2021 Bank M&A Survey Results: Uncertainty Stalls Growth Plans

Will bank M&A activity thaw out in 2021?

Bank deals have been in deep freeze due to Covid-19 and the related economic downturn, but most of the executives and directors responding to Bank Director’s 2021 Bank M&A Survey, sponsored by Crowe LLP, say their bank remains open to doing deals.

More than one-third say their institution is likely to purchase a bank by the end of 2021; this represents a significant decline compared to last year’s survey, when 44% believed an acquisition likely in 2020. Branch and loan portfolio acquisitions also look slightly less attractive compared to a year ago.

The barriers to dealmaking may prove difficult to surmount in today’s uncertain economic and political environment.

With pressures on small businesses and the commercial real estate market exacerbated by remote work and social distancing measures, the recovery of the U.S. economy — and bank M&A — may hinge on conquering the coronavirus. In response, bank leaders are focused on credit quality: 63% point to concerns about the quality of a potential target’s loan book as a top barrier to making an acquisition, up significantly from last year’s survey (36%).

Despite concerns about credit quality and profitability, 85% say their bank is no more likely to sell due to Covid-19, and just 7% regret that they didn’t sell before the current downturn, when target banks could expect to command a higher price.

This willingness to carry on and weather these challenges may find its foundation in respondents’ long-term expectations. More than half anticipate a slow rebound for the U.S. economy. Twenty-eight percent don’t expect to return to pre-crisis levels in 2021, and 7% believe the recession will deepen.

Still, half believe that when the crisis abates, their bank will be just as strong as it was earlier this year. Forty-four percent express even greater optimism, believing they’ll emerge even stronger.

Key Findings

Loan Losses
More than half (57%) believe their bank’s loan loss allowance will be sufficient to cover expected losses over the next 12 months. Two-thirds say that less than 5% of residential mortgages will default and 64% that less than 5% of commercial loans will default.

Willing to Pay for Quality
When describing their bank’s acquisition strategy, 44% indicate that they seek strategic acquisitions, regardless of price. One-quarter look for low-priced acquisitions of historically well-run banks; 27% are comfortable paying a premium for well-managed banks.

Tech Acquisitions Rare
Just 11% believe they’ll purchase a technology company. Of these, 63% express interest in buying a business or commercial lending platform; 63% are open to acquiring a consumer deposit-gathering platform. Almost half seek data analytics capabilities.

Price Remains a Barrier
Potential acquirers’ concerns about pricing as a barrier to dealmaking have dropped significantly — from 72% last year to 60% in this year’s survey. However, more respondents express concern about their ability to use stock as currency in a deal, as well as demands on their capital should they acquire.

Effects on Capital
Most believe their bank’s capital levels are sufficient to weather the economic downturn, assuming a rapid (98%) or slow (98%) recovery in 2021, or mild recession (97%). Eighty-one percent believe they can weather a deeper recession. Just one-quarter plan to raise capital over the next six months.

High Marks for Trump
An overwhelming majority award President Trump’s administration positive marks for the rollout of Paycheck Protection Program loans (90%) and stimulus payments (91%), and its support of the U.S. economy (88%). Two-thirds believe the administration has effectively responded to the pandemic.

To view the full results of the survey, click here.

Compensation, Talent Challenges Abound in Pandemic Environment

The coronavirus pandemic has not altered the toughest hiring and talent challenges that banks face; it has accelerated them.

These range from finding and hiring the right people to compensating them meaningfully to succession planning. Day Three of Bank Director’s 2020 BankBEYOND experience explores all of these topics and more through the lens of investing in and cultivating talent.

Institutions looking to thrive, not merely survive, in an environment with low loan demand and heightened credit risk need talented, diverse people with essential competencies. But skills in information security, technology, lending and risk have been getting harder to find and retain, according to more than 70% of directors, CEOs, human resources officers and other senior executives responding to Bank Director’s 2020 Compensation Survey this spring.

On top of that, the remote environment that many are still operating under has made it harder to interview and onboard these individuals. And managing employees working outside the office may require a different approach than managing them on-site. There are a handful of other timely challenges, pandemic or not, that banks must be prepared to encounter.

Compensation Challenges
The pandemic has also compound challenging trends in hiring and compensation that banks already face. Headcount and associated compensation costs are one of a bank’s biggest variable expenses; in a tough earnings environment, it is more important than ever that they control that while still crafting pay that rewards prudent performance. Executives and boards may also need to contend with incentive compensation plans containing metrics or parameters that are no longer relevant or realistic, and how to message and reward employees for performance in this uncertain environment.

Retaining, Hiring Employees
Banks must recruit and retain younger and diverse employees who fit within the organization’s culture. Half of respondents to our survey indicated that it’s difficult to attract and retain entry-level employees; 30% cited recruiting younger talent as a top-three challenge this year, compared to 21% in 2017.

But banks and many other companies may encounter another trend: parents, especially women, leaving the workforce. Child-rearing responsibilities and distance-learning complications have forced working parents without effective support systems to prioritize between their children and their career. More than 800,000 women left the job market in September, making up the bulk of the 1.1 million people who opted out. Those departures were responsible for driving most of the declines in the unemployment rate that month.

Diversity & Inclusion
Fewer women working at banks means less gender diversity — which is an area where many banks already struggle. That could be in part due to the fact many banks haven’t prioritized measuring that and other diversity and inclusion metrics like race, ethnicity or status of disability or military service.

In Bank Director’s 2020 Governance Best Practices Survey, almost half of directors expressed skepticism that diversity on the board has a positive effect on corporate performance. Perhaps it’s not surprising that in our Compensation Survey, 42% of respondents say they don’t have a formal D&I program.

To access the 2020 BankBEYOND recordings, click here to register.

Revisiting Growth, Strategy in the Face of Banking’s Known Unknowns

It’s time to hunker down.

For the last several quarters, the banking industry has been whipsawed by rapid changes in the economy due to the coronavirus pandemic, as well as the response required to keep the fallout at bay. They worked with borrowers to offer widespread deferments, rolled out the Small Business Administration’s Paycheck Protection Program loans and regraded their loan portfolios. With much of that activity winding down, institutions are getting back to the basics of block-and-tackling banking, and bracing for a prolonged period of muted loan growth and sustained low interest rates.

In this environment, the risks can sometimes seem more numerous than the opportunities. In response, banking experts weighed in on how institutions can craft a resilient and flexible strategy while planning for future growth during the first day of Bank Director’s 2020 BankBEYOND experience. Net interest margin compression, keeping up with customer demand for digital offerings and continued industry consolidation topped the list of long-term viability concerns for the CEOs and board members responding to Bank Director’s 2020 Governance Best Practices Survey; organic growth was not far behind. Notably, that survey was conducted in February and March, before Covid-19 spread through the U.S.

While loans deferrals have declined, Hovde Group Chairman and CEO Steve Hovde says he still expects to see “credit quality issues, reserve issues” emerging in the fourth quarter and into 2021, depending on whether lawmakers allocate more stimulus. He also touches on the forces compressing NIMs and what banks can do to address it.

One way that bank leaders can address these concerns is by revisiting the fundamentals of operational excellence as they craft strategies to grow and maneuver safely in this challenging landscape. People, processes and vision are the building blocks of an effective board, says Jim McAlpin, a partner and global leader of Bryan Cave Leighton Paisner’s banking practice group — but these are also the building blocks of an effective bank. Directors should be vigilant in the role they play of engaging in risk oversight and management, McAlpin says, given that they can have a “significant impact” on the bank’s risk appetite.

On the funding side, banks should reconsider how they will amass and defend their core deposit base efficiently, given the decline in branch traffic and increasing digital channel activity. Community banks need to keep their customers engaged as they continually strengthen their digital experience. They should focus on existing customers, listen to what they want, leverage data to identify and understand clients, and maintain their service cultures by personalizing interactions.

“Shut the back door, rather than worry about what’s coming in the front door,” says Bob Reggiannini, a senior manager at Crowe.

But in positioning themselves for growth, McAlpin adds that banks should ensure they have the right type of people at their institutions and on their boards. Diversity in this environment is a strength, given the perspectives and approaches that can come from individuals representing a variety of demographics, identities and backgrounds. In our recent Governance Best Practices Survey, 52% of respondents agreed that greater diversity, defined by race, gender and ethnicity, improves the performance of a corporate board; only 8% said no. Nearly 40% of respondents said they had several members who fit that definition of diversity, and another 30% said they had one or two but wanted to recruit more.

How to Combat Bank D&O Headwinds

Banks and their boards are at a crossroads of a hardening director and officers (D&O) insurance market, which is creating some challenging conversations as they approach their D&O renewal.

Prior to Covid-19, banks were seeing rate increase ranging from 3% to 26%, strictly based on an overall hardening of the D&O market. But the pandemic has had several specific impacts to the bank D&O renewal process.

Bank D&O underwriters realized very quickly that they would need substantially more information regarding an institution’s response to Covid-19 before they can comfortably offer terms. These questions cover how the bank reacted to their employee base, their response to their customers, their loan and investment exposure to certain high-risk industries and even the impact to the network with so many employees working remotely. Here is a list of the most common coronavirus-related questions a bank can expect.

The analysis of these additional questions means what used to take weeks to produce a quote can now take months. Everything now is a bit more delayed; banks need to budget more time allowances throughout the renewal process.

The pandemic has made multi-year options a thing of the past. Uncertainty associated with the virus and how quickly it caused fact patterns to change has challenged underwriters in ascertaining what the will look like over the next 12 months. Two-year or three-year options are virtually non-existent except for smaller privately held banks from the incumbent carrier.

D&O underwriters are almost paralyzed with fear of offering competing quotes on a bank they do not already have a relationship with. They worry about taking on a new bank and some unanticipated, unexpected pandemic-related claim happens during that first year for which they would be responsible.

The pandemic has made the insurance marketplace messier than it has ever been. Capacity is down, rates are up and underwriters are scrutinizing all new and existing business. Here’s what AHT has been doing for banking clients as they approach their renewal:

1. Set expectations early. Hold your renewal strategy presentation three to four months in advance and make sure you understand what the recent rate increases have been for your broker’s other banking clients to aid in the budgeting process. It can be a difficult message, but it is much better to understand what the rate environment is for similar banks based on the current data months in advance of the renewal.

2. Differentiate your institutions among your peers. We have been doing this for years in meetings with D&O underwriters, but it is more critical than ever. Because D&O lacks actuarial studies that can somewhat predict the probability of a claim, underwriters use the proxy of what I call ‘perceived quality of management.’ The best way for them to experience this is via hearing executives speak on the bank’s operations, compared to written responses.

We include a host of underwriters dedicated to the bank D&O space, including the incumbent underwriter. We begin with a general overview by the executive team of the bank and then open it up for questions from the underwriters, many of which are requested and shared in advance of the meeting.

These meetings expedite the process, especially the questions portion. We typically go from meeting to quote to bind with fewer delays or subjectivities. That’s because Underwriters get a better understanding of the risk, outside of information strictly available on the application and public filings. Some information included in those documents may not paint as full a picture as one that has the additional color added.

Including incumbents in the meeting allows them to experience the interest from competitors. This does not mean we recommended moving from incumbents; It simply means that they gain an understanding that they may need to ‘sharpen their pencils.’ It also increases the chance of gaining some interest from alternative carriers where there may not have been without the meeting.

3. Where there may be fewer alternative options, also look at options with higher retentions.

4. Look for a summary of renewal options as early as possible, understanding that D&O underwriters usually do not quote more than a month in advance. Two weeks prior is a good time to review options.

5. Lastly, more than ever, I am being asked to summarize the process and the results at the subsequent board meeting.

We are seeing challenging renewals the like that we have not seen for years, but your bank can mitigate the challenges by being as proactive and as transparent as possible.

Covid-19 Fraud: A Financial Pandemic

Even as some regulators have reduced reporting requirements, the Financial Crimes Enforcement Network (FinCEN) has opted for a less-relaxed approach in regard to financial institutions and Bank Secrecy Act compliance.

Earlier this year, FinCEN offered some insight into its expectations regarding the Covid-19 pandemic as it applies to BSA. It noted that financial institutions will face challenges related to the pandemic but “expects financial institutions to continue following a risk-based approach” to combat money laundering and related crimes and “diligently adhere” to current BSA obligations. There are some special issues that banks should look out for, along with reporting requirements surrounding those issues.

Potential Fraud Indicators
An 2017 advisory letter outlines some potential fraudulent activities that can occur during a natural disaster or relief efforts. The release was intended to help financial institutions identify and prevent fraudulent activity that may interfere with legitimate relief efforts. The following are likely issues that could arise in the wake of a disaster.

  • Benefits Fraud — Benefits fraud typically occurs when individuals apply for emergency assistance benefits to which they are not entitled. Financial institutions are at risk when fraudsters seek to deposit or obtain cash derived from the emergency assistance payments. FinCEN noted that fraudsters often used wire transfers to perpetrate these scams. In those situations, they request withdrawals and the banks wire funds to the accounts, where the fraudster immediately withdraws the funds.
  • Charities Fraud — Charities provide a vehicle for donations to assist disaster victims; during times of disaster, criminals seek to exploit these vehicles for their own gain. Both legitimate and fraudulent contribution solicitations and schemes can originate from social media, emails, websites, door-to-door collections, flyers, mailings, telephone calls and other similar methods.
  • Cyber-Related Fraud — Cyber actors take advantage of public interest during natural disasters in order to conduct financial fraud and disseminate malware. The Center for Internet Security expects this trend to continue, as new and recycled scams emerge involving financial fraud and malware related to natural disasters.

According to an October release, FinCEN advised financial institutions to remain alert when it comes to fraudulent transactions that resemble those that occur in the wake of natural disasters. FinCEN is monitoring public reports and BSA reports of potential illicit behavior connected to Covid-19 and notes some emerging trends, in addition to those issues identified above.

  • Imposter Scams — Bad actors could attempt to solicit donations, steal personal information or distribute malware by impersonating healthcare organizations or agencies like the Centers for Disease Control and Prevention or the World Health Organization.
  • Investment Scams — The U.S. Securities and Exchange Commission urged investors to be wary of coronavirus-related investment scams, such as promotions that falsely claim that the products or services of publicly traded companies can prevent, detect or cure coronavirus.
  • Product Scams — The U.S. Federal Trade Commission and U.S. Food and Drug Administration have issued public statements and warning letters to companies selling unapproved or misbranded products that make false health claims pertaining to Covid-19. Additionally, FinCEN has received reports regarding fraudulent marketing of coronavirus-related supplies, such as certain face masks.
  • Insider Trading — FinCEN has received reports regarding suspected coronavirus-related insider trading.

Suspicious Activity Reporting
FinCEN still expects institutions to report suspicious activity — however, there are some special expectations within the reporting fields. FinCEN requests, though does not require, that financial institutions reference the 2017 advisory letter and include the key term “disaster-related fraud” in the SAR narrative and in SAR field 31(z) (Fraud-Other) to indicate a connection between the suspicious activity being reported and possible misuse of relief funds.

New FinCEN COVID-19 Online Contact Mechanism
FinCEN has created a coronavirus-specific online contact mechanism, via a specific drop-down category, for financial institutions to communicate related concerns to FinCEN while adhering to their BSA obligations. While this reporting program is in place, FinCEN has not committed to more than an automated response to any communications received.

FinCEN has continued to encourage banks to follow existing guidance and regulation in an effort to secure transactions within the financial services space. FinCEN will offer additional guidance as fraudsters are identified and their efforts are better understood. Until then, financial institutions may do well to ensure that their BSA and anti-money laundering programs are prepared to weather the storm.

New Pandemic Safety and Soundness Standards for Banks

In June, financial regulators jointly issued “Interagency Examiner Guidance for Assessing Safety and Soundness Considering the Effect of the COVID-19 Pandemic on Institutions.” In addition to existing rating systems such as CAMELS, examiners will also assess management’s responsiveness to Covid-19 stresses. With this in mind, CLA is offering financial institutions our interpretation of, and key takeaways from, the guidance.

Asset quality
Asset quality will be a primary focus for all examiners. Safety and soundness exam standards have not changed despite the impacts of Covid-19. Assess and document the changing risk in your loan portfolio and appropriately respond with necessary changes to policies, procedures and programs that help customers, borrowers and communities.

Credit classification and credit risk review
The rise in credit risk due to the pandemic is widespread; no community or financial institution is untouched. As such, the June guidance emphasizes that you should reevaluate assigned credit ratings on the regulatory credit risk rating scale to assess if a change is necessary due to coronavirus-related challenges.

An objective credit risk review will help validate assigned ratings and eliminate “surprises” that could occur during your regulatory examination. In May, regulators released the “Interagency Guidance on Credit Risk Review Systems” and re-emphasized the fundamental concept of an independent credit risk review, which echoes the significance of the process at a critical time.

Credit modifications
Regulators continue to emphasize their support for banks working prudently with borrowers through the pandemic. In August, the Federal Financial Institutions Examination Council explored the need for additional accommodations for certain borrowers via loan modifications. While working with borrowers, banks should obtain current financial information to assess the viability of additional accommodations. Establishing and documenting a systematic approach to loan modifications is prudent and shows what, if any, considerations are being made to the credit risk rating as multiple modifications continue.

Earnings
Despite strong earnings in recent years, the guidance clearly communicates a distinct possibility that bank core earnings could be reduced by the pandemic. Analyze the pandemic’s impact on your current year earnings, how it will detract or enhance your earnings potential, and document accordingly.

Capital
Strong capital and a well-developed plan lead to enhanced viability. Loan growth, deposit growth, and inflows from government stimulus have happened quickly, without an opportunity to fully assess the capital impact. Regulators have even encouraged the use of capital buffers to promote lending activities. Given the pandemic-related changes, updating your capital plan and previously established limits and triggers is essential. Additionally, a current assessment of your overall risk profile and forecasted risks allows you to develop relevant strategies that address risk in your capital.

Liquidity
Most financial institutions have been liquid since the last recession, with less dependency on third parties for funding. Also, as happened during the last recession, there has been an inflow of funds from consumer savings due to economic uncertainty. The guidance readily admits liquidity profiles for financial institutions remain uncertain due to the coronavirus; yet, amid the uncertainty, expectations to employ smart strategies remain — which only places greater emphasis on your overall funding strategy and contingency plans.

Sensitivity to market risk
Earnings and capital evaluations require an assessment of sensitivity to market risk, primarily in the form of interest rate risk. Reassess your asset liability management (ALM) policies and related models to address changes that have occurred to your interest rate risk profile. Decipher between risks that are temporary and risks that will have longer-term effects.

These points will impact assumptions and data incorporated in ALM models, including the impact of loan modifications, payment timing and deposit growth. Additionally, stress testing models are important tools during the pandemic. Incorporate stress scenarios such as fluctuations in unemployment and the impact of possible future shutdowns to manage your risk. Like credit review, banks should strongly consider engaging independent verification of these models to confirm integrity, accuracy and reasonableness.

Management
Management should serve as the driving navigational force during this time of uncertainty. The guidance specifically states examiners will evaluate management’s actions in response to the pandemic. Management can demonstrate responsiveness by fostering open lines of internal communication on a day-to-day basis, and by engaging with the board of directors to obtain a different perspective that could enhance your risk assessment process. Prioritize documentation, which includes an assessment of what policies, procedures and risk assessments need to be revised based on decisions made in response to the pandemic.

Pandemic Presents Technology Ecosystem Opportunities for Banks

Historically, banks have relied on a small number of monolithic suppliers and systems to provide them with broad capabilities, augmenting their own internal development, to provide all their infrastructure.

These systems are patched to add features as banks grow and markets evolve. Mergers can lead to overlapping, incompatible systems; the bank’s infrastructure can make these systems brittle, costly and time-consuming to change.

Still, this suits the entrenched oligopoly of suppliers: locked-in customers unable to sunset anything but stuck paying substantial recurring license fees. Interfaces between systems are often proprietary, making integrations multi-year projects. Most of these are undertaken by a select group of implementation firms that are incentivized to install systems that maximize billable hours and ensure years of lucrative integration work.

Covid-19 and the subsequent government interventions, however, are forcing banks to move quickly: multi-year projects would never adequately address the emergency needs of customers and existential challenges of businesses. The crisis comes at a seminal moment for the industry, when many banks are beginning to experiment with cloud infrastructure. These solutions are able to provision (or decommission) infrastructure in seconds what previously would have taken years, and are well suited for rapid experimentation. This has led to an appetite at banks to try new things and “fail fast.”

The Darwinian effect of running multiple parallel experiments lends itself to thinking of a bank as an ecosystem, where the best providers can be brought in for each functional area. Meanwhile, the bank’s own technologists can focus their people and budgets on key priorities, rather than spending large portions of ever-shrinking budgets patching a leaky ship.

This requires a change in emphasis for financial technology firms: Rather than attempting to disrupt incumbents, there is now a unique opportunity to cooperate with them, providing a much-needed injection of innovation and dynamism at a crucial moment for the economy and communities. Fintechs need to be able to prove their value fast, so the emphasis is on deep vertical expertise that can be deployed rapidly in a variety of environments. Having open APIs and the ability to play a part in a diverse ecosystem of providers is an absolute necessity. Suppliers with “Mechanical Turk” solutions that paper over missing functionality with services will battle to scale rapidly enough and struggle to meet the demand from multiple client banks.

The qualities required to thrive in this new order already exist at banks and fintechs; the winners will be those that can get out of their own way and utilize these strengths. Over the last few years, banks have learned how to integrate disparate systems. The pandemic is forcing them to learn how to do to this quickly.

They need to remove obstacles in their purchasing processes that entrench large suppliers and prevent them from building tech stacks made up of agile and best-in-class solutions. If they back their own ability to craft a cohesive and comprehensive ecosystem, they can tailor this end-state to achieve their desired results. Fintechs are used to bringing innovation and dynamism to the table. Creating lasting impact requires them to follow through and turn this into tangible products. There will be no shortage of opportunities for them to prove their value.

The extraordinary circumstances brought about by the coronavirus have led to a moment of unique opportunity for both banks and fintechs. The economic environment and policy responses by the federal government has meant that banks are forced to act with surprising resourcefulness and agility. They are now seeking to carry this momentum to radically transform projects that seemed previously destined to move at a snail’s pace.

To do this at speed and at scale, they have had to look beyond the short list of traditional vendors and implementation partners more accustomed to project timelines of several years, to a constellation of smaller, more agile fintechs that are able to meet specific needs at a rapid pace. The Davids and Goliaths are finally working together — so far, the outcomes have been pretty phenomenal.

Scaling Quality Customer Service in the Pandemic Era

Since February 2020, the pandemic has reshaped everyone’s daily reality, creating a perfect storm of financial challenges.

In early March 2020, the economy was thriving. Six weeks later, over 30 million U.S. workers had filed for unemployment. The pandemic has exacerbated alreadycrushing consumer debt loads. At the end of the first quarter, nearly 11% of the $1.54 trillion student loan debt was over 90 days past due. Emergency lending programs like the Small Business Administration’s Paycheck Protection Program have not been renewed.  

Guiding consumers, especially millennials and Gen Z, to financial wellness is critical to the future of financial institutions. These demographics bring long-term value to banks, given their combined spending power of over $3 trillion.

But the banking support system is straining under incredible demand from millions of consumers, and it feels broken for many. Consumers are scrambling for help from their banks; their banks are failing them. With hold times ranging from 20 minutes to three hours, compared with an average of 41 seconds in normal times, customers are having an increasingly aggravating experience. And website content isn’t helping either. Often too generic or laced with confusing jargon like “forbearance,” customers can’t get advice that is relevant to their unique situation and  make good financial choices.

All this comes at a time of restricted branch access. Gone are the days when customers could easily walk into their local branch for product advice. Afraid of coronavirus exposure, most consumers have gone digital. Moreover, many branches are closed, reduced hours or use appointments due to the pandemic. No wonder digital has become an urgent imperative.

How can community banks scale high-quality service and advice cost-effectively in the pandemic era and beyond? The answer lies in a new breed of technology, pioneered by digital engagement automation, powered by artificial intelligence and knowledge. Here is what you can do with it.

Deliver smarter digital services. AI-automated digital self-service enables banks to deliver service to more customers, while lowering costs. For example, next-gen chatbots are often just as effective as human assistance for solving a broad range of basic banking queries, such as bill payments, money transfers and disputed charges. The average cost per agent call could be as high as $35; an AI-powered chatbot session costs only a few pennies, according to industry analysts.

Provide instant access to help. The next generation of chatbots go beyond “meet and greet” and can solve customer issues through AI and knowledge-guided conversations. This capability takes more load off the contact center. Chatbots can walk customers through a dialog to best understand their situation and deliver the most relevant guidance and financial health tips. Where needed, they transition the conversation to human agents with all the context, captured from the self-service conversation for a seamless experience.

Satisfy digital natives. Enhancing digital services is also critical to attracting and keeping younger, digital-native customers. Millennials and Gen Z prefer to use digital touchpoints for service. But in the pandemic era, older consumers have also jumped on the bandwagon due to contact risk.

Many of blue-chip companies have scaled customer service and engagement effectively with digital engagement automation. A leading financial services company implemented our virtual assistant chatbot, which answers customer questions while looking for opportunities to sell premium advice, offered by human advisors. These advisors use our chat and co-browse solution to answer customer questions and help them fill forms collaboratively. The chatbot successfully resolved over 50% of incoming service queries.

The client then deployed the capability for their IT helpdesk, where it resolved 81% of the inquiries. Since then the client has rolled out additional domain-specific virtual assistants for other functional groups. Together, these virtual assistants processed over 2 million interactions in the last 12 months.

The economic road ahead will be rocky, and financial institutions cannot afford to lose customers. Digital engagement automation with AI and knowledge can help scale up customer service without sacrificing quality. So why not get going?

When All The Examiners Left

What would happen if all the bank examiners left?

In 1983, the ninth district of the Federal Home Loan Bank lost almost all of its examiners when the office hastily relocated from Little Rock, Arkansas, to Dallas. The move was the culmination of a campaign from congressional and business efforts beginning in the 1950s, the efforts of which had previously been staved off by Arkansas’ representatives.

In response, 37 of 48 employees in the department of supervision chose not to relocate and left, according to Washington Post archival articles; the remaining 11 were mostly low-level administrators. The two remaining field agents split monitoring almost 500 savings and loans across a 550,000 square-mile area.

The move was capricious, political, expensive and, ultimately, disastrous.

The result was a rare natural experiment that explores the importance that bank supervision plays in regulation and enforcement, according to a recent fascinating paper published by Federal Reserve Bank economists John Kandrac and Bernd Schlusche.

The situation became so bad that the Federal Home Loan Bank Board in Washington implemented a supervision blitz in 1986, sending 250 supervisory and examination staffers from across the country to conduct intensive exams in the region. The number of exams conducted during the six weeks was more than three times the number performed in 1985; for many institutions, it was their first comprehensive exam in two or three years.

Here are several takeaways from the paper.

Major Setback to Supervision
The dramatic loss of expertise within the supervision division plagued the FHLB’s ninth district for at least two years. Even though Dallas is the region’s financial capital, it would take years to tutor supervision trainees to the level of the departed senior examiners. The other option the bank had was trying to poach examiners from another region or agency, which creates deficiencies of its own.

When the Cat’s Away, the Mice Will Play
The paper finds that less intensive supervision and less frequent supervision comes with some risk to the stability of institutions.

Unsupervised thrifts increased their risk-taking behaviors and appetites compared to both thrifts outside the region receiving regular examinations and commercial banks in the region. They grew “much more rapidly” by entering newly deregulated and riskier lending spaces, funded the growth with funds like brokered deposits and “readily engaged in accounting gimmicks to inflate their reported capital ratios.”

“[A]ffected institutions increased their risky real estate investments as a share of assets by about 7 percentage points. The size of the treatment effect is economically large,” the paper finds, adding later: “Our results are consistent with the hypothesis that risk taking is a function of supervisory attention.”

Some of this risk-taking led to insolvency. The paper found that the lack of supervision activity led to about 24 additional failures, which cost the insurance fund about $5.4 billion — over $10 billion in 2018 dollars.

Someone Needs to Enforce the Rules
Rules alone were insufficient for these institutions to manage their risk. The paper stresses the role that examiners play in effective enforcement of regulation — an issue that has taken on renewed relevancy given both a lengthening of the examination cycle to 18 months for some community banks and the changes in in-person visits due to the coronavirus pandemic.

Bank supervisors have many tools — formal and informal — by which they can influence a bank’s behavior. The paper notes how regular interactions and conversations, coupled with power of bank regulation itself, seem to be more effective at curbing or correcting risky behavior at banks than self-regulation alone. The six-week supervision blitz in 1986 led to a 76% increase in enforcement actions compared to the year prior, as well as management replacement actions, liquidation requests and 500 criminal referrals to the Department of Justice.

“[S]upervision and examination matter even for what many considered to be the most ineffectual supervisor in the United States. Therefore, even if the importance of supervision has diminished over time on average, we should still expect modern supervisors to meaningfully limit bank risk taking,” the paper reads.

Four Traits That Will Define Successful Lenders in the Future

Covid-19 and the Paycheck Protection Program have fundamentally changed the banking industry.

In just a few months, lenders were forced to learn how to process a year’s worth of loans in six weeks. Numerated worked with lenders to process nearly a quarter of a million PPP loans on our platform. We had a front-row seat to how the pandemic transformed lending and drove a technological reckoning (which we shared with Bank Director).

We’ve identified a number of strategies, perspectives and traits that contributed to lenders’ success during the crisis. Working with banks to shift their focus to a post-PPP world, we’re seeing how incorporating these key learnings from the program will separate the winners from the losers going forward.

As banks and credit unions pivot to the new normal, the most successful lenders will be those who accomplish these four things:

Successful lenders will lean in on digital. It goes without saying that in the middle of a pandemic, every bank needed to figure out how to serve customers with closed branches. Digital capabilities were put to the test — everyone quickly figured out where their digital footprint fell short. A lot of sensitive documents were emailed, workflow was lost and most processes wouldn’t have passed audits in normal times. Digitally-mature lenders and those who successfully adopted technology for PPP had efficient, secure processes that didn’t burn out their customers or employees. Technology will be key to keeping customers satisfied and employees happy during inevitable future crises or unexpected shifts in the industry.

Successful lenders will prioritize speed to market. When Congress first announced the PPP, lenders had to make a quick decision: lean in and figure out how to help their businesses or sit it out. One of the biggest differences in PPP performance we’ve identified was how quickly lenders got into the market.

Two client banks in California both did the same number of PPP loans — despite one being 10 times larger than the other. The smaller bank identified their needs, adopted our platform and rapidly rolled it out to their borrowers faster than their larger counterpart. This gave the smaller bank a foot up in the market. Some banks think committees and consensus mean they can’t move quickly. In 2021, successful banks will understand speed matters, crisis or not.

Successful lenders will achieve efficiency ratios not previously thought possible. The workflow on Small Business Administration loans is complicated; despite the SBA’s best efforts, this was true for PPP as well. The best lenders leveraged technology to get PPP loans done the same day as applications. They pre-filled applications, automated decisions, automatically generated and digitally executed loan documents, and used APIs to board to the SBA. Loans that would have taken a banker five to six hours were done in less than an hour.

At the height of PPP, we saw lenders processing nearly two loans a second — the equivalent of $250 million of PPP loans per hour. Banks will need to find radical efficiencies like these to grow earnings in a challenging 2021 budget season. The most successful lenders are already using PPP learnings to reengineer their normal loan operations.

Using data is key. In 2021 and beyond, it will no longer be enough for lenders to digitize their processes. Going beyond these commonplace efficiency gains will require using reliable, actionable data that can automate and eliminate work. Unfortunately, as anyone who’s worked with financial technology knows, bank data is a mess.

During PPP, we worked with the SBA to create a connection to their systems that let us detect errors in our banks’ data. There were many, many errors; enabling our banks to fix these data issues saved countless hours of rework. Successful lenders are finding ways to clean their data so that software can automate more of their normal lending processes. These conversations are integral to their 2021 plans.

As the pandemic still grips the nation and without further government assistance in the immediate future, banks find themselves in uncharted waters as they set their budgets for the new year.

One of Numerated’s investors is Patriot Financial Partners’ Kirk Wycoff — one of the most successful community bank investors in the United States. In a recent Numerated webinar, he shared his perspective that this year’s budget conversations will be more focused on technology than ever before. “We need to get that message across to senior leadership teams that for investment in technology, there needs to be a realization that the building’s on fire.”

The ability to put out that fire effectively will determine much of lenders’ success in 2021 and beyond.