a home, prices still haven’t reached the levels seen before the financial crisis — in real dollars, they’re not worth what they once were.

And homes aren’t a liquid asset. Middle class Americans used to hold more than 20% of their assets in deposit accounts, but that’s declined dramatically. All told, low interest rates severely punish savers, who actually lose money when one adjusts for inflation.

Average real wages haven’t budged in decades — but the costs for everything else have risen, from medical expenses to childcare to education and housing. So, what’s paying for all that if savings yield little and incomes are stagnant? Debt. And a lot of it, at least for the middle class, whose debt-to-income ratio has grown to a whopping 120% — almost double what it was in 1983. For the top 1%, it’s more than halved, to 35% of income.

Middle class households were in survival mode before the pandemic hit, explains Petrou.

“All of the Fed’s monetary-policy thinking is premised on the view that ultra-low rates spur economic growth, but most low-cost debt isn’t available to lower-income households, and most middle-income households are already over their head in debt,” she writes. “Monetary policy has failed in part because the Fed failed to understand America as it bought, saved and borrowed.”

Debt can be wonderful; it can build businesses and make buying a home possible for many. But that dream is disappearing. Coupled with the regulatory regime, low interest rates have changed traditional banking, explains Petrou. Financial institutions are forced to chase fee income, found in wealth management and similar products and services. And lending to more affluent customers makes better business sense.

Petrou wants the Fed to gradually raise rates to “ensure a positive real return.” Combined with other factors, rising rates would “make saving for the future not just virtuous, but successful,” she writes, “giving families with growing wages in a more productive economy a better chance for wealth accumulation, intergenerational mobility, and a secure retirement.”

It won’t fix everything, but it will help middle and lower-income families save for their homes, save for college and even pay down some of that debt.

Petrou is clear — in her book and in my interview with her — that the Fed isn’t ill-intentioned. But the agency is ill informed, she believes, relying on aggregate data that doesn’t reflect a full picture of the economy.

“The economy we’re in is not the one in which most of us grew up,” she says, referring to the baby boomers who form the majority of bank boards and C-suites. The top 10% hold a much greater share of wealth, and that share is growing. The things that many boomers took for granted, she says, are increasingly unattainable, or require an unsustainable debt burden.

College tuition offers a measurable example of how much things have changed. Adjusted for 2018-19 dollars, baby boomers paid an average $7,719 a year to attend a four-year public college, according to the U.S. Department of Education. Generation Z is now entering college paying roughly 2.5 times that amount — contributing to the growing volume of student loans.

“Assuming that [the economy] works equitably because there’s a large middle class means that banks will make strategic errors, misunderstanding their customers and communities,” Petrou tells me. “And that the Fed will make terrific financial policy mistakes.”