Identify Your Customers Based On Need, Not Revenue


segmentation-3-28-16.pngFor banks that don’t specialize in a particular market, it can be difficult to truly know every customer’s changing wants and needs. And while there’s significant customer research available on retail consumers and large corporate clients, there’s less help available when it comes to understanding mid-market corporate customers.

Despite the lack of information readily available, mid-market companies are a fast-growing segment of customers that banks can’t afford to ignore. In fact, a recent Citizens Commercial Banking survey found that a quarter of mid-market companies, defined as having $500 million to $2 billion in annual revenues, are actively engaged in raising capital, while another 40 percent are looking for opportunities to do so. Additionally, more than half of the mid-market companies in the US alone indicated they are actively seeking M&A deals in 2016.

In an effort to capture and better understand commercial customers, banks have historically tried to segment companies based on the value of their annual sales or revenue range (e.g. less than $5 million, $5 million to $20 million, etc.). However, these revenue estimates are extremely unreliable, because typically, mid-market companies aren’t public companies. They have no obligation to report revenue and are not subject to strict audit guidelines. This means that the main metric banks are using to understand their mid-market customers is self-reported, without any independent validation.

But more important than yielding unreliable data, revenue segmentation really doesn’t give banks much insight into a customer’s needs, aside from their credit need or credit worthiness. This is a severely flawed approach to understanding customers because there are so many non-credit products that banks can profit from.

Take payments, for instance. With payments, the needs of a $5 million construction company have little in common with the needs of a $5 million healthcare services company. While technically in the same revenue segment, the two companies have vastly different payment transaction numbers, payment processes and workflow, payables vs. receivables, and enterprise resource planning and accounting systems.

Simply put, revenue is a misguided way for banks to segment their corporate customers, particularly when it comes to the mid-market. Except in rare cases when revenue estimates are actually reliable and indicative of customers’ needs, the knowledge gleaned from a single revenue figure is minimal, and it doesn’t help banks better understand and serve their customers.

The good news is, there are other ways for banks to effectively target customers and strengthen customer relationships. One approach is to use transactional data as a means to develop detailed portraits of customers and their needs. By identifying and segmenting customers by need (rather than revenue), banks can establish stronger relationships and drive new fee income by offering solutions to address those needs. For example, banks could learn a lot about a customer by looking at their outgoing payments. How many payments are they making each month? What methods are they using to make these payments—paper checks, ACH, credit cards, debit cards?

Understanding the volume and value of payments for specific businesses can be extremely valuable for determining how to market and sell existing products more effectively. It can also expose areas where a bank might be failing its customers and losing good grace with otherwise loyal organizations. For example, seeing that a large group of customers is making payments through third-party solutions is an obvious sign that it’s time for a bank to develop a new or better payments solution of its own.

Banks are sitting on literally millions of customer records that can offer invaluable insights into customers’ wants and needs, however this data is often unused or under-leveraged. It’s an unfortunate reality, but one that can be easily addressed.

In today’s golden age of big data and analytics, banks need to leverage far more than just revenue figures to better understand their customers. By failing to fully understand customers, banks won’t be able to serve customers well, and they’ll run the risk of losing customers to hungrier and more innovative competitors as a result. Luckily, the treasure trove of existing transactional data can provide banks with infinite ways to better segment customers, and the breadth of that data will allow them to serve their customers more precisely and comprehensively.

Identify Your Customers Based On Need, Not Revenue


segmentation-3-28-16.png

For banks that don’t specialize in a particular market, it can be difficult to truly know every customer’s changing wants and needs. And while there’s significant customer research available on retail consumers and large corporate clients, there’s less help available when it comes to understanding mid-market corporate customers.

Despite the lack of information readily available, mid-market companies are a fast-growing segment of customers that banks can’t afford to ignore. In fact, a recent Citizens Commercial Banking survey found that a quarter of mid-market companies, defined as having $500 million to $2 billion in annual revenues, are actively engaged in raising capital, while another 40 percent are looking for opportunities to do so. Additionally, more than half of the mid-market companies in the US alone indicated they are actively seeking M&A deals in 2016.

In an effort to capture and better understand commercial customers, banks have historically tried to segment companies based on the value of their annual sales or revenue range (e.g. less than $5 million, $5 million to $20 million, etc.). However, these revenue estimates are extremely unreliable, because typically, mid-market companies aren’t public companies. They have no obligation to report revenue and are not subject to strict audit guidelines. This means that the main metric banks are using to understand their mid-market customers is self-reported, without any independent validation.

But more important than yielding unreliable data, revenue segmentation really doesn’t give banks much insight into a customer’s needs, aside from their credit need or credit worthiness. This is a severely flawed approach to understanding customers because there are so many non-credit products that banks can profit from.

Take payments, for instance. With payments, the needs of a $5 million construction company have little in common with the needs of a $5 million healthcare services company. While technically in the same revenue segment, the two companies have vastly different payment transaction numbers, payment processes and workflow, payables vs. receivables, and enterprise resource planning and accounting systems.

Simply put, revenue is a misguided way for banks to segment their corporate customers, particularly when it comes to the mid-market. Except in rare cases when revenue estimates are actually reliable and indicative of customers’ needs, the knowledge gleaned from a single revenue figure is minimal, and it doesn’t help banks better understand and serve their customers.

The good news is, there are other ways for banks to effectively target customers and strengthen customer relationships. One approach is to use transactional data as a means to develop detailed portraits of customers and their needs. By identifying and segmenting customers by need (rather than revenue), banks can establish stronger relationships and drive new fee income by offering solutions to address those needs. For example, banks could learn a lot about a customer by looking at their outgoing payments. How many payments are they making each month? What methods are they using to make these payments—paper checks, ACH, credit cards, debit cards?

Understanding the volume and value of payments for specific businesses can be extremely valuable for determining how to market and sell existing products more effectively. It can also expose areas where a bank might be failing its customers and losing good grace with otherwise loyal organizations. For example, seeing that a large group of customers is making payments through third-party solutions is an obvious sign that it’s time for a bank to develop a new or better payments solution of its own.

Banks are sitting on literally millions of customer records that can offer invaluable insights into customers’ wants and needs, however this data is often unused or under-leveraged. It’s an unfortunate reality, but one that can be easily addressed.

In today’s golden age of big data and analytics, banks need to leverage far more than just revenue figures to better understand their customers. By failing to fully understand customers, banks won’t be able to serve customers well, and they’ll run the risk of losing customers to hungrier and more innovative competitors as a result. Luckily, the treasure trove of existing transactional data can provide banks with infinite ways to better segment customers, and the breadth of that data will allow them to serve their customers more precisely and comprehensively.

The Growing Imperative of Scale


bank-scale-2-1-16.pngWhy are there so many people attending Bank Director’s 2016 Acquire or Be Acquired Conference this year, which at over 900 people is the largest number of attendees in the 22 years that we have been holding this event? Clearly the participants are interested in learning about the mechanics of bank M&A and the trends that are driving the market. But something seems to be different. I sense that more boards and their management teams are seriously considering M&A as a growth plan than perhaps ever before.

The heightened level of interest could certainly be explained by the continued margin pressure that banks have been operating under for the last several years. The Federal Reserve increased interest rates in December by 25 basis points–the first rate hike since 2006. But Fed Chairman Janet Yellen has said that a tightening of monetary policy will occur gradually over a protracted period of time, so any significant rate relief for the industry will be a long time in coming.

Other factors that are frequently credited with driving M&A activity include the escalation in regulatory compliance costs – which have skyrocketed since the financial crisis – and management succession issues where older bank CEOs would like to retire but have no capable successor available. But these challenges have been present for years, and there’s no logical reason why they would be more pressing in 2016 than, say, 2013.

What I think is different is a growing consensus that size and scale are becoming material differentiators between those banks that can look forward to a profitable future as an independent entity and those that will struggle to survive in an industry that continues to consolidate at a very rapid rate.

In a presentation this morning, Tom Michaud, the president and CEO at Keefe, Bruyette & Woods, showed a table that neatly framed the challenge that small banks have today in terms of their financial performance. Michaud had broken the industry into seven asset categories from largest to smallest. Banks with $500 million in assets or less had the lowest ratio of pre-tax, pre-provision revenue as a percentage of risk weighted assets – at 1.41 percent – of any category. Not only that, but the profitability of the next four asset classes grew increasingly larger, culminating in banks $5 billion to $10 billion in size, which had a ratio of 2.27 percent. Profitably then declined for banks in the $10 billion to $50 billion and $50 billion plus categories. Banks in the $5 billion to $10 billion are often described as occupying a sweet spot where they are large enough to enjoy economies of scale but still small enough that they are not regulated directly by the Consumer Financial Protection Bureau or are subject to restrictions on their card interchange fees under the Durbin Amendment.

Size allows you to spread technology and compliance costs over a wider base, which can yield valuable efficiency gains. It makes it easier for banks to raise capital, which can be used to exploit growth opportunities in existing businesses or to invest in new business lines. And larger banks also have an easier time attracting talent, which is the raw material of any successful company.

There will always be exceptions to the rule, and some smaller banks will be able to outperform their peers thanks to the blessings of a strong market and highly capable management. But I believe that many banks under $1 billion is assets are beginning to see that only by growing larger will they be able to survive in an industry becoming increasingly more concentrated every year. And for banks in slow growth markets, that will require an acquisition.

A Look Ahead to 2020: How Bank Directors Can Guard Against Risk


risk-12-11-15.pngAs banks look to the year 2020, we’ve identified five key risks that need to be actively assessed and monitored as the industry changes and adapts to consumer demands and competition. When it comes to data security and technology, regulatory risk, finding qualified personnel, profitability, and bank survival, bank directors need to ask:

  • How do we as an organization identify these risks on an ongoing basis?
  • How do they affect our organization?
  • How can we work with management to manage future risks?

Here’s a snapshot of the risk areas, what’s anticipated as we look to the future, and steps you can take to stay competitive and mitigate risk.

Data Security & Technology
It’s important to keep up with your peers and provide services as your clients demand them. More sophisticated payment platforms that make it easier to access and transfer funds will continue to gain popularity, particularly mobile platforms.

Being competitive requires innovation, which means software, bank integration, and sophisticated marketing and delivery. Third-party service providers may be the answer to help cut expenses and improve competition, but they also present their own unique risks.

With innovation comes opportunity: attacks on data security will increase, making the safeguarding of data a high priority for banks. While technology is an important element to this issue, the primary cause of breaches is human error. To this end, it’s essential for management to set the example from the top while promoting security awareness and training.

Regulatory Risk
Expectations from the Consumer Financial Protection Bureau regarding consumer protection will intensify. Anticipate some added expenditure to hire and retain technical experts to manage these expectations. Regulations are on the way for small business and minority lending reporting, as well as the structure of overdraft protection and deposit product add-ons, among others. Directors and management need to evaluate:

  • Compliance management infrastructure
  • Staffing needs and costs
  • Impact of proposed regulatory change to the bottom line

Qualified Personnel
For instance, baby boomers are retiring at a rate faster than Generation X can replenish, making it more difficult and costly to attract and retain skilled people. Meanwhile, the shrinking availability of skilled labor in this country is costing organizations throughout the United States billions of dollars a year in lost productivity, increased training and longer integration times.

A bank’s succession plan for its people should:

  • Identify key roles and technical abilities in your organization
  • Assess projected employee tenure
  • Develop a comprehensive employee replacement strategy
  • Prioritize training and apprentice programs

Profitability
The bottom line at traditional banks will continue to be stressed as momentum builds for institutions to reduce product and service-related fees. Overhead expenses also will continue to increase as banks boost spending for IT infrastructure to support demands by customers for mobile technology and technical innovation and finding and retaining qualified personnel to manage complex regulatory requirements. Responses to these trends are already underway. Some institutions are:

  • Divesting of consumer-related products laden with heavy regulatory requirements
  • Sharpening strategic focus on holistic customer relationships with professional and small business customers to increase relationship-driven revenue
  • Exploring new or more complex commercial lending products and partnerships designed to increase interest income to attract customers in new markets

Banks will need to closely monitor the impact of regulatory initiatives on future earnings from fees and alternative revenue sources.

Bank Survival
Here are some proactive steps to consider as your bank prepares for 2020:

  • Develop an ongoing strategy for mergers and acquisitions to expand capital
  • Consider charter conversions to lend flexibility in expanded product and service offerings or a change in regulatory expectations or intensity
  • Evaluate the impact of higher regulatory expectations

To help identify and manage risk, management should plan regular discussions in the form of annual strategic planning meetings, regular board meeting agendas, and targeted meetings for specific events. The focus should extend beyond known institutional risks, such as credit, interest rate and operational, but should also look at key strategic risks.

If your institution can innovate with the times to stay ahead of risk and competition with a systematic approach, then the path to 2020 will be less fraught with difficulties.

Buyer Beware: How Banks Can Avoid a Transaction Disaster


acquisition-10-26-15.pngMergers and acquisitions are exciting: they make the news, they show a position of strength to competitors, and most deals promise benefits for customers, employees and shareholders. Transactions have the same kind of excitement one might experience when buying a car. And like buying the car, that new car smell, or in this case, the allure of growth and synergies, can wear off quickly once you realize all of the work required to successfully integrate two institutions. Worse still is the feeling you have bought a lemon. There are, however, strategies that banks can employ before an integration to make sure they are getting a good deal.

Ensure You Have the Right, Experienced Resources
There is a reason that most professional services firms have an M&A practice: mergers and acquisitions are hard. In the middle market, it is even more important to look at current staff or partners that can support integration and bring the much needed experience to the table. No other industry is as complex as banking in terms of converting systems and processes. Banks require a unique set of skills to navigate the complexities of core systems, online banking, debit/credit cards, treasury management and lending.

Conduct an Operational and Technical Assessment of Your Target
Looking at the operational and technical complexities before a deal is made will improve the chances of a successful integration. Assess the scalability and interoperability of your technology and process landscape (as well as the target’s landscape) so that you can identify risks to the integration early and put together a mitigation plan quickly. All too often, middle market transactions focus only on diligence conducted by bankers, lawyers and accountants. Operational and technology diligence are de-prioritized.

Knowing how much car you can afford before even thinking about a deal puts you ahead of other bidders in terms of understanding how a target will fit into your garage. An operational and technical assessment provides the opportunity to understand and potentially implement systems, processes and products that will create a scalable and flexible operating model.

Evaluate Third Party Relationships
Understanding how your service providers can flex (or not) is critical to understanding the level of effort and cost of integration, along with the risks that need to be mitigated. Do your vendors have dedicated conversion teams? Are you the largest client of your core provider? Is there information available from your peers on the pros and cons of particular solutions in terms of integration? What are the service areas that could be improved through an acquisition?

Know Your Customer
Don’t forget the customer. Most transactions are driven by the desire to grow an institution’s customer base. But, in the frenzy of bringing two institutions together, customers often take a backseat to other integration priorities. Reacting to problems once customers start to leave is too late—the damage is already done. You will continue to hemorrhage customers while you course correct. Consider how well you know your customers before a deal is on the table. Do you have a way to make sure the customer’s voice is heard? Mapping the customer impact during diligence will prepare you to monitor (and hopefully improve) customer experience through the integration.

During integration, avoid focusing solely on cost synergies at the expense of customer experiences that could undermine revenue objectives. Whatever the changes, make sure communications to customers are clear, regular and transparent. You can never over communicate change to customers. Lastly, don’t assume that postponing changes is always best for customers. In many cases, making changes early and communicating them effectively will offer the most seamless customer experience across all channels (branches, digital, etc.).

Never Underestimate the Importance of Culture
It’s easy to sweep culture under the rug and consider it too soft and fuzzy for due diligence and integration. Many find it hard to put concrete metrics and plans around culture. Generational changes continue to change the way companies recruit, retain and operate—and that’s forcing companies to rethink their priorities in order to avoid costly turnover.

Having tools in place to implement change management is a best practice. This starts with knowing what your own cultural identity and management style is and what that means in terms of potential deals. If you’re into sports cars, don’t look at SUVs. By having your own cultural assessment up front, you can start analyzing cultural differences earlier in the process.

Assess Your M&A Readiness Before You Buy
If you want to successfully retain customers and key employees while achieving financial synergies, take the time to kick your own tires before looking at a new deal. An internal M&A readiness assessment is not only valuable if you are a buyer, but as a potential seller as well. An assessment will identify both deficiencies and differentiators in your operating model that a potential buyer will notice during due diligence. This knowledge gives you better negotiating power and can put you in the driver’s seat.

How CRE Lending Has Evolved


growth-strategies-9-17-15.pngFor most banks, organic growth comes from loans. Commercial real estate (CRE) lending is the top source for loan growth, according to the executives and board members responding to Bank Director’s 2015 Growth Strategy Survey. With financial institutions continuously looking for organic growth opportunities, Bank Director asked our program members: “How has your bank’s commercial real estate lending strategy changed or evolved for your institution in recent years?” 

Here is a selection of their responses.

“Our CRE strategy remains in place in that we seek opportunities that fit within our risk appetite. We have evolved in that we are adding talent to the organization for commercial & industrial (C&I) banking as well as specialty finance. This broadens our profile and puts less dependency on CRE as the only source of commercial revenue.”

“We are going longer for term loans, focusing more on owner-occupied real estate, and doing employee lift-outs to take advantage of loan officers’ contacts.”

“Our strategies related to commercial real estate lending have evolved over the last five years. We are much more focused today on maintaining more diversity in the portfolio, and paying close attention to concentration levels in the portfolio relating to geography and purpose. We have lowered our ‘hold’ levels significantly, and tend to participate out larger levels of credit exposure to partner banks. We underwrite to stricter standards, including debt service coverage, and very rarely, if ever, approve any policy exceptions.”

“We have not really changed any of our philosophies regarding commercial real estate over the last several years. We do insist on seeing leases for new construction of strip centers that will show a minimum of 75 percent occupancy to start. Owner-occupied [real estate] requires a lower loan-to-value [ratio].”

“One thing we have not done in order to grow our CRE portfolio is compromise our underwriting standards. Two strategic things we changed is [to] raise our self-imposed lending limit, and how we aggregate relationships with similar ownership. Both of these changes provide us with a greater ability to meet the borrowing needs of commercial customers, reduce our outbound participation activity and provide growth in the portfolio.”

“The bank whose board I sit on hasn’t changed much, other than adding a new business line, quick-service franchise restaurant financing. Our focus is still on relationships, which generate core deposits.”

We hope this spirit of sharing provides insight and value to your bank’s board. If you have a question you need answered, please send your inquiries to mking@bankdirector.com. We also encourage you to comment below if you would like to share how your bank’s CRE lending strategy has evolved.

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.

Saving Money as Part of Due Diligence


due-diligence-8-18-15.pngAs acquisitions continue to play a major role in financial institutions’ strategic growth plans, management teams and boards are under increasing pressure to deliver results—with minimal surprises. Though due diligence often is seen as a necessary evil to completing a transaction, it can help identify opportunities to drive profitability and assess integration hurdles so an acquirer effectively can plan for and mitigate the risk of an unsuccessful integration.

Cost savings often are touted as a primary driver of acquisitions in banking. Many public filings show that estimated cost savings of a target’s expense structure run north of 25 percent. Preliminary cost estimates that are provided by management or investment advisers often are based on high level analysis prior to a letter of intent (LOI) being signed. Once an LOI is signed, due diligence should be performed to verify the extent, timing, and operational effects of the proposed cost savings as these are critical to recognizing the value in many acquisitions. Cost saving estimates should be continually adjusted throughout the due diligence process as new facts come to light.

Following are three areas of significant cost saving estimates and examples of how thinking through integration objectives throughout the due diligence process will help eliminate surprises.

  1. Back Office Consolidation
    Significant cost savings can be realized through back office consolidation. Consolidating back office operations can get delayed, however, due to vendor backlogs for conversion or de-conversion of data. Product mapping issues also might delay moving from one core processor to another. Such delays can have significant impact on the returns analysis as the savings are delayed and two operating structures remain for extended periods of time. While it might not be possible to fully address all factors that can potentially affect the integration, reviewing product mapping and starting the system conversion timeline discussions during due diligence will provide insights into timing and possible roadblocks.
  2. Branch Rationalization
    Eliminating branch overlap or consolidating unprofitable locations can be a source of cost savings. A branch profitability analysis can identify the product usage, transaction activity, and relationship value and should be performed during due diligence. However, the costs associated with exiting facilities as well as operational drag must be considered. Acquisition accounting requires recognizing the assets and liabilities at fair value upon the change in control, and operational costs to exit or restructure a bank generally are represented through the acquirer’s income statement post-combination.
  3. Vendor Management
    While combining core processing systems are a given for cost savings, comprehensive vendor management cost savings often are overlooked in the initial transaction value proposition. Again, considering integration while performing due diligence can help executive teams concentrate vendors across the combined organization. Thinking in terms of pricing power, service level expectations, integration support, and breadth of service, acquisitions often set the stage for new conversations with vendors. Taking the time during due diligence to analyze the future stable of vendors to eliminate overlap or consolidate platforms can be a significant value driver. Analyzing vendors early on allows acquirers to execute formal vendor selection processes shortly after the transaction announcement and realize cost savings soon after legal closing.

Best Practices to Follow
Here are best practice recommendations for achieving targeted cost savings:

  • Each cost savings assumption should be championed or assigned to a cost savings owner.
  • The cost savings owner should help establish the initial savings estimate and timeline to recognize cost savings during due diligence.
  • The cost savings owner should be able to affect the integration plan to achieve the cost savings objective.
  • The integration vision should be defined during due diligence to accomplish the cost savings.
  • Cost savings estimates should be revisited throughout the due diligence process to adjust for one time costs identified and for revisions to the plan.

This article originally appeared in Bank Director digital magazine’s Growth issue. Download the digital magazine app here.

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.