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.

The Big Banks Are Back


banks-1-28-19.pngIs it now a big bank world that the rest of the industry is just living in?

One could justifiably come to that conclusion based on comments by Tom Michaud, president and chief executive officer at the investment bank Keefe Bruyette & Woods during a presentation on the opening day of Bank Director’s Acquire or Be Acquired conference Sunday in Phoenix.

Approximately 1,300 people are attending the 25th anniversary of Bank Director’s Acquire or Be Acquired event at the JW Marriott Phoenix Desert Ridge resort, which will run through Tuesday.

It’s no secret the four largest U.S. banks—JPMorgan Chase & Co., Bank of America Corp., Wells Fargo & Co. and Citigroup—hold dominant positions in the country’s banking market. These four megabanks control approximately 45 percent of the U.S. deposits. But historically, large institutions have been less profitable than much smaller ones in part because their size and complexity have made them more difficult to manage.

That is now changing, according to Michaud.

Bank of America, for example, posted a return on tangible common equity (ROTCE) in 2017 of 10.8 percent. The bank’s ROTCE rose to 15.4 percent in 2018 and is projected to hit 15.9 and 16.5 percent in 2019 and 2020, respectively.

Similar ROTCE increases are forecasted for JPMorgan, Wells and Citi through 2020.

The reason these banks are now operating at a much higher level of profitability is in part because their management teams have figured out how to turn their enormous size into an advantage. Although analysts, consultants and the banks themselves have often touted the advantage of size, it has had an averaging effect on their financial performance as they have grown increasingly larger in recent years.

“It seems now that the scale argument has a lot more traction,” said Michaud.

Just three years ago, the most profitable U.S. banks based on their performance metrics were in the $5 billion to $10 billion asset category—just large enough to gain some benefits from scale but still small enough to escape the averaging effect. This so-called “sweet spot” shifted in 2017 to banks with assets greater than $40 billion, and Michaud expects these large institutions to again claim the sweet spot in 2018 by an even wider margin once the industry’s profitability data are finalized.

One important place large banks have been able to use scale to their advantage is in technology. The U.S. economy is in the midst of a digital revolution, and the banking industry is being forced to embrace digital distribution of consumer products like checking accounts and mortgages. “Consumers really like the digital delivery of retail banking services,” Michaud said.

And it’s the national and super-regional banks that are capturing the greatest share of “switchers”—consumers who are leaving their current bank for another institution that offers a better digital experience. Michaud cited data from the consulting firm AT Kearney showing that national banks are capturing about 41 percent of the digital switchers, with super-regionals taking 28 percent. Even direct banks at 11 percent have been gaining a larger share of switchers than regional banks, local banks and credit unions.

The advantage of scale becomes most apparent when you look at the amount of money large banks are able to invest to upgrade their digital capabilities. Each of the big four banks are expected to invest a minimum of $3 billion a year over the next few years in technology—and some of them will invest significantly more. For instance, JPMorgan’s annual technology spend is expected to average around $10.8 billion.

While not all of that will be invested in digital distribution, the country’s largest bank is investing heavily to build a digital banking capability capable of penetrating any consumer market anywhere in the country.

Your M&A Success Could Depend On This One Thing


merger-12-19-18.pngBenchmarking key performance indicators (KPIs) can help you more fully understand your bank’s financial condition and operating results, as well as the true value in a potential M&A market.

The success of your M&A strategy – whether buy, sell or stay – measurably increases with a sound grasp of the metrics that drive shareholder value.

KPIs as M&A drivers
KPIs can help you to identify important strengths in your target organization and your own institution. This can help determine the areas you could strengthen in an acquisition, or understand where your bank’s value lies within a merger. You can also learn about your organization’s, or your target institution’s, primary challenges and how this might impact the transaction.

These metrics can also help the organization evaluate the success of the transaction after completion. Have the key performance indicators drastically changed? Was that change different from the anticipated adjustment from the combination of the two entities? Understanding the metrics, and some of the forces impacting them, can be a strong foundation for successful M&A transactions.

Q3 2018 KPI observations
Community banks throughout the U.S. used the strong economy and relatively stable interest rate environment to maintain steady operations throughout the third quarter of 2018.

Baker Tilly’s banking industry key performance indicator (KPI) report reflected almost no change in comparison to the same benchmarks for the second quarter of 2018. Earnings, credit quality and capital adequacy benchmarks all remained essentially the same. This consistency appears to reflect a more stable economic environment, disciplined management of credit pricing and quality, notwithstanding a continued highly competitive environment, and the early stages of a move to higher interest rates.

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If there is anything to take away from the relatively unchanged KPIs over the first nine months of 2018, it is that community bankers have diligently pursued the opportunities emerging from the strong economy.

Loan growth, reflected in the comparison of the loan-to-deposits ratios each quarter, has been somewhat subdued. Potential drivers of this include increasing liquidity pressures arising from changes in interest rates, early stages of the potential for a downward credit cycle and the uncertainty of the November midterm elections. These factors kept many community bankers focused on internal matters such as compliance and technology during the second and third quarters of 2018.

Many banks continued to assess consolidation opportunities on both the buy and sell side. Until the recent series of market declines, bank equity currency remained quite strong, supporting a continued active consolidation of the industry, at price points that, on average, exceed 1.5 – 1.7 times book value.

We expect more of the same consistency in the KPIs as we have seen throughout 2018. It does not appear there will be any significant shifts in either direction arising from changes in economic policy. However, the pace of deregulation may subside due to the change in leadership in the U.S. House of Representatives.

If equity markets rebound following the midterms and the Federal Reserve pauses its increase of interest rates, we may see a re-acceleration of the consolidation of community banks, especially those with assets of $500 million or less. Other than an increased emphasis on securing and maintaining low cost deposits, we anticipate community banks to maintain a steady course into early 2019.