A Dangerous Force in Banking


culture-8-23-19.pngThe more you learn about banking, the more you realize that just a few qualities separate top-performing bankers from the rest.

One of the most important of these qualities, I believe, is the ability of bankers to combat what famed investor Warren Buffett calls the “institutional imperative.”

Buffett, the chairman and CEO of Berkshire Hathaway, wrote about this in his 1990 shareholder letter:

“The banking business is no favorite of ours. When assets are twenty times equity — a common ratio in this industry — mistakes that involve only a small portion of assets can destroy a major portion of equity. And mistakes have been the rule rather than the exception at many major banks. Most have resulted from a managerial failing that we described last year when discussing the ‘institutional imperative:’ the tendency of executives to mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so.”

At the time, Buffett was referring to a credit-fueled bubble in the commercial real estate market. The bubble was in the process of popping; commercial real estate prices would decline 27% between 1989 and 1994.

The subprime mortgage and leveraged lending markets in the lead-up to the financial crisis offer more recent examples. No bank wanted to lose market share in either business line, even if doing so was prudent. This was the impetus for Citigroup CEO Chuck Prince III’s oft-repeated quote about having to dance until the music stops.

“When the music stops, in terms of liquidity, things will be complicated,” Prince told the Financial Times in 2007. “But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”

Here’s the problem: A bank that loses market share is vulnerable to criticism by analysts and commentators.

In 2006, for instance, JPMorgan Chase & Co. began offloading sub-prime mortgages and pulling back from the market for collateralized debt obligations. “Analysts responded by giving JPMorgan Chase what one insider calls ‘a world of [expletive] for our fixed-income revenues,’” writes Duff McDonald in “Last Man Standing: The Ascent of Jamie Dimon and JPMorgan Chase.”

“One of the toughest jobs of the CEO is to look at all the stupid stuff other people are doing and to not do them,” a long-time former colleague of JPMorgan’s Chairman and CEO Jamie Dimon told McDonald.

You would think that analysts and commentators would, at some point, realize that it’s ill-advised to pressure bankers into prioritizing short-term results over long-term solvency, but there’s no evidence of that.

Darren King, the chief financial officer of M&T Bank Corp., noted at a conference in late 2018 that, “The narrative around the industry is that M&T has forgotten how to lend.”

M&T Bank has been one of the top-performing banks in the country since the early 1980s. King was referring to analysts and commentators’ reaction to the fact that M&T’s loan growth over the past two years has lagged the broader industry.

But as King went on to explain: “Generally what you find is when economic times are strong, we’re growing but generally not as fast as the industry. And in times of more economic stress, we tend to grow faster.”

So, how does a bank combat the institutional imperative?

The simple answer is that banks need to cultivate a culture that insulates decision-makers from external pressures to chase short-term performance. This culture is a product of temperament and training, as well as institutional knowledge about the frequency and consequences of past credit cycles.

This culture should be buttressed by structural support, too. Skin in the game among executives is a good example; a supportive board focused on the long term is another. A low efficiency ratio also enables a bank to focus on making better long-term decisions while still generating satisfactory returns.

In short, while the institutional imperative may be one of the most dangerous forces in banking, there are ways to defeat it.

The Evolution of Regional Champions



Over the past decade, regional champions have emerged as strong performers in today’s banking environment, entering new markets and gaining market share through acquisitions. In this panel discussion led by Scott Anderson and Joe Berry of Keefe Bruyette & Woods, John Asbury of Union Bankshares, Robert Sarver of Western Alliance Bancorp. and David Zalman of Prosperity Bancshares share their views on strategic growth opportunities in the marketplace, and why culture and talent reign supreme in M&A.

Highlights from this video:

  • Characteristics of Regional Champions
  • Identifying Strategic Opportunities
  • Why Scale Might Be Overrated
  • Lessons Learned in M&A
  • What Makes a Good Acquisition Target

Video length: 41 minutes

 

Are You Overlooking a Major M&A Obstacle?


merger-1-1-18.pngPeople often think about the Herfindahl-Hirschman Index (HHI) in relation to its effect on large, public transactions. However, as smaller community banks look to merge with other small banks in their markets or in adjacent communities, the HHI is increasingly becoming an issue. This often overlooked component of a merger could cause significant regulatory impacts on the structure and success of a transaction. For example, one small community bank recently had to withdraw from a bid process because of insurmountable HHI concerns cited by the federal regulators.

What is the HHI?
The HHI is a commonly accepted measure of market concentration that is generally used when evaluating business combinations. It is calculated by squaring the market share of each bank competing in a given market and then summing the resulting numbers. As the number of banks in a market decreases or the disparity in size increases, the HHI will increase proportionately. A moderately concentrated market has an HHI of 1,500 to 2,500 points, and anything greater than 2,500 is considered heavily concentrated. Generally, if an acquisition will increase the HHI by more than 200 points, it will be heavily scrutinized by the federal regulators and may ultimately be rejected.

How Can You Assess Your Bank’s HHI Market?
The U.S. Department of Justice and the Federal Reserve created the Competitive Analysis and Structure Source Instrument for Depository Institutions (CASSIDI) to allow financial institutions to easily determine the effect that a proposed merger would have on the market’s HHI. It is a simple tool that allows anyone to run the HHI calculation on the financial institution of his or her choosing. The CASSIDI calculation can help bank management teams determine the necessary steps they may have to undertake in order to get a deal approved.

As explained above, the HHI calculation takes into account all banks in a certain market. CASSIDI allows users to search the markets to determine which market that a deal would fall into. However, the DOJ and the Federal Reserve have the ability to amend the market to include a larger or smaller area in the HHI calculation. Therefore, while CASSIDI may be very helpful, it can be an imperfect indicator of the validity of your transaction under the HHI calculation. It is important to contact your local regulator to determine the exact market that would be used for your proposed transaction. Your regulator will be able to assist you in running a more exact calculation if you suspect your proposed transaction may increase the HHI by over 200 points.

Are Credit Unions Included in the HHI?
At this time, the CASSIDI calculation does not include any market share held by credit unions. However, regulators may consider including credit unions in the structural concentration calculations in the event an application exceeds the delegation criteria in a given market. Generally, credit unions may be included in these calculations if two conditions are met: first, the field of membership includes all, or almost all, of the market population, and second, the credit union’s branches are easily accessible to the general public. In such instances and at the regulator’s discretion, a credit union’s deposits will be given 50 percent weight. If a credit union has a significant commercial lending presence and staff available for small business services, then its deposits may be eligible for 100 percent weighting, though such an outcome is very rare.

How Can You Fix an HHI Issue?
If you perform an HHI calculation and find that your proposed transaction will exceed the 200 point threshold, there are a few options to consider. You can assert that there are mitigating factors at play, or that a broader market should be considered. Another common solution is to divest certain legacy or acquired assets. For example, financial institutions will sometimes sell a branch in markets where the two parties compete directly in order to complete a merger. Over the past 40 years, divestiture has become an important antitrust remedy for parties looking to complete their deals. That being said, divestiture may not always be practical in a merger of two small banks with limited branch locations.

Financial institutions continue to see a large volume of merger activity. The current costs of operating a bank indicate that this activity will continue to grow. While the HHI is an obvious concern for large deals, it should be on the radar of small community banks as well. Your bank’s board and management team should analyze the anti-competitive effects of any proposed transaction early in the negotiation process.

The Battle Is Back On for Checking Customers


As I was driving to a meeting the other week listening to the radio, I heard back-to-back commercials from two different banks about checking accounts. The first was a super-regional bank promoting that they would pay me $250 to move my checking account to them. The second, one of the mega banks (a top five bank in asset size) promoted a similar message but upped the incentive to $300 to switch.

When I got home later that day, I found a direct mail offer from another mega bank upping the incentive to $500.

CHASE500_card2.jpg

I looked closer at the conditions of these incentives and found a similar nuanced strategic objective. These banks (and a few others I found online making similar offers) are clearly not returning to the days of “open a free account, get a free gift.” They aren’t looking for just consumers willing to switch their account to a free account with no commitment other than the minimum balance to open requirement (usually less than $50).

Rather, they are looking for those willing to switch their relationships that require a certain level of funding and banking activity (direct deposit, mobile banking activation, etc.) to earn part or all of the cash incentive. And these banks aren’t offering a totally free checking account.

Recognizing this as the objective, I perused a major online marketing research company to look for competitive responses from community financial institutions and found hardly any similar monetary offers. Those that were similar were mainly promoted just on their respective websites.

So what do these large banks know about these types of offers that community financial institutions don’t know (or deem important enough) to mount a credible competitive response? Reading and listening to presentations made to stock analysts by big bank management reveal that they know they can simply out market smaller community financial institutions, which don’t have or want to devote the financial resources for incentives at these levels.

They also know these smaller institutions’ customers, namely millennials, have grown disenchanted with inferior mobile banking products, and are looking for superior mobile products that the larger banks typically have. They are capitalizing on a growing attitude taking place in the market regarding consumers who switch accounts — 65 percent of switchers say mobile banking was extremely important or important to their switching decision, according to a survey by Alix Partners.

So by out-marketing and out-innovating retail products, larger banks know the battle is on to attract profitable or quick to be profitable customers, traditional ones right down to millennials who never set foot in a branch, by offering an attractive “earned” incentive to move and providing better mobile products along with a wider variety of other retail products and services.

Now community bankers reading this may be thinking, “That’s not happening at my bank.” Well, you better double-check. Last year, 78 percent of account switchers nationally were picked off by the 10 largest U.S. banks (and 82 percent of younger switchers) at the expense of community banks. Community banks lost 5 percent of switcher market share and credit unions lost 6 percent, according to Alix Partners.

And once these larger banks get these relationships, they aren’t losing them. Take a look at JPMorgan Chase & Co. Chase Bank has driven down its attrition rate from over 14 percent in 2011 to just 9 percent in 2014 (an industry benchmark attrition rate is 18 percent). Also from 2010 to 2014, it has increased its cross-sell ratio by nearly 10 percent and average checking account balances have doubled.

With this kind of financial performance (not only by Chase but nearly all the top 10 largest banks), a negligible competitive marketing response from community institutions and a tentativeness to prioritize enhancing mobile checking related products, their cash offers from $250 to $500 to get consumers to switch accounts is a small price to pay.

Combining this with well-financed and marketing savvy fintech competitors also joining the battle to get customers to switch, the competitive heat will only get hotter as they attack the retail checking market share held by community institutions slow to respond or unwilling to do so.

So community banks and credit unions, what’s your next move?

How Community Banks Can Maximize Mortgage Revenues


With interest rates still at record low levels, there is still many opportunities for banks to grow their mortgage book of business. Niket Patankar, senior vice president of financial services for Sutherland Global Services, discusses ways banks can increase market share now and in the future.

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