Identify Your Customers Based On Need, Not Revenue


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

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

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

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

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

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

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

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

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

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

Identify Your Customers Based On Need, Not Revenue


segmentation-3-28-16.png

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

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

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

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

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

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

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

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

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

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

Time to Develop an M&A Survival Strategy


Thirty years ago there were a record high 18,000+ banks in the United States. We’re now down to around 6,700 with all indications pointing to further consolidation. Meanwhile, new bank charters have dwindled to near non-existence with one new bank opened between the end of 2010 and 2013.

  20 years ago 10 years ago Today
 Total number of institutions 12,644 9,129 6,739
 Total number of banks $1 – $50B in assets 554 553 642
 Total number of banks $50B+ in assets 8 27 37
 Total number of banks less than $500MM in assets 11,688 8,022 5,382

Between the number of industry disrupters trying to win a slice of the traditional banking business and the plethora of investment opportunities in other industries with less regulation, it’s easy to imagine the number of banks falling by a full 50 percent in the next 20 years.

For better or worse, banking has become a scale business. The costs of regulatory compliance, necessary investments in new technology, physical and digital channels, and thinning industry margins mean banks will either need to be of a certain size or have a defensible niche built on knowledge rather than transactions.

For the better part of the past decade, the folks at Cornerstone have touted the $1 billion asset threshold as a marker of scale. Because of our friends in Washington and the dizzying pace with which technology has changed our industry, I think the new threshold to reach in the next five to seven years is more in the $5 billion asset neighborhood. If my prediction bears out, the vast majority of M&A activity and consolidation will take place in the midsize bank space ($1 – $50 billion), either with smaller midsize banks buying community banks or banks at the upper end acquiring $5 and $8 billion banks.

I have always been a proponent of having a solid organic growth strategy, but midsize banks will need to develop AND execute upon a solid M&A strategy to survive. Most banks lamely describe their M&A strategy as “opportunistic,” which is code word for: “waiting for the investment banker to call with a proposed deal.” This simply won’t cut it in the fast-consolidating, commoditized industry we call banking today. Here are some key areas your M&A strategy should address.

  • Define Your Value Proposition. Define in financial AND human terms what makes you an attractive acquirer. The list of possibilities are endless: opportunities for stock value gains, opportunities for employee growth at a larger bank, track record of performance, a willingness to negotiate system choices, or a holding company type business model that allows the acquired bank to maintain its brand and management team.
  • Identify M&A Partners. Define filters to narrow down what targets make the list including qualities like geography, asset size, branch network, balance sheet mix, capital levels and niche businesses. Tools like the Federal Deposit Insurance Corp. website or SNL Financial can easily help you produce your target list. Stack rank your target list starting with the most attractive to the least by assigning weighted values to your filters.
  • Cultivate the Courtship. If you are the acquirer, you need an active outreach program that includes management, directors and shareholders, with the mix changing depending on the target. Your outreach program needs to involve a consistent manner of communicating your value to your targets. Get creative. Courtship could involve providing shared services for a common core platform, inviting select management and directors to your strategic planning session, or offering to outsource from your niche expertise like trust and wealth management platforms.
  • Define the Merger Value. Once you find a receptive bank, you will need to paint a clear picture of the value a merger will bring to shareholders and management of the target bank that goes beyond the pro forma financial model. The target bank will want to know about management team composition, board seats, branch closures, surviving systems and products, efficiency targets, headcount reductions, and branding, to name a few.
  • Conduct Due Diligence and Begin Negotiations. If you’ve made it this far, the M&A strategy and framework you have laid out is obviously working. Now, the formal process begins.

At the end of the day, midsize banks have two choices: rely on a decades-old organic growth strategy combined with opportunistic M&A, or get in the game and execute upon a carefully defined M&A strategy. The risk of being left behind as other midsize banks scale up is not one I would want to take with my bank.

Could a Republican President Mean More M&A Activity?


Banking-Industry-8-12-15.pngWith the first prime time Republican primary debate of the 2016 election cycle in the rear view mirror, we have all gotten an inkling of what the candidates think about the banking industry. I did take particular note of Senator Marco Rubio when he stressed the importance of repealing the Dodd-Frank Act. As Commerce Street Holdings’ CEO shared in an article on BankDirector.com, “many bankers feel that given the legislative and regulatory environment coupled with low rates, low margins, low loan demand and high competition, growth is very difficult.”  So repealing Dodd-Frank is a dream for many officers and directors, and Rubio is echoing their concerns.

Senator Rubio’s comments build on those of former Texas Governor Rick Perry, who recently laid out a sweeping financial reform agenda earlier. He believes the biggest banks need to hold even more capital—or Congress should possibly reinstitute elements of the Glass-Steagall Act. While his campaign appears to be winding down, I do agree with his call for government to work harder to “level the playing field” between Wall Street banks and community institutions.

With so much political scrutiny already placed on banks, it is interesting to think of the pressures being placed on institutions to grow today. On one side, you have politicians weighing in on how banking should operate. On the other, regulatory and investor expectations are higher now than in recent years. Buckle up, because I believe the coming election will only further encourage politicians with opinions, but little in the way of detailed plans, about “revitalizing” the economy.

Against this political backdrop, today’s business environment offers promising opportunity for bold, innovative and disciplined executives to transform their franchises. But I believe regulatory hurdles are making it tougher to do deals. Indeed, the recently approved merger of CIT Group and OneWest Bank creates a SIFI [Systemically Important Financial Institution] which will have to submit to increased regulation and scrutiny. However, when the deal was first announced, CIT’s CEO, John Thain, suggested that his purchase of OneWest could spur other big banks to become buyers. A year later and such activity has yet to be seen.

I see the absence of bigger deals reflecting a reality where any transaction comes with increased compliance and regulatory hurdles. For CIT, going over the $50 billion hurdle meant annual stress tests will now be dictated by the government, as opposed to run by the bank. The institution will have to maintain higher capital levels. Thain seems to think that those added costs and burdens are worth it. By the lack of action, other banks haven’t yet agreed.

Without a doubt, regulatory focus has impacted strategic options within our industry. For instance, we learn about CRA [Community Reinvestment Act] impacting deals and also find fair lending concerns and/or the Bank Secrecy Act delaying or ending potential mergers. Consequently, deals are more difficult to complete. As much as a bank like CIT can add cost savings with scalability to become more efficient, you can understand why banks in certain parts of the country need to debate whether it is better to sell today or to grow the bank’s earnings and sell in three to five years.

The evidence is clear that big banks are not doing deals. Maybe a GOP victory in the next election will thaw certain icebergs, creating a regulatory environment more friendly to banks. While regulators have to comply with existing laws, the leadership of regulatory institutions is appointed by the president and the tone at the top is critical in interpreting those laws. Until we see real action replace cheap talk, I’m looking at CIT as an outlier and simply hoping that political rhetoric doesn’t give false hope to those looking to grow through M&A.

What New Directors Are You Adding to Your Board?


board-effectiveness-7-17-15.pngWhat types of new directors are banks adding to their boards? The following are responses from DirectorCorps-member banks, a diverse bunch of publicly traded and private banks ranging in asset size from less than $100 million to $10 billion. While hardly a scientific poll, the responses show that banks are looking for specific expertise that helps them accomplish their strategic goals. For small institutions, that primarily means adding board members who can bring business to the bank as well as knowledge about their communities. It may also mean mergers and acquisition expertise or financial acumen. Interestingly enough, no one said they had recently added a risk expert or a technology expert, types that some of the larger banks are increasingly adding to their boards.

Here is what we asked:

Q. If you have added new directors to the board in the past two years, what skills or backgrounds do they have and how are they different from the skills or backgrounds of existing members? Please write 2-3 sentences, telling why these skills are now important to your bank.

When we started our bank in 2000, our board was composed almost entirely of successful entrepreneurs. Our board is still strongly entrepreneurial in nature but as the bank has grown, we have added new members with more corporate executive level experience to enhance our perspective on the issues and opportunities facing a more complex and growing organization. Going forward, we may need to add member(s) who meet the regulatory requirements of a “financial expert” to give our audit committee greater depth and to provide for future succession as audit committee chairman.

—Director of a publicly traded bank with more than $1 billion in assets

Our bank added two new directors in 2014. Their respective skill sets and backgrounds further broadened our board’s capabilities in two key areas: expanding our community development efforts and the growth of our business banking enterprise. One director is the executive director at one of our community’s largest nonprofits; the other is the chief executive of a well-known business with significant ties to the local and regional business communities. In both cases, they have contributed to these areas and others in the short period they’ve been with us.

—CEO of a privately owned bank with more than $1 billion in assets

We added a new director last fall [who] is from one of our newer and potentially large marketing areas. He is a lawyer with a background in banking law and bank M&A. These are two areas where we have no board member with expertise. While we have acquired banks in the past, we don’t have anyone with his kind of expertise.

—Director of publicly traded bank with more than $2 billion in assets

Our last two directors are at the top of their respective professions.  They are well connected in the business community which is good for new business development at our bank. Our board has a business development culture. The new directors bring additional prospects to the table.

—Director of publicly traded bank with more than $1 billion in assets

Will Nonbanks Impact Bank M&A?


Bank-manda-6-16-15.pngBank boards should be particularly mindful of shadow banking’s strong growth. Earlier this month, FT Partners, an investment bank, presented its “CEO Monthly Securities and Capital Markets Technology Market Analysis.” Focused exclusively on the financial technology (FinTech) sector, the company lays out investor interest and pricing expectations for FinTech companies. When it comes to values assigned financial technology companies, there is quite a juxtaposition when compared to traditional banks, brokerage firms and trust service banks.

FT Partners also lists recent funding announcements with details on each FinTech company.

With lots of money—and potential customers—at stake, I believe more banks should consider aggressively growing one’s franchise through M&A than in previous years. Competition comes in so many shapes and forms that sitting idle while others take market share does not bode well. This is especially true for the 5,705 banks under $1 billion in assets as challengers offer tools and products designed for small businesses and borrowers—two key sources of revenue for community banks.

Among the most well known stealing market share from banks are Lending Club and Prosper, online lending marketplaces that offer loans to consumers and small business alike, funded by private investors and institutional money. On a side note, Goldman Sachs just entered the fray, announcing plans to offer an online lending platform to compete with the online lenders.

Although the biggest banks are not—and can’t be—pursuing an acquisition, this does not mean they are not aggressively trying to grow. Many continue to explore opportunities by making deals for smaller product/technology/capability-based companies, investing in analytics and expanding digital offerings.

With competition coming from both the top of the market and from non-traditional players, it is imperative for community banks to focus on improving efficiencies and enhancing organic growth prospects. The corollary to this is as big banks invest in customer acquisition, and non-traditional players continue to eat away at earnings potential, bank CEOs and boards need to think about what a successful deal looks like—and when such a deal can be executed.

Yes, I realize small banks are becoming more willing to consider a sale as the future operating environment, regulatory standards and valuations remain uncertain. However, being open to the idea and aggressively pursuing opportunities are two different business philosophies. Building an institution with the ability to generate earning assets at relatively high yields will become increasingly valuable. Positioning a bank with diverse revenue streams not just builds value but provides a buffer from nonbanks looking to steal customers.

Many small banks in the country simply don’t have the currency to do acquisitions, and they’re unwilling to sell. I believe many of those banks are in trouble.

At a time when retail banks are facing increasing pressure from non-traditional entrants that offer retail banking services, now is the time to think bigger, not just because of the economics of a deal, but because of the competition lining up.

Mind These Gaps


5-13-15-Al.pngProbably one of the worst moments for a bank board and management team is to make an acquisition and find out it was a bad one. Over the past few years, it strikes me that three pitfalls typically upend deals that, on paper, looked promising:

  • Loss of key talent/integration problems;
  • Due diligence and regulatory minefields; and
  • Bad timing/market conditions.

While timing is everything, I thought to address the first two pitfalls here.

Losing Key Talent
A CEO with experience selling a bank tells me that number one on her list is to “personally reach out to top revenue generators ASAP and let them know they are going to have a great future in the combined company. It always amazes me how key leaders think they can wait on that while they talk to staff folks.”

But don’t stop there. If the merger is designed to significantly reduce costs and there is a lot of overlap, your staff will know that there are going to be significant job losses. “My advice, be honest,’’ the CEO says. “If you have a plan or process, tell them what it is. If you don’t tell them, you will let them know the second you do. Don’t sugar coat it. Call the key ones you know you will need with a retention offer ASAP.”

This advice had me seeking the counsel of Todd Leone, a principal with the management consulting firm of McLagan. Leone suggests those in key positions with change-in-control contracts usually stay as they are going to get paid.  Also, those in true key positions negotiate at the time of the deal to stay on after the merger. However, it can be complicated to retain the next level of staff.  As Todd says, “[It’s best to] negotiate at time of deal.”

Regulatory and Due Diligence Minefields
Now, as much as the drain of talent threatens the long-term success of a deal, there are other minefields to navigate. Bill Hickey, principal and co-head of the Investment Banking Group at Sandler O’Neill + Partners, cautions me that in today’s interest rate environment, significant loan pay-downs could be looming.

Another due diligence matter is an IT contract that requires large termination fees. Aaron Silva, the president and CEO of Paladin fs, says that banks need to implement terms and conditions into their agreements ahead of time that protect shareholders from unreasonable termination risk, separation expense and other obligations that may impact any M&A strategy.

Building on these talent and technology risks, John Dugan and Rusty Conner, both partners at the law firm of Covington & Burling, say that in today’s bank M&A market, “all of the historical issues related to pricing, diligence, and integration remain very relevant, but there are three issues that have taken on new prominence thereby impacting execution and certainty of closing.”  They are:

  • The reaction of the regulators to the proposed transaction—particularly if the acquiring institution is approaching a designated size threshold;
  • Protests by community groups—which can materially delay a transaction even if the complaint is without merit—especially [since] these groups are now targeting much smaller deals than ever before; and
  • Shareholder suits by the acquired institution’s shareholders—which are also increasingly making their way to smaller deals.

As Dugan opines, “parties need to anticipate and build into their pricing and timing the impact of these factors.”

Their views complement those of Curtis Carpenter, managing director of Sheshunoff & Co. He’s of the opinion that in today’s market, “regulatory and compliance matters have become critical components for both the seller and buyer. It is more important than ever for sellers to put in place generous pay-to-stay bonuses for key personnel who are in positions likely to be eliminated in the merger. The heightened regulatory scrutiny surrounding the merger process can result in long approval periods—sometimes many months.” 

Where most bank mergers fail isn’t in the transaction itself. No two deals are alike, but addressing these challenges is simply good business.