Turning to Technology as Margins Shrink

It’s a perfect storm for bank directors and their institutions: Increasing credit risk, low interest rates and the corrosive effects of the coronavirus culminating into a squeeze on their margins.

The pressure on margins comes at the same time as directors contend with a fundamental new reality: Traditional banking, as we know it, is changing. These changes, and the speed at which they occur, mean directors are wrestling with the urgent task of helping their organizations adapt to a changing environment, or risk being left behind.

As books close on 2020 with a still-uncertain outlook, the most recent release of the Federal Deposit Insurance Corp.’s Quarterly Banking Profile underlines the substantial impact of low rates. For the second straight quarter, the average net interest margin at the nation’s banks dropped to its lowest reported level.

The data shows that larger financial institutions have felt the pain brought about by this low-rate environment first. But as those in the industry know, it is often only a matter of time until smaller institutions feel the more-profound effects of the margin contraction. The Federal Reserve, after all, has said it will likely hold rates at their current levels through 2023.

In normal times, banks would respond to such challenges by cutting expenses. But these are not normal times: Such strategies will simply not provide the same long-term economic benefits. The answer lies in technology. Making strategic investments throughout an organization can streamline operations, improve margins and give customers what they want.

Survey data bears this out. Throughout the pandemic, J.D. Power has asked consumers how they plan to act when the crisis subsides. When asked in April about how in-person interactions would look with a bank or financial services provider once the crisis was over, 46% of respondents said they would go back to pre-coronavirus behaviors. But only 36% of respondents indicated that they would go back to pre-Covid behaviors when asked the same question in September. Consumers are becoming much more likely to use digital channels, like online or mobile banking.

These responses should not come as a surprise. The longer consumers and businesses live and operate in this environment, the more likely their behaviors will change, and how banks will need to interact with them.

Bank directors need to assess how their organizations will balance profitability with long-term investments to ensure that the persistent low-rate environment doesn’t become a drag on revenue that creates a more-difficult operating situation in the future.

The path forward may be long and difficult, but one thing is certain: Banks that aren’t evaluating digital and innovative options will fall behind. Here are three key areas that we’ve identified as areas of focus.

  • Technology that streamlines the back office. Simply reducing headcount solves one issue in cost management, which is why strategic investments in streamlining, innovating and enhancing back-office processes and operations will become critical to any bank’s long-term success.
  • Technology that improves top-line revenues. Top-line revenue does not grow simply by making investments in back-office technologies, which is why executives must consider solutions that maximize efforts to grow revenues. These include leveraging data to make decisions and improving the customer experience in a way that allows banks to rely less on branches for growth.
  • Technology that promotes a new working environment. As banks pivoted to a remote environment, the adoption of these technologies will lead to a radically different working environment that makes remote or alternative working arrangements an option.

While we do not expect branch banking to disappear, we do expect it to change. And while all three technology investment alternatives are reasonable options for banks to adapt and survive in tomorrow’s next normal, it is important to know that failing to appropriately invest will lead to challenges that may be far greater than what are being experienced today.

Why Banks Should Focus on Financial Strength in 2021

Winston Churchill is credited with having famously stated, “Never let a good crisis go to waste.” After a year of profound challenges on many fronts, there very much remains a crisis, causing especially deep financial turmoil for millions of unemployed Americans as a result Covid-19.

Many are undoubtedly feeling financial uncertainty, stress and fear. This crisis represents a singular opportunity for banks to earn and establish deep foundations of trust with customers navigating the murky waters of their financial stress. These efforts will garner a loyalty and connection that will bear incredible fruit in the future, as those customers come out of their own individual crises. Banks should earn this deep trust by making their customers’ financial strength an urgent, key focus in 2021.

Many financial institutions are tuned into this urgency, according to our ongoing original research into financial services. Our recent survey of 220 bankers at institutions spanning the financial industry showed that two of the most significant shifts in business objectives for 2021 are toward recognizing the urgency of digital experience and financial wellness tools.

These two initiatives go hand in hand, especially following a year of branch closures. People are increasingly looking for ways to get financial guidance directly on their phones. We’ve found that 84% of consumers use their mobile banking app at least weekly and 26% use it daily. By contrast, 83% of consumers say they go into a branch once a month or less — and a third say that they plan to visit bank branches less frequently than they did before the pandemic once it is over.

Put simply, your customers need and expect real-time financial guidance on their devices. Here are three ways to offer that:

1. Show People Where They Are Today
First, people need to know where they are currently — financially speaking. Offering a money experience that provides users with a 360-degree view of their accounts in one place is like  seeing the words “You Are Here” on a map. That alone can provide tremendous relief, especially if an individual sees that they are not too far from help.

The same is true for finances. People need clarity about their broad financial picture. They need to be able to quickly see how they’ve been doing, with transactions that are cleansed, categorized, and augmented — and then visualized simply. The days of manually documenting every single check from a checkbook are long gone; very few people have the time or patience to do that kind of work. To be competitive, people need you to do the work for them. It’s not about money management. It’s about a money experience.

2. Help Them Look Ahead
Second, people need to know where to go next. This experience should be a GPS for finances, detailing what true financial strength looks like and laying out general principles to get to that destination. This means that people should be able to quickly see their savings goals, receive recommendations on what route to take and quickly choose or simply confirm automatic funneling of money toward those specific goals, without having to pause their busy life.

3. Get Personal
Third, the money experience should also guide and protect users by offering personalized advice and warnings moment to moment — leading user toward what they need to do. This requires a foundational corpus of clean, enriched data coupled with powerful algorithms behind the scenes to even have a shot at offering an elegant, personalized experience. It is exactly the kind of money experience that will establish trust and build loyalty, especially from customers in dire need of it. This will also become more and more critical as customers desire going into a branch less and less.

Creating a money experience that follows these principles will help create a world where individuals are empowered to be financially strong, where fewer and fewer face personal financial crises.

For me, this mission is personal. I’ve taken an entrepreneurial approach to my career, bounding between exhilarating highs and anxiety-inducing lows. I’ve experienced four separate times where my income dropped to zero, and felt the overwhelming weight of trying to navigate my finances as a young husband and father. I empathize with anyone who feels that stress. Similarly, I can also empathize with the deep trust and lifetime loyalty that can be established when someone helped navigate out of those tough situations. This understanding motivates me to help banks and fintech companies offer a money experience that empowers true financial strength in 2021.

An Audit Expert Explains What’s Changed

An audit committee seat can one of the biggest challenges — and one of the greatest responsibilities — for a bank director, even without a global pandemic and economic recession. The audit committee sets the tone at the top for the bank. How does its role change in a pandemic? It’s an increasingly important responsibility, says Jon Tomberlin, managing partner in Dixon Hughes Goodman LLP’s financial services practice, participating in a panel discussion focusing on audit matters at Bank Director’s BankBEYOND 2020 experience. “There’s a lot of risk and difficulty in being on the audit committee,” he says. “They are one of the most important elements of the bank.” The audit committee creates and maintains an conditions and expectations that support the integrity of the bank’s financial controls — an environment that may have altered or become strained under the pandemic’s forceful impact or the severe economic fallout. Tomberlin says he sees many roles for audit committee in this turbulent environment, overseeing and challenging the appropriateness of internal controls and management’s risk assessment. Joining Tomberlin in this conversation with Bank Director’s Editor-At-Large Jack Milligan were Michael Ososki, a partner at BKD LLP, and Mandi Simpson, a partner at Crowe LLP. You can access all of the BankBEYOND 2020 sessions by registering here.

How Digital Transformation is Driving Bank M&A

Three large bank acquisitions announced in the closing quarter of 2020 may signal a fundamental shift in how a growing number of regional banks envision the future.

While each deal is its own distinct story, there is a common thread that ties them together: the growing demand for scale in an industry undergoing a technological transformation that accelerated during the pandemic. Even large regional banks are hard pressed to afford the kind of technology investments that will help them keep pace with mega-banks like JPMorgan Chase & Co. and Bank of America Corp., which spend billions of dollars a year between them on their own digital transformation.

In October, First Citizens BancShares acquired New York-based CIT Group. Valued at $2.2 billion, the deal will create a top 20 U.S. bank with over $100 billion in assets, and combines the Raleigh, North Carolina-based bank’s low-cost retail funding base with CIT’s national commercial lending platform.

The two companies are a good strategic fit, according to H. Rodgin Cohen, the senior chair at Sullivan & Cromwell, who represented CIT. “If you look at it from CIT’s perspective, you can finance your loans at a much-cheaper cost,” says Cohen in an interview. “From a First Citizen perspective, you have the ability to use that incredible funding base for new categories of relatively higher-yielding loans.”

But digital transformation of banking was an underlying factor in this deal, as increasing numbers of customers shift their transactions to online and mobile channels. The fact that the pandemic forced most banks to close their branches for significant periods of 2020 only accelerated that trend.

“There is enormous pressure to migrate to a more digital technology-driven approach — in society as a whole — but particularly in banking,” Cohen says. “The key is to be able to spread that technology cost, that transformational cost, across the broadest possible customer base.  It doesn’t take a lot of direct savings on technology, simply by leveraging a broader customer base, to make a transaction of size really meaningful.”

A second scale-driven deal is PNC Financial Services Group’s $11.6 billion acquisition of BBVA USA, the U.S. arm of the Spanish bank Banco Bilbao Vizcaya Argentaria. Announced in mid-November, the deal will extend Pittsburgh-based PNC’s retail and middle-market commercial franchise — now based in the Mid-Atlantic, South and Midwest — to Colorado, New Mexico, Arizona and California, with overlapping locations in Texas, Alabama and Florida. In a statement, PNC Chairman and CEO William Demchak said the acquisition provided the bank with the opportunity to “bring our industry-leading technology and innovative products and services to new markets and clients.”

The deal will create the fifth-largest U.S. bank, with assets of approximately $566 billion. But Demchak has made it clear in past statements that PNC needs to grow larger to compete in a consolidating industry dominated by the likes of JPMorgan and Bank of America.

Lastly, in a $6 billion deal announced in mid-December, Columbus, Ohio-based Huntington Bancshares is acquiring Detroit-based TCF Financial Corp. to form the tenth largest U.S. bank, with assets of approximately $170 billion. Chairman and CEO Stephen Steinour says the two companies are an excellent fit with similar cultures and strategies.

“It’s a terrific bank,” Steinour says in an interview. “I’ve known their chairman for a couple of decades. Many of our colleagues have friends there, or family members. We compete against them. We see how they operate. There’s a lot to like about what they’ve built.”

The acquisition will extend Huntington’s retail footprint to Minnesota, Colorado, Wisconsin and South Dakota, while deepening its presence in the large Chicago market. And with extensive overlapping operations in Michigan, Huntington expects the deal to yield approximately $490 million in cost saves, which is equivalent to 37% of TCF’s noninterest expense.

But this deal is predicated on much more than just anticipated cost saves, according to Steinour.

What Apple and Google and Amazon are doing is teaching people how to become digitally literate and creating expectations,” he says. “And our industry is going to have to follow that in terms of matching those capabilities. This combination is an opportunity to accelerate and substantially increase our digital investment. We have to do more, and we have to go faster, because our customers are going to expect it.”

Steinour hedges on if these recent deals also signal that banking is entering a new phase of consolidation, in which regionals pair off to get bigger in a new environment where scale matters. But last year’s $66 billion merger of BB&T Corp. and SunTrust Banks Inc. to form Truist Financial Corp. — currently the fifth-largest U.S. bank, although the post-merger PNC will drop it down a peg — was also driven by a perceived need for more scale. Senior executives at both companies said the primary impetus behind the deal was the ability to spread technology costs over a wider base.

But clearly, the need for scale was a factor for Huntington as well. “We’re investing heavily in this opportunity to combine two good companies, get a lot stronger, accelerate our investments and spread that over a much bigger customer base,” he says. “That makes eminent sense to us.”

As Steinour comments later, “We’ll be stronger together.”

Strategic Insights From Leading Bankers: First Financial Bankshares

Few banks have built value for their shareholders like Abilene, Texas-based First Financial Bankshares.

Over the 20-year period ending June 30, 2020 — the cut-off date for institutions featured in Bank Director’s 2021 RankingBanking study, sponsored by Crowe LLP — the $10.6 billion bank generated a 2,074% total shareholder return. That figure is second only to Bank OZK in Little Rock, Arkansas, for the entire banking industry. First Financial placed sixth overall in the study and earned top honors in the Best Bank for Creating Value category. It also rated highly for its retail strategy.

“They’re one of the best banks out there,” says Brett Rabatin, head of equity research at Hovde Group. First Financial’s culture, M&A track record and competitive strategy — delivering a high level of service in small-town markets — set it apart. “A lot of banks like to say, ‘we’re relationship lenders,’ [but] this is one of the few banks where it shows up. It shows up in their loan yield, it shows up in the profitability.”

To delve further into First Financial’s performance for the RankingBanking study, Bank Director Vice President of Research Emily McCormick interviewed First Financial Chairman and CEO Scott Dueser about the bank’s customer-centric philosophy, prospective M&A opportunities and how he leverages his Texas connections. The interview was conducted on Oct. 14, 2020, and has been edited for brevity, clarity and flow.

BD: Based on my earlier reporting on First Financial and its culture, I know you have placed a strong cultural emphasis on building excellence and serving the customer. How does that differentiate First Financial from other institutions in its markets?

SD: I like to think of us as the Ritz-Carlton of banks because of what [Ritz-Carlton Hotel Co. co-founder] Horst Schulze has done for us. Horst has been outstanding, not only [in] training us [on] customer service, but also as a mentor on business and dealing with people. Horst doesn’t call it hiring people; you select people and that changes your whole attitude about it. We have a very strong team of people that work together extremely well.

I’m disappointed if somebody leaves our bank and is not extremely happy. That’s what we want to accomplish every time somebody walks in.

Our philosophy of how we do business is very important to us, and adds to the bottom line and the value of our stock. That’s the fact that we’re not in the big city, we’re in the small towns around the big city, where we can be the big fish in the little pond and be the No. 1 bank. We’re not in the big cities fighting the big boys; that takes a lot of money and a lot of time, and it’s a battle that frankly, I don’t think we can win. Why not stay in the areas [where] we do well and focus on that? That’s been our focus, along with credit quality and going after the better customers in our markets. 

BD: Covid-19 has impacted how banks serve the customer. Has anything really shifted for your bank in that regard, or do you feel like the situation is proving your strategy out in a way?

SD: It’s proven the strategy out. I will tell you the best thing that we did was we never closed our doors. We stayed open, and we came to work every day, and we learned how to work through Covid and how to serve the customer [in that environment]. We got a lot of business from it, because when customers went to their bank and found it locked, they didn’t like it. Those banks that locked their doors lost a lot of business, because 33% of the [Paycheck Protection Program] loans that we made were somebody else’s customers. To do that, we asked [those customers] for all their business, and they moved all their business. We grew about a billion dollars through the pandemic.

We made the decision not to cut hours and not to lock our doors, but to be here. We split big departments [where] half the people went home, half the people stayed here, but everybody that was customer facing had to come to work. Our goal was to make the workplace the safest place our people could be. Frankly, today we still feel like the safest place to be is here at work. We’ve kind of managed Covid, not that we haven’t gotten it. We manage it by masking and social distancing, and don’t come to work if you feel bad. We don’t want you to work [then]. That’s kind of the main rules.

I have been on the governor’s task force to reopen Texas. That has helped me tremendously, because I knew the inside scoop of how the state was fighting Covid.

BD: You also had a hand in the Texas Tech Excellence in Banking program that opened in 2020. I assume you see some indirect benefits to keeping those types of networks and communication lines open.

SD: No question. The Excellence of Banking Program was something that I took to Tech and said, “We really need to do this. It will be great for Tech. It’ll be great for the banking industry.” We were able to raise $12 million to endow that program; that’s from foundations and banks. There were about 50 banks involved in that program that gave $1,000 and above.

What’s neat about this program is it is focused [on] bringing minorities and women into banking. That’s something that we really need. We had interns from that program here this summer, and I’m very impressed with the high level of students that we have. I think all the banks that have participated are impressed with the interns that they got out of it. We are hiring people out of that program as we speak. It’s a direct benefit to the bank, but also a direct benefit to my alma mater.

BD: Looking at your past few M&A deals, First Financial does an excellent job of keeping costs down. With pricing coming down, do you see some opportunities on the horizon?

SD: I think there’ll be lots of opportunities next year. I do think Covid has made a lot of people think about whether they want to stay in the industry or not, and whether they want to keep their bank. If they don’t have people lined up to run their bank, they probably need to put it on the market. I think we’ll see a lot of banks go on the market, especially from the fact that a lot of banks missed their heyday when they could have gotten a premier price a year ago. That’s not going to happen today. Pricing is down. They’re going to say, “Hey, I’d rather take today’s price and see what happens next.”

With our price and our premium on the price, even in today’s market, we can go buy some banks that other people probably can’t, because they can’t make the deal work. With our stock price, we can make the deal work.

RankingBanking will be examined further as part of Bank Director’s Inspired By Acquire or Be Acquired virtual platform. Click here to access the agenda.

Why Nailing the Customer Experience Comes Down to Empathy

While this pandemic has brought many challenges to the financial industry, it’s also brought the opportunity of accelerating customer adoption of your digital banking services.

But it’s also presented an opening for your bank to build genuine customer loyalty and turbocharge your net promoter score.

Difficult times bring out the best and the worst in both people and companies. It’s easy to offer amazing service when things are going well, but it’s how you treat your customers during tough times that builds, or breaks, loyalty. American poet and civil rights activist Maya Angelou said, “People will forget what you said, people will forget what you did, but people will never forget how you made them feel.”

Right now is your opportunity to make your customer feel valued, supported and secure. To do that, you need to be empathetic to your customers and your staff.

Consider your customers. They’re stressed.

This is a stressful time for them. Many are financially strained and need advice on the new programs and policies put in place to help them. They’re socially isolated and trying to avoid public places in an effort to stay safe. So, naturally, they’re increasingly banking through your digital channels — but that’s stressful too. How do I use mobile banking? Is it secure? How do I make sure I don’t send money to the wrong person?

To navigate these tricky waters, your customers need access to knowledgeable people who can guide them through your technology, and help them understand how to use your products and services.

Your frontline is your bank. It’s through your frontline that your customers experience your bank. And these are difficult times for frontline staff, too. Many are working from home, and have had to switch roles to handle the increased volume of remote support requests.

At the same time, they don’t have the in-person support of their colleagues, and they don’t have the same toolsets at their disposal. And new programs and policies are being rolled out faster than ever. All this at a time when many of them are experiencing personal difficulties.

You need to provide them with the knowledge, skills, and tools to deliver an exceptional customer experience. For the knowledge and skills part, they need practical training, which has been made more difficult by the pandemic. Instructor-led trainings are off the table, your learning management system could be better. You need an engaging and effective way to train remote staff so they can offer the right solution at the right time for your customers.

One of the biggest holes you need to plug is the lack of employee knowledge and familiarity with your digital products — the very ones you customers need to rely on right now. Many of your staff don’t bank with you, so they’ve never experienced your digital tools. If they’re not familiar with your tech, how can they be expected to promote and support it? To empower them, you need to train them on your tech and give them tools to help customers navigate transactions.

It all works together. The goal during this pandemic is to deliver an exceptional customer experience, to make customers feel secure and valued during a difficult time. Banks that can pull this off will build coveted long lasting customer loyalty. My contention is that empathy is the key to success.

Your customer experience is curated by your frontline employees. If you can remove stress from their jobs with training and support tools, they’ll be in a better position to help your customers. Investing in your frontline and showing them that you care about them will make them feel valued and help you build staff loyalty.

A well-trained, supported and secure frontline will do a much better job of helping your customers get through these tough times. Armed with the knowledge, skills and tools they need, frontline staff will be able make prescient recommendations that promote your products while making the customer feel confident and secure with their banking situation.

In the long run your customers won’t remember the details of each transaction and how it was handled. They’ll remember whether their bank added to their stress, or gave them one less thing to worry about during a trying time.

What Banks Can Learn from OceanFirst’s Loan Sale

As the coronavirus continues to whipsaw the economy, when will bank asset quality begin to crack and losses start to materialize?

One bank, at least, has decided not to wait for that day to arrive.

OceanFirst Financial Corp., a $12 billion institution based in Red Bank, New Jersey, accelerated the resolution of some of its credit losses by selling an $81 million in higher-risk commercial loans with forbearance exposure in late September and October. All of the loans had an underlying, systemic weakness that the bank believed would persist after the coronavirus pandemic subsided.

The sales included $30 million in New York exposure and $51 million in New Jersey and Pennsylvania, executives said. Hotel exposure made up $15 million, $12 million was related to restaurant and food and over $4 million was in gym and fitness exposure. The bank recorded a $14 million mark on the loans, which it took as a charge to third quarter earnings.

The bank also decided to sell its loans associated with the Small Business Administration’s Paycheck Protection Program during the quarter. These sales, along with additional provisioning, contributed to a net loss in the third quarter of $6 million, or 10 cents per diluted share.

First Loss is the Best Loss
Banks of all sizes are weighing their options for dealing with trouble credits, and what a credit workout will cost them in time, staffing and expenses, Greenland says.

“The friction of handling non-performing loans at a bank is huge. It’s not what banks are meant to do,” he says. “Most of the choices a bank has right now are working it out, selling it or owning the real estate.”

OceanFirst Chairman and CEO Christopher Maher says that proactively identifying and recognizing credit risk leads to smaller losses and faster recoveries. According to Maher, OceanFirst sold loans in 2007 and recovered around 70 cents on the dollar; in a year, those assets traded closer to 40 cents.

“Many bankers will say that your first loss is your best loss,” he says. “If you’re early to do something, you will get a good recovery; if you hem and haw and wait, the numbers don’t get better.”

Maher acknowledges that the ultimate recovery rates on the sold loans may have been higher if the bank had held onto them. But that recovery could take years, consuming valuable time and attention to deal with the questionable credit quality.

“There’s a finality that comes with the disposition. We were very conscious that had we merely kept these on the books, established a risk pool and taken a reserve for the $14 million — that may have proven to earn us more money in the long run. But it may also have led to several quarters of discussions about valuations with a lot of stakeholders … explaining why you thought a fitness center or a hotel property was actually valued where you think it is,” he said during the bank’s third-quarter earnings call. “This way, we get the final disposition. We know exactly what the answer is. We can be certain that we took those risks off the balance sheet.”

Strike While the Iron is Hot
Interest in distressed assets is high right now. Kingsley Greenland, CEO of loan marketplace DebtX, says that many of interested buyers using his platform had proactively raised funds in 2019 in advance of a mild downturn and are now sitting on “dry powder.” Prospective buyers are visiting the site more frequency, and both the number of buyers that enter into a nondisclosure agreement to conduct due diligence on an asset and the number of bids are up.

Throughout 2020, DebtX has seen a number of sellers listing hotel loans and now labor-intensive small business loans; Greenland expects retail and office commercial real estate loans to appear in greater numbers in 2021.

OceanFirst managed the sale of its New York portfolio alone, capitalizing on a group of real estate investors who specialize in the city and in those types of assets. It used investment bank Piper Sandler to manage the sale of the $51 million pool of loans covering New Jersey and Pennsylvania, since the bidder base consisted of institutional credit fund buyers looking for distressed loan notes. He says working with a partner helped when it came to assembling the data rooms and legal agreements.

“We made the decision that if there are buyers, we can get good recoveries now,” he says. “There will be the same buyers next year, but there will be more loan sales and they will not be at the [price] we got.”

Back to (Growing the) Business
Maher said the sale “liberated” resources the bank could use as it refocuses on growing profits by rebuilding its net interest margin and boosting operating margins. The two blocks of loan sales lowered its loan-to-deposit ratio to under 90% and generated $388 million in cash proceeds that the bank could deploy toward capital management actions that include repurchases and acquisitions. It also makes it easier to navigate conversations with regulators and prospective sellers that they have a handle on their credit risk.

“Putting this behind us allows us to potentially have stronger and more stable earnings in 2021, which should hopefully translate into a better stock multiple,” he says. “As we transition to next year, investors in general are not going to want to hear about credit surprise and provisions.”

The Board’s Blessing is Important
Maher says credit mitigation work can be tough for bankers, who pride themselves on their close relationships with borrowers and their ability to make good loans. That can make them feel vulnerable when credit quality turns, complicating efforts to resolve credit in a timely fashion, or lead to holding onto troubled loans longer than is prudent.

“The admission that a loan may be troubled is hard. It feels like a personal failure,” Maher says, adding that he has experience with this as a commercial lender. “There’s always this hope that if I give it a little more time, it’ll be OK and I won’t have this black mark or this failure.”

The board has an important role to play in these moments, diffusing emotions and helping management look ahead. Boards should make it clear that they don’t want to cast blame on the previous decisions to extend these loans, but instead focus on decisions that will strengthen the bank moving forward.

“The board plays a role here. If management feels vulnerable or that they’re going to be criticized, then they’re going to be less likely to do it,” Maher says. “I think often, the board/management interaction can perpetuate this failure to just deal with it.”

Recommendations for Banks Prepping for LIBOR Transitions, Updated Timelines

While much of the focus this summer was on Covid-19, the decline in GDP and the fluctuating UE rates, some pockets of the market kept a different acronym in the mix of hot topics.

Regulators, advisors and trade groups have made significant movement and provided guidance to help banks prepare for the eventual exit of the London Interbank Offered Rate, commonly abbreviated to LIBOR, at the end of 2021. These new updates include best practice recommendations, updated fallback language for loans and key dates to no longer offer new originations in LIBOR.

Why does this matter to community banks? Syndicated loans make up only 1.7% of the nearly $200 trillion debt market that is tied to LIBOR — a figure that includes derivatives, loan, securities and mortgages. Many community banks hold syndicated loans on their balance sheets, which means they’re directly affected by efforts to replace LIBOR with a new reference rate.

A quick history refresher: In 2014, U.S. federal bank regulators convened the Alternative Rates Reference Committee (ARRC) in response to LIBOR manipulation by the reporting banks during the financial crisis. A wide range of firms, market participants and consumer advocacy groups — totaling about 1,500 individuals — participate in the ARRC’s working groups, according to the New York Federal Reserve. The ARRC designated the Secured Overnight Financing Rate (SOFR) as a replacement rate to LIBOR and has been instrumental in providing workpapers and guidelines on SOFR’s implementation.

In April 2019, the ARRC released proposed fallback language that firms could incorporate into syndicated loan credit agreements during initial origination, or by way of amendment before the cessation of LIBOR occurs. The two methods they recommended were the “hardwired approach” and the “amendment approach.” After a year, the amendment approach was used almost exclusively by the market.

In June 2020, the ARRC released refreshed Hardwired Fallbacks language for syndicated loans. The updates include language that when LIBOR ceases or is declared unrepresentative, the-LIBOR based loan will “fall back” to a variation of SOFR plus a “spread adjustment” meant to minimize the difference between LIBOR and SOFR. This is what all other markets are doing and reduces the need for thousands of amendments shortly after LIBOR cessation.

In addition, the ARRC stated that as of Sept. 30, lenders should start using hardwired fallbacks in new loans and refinancings. As of June 30, 2021, lenders should not originate any more loans that use LIBOR as an index rate.

As the market continues to prepare for LIBOR’s eventual exit, BancAlliance recommends banks take several steps to prepare for this transition:

  • Follow the ARRC’s recommendations for identifying your bank’s LIBOR-based contracts and be aware of the fallback language that currently exists in each credit agreement. Most syndicated loans already have fallback language in existing credit agreements, but the key distinction is the extent of input the lenders have with respect to the new rate.
  • Keep up-to-date with new pronouncements and maintain a file of relevant updates, as a way to demonstrate your understanding of the evolving environment to auditors and regulators.
  • Have patience. The new SOFR-based credit agreements are not expected until summer 2021 at the earliest, and there is always a chance that the phase-out of LIBOR could be extended.

Steering a De Novo Through a Crisis and Beyond

New York-based Piermont Bank opened its doors in July 2019. Just eight months later — on March 1 — a New York woman returning home from Iran became the city’s first Covid-19 case. By March 20, with cases in the state rapidly climbing, Gov. Andrew Cuomo mandated that non-essential businesses close. One hundred days after reporting its first case, New York began reopening — but as of Nov. 19, restrictions remained in place, and New York City public schools recently returned to virtual learning to combat a resurgence of Covid-19 cases.

What a time to run a bank — especially a new one.

It sounds counterintuitive at first blush, but Wendy Cai-Lee, the bank’s founder and chief executive, believes Piermont is well positioned to serve customers. The $117 million bank focuses heavily on commercial real estate loans; it also makes commercial and industrial (C&I) loans.

She points out that as a de novo, the bank’s balance sheet is clean; her team didn’t have to devote attention to working with troubled borrowers. Piermont also has a lot of capital on hand, with a leverage ratio of 32.82% as of June 30.

But Cai-Lee recognizes the broader, longer-term impact the pandemic could have on the New York market. “We have seen appraisal values essentially drop anywhere between 10% to 35%,” she says. Her team has a risk assessment meeting every Monday; when we spoke in October, they were evaluating the potential fallout from the end of unemployment benefits through the CARES Act, set to expire at the end of the year. “That’s going to impact people’s ability to pay their rent, and I do think that’s going to bring some impact to multi-family that we haven’t seen so far,” she says.

Serving customers during the pandemic had some banks scrambling to adopt new technology to serve customers; in contrast, Piermont was already positioning itself as a “tech-enabled” bank. “When it comes to innovation, I’m a big believer that it’s not only technology that we need to focus on, but also process,” says Cai-Lee. She aims to create an end-to-end digitized process without sacrificing on risk controls.

“I use technology to digitize everything that the client doesn’t see so that I can move all those resources to allow my bankers to spend the time with the client to find specific pain points” and identify the right solution, she explains. “This allows my bankers to engage the client very differently.” Piermont can close commercial loans in three days, she says, rather than a couple of weeks. And innovation isn’t limited to technology; Piermont offers subscription pricing for its services, for example, and recently announced a banking-as-a-service platform it’s offering through a partnership with Treasury Prime.

I spoke with Cai-Lee before that announcement. “We’re actually not going to be that anonymous bank behind these fintechs,” she says. “We’re actually going to market front and center along with the API partner so that we can actually focus on creating the right product for them.”

Piermont Bank also seeks to serve women- and minority-owned businesses, which have been particularly devastated by the pandemic and have historically lacked access to credit and investor capital. A lot of banks say they want to serve women and minority entrepreneurs, yet these groups remain underserved. When I ask how Cai-Lee’s plans differ from other institutions’ efforts, she credits Piermont’s diverse team.

Cai-Lee is Asian American; before founding Piermont, she led the commercial real estate, commercial lending, and consumer and business banking divisions at $50 billion, Pasadena, California-based East West Bancorp, which serves markets in the U.S. and China. Before that, she spent almost a decade at Deloitte, where she was literally the poster child for diversity. “They had a [life-size] cutout of me made and had it in the lobby of every Deloitte domestic office,” she recalls.

When she founded Piermont Bank, she prioritized adding a diverse array of voices and backgrounds when she assembled her team. She believes it’s a strength for the bank. “The reason why [women and minorities are] underserved is — no different from serving any industry or any demographic out there — unless you understand their pain points, it’s hard to come up with the right product and service to serve them,” says Cai-Lee. “If you don’t have enough representation of women, of minorities on your board and senior management [team], how do you foster an environment where [you can] address that demographic?”

The Promise, and Peril, of Risk Technology

The pandemic has underlined how essential risk technology is for proactive and responsive financial institutions.

Prior to the coronavirus outbreak, bank risk managers were already incorporating such technology to manage, sift and monitor various inputs and information. The pandemic has complicated those efforts to get a handle on emerging and persistent risks — even as it becomes increasingly critical to incorporate into day-to-day decision-making.

Data, and getting insights from it, has always been central to how risk managers have worked. That hasn’t changed,” says Sandeep Mangaraj, an industry executive at Microsoft who focuses on digital banking transformations.

Prior to the pandemic, concerns about operational risk had increased “somewhat” or “significantly” among 51% of CEOs, chief risk officers and directors responding to Bank Director’s 2020 Risk Survey, which was completed just before the pandemic. More than half also revealed heightened concerns around cybersecurity, credit and interest rate risk, and strategic risk.

That survey also found respondents indicating there was room for technology to improve their compliance with Bank Secrecy Act and anti-money laundering rules (76%), know your customer (50%) requirements, and vendor management requirements.

One way executives and risk managers can keep up is by incorporating risk technology to help sift through reams of data to derive actionable insights. These technologies can create a unified view of risk across exposure types and aggregation levels — product, business line, region — so executives can see how risk manifests within the bank. Some of these solutions can also capture and provide real-time information, supplementing slower traditional sources or replacing end-of-day reports.

But the pandemic led more than half of respondents to Bank Director’s 2020 Technology Survey to alter or adjust their technology roadmaps — including 82% of respondents at institutions with more than $10 billion in assets. Two-thirds said they would upgrade existing technology; just 16% planned to add technology to improve regulatory compliance.

Artificial intelligence holds a lot of promise in helping banks more efficiently and effectively comply with regulations and manage risk. Many banks are still early in their risk technology journeys, and are working to identify areas or situations that can be serviced or assisted by risk technologies. Forty-six percent of respondents to Bank Director’s Technology Survey say they are not utilizing AI yet.

Those that have are applying it to situations like fraud monitoring, which generates large amounts of data that the bank can correlate and act on, Mangaraj says. Others have applied it to process intelligence and process improvement, or used it to enhance the control environment. Key to the success of any AI or risk-technology endeavor is finding the right, measurable application where a bank can capture value for heightened risk or capabilities.

“We have a client who uses AI to monitor trader conversations that can proactively flag any compliance issues that may be coming up,” he says. “There are lots and lots of ways in which you can start using it. Key is identify cases, make sure you have clear measurement of value, monitor it and celebrate it. Success breeds success.”

The addition and incorporation of innovative risk technologies coincides with many banks’ digital transformations. While these changes can often complement each other, they can also make it difficult for a bank to manage and measure its risk, or could even introduce risk.

A strong management team, effective controls and active monitoring of the results are essential keys to a bank’s success with these technology endeavors, says James Watkins, senior managing director at the Isaac-Milstein Group. Watkins served at the FDIC for nearly 40 years as the senior deputy director of supervisory examinations, overseeing the agency’s risk management examination program.

“It’s time for a fresh look of the safeguards and controls that banks have in place — the internal controls and the reliability of the bank system’s and monitoring apparatuses. All of those are extremely important,” he says.

Bank executives and boards of directors must have the processes and procedures in place to ensure they’re using this technology and contextualizing its outcomes in a prudent manner.

“I think the importance of general contingency planning, crisis management strategies, thinking strategically — these are all areas that boards of directors and senior management really need to be attuned to and be prepared for,” Watkins says.