One Bank Reworks a Key Metric for the Pandemic Era

One of the most efficient banks in the country is measuring its performance using a new metric that captures how the pandemic has changed the operating landscape.

Johnny Allison, chairman and CEO of Conway, Arkansas-based Home BancShares, debuted a new metric during bank unit Centennial Bank’s third-quarter 2020 earnings announcement that measures the bank’s performance and earnings power. The metric provides insight into how well a bank is able to convert revenue into profits; it comes at a time when bank provisions and allowances remain elevated, and generally staid earnings results are lumpier and noisier than ever.

“I love the numbers and I love to play with them,” Allison says in an interview, describing how he came up with the approach. He was looking at the third-quarter earnings table for the $16.4 billion bank and saw total revenue and pre-tax, pre-provision net revenue listed near each other.

“When I looked at those, I thought ‘[Wow], look how much we brought down pre-tax pre-provision out of the total revenue of this corporation,” he says. “That got my attention. I thought ‘I wonder what the percentage that is?’”

The non-GAAP metric is derived from two items in the earnings statement: pre-tax net income, excluding provision for credit losses and unfunded commitment expense, or PPNR, divided by total net revenue. Allison calls it “P5NR” or “profit percentage.” An efficient operator, Home BancShares converted 59.28% of its net revenue into profits before taxes and provision expense in the third quarter of 2020. It was 59.19% in the fourth quarter.

The metric has its fans.

“[P5NR] measures how much of a bank’s revenue turns into profits before taxes and provision expense,” wrote Christopher Marinac, director of research at Janney Montgomery Scott, in an October 2020 report. “We favor this new metric since it shows [how] much $1 of revenue is turned into core profits — the higher, the better.”

P5NR is related to another popular metric on the earnings report: the efficiency ratio. The ratio measures how effectively a bank spends money; the lower the ratio, the more efficient a bank is. Banks can achieve a low efficiency ratio either through keeping costs low or increasing revenue, known as positive operating leverage. Home’s third-quarter 2020 efficiency ratio was 39.56%; it was 39.64% in the fourth quarter.

Allison calls P5NR the “reverse” of the efficiency ratio because a higher number is better, but ties the figure to positive operating leverage. He says Donna Townsell, now director of investor relations, did much of the work starting in 2008 that made the bank more efficient. While the efficiency ratio is still useful, PPNR and P5NR show how much revenue a bank converts to profits, especially in an environment with high credit costs.

P5NR also speaks to the industry’s focus on bank PPNR, which the Federal Reserve defines as “net interest income plus noninterest income minus noninterest expense.” In an interview, Marinac says the metric came into focus as part of the annual stress test exercise that big banks must complete — capturing the earnings at a bank before it deducts credit costs. It’s not surprising the metric has been popular with analysts trying to look past the lumpiness of quarterly results to the underlying earnings power of a bank. Building up reserves subtracts from earnings, and releasing them can pump up earnings — both activities that can make it hard to assess the underlying revenue and profits of a bank.

Home included the figure for third and fourth quarter 2020 earnings, along with backdated calculations for previous quarters, but is cautious about leading with it. Like many bank-specific metrics, it is non-GAAP — a profit calculation that doesn’t follow a standard, required calculation for companies to disclose under generally accepted accounting principles. Allison says Home also includes the number in its monthly profit and loss statement and plans to include it in future earnings reports.

Not surprisingly, Home BancShares is touting a metric that makes the bank look good. Marinac’s report pointed out that Home Bancshares had the best P5NR of all banks early reporting during the third quarter of 2020, but says the metric still has application for other banks.

“It’s not hard to do the math. When Johnny said it, it made a ton of sense,” he says. “It makes our job easy, and it’s a simple concept that everyone should follow.”

Tackling Credit Risk Uncertainty Head On

I’ve spoken to many bankers lately who know, intuitively, that “the other credit-quality shoe” will inevitably drop.

Despite federal stimulus initiatives, including the latest round of Paycheck Protection Program loans from the Small Business Administration, temporary regulatory relief and the advent of coronavirus vaccines and therapies, bankers realize that so-called credit tails always extend longer than the economic shocks that precipitate changing credit cycles. Although the Wall Street rebound has dominated U.S. business news, commercial bank credit lives on Main Street — and Main Street is in a recession.

During the Great Recession, the damaging impact on bank portfolios was largely focused on one sector of the housing industry: one-to-four family mortgages. Unlike that scenario, coronavirus’ most vexing legacy to bankers might be its effect throughout multiple, disparate businesses in loan portfolios. Bankers must now emphasize dealing with borrowers’ survivability than on growing their investment potential. Government actions during the pandemic averted an economic calamity. But they’ve also masked the true nature of credit quality within our portfolios. These moves created unmatched uncertainty among bank stakeholders — anathema to anyone managing credit risk.

Even amid the industry’s talk of renewed merger and acquisition activity this year, seasoned investment bankers bemoan this level of ambiguity. The temptation to use 2020’s defense that “it’s beyond our control” likely won’t cut it in 2021. All stakeholders — particularly regulators — will expect and demand that banks write their own credible narrative quantifying its unique credit risk profile. They expect bankers to be captain of their ships.

Effectively reducing uncertainty — if not eliminating it — will be priority one this year in response to those expectations. The key to accomplishing this goal will lie largely with your bank’s idiosyncratic, non-public loan data. Only you are privy to this internal information; external stakeholders and peers see your bank through the lens of public data such as call reports. In order to address this concern, I advise bankers to take five steps.

Recognize the trap of focusing on the credit metrics of the portfolio in its entirety.
While tempting, an overall credit perspective can miss the divergent economic forces at work within subsets of the portfolio. For every reassurance indicating that your bank’s credit is  performing well on the whole, there’s the caveat of focusing on the forest while the trees may show patches of trouble.

Create portfolio subsets to identify, isolate credit hotspots.
Employ practical and affordable tools that allow your credit team to identify potential credit hotspots with the same analytical representations you’d use in evaluating the total portfolio. For instance, where do bankers see the most problematic migrations within pass-rated risk grades? What danger signs are emerging in particular industries? Concentrated assessments of portfolio subsets are far more informative and predictive compared to the bluntness of the regulatory guidance on commercial real estate lending.

Drill down into suspect or troubled borrowers.
Any tool or analysis that provides aggregated trends, even within portfolio subsets, should produce an inventory of loans that make up those trends. Instantly peeling the onion down to the borrowers of most potential concern connects the quantitative data to qualitative issues that may need urgent attention and management.

Adopt an alternative servicing process for targeted loans.
These are not ordinary times. Redirecting credit servicing strategies to risk hotspots will prove beneficial. Regulators rightfully hold banks accountable for their policies; I recommend nuanced and enhanced servicing, stress testing and loan review protocols. And accordingly, banks should consider appropriate adjustments to their written procedures, as needed.

Write your own script for all of the above — the good and bad.
All outside stakeholders, especially regulators, must perceive banks as the experts on their credit risk profile. The above steps should enable banks, credibly, to write these scripts.

There is a proven correlation between the early detection of credit problems and two desired outcomes: reduced levels of loss and nonperformance, and greater flexibility to manage the problems out of the bank. Time is of the essence when ferreting out stressed credits. The magnitude of today’s credit uncertainties adds to the challenge of realizing this maxim — but they can be overcome.

IntelliCredit will present as part of Bank Director’s Inspired By Acquired or Be Acquired, an online board-level intelligence package for members of the board or C-suite. This live session is titled “How Best To Deal With 2021 Credit Uncertainties” and is February 9 at 2:00pm EDT. Click here to review program description.

A Pandemic-Proof Process Transformation Game Plan

Initiatives without execution are dreams that never become plans.

At MX, we’re helping banks use financial data to improve the financial lives of more than 30 million people. Banks need a secure foundation to build on at a time when profits have stalled, laying the groundwork for ways to increase revenue, offset losses and impact to your bottom line.

To get a better understanding of what financial institutions are focusing on, we recently surveyed more than 400 financial institution clients for their top initiatives this year and beyond. We believe these priorities will gain even more importance across the industry. The top five initiatives are:

  1. Enabling Emerging Technologies, Continued Innovation
  2. Improving Analytics, Insights
  3. Increasing Customer Engagement
  4. Leveraging Open Banking, API Partnerships
  5. Strategically Growing Customer Acquisition, Accounts

But identifying the initiatives to prioritize is merely the first step. Banks need to align their top initiatives throughout their organization to lay down the project’s foundation. Sustainable transformation is not accomplished by simply plugging in a new technology or process. True transformation requires a shift in the way the organization operates day to day. Without a commitment to changing the way you do business your efforts will be stunted and you will not achieve the outcomes promised in the initial business case.

The first thing banks need to do is ensure that their organizational goals translate top down, from executive leadership through department levels, all the way to individual contributors. If certain priorities don’t align from top to bottom, it’s important to address these outliers right away to ensure everyone is moving ahead in the same direction.

Banks will also want to make sure they’re effectively tracking their performance against the company strategy and organizational vision through Objectives and Key Results (OKRs) and department metrics. Look at the top initiatives in the industry and see how they align within your bank’s own organizational goals.

This practice might reveal that that not all initiatives work together. Three critical questions to ask during this process are: Are we focused on understanding and solving the needs of our customers? How do we shift priorities to align with where we should be going as an organization? Where is overlap or conflict of priorities between all stakeholders?

Here’s a brief overview of how banks can create a game plan to guide their process transformation:

1. Align OKRs With Vision
Break down your bank’s vision into objectives. This can be anything from helping employees develop the right skills to acquiring the right technologies and so on. From there, break those objectives down into quarterly Objectives and Key Results and translate them across each department and individual employee.

2. Specify Metrics
Ensure your bank has the right metrics in place for measuring your OKRs. The more clarity your bank can get around what you’re measuring and why, the easier it will be to understand if your efforts’ progress and success.

3. Find Champions
Identifying champions within your organization is a great way to move things forward. These critical stakeholders will be just as motivated as you to get certain things done. If you’re considering new technologies or new programs, work with them to translate the need and opportunity to the executive suite.

4. Identify Trusted Partners 
Now’s the time to lean on trusted partners for support. Your customers are actively looking to you for alternative digital solutions to manage their money. Instead of going at it alone and trying to build everything in-house, it may be faster to partner with financial technology firms and other third parties that can get your products to market more efficiently.  

At MX, we’re working closely with our partners and clients to ensure they have the tools they need to optimize their digital experiences and complete their top initiatives, even in these challenging times. Banks must create comprehensive strategies around their digital channels and offerings, so they can continue to lead during uncertainty and change. This is a valuable opportunity for all of us to be better to one another and to the communities we serve.

Currency Rates Become Wildly Important

As we’re seeing with the COVID-19 crisis, very little in our economy is purely local.

Currency markets are one example. The markets are reflections of what is happening globally. They serve as the ultimate sentiment indicator, telling us what the future may bring for a country, region or the world at large.

But the sentiment can be costly — changes in currency rates can alter business costs in the blink of an eye. Still, many have no understanding of how currencies work, an opportunity ripe for your bank to offer some education.

While most would assume that the stock market is the biggest asset class on the trade block, it pales in comparison to currency trading volumes. Bloomberg reports that $6.6 trillion USD traded daily in 2019.

Since the 1920s, the U.S. dollar has enjoyed a long period of stability. This has allowed most business owners to go about their lives barely giving currency a fleeting thought, except perhaps when they’re traveling abroad or making a major international purchase.

But here’s another surprising undercurrent to this impression: Much of what we think of as domestic buying is an illusion.

Your business clients may buy a product from a local manufacturer, but where does that manufacturer buy its machinery? Where do they buy supplies to create their goods? Even local businesses tend to have international partners somewhere in their supply chains. Because of this, prices of the local goods are affected by currency rates.

Further, the world of currencies is surprisingly abstract. The U.S. dollar doesn’t have a single price. It has a unique price relative to the 200 or so other currencies in the world.

All of those prices fluctuate moment to moment because currency rates aren’t anchored by specific metrics. Instead, they reflect how buyers feel about the economic outlook of one country compared to another at any given time.

Buyers speculate about a country’s future inflation and interest rates, as well as intangibles like politics and socioeconomics. The pricing of currency is more art than science; more emotion than math. It’s enough to make heads spin.

The speculative nature of currency valuations makes them volatile. They are highly susceptible to world affairs; bad news can easily send them into an overnight tailspin. The global coronavirus crisis is the most recent example of this, sending currencies around the world reeling.

This is why your business clients can no longer be complacent. Outside the pandemic, previously stable countries have become unsettled by climate change. Once developing economies are maturing. It’s no longer the case that any particular currency is the safest bet. More and more, the name of the game is currency diversification.

But the good news is, your bank can help business clients protect themselves from currency fluctuations. The first step is to figure out how they’re at risk.

Advise business owners to figure out what percentage of their costs are in foreign currencies. If rates changed and suddenly those costs were 15% higher, could they absorb it? What about 20%? What is their back-up plan if they can no longer afford these suppliers?

Based on what they discover, your clients should consider diversifying their business costs through currency to help reduce the chances of over-exposure to any particular one.

Finally, advise your clients to increase their awareness of currencies. Suggest that they select a few that most affect their business and track them to see how their movements could affect their company’s well-being over time.

It’s true that uncertainty is always part of life, but preparation creates resilience.

How Consolidation Changed Banking in Five Charts

Over the past 35 years, few secular trends have reshaped the U.S. banking industry more than consolidation. From over 18,000 banks in the mid-1980s, 5,300 remain today.

Consolidation has created some very large U.S. banks, including four that top $1 trillion in assets. The country’s largest bank, JPMorgan Chase & Co., has $2.7 trillion in assets.

Historically, very large banks have been less profitable on performance metrics like return on average assets (ROAA) and return on average tangible common equity (ROTCE) than smaller banks. The standard theory is that banks benefit from economies of scale as they grow until they reach a certain size, at which point diseconomies of scale begin to drag down their performance.

This might be changing, according to interesting data offered Keefe, Bruyette & Woods CEO Thomas Michaud in the opening presentation at Bank Director’s 2020 Acquire or Be Acquired conference. The rising profitability of large publicly traded banks and one of the underlying factors can be seen in five charts from Michaud’s presentation.

Profitability is High

Profitability
Banking has been highly profitable since the early 1990s — except, of course, for that big dip starting in 2006 when earnings nosedived during the financial crisis. The industry’s profitability reached a post-crisis high in the third quarter of 2018 when its ROAA hit 1.41%. Keep in mind, however, this chart looks at the entire industry and averages all 5,300 banks.

Banking 2016

Sweet Spot of Profitability
Banking is also highly differentiated by asset size: many very small institutions at the bottom of the stack,  four behemoths at the top. Michaud’s “sweet spot” in banking refers to a specific asset category that allows banks to maximize their profitability relative to other size categories. They have enough scale to be efficient but are still manageable enterprises. In 2016, this sweet spot was in the $5 billion to $10 billion asset category, where the banks’ pre-tax, pre-provision income was 2.32% of risk weighted assets.

Banking 2019

Sweet Spot Shifts
It’s a different story three years later. In 2019, the category of banks with $50 billion in assets and above captured the profitability sweet spot, with pre-tax, pre-provision income of 2.43% of risk weighted assets. What’s especially interesting about this shift is that, by my count, there are just 31 U.S. domiciled banks in this size category. (I excluded the U.S. subsidiaries of foreign banks, but included The Goldman Sachs Group and Morgan Stanley.) Of course, these 31 banks control an overwhelming percentage of the industry’s assets and deposits, so they wield disproportionate power to their actual numbers. But what I find most interesting is that as a group, the biggest banks are now the most profitable.

Big Banks

Big Bank Profitability
Even the behemoths have stepped up their game. You can see from the chart that KBW expects five of the six big banks — Bank of America Corp., JPMorgan, Wells Fargo & Co., Morgan Stanley and Goldman Sachs — to post ROTCEs of 12% or better for 2019. And some, like JPMorgan and Bank of America, are expected to perform significantly better. KBW expects this trend to continue through 2021, for the most part. What’s behind this improved performance? Buying back stock is one explanation. For example, between 2017 and 2021, KBW expects Bank of America to have repurchased 27.6% of its outstanding stock at 2017 levels. But there is more to the story than that.

bank share

Taking Market Share
The 20 largest U.S. banks have aggressively grown their national deposit market share – a trend that seems to be accelerating. Beginning during the financial crisis in 2008, the top 20 began gaining market share at a faster rate than the rest of the industry. The differential continues to widen through at least the third quarter of last year. But the financial crisis ended over a decade ago, so a flight to safety can no longer explain this trend. Something else is clearly going on.

Consumers across the board are increasingly doing their banking through digital channels. Digital banking requires a significant investment in technology, and this is where the biggest banks have a clear advantage. Digital has essentially aggregated local deposit markets into a single national deposit market, and the largest banks’ ability to tap this market through technology gives them a significant competitive advantage that is beginning to drive their profitability.

Having too much scale was once a disadvantage in terms of performance — that may no longer be the case. Banking increasingly is becoming a technology-driven business and the ability to fund ambitious innovation programs is quickly becoming table stakes.

One Bank’s Approach to Improving Its Culture

Merriam-Webster defines culture as “the set of shared attitudes, values, goals, and practices that characterizes an institution or organization.” These attributes are central to a company’s success.

Corporations with strong cultures tend to have financial performance that matches, according to studies that have investigated the relationship. The corporate review website Glassdoor found in 2015 that the companies on its “Best Places to Work” list, as well as Fortune’s “Best Companies to Work For” list, outperformed the S&P 500 from 2009 to 2014 by as much as 122%. In contrast, Glassdoor’s lowest-rated public companies underperformed the broader market over the same period.

Unlike the financial metrics banks rely on to measure their performance, culture is harder to measure and describe in a meaningful way. How can a bank’s leadership team — particularly its board, which operates outside the organization — properly oversee their institution’s cultural health?

“A lot of boards talk about the board being the center of cultural influence within the bank, and that’s absolutely true,” says Jim McAlpin, a partner at the law firm Bryan Cave Leighton Paisner and leader of its banking practice group. As a result, they should “be mindful of the important role [they] serve [in] modeling the culture and forming the culture and overseeing the culture of the institution.”

Winter Haven, Florida-based CenterState Bank Corp., with $17.1 billion in assets, values culture so highly that the board created a culture-focused committee, leveraging its directors’ expertise.

CenterState wants “to create an incredible culture for their employees to enjoy and their customers to enjoy,” says David Salyers, a former Chick-fil-A executive who joined CenterState’s board in 2017. He’s also the author of a book on corporate culture, “Remarkable!: Maximizing Results through Value Creation.”

Salyers knew he could help the bank fulfill this mission. “I want to recreate for others what Truett Cathy created for me,” he says, referring to the founder of Chick-fil-A. “I love to see cultures where people love what they do, they love who they do it with, they love the mission that they’re on, and they love who they’re becoming in the process of accomplishing that mission.”

Few banks have a board-level culture committee. Boston-based Berkshire Hills Bancorp, with $13.2 billion in assets, established a similar corporate responsibility and culture committee in early 2019 to oversee the company’s corporate social responsibility, diversity and inclusion, and other cultural initiatives. Citigroup established its ethics, conduct and culture committee in 2014, which focuses on ethical decision-making and the global bank’s conduct risk management program — not the experience of its various stakeholders.

CenterState’s board culture committee, established in 2018, stands out for its focus on the bank’s values and employees. Among the 14 responsibilities outlined in its charter, the committee is tasked with promoting the bank’s vision and values to its employees, customers and other stakeholders; overseeing talent development, including new hire orientation; advising management on employee engagement initiatives; and monitoring CenterState’s diversity initiatives.  

The committee was Salyers’ suggestion, and he offered to chair it. “I said, ‘What we need to do, if you want to create the kind of culture you’re talking about, [is] we ought to elevate it to a board level. It needs to get top priority,’” he says. “We’re trying to cultivate and develop the things that will take that culture to the next level.”

As a result of the committee’s focus over the past year, CenterState has surveyed staff to understand how to make their lives better. It also created a program to develop employees. These initiatives are having a positive impact on the employee experience at the bank, says Salyers.

Creating a culture committee could be a valuable practice for some boards, particularly for regional banks that are weighing transformative deals, says McAlpin. CenterState has closed 11 transactions since 2011. In January, it announced it will merge with $15.9 billion asset South State Corp., based in Columbia, South Carolina. The merger of equals will create a $34 billion organization.  

“At the board level, there’s a focus on making sure there is a common culture [within] the now very large, combined institution,” says McAlpin, referencing CenterState. “And that’s not easy to accomplish, so the board should be congratulated for that … to form a [culture] committee is a very good step.”

CenterState’s culture committee leverages the passion and expertise of its directors. Both Salyers and fellow director Jody Dreyer, a retired Disney executive, possess strong backgrounds in customer service and employee satisfaction at companies well-regarded for their corporate culture. While this expertise can be found on the boards of Starbucks Corp. and luxury retailer Nordstrom, few bank boards possess these traits.

Focusing on culture and the employee experience from the top down is vital to create loyal customers.

“The best companies know that culture trumps everything else, so they are intentional about crafting engaging and compelling environments,” Salyers wrote in his book. “A company’s culture is its greatest competitive advantage, and it will either multiply a company’s efforts, or divide both its performance and its people.”

The Evolution of Strategic Business Objectives in Annual Incentive Plans


incentive-8-19-19.pngBoards are increasingly looking for ways to appropriately align pay and performance for bankers in the face of the disruptive changes in the industry.

Post-financial crisis, many bank boards shifted to a scorecard approach as a way to improve their compensation governance and accountability. However, industry disruption has sparked an evolution of the scorecard itself.

Before the financial crisis, determining annual bonus payouts at banks was a singular, annual event. The compensation committee and the CEO compared the bank’s current financial results to the prior year, assessed the operating environment, considered last year’s bonus pool and adjusted bonus accruals accordingly. Higher performers got a little more than prior year; poor performers looked for new jobs.

Following the financial crisis, a search for improved compensation governance and accountability ushered in a movement to construct incentive plans with payouts specifically tied to financial outcomes. This resulted in the popular financial scorecard approach used by many banks today.

Most scorecards include “hardwired” financial goals (usually earnings per share, net income and return on equity), banking-specific metrics (deposits, credit quality metrics and expense management) and a component that reflects “individual” or “discretionary” evaluations of performance.

Scorecards have served the industry well and addressed concerns that the lack of transparency into banking incentive plans resulted in shareholders being unclear of exactly what performance they were rewarding. The industry is now in the midst of a new phase of disruption that has banks reexamining their business models and entering a period of significant transformation.

In response, boards are increasingly enhancing the qualitative component of their scorecards to add balance and encompass the progress executives have made against clearly articulated strategic business objectives (SBOs). These strategic components balance the “backward-looking” nature of financial metrics with a “forward-looking” assessment that focuses on improving future financial performance.

Trends in Strategic Business Objectives
An SBO is a goal or metric that generally supports a key business priority and can be measured and objectively evaluated. For many boards, delivering against SBOs is critical to ensuring sustainability of their franchise. While growing earnings per share is a proven measure of current business success, achieving other critical outcomes is essential to creating long-term value for shareholders.

Detailed SBOs are specific to each bank and reflect where the bank is in its life cycle or period of transformation. Recently, we have observed banks incorporating the following eight categories into their SBOs for bank bonus plans:

  1. Executing the Digital Strategy: Depending on the bank’s current digital state, this category evaluates the success of critical milestones, such as percentage of paperless customers, “app” rollout and usage rates and expansion of service offerings through the digital interface.
  2. Technology Enhancements: This can include initiatives such as cybersecurity upgrades, automated fraud detection and general infrastructure enhancements like enterprise resource planning rollout.
  3. Corporate Development: This objective centers on the bank’s execution of its M&A strategy. It reflects the board’s evaluation of acquisitions, divestitures and integrations throughout the year. Banks often set goals based on quality, rather than quantity, to avoid incentivizing “bad deals.”
  4. Branch Strategy: This rewards the expansion, contraction or footprint-specific goals tied to the bank’s strategy for brick-and-mortar branch presence.
  5. Fee-Income Initiatives: Boards want to compensate for successful growing non-interest income from existing products, new products and complimentary service offerings.
  6. Customer Metrics: This can be measured through various means, such as net promoter score, internal customer satisfaction ratings, call center resolution rates and client retention statistics.
  7. Compliance: This generally focuses on the performance against anti-money laundering (AML) objectives and other regulator-specific compliance priorities.
  8. Risk Management: Boards define this SBO by evaluating process-related rollouts, infrastructure enhancements and talent upgrades across the risk function.

Banks are looking to drive their key initiatives during this time of significant transition in the industry. To do so, they are increasingly using SBOs to underpin the strategic drivers of future value creation in their business. Linking these initiatives to annual incentive compensation can communicate the importance of the strategies to the organization, and align compensation to the successful execution of these strategies.

Getting your Digital Growth Strategy Right from the Start


Digital growth is only as good as the metrics used to measure it.

Growth is one of an executives’ most important responsibilities, whether that comes from the branch, through mergers and acquisitions or digital channels. Digital growth can be a scalable and predictable way for a bank to grow, if executives can effectively and accurately measure and execute their efforts. By using Net Present Value as the lens to evaluate digital marketing, a bank’s leadership team can make informed decisions on the future of the organization.

Banks need a well-thought-out digital growth strategy because of the changing role of the branch and big bank competition. The branch used to spearhead an institution’s growth efforts, but that is changing as branch sales decline. At the same time, the three biggest banks in the country rang up 50% of the new deposit account openings last year (even though they have only 24% of branches) as they lure depositors away from community banks, given regulators’ prohibition on acquisition.

Physical Branch Decline chart.pngImage courtesy of Ron Shevlin of Cornerstone Advisors

Even in the face of these changes, many institutions are nervous about adopting an aggressive digital growth plan or falter in their execution.

A typical bank’s digital marketing efforts frequently rely on analytics that have been designed for another business altogether. They may want to place a series of ads on digital channels or social media sites, but how will they know if those work? They may use data points such as clicks or views to gauge the effectiveness of a campaign, even if those metrics don’t speak to the conversion process. They will also track metrics such as the number of new accounts opened after the start of a campaign or relate the number of clicks placed in new accounts.

But this approach assumes a direct link between the campaign and the new customers. In addition, acquisition and data teams will spend valuable time creating reports from disparate data sources to get the proper measurement, instead of analyzing generated reports to come up with better strategies.

Additionally, a bank’s CFO can’t really measure the effectiveness of an acquisition campaign if they aren’t able to see how the relationships with these new customers flourish and provides value to the institution. The conversion is not over with a click — it’s continuous.

This leads to another obstacle to measuring digital growth efforts: communication. Banks use three internal teams to generate growth: finance to fund the efforts; marketing to execute and measure it; and operations to provide the workflow to fulfill it.

Each team measures and expresses success differently, and each has its inherent shortcomings. Finance would like to know the cost and profitability of the new deposits generated, to assess the efficiency of the spend. Marketing might consider clicks or views. Operations will report on the number of accounts opened, but do not know definitively if existing workflows support the market segmentation that the bank seeks.

There is not a single group of metrics shared by the teams. However, the CEO will be most interested in cost of acquisition, the long-term profitability of the accounts and the return on investment of the total efforts.

But it’s now possible for banks to see the full measurement of their digital campaigns, from the disbursement of funds provided by the finance group to the success of these campaigns, in terms of deposits raised and net present value generated. These ads entice prospects into the account origination funnel, managed by operations, who open accounts and deposit initial funds. Those new customers then go through an onboarding process to switch their direct deposits and bill pay accounts. The new customer’s engagement can be measured six to 12 months later for value, and tied back to the original investment that brought them in the first place.

Bank leadership needs to be able to make decisions for the long-term health of their organizations. CEOs tell us they have a “data problem” when it comes to empowering their decisions. For this to work, the core system, the account origination funnel and the marketing channels all need to be tied together. This is true Integrated Value Measurement.

Six Ways to Grow Treasury Department Revenue


retail-6-6-19.pngBankers looking to grow revenue from their treasury departments will need the support of branch staff to drive the effort.

Banks large and small sometimes struggle to maximize the lucrative opportunity of their treasury departments. To increase revenue, it is vital that employees in the branch discuss treasury products with new and existing customers. Here are six steps to get started.

Step 1: Create a Top-Down Directive
Everyone from the bank president to newly hired employees should understand the importance that treasury revenue plays in overall operations. Banks should not rely on branch staff to execute this initiative. Leadership must prioritize discussing and promoting treasury products if they hope to see a pickup in demand and improvement in revenue. All employees should be on board, and there should be a top-down directive from upper management on the importance of cross-selling treasury products.

Step 2: Set Goals and Metrics for Employees
After bank leadership has discussed the importance of treasury products and how they can serve customers’ needs, they should set measurable and attainable goals for branches and staff.

Banks should monitor and track the actual performance against the set goals over time and follow up on them. Recognize bank employees that meet or exceed expectations, which will boost motivation.

Step 3: Run an ACH Report
Tap into existing customers by mining Automated Clearing House data. Merchant services providers can provide a list of ACH descriptors that allows banks to identify customers who are using processing services outside the bank. From there, executives will need to determine what other products their existing customers are using. These leads are invaluable, and this is an easy way to identify cross-selling opportunities for existing customers who already have a trusted relationship with the bank. Banks should assign an employee to follow up with all the customers on these reports.

Step 4: Incentivize Referral Activity
Executives should incentivize their employees to promote treasury products through referral bonuses, commissions, referral campaigns and recognition. Use these campaigns regularly, but change them so they remain enticing for employees. One place to start could be with a quarterly referral campaign partnered with the current merchant services provider, which can be mutually beneficial and bolster excitement about treasury department offerings.

Step 5: Require Treasury Products with New Business Loans
Banks can also require customers to add certain treasury products as a loan covenant on new business loans. However, they should take pains to consider the needs of the prospective customer before requiring a product.

Adding this requirement means it will be vital to have treasury management specialists involved in initial meetings with prospective customers. After a proper needs assessment, they can craft a customized proposal that includes treasury products that will be of most use to the customer.

Step 6: Educate Staff
Bank employees will always be hesitant to bring up products that they do not fully understand, and may be concerned about asking questions. Education is central to combatting this, and the success of any effort to promote a bank’s treasury department.

Banks should implement cross-training seminars to educate all employees about product offerings. It should also be ongoing to keep employees engaged, and can include webinars, lunch-and-learns and new employee boot camps, among other approaches.

The Secret to a Low Efficiency Ratio


efficiency-5-31-19.pngOne of the most important metrics in banking is the efficiency ratio, which is generally viewed as a measurement of how carefully a bank spends money. Following this definition to its logical conclusion, the more parsimonious the bank, the lower its efficiency ratio should be.

But this common understanding fails to capture the true nature of what the efficiency ratio actually measures. It is in reality a fraction that expresses the interrelationship between the two most dynamic forces within any business organization: the growth of revenue and expenses.

Looked at this way, the efficiency ratio is actually a measurement of effective spending—how much revenue does every dollar of spending produce. And embedded within the efficiency ratio is a simple but extraordinarily important concept that is the key to high profitability—positive operating leverage.

But first, let’s look at how the efficiency ratio works. It’s an easy calculation. The numerator, which is the top half of the fraction, is expenses. And the denominator, which sits below it, is revenue. A bank that reports $50 of expenses and $100 of revenue in a quarter has an efficiency ratio of 50 percent, which is the benchmark for most banks (although most fall short).

However, not all 50 percent efficiency ratios are created equal.

Consider two examples. Bank Cheapskate reports $40 of expenses and $100 of revenue in its most recent quarter, for an efficiency ratio of 40 percent. Coming in 10 percentage points under the benchmark rate of 50 percent, Bank Cheapskate performs admirably.

Bank Topline reports $50 in expenses and $125 in revenue in its most recent quarter. This performance also results in an efficiency ratio of 40 percent, equivalent to Bank Cheapskate’s ratio. Again, an impressive performance.

While the two ratios are the same, it is unlikely that most institutional investors will value them equally. The important distinction is how they got there.

The argument in favor of Bank Cheapskate’s approach is simple and compelling. Being a low-cost producer is a tremendous competitive advantage in an industry like banking, which has seen a long-term decline in its net interest margin. It allows to a bank to keep deposits costs low in a tight funding market, or back away from an underpriced and poorly structured credit in a competitive loan market. It gives the bank’s management team optionality.

The case for Bank Topline’s approach is probably more appealing. Investors appreciate the efficiency of a low-cost producer, but I think they would place greater value on the business development skills of a growth bank. In my experience, most investors prefer a growth story over an expense story. Bank Topline spends more money than Bank Cheapskate, but it delivers more of what investors value most—revenue growth.

To be clear, the choice between revenue and expenses isn’t binary—this is where positive operating leverage comes in.

Positive operating leverage occurs when revenue growth exceeds expense growth. Costs increase, but revenue increases at a faster rate. This is the secret to profitability in banking, and the best management teams practice it.

A real-life example is Phoenix-based Western Alliance Bancorp. The bank’s operating efficiency ratio in 2018 was an exemplary 41.9 percent. The management team there places great importance on efficiency, although the bank’s expenses did rise last year. But this increase was more than offset by strong revenue growth, which exceeded expense growth by approximately 250 percent. This is a good example of positive operating leverage and it’s the real story behind the bank’s low efficiency ratio.

The greater the operating leverage, the lower the efficiency ratio because the ratio is relational. It is not solely a cost-driven metric. At Western Alliance and other banks that focus on creating positive operating leverage, it’s not just how much you spend—it’s how many dollars of revenue each dollar of expense creates.

To understand the real significance of a bank’s efficiency ratio, you have to look at the story behind the numbers.