Fintech Acquisitions Are Rare Among Banks; Here’s One Exception

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Few banks seem interested in purchasing financial technology firms. Just five such deals were announced this year as of July 14, based on a list of acquisitions compiled by Piper Sandler & Co. for Bank Director, using data from S&P Global Market Intelligence. Six of these deals were announced in 2020. Bank Director’s 2021 Bank M&A Survey found that a paltry 11% of respondents — primarily representing banks above $1 billion in assets — said their bank was likely to purchase a technology company in 2021.

Piper Sandler Managing Director Chris Donat believes banks are more interested in the tools and the solutions — more easily obtained through vendor relationships and collaborations — than in owning these companies outright.

Our list of recent fintech acquisitions by banks finds that as a group, big banks are the most active acquirers. But one small bank has been exceptionally active in this space: $2.7 billion MVB Financial Corp., based in ​​Fairmont, West Virginia. Working with fintechs has become a core element of the bank’s strategy.

MVB’s strategic shift dates back to 2016, when CEO Larry Mazza and CFO Don Robinson were trying to come up with a strategy to generate deposits to fuel the bank’s loan growth. They were inspired, says Robinson, by companies outside the banking sector that were housing deposits in loyalty programs and digital apps.

Examples include Starbucks Corp. and DraftKings, a sports betting app that reported $288 million in “cash reserved for users” — essentially deposits — in its 2020 annual report. Meanwhile, Starbucks recorded $1.6 billion in “stored value card liability” as of June 27; these funds are tied to the coffee purveyor’s prepaid cards, which customers can purchase and replenish online or in stores. Neither of these companies aim to be a bank, but they do draw dollars that their customers can use to buy coffee or gamble online — money that isn’t going to their primary bank account.

To better understand this evolving landscape, Robinson and Mazza reallocated marketing dollars to invest in fintech companies, viewing it as research and development. They took an active role in their investments, sitting on their boards. “We had a day-to-day involvement, kind of front row seat to their interactions,” says Robinson.

Today, the bank provides banking-as-a-service (BaaS) to fintech clients such as the personal finance company Credit Karma, which was itself acquired by Intuit last year. (Other BaaS banks include Coastal Financial Corp., NBKC Bank and Celtic Bank Corp.) The business has led to a huge increase in deposits. Fintech deposits totaled $533 million at the end of 2020, an increase of $382 million (255%) over the previous year — accounting for more than a quarter of MVB’s $1.98 billion in total deposits. Most of the fintech deposits ($358 million) come from the gaming industry. MVB’s return on average equity has more than doubled in the last two years, to 16.7% in 2020. Its return on average assets was 1.7%, up from 0.7% in 2018.

MVB has specific requirements for investing in fintech companies. There needs to be a market for the solution, which must solve problems faced by the industry or the bank’s clients. The management team should have a proven track record and resources for growing and scaling the company. And MVB wants to see what it can bring to the table. “We’re looking at that strategic partnership,” says Robinson. “How can we work with this [company]?”

The approach has resulted in a diverse array of acquisitions and investments, including Invest Forward, which offers a digital savings account; Paladin, focused on fraud prevention; and Trabian Technology, a software developer.

In a release explaining the rationale behind the Trabian acquisition, Mazza noted that the company adds “a new revenue stream and profit center and technological expertise that will benefit MVB and all of our stakeholders.”

Acquisitions that extend MVB further into areas like software development and fraud protection help the bank turn cost centers into profit centers, explains Robinson. “Trabian does work for, not only MVB, but it also does work for third parties,” he says. “As we look at the fintech world, one of the key pieces for us was looking at, how do you bring that expertise in house?”

The bank launched MVB Edge Ventures in June to oversee its technology investments and tackle two challenges that would vex any bank considering putting its capital into a fintech: valuation and culture.

To address valuations, MVB does its homework. “These are not public companies, right? So there’s a lot of diligence we have to do to make sure we understand the overall market,” says Robinson. “[We] try to stay away from pre-revenue companies, and we don’t invest in concepts.”

And the new venture arm addresses the cultural piece, along with regular communication with Robinson and Mazza.

“We have a team [that] work[s] together on a regular basis [to] integrate the companies and provide that platform,” says Robinson. He and Mazza regularly communicate with their portfolio fintechs, and Robinson says they have a lot to learn from one another. “They’re sharing the challenges and pitfalls they’re seeing,” he says, “and also the opportunities.”

Of course, MVB is not the only bank looking to fintech acquisitions to fuel growth. Earlier this month, Fifth Third Bancorp closed its acquisition of Provide. The digital platform offers deposit accounts, insurance coverage and financing to healthcare providers, originating $300 million in loans in the first half of 2021, according to Fifth Third’s July 21 earnings call.

“Our focus is on nonbank transactions that enhance our product and service capabilities,” Fifth Third CEO Greg Carmichael said on the call. “Provide would be a great example of that.” Fifth Third started investing in the company in 2018, and began funding loans through the platform around two years later. Provide will continue to operate as a subsidiary of the Cincinnati-based regional bank, which expects the platform to generate around $400 million in originations in the second half of 2021 and $1 billion in 2022.

2020-2021 (YTD) Fintech Acquisitions by Banks

Acquiring Bank Name Ticker Fintech Target Announcement Deal Value ($M)
Fifth Third Bancorp FITB Provide 6/22/2021 Undisclosed
Axos Financial AX E*TRADE Advisor Services 4/20/2021 $55
MVB Financial Corp. MVBF Trabian Technology 4/16/2021 Undisclosed
Bank of America Corp. BAC Axia Technologies 4/1/2021 Undisclosed
PNC Financial Services Group PNC Tempus Technologies 1/27/2021 Undisclosed
Alliance Data Systems Corp. (Comenity Bank) ADS Lon Operations 10/28/2020 $450
CRB Group (Cross River Bank) n/a Synthetic P2P Holdings Corp. (d/b/a PeerIQ) 8/21/2020 Undisclosed
American Express Co. AXP Kabbage 8/17/2020 Undisclosed
MVB Financial Corp. MVBF Invest Forward 8/7/2020 $1
MVB Financial Corp. MVBF Paladin 4/17/2020 Undisclosed
Bank of Montreal BMO Clearpool Group 1/22/2020 $147

Source: Piper Sandler & Co. using data from S&P Global Market Intelligence.

The Robust Potential of Robo-Advisors

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When the New York Stock Exchange closed its doors on its physical trading floors in March of 2020, the immediate future of investing looked fraught with trepidation. The Dow Jones Index had plunged nearly 3,000 points on March 16 — the largest point drop in its history — and many saw this as a grim indicator of the months to come.

Others saw an opportunity.

During the second quarter of 2020, at the onslaught of the pandemic, Apex Clearing’s Next Investor Outlook Report saw a 27.5% increase in volume of trades as compared to the first quarter. A Charles Schwab study found that 15% of U.S. investors entered the market for the first time during 2020. Robinhood claimed 13 million users by the end 2020, a number some now believe to be near 20 million, according to the news publication CNBC.

Interest in investing has arguably never been more popular, and this trend has no signs of slowing down. CB Insights’ State of Wealth Tech Q1’21 reported that the wealth tech sector raised $5.6 billion in capital in the first quarter of 2021, surpassing the total amount raised during all of 2020 ($5.2 billion). Investors plowed the most money into retail investing, with $4.2 billion raised during the first quarter.

Consumers, specifically new individual investors, are showing that they want in on the action. And banks are in a prime position to introduce their customers to all types of services associated with wealth management via robo-advising technology.

Implementing robo-advising capabilities is an affordable way for banks to provide personalized financial advice to a broad segment of customers. There is typically no asset minimum, and services are available at any time. Also worth noting, banks don’t have to pull professionals away from their high net worth clients and accounts.

Robo-advisors aren’t strictly rooted in investment capabilities. Robinhood and other similar retail investment technology platforms get a lot of press, but there are hundreds of wealth management companies around the world that offer retirement, personal finance management, savings, onboarding, back office automation, reporting, portfolio analytics and aggregation, as well as automated trade execution services.

ABAKA, for example, is a London-based fintech that uses its artificial intelligence technology to offer bank customers retirement, wealth management, banking, workplace and mortgage advice, among other services. Their technology isn’t limited to one sector of wealth management, and customers are in control of what type of advice they seek out depending on their current needs.

Bambu takes a similar stance when it comes to offering individuals specific financial advice at specific moments in time. “Everybody wants a better financial life,” says Ned Phillips, CEO and founder of the Singaporean digital wealth management technology developer. And while this is a universal want, the path to financial security is as unique as snowflakes are.

Phillips points out that the banks that will succeed in keeping customer accounts will be the ones that understand their goals and desires, and subsequently provide personal and actionable advice, as well as recommended next steps. “You need a smaller, nimble company to provide that tech,” he adds. And currently, he thinks fintechs are much better positioned than a bank to understand how to make this attainable for each individual user.

While robo-advisors are an incredible way to both democratize and personalize financial advice, they do not diminish the importance of professional advisor and management services a bank may offer. There will be customers whose needs surpass the services a robo-advisor can offer, and should be transferred to a physical advisor when the time comes.

There isn’t enough time in the world for each individual person to sit down with a financial advisor, but wealth techs with robo-advice capabilities can at least offer it as an option to bank customers. For many, this may be the first time they ever receive financial advice that is tailored to their wants and needs.

Making these services accessible to all will be what sets a bank apart from the rest. And Phillips believes that we’ve barely scratched the surface regarding robo-advising technology and its potential impact on consumer financial wellness. “Today, we’re not even at the beginning.”

Five Assessments that Every Acquirer Should Make

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Acquiring another bank will be one of the most important decisions that a board of directors ever makes. A well-played acquisition can be a transformational event for a bank, strengthening its market presence or expanding it into new markets, and enhancing its profitability.

But an acquisition is not without risk, and a poorly conceived or poorly executed transaction could also result in a significant setback for your bank. Failing to deliver on promises that have been made to the bank’s shareholders and other stakeholders could preclude you from making additional acquisitions in the future. Banking is a consolidating industry, and acquisitive banks earn the opportunity to participate one deal at a time.

When a board is considering a potential acquisition, there are five critical assessments of the target institution that it should make.

Talent
When you are acquiring a bank, you’re getting more than just a balance sheet and branches; you’re also acquiring talent, and it is critical that you assess the quality of that asset. If your bank has a more expansive product set than the target, or has a more aggressive sales culture, how willing and able will the target’s people be to adapt to these changes in strategy and operations? Who are the really talented people in the target’s organization you want to keep? It’s important to identify these individuals in advance and have a plan for retaining them after the deal closes. Does the target have executives at certain positions who are stronger than members of your team? Let’s say your bank’s chief financial officer is nearing retirement age and you haven’t identified a clear successor. Could the target bank’s CFO eventually take his or her place?

Technology
Making a thorough technology assessment is crucial, and it begins with the target’s core processing arrangement. If the target uses a different third-party processor, how much would it cost to get out of that contract, and how would that affect the purchase price from your perspective? Can the target’s systems easily accommodate your products if some of them are more advanced, or will significant investments have to be made to offer their customers your products?

Culture
It can be difficult to assess another bank’s culture because you’re often dealing with things that are less tangible, like attitudes and values. But cultural incompatibility between two merger partners can prevent a deal from reaching its full potential. Cultural differences can be expressed in many different ways. For example, how do the target’s compensation philosophy and practices align with yours? Does one organization place more emphasis on incentive compensation that the other? Board culture is also important if you’re planning on inviting members of the target’s board to join yours as part of the deal. How do the target’s directors see the roles of management and the board compared to yours? Unless the transaction has been structured as a merger of equals, the acquirer often assumes that its culture will have primacy going forward, but there might be aspects of the target’s culture that are superior, and the acquirer would do well to consider how to inculcate those values or practices in the new organization.

Return on Investment
A bank board may have various motivations for doing an acquisition, but usually there is only one thing most investors care about – how long before the acquisition is accretive to earnings per share? Generally, most investors expect an acquisition to begin making a positive contribution to earnings within one or two years. There are a number of factors that help determine this, beginning with the purchase price. If the acquirer is paying a significant premium, it may take longer for the transaction to become accretive. Other factors that will influence this include duplicative overhead (two CFOs, two corporate secretaries) and overlapping operations (two data centers, branches on opposite corners of the same intersection) that can be eliminated to save costs, as well as revenue enhancements (selling a new product into the target’s customer base) that can help drive earnings.

Capabilities of Your M&A Team
A well-conceived acquisition can still stumble if the integration is handled poorly. If this is your bank’s first acquisition, take the time to identify which executives in your organization will be in charge of combining the two banks into a single, smoothly functioning organization, and honestly assess whether they are equal to the task. Many successful banks find they don’t possess the necessary internal talent and need to engage third parties to ensure a successful integration. In any case, the acquiring bank’s CEO should not be in charge of the integration project. While the CEO may feel it’s imperative that they take control of the process to ensure its success, the greater danger is that it distracts them from running the wider organization to its detriment.

Any acquisition comes with a certain amount of risk. However, proactive consideration toward talent, technology, culture, ROI and a thoughtful selection of the integration team will help enable the board to evaluate the opportunity and positions the acquiring institution for a smooth and successful transition.

Why This 17-Year-Old Investor Prefers Community Banks

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Maya Peterson graduates from high school at the end of summer. She’s also the author of two books: “Early Bird: The Power of Investing Young” — which she wrote when she was just 13 years old — and “Lighthouse: Women Leading the Way in Finance,” which published in April.

To call her precocious may be an understatement: Peterson started investing when she was just 9 years old. At 10, most kids just want to play video games; instead, Peterson attended Berkshire Hathaway’s annual shareholders’ meeting to hear Warren Buffett speak and meet personal heroes like Lauren Templeton, the founder and president of Templeton & Phillips Capital Management. Templeton is one of the 20 women featured in “Lighthouse.”

Peterson researches every investment she makes, from the company’s financials to its competitive position in the marketplace and the state of its industry. “Investing is simple to understand: You put in your work, try to understand the business, and do your best to pick stocks; however, the world is unpredictable, and things do not always go as planned,” she writes in “Lighthouse.”

“Over the past seven years, I have developed an investing mindset of patience, frugality, nerdiness, humility and discipline.”  

In August, I interviewed Peterson about why she’s fascinated by women in finance and what she values in an investment. The transcript that follows has been edited for brevity and flow.

BD: As an investor, how do you view the banking sector?
MP: I stick to investing in what I know, so I started out buying [The] Procter & Gamble [Co.] and Johnson & Johnson. The big banks are complicated for outside investors, and I try to keep it simple. For smaller banks, I think new investors have a better chance to be able to analyze them, but there is still a lot of banking jargon to wade through. Overall, seeing how banks adapt to accommodate their customers over the long haul, the quality of their loans and how they serve their community is something that I look for. I find this much easier to see in smaller banks.

BD: You spent time with Robert and Patrick Gaughen of Hingham Institution for Savings, who explained to you how they built their bank. You own shares in Hingham. What did you learn from them?
MP: The biggest key to Hingham’s success has been its culture. They are really customer focused, and they do not overcomplicate their business model with growth for growth’s sake. Their loan quality over many years shows a clear focus on risk quality. There was a quote in [their] 2014 Annual Report, where Robert Gaughen summed it up as, “Balance sheet growth at Hingham must be safe and it must be profitable, in that order.”

[Editor’s Note: Bank Director also spoke with the Gaughens for our report on the Six Tenets of Extraordinary Banks.]

BD: You’re an experienced investor, particularly given your age. What do you value when you look at a company?
MP: I value social responsibility. I invest for the long haul, so the companies I am a shareholder of are ones I think will be around and successful in 20 years. These businesses realize that it is their future too. It is easy to fall into the trap of thinking that capitalism is a short-term game, but most great businesses are built by long-term thinkers. Our thinking has to grow beyond thoughts of, “What is cheapest now?”

[Investor] Jeremy Grantham said [at a 2018 MorningStar conference] that, “Capitalism also has a severe problem with the very long term … anything that happens to a corporation over 25 years out doesn’t [exist for] them. Therefore, grandchildren, I like to say, have no value. … We deforest the land, we degrade our soils, we pollute and overuse our water, and treat air like an open sewer. [We do it] all off balance sheet and off the income statement.”

Investing works over the long run, whether that is competitive advantage, fair prices or good management, and social responsibility is a long-term mindset as well. It focuses on how the business benefits society through diversity within the workplace, their environmental impact and so on.

[Socially responsible investing] brings these two long-term perspectives together.

BD: I decorated my room as a teenager with rock band posters, but you write in the introduction to “Lighthouse” that you wallpapered your room with the photos of 58 female CFOs to inspire you. As a young woman, why does finance appeal to you? Based on what you’ve learned, what are your thoughts now about possibly entering a male-dominated field?
MP: Hearing stories about Lauren Templeton’s childhood full of investing, I was excited to become a young shareholder, too. Those stories launched me into researching and discovering other women in investing and in finance, which was where I began seeking out stories of female CFOs. I think similar to other kids’ posters, these women were larger-than-life figures that taught me the importance of drive. They became my daily reminders to keep learning and asking questions. Once I ventured into investing, I saw the limitless potential to learn, and that is what made finance [appealing] to me. If I ran out of questions, then I couldn’t be thinking hard enough.

 

As a young woman, investing gave me the opportunity to make adult decisions at a young age without being judged by my age or gender. I had control over something in a way I had not yet had at such a young age. Investing felt like my window into the real, adult world.

 

BD: Finally, you’re in school now, but you’re obviously thinking ahead about your career. You come from a unique perspective compared to your peers, in that you really dug into companies and what makes them tick. And a lot of companies struggle to attract younger, skilled talent. With that in mind, what do you hope to see from a future employer?
MP: Emphasis on community. Right now, it is so critical that those who can give are giving to others in many ways. To me, this means having coworkers and employees that represent the customers they are serving, incentivizing and encouraging donating and volunteer work, companies allocating money to give to a good cause and being socially responsible from the inside out.

I think employers who want to attract the younger generation should have a longer-term outlook and ideas on how to make a positive impact on the future. There is no one size fits all — it is different for different types of businesses — but working to make a difference definitely matters in attracting younger employees.

BOLI Carriers Prepare for COVID-19 Impact

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Purchases of bank-owned life insurance were strong in 2019 as bankers capitalized on its attractive yields relative to other investments available to banks.

What 2020 holds remains to be seen, given trends in the market and broader economy. Total BOLI purchases likely could be lower this year, as carriers are generally not willing to accept large premiums from a single policyholder. However, BOLI activity in the $10 million and under purchase size may be similar to 2019 levels. At the close of the first quarter, it is too early to know the full impact of COVID-19, but we have a few observations based on discussions with several major BOLI carriers:

  1. The carriers have not priced in any risk premium for potentially higher mortality rates and do not expect to do so. In addition, the carriers do not expect to tighten the requirements to obtain guaranteed issue underwriting. In a guaranteed issue BOLI case, the insureds answer several questions, but no physicals are required. Guaranteed issue underwriting can be obtained with as few as 10 insureds.
  2. It is virtually impossible for carriers to find fixed income investments that produce yields that approximate the yield on the existing portfolio, given that short-term interest rates have dropped to near zero and the 10-year Treasury declined from 2.49% on April 1, 2019 to 62 basis points a year later.
  3. While carriers continue to accept new BOLI premium, some are reluctant to take a large premium from any one customer to avoid diluting the portfolio for existing policyholders. Movements in the yield of the portfolio tend to lag the market because carriers’ portfolios are very large (often $50 billion to $200 billion) and generally have a duration of five to 10 years. For this reason, current crediting rates for several carriers remain above 3%.
  4. Several carriers indicated that they started reducing credit exposure and increasing asset diversification several years ago. While they did not anticipate a pandemic, the market had been good for so long and they thought it would be wise to start reducing the risk in the portfolio ahead of a potential downturn. In addition, credit spreads had also narrowed, so there was less reward for additional risk.
  5. Carriers primarily invest in fixed-income investments; a decline in the stock market has minimal impact on most carrier investment portfolios.

BOLI Growth In 2019
BOLI purchases totaled $4.3 billion in 2019, an increase of 147% over the 2018 total, according to IBIS Associates, an independent market research firm. The total represents the third-highest amount of BOLI purchases in the past dozen years.

It’s even more impressive when considering that most banks continued to have strong loan demand and less liquidity than in most previous years. At year-end 2019, BOLI cash surrender value (CSV) held on the balance sheets of U.S. banks totaled $178 billion, according to the December 2019 NFP-Michael White report.

Robust BOLI activity has been driven by attractive tax-equivalent yields, strong credit quality and leverage ($1 invested in BOLI typically returns $3 to $4 of tax-free death benefits). Banks can use BOLI as a way to retain key employees by providing life insurance benefits or informally funding nonqualified benefit plans; BOLI earnings can also be used to offset and recover health care and 401(k) or other retirement plan expenses.

According to the IBIS report, 77% of 2019 BOLI purchases were for general account, 22% for variable separate account and just 1% was for hybrid separate account. In general account policies, the general assets of the insurance company issuing the policies support the CSV. In variable separate and hybrid separate products, the CSVs are legally segregated from the general assets of the carrier, which provides enhanced credit protection in the event of carrier insolvency. The credit risk and price risk of the underlying assets remain with the policyholder in a variable policy, whereas the carrier retains those risks in a general account or hybrid policy.

Purchases of variable separate accounts dominated the market in 2006-07; since that time, general account BOLI has typically led the way. This is due to the simplicity of general account products relative to variable separate products as well as the increased product options, generally higher yields, and the high comfort level bankers have with the creditworthiness of mainstream BOLI carriers.

According to the IBIS data, 2019 general account BOLI purchases were at their highest level in the last 16 years. According to the NFP-Michael White report, 3,346 banks — representing 64.6% of all US banks — now hold BOLI assets. This is an increase from the 64.1% of banks that held BOLI at the end of 2018. Seventy-one percent of banks with over $100 million in assets hold BOLI; 77.3% of banks with over $300 million in assets do.

Bracing for Changes in the Bank Control Rules

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Executives and directors at public banks need to prepare for new rules this spring that will make it easier for investors to accumulate meaningful stakes in their companies.

The Federal Reserve Board has approved an update to the control framework for investors in banks or bank holding companies that goes into effect April 1. The update comes as the marketplace undergoes a structural shift in flows from active fund management to passive investing. The changes should make it easier for investors — both passive and active — to determine whether they have a controlling influence over a bank, and provides both banks and investors with greater flexibility.

“Anything that’s pro-shareholder, a bank CEO and board should always be happy to support,” says Larry Mazza, CEO at Fairmont, West Virginia-based MVB Financial, which has $1.9 billion in assets. “The more shareholders and possible shareholders you can have, it’s very positive for the owners.”

The Fed last updated control rules in 2008. This update codifies the regulator’s unwritten precedent and legal interpretations around control issues, which should increase transparency for investors, says Joseph Silvia, a partner at Howard & Howard.

“The goal of the regulators is to make sure that they understand who owns those entities, who runs those entities and who’s in charge, because those entities are backed by the Federal Deposit Insurance Corp.,” he says. “The regulators take a keen interest, especially the Fed, in who’s running these entities.”

The question of who controls a bank has always been complicated, and much of the Fed’s approach has been “ad hoc,” Silvia says. The latest rule is largely a reflection of the Fed’s current practice and contains few changes or surprises — helpful for banks and their investors that are seeking consistency. Large shareholder should be able to determine if their stakes in a bank constitute control in a faster and more-straightforward way. They also may be able to increase their stakes, in some circumstances. Silvia specifically highlights a “fantastic,” “wildly helpful” grid that breaks down what the regulator sees as various indicia of control, which observers can find in the rule’s appendix.

“A lot of investors don’t like the pain of some of these regulations — that helps and hurts. [The] regulation creates predictability and stability,” Mazza says. “Where it hurts is that investors may not go forward with additional investments, which hurts all shareholders.”

Shareholders, and banks themselves that may want to take stakes in other companies, now have increased flexibility on how much money they can invest and how to structure those investments between voting and non-voting shares, as well as how board representation should figure in. Silvia says this should advance the conversations between legal counsel and investors, and spare the Fed from weighing in on “countless inquires” as to what constitutes control.

“Both banks and shareholders will likely benefit from the changes, as it could lower the cost of capital for banks while allowing for a greater presence of independent perspectives in the board room,” wrote Blue Lion Capital partner and analyst Justin Hughes in an email. Blue Lion invests in bank stocks.

The change impacts active and passive investors, the latter of which have grown to be significant holders of bank stocks. Passive vehicles like exchange-traded and mutual funds have experienced $3 trillion in cumulative inflows since 2006, while actively managed funds have seen $2.1 trillion in outflows, according to Keefe, Bruyette & Woods CEO Tom Michaud. Passive ownership of bank stocks has increased 800 basis points since 2013, representing 17.1% of total shares outstanding in the third quarter of 2019. Some funds may be able to increase their stakes in banks without needing to declare control, depending on how the investments are structured.

Still, banks may be concerned about the potential for increased activism in their shares once the rule goes into effect. Silvia says the Fed is familiar with many of the activists in the bank space and will watch investment activity after the rule. They also included language in the final update that encourages investment vehicles who have not been reviewed for indicia of control from the Fed to get in touch, given than no grandfathering was provided to funds that had not been reviewed.

“They’re not really grandfathering any investments,” Silvia says. “There’s not a lot of additional protection.”

If nothing else, the rule is a chance for bank executives and directors to revisit their shareholder base and makeup and learn more about their owners, he adds. They should keep track if the makeup of their shareholders’ stakes changes once the rule goes into effect, especially investors that may become activists.

Weighing the Value of a Bank Holding Company

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governance-6-24-19.pngIn May, Northeast Bank became the fourth banking organization in two years to eliminate its holding company. Northeast joins Zions Bancorporation, N.A., BancorpSouth Bank and Bank OZK in forgoing their holding companies.

All of the restructurings were motivated in part by improved efficiencies that eliminated redundant corporate infrastructure and activities. The moves also removed a second level of supervision by the Federal Reserve Board. Bank specific reasons may also drive the decision to eliminate a holding company.

Zions successfully petitioned to be de-designated as a systemically important financial institution in connection with its holding company elimination. In its announcement, Northeast replaced commitments it made to the Fed with policies and procedures relating to its capital levels and loan composition that should allow for more loan growth in the long run.

Banks are weighing the role their holding companies play in daily operations. Some maintain the structure in order to engage in activities that are not permissible at the bank level. Others may not have considered the issue. Now may be a good time to ask: Is the holding company worth it?

Defined Corporate Governance
Holding companies are typically organized as business corporations under state corporate law, which often provides more clarity than banking law for matters such as indemnification, anti-takeover protections and shareholder rights.

Transaction Flexibility
Holding companies provide flexibility in structuring strategic transactions because they can operate acquired banks as separate subsidiaries. This setup might be desirable for potential partners because it keeps the target’s legal and corporate identity, board and management structure. But even without a holding company, banks can still preserve the identity of a strategic partner by operating it as a division of the surviving bank.

Additional Governance Requirements
A holding company’s status as a separate legal entity subjects it to additional corporate governance and recordkeeping requirements. A holding company must hold separate board of directors and committee meetings with separate minutes, enter into expense-sharing and tax-sharing agreements with its bank subsidiary and observe other corporate formalities to maintain separate corporate identities. In addition, the relationship between the holding company and its subsidiary bank is subject to Section 23A and Section 23B of the Federal Reserve Act, an additional regulatory compliance burden.

Additional Regulatory Oversight
Holding companies are also subject to the Fed’s supervision, examination and reporting requirements, which carry additional compliance costs and consume significant management attention. The Fed also expects bank holding companies to serve as a source of financial strength to their subsidiary banks, an expectation that was formalized in the Dodd-Frank Act.

Diminished Capital Advantages
Historically, holding companies could issue Tier 1 capital instruments that were not feasible or permissible for their bank subsidiaries, such as trust preferred securities and cumulative perpetual preferred stock. They also enjoyed additional flexibility to redeem capital, an advantage that has largely been eliminated by the Basel III rulemaking and Fed supervisory requirements. A holding company with existing grandfathered trust preferred securities or with registered DRIPs may find them useful capital management tools. Holding companies with less than $3 billion in consolidated assets that qualify under the Small Bank Holding Company and Savings and Loan Holding Company Policy Statement are not subject to the Fed’s risk-based capital rules. These companies are permitted to have higher levels of debt than other holding companies and banks.

Broader Activities, Investments
Bank holding companies, especially those that elect to be financial holding companies, can engage in non-banking activities and activities that are financial in nature through non-bank subsidiaries that are bank affiliates. In some cases, these activities may not be bank permissible, such as insurance underwriting and merchant banking. The Fed also has authority to approve additional activities that are financial in nature or incidental or complementary to a financial activity on a case-by-case basis.

Bank holding companies can also make passive, non-controlling minority investments that do not exceed 5 percent of any class of voting securities in any company, regardless of that company’s activities. By comparison, banks are limited to making investments in companies that are engaged solely in bank-permissible activities or must rely on authorities such as community development or public welfare authority to make investments. Banks may also have limited leeway authority to invest in specific securities or types of securities designated under the applicable state banking law or by the applicable state banking regulator.

Banks that are not interested in activities or investment opportunities available to holding companies may be less concerned about eliminating the structure. But an organization that engages in activities at the holding company level that are not permissible for banks or that desires to maintain its grandfathered rights as a unitary savings and loan holding company may not wish to eliminate its holding company.

Operating without a holding company would result in more streamlined regulatory oversight, corporate governance and recordkeeping processes. But a holding company provides the flexibility to engage in activities, to make investments and to create structures that a bank may not. Bank boards should weigh these costs and benefits carefully against their strategic and capital management plans.

Five Critical Mistakes to Avoid in Any Headquarters Project

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headquarters-5-15-19.pngCorporate headquarter projects are likely one of the biggest investments a bank will make in itself.

With a lot of time and money on the line, it is no surprise that these massive projects quickly become an area of major stress for executives. Most management teams have limited experience in executing projects of this kind. The stakes are high. Bad workplace design costs U.S. businesses at least $330 billion annually in lost efficiency, productivity and overall employee engagement, according to Facility Executive.

A lot can go wrong when planning a corporate headquarters. Executives should use a data-based approach and address these issues in order to avoid five critical oversights:

1. Overpromising and Under-delivering to the Board
You should feel confident that every decision for your planned headquarters is the right one. The last thing you want to do after you get the board’s approval on the size, budget and completion date for the project is go back for more money and time because of educated guesses or bad estimates.

Avoiding this comes down to how you approach the project. Select a design-build firm that considers your needs and asks about historical and projected growth, trends and amenities, among other issues. This will help mitigate risk and create a plan, budget and timeline based on research and deliberation

2. Miscommunication Between Design and Construction
Partnering with a design-build firm helps alleviate the potential for miscommunication and costly changes between architects and construction crews. Look for firms with a full understanding of costs, locally available resources and current rates, so they can design with a budget in mind. Some firms offer a guaranteed maximum price on a project that can eliminate surprises. 

3. Missing the Mark on Efficiencies and Adjacencies
The way employees work individually and collaborate with others is changing. Growing demand for work areas like increased “focus spaces,” more intimate conference rooms and other amenities should not to be ignored. Forgetting to consider which departments should be next to each other to foster efficiency is also an oversight that could dampen your bank’s overall return. Look for a firm that has an understanding of banking and how adjacencies can play a role in efficiency that can guide you toward which trends are right for your bank.

4. Outgrowing the New Space too Soon
I have witnessed a project that was not properly planned, and the board was asked to fund another project for a new, larger building only five years after the first one. As you can probably imagine, the next project is being watched and scrutinized at every turn.

Most architectural designers will ask you what you want and may look at whatever historical data you provide. Beyond that, how will you know if the building will last? A good design-build firm should incorporate trends from the financial industry into your design; a great one will provide you with data, projected growth patterns and research, so you can demonstrate to the board that the bank is making the right investment and that the new space will last.

5. Forgetting the People Piece
Not communicating with your employees or leadership on the reasons behind the change or how to use the new space often means leaving money and happiness on the table. The design and the features of the building frame the company culture, but the people complete the picture.

Make sure to show your workforce the purpose of the new space. Help get everyone excited and on the same page with the use, process and procedures. Do not drop the ball after the hard work of building the headquarters.

When it comes to any project—especially one of this size and magnitude—always measure twice and cut once.

How to Design a Winning Capital Management Plan

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capital-4-22-19.pngThe significant downturn in bank stock prices witnessed during the fourth quarter of 2018 prompted a number of boards and managements to authorize share repurchase plans, to increase the amounts authorized under existing plans and to revive activity under existing plans. And in several instances, repurchases have been accomplished through accelerated plans.

Beyond the generally bullish sentiment behind these actions, the activity shines a light on the value of a proactive capital management strategy to a board and management.

The importance of a strong capital management plan can’t be overstated and shouldn’t be confused with a capital management policy. A capital management policy is required by regulators, while a capital management plan is strategic. Effective capital management is, in large part, an exercise in identifying and understanding future risks today. Capital and strategy are tightly linked — a bank’s strategic plan is highly dependent on its capital levels and its ability to generate and manage it.

There are a couple of guidelines that executives should bear in mind as they develop their capital management plans. First, the plan needs to be realistic and achievable. The windows for accessing capital are highly cyclical. There’s limited value in building a plan around an outcome that is unrealistic. Second, if there is credible information from trusted sources indicating that capital is available – go get it! Certain banks, by virtue of their outstanding and sustained performance, may be able to manage the just-in-time model of capital, but that’s a perilous strategy for most.

Managements have a number of levers available to manage capital. The key as to when and which lever to pull are a function of the strategic plan. A strong plan is predicated on staying disciplined but it also needs to retain enough nimbleness to address the unforeseen curveballs that are inevitable.

Share Repurchases
Share repurchases are an effective way to return excess capital to shareholders. They are a more tax-efficient way to return capital when compared to cash dividends. Moreover, a repurchase will generally lift the value of a stock through the reduction in shares outstanding, which should increase earnings per share and the stock price itself. Share repurchases are generally the favored mechanism of institutional owners and can make tremendous sense for broadly held and liquid stocks.

Cash Dividends
Returning capital to shareholders in the form of cash dividends is generally viewed very positively in the banking industry. Banks historically have been known as cash-dividend paying entities, and the ability and willingness to pay them is often perceived as a mark of a healthy and stable company. A company’s decision regarding whether to increase a cash dividend or to repurchase shares can be driven by the composition of the shareholder base. Cash dividends are generally valued more by individual shareholders than institutional shareholders.

Business Line Investment
Community banking at its core is a spread dependent business. The ability to diversify the revenue stream through the development or acquisition of a fee generating business can be an effective and worthwhile use of capital. Common areas of investment include mortgage banking, wealth management, investment products and services and insurance. Funding the lift out of lending teams can also be a legitimate use of capital. A recent development for some is investment in technology as an offensive play rather than a defensive measure.

Capital Markets Access
Effective capital management plans also consider the ability to access the capital markets. In the community banking space, accessing capital is not always a foregone conclusion. Over the past couple of years, the most common forms of capital available have been common equity and subordinated debt. For banks of a certain size and market cap, it’s a prudent capital management strategy to file a shelf registration, also known as form S-3, which provides companies with flexibility as to how and when they access the capital markets. The optionality provided by having a shelf registration far outweighs the concern that the shelf itself suggests a shareholder dilutive activity is on the horizon.

It’s important to note that these capital management activities can be utilized individually or in combination. An acquisition may necessitate the need to access the capital markets. Or given the relative inexpensiveness of sub debt, raising some for the purpose of a share repurchase could make sense. A strong capital management plan can allow a management team to be ready both offensively and defensively to drive their businesses forward in optimal fashion.

Information contained herein is from sources we consider reliable, but is not guaranteed, and we are not soliciting any action based upon it. Any opinions expressed are those of the author, based on interpretation of data available at the time of original publication of this article. These opinions are subject to change at any time without notice.

The Case for Rating Community Banks Investment Grade

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investment-9-18-18.pngFor years, legacy rating agency thinking held that community banks could not be rated investment grade. They were too small, the thinking went, and therefore could not compete with scale-advantaged larger banks. Moreover, this structural deficiency likely made community banks riskier, as they were naturally subject to adverse selection in terms of loan originations.

All of this is intuitive. But it doesn’t stand up to further scrutiny.

If we consider the history of bank failures, we see that very small banks and very large banks are disproportionately represented. Meanwhile, well-run community banks, with long-standing ties to local markets, core deposit funding and well diversified risks have a long history of successfully riding out credit cycles. That piqued our interest. But we still needed to get over the hump of competitiveness. How could a community bank’s cost structure—the basis for pricing assets and liabilities—match the efficiency of the largest banks? We took a closer look.

Started with funding costs. Turns out that government guaranteed deposit funding—available to all FDIC-insured institutions, large and small, is a great equalizer. In fact, most community banks derive substantial amounts of their funding via core deposits, giving them an advantage over the largest banks that require substantial sums of more expensive market-sourced funding.

What about operating costs? Surely, the largest banks enjoy substantial economies of scale relative to community banks. That may be true, especially in terms of being able to absorb things like the significant increases in regulatory reporting and compliance costs. What we found interesting, however, is that the efficiency ratios of community banks in many cases compare favorably to those of the larger banks. Our research came up with two explanatory considerations. First, according to the FDIC, the benefits of economies of scale are realized with as little as $100 million in assets, and second, among larger banks, the benefits of scale are typically offset by the added costs brought on by complexity and administrative friction. This serves as a reminder that, in terms of competitiveness, banking, especially small to mid-sized commercial banking, is a local scale business, not a national (or international) one.

Now, you might point out, broader and more sophisticated product offerings must tip the scale in favor of larger banks. And there must be some benefit to the substantial technology and marketing spend of the larger banks. We wouldn’t disagree. But we also believe community banks can punch back with value of their own created out of local market knowledge and relationships as well as superior responsiveness. And most small businesses really don’t demand a sophisticated product set, and marketing spend generally creates value in consumer financial services, much of which left community banking some time ago.

So, what about the risk side of the equation? Larger banks by definition will have greater spread-of-risk than community banks, where risks are more concentrated, certainly in terms of geography, and quite possibly loan type (most notably CRE). What our research found was that through cycles, community banks’ loss rates per loan type were typically better than those of larger banks. In other words, no evidence of adverse selection, and a realization that most markets in the U.S. are relatively well diversified economically.

This is not to say that all community banks are investment grade. Well-run community banks can be rated investment grade. Therein lies an essential element of our rating determination—an in-depth due diligence session with senior management. Here, we look to understand the framework and priorities for managing risk, key aspects of growth strategies, and the rationale underpinning capital and liquidity structure. This is a story sector, and the management evaluation is critical to our rating outcome.

Our research suggests that well-run community banks can compete successfully with larger banks, and generate solid fundamental performance through the cycle. We rated our first community bank in 2012, and today that figure stands at 115 and counting, testament that our approach has resonated with investors and depositors alike.