Cash for Truckers Turns Into Cash for Bankers


specialty-finance-7-15-16.pngCash4truckers.com* sounds like something you’d see on a roadside billboard, not a message coming from a community bank. In fact, the domain name is owned by Triumph Business Capital, a subsidiary of a $1.7 billion asset community banking company named Triumph Bancorp in Dallas, Texas.

“You’d have no idea it was a bank,’’ Triumph Bancorp Vice Chairman and CEO Aaron Graft said about the web site at a recent Bank Director conference. “We don’t wait for a customer to show up in one of our primary markets.”

Triumph Business Capital, then known as Advance Business Capital, was founded in 2004 and sold to a group of Dallas area investors in 2012 led by Graft. Triumph has very little presence in the Dallas market where it is headquartered but has 40 percent of its loan portfolio in specialty finance nationwide. It is doing something unusual for a community bank. It’s trying to compete in the realm of factoring and asset-based lending for small businesses, including construction, transportation and trucking businesses as small as one guy with his one truck. Triumph will buy an invoice from a trucker, for example, charging 1.5 or 2 percent of the size of the invoice. That has helped the bank achieve an adjusted net interest margin of 5.61 percent, 203 basis points higher than the average for banks $1 billion to $10 billion in asset size, according to data from the Federal Deposit Insurance Corp.

The trucker gets the cash and Triumph pursues collection from the customer who received the shipment. So the credit risk is analyzing whether or not the customer, not the trucker, will pay the bill. The trucker also gets additional services including discount fuel cards as well as having someone else manage invoices while they’re on the road.

Not a lot of banks want to get into this business. Larger companies are able to finance their working capital needs through the likes of big banks such as CIT Group. Small businesses take just as much work as the big companies to finance, but the loans are smaller. Many small banks don’t want to invest in that type of lending because it requires so much expertise to manage and keep track of the loans.

This is where Triumph comes in. “We are willing to serve the smaller end of the market because we think they need it more and because we think that’s where the opportunity is,” says Graft.

It’s a strategy born in an age of slow growth and low interest rates, where banks are scrambling to grow loan portfolios and profits. The Office of the Comptroller of the Currency recently warned in its semi-annual risk report that growing competitive pressures have led to lowering underwriting quality and increased credit risk.

Graft says he’s dealing with the risk inherent in his strategy by bulking up his specialty finance staffing and expertise. As an example, more than 100 people work in factoring with a loan book of about $150 million. The bank reviews invoices for fraud, hoping to catch people submitting false invoices. Graft says he’s dealing with regulatory risk by communicating the bank’s strategy to regulators, to serve both as a community bank and as a national specialty finance company. The bank’s subsidiaries offer business-related services such as treasury management and insurance, as well as branch banking through Triumph Community Bank in the Chicago area. Triumph also announced plans in March to purchase a bank based in Lamar, Colorado, with $759 million in assets and 17 branches, which will make Triumph a $2.5 billion asset holding company.

“It’s a little outside the box,’’ says stock analyst Brad Milsaps of Sandler O’Neill + Partners, who covers the bank. He says Triumph is growing by buying community banks to acquire deposits and use those deposits to lend nationally. The bank’s return on assets was 1.20 percent in the first quarter, up from 1.10 percent in the same quarter a year ago, but some of that was the impact of bargain purchase gains from acquisitions, Milsaps says. “They’ve got the operational controls and experience in that business to hopefully mitigate the risk,’’ he says. “If you don’t have the systems and people in place in that space, you’ll get burned very, very quickly.”

*Note: Triumph owns cash4ftruckers.com but has begun redirecting viewers to invoicefactoring.com. Cashfortruckers.com has a similar name but is owned by a different company.

Even: Friend or Foe


friend-or-foe-3.png

Can you find financial stability in an app? Even, an alternative to payday loans, thinks you can. The application provides a money management tool for those with low or fluctuating incomes.

THE GOOD:
Jon Schlossberg, Even’s CEO, believes it is expensive to be poor. His company started on the basis of wanting to help those in poverty from being tricked into further debt from unfair fees and high interest rates. According to Schlossberg’s blog, over $100 billion is spent annually on items such as payday loans, overdraft fees, low balance fees and late bill fees—and the average working class American spends 10 percent to 20 percent of his or her salary on these items. Premised on the idea that you get “extra money when your pay is low, interest-free” and “intelligent savings when your pay is high,” this tool should immediately appeal to low-income workers or those who find it difficult to manage their money through peaks and valleys.

THE BAD:
The industry that Even seeks to disrupt is worth $100 billion a year—no small amount of revenue displaced. While many charges such as overdraft fees that consumers pay could be unreasonable, we are willing to bet there are many customers whose spending patterns are routinely careless. Even is basically providing interest-free loans in exchange for $3 per week. For Even’s sake, we hope there is some accountability forced upon its customers to ensure quality spending behaviors, and a safety net catch for multiple offenders. For a customer without a guilty conscience, $3 per week may be worth the price to overspend, and for Even, this could be a business model killer.

OUR VERDICT: FRIEND
Even has set out to be a “different” kind of bank…but the catch is, it’s not really a bank, by traditional terms. Although customers’ savings are insured by the Federal Deposit Insurance Corp., Even itself is not a bank; rather, it’s a partner to banks. While Even may not add significant financial reward to your institution, its contribution to a healthier consumer (and economy overall) should appeal to digitally savvy consumers that want to be part of a more financially stable population.

What to Do About the 35% of Checking Customers Costing You Money


Consumer checking, while the simple hub product for most retail deposit and loan relationships, produces some not so simple challenges related to financial performance.

Here’s the composition of a typical financial institution’s checking portfolio, based on the revenue generated by a household relationship. “Super” customers generate the highest percentage of a typical bank’s revenues although they make up only about 10 percent of its customers. Super customers also make up the highest percentage of overall relationship dollars, meaning they have more combined deposit and loan balances with the bank.strategycorps-chart-5-11.png

Super: household produces annual revenue over $5,000. Mass Market: produces $350 to $5,000 in revenue. Small: produces $250 to $350 in revenue. Low: produces less than $250 in revenue. Figures are based on the average bank in StrategyCorps’ proprietary database of more than 4 million accounts.

The challenge: What to do with the Small and Low relationships that make up 35 percent of customers yet represent only 1.6 percent of all relationship dollars and 2.9 percent of revenue?

A deeper dive into the profile of these segments is enlightening.

Segments Small $250-$350 Low <$250
Distribution 9% 26%
Per Account Averages Averages
Relationship Statistics    
DDA Balances $1,561 $682
Relationship Deposits $444 $117
Relationship Loans $161 $32
Total Relationships $2,166 $831
Revenue Statistics    
Total DDA Income (NII + Fees + NSF) $160 $62
Relationship Deposit NII $16 $4
Relationship Loan NII $6 $1
Total Revenue $182 $67
Account Statistics    
Have More Than One DDA 28.9% 14.5%
Have a Debit Card 71.4% 57.1%
Have Online Banking 27.3% 22.0%
Have eStatement 17.1% 13.9%
Debit Card Trans (month) 13.3 5.0
Have a Relationship Deposit 31.5% 17.9%
Have a Relationship Loan 7.1% 2.7%
Have Both a Deposit and Loan 2.5% 0.7%
Average Age of Account 3.1 3.4
Average Age of Account Holder 48.9 48.8

Obvious is the lack of revenue generation from these segments given average demand deposit account (DDA) balances and relationship deposit and loan balances on an absolute dollar basis and a comparative basis to the Mass and Super segments.

Less obvious is that the other revenue-generating (debit cards) or cost-saving activities (online banking, e-statements) of the average customer in the Small and Low segments is not materially different from the Mass and Super relationship segments. For some products, like a debit card, the percentage of customers in the Small and Low segments who have one is higher than Mass and Super segments.

The natural response from bankers when confronted with this information is, “let’s cross-sell these Small and Low relationships into more financial productivity.” This is well-intentioned, but elusive and arguably impractical.

First, for many consumers in these relationship segments, your FI isn’t their primary FI, so they are most likely Mass or Super segment customers at another institution. Second, if you are the primary FI, these segments simply don’t have financial resources or the need for additional financial products beyond what they already have today. At their best, these are effectively single service, low balance and low or no fee customers. Therefore, traditional cross-selling efforts either compete unsuccessfully with the primary FI’s cross-selling efforts or don’t matter because there aren’t available financial resources to be placed in other products.

How then does your FI competitively and financially engage with these Small and Low relationship segments to improve their financial contribution by increasing the DDA balances, relationship balances or generating more fee income? The answer is to relevantly offer them a product that impacts how they bank with your institution.

More specifically in today’s marketplace, this relevant offering is accomplished by being a bigger part of your customers’ mobile and online lifestyle. Consumers of all types are in a relationship with their smart phone, tablets and computers. A FI’s checking product has to be a bigger part of that relationship. It can’t just be another online or mobile banking product they can get at pretty much any FI. For the unprofitable customers who have a primary FI somewhere else, the mobile and online offerings have to be engaging and rewarding enough to move deposit balances to your bank or buy more products from your bank to generate more revenue.

For those unprofitable customers who simply don’t have the financial resources to aggregate deposits or be cross-sold, the mobile and online banking solutions have to include value worthy enough to willingly pay for. Why? Because generating recurring, customer-friendly fee income based on non-traditional benefits or functionality is the only way you’re going to make them more profitable. Top retailers like Costco, AAA, Amazon and Spotify understand this retailing principle, which is transferable to FIs if they will design and build their checking products like a retailer would instead of a banker.

For consumer checking financial performance on both the Small and Low relationship segments as well as the Super and Mass ones, a more detailed executive report is available if you’d like more information.

A New Dawn for De Novo Banks?


denovo-3-11-16.pngOn March 17, 2015, the Federal Deposit Insurance Corporation (FDIC) conditionally approved a de novo charter for the first time in several years. Primary Bank, based in Bedford, New Hampshire, opened its doors for business on July 28, 2015, after raising $29 million in capital.

And Primary Bank is not alone. There are two additional de novo applications awaiting action by the FDIC. Clearly, there are investors who see opportunities for new banks. Even the FDIC is speaking publicly to signal its openness to de novo activity. The FDIC recently noted that it “welcomes proposals for deposit insurance and staff are available to discuss the application process and possible business plans with potential applicants. In addition, former FDIC Chairman Sheila Bair noted earlier this year that the FDIC recognizes the importance of new institutions being formed, but wants to see very well capitalized banks with good business plans and managers that have diversified lending platforms.

The question is whether these recent de novo entrants will open the gates for other investors across the country.

A De Novo Drought
During the five years immediately prior to the start of the financial crisis in 2008 (2003-2007), there were a total of 629 de novo banks formed in the United States, averaging nearly 126 new banks each year.  That number tapered precipitously as the financial crisis began in 2008 and 2009, during which only 73 and 20 de novos opened for business, respectively. Since 2009, forming a new bank has been nearly out of the question, with only three new charters approved between 2010 and 2014 (compared to 15 new credit unions during that same period). This de novo drought, coupled with ongoing M&A activity and failures, has accelerated the decline in the number of bank charters in recent years.

Looking at the fate of many of the de novos formed just before the last recession, one can understand why regulators remain hesitant to allow new investor groups to enter the market.  Of the 629 charters in the five years prior to 2008, 238 no longer exist, either due to failure (75), M&A activity (157) or liquidations (5). Although a large portion of this decline was due to M&A activity rather than failure, no doubt many of those selling institutions were forced into a sale as the result of a deteriorating financial condition during the crisis. It is well documented that de novos formed during the years immediately prior to the financial crisis constituted a disproportionate number of the resulting bank failures and troubled institutions.

Why Start a De Novo?
Besides the traditional factors that have motivated bankers and investors in the past, there are a couple of unique reasons why now might be one of the best times for a group of visionary investors to form their own bank.

Community banks are in the midst of a once-in-a-generation inflection point with respect to their operations. The branch is being de-emphasized as a result of new technology, and branches of the future look more like interactive work spaces than traditional locations. Some new branches emulate coffee shops, Apple stores, or start-up incubators. Morphing a traditional branch location into one of these new conceptual branches requires a major capital investment and shift in culture and thinking. A de novo would have the luxury of creating its own culture, location, products, and services to take advantage of new technologies and branching trends, which would immediately distinguish it from existing bank franchises and position it for growth.

The next handful of de novos will enjoy tremendous publicity, both locally and, perhaps, nationally. That publicity drives more interest and opportunities from investors, talent, and prospective customers. Primary Bank exemplified this phenomenon. Due in part to all the attention it received, it exceeded its capital raising expectations and received national media attention. With the right people and message, the next few de novos could gain a similar strategic advantage.

What Will It Take?
In September of 2015, the FDIC held a joint training session with state bank regulators across the country to ensure such regulators are on the same page when it comes to de novo applications. It is safe to assume the application process will be more rigorous than in the past, including the need for more start-up capital and a superior management team. However, regulatory agencies appear to be preparing themselves to approve worthy applicants.

Conclusion
It is not a question of whether there will be another de novo bank, but when. Despite the challenges of running a community bank, a unique opportunity to start a new bank awaits the right investor group.

What’s Changing in Bank D&O Insurance


To quote Shakespeare, “What’s past is prologue.” By looking back at Federal Deposit Insurance Corp. (FDIC) actions in 2015 and beyond, I believe it provides a good template for what we can expect for insurance in 2016. For purposes of this article, there are two areas we will look at: FDIC settlements and regulators’ civil money penalties (CMPs).

The Impact of the Wave of Failed Banks
Here are the trends with regards to the impact that failed banks have had on FDIC suits and then on FDIC settlements:

Year Failed Banks # of FDIC Suits # of FDIC Settlements Settlement $ (total)
2008 25      
2009 140      
2010 157 2    
2011 92 16 1 $700,000
2012 51 26 7 $186,345,000
2013 24 40 9 $49,466,093
2014 18 21 23 $90,800,500
2015 8 3 45 $347,947,183
Totals 515 108 85 $675,258,776

We see an interesting chain reaction that begins with failed banks. Since 2008, there have been 515 total failed banks, with a peak of 157 in 2010. We see a similar trend with the number of FDIC suits against banks, albeit with a three-year lag, which is consistent with the statute of limitations. This trend continues with FDIC settlements, which generally have a two-year delay following the lawsuit. For example, a bank that failed in 2010 will typically be sued in 2013 and settle in 2015. And a vast majority of those settlements are represented as directors and officers’ (D&O) claims payments associated with the D&O insurance policy that existed at the time the bank failed.

A majority of the claims are being paid by the same insurance carriers that currently represent today’s community and regional banks. This implies that healthy banks will continue to pay for the sins of their ancestors. The good news is that it is fair to say that settlements against bank directors and officers peaked in 2015. So while we can expect slightly higher D&O rates at least until the time when these claims amortize off the carrier’s books, fewer settlements in 2016 should begin to put downward pressure on prices for D&O insurance.

The best way to mitigate against these increases is to make sure your bank is seen for its strengths. We recommend hosting an underwriting meeting/call approximately six weeks prior to the renewal, which should include both the incumbent D&O underwriter and one or two of the  alternative underwriters who typically will offer terms for similar banks.

FDIC Civil Money Penalties (CMP)
Since 1996, the FDIC has forbidden banks from insuring against CMP payments for their officers and directors. However, we regularly saw civil money penalty endorsements on D&O policies up until 2013. On October 10th of 2013, the FDIC sent out the letter FIL-47-2013 which explicitly reinforced that civil money penalties (CMPs) can neither be indemnified by the banking institution or covered under the bank’s D&O policy. Once that letter came out, most insurance carriers refused to offer the CMP endorsement(s) previously provided, thus creating a significant gap in coverage for all bank directors and officers.

Since then, we have seen several new insurance products created to address this gap and we continue to get inquiries about them. Remember, since the bank cannot cover the CMP, the individual must complete the application and pay for the coverage themselves. And it will be the individual’s name as the only named insured listed on the policy.

Here is the 2014 vs. 2015 data with regards to the CMP trends against individual D&Os:

  • The average CMP amount increased from $67,646 to $74,980
  • The median CMP amount increased from $15,000 to $50,000
  • The maximum individual CMP in 2014 was $500,000 and in 2015, $545,000
  • In the past two years, approximately 29 percent of CMPs were for failed institutions
CMP Fine Size 2014 2015
<= $50K 71% 64%
$51K – $100K 10% 12%
$101K – $150K 10% 12%
$151K – $250K 2% 8%

Since a vast majority of banks cited are solvent, it behooves D&Os of even the healthiest institutions to consider this coverage. Factors that go into eligibility are the regulatory status of the bank and any past regulatory history of the individuals. So if you are interested, it is better to inquire prior to any type of regulatory restriction, although that would not disqualify you for the coverage.

Executive Benefit Plans in 2016: Emerging Trends


benefit-plan-1-27-16.pngSince the credit crisis, most community banks have been able to grow and improve their financial condition. According to the Federal Deposit Insurance Corp. (FDIC), almost 60 percent of community banks reported higher year-over-year earnings for the period ending in the third quarter of 2015. In addition, community banks have increased assets by 5.6 percent and total loans and leases by 8.5 percent for the same period adjusted for mergers. While these growth numbers do not represent the pre-credit crisis years, the industry is showing an improvement. The percentage of unprofitable community banks are at the lowest level in many years. Community banks are defined by the FDIC Community Bank Study, December 2012, and one of the criteria is that these banks are “likely to be owned privately or have public shares that are not widely traded.”

What do improving conditions mean to banks and their compensation plans? Some banks have seen challenges in retaining key officers given increased competition for top talent, while other bankers believe they are now in a position to invest in additional key talent to grow their organization. For banks that have implemented various types of compensation plans, it may mean including an additional key officer in these plans. Attractive executive compensation plans include market-based salary, annual bonus based on performance, stock options or restricted stock (where applicable), reasonable contributions to a 401(k) or other qualified retirement plan, medical care and other standard benefits, change- in-control agreement and a custom-tailored nonqualified retirement plan.

Another important trend is the disruption created in many markets by mergers. The purchasing bank wants to retain the top lenders and others revenue generators, but the change in ownership can cause those individuals to consider other options. Competing banks that have developed a game plan for such situations will be positioned to hire some of these talented individuals. A nonqualified plan (customized for each executive) can play a vital role in attracting and retaining these individuals.

Another trend that has been taking place is an increase in the number of community banks that previously only offered salary and annual bonus plans, but are now providing more comprehensive compensation packages for key executives. This is a result of increased competition for executives as well as improved earnings.

Nonqualified plans need to be tailored to meet the needs of the individual. For example, a younger officer in his or her 30s may not see the value of a retirement benefit targeted at age 67, but would see value in a plan that allows for earlier cash distributions to pay for a child’s college education or that allows for early retirement at age 55. Many organizations use a combination of plans and approaches to attract and retain their key people. Here are some examples of situations and challenges bankers have faced when contemplating compensation plans:

  1. You have an executive in his mid-50s who has contributed to leading and growing the organization but has not yet been rewarded for his efforts. This executive’s compensation focus is now being more directed at retirement and wealth building rather than solely increases in current cash compensation. Consider a supplemental executive retirement plan (SERP) plan and perhaps a long-term incentive plan. He may also be interested in deferring current salary.
  2. You have young officers in their 30s and 40s who are high producers and need to be compensated for their efforts with more than just base salary and annual bonus amounts. Consider a performance-based nonqualified benefit plan or a combination of a SERP and performance-based nonqualified plan. It is important to tie these individuals to your bank if you remain independent, but it can also enhance the sales price if these individuals stay with the purchasing bank in the event your bank is sold. Properly designed nonqualified plans can substantially increase the probability they will stay in either scenario.
  3. For closely held banks that would like their management team to think like owners, consider nonqualified plans using a phantom stock or stock appreciation rights approach or, if another type of deferred compensation plan is adopted, consider linking the interest credited to the executive’s account to the bank’s return on equity.

Summary
With an improving economy and asset growth of community banks, along with a higher than normal level of merger activity, banks have been adding officers to existing long term incentive and nonqualified benefit plans or developing and implementing new plans to compete with other banks for talent. Utilizing more than one compensation strategy or plan can be an important element in attracting and retaining talent. The bank’s franchise value is dependent on its level of success in attracting and retaining key executives.

Equias Alliance offers securities through ProEquities, Inc. member FINRA & SIPC. Equias Alliance is independent of ProEquities, Inc.

Making the Tough Call on Trust Preferred Securities


In recent months, three bank holding companies in or nearing default on the payment of deferred interest on trust preferred securities have elected to sell their institutions under Section 363 of the U.S. Bankruptcy Code. While this certainly must have been a difficult step to have taken, it does suggest that the boards of directors of these companies are making appropriate, though wrenching, choices to protect their bank subsidiaries, the communities they serve and the FDIC insurance fund. However, there are many similarly situated companies that are delaying taking their medicine, and these companies may be placing their banks at risk.

Before the onset of the economic crisis, many institutions, seeing growth opportunities ahead, established trust subsidiaries that issued trust preferred securities. The trust subsidiaries used the proceeds to purchase subordinated debt from their holding companies, which then contributed the proceeds to their bank subsidiaries to increase capital to support anticipated growth. In order to treat the subordinated debt as capital, the instruments were required to permit issuers to defer the payment of interest for up to 20 consecutive quarters.

When the economy soured, many of these holding companies had to exercise their deferral options. Most holding companies in this predicament now have regulatory agreements that prohibit the payment of dividends by their bank subsidiaries and the payment of interest on trust preferred securities without approval. These companies are now nearing, or in some cases have already reached, the end of their 20-quarter deferral periods and are in danger of defaulting.

There are remedies available for these companies, although many of them are difficult to accomplish or could be unpalatable. Most desirable is obtaining regulatory approval to pay a dividend from the bank and use the proceeds to pay deferred interest on the trust preferred securities. Before granting approval, regulators will want to see a reliable earnings stream and sufficient remaining capital at the bank.

Other remedies are less appealing. A company may seek to raise capital. However, it can be difficult for troubled institutions, especially smaller community banks, to raise capital from institutional investors, and a capital raise is also likely to be highly dilutive to existing stockholders.

Other companies may find themselves forced to seek a merger partner with the resources to assume the company’s obligations under its trust preferred securities. While eliminating default risk, a merger results in the loss of independence.

Companies also may seek to negotiate a resolution with creditors. This is extremely difficult, if not impossible, to accomplish, given that most trust preferred securities are held by special purpose entities, many of which are not actively managed.

When all else fails, creditors can be forced to accept a sale of the bank under Section 363, an action that often will achieve little or no value for stockholders.

It is natural for boards of directors to resist diluting or wiping out stockholders or surrendering their independence. However, the consequences of failing to act can be severe. Regulators are keenly aware when bank holding companies are nearing default and will strongly pressure their boards of directors to take action. And once a company is in default, creditors can act to recover their principal and may even act in ways that may not seem economically rational but make sense to them if they are more concerned about their entire portfolio of companies than they are about any single company. Indeed, we have seen two situations where creditors have filed petitions for involuntary bankruptcy.

Even where boards of directors decide to act, it can take time to accomplish any transaction, so it is critical to act sufficiently in advance of the default date. Once default occurs, if creditors choose to take action unilaterally, boards of directors could lose control of their destinies, and key decisions may end up in the hands of creditors or judges. These types of disputes can harm a bank’s reputation and, in extreme cases, create liquidity risk.

So for companies with a default date looming, it is critical to accept reality and then plan and act well in advance of the default date. The action may be difficult to accept, but in the long run it might be the best thing for the bank and its customers.

How Banks Can Improve Crisis Planning


We discovered last month that cyber risk was the thing most directors worried about when we informally polled members of our bank services program. This month, we decided to poll experts on what banks could do to improve crisis planning. Not surprisingly, cyber risk planning came up often as an area that could use some improvement. Several of the people polled think banks could benefit from role playing exercises that would walk employees and the board through possible scenarios. The Federal Deposit Insurance Corp. has a few videos that help banks imagine some scenarios. Although planning documents are widely recommended, one consultant says they are pretty useless in a real emergency. Below are their responses.

How Could Banks Improve Crisis Planning?

Mills-Scott.pngCrisis planning is getting more attention these days because we are constantly reminded of events that could not only impact our business, but have significant impact on our reputations. One data breach and we stand to lose faith in our ability to safeguard our clients’ money. While planning is expected, bankers could really get value from practice in two areas: 1) tabletop exercises and 2) media training. Tabletop exercises are role playing crisis scenarios whereby bank management gets on a conference call and develops responses, assigns roles, identifies tasks and develops timelines. Banks would benefit from doing this on a quarterly basis. Media training allows bank executives to learn how to look and respond appropriately to a tense situation only after they learn how to answer questions and the ground rules for working with the media. Turn on a video camera and see how well your team does. Crisis planning is better if treated as an ongoing discipline.

—Scott Mills is president of the William Mills Agency, a public relations and marketing firm specializing in financial services

Taylor-Nathan.pngTesting, testing and more testing! Banks typically have multiple plans that can be triggered in the event of a significant cyber-related “crisis,” including, for example, a business continuity plan, incident response plan and crisis communication plan. Multiple groups within a bank likely have responsibility for these plans. And, the plans may not be aligned from a response standpoint with respect to significant cyber events. In the event of such a crisis, it is critical for a bank to be able to respond in a uniform and effective way at the enterprise level. Bringing a bank’s various teams together to test or tabletop a significant cyber event can shed light on how the bank’s various plans (and teams) will work together. This will also provide a valuable opportunity for refinement and alignment of the bank’s related response plans.

—Nathan Taylor is an attorney and cybersecurity expert at Morrison Foerster LLP

Miller-RaeAnn.pngBusiness continuity and disaster recovery considerations are an important component of a bank’s business model. In addition to preparing for natural disasters and other physical threats, continuity also means preserving access to customer data and the integrity and security of that data in the face of cyberattacks. For this reason, the FDIC  encourages banks to practice responses to cyber risk as part of their regular disaster planning and business-continuity exercises. They can use the FDIC’s cyber challenge program, which is available on the FDIC website. Cyber challenge was designed to encourage community bank directors to discuss operational risk issues and the potential impact of information technology disruptions.

—Rae-Ann Miller is associate director of the FDIC’s Division of Risk Management Supervision

Sacks-Jeff.pngBanks can improve planning by developing a crisis plan ahead of a data breach or cybersecurity issue. These action plans should include:

  1. Determining data to be protected along with the protection level required.
  2. Classifying incidents or scenarios into categories.
  3. Understanding threats the bank may face, starting with known threats, then creating on-going monitoring for emerging threats.
  4. Determining the stakeholders and defining the incident response team.
  5. Setting up a command center and appointing a command center leader.
  6. Developing an incident plan, including a containment and investigation strategy.
  7. Executing a communication plan to customers, media and agencies.
  8. Testing and training end users in the application of the incident response plan.
  9. Conducting a “lessons learned” session and updating [Incident Response Plan] procedures.

—Jeff Sacks is a principal in Risk Consulting for Crowe Horwath LLP, specializing in technology risk

McBride-Neil.pngThough banks understand the risk of cyberattacks, many are unprepared to act quickly and effectively to mitigate damage when faced with a serious cyber breach. To improve crisis planning, banks should consider conducting simulated cybersecurity exercises involving key personnel. Moving quickly following a cyber breach is critical to limiting unauthorized access to sensitive data and the resulting harm. Such exercises demonstrate why an effective cybersecurity program is more than an “tech issue,” and requires coordinated institutional mobilization across business segments, with oversight from senior management. Most banks will eventually find themselves in a hacker’s crosshairs no matter how advanced their defenses, and a coordinated, rapid response will not only limit short-term data loss and legal exposure, but will also help preserve a bank’s reputation and customer relationships.

—Neil MacBride is a partner at Davis Polk & Wardwell

Carroll-Steve.pngPlanning activities generate lots of documents, which are fascinating to auditors but useless in an emergency. You don’t have to give planning reports to your response team. Your phone is a perfect emergency communications console. Social media, including Twitter, YouTube and even Facebook, are indispensable as communications tools. You can monitor events as they unfold or push messages out to staff and public. Cyber is the new disaster. Compare today’s threat assessment with one from 2010. Notice that blizzards and hurricanes have dropped out of the top ten, replaced by data breaches and identity theft.

—Steve Carroll is a director with Cornerstone Advisors, a consulting firm specializing in bank management, strategy and technology advisory services

Time to Develop an M&A Survival Strategy


Thirty years ago there were a record high 18,000+ banks in the United States. We’re now down to around 6,700 with all indications pointing to further consolidation. Meanwhile, new bank charters have dwindled to near non-existence with one new bank opened between the end of 2010 and 2013.

  20 years ago 10 years ago Today
 Total number of institutions 12,644 9,129 6,739
 Total number of banks $1 – $50B in assets 554 553 642
 Total number of banks $50B+ in assets 8 27 37
 Total number of banks less than $500MM in assets 11,688 8,022 5,382

Between the number of industry disrupters trying to win a slice of the traditional banking business and the plethora of investment opportunities in other industries with less regulation, it’s easy to imagine the number of banks falling by a full 50 percent in the next 20 years.

For better or worse, banking has become a scale business. The costs of regulatory compliance, necessary investments in new technology, physical and digital channels, and thinning industry margins mean banks will either need to be of a certain size or have a defensible niche built on knowledge rather than transactions.

For the better part of the past decade, the folks at Cornerstone have touted the $1 billion asset threshold as a marker of scale. Because of our friends in Washington and the dizzying pace with which technology has changed our industry, I think the new threshold to reach in the next five to seven years is more in the $5 billion asset neighborhood. If my prediction bears out, the vast majority of M&A activity and consolidation will take place in the midsize bank space ($1 – $50 billion), either with smaller midsize banks buying community banks or banks at the upper end acquiring $5 and $8 billion banks.

I have always been a proponent of having a solid organic growth strategy, but midsize banks will need to develop AND execute upon a solid M&A strategy to survive. Most banks lamely describe their M&A strategy as “opportunistic,” which is code word for: “waiting for the investment banker to call with a proposed deal.” This simply won’t cut it in the fast-consolidating, commoditized industry we call banking today. Here are some key areas your M&A strategy should address.

  • Define Your Value Proposition. Define in financial AND human terms what makes you an attractive acquirer. The list of possibilities are endless: opportunities for stock value gains, opportunities for employee growth at a larger bank, track record of performance, a willingness to negotiate system choices, or a holding company type business model that allows the acquired bank to maintain its brand and management team.
  • Identify M&A Partners. Define filters to narrow down what targets make the list including qualities like geography, asset size, branch network, balance sheet mix, capital levels and niche businesses. Tools like the Federal Deposit Insurance Corp. website or SNL Financial can easily help you produce your target list. Stack rank your target list starting with the most attractive to the least by assigning weighted values to your filters.
  • Cultivate the Courtship. If you are the acquirer, you need an active outreach program that includes management, directors and shareholders, with the mix changing depending on the target. Your outreach program needs to involve a consistent manner of communicating your value to your targets. Get creative. Courtship could involve providing shared services for a common core platform, inviting select management and directors to your strategic planning session, or offering to outsource from your niche expertise like trust and wealth management platforms.
  • Define the Merger Value. Once you find a receptive bank, you will need to paint a clear picture of the value a merger will bring to shareholders and management of the target bank that goes beyond the pro forma financial model. The target bank will want to know about management team composition, board seats, branch closures, surviving systems and products, efficiency targets, headcount reductions, and branding, to name a few.
  • Conduct Due Diligence and Begin Negotiations. If you’ve made it this far, the M&A strategy and framework you have laid out is obviously working. Now, the formal process begins.

At the end of the day, midsize banks have two choices: rely on a decades-old organic growth strategy combined with opportunistic M&A, or get in the game and execute upon a carefully defined M&A strategy. The risk of being left behind as other midsize banks scale up is not one I would want to take with my bank.

How the New FDIC Assessment Proposal Will Impact Your Bank


growth-strategy-8-14-15.pngIn June, the Federal Deposit Insurance Corp. (FDIC) issued a rulemaking that proposes to revise how it calculates deposit insurance assessments for banks with $10 billion in assets or less. Scheduled to become effective upon the FDIC’s reserve ratio for the deposit insurance fund (DIF) reaching a targeted level of 1.15 percent, these proposed rules provide an interesting perspective on the underwriting practices and risk forecasting of the FDIC.

The new rules broadly reflect the lessons of the recent community bank crisis and, in response, attempt to more finely tune deposit insurance assessments to reflect a bank’s risk of future failure. Unlike the current assessment rules, which reflect only the bank’s CAMELS ratings and certain simple financial ratios, the proposed assessment rates reflect the bank’s net income, non-performing loan ratios, OREO ratios, core deposit ratios, one-year asset growth, and a loan mix index. The new assessment rates are subject to caps for CAMELS 1- and 2-rated institutions and subject to floors for those institutions that are not in solid regulatory standing.

While the proposed assessment rates reflect a number of measures of an institution’s health, provisions relating to annual asset growth and loan mix may influence a bank’s focus on certain categories of loans and the growth strategies employed by many community banks in the future. We’ll discuss each of these new assessment categories in turn.

One Year Asset Growth
Under the proposed assessment rules, year-over-year asset growth is subject to a multiplier that would have, all other things being equal, the effect of creating a marginal assessment rate on a bank’s growth. In the supporting materials for the FDIC’s rulemaking, the FDIC indicates that it found a direct correlation between rapid asset growth and bank failures over the last several years. But while organic asset growth is subject to the new assessment rate, asset growth resulting from merger activity or failed bank acquisitions is expressly excluded from the proposed assessment rate. This approach is somewhat counterintuitive in that most bankers would view merger activity as entailing more risk than organic growth or growing through the hiring of new teams of bankers. While the new assessment rate might not be significant enough to impact community bank growth strategies on a wide scale, it may offset some of the added expense of a growth strategy based upon merger and acquisition activity.

Loan Mix Index Component
This component of the assessment model requires a bank to calculate each of its loan categories as a percentage of assets and then to multiply each category by a historical charge-off rate provided by the FDIC. The higher the 15-year historical charge-off rate, as weighted according to the number of banks that failed in each year, the higher the assessment under the proposed rules. Unsurprisingly, the proposed rules assign the highest historical charge-off rate (4.50 percent) to construction and development loans, with the next highest category being commercial and industrial loans at 1.60 percent. Interestingly, the types of loans with the lowest historical charge rates are farm-related, with agricultural land and agriculture business loans each having a 0.24 percent charge-off rate.

While the new loan mix index component is a clear reflection of the impact of recent bank failures on the current assessment rates, it may also create economic obstacles to construction lending, which continues to be performed safely by many community banks nationwide. Despite these positive stories, there is no doubt as to the regulators’ views of construction lending—in conjunction with the new Basel III risk-weights also applicable to certain construction loans, community banks face some downside in continuing to focus on this category of loan.

However, when considering the asset growth and loan index components together, community banks that have a strong pipeline of construction loans may have added incentive to complete an acquisition, particularly of an institution in a rural market. Not only can the acquiring bank continue to grow its assets while incurring a lower assessment rate, it can also favorably adjust its loan mix, particularly if the seller has a concentration of agricultural loans in its portfolio. In general, acquirers have recently focused their acquisition efforts on metro areas with greater growth prospects, but the assessment rules may provide an incentive to alter that focus in the future. In many ways, the proposed assessment rates provide bankers an interesting look “behind the curtain” of the FDIC, as this proposal clearly reflects the FDIC’s current points of regulatory concern and emphasis. And while none of the components of the proposed deposit insurance assessments may have an immediate impact on community banks, some institutions may be able to reap a substantial benefit if they can effectively reflect the new assessment components in their business plan going forward.