Will deal volume pick up pace in 2021? Despite credit concerns and negotiation hurdles, Stinson LLP Partner Adam Maier predicts a stronger appetite for deals — but adds that potential acquirers will have to be aggressive in pursuing targets that align with their strategic goals.
nCino, a cloud-based technology and lending platform for banks, navigated the challenges of going public while working remotely. The firm’s success story speaks to the critical importance of digital transformations to the survival of any company, especially as the pandemic has changed consumer mindsets about delivery and the way banks approach their business.
nCino CEO Pierre Naudé virtually sat down with Bank Director CEO Al Dominick to share the lessons he took from the IPO experience and maintains the company culture now that it’s public. Banks can also hear about how nCino strengthened its board, and managed communications in the remote environment.
Community banks should measure their goals and objectives against four tests in order to craft sustainable approaches and outcomes.
Community banks set goals: growth targets for loans or deposits, an earnings target for the security portfolio, an return on equity target for the year. But aggressive loan growth may not be a prudent idea if loan-to-asset levels are already high entering a credit downturn. Earnings targets can be dangerous if they are pursued at any cost, regardless of risk. However, in the right context, each of these can lead to good outcomes.
The first test of any useful goal is answering whether it’s a good idea.
One personal example is that about a year ago I set a new goal to lose 100 pounds. I consulted with my doctor and we agreed that it was a good idea. So then we moved to the second test of a useful goal: Is it sustainable?
As “Atomic Habits: An Easy & Proven Way to Build Good Habits & Break Bad Ones” author James Clear puts it: “You do not rise to the level of your goals, you fall to the level of your process and systems.”
What good would my weight loss goal be if it wasn’t sustainable? If the approach I took did not change my habits and instead put me through a shock program, there would be little reason to doubt that the approaches and habits that led me to create this goal would bring me back there again. The only way to pursue my goal in a sustainable fashion would changing my habits — my personal processes and systems.
Banks often pursue goals in unstainable ways as well.
Consider a bank that set a goal in June 2018 of earning $3 million annually from its $100 million securities portfolio with no more than 5 years’ duration (sometimes called a “yield bogey”). Given a choice between a 5-year bullet agency at 2.86% and a 5-year, non-call 2-year agency at 3.10%, only the latter meets or beats the goal. A 3.10% yield earns $310,000 for this portfolio.
In June 2020, the callable bond got called and was replaced by a similar length bond yielding only 40 basis points, or $40,000, for the remaining three years. The sustainable plan would have earned us $286,000 for the past two years — but also $286,000 for the next three. To make earnings sustainable, banks always need to consider multiple scenarios, a longer timeframe and potentially relaxing their rigid “bogey” that may cost them future performance.
The third test of a useful goal is specifying action.
The late New York Governor Mario Cuomo once said, “There are only two rules for being successful: One, figure out what exactly you want to do, and two, do it.”
In my case, I didn’t do anything unsustainable. In fact, I did not do anything at all to work toward my long-term goal. When I checked my weight six months later, it should not have surprised me to see I had lost zero pounds. A goal that you do not change your habits for is not an authentic goal; it is at best a wish.
My wish had gotten exactly what you would expect: nothing. Upon realizing this, I took two material steps. It was not a matter of degree, but of specific, detailed plans. I changed my diet, joined a gym and spent $100 to fix my bicycle.
The fourth test of a useful goal is if it is based on positive changes to habits.
Banks must often do something similar to transform their objectives from wishes to authentic goals. Habits — or as we call them organizationally, processes and systems — must be elevated. A process of setting an earnings or yield bogey for the bond portfolio relied on the hope that other considerations, such as call protection and rate changes, wouldn’t come into play.
An elevated process would plan for earnings needs in multiple scenarios over a reasonable time period. Like repairing my bike, it may have required “spending” a little bit in current yield to actually reach a worthy outcome, no matter which scenario actually played out.
If your management team does not intentionally pursue positive changes to processes and systems (habits), its goals may plod along as mere wishes. As for me, six months after making changes to my habits, I have lost 50 pounds with 50 more to go. Everything changed the day I finally took the action to turn a wish into a useful goal.
If you want to understand innovation and success, a good person to ask is Jeff Bezos, the chairman and CEO of Amazon.com.
“I very frequently get the question: ‘What’s going to change in the next 10 years?’ And that is a very interesting question,” Bezos said in 2012. “I almost never get the question: ‘What’s not going to change in the next 10 years?’ And I submit to you that that second question is actually the more important of the two, because you can build a business strategy around the things that are stable in time.”
In few industries is this truer than banking.
Much of the conversation in banking in recent years has focused on the ever-evolving technological, regulatory and operational landscapes. The vast majority of deposit transactions at large banks nowadays are made over digital channels, we’re told, as are a growing share of loan originations. As a result, banks that don’t change could soon go the way of the dinosaurs.
This argument has merit. But it also needs to be kept in perspective. Technology is not an end in itself for banks, it’s a means to an end — the end being to help people better manage their financial lives. Doing this in a sustainable way calls for a marriage of technology with the timeless tenets of banking.
The report is based on interviews of more than a dozen CEOs from top-performing financial institutions, including Brian Moynihan at Bank of America Corp., Rene Jones at M&T Bank Corp. and Greg Carmichael at Fifth Third Bancorp. It offers unique and invaluable insights on leadership, growth, risk management, culture, stakeholder prioritization and capital allocation.
The future of banking is hard to predict. There is no roadmap to reveal the way. But a mastery of these tenets will help banks charge ahead with confidence and, in Bezos’ words, build business strategies around things that are stable in time.
The Six Tenets of Extraordinary Banks
Jonathan Rowe of nCino describes the traits that set exceptional banks — and their leaders — apart from the industry.
If you talk to enough executives at top-performing banks, one thing you may notice is that not all of them see themselves as bankers. Many of them identify instead as investors who run banks.
It’s a subtle nuance. But it’s an important one that may help explain the extraordinary success of their institutions.
This came up in a conversation I had last week with the president and chief operating officer of a $2.6 billion asset bank based in New England. (I’d share the bank’s name, but they prefer to keep a low profile.)
His bank is among the most profitable in the country and is a regular fixture atop industry rankings, including our latest Bank Performance Scorecard.
Its profitability and earnings growth are consistently at the top of its peer group each year. More importantly, its total shareholder return (dividends plus share price appreciation) ranks in the top 3% of all publicly traded banks since the current leadership team gained control in 1993.
The distinction between investors and bankers seems to lay in how they prioritize operations and capital allocation.
For many bankers, capital allocation plays a supporting role to operations. It’s a pressure release valve that purges a bank’s balance sheet of the excess capital generated by operations. As capital builds up on the balance sheet, it impairs return on equity, which can foster the illusion that a bank isn’t earning its cost of capital.
To investors, the relationship between operating a bank and allocating its capital is inverted: The operations are the source of capital, while the efficient allocation of that capital is the ultimate objective.
Bankers who identify as investors also tend to be agnostic about banking. If a different industry offered better returns on their capital, they’d go elsewhere. They’ve gravitated to banking only because it’s a peculiarly profitable endeavor. In no other industry are businesses leveraged by a factor of 10 to 1 and financed with government-insured funds.
There are plenty of other bankers that fall into this categorization. The recently retired chairman of Citigroup, Michael O’Neill, is one of them. He said this when I interviewed him recently for a profile to be published in the upcoming issue of Bank Director magazine.
O’Neill’s time as chairman and CEO of Bank of Hawaii bears this out. A major objective of his, after refocusing its geographic footprint, was reducing the bank’s outstanding share count.
Bank of Hawaii had 80 million shares outstanding when O’Neill became CEO in 2000. When he left 4 years later, that had declined by 38% to only 55 million outstanding shares. This helped the bank’s stock price more than triple over the same stretch.
Another example is the Turner family, which has run Great Southern Bancorp for almost half a century. Since going public in 1991, Great Southern has repurchased nearly 40% of its original outstanding share count. A $2 million investment during the initial public offering would have been worth $140 million last year.
The Turners never said this when I talked with them last year, but it seems safe to infer that they view banking in a similar way. They’re not trying to build a banking empire for the sake of running a big bank. Instead, they’re focused on creating superior long-term value.
This philosophical approach coupled with meaningful skin in the game insulates a bank’s executives from external pressures to chase short-term growth and profitability at the expense of long-term solvency and performance.
“Having a big investment in the company … gives you credibility with institutional investors,” Great Southern CEO Joe Turner told me last year. “When we tell them we’re thinking long term, they believe us. We never meet with an investor that our family doesn’t own at least twice as much stock in the bank as they do.”
M&T Bank Corp. offers yet another textbook example of this. Of the largest 100 banks operating in 1983, when its current leadership team took over, only 23 remain today. Among those, M&T ranks first when it comes to stock price growth
I once asked its chairman and CEO René Jones what has enabled the bank to create so much value. One of the main reasons, he told me, was that they could gather 60% of the voting interests in the bank around the coffee table in his predecessor’s office.
And the bank in New England that I mentioned at the top of this article is the same way. The family that runs it, along with its directors, collectively hold 40% of the bank’s stock.
The moral of the story is that it’s tempting to think that capital allocation should play second fiddle to a bank’s operations. But many of the country’s best bankers see things the other way around.
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.
There are five services via the smartphone that the top five banks in the country all offer: mobile banking, mobile bill pay, mobile check deposit, person-to-person payments, and ATM/branch locator. Does your bank have all five?
The question was posed at Bank Director’s Bank Board Growth and Innovation Conference in New Orleans on Wednesday. With more than 150 bank directors and officers in the room, only a handful raised their hands.
The speaker, Dave DeFazio, a partner at StrategyCorps, which provides deposit account and mobile phone products to banks, said all of these services are necessary. The nation’s population is increasingly in love with smartphones. If people lose their phone, they feel out of sorts, disconnected. It’s the first thing many people touch in the morning when they wake up. They use their smartphones when they’re driving (not a good idea). They check Facebook at work.
The end result is that banks that don’t provide easy-to-use, indispensable mobile apps will increasingly find themselves losing the battle for market share in the years ahead, DeFazio said.
Mobile service vendors are not the only ones who think mobile matters. There are now more mobile phones than landline phones in the United States. Sixty percent of smartphone or tablet owners who switched financial institutions said mobile played an important or very important role in their decision to switch, according to a survey by the consulting firm AlixPartners.
It’s important not to confuse mobile services with online services for a laptop or desktop. Young people use their phones, and less frequently, their laptops. Your customers shouldn’t have to sign up for mobile banking services using an online portal for a laptop or desktop, he said.
“I have young people in my house who barely touch their laptops anymore,’’ DeFazio said. “Make it your mission to have an app people can’t live without.”
Millennials, the generation that tends to be in their late teens through early 30s, are distrustful of the biggest banks, but a greater percentage of them switch to big banks than older generations, according to the survey by AlixPartners. The reason? Millennials want digital services that are convenient and easy-to-use, and small banks don’t provide the same level of mobile services that big banks do, in general. Millennials aren’t as interested in going into a branch and speaking to a banker face to face as older generations are.
Not everyone in the crowd at the Bank Board Growth and Innovation Conference was impressed. One attendee questioned whether his bank should want to attract millennials. He pointed out that most of the more successful banks profiled at the conference focus on commercial customers. DeFazio answered that whatever its audience, a bank should pay attention to its mobile offerings.
“There are as many digital baby boomers as digital millennials,’’ he said. There are other reasons as well. Those most interested in using mobile services from their banks are the young and those with higher incomes. People who use mobile banking services tend to get a higher number of banking products from their bank than the average customer, according to AlixPartners.
Smaller banks may not have as many offerings as large banks, but some of them have leaders who don’t want their banks to fall behind. Brian Unruh, president and CEO of $600 million asset National Bank of Kansas City, in Overland Park, Kansas, says it’s almost overwhelming how many different technology companies are out there offering services to banks. But his bank is committed to offering mobile banking services. It recently switched Internet banking providers, and went with Austin, Texas-based Q2 Software, a smaller and more nimble company, he said. His bank recently hired a software developer and may hire a second, to develop mobile apps in-house.
Mobile services are definitely necessary, he said. “You have to get it to attract new customers,’’ he said.
Finding themselves stymied by low interest rates and a hyper-competitive business loan market, growth has become the Holy Grail for a great many banks today. There are essentially two strategies that banks can employ to grow their top lines. One is the tried-and-true acquisition method, where banks essentially buy their growth. Over the past several decades vast banking empires in the United States have been built this way, including, but by no means limited to, the country’s two largest banks—JPMorgan Chase & Co. and Bank of America Corp. But acquisitions are not without their risk. A poorly conceived, over-priced and badly executed acquisition can so thoroughly damage a bank’s stock price (not to mention its reputation) that it can take years for it to recover and for the bank to rebuild its credibility with the investor community.
Organic growth is the second growth strategy, and while it is not without its risk—growing too fast in a volatile asset class can lead to significant concentration problems later on—many analysts and investors seem to appreciate a good organic growth story. Three very different growth stories were presented at Bank Director’s 2015 Bank Board Growth & Innovation Conference Tuesday by Bryce Rowe, a senior research analyst at Robert W. Baird & Co.
The first bank that Rowe profiled was $6 billion asset Pinnacle Financial Partners in Nashville, which was founded in 2000. Pinnacle has benefited from two trends over the last two and a half decades, beginning with the impressive growth of the Nashville metro area. Nashville’s economy has grown impressively over this period of time and Pinnacle, which focuses on businesses and their owners and employees, as well as affluent consumers, has benefited handsomely from that growth. The 1990s and early 2000s were also a time of considerable consolidation in many U.S. banking markets, including Nashville, and Pinnacle also benefitted from the service disruptions that many of the market’s big mergers created. By emphasizing service, Pinnacle has been able to beat many larger banks at their own game. Since its inception, Pinnacle has grown its loan portfolio at a compounded annualized growth rate of 53 percent. Investors have rewarded the bank’s stock with a strong valuation, which currently trades around 285 percent of its tangible book value. After a long hiatus, Pinnacle recently returned to the acquisition market with two announced deals for banks in the Chattanooga and Memphis markets. Acquisitions that Pinnacle made in 2006 and 2007 accelerated its penetration of the Nashville market, but also increased its exposure to the commercial real estate market—and credit issues during the recession. Historically, Pinnacle has placed more emphasis on organic growth than growth through acquisitions.
The second bank that Rowe looked at was County Bancorp in Manitowoc, Wisconsin. This $770 million asset institution is heavily focused on agricultural and business banking in the dairy state. County benefits in part from a lack of other lenders in its space. Its primary competitors in most of its markets are the Farm Credit System and BMO Harris, the U.S. subsidiary of Canadian-based Bank of Montreal. County also benefits from specialization, since it knows the agricultural business so well and has a deep appreciation for how that sector performs over time. In fact, County uses a “boots to driveway” philosophy where it currently employs 10 ag lenders who actually grew up on dairy farms. County has been able to achieve strong and consistent loan growth since its inception in 1996 without sacrificing profitability, achieving a pre-provision return on assets (PPROA) of 1.89 percent in 2014.
The final bank in Rowe’s growth trilogy provides something of a cautionary tale. Tristate Capital, a $2.8 billion asset specialized bank lender that focuses on middle market commercial lending from a regional office network, has been able to generate an impressive 45 percent compounded annualized rate for loans since its inception in 2007, but its concentration in the highly competitive commercial loan market–where profit margins tend to be much thinner than in other loan categories—have reduced its profitability. The Pittsburgh-based bank’s price-to-tangible book value was 117 percent in 2014 compared to a peer median of 142 percent. In an effort to improve its profitability, Tristate has pulled back somewhat from the commercial loan market and placed greater emphasis on higher margin private banking loans that it sources via a network of financial intermediaries. The moral to Tristate’s story is that while growth is important, the investor community also wants profitability—which means the two must be kept in balance.
How does technology play a role in a bank’s growth and profitability? When asked to rank the importance of certain factors as drivers of their bank’s organic growth plans—culture and people, technology, unique products and services, and brand—technology placed second for 74 attendees who participated in an on-site audience poll at Bank Director’s Acquire or Be Acquired, held in Scottsdale, Arizona, in January, and the Bank Board Training Forum, last week in Nashville, Tennessee. The responses came mostly from bank directors, chairmen and CEOs.
In terms of importance to the organic growth of your bank, rank the following:
*Score is a weighted calculation, with items ranked as first receiving a higher value, or weight, of 4, second weighted as 3, etc… The score is the sum of all weighted values. Source: Bank Director
Technology continues to change the way customers interact with their banks. Respondents were also asked about their biggest fear—an open response about what keeps them up at night—and 10 percent cite non-bank competition. One of the speakers at the Bank Board Training Forum mentioned that Staples plans to begin offering small business loans. The Apples, Googles and retailers of the world are an increasing concern for bank boards, but will a focus on short-term profitability impede a director’s ability to take a long view of the business?
“Technology can move from an expense to a competitive advantage, if you do it right,” says George McGourty, president of the financial services group at Computer Services Inc. Big banks used to have the advantage with a significantly larger branch footprint, but technology can erase this advantage.
Looking at profitability for your bank in 2015, what do you believe will have the most positive impact?
Looking at profitability for your bank in 2015, what do you believe will have the most negative impact?
Sixty-nine percent of survey participants see loan growth as the factor with the most positive impact on the profitability of their financial institution, while no one cites technological innovations. Yet the right use of technology—and the right partnerships—can expand a community bank’s reach and help drive demand. Titan Bank, a $79.4 million asset bank based in Mineral Wells, Texas, partners with San Francisco-based peer-to-peer online lenders Prosper Marketplace and Lending Club to make small business loans, according to a spokesperson at the bank. These relationships help expand the bank’s reach beyond its local markets. (In addition to its Mineral Wells headquarters, the bank has a branch in nearby Graford, Texas, and a loan production office in Dallas, about 90 miles away.)
For Bethesda, Maryland’s Congressional Bank, with $446 million in assets, Lending Club helps the bank diversify its loan portfolio through the purchase of unsecured consumer loans, according to Jeffrey Lipson, the bank’s president and CEO. In February 2015, Lending Club partnered with BancAlliance, giving members of the Chevy Chase, Maryland-based lending platform—roughly 200 community banks—access to Lending Club’s expanded market for consumer loans.
Another technological opportunity is the use of data analytics. Too few banks take advantage of personal financial management tools and even for those that do, few effectively use the valuable customer data it provides, says Bradley Leimer, senior vice president and head of innovation at Santander Bank, N.A., the U.S. subsidiary of Banco Santander, S.A., headquartered in Madrid, Spain. Leimer just joined Santander in September 2014: He previously served as vice president of digital strategy at Richmond, California-based Mechanics Bank, with $3.4 billion in assets, from January 2010 to September 2014. During his tenure, almost 40 percent of Mechanics Bank’s customers used personal financial management tools, with the majority aggregating financial data from external accounts. The bank was able to use that information to target offers to its customers. “There’s money to be had in looking at the data that your customers provide you,” he says.
One-quarter of those polled in Bank Director’s survey view cybersecurity as their biggest fear. Do concerns about cybersecurity turn technology, in the minds of these board members and CEOs, into a potentially disastrous threat? Technology helps fuel growth, but it’s also a big expense. Finding technology’s place in a profitable bank isn’t easy. But bankers that view technology simply as an expense item, and not a way to grow, may find it difficult to get ahead. “If they look at [technology] clearly as an expense, I think they’re going to make some bad strategic decisions,” says McGourty.