In a post-pandemic world, legacy financial institution must accelerate their digital processes quickly, or risk ceasing to be relevant.
With financial technology companies like Chime, Varo Money, Social Finance (or SoFi) and Current on the rise, change is inevitable. Alongside the nimble fintech competition, banks face pressure to rapidly deliver new products, as was the case with the Small Business Administration’s Paycheck Protection Program loans. While most legacy institutions try to respond to these business opportunities with manual processes, companies like Lendio and Customers Bank can simply automate much of the application process over digital channels.
Legacy institutions lack the access to the latest technology that digital challengers and fintechs enjoy due to technology ecosystem constraints. And without the same competitive edge, they are seeing declining profit margins. According to Gartner, 80% of legacy financial services firms that fail to adapt and digitize their systems will become irrelevant, and will either go out of business or be forced to sell by 2030. The question isn’t if financial institutions should evolve — it’s how.
To fuel long-term growth, traditional banks should focus on increasing their geographic footprint by removing friction and automating the customer’s digital experience to meet their needs. Millions of Generation Z adults are entering the workforce. This generation is 100% digitally native, born into a world of vast and innovative technology, and has never known life without Facebook, Snapchat, TikTok or Robinhood. In a couple of years, most consumers will prefer minimal human interaction, and expect fast and frictionless user experience in managing their money, all from their smartphone.
Some solutions that traditional banks s have undertaken to enhance their digital experience include:
Extending on top of their existing tech stack. In this scenario, financial institutions acquire digital/fintech startups to jump-start a move into digital banking. However, there are far fewer options to buy than there are banks, and few of the best fintechs are for sale.
Totally transforming to modern technology. This option replaces the legacy system with new digital platforms. It can come with significant risks and costs, but also help accelerate new product launches for banks that are willing to pay a higher initial investment. Transformations can last years, and often disrupt the operations of the current business.
Using the extensibility approach. Another way forward is to use the extensibility approach as a sub-ledger, extending the legacy system to go to market quickly. This approach is a progressive way to deliver fit-for-purpose business capabilities by leveraging, accelerating and extending your current ecosystem.
Institutions that want to enter a market quickly can also opt for the speedboat approach. This includes developing a separate digital bank that operates independently from the parent organization. Speedboats are fintechs with their own identity, use the latest technology and provide a personalized customer experience. They can be quickly launched and move into new markets and unrestricted geography effortlessly. For example, the Dutch banking giant ABN AMRO wanted to create a fully digital lending platform for small to medium enterprises; in four months, the bank launched New10, a digital lending spinoff.
A speedboat is an investment in innovation — meant to be unimpeded by traditional organizational processes to address a specific need. Since there is a lot of extensibility, the technology can be any area the bank wants to prioritize: APIs, automation, cloud and mobile-first thinking. Banks can generate value by leveraging new technology to streamline operations, automate processes and reduce costs using this approach.
Being unencumbered by legacy processes because the new bank is cloud native.
The ability to design the ideal bank through partners it selects, without vendor lock-in.
Easier adaption to market and consumer changes through the bank’s nimble and agile infrastructure.
Lower costs through automation, artificial intelligence and big data.
Leveraging a plug-and-play, API-first open banking approach to deliver business goals.
By launching their own spin-off, legacy banks can go to market and develop a competitive edge at the same speed as fintechs. Modern cloud technology allows banks to deliver innovative customer experiences and products while devoting fewer resources to system maintenance and operational inefficiencies.
If a financial institution cannot make the leap to replace the core through a lengthy transformational journey and wants to reach new clients and markets with next-generation technology, launching a speedboat born in the cloud or opting for the extensibility approach opens up numerous opportunities.
Imagine a local manufacturer, beloved as an employer and a pillar of the community. The company uses 100% renewable energy and carefully manages its supply chain to be environmentally conscious. The manufacturer has a diverse group of employees, upper managers and board. It pays well and provides health benefits. It might be considered a star when it comes to environmental, social and governance (ESG) parameters.
Now imagine news breaks: Its product causes some customers to develop cancer, an outcome the company ignored for years. How did a good corporate citizen not care about this? You could say this was a governance failure. Everyone would agree that it was a trust-busting event for customers.
ESG, at its root, is about looking at the overall impact of a company. The most profound impact of banks is the impact of banking products. Most bank products are built for use in a perfect world with perfect compliance, but perfect compliance is hard for some people. Noncompliance disproportionately affects the most vulnerable customers ⎯ people living paycheck-to-paycheck and managing their money with little margin to spare. That isn’t to say that these individuals are all under or near the poverty line: Fully 18% of people who earn more than $100,000 say they live paycheck to paycheck, according to a survey of 8,000 U.S. workers by global advisory firm Willis Towers Watson. There is growing recognition that bank products need to reflect the realities of more and more Americans.
Years ago, Columbus, Ohio-based Huntington Bancshares started working on better overdraft solutions for customers whose financial lives were far from perfect. Currently, the $123 billion regional bank will not charge for overdrafts under $50 if a customer automatically deposits their paycheck. If the customer overdrafts $50 or more, the bank sends them an alert to correct it within 24 hours.
Likewise, Pittsburgh-based PNC Financial Services Group recently announced a new feature that gives PNC Virtual Wallet customers 24 hours to cure an overdraft without having to pay a fee. If not corrected, an overdraft amounts to a maximum of $36 per day.
“With this new tool, we’re able to shift away from the industry’s widely used overdraft approach, which we believe is unsustainable,” said William Demchak, chairman and CEO of the $474 billion bank, in a statement. The statement alone reframes what sustainability means for banking.
The banks that become ESG leaders will create products that improve the long-term financial health of their retail and small businesses customers. To do so, some financial institutions are asking their customers to measure their current financial realities in order to provide better solutions.
For example, Credit Human, a $3.2 billion credit union in San Antonio, is putting financial health front and center both in their branches and digitally. Their onboarding process directs individuals to a financial health analysis supported by FinHealthCheck, a data tool that helps banks and credit unions measure the financial health of customers and the potential outcomes of the products they offer. The goal of Credit Human is to improve the financial health of their customers and eventually make it a part of the overall measurement of the product’s performance.
Measurement alone will not build better bank products. But it will provide banks and credit union executives with critical information to align their products with customer well being. With the implementation of overdraft avoidance programs such as PNC’s Low Cash Mode, the bank expects to help its customers avoid approximately $125 million to $150 million in overdraft fees annually. PNC benefits its bottom line by driving more customers to its Virtual Wallet, nabbing merchant fee income and creating customer loyalty in the process. PNC’s move makes it clear that they believe promoting the long-term financial health of their customers promotes the long-term financial health of the company.
Banks need to avoid appearing to care about ESG, while failing to care about customers. The banks that include customer financial health in their ESG measurement will survive, thrive and become the true ESG stars.
According to the Federal Reserve’s report on the economic well-being of U.S. households in 2019, 6% of American adults were “unbanked” and 16% of U.S. adults make up the “underbanked” segment.
Source: Federal Reserve
With evolving technological advancements and broader access to digital innovations, financial institutions are better equipped to close the gap on financial inclusivity and reach the underserved consumers. But to do so successfully, banks first need to address a few dimensions.
Lack of credit bureau information on the so-called “credit invisible” or “thin file” portions of unbanked/underbanked credit application has been a key challenge to accurately assessing credit risk. Banks can successfully address this information asymmetry with Fair Credit Reporting Act compliant augmented data sources, such as telecom, utility or alternative financing data. Moreover, leveraging the deposits and spend behavior can help institutions understand the needs of the underbanked and unbanked better.
Pairing augmented data with artificial intelligence and machine learning algorithms can further enhance a bank’s ability to identify low risk, underserved consumers. Algorithms powered by machine learning can identify non-linear patterns, otherwise invisible to decision makers, and enhance their ability to screen applications for creditworthiness. Banks could increase loan approvals easily by 15% to 40% without taking on more risk, enhancing lives and reinforcing their commitment towards the financial inclusion.
Financial Inclusion Scope and Regulation
Like the Community Reinvestment Act, acts of law encourage banks to “help meet the credit needs of the communities in which they operate, including low- and moderate-income (LMI) neighborhoods, consistent with safe and sound banking operations.” While legislations like the CRA provide adequate guidance and framework on providing access to credit to the underserved communities, there is still much to be covered in mandating practices around deposit products.
Banks themselves have a role to play in redefining and broadening the lens through which the customer relationship is viewed. A comprehensive approach to financial inclusion cannot rest alone on the credit or lending relationships. Banks must both assess the overall banking, checking and savings needs of the underbanked and unbanked and provide for simple products catering to those needs.
“Keep it simple” has generally been a mantra for success in promoting financial inclusion. A simple checking or savings account with effective check cashing facilities and a clear overdraft fee structure would attract “unbanked” who may have avoided formal banking systems due to their complexities and product configurations. Similarly, customized lending solutions with simplified term/loan requirements for customers promotes the formal credit environment.
Technology advancements in processing speed and availability of digital platforms have paved the way for banks to offer these products at a cost structure and speed that benefits everybody.
The benefits of offering more financially inclusive products cannot be overstated. Surveys indicate that consumers who have banking accounts are more likely to save money and are more financially disciplined.
From a bank’s perspective, a commitment to supporting financial inclusivity supports the entire banking ecosystem. It supports future growth through account acquisition — both from the addition of new customers into the banking system and also among millennial and Gen Z consumers with a demonstrated preference for providers that share their commitment to social responsibility initiatives.
When it comes to successfully executing financial inclusion outreach, community banks are ideally positioned to meet the need — much more so than their larger competitors. While large institutions may take a broader strategy to address financial inclusion, community banks can personalize their offerings to be more relevant to underserved consumers within their own local markets.
The concept of financial inclusion has evolved in recent years. With the technological advancements in the use of alternative data and machine learning algorithms, banks are now positioned to market to and acquire new customers in a way that supports long-term profitability without adding undue risk.
Banks below $50 billion in assets aren’t required to conduct an annual stress test, following regulatory relief passed by Congress in May 2018. But most banks still conduct one or more annual tests, according to Bank Director’s 2021 Risk Survey.
A stress test determines whether a bank would have adequate capital or liquidity to survive an adverse event, based on historical or hypothetical scenarios. Financial institutions found value in the practice through the Covid-19 pandemic and related economic events, which created significant uncertainty around credit — particularly around commercial real estate loans and loans made to the hospitality sector, which includes hotels and restaurants.
“It gives you a peace of mind that we are prepared for some pretty big disasters,” says Craig Dwight, chair and CEO at $5.9 billion Horizon Bancorp, based in Michigan City, Indiana. Horizon disclosed its stress test results in third quarter 2020 to reassure its investors, as well as regulators, customers and its communities, about the safety and soundness of the bank. “We were well-capitalized, even under two-times the worst-case scenario,” he says. “[T]hat was an important message to deliver.”
Horizon Bancorp has been stress testing for years now. The two-times worst case scenario he mentions refers to loss history data from the Office of the Comptroller of the Currency; the bank examines the worst losses in that data, and then doubles those losses in a separate analysis. Horizon also looks at its own loan loss history.
The bank includes other data sets, as well. Dwight’s a big fan of the national and Midwest leading indicators provided by the Federal Reserve Bank of Chicago; each of those include roughly 18 indicators. “It takes into consideration unemployment, bankruptcy trends, the money supply and the velocity of money,” he says.
It’s a credit to the widespread adoption of stress testing in the years following the financial crisis of 2008-09. “All the infrastructure’s in place, so [bank management teams] can turn on their thinking fairly quickly, and [they] aren’t disconnected [from] what’s happening in the world,” says Steve Turner, managing director at Empyrean Solutions, a technology provider focused on financial risk management.
However, Covid-19 revealed the deficiencies of an exercise that relies on historical data and economic models that didn’t have the unexpected — like a global pandemic — in mind. In response, 60% of survey respondents whose bank conducts an annual stress test say they’ve expanded the quantity and/or depth of economic scenarios examined in this analysis.
“We have tested pandemics, but we really haven’t tested a shutdown of the economy,” says Dwight. “This pandemic was unforeseen by us.”
Getting Granular The specific pain points felt by the pandemic — which injured some industries and left others thriving — had banks getting more granular about their loan portfolios. This should continue, says Craig Sanders, a partner at Moss Adams LLP. Moss Adams sponsored Bank Director’s 2021 Risk Survey.
Sanders and Turner offer several suggestions of how to strengthen stress testing in the wake of the pandemic. “[D]issect the portfolio … and understand where the risks are based on lending type or lending category,” says Sanders. “It’s going to require the banks to partner a little more closely with their clients and understand their business, and be an advisor to them and apply some data analytics to the client’s business model.” How will shifting behaviors affect the viability of the business? How does the business need to adjust in response?
He recommends an annual analysis of the entire portfolio, but then stratifying it based on the level of risk. High risk areas should be examined more frequently. “You’re focusing that time, energy and capital on the higher-risk areas of the bank,” says Sanders.
The survey finds two-thirds of respondents concerned about overconcentrations in their bank’s loan portfolio, and 43% of respondents worried specifically about commercial real estate loan concentrations. This represents a sharp — but expected — increase from the prior year, which found 78% expressing no concerns about portfolio concentrations.
We’re still not out of the woods yet. Many companies are now discussing what their workplace looks like in the new environment, which could have them reducing office spaces to accommodate remote workers. If a bank’s client has a loan on an office space, which they then rent to other businesses, will they be able to fill the building with new tenants?
If this leads to defaults in 2021-22, then banks need to understand the value of any loan collateral, says Sanders. “Is the collateral still worth what we think it was worth when we wrote the loan?”
It’s hard to predict the future, but Sanders says executives and boards need to evaluate and discuss other long-term effects of the pandemic on the loan portfolio. Today’s underlying issues may rise to the surface in the next couple of years.
Knowing What Will Break Your Bank Stress testing doesn’t tend to focus on low-probability events — like the pandemic, which (we hope) will prove to be a once-in-a-lifetime occurrence. Turners says bank leaders need to bring a broader, more strategic focus to events that could “break” their bank. That could have been the pandemic, without the passage of government support like the CARES Act.
It’s a practice called reverse stress testing.
“Reverse stress testing helps to explore so-called ‘break the bank’ situations, allowing a banking organization to set aside the issue of estimating the likelihood of severe events and to focus more on what kinds of events could threaten the viability of the banking organization,” according to guidance issued by the Federal Reserve, Federal Deposit Insurance Corp. and OCC in 2012. The practice “helps a banking organization evaluate the combined effect of several types of extreme events and circumstances that might threaten the survival of the banking organization, even if in isolation each of the effects might be manageable.”
Statistical models that rely on historical norms are less useful in an unforeseen event, says Turner. “[I]f someone told you in February of 2020 that you should be running a stress test where the entire economy shuts down, you’d say, ‘Nah!’” he says. “What are the events, what are the scenarios that could happen that will break me? And that way I don’t have to rely on my statistical models to explore that space.”
Testing for black swan events that are rare but can have devastating consequences adds another layer to a bank’s stress testing approach, says Turner. These discussions deal in hypotheticals, but they should be data driven. And they shouldn’t replace statistical modeling around the impact of more statistically normal events on the balance sheet. “It’s not, ‘what do we replace,’” says Turner, “but, ‘what do we add?’”
With stress testing, less isn’t more. “My advice is to run multiple scenarios, not just one stress test. For me, it’s gotta be the worst-case stress test,” says Dwight. And stress testing can’t simply check a box. “Can you sleep at night with that worst case scenario, or do you have a plan?”
Bank Director’s 2021 Risk Survey, sponsored by Moss Adams LLP, 188 independent directors, chief executive officers, chief risk officers and other senior executives of U.S. banks below $50 billion in assets. The survey was conducted in January 2021, and focuses on the key risks facing the industry today and how banks will emerge from the pandemic environment.
What a difference a year makes. Spring 2020 was like nothing we had ever seen: scheduled gatherings were cancelled and economic activity came to a screeching halt.
Yet today, after a year highlighted by social distancing, lockdowns and restrictions, there is a sense of anticipation that feels like a wave of pent-up demand ready to break-out, much like the buds on a flowering tree. Loans last year saw the prime rate plunge to 3.25% from its recent peak of 5%, as the Federal Reserve pushed its target back to zero to help keep the economy afloat. Banks and credit unions that built up significant portfolios of variable-rate loans experienced the pain of this unexpected rate shock in the form of margin compression.
But as flowers begin to bloom this spring, there is very little hope that short-term rates will follow suit. The Federal Open Market Committee signaled at its mid-March meeting that it expects to maintain a near-zero Fed Funds target all the way through 2023 with a goal of seeing inflation rise to more normal levels. For lenders holding floating-rate assets, waiting until the 2024 presidential primary season to experience any benefit from higher yields might seem unbearable. And with the sting of last year’s free fall still fresh, the prospect of slow and steady quarter-point bumps thereafter is not appealing.
Interestingly, there is a different story playing out when we examine the yields on longer-dated bonds. Because inflation erodes the future value of fixed-income coupon payments, bond market investors have grown nervous about the Fed’s increased desire and tolerance for rising prices. Consequently, while short-term rates have remained anchored, 10-year bond yields have surged by a full percentage point in less than six months, creating a sharply steeper yield curve. This is excellent news for asset-sensitive institutions that have interest rate hedging capabilities in their risk management toolkits. Rather than simply accepting their fate and holding onto low-yielding floating-rate assets in hopes the Fed will move earlier than expected, banks with access to swaps can execute a strategy that creates an immediate positive impact on net interest margin.
To illustrate, consider an asset-sensitive institution with a portfolio of prime-based loans. Using an interest rate swap, the lender can elect to pay away the prime-based interest payments currently at a 3.25% yield and receive back fixed interest payments based on the desired term of the swap. As of March 23, 2021, those fixed rates would be 3.90% for 5 years, 4.25% for 7 years, and 4.50% for 10 years. So, with no waiting and no “ramp,” the loans in question would instantly increase in yield by 0.65%, 1% or 1.25% for 5, 7 and 10 years, respectively, once the swap economics are considered.
The trade-off for receiving this immediate yield boost is that the earning rate remains locked for the term of the swap. In other words, when prime is below the swap rate (as it is on Day One) the lender accrues interest at the higher fixed rate; when prime exceeds the swap rate, the lender sacrifices what is then the higher floating-rate yield.
This strategy uses a straightforward “vanilla” interest rate swap, with a widely used hedge accounting designation. For banks that have avoided balance sheet hedging due to complexity concerns, an independent advisor can help with the set-up process that will open the door to access this simple but powerful tool.
In the days following March 2020 we often heard that “the only thing certain in uncertain times is uncertainty.” With swaps in the toolkit, financial institutions have the power to convert uncertain interest flows to certain, taking control of the margin and managing exposure to changing interest rates in a more nimble and thoughtful manner.
At some point, your bank will find an operation or process isn’t working or failing on intent. When that happens, don’t fall prey to the impulse to fix the wrong problem without looking below the surface for the root cause.
No matter the scenario, your best position is always to self-identify an issue and kick off remediation before a customer or regulator reports a problem. Once external forces step in, the stakes run even higher; you really can’t afford a misstep. Without question, the most common way that banks err is by starting on the wrong foot.
In my front-line experiences, I’ve seen financial institutions work ambitiously on remediating issues only to have regulators assign a failing grade. While no bank wants to be under a regulatory finding’s shadow, working smart and rejecting shortcuts is the only way to deliver the right solution and minimize future risk. With compliance costs expected to more than double and reach 10% of revenue spend by 2022, banks can’t afford to get it wrong.
Here are the steps for an effective remediation:
1.Take a breath — then dive into the deep end
Too often, companies fix what they think is the problem, only to learn that they’ve missed the mark and broken other things along the way. Not understanding the crux of the issue wastes a bank’s time, energy and resources.
If you’re dealing with a regulatory finding, be sure to engage your legal and compliance teams to ensure you understand the issue and solve for exactly what’s at risk, especially for issues with broader scope and breadth. Those leading your remediation plan should dig deeper into root problems by asking “why?” up to five times, peeling off another layer each time as you strive toward the core issue. Apply those questions to your business problem until you’ve identified the precise thing that needs to be fixed.
2. Know how to get from Point A to Point Z
Develop a roadmap to move effectively and efficiently from understanding the issue and identifying root causes to implementing solutions. From aligning on stakeholder engagement to technology resources, no solution happens overnight. Some regulatory remediation activities can take 12 to 18 months to resolve.
3. Make sure everyone’s on the same journey
Nothing derails remediation more than missed consensus on its direction and end goal. Remain focused on actions to fix your root issue, ease regulator or auditor concerns and reduce customer complaints. Engage the right people in the right roles. Involving too many people can water down intent, while involving too few means you might miss capturing relevant insights from key parts of your business.
4. Document your journey
A comprehensive action plan can take time to execute. During that time, people in key roles might leave and business processes, and objectives, technology or regulations could change. Thorough and complete documentation keeps a record of execution activities, action plan or intent changes, and provides evidence of key decisions.
5. You’re not finished until you get an official pat on the back
Did your action plan include time to validate your work? Whether you have a third-line audit, loan review finding or a regulatory ruling, the issuer will return to confirm you solved the right problem completely. Build in solid testing to validate your solution fulfills on its intent, with no side effects that disrupt other processes. Also, if possible, check in with third-line partners regularly or when hitting major milestones to prevent surprises.
Remediation success comes with both the assessor’s endorsement, as well as sustained results from your action plan as evidenced by reporting and monitoring put into place. More importantly, don’t overlook this moment to repurpose your team’s learnings and experiences as the foundation for a repeatable remediation framework. When the next issue arises — and it will — your bank will already have a strategy and blueprint for smart action with minimal risk.
The coronavirus pandemic has been a pivotal catalyst within the financial services industry, as banks of all sizes adopt and launch digital tools and services at an unprecedented pace. While not a new initiative, e-signatures suddenly became a top priority for banks, as customer sought ways to complete their financial transactions and certify documents remotely. According to BAI’s August Banking Outlook research on digital banking trends during Covid-19, half of consumers use digital products more since the pandemic, and 87% indicate they plan to continue after the pandemic. Banks now realize they must implement a digital transformation strategy in order to navigate these challenging times and new consumer expectations.
However, some financial institutions still view e-signatures as a luxury — a solution that holds benefit and value but is not at the top of their list of digital priorities. To defend their market share and ensure future success, banks must embrace digital transformation and provide customers with a more personalized, engaging experience. The crucial link is e-signatures.
The coronavirus means banking customers need to be able to conduct banking business, open new accounts, obtain new loans or modify or extend existing loans while avoiding traditional in-person contact and interaction with bank staff. It has never been more important to transmute traditional, paper-based processes to the digital realm. Declines in branch visits and ATM transactions, an increased focus on touchless interactions and payments and the rapid operational migration to remote operations moved e-signatures from a nice-to-have, convenient solution to a critical tool every bank must offer to empower their customers to process daily transactions.
Adoption rates for e-signatures were on the rise prior to the pandemic, but have now taken on an even larger and more significant role, enabling banks to move transactions forward in an era of social distancing. E-signatures allow the continuation of normal banking activities in a secure environment while protecting the safety of both the customer as well as the bank employee. It’s apparent that other unexpected conditions could arise in the future that would force the same technological need. They’ve moved from a convenience offering to a banking infrastructure necessity.
Basic banking services like opening an account, arranging a line of credit and applying for a mortgage all require an exchange of documents. In the age of Covid-19, the ability to do that electronically has become mandatory. The most frequent use for of e-signatures has been with new account opening and new loan origination and closing processes. The Small Business Administration’s Paycheck Protection Program also drove a dramatic rise in e-signature requirements. Banks are leveraging e-signatures to enable daily account service and maintenance transactions such as address changes, name changes, stop payment requests, wire transfer requests and credit card disputes. E-signatures provide service convenience to customers as they move through the stages of the lending process or digital account opening.
Financial institutions are experiencing a boom in digital-first relationships with new and existing customers. Customers are requesting new account openings and loan applications online, and perhaps modifying or extending existing loans. It all must be done electronically. Additionally, the day-to-day demand of account service and maintenance transactions have only increased, and require a new solution to those daily operational activities. E-signatures are one way to place electronically fillable forms on an bank’s website or online banking center so allow customers can complete and sign the appropriate documents and submit directly to the bank. Now more than ever, e-signatures and digital transaction management are critical technologies for financial institutions.
The nationwide pandemic and persistent economic uncertainty hasn’t slowed the growth of Idaho Central Credit Union.
The credit union is located in Chubbuck, Idaho, a town of 15,600 near the southeast corner, and is one of the fastest growing in the nation. It has nearly tripled in size over the last five years, mostly from organic growth, according to an analysis by CEO Advisory Group of the 50 fastest growing credit unions. It also has some of the highest earnings among credit unions — with a return on average assets of 1.6% last year — an enviable figure, even among banks.
“This is an example of a credit union that is large enough, [say] $6 billion in assets, that they can be dominant in their state and in a lot of small- and medium-sized markets,” says Glenn Christensen, president of CEO Advisory Group, which advises credit unions.
Unsurprisingly, growth and earnings often go hand in hand. Many of the nation’s fastest growing credit unions are also high earners. Size and strength matter in the world of credit unions, as larger credit unions are able to afford the technology that attract and keep members, just like banks need technology to keep customers. These institutions also are able to offer competitive rates and convenience over smaller or less-efficient institutions.
“Economies of scale are real in our industry, and required for credit unions to continue to compete,” says Christensen.
The largest credit unions, indeed, have been taking an ever-larger share of the industry. Deposits at the top 20 credit unions increased 9.5% over the last five years; institutions with below $1 billion in assets grew deposits at 2.4% on average,” says Peter Duffy, managing director at Piper Sandler & Co. who focuses on credit unions.
As of the end of 2019, only 6% of credit unions had more than $1 billion in assets, or 332 out of about 5,200. That 6% represented 70% of the industry’s total deposit shares, Duffy says. Members gravitate to these institutions because they offer what members want: digital banking, convenience and better rates on deposits and loans.
“The only ones that can consistently deliver the best rates, as well as the best technology suites, are the ones with scale,” Duffy says.
Duffy doesn’t think there’s a fixed optimal size for all credit unions. It depends on the market: A credit union in Los Angeles might need $5 billion in assets to compete effectively, while one in Nashville, Tennessee, might need $2 billion.
There are a lot of obstacles to building size and scale in the credit union industry, however. Large mergers in the space are relatively rare compared to banks — and they became even rarer during the coronavirus pandemic. Part of it is a lack of urgency around growth.
“For credit unions, since they don’t have shareholders, they aren’t looking to provide liquidity for shareholders or to get a good price,” says Christensen.
Prospective merger partners face a host of sensitive, difficult questions: Who will be in charge? Which board members will remain? What happens to the staff? What are the goals of the combined organization? What kind of change-in-control agreements are there for executives who lose their jobs?
These social issues can make deals fall apart. Perhaps the sheer difficulty of navigating credit union mergers is one contributor to the nascent trend of credit unions buying banks. A full $6.2 billion of the $27.7 billion in merged credit union assets in the last five years came from banks, Christensen says.
Institutions such as Lakeland, Florida-based MIDFLORIDA Credit Union are buying banks. In 2019, MIDFLORIDA purchased Ocala, Florida-based Community Bank & Trust of Florida, with $743 million in assets, and the Florida assets of $675 million First American Bank. The Fort Dodge, Iowa-based bank was later acquired by GreenState Credit Union in early 2020.
The $5 billion asset MIDFLORIDA was interested in an acquisition to gain more branches, as well as Community Bank & Trust’s treasury management department, which provides financial services to commercial customers.
MIDFLORIDA President Steve Moseley says it’s probably easier to buy a healthy bank than a healthy credit union. “The old saying is, ‘Everything is for sale [for the right price],’” he says. “Credit unions are not for sale.”
Still, despite the difficulties of completing mergers, the most-significant trend shaping the credit union landscape is that the nation’s numerous small institutions are going away. About 3% of credit unions disappear every year, mostly as a result of a merger, says Christensen. He projects that the current level of 5,271 credit unions with an average asset size of $335.6 million will drop to 3,903 credit unions by 2030 — with an average asset size of $1.1 billion.
CEO Advisory Credit Union Industry Consolidation Forecast
The pandemic’s economic uncertainty dropped deal-making activity down to 65 in the first half of 2020, compared to 72 during the same period in 2019 and 90 in the first half of 2018, according to S&P Global Market Intelligence. Still, Christensen and Duffy expect that figure to pick up as credit unions become more comfortable figuring out potential partners’ credit risks.
In the last five years, the fastest growing credit unions that have more than $500 million in assets have been acquirers. Based on deposits, Vibe Credit Union in Novi, Michigan, ranked the fastest growing acquirer above $500 million in assets between 2015 and 2020, according to the analysis by CEO Advisory Group. The $1 billion institution merged with Oakland County Credit Union in 2019.
Gurnee, Illinois-based Consumers Cooperative Credit Union ranked second. The $2.6 billion Consumers has done four mergers in that time, including the 2019 marriage to Andigo Credit Union in Schaumberg, Illinois. Still, much of its growth has been organic.
Canyon State Credit Union in Phoenix, which subsequently changed its name to Copper State Credit Union, and Community First Credit Union in Santa Rosa, California, were the third and fourth fastest growing acquirers in the last five years. Copper State, which has $520 million in assets, recorded a deposit growth rate of 225%. Community First , with $622 million in assets, notched 206%. The average deposit growth rate for all credit unions above $500 million in assets was 57.9%.
CEO Advisory Group Top 50 Fastest Growing Credit Unions
“A number of organizations look to build membership to build scale, so they can continue to invest,” says Rick Childs, a partner in the public accounting and consulting firm Crowe LLP.
Idaho Central is trying to do that mostly organically, becoming the sixth-fastest growing credit union above $500 million in assets. Instead of losing business during a pandemic, loans are growing — particularly mortgages and refinances — as well as auto loans.
“It’s almost counterintuitive,” says Mark Willden, the chief information officer. “Are we apprehensive? Of course we are.”
He points out that unemployment remained relatively low in Idaho, at 6.1% in September, compared to 7.9% nationally. The credit union also participated in the Small Business Administration’s Paycheck Protection Program, lending out about $200 million, which helped grow loans.
Idaho Central is also investing in technology to improve customer service. It launched a new digital account opening platform in January 2020, which allows for automated approvals and offers a way for new members to fund their accounts right away. The credit union also purchased the platform from Temenos and customized the software using an in-house team of developers, software architects and user experience designers. It purchased Salesforce.com customer relationship management software, which gives employees a full view of each member they are serving, reducing wait times and providing better service.
But like Idaho Central, many of the fastest growing institutions aren’t growing through mergers, but organically. And boy, are they growing.
Latino Community Credit Union in Durham, North Carolina, grew assets 178% over the last five years by catering to Spanish-language and immigrant communities. It funds much of that growth with grants and subordinated debt, says Christensen.
Currently, only designated low-income credit unions such as the $536.5 million asset Latino Community can raise secondary capital, such as subordinated debt. But the National Credit Union Administration finalized a rule that goes into effect January 1, 2022, permiting non-low income credit unions to issue subordinated debt to comply with another set of rules. NCUA’s impending risk-based capital requirement would require credit unions to hold total capital equal to 10% of their risk-weighted assets, according to Richard Garabedian, an attorney at Hunton Andrews Kurth. He expects that the proposed rule likely will go into effect in 2021.
Unlike banks, credit unions can’t issue stock to investors. Many institutions use earnings to fuel their growth, and the two measures are closely linked. Easing the restrictions will give them a way to raise secondary capital.
A separate analysis by Piper Sandler’s Duffy of the top 263 credit unions based on share growth, membership growth and return on average assets found that the average top performer grew members by 54% in the last six years, while all other credit unions had an average growth rate of less than 1%.
Many of the fastest growing credit unions also happen to be among the top 25 highest earners, according to a list compiled by Piper Sandler. Among them: Burton, Michigan-based ELGA Credit Union, MIDFLORIDA Credit Union, Vibe and Idaho Central. All of them had a return on average assets of more than 1.5%. That’s no accident.
Top 25 High Performing Credit Unions
Credit unions above $1 billion in assets have a median return on average assets of 0.94%, compared to 0.49% for those below $1 billion in assets. Of the top 25 credit unions with the highest return on average assets in 2019, only a handful were below $1 billion in assets, according to Duffy.
Duffy frequently talks about the divide between credit unions that have forward momentum on growth and earnings and those who do not. Those who do not are “not going to be able, and have not been able, to keep up.”
Winston Churchill is credited with having famously stated, “Never let a good crisis go to waste.” After a year of profound challenges on many fronts, there very much remains a crisis, causing especially deep financial turmoil for millions of unemployed Americans as a result Covid-19.
Many are undoubtedly feeling financial uncertainty, stress and fear. This crisis represents a singular opportunity for banks to earn and establish deep foundations of trust with customers navigating the murky waters of their financial stress. These efforts will garner a loyalty and connection that will bear incredible fruit in the future, as those customers come out of their own individual crises. Banks should earn this deep trust by making their customers’ financial strength an urgent, key focus in 2021.
Many financial institutions are tuned into this urgency, according to our ongoing original research into financial services. Our recent survey of 220 bankers at institutions spanning the financial industry showed that two of the most significant shifts in business objectives for 2021 are toward recognizing the urgency of digital experience and financial wellness tools.
These two initiatives go hand in hand, especially following a year of branch closures. People are increasingly looking for ways to get financial guidance directly on their phones. We’ve found that 84% of consumers use their mobile banking app at least weekly and 26% use it daily. By contrast, 83% of consumers say they go into a branch once a month or less — and a third say that they plan to visit bank branches less frequently than they did before the pandemic once it is over.
Put simply, your customers need and expect real-time financial guidance on their devices. Here are three ways to offer that:
1. Show People Where They Are Today
First, people need to know where they are currently — financially speaking. Offering a money experience that provides users with a 360-degree view of their accounts in one place is like seeing the words “You Are Here” on a map. That alone can provide tremendous relief, especially if an individual sees that they are not too far from help.
The same is true for finances. People need clarity about their broad financial picture. They need to be able to quickly see how they’ve been doing, with transactions that are cleansed, categorized, and augmented — and then visualized simply. The days of manually documenting every single check from a checkbook are long gone; very few people have the time or patience to do that kind of work. To be competitive, people need you to do the work for them. It’s not about money management. It’s about a money experience.
2. Help Them Look Ahead
Second, people need to know where to go next. This experience should be a GPS for finances, detailing what true financial strength looks like and laying out general principles to get to that destination. This means that people should be able to quickly see their savings goals, receive recommendations on what route to take and quickly choose or simply confirm automatic funneling of money toward those specific goals, without having to pause their busy life.
3. Get Personal
Third, the money experience should also guide and protect users by offering personalized advice and warnings moment to moment — leading user toward what they need to do. This requires a foundational corpus of clean, enriched data coupled with powerful algorithms behind the scenes to even have a shot at offering an elegant, personalized experience. It is exactly the kind of money experience that will establish trust and build loyalty, especially from customers in dire need of it. This will also become more and more critical as customers desire going into a branch less and less.
Creating a money experience that follows these principles will help create a world where individuals are empowered to be financially strong, where fewer and fewer face personal financial crises.
For me, this mission is personal. I’ve taken an entrepreneurial approach to my career, bounding between exhilarating highs and anxiety-inducing lows. I’ve experienced four separate times where my income dropped to zero, and felt the overwhelming weight of trying to navigate my finances as a young husband and father. I empathize with anyone who feels that stress. Similarly, I can also empathize with the deep trust and lifetime loyalty that can be established when someone helped navigate out of those tough situations. This understanding motivates me to help banks and fintech companies offer a money experience that empowers true financial strength in 2021.
With more businesses choosing fintechs and neo-banks to address their financial needs, banks must innovate quickly and stay up-to-date with the latest business banking trends to get ahead of the competition.
In fact, 62% of businesses say that their business banking accounts offer no more features or benefits than their personal accounts. Fintechs have seized on this opportunity. Banks are struggling to keep up with the more than 140 firms competing to help business customers like yours manage their finances.
Narmi interviewed businesses to identify what their current business banking experience is like, and what additional features they would like to have. To help banks better understand what makes a great business banking experience, we’ve put together Designing a Banking Experience that Empowers Businesses to Succeed, a free online resource free for bank executives.
A banking platform built with business owners in mind will help them focus on what matters most — running a successful company. In turn, banks will be able to grow accounts, drive business deposits and get ahead of fintech competitors encroaching on their market share.
Understanding How Businesses Bank No business is the same. Each has different financial needs and a way of operating. Narmi chose to talk with a range of business owners via video chat, including an early-stage startup, a dog-walking service, a bakery, a design agency and a CPA firm.
Each business used a variety of banks, including Wells Fargo & Co., JPMorgan Chase & Co., SVB Financial Group, Bank of America Corp. and more.
A few of the questions we asked:
How is your current business banking experience?
Which tools do you most frequently use to help your business run smoothly?
How often do you log in?
What are the permissions like on your business banking platform?
What features do you wish your business banking platform could provide?
We conducted more than 20 hour-long interviews with the goal of better understanding how business owners use their bank: what they liked and disliked about their banking experience, how they would want to assign access to other employees, and explore possible new features.
We learned that businesses tended to choose a financial institution on three factors: familiarity and ease, an understanding of what they do and competitive loan offers. Business owners shared with us how their experience with the Small Business Administration’s Paycheck Protection Program factored into their decision about where they currently bank.
They tended to log into their accounts between once a day and once a week and oscillated between their phone and computers; the more transactions they had, the more frequently they checked their accounts. They appreciated when their institution offered a clean and intuitive user experience.
We also uncovered:
How do businesses handle their payments.
What do businesses think of their current banking features.
How do business owners want to manage permissions.