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.”

Embracing a Challenging Environment to Evolve

New York University economist Paul Romer once said, “A crisis is a terrible thing to waste.”

With a nod to Dr. Romer, we believe banks have an extraordinary opportunity to embrace the challenging environment created by the Covid-19 pandemic to enhance critical housekeeping matters. Here are five areas where banks may find opportunities to declutter or reengineer policies, procedures and best practices.

One of the most obvious opportunities for banks is to focus on culture. Employees working from home has eliminated the ability to have typical office parties, barbeques and other events to build comradery. Remote and semi-remote working environments are challenging employees in many difficult ways. Fortunately, banks are finding simple, yet creative, ways to stay in contact with their employees and build culture through additional correspondence and feedback — electronic happy hours, car parades, and socially distant visits, for example. Creatively maintaining high engagement in challenging times will serve to improve communication and culture over the long term. As management consultant Peter Drucker once said, “Culture eats strategy for breakfast.”

Cybersecurity risk continues to be top of mind for bankers and regulators given the remote work brought on by Covid. Certainly, most banks’ cybersecurity risk management planning did not contemplate the immediate scale of remote work, but the extreme experience is an opportunity to drill down on underlying policies and procedures. Banking agencies have provided the general blueprint on sound risk management for cybersecurity.

This heightened risk environment provides executives with a perfect opportunity to note where their vulnerabilities may exist or be discovered, where cyberattacks focus and what works—or doesn’t —for your bank. Use the guidance provided to assess your bank’s response and resilience capabilities. Consider the overall map and configuration of your cyber architecture. Consider authentication requirements and permissions to protect against unauthorized access. Take the time to work with information technology experts to clean up access controls and response plans. This is an active situation that provides bankers the unique opportunity to learn and adapt in real time.

Banks also face enhanced compliance originating from federal programs aimed at keeping businesses afloat. A worthy endeavor to be sure, but the rollout of some federal programs such as the Small Business Administration’s Paycheck Protection Program has far outpaced the guidance for banks tasked with implementation. The trickle of (often inconsistent) guidance on the documentation, eligibility and certification adds compliance challenges in reporting under the Bank Secrecy Act, fair lending under the Equal Credit Opportunity Act and unfair or deceptive acts and practices under the Federal Trade Commission Act, for example.

Compliance teams have an opportunity to shine at something they are already extraordinarily good at: documentation. They should document the processes and practices they deploy to demonstrate compliance, despite the uncertainty and pace at which they are expected to operate. This documentation can support real-time decision-making that may come up with regulators in the future, and can serve as a basis for improvement on future best practices and training. Compliance teams will discover new questions to ask, novel scenarios to address and gaps to fill.

Operational Planning
The best time to consider the impacts of Covid on your bank’s operations is while events and memories are fresh. Banks all over the country are experiencing what a handful of institutions may go through in the wake of a natural disaster: devastation, uncertainty and a need for banking support. This is the time to review your bank’s disaster recovery and business continuity plans, specifically including pandemic planning, to assess the plans against reality.  

To help, the Federal Financial Institutions Examination Council released an updated statement on pandemic planning suggesting actions that banks can take to potentially minimize a pandemic’s adverse effects. This is an chance to improve business continuity planning for similar future events, understanding that they may not be as deep or prolonged as the coronavirus. Exercising the plans in real time, compared to a scheduled test, can reveal helpful improvements that will only strengthen the bank.

Customer Experience
Coping with remote work and providing banking services outside of a branch provides the opportunity for banks to consider strategies around technology and financial technology partnerships. Customers have been rerouted to electronic avenues, and many seem to have embraced technology to deposit checks, access accounts online and transact business.

This evolution offers banks the opportunity to adapt and recognize the use of financial technologies. Many customers will understandably return to branches to conduct some of their business when they reopen, but may require them less. Banks may want to consider how they can satisfy future customer demand and improve the customer experience more broadly. These are just five areas where we see opportunities for banks of all levels and complexity to enhance their policies, procedures and best practices as they prepare to move forward.

Three Financial Institutions, Three Ways to Improve Operations

cinchy.pngIt can be hard for banks to invest in changing their operations, especially when new systems or vendors are involved. Unlike loans or accounts, assigning a price tag to the value banks get from improving their operations is far from straightforward.

With this in mind, Bank Director looked at how three fintechs — Cinchy, Empyrean Solutions and INETCO Systems Limited — have helped three financial institutions streamline data sharing, financial modeling and real time transaction modeling.

Cinchy, a data collaboration platform that manages data as a network and enables banks to build their own business applications, won Best Solution for Improving Operations at Bank Director’s 2020 Best of FinXTech Awards in May. Modeling platform Empyrean Solutions and transactions intelligence firm INETCO Systems Limited were finalists for the category.

Cinchy: A Tool to Build Tools
National Bank of Canada wanted to custom build a tool that would integrate and easily share internal information and documentation with data scientists and business intelligence teams to support its big data efforts. Some solutions on the market were focused more on governance, rather than data pooling and aggregation — which was like “buying a plane to get a bicycle,” says Sebastien Beaulieu, senior manager of data, business intelligence and analytics strategy at the bank.

Enter Cinchy. Cinchy’s customization and flexibility gave various internal stakeholders a way to collaborate within the bank’s ecosystem to build the right tool. Beaulieu calls it “play dough.”

The Cinchy tool sits on top of the bank’s SQL (Structured Query Language) server. Implementation took six months, but Beaulieu says it could’ve taken as little as three.

While he wasn’t authorized to share specific performance metrics, he says there has been “tremendous value” from having a centralized, federated data lake. It used to take up to 200 days to integrate a new data source into the bank’s previous Oracle tool; with Cinchy, it now takes 10 days.

Empyrean Solutions: Modeling Everything
Pinnacle Financial Partners was preparing to grow over $10 billion in assets and knew its existing asset-liability management (ALM) platform wouldn’t meet the heightened regulatory expectations that come with crossing the threshold.

It learned about Empyrean Solutions from the recommendation of several larger peers. Today, the $29 billion bank uses the modeling platform for “just about everything,” says Brian Gilbert, the bank’s asset liability manager.

The Nashville, Tennessee-based bank uses Empyrean to model ALM, credit, funds transfer pricing, non-maturity deposits, contingency liquidity and net interest margin forecast. The bank is also using it to calculate its allowance under the current expected credit loss model, or CECL. Running 17 scenarios on the platform now only takes 17 minutes, he says. Such pulls can take hours to run at other banks; the time saved allows him to focus on the inputs in each situation and create multiple scenarios.

Gilbert couldn’t devote continuous full days to the implementation but estimated that a dedicated team could do it in a week. The platform doesn’t connect to a bank’s core; instead, users load data and financial information directly into it. These data sets can then be made available for any modeling, reducing the amount of raw extracts that Gilbert needs to perform.

“It’s hard for me to say how many more people we would need to have on my team if we didn’t have Empyrean. We would need more than four people to run interest rate forecasting,” he says.

INETCO Systems Limited: ATM Oversight
Boeing Employees’ Credit Union, or BECU, relies on its fleet of ATMs to deliver a large percentage of its financial services to members. It’s not unusual for one of its ATMs to have 14,000 transactions a month. So it’s a big deal when one goes offline and needs to be repaired or serviced, says Shirley Taylor, digital channel manager at the Tukwila, Washington-based credit union.

The $22 billion credit union wasn’t finding out about ATM outages or errors in a reliable or timely manner, in part because machines would occasionally go offline. Its ATM vendor introduced the credit union to INETCO, an operations intelligence platform that monitors transactions.

The credit union liked that the platform created alerts when there was an interruption in an ATM’s normal activity or when transactions failed to process — signs of a problem. Those alerts mean that fewer ATMs stay out of commission, allowing members to use its machines instead of sending them elsewhere. The fintech also generates potential fraud alerts and helps Taylor generate regular usage reports much faster. What used to take four to six weeks and involved reaching out to three other colleagues for data now takes an hour, she says.

Changing bank operations is never easy. But Cinchy, Empyrean Solutions and INETCO Systems Limited show how bankers can improve their institutions, saving employees valuable time and reducing the number needed to conduct essential operations.