The factors that help banks maximize value—including growth and profitability—are relatively timeless, though the importance of each value driver tend to change with the operating environment. But the way a bank pursues a sale impacts its valuation. In this video, Christopher Olsen of Olsen Palmer outlines the three ways a bank can pursue a sale. He also explains why discretion is key to preserving franchise value.
There are many alternatives to core deposits that banks can utilize to fund loans. Internet listing services, for example, have become popular. Unlike brokered deposits, there are no regulatory deterrents against their use. Still, internet listing-service deposits tend to be more expensive and more price sensitive—hence less stable—than traditional core deposits because they often come from out-of-market customers who chase rates rather than from local customers looking to establish a relationship.
Banks have another important, and arguably better, deposit-gathering tool at their disposal—reciprocal deposits. Thanks to the Economic Growth, Regulatory Relief and Consumer Protection Act, most reciprocal deposits now receive nonbrokered status.
What are reciprocal deposits? These are funds received by a bank through a deposit placement network in return for placing a matching amount of deposits at other network banks. Why would banks exchange equal amounts of money with each other? The mechanics of different reciprocal deposit services vary, but the gist is that a bank that participates in a reciprocal deposit network can offer access to FDIC insurance beyond $250,000 to attract safety-conscious customers who might otherwise consider various alternatives, including: Depositing large sums into a money-center bank, foregoing some access to FDIC insurance and perhaps relying on ratings agencies, like Standard & Poor’s or Fitch, to help assess bank stability Requiring that a bank collateralize or otherwise secure a large deposit with Treasuries or other ultra-safe, highly liquid government securities Manually splitting a large deposit among multiple banks, maintaining relationships with each and negotiating different interest rates, signing multiple agreements and receiving multiple statements
Banks that participate in a reciprocal deposit network like the ability to more effectively pursue these large-dollar deposits from local customers who were previously beyond their reach, or whose collateralization requirements raised tracking and opportunity costs and lowered margins. Banks like that they can take multi-million-dollar deposits and place them through a reciprocal deposit network into other banks participating in the same network in increments below $250,000. The spreading out of the funds into multiple banks makes the entire amount eligible for FDIC insurance. This process enables a customer to access FDIC protection from many banks while working directly with just one. And the originating bank maintains ownership of the customer relationship.
Banks that receive reciprocal deposits from another bank are willing to take those funds because they are doing the same thing with their customers’ money. All told, participating banks exchange funds on a dollar-for-dollar basis so each comes out whole—giving rise to the term reciprocal deposits.
“Reciprocal deposits are popular because they tend to be associated with multi-million-dollar depositors, enabling banks to attract deposits in large chunks with lower acquisition and maintenance costs as costs tend to be spread over much larger deposit amounts,” explains Mark Thompson, president of CenterState Bank in Davenport, Florida. “Moreover, they tend to come from local customers at rates that are more in line with local pricing norms. They also tend to come from customers who are more likely to be interested in a broader, more long-term relationship that may include mortgages, credit cards and other profit-generating services.”
“In stark contrast to listing-service deposits, reciprocal deposits help a bank build franchise value,” according to James Di Misa, executive vice president and chief operating officer of Community Bank of the Chesapeake in Waldorf, Maryland. “Quite simply, reciprocal deposits tend to be large, lower-cost, in-market deposits and, as such, offer greater potential for opportunity and efficiency. For this reason, many banks are replacing at least a portion of their listing-service deposits with reciprocal deposits.”
Banks that don’t want to trade out listing-service deposits entirely can still use reciprocal deposits to augment their usage of listing-service funding. For example, they can use a reciprocal deposit offering to lure more business from a safety-conscious listing-service customer who keeps funds protected at multiple FDIC-insured institutions and who might consolidate some, or all, of their deposits with a bank that can offer access to FDIC protection far beyond $250,000.
And of course, reciprocal deposits can be a good replacement for collateralized deposits and wholesale funding options.
As the competition for deposits heats up, now is a good time for every bank to consider making reciprocal deposits a larger part of its funding strategy.
For years, I’ve shared one of my favorite proverbs when talking about the value of high-performing teams: to go fast, go alone; to go far, go together. Now, as we prepare to welcome nearly 200 people to the Four Seasons Chicago for our annual Bank Board Training Forum, this mindset once again comes front and center.
In many ways, banks may appear to be on solid footing. Unfortunately, evolving cyber risks, the battle for deposits and pressures to effectively leverage technology make clear that banking leaders have challenges aplenty. Given the industry’s rapid pace of change, one would be forgiven to think the best course of action would be to go fast at certain challenges. However, at the board level, navigating an industry marked by both consolidation and emerging threats demands coordinated, strategic planning.
Our efforts in the days ahead aim to provide finely tailored insight to help a bank’s board go further, together.
This annual forum caters to an exclusive audience of bank CEOs, chairmen and members of the board. It is a delight to have Katherine Quinn, vice chairmanand chief administrative officer, from U.S. Bancorp, as our keynote speaker. U.S. Bancorp has the highest debt rating among all banks and consistently leads its peer group in terms of profitability, efficiency and innovation. Bank Director Executive Editor John Maxfield will have a one-on-one conversation with Quinn and cover everything from the qualities of good leadership to diversity to the Super Bowl.
Following her remarks, we explore strategic issues like building franchise value, creating a vibrant culture and preparing for the unexpected. Against the backdrop of this year’s agenda, there are five elements that characterize the boards at many high-performing banks today. Some are specific to the individual director; others, to the team as a whole.
#1: The Board Sees Tomorrow’s Challenges as Today’s Opportunities Despite offering similar products and services, a small number of banks consistently outperform others in the industry. One reason: their boards realize we’re in a period of significant change, where the basic premise of “what is a bank” is under considerable scrutiny. Rather than cower, they’ve set a clear vision for what they want to be and hold their team accountable to concepts such as efficiency, discipline and the smart allocation of capital.
#2: Each Board Member Embraces a Learner’s Mindset Great leaders aren’t afraid to get up from their desks and explore the unknown. Brian Moynihan, the chairman and CEO of Bank of America, recently told Maxfield that “reading is a bit of a shorthand for a broader type of curiosity. The reason I attend conferences is to listen to other people, to pick up what they’re talking and thinking about… it’s about being willing to listen to people, think about what they say. It’s about being curious and trying to learn… The minute you quit being educated formally your brain power starts to shrink unless you educate yourself informally.”
#3: The Board Prizes Efficiency In simplest terms, an efficiently run bank earns more money. This allows it to write better loans, to suffer less during downturns in a credit cycle, to position it to buy less-prudent peers at a discount all while gaining economies of scale.
#4: Each Board Member Stays Disciplined While discipline applies to many issues, those with a laser focus on building franchise value truly understand what their bank is worth now — and might be in the future. Each independent director prizes a culture of prudence, one that applies to everything from underwriting loans to third-party relationships.
#5: The Board Adheres to a People-Products-Performance Approach Smart boards don’t pay lip service to this mindset. Collectively, they understand their institution needs to (a) have the right people, (b) strategically set expectations around core concepts of how the bank makes money, approaches credit, structures loans, attracts deposits and prices its products in order to (c) perform on an appropriate and repeatable level.
Looking ahead, a sixth pillar could emerge for leading institutions; namely, diversity of talent. Now, I’m not talking diversity for the sake of diversity. I’m looking at getting the best people with different backgrounds, experiencesand talents into the bank’s leadership ranks. Unfortunately, while many talk the talk on diversity, far fewer walk the walk. For instance, a recent New York Times piece that revealed female executives generally still lack the same opportunities to move up the ranks and there are still simply fewer women in the upper management pipeline at most companies.
At Bank Director, we believe ambitious bank boards see the call for greater diversity as a true opportunity to create a competitive advantage. This aligns with Bank Director’s 2018 Compensation Survey, where 87 percent of bank CEOs, executives and directors surveyed believe a diverse board has a positive impact on the performance of the bank. Yet, just 5 percent of CEOs above $1 billion in assets are female, 77 percent don’t have a single diverse member on their board and only 20 percent have a woman on the board.
So as we prepare to explore the strong board, strong bank concept in Chicago, keep in mind one last adage from Henry Ford: if all you ever do is all you’ve ever done, then all you’ll ever get is all you’ve ever got.
Oh, what a difference a year can make. Or more to the point, what a difference just three months can make. At Bank Director’s Acquire or Be Acquired Conference last year, bank stocks were in the proverbial dumpster having been thoroughly trashed by declining oil prices, concerns about an economic slowdown in China and the slight chance that the slowly growing U.S. economy could be dragged into a recession in the second half of 2016.
Oil prices have since firmed up somewhat and the U.S. economy did not experience a downturn in the second half of the year, but all things considered, 2016 was a bumpy ride for bank stocks—until November 8, when Donald Trump’s surprise victory in the presidential election sent bank stock prices rocketing skyward. Valuations have been slowly recovering ever since the depths of the financial crisis in 2008, with some dips along the way. But since election day, stocks for banks above $250 million in assets have increased 21.2 percent to 24.8 percent, depending on their specific asset category, according to data provided by investment bank Keefe, Bruyette & Woods President and Chief Executive Officer Tom Michaud, who gave the lead presentation on the first day of the 2017 Acquire or Be Acquired Conference in Phoenix, Arizona.
What’s driving the surge in valuations is lots of promising talk about a possible cut in the corporate tax rate and various forms of deregulation, including the possible repeal of the Dodd-Frank Act and dismantling of the Consumer Financial Protection Bureau (CFPB). These tantalizing possibilities (at least from the perspective of many bankers), combined with the expectation that a series of interest rate increases by the Federal Reserve this year could ease the banking industry’s margin pressure and further boost profitability, has been like a liberal application of Miracle Grow to bank stock prices.
Michaud made the intriguing observation that investor optimism over what might happen in 2017 and 2018—but hasn’t happened yet—accounts for much of the jump in valuations since the election. “In my opinion, a lot of the good news is already in the stocks even though a lot of it hasn’t happened yet,” Michaud said. In fact, virtually none of it has happened yet. Investors have already priced in much of the increase in valuations resulting from a tax cut, higher interest rates and deregulation as if they have already occurred, which makes me wonder what will happen to valuations if any of these things don’t come through. I assume that valuations would then decline, although no one knows for sure, least of all me. But it should be acknowledged that the attainment of some of the already-priced-in-benefits of a Trump presidency, such as getting rid of Dodd-Frank and the CFPB, would have to overcome fierce opposition from Congressional Democrats while others, such as the combination of a corporate tax cut and a massive infrastructure spending program (which Trump has also talked about) would have to get past fiscally conservative Congressional Republicans. You’re probably familiar with the old saying that investors buy on the rumor and sell on the news. This could end up as an example of investors buying on the promise and selling on the disappointment.
Here’s the dilemma I think this sharp increase in valuations poses in terms of selling your bank or raising capital. If you’re an optimist, you probably will wait for another year or two in hopes of getting an even higher price for your franchise or stock. And if you’re a pessimist who worries about the sustainability of this industry-wide rise in valuations and the possibility that most of the upside from Trump’s election has already been priced into your stock, I think you’ll probably take the money and run.
The concept of building franchise value was core to our Bank Board Growth & Innovation Conference in April. In this session, Fred Cannon, director of research for Keefe, Bruyette & Woods, breaks down franchise value.
Banks with dedicated customer bases enjoy significant advantages over any potential competitors. So how should a bank’s CEO and board think about franchise value—both in current terms and with an eye to the future?
Fred Cannon—is director of research at Keefe, Bruyette & Woods, Inc. He joined KBW in 2003. In his dual role as director of research and chief equity strategist, Cannon guides the research efforts at KBW, which provides industry leading research on the financial sector and research coverage on more than 540 financial services firms.