Cautious Optimism for Bank M&A


industry-1-29-18.pngThere is a general sense of optimism about the state of deal-making in the banking industry at Bank Director’s Acquire or Be Acquired conference in Phoenix, Arizona. Bankers and industry observers pointed repeatedly throughout the first day to the fact that bank stock valuations have soared in the 14 months since the 2016 presidential election, opening up new possibilities for interested buyers and sellers.

Bank stocks faced an uncertain if not bleak future two years ago, a point that Thomas Michaud, president and CEO of Keefe, Bruyette & Woods, used to set the scene for the state of banking in 2018. Oil prices had dropped to below $30 a barrel, economic growth in China seemed to be tempering and the United Kingdom was lurching towards a nationwide referendum on quitting the European Union. This trifecta of bad news led bank stocks to drop, producing a dour outlook for prospective sellers.

Yet, you only had to flash forward to the end of 2016 to find a dramatically altered landscape. Stocks soared following the presidential election. And no industry benefited more than banks, where share prices rose by nearly a third over the next four months. Since the beginning of 2016, large-cap bank stocks have climbed 55 percent while regional bank stocks have gained 44 percent—both having bettered the S&P 500’s 36 percent advance over the same stretch.

This has resulted in meaningfully higher valuations, a core driver of deal activity. Prior to the presidential election, banks were valued below their 15-year median of 15.2 times forward earnings per share estimates. After peaking at 18.8 times forward earnings in the immediate wake of the election, they have settled at 15.4. But even though bank valuations are up, which makes deals more attractive to buyers and sellers with higher multiples, they are nowhere near euphoric levels, given the mere 20 basis point premium over the long-run average.

Virtually everyone you talk to at this year’s gathering of more than 1,000 bankers from across the country believes there is still room for these valuations to climb even higher. This was a point made in a session on the drivers of a bank’s value by Curtis Carpenter, principal and head of investment banking at Sheshunoff & Co. Investment Banking. In just the last five weeks of 2017, six deals priced for more than two times tangible book value were announced, creating strong momentum for 2018.

Underlying all of this is an improved outlook for bank profitability, the primary determinate of valuation. In the immediate wake of the financial crisis, it was common to hear people say that banks would be lucky to return 1 percent on their assets. Now, a combination of factors is leading people like Michaud to forecast that the average bank will generate a 1.2 percent return on assets.

Multiple factors are playing into this, beginning with the pristine state of the industry’s asset quality. You have to go back to the 1970s to find the last time the current credit outlook for banks was this good, says Michaud. This has some industry observers watching closely. One of them is Tim Johnson, who leads KPMG LLP’s deal advisory financial services sector. Johnson commented in a panel discussion on deal-making that he believes the consumer credit cycle could take a turn for the worse this year. But there are others, like Tom Brown, founder and chief executive officer of the hedge fund Second Curve Capital, who doesn’t see any reason to be worried about consumer credit trends in light of the low unemployment rate and high consumer confidence.

The expected changing of the guard atop the regulatory agencies is a second factor fueling optimism that profitability will improve this year. Former banker Joseph Otting is the new comptroller of the currency, while Jerome Powell has been confirmed as the new chair of the Federal Reserve Board. Jelena McWilliams awaits confirmation by the U.S. Senate as the new chairman of the Federal Deposit Insurance Corp., and President Donald Trump is expected to nominate a new director to lead the Consumer Financial Protection Bureau. While there are few signs of tangible benefits in terms of a lower compliance burden from the new administration, this should eventually change once new leaders are in place at the top of all of the agencies.

Last but not least, the biggest boost to profitability in the industry will come from the recently enacted corporate tax cuts, which lower the corporate income tax rate from 35 percent down to 21 percent. The drop is so significant that it caused KBW to raise its earnings estimates for banks by 14 percent in 2018 and 12 percent in 2019. And when you factor in the likelihood that many banks will use the savings to buy back stock, KBW projects that earnings per share in the industry will climb this year by 25.6 percent over 2017.

The atmosphere on the first day of the conference was thus upbeat, with presenters and attendees projecting a sense of cautious optimism over the improved outlook for the industry. At the same time, there is recognition that the longer-term macro consolidation cycle that shifted into high gear following the elimination of laws against interstate banking in the mid-1990s could soon reach critical mass. If that were to happen, banks that don’t capitalize on today’s improved outlook by seeking a partner could be left standing alone at the merger alter.

Ten Reasons for Banks to Focus on SBA Lending


lending-12-15-17.pngLending teams are often unable to underwrite loans that don’t fit within the bank’s commercial lending policy, but many of these loans could be done as Small Business Administration loans. For example, 10-year equipment financing is an option with the SBA program, but most banks only provide terms of up to 5 years. Providing low risk alternative financing structures for borrowers can increase profits for the bank.

Banks can quickly begin an SBA lending operation by outsourcing through a lender service provider. This ensures that the bank’s SBA loans are done correctly. Fees are only incurred when the loans close, and the bank is making money.

As chief executives and their management teams consider how to increase the bank’s profitability in the coming year, here are 10 reasons to include SBA lending as a tool for success.

  1. A small SBA lending department underwriting $8 million to $10 million in loans annually can expect to generate $600,000 to $750,000 per year in pretax income.
  2. The SBA guaranty can mitigate the bank’s risk on any loan, but especially on under-secured loans. The SBA will cover 75 percent of the loss if there is a default on the loan.
  3. For smaller banks, the SBA guaranty program expands the legal lending limit, since only the unguaranteed portion of an SBA loan is counted against a bank’s lending limit. Given the SBA’s 75 percent guaranty on loans, a bank with a $1 million legal limit could underwrite a $4 million SBA loan.v
  4. SBA loans can help a bank improve its activities under the Community Reinvestment Act (CRA) by reducing risk, and providing small businesses with longer terms and enhanced cash flow.
  5. The SBA allows banks to refinance existing loans in their portfolios. This can help the institution to restructure its loans with longer terms, manage loan concentrations and reduce risk.v
  6. SBA loans typically have a variable rate and provide the bank with a higher yield than a conventional loan. Given this, creating an SBA portfolio can help improve a bank’s interest yield on its portfolio.
  7. Capital and loan loss reserve requirements are lower on SBA loans.
  8. A bank can grow its portfolio more rapidly through SBA lending.
  9. Guarantees on SBA loans increase liquidity for the bank.
  10. SBA loans produce more fee income.

To illustrate these benefits, let’s consider the following example. A $300 million asset bank earns $2.4 million in net income annually, a 0.8 percent return on assets (ROA). If the bank starts an SBA department the next year, funds $10 million in SBA loans and then sells the guarantees, the bank will likely earn an additional $600,000 in after-tax income. That additional income will push the bank to the 1 percent ROA level. If the same bank has 3 million shares of stock outstanding, the increased earnings will likely move the stock price from $8 to $10 a share, assuming a price to earnings (P/E) ratio of 10. This improvement in financial performance will reflect positively on management, and the SBA loan portfolio only increases by $2.5 million, or one-quarter of SBA loans that are not guaranteed.

All bankers come across loans they would like to fund, but can’t, or loans they are confident are good loans but don’t quite fit into the bank’s commercial lending policy. We have seen many banks utilize SBA lending to provide better financing terms to their clients, mitigate risk and make these loans bankable. The result is more satisfied clients and higher profits.

Lending Automation: The Risk of Delayed Entry


lending-1.png

Technology is rapidly enhancing the banking industry’s ability to comprehensively and efficiently evaluate the credit worthiness of businesses and consumers alike. The abundance of available information on borrowers and the effective management of big data enables banks to minimize risk, reduce defaults and maximize returns. The challenge is leveraging that data to realize its full potential value.

Data and technology go hand in hand. Banks already have a lot of great data on the customers they serve. The problem is, unless they take advantage of available technology, most banks won’t come close to maximizing the value of the customer information they have collected.

Only through technology can banks collect, aggregate and analyze massive amounts of data in a timely manner, allowing for quick, accurate decisioning of borrower information and the streamlining of the myriad of steps that make up the end-to-end lending process. Financial institutions that do the best job of adopting new financial technology stand to gain a huge competitive advantage over those that lag behind.

For those banks slow to adopt state-of-the-art lending technology, the risks of falling behind are significant. The failure to take advantage of the innovative resources available today puts the bank at a competitive disadvantage, and has negative impacts both financially and in terms of human costs.

Customers have grown to expect the convenience and speed that come with a digital experience and judge their financial institution by how it meets those technological expectations. As a result, customers are seeking out banks with a strong fintech brand. With both business and personal borrowers, one of the key drivers is the speed in which they can have access to the capital they need to solve their financial problems. Banks that respond the fastest typically have incorporated technology into the lending process. That results in increased customer retention and higher customer satisfaction scores.

Technology not only impacts the bank’s “customer experience,” it has a major impact on the quality of the “banker experience” as well. Technology enables bankers to focus their energies on activities that enhance their productivity. When customer data is quickly translated into actionable information, it allows bankers to ask better questions, solve more problems and meet more customer needs. This enhanced “banker experience” results in greater employee retention, loan portfolio growth and increased account penetration.

Efficiencies gained through technology also have a big impact on profitability. Loans that were once loss leaders are now able to be executed profitably. It costs just as much for a bank to take a $25,000 loan through the underwriting process as it does for a $900,000 loan. With the efficiencies gained through technology, smaller loans that were once loss leaders may now be executed profitably. This impact can best be seen in the critical small business lending space. Loans that have not been pursued by banks, and in some cases even turned away, are now able to be done profitably, which opens up new markets for banks and helps them better serve their local communities. Technology enables the collection, aggregation and analysis of data in a much more cost effective way and allows for automated, streamlined processes that enhance profitability.

Finally, regulators are also trending toward more comprehensive risk analysis and the expectation of predictive modeling as an objective way to make lending decisions and monitor loan portfolios. Current Expected Credit Loss standards (CECL) are being developed requiring “life of loan” estimates of losses. More and more, banks have to rely on their ability to manipulate available data as a way to meet the regulators’ demands. That kind of analysis is difficult to accomplish consistently and accurately using manual processes, but is much easier to achieve with technology.

Embracing financial technology is the key to survival in the lending world. Banks that adopt new lending technologies early will have significant advantages in the marketplace and will slow market share losses to aggressive, tech-oriented marketplace lenders.

The Breakdown of What SBA Lending Can Do For Your Bank


sba-lending-6-29-16.pngIn today’s challenging banking market, community banks are always looking for ways to increase profits, minimize expenses and diversify their loan portfolios. One solution many banks are utilizing is to add an SBA lending department into their mix of loan products.

The primary SBA lending program is the SBA 7(a) loan program, which allows the bank to make small business loans and receive a 75 percent guarantee from the U.S. government. The guaranteed portions of these loans can be sold in a secondary market, with current gain on sale premiums of 13.5 percent net to the bank.

SBA lending is not only a great way to increase the number of business clients that your bank can serve, but can also be very profitable.

Profitability Model
Let’s assume that you hire your underwriting and processing staff and the lending staff brings in $10 million in SBA loans. If the bank sells the 75 percent portion of the loans that is guaranteed, or $7.5 million, it should earn at least a 12 percent premium in today’s market, or $900,000. For simplicity sake, we will exclude interest and servicing income from this analysis. If you can generate the $10 million with an internal lending staff, the bank will generally have the $200,000 processing and underwriting expense, and therefore generate $700,000 in profit.

Impact on Stock Price
Let’s say your bank currently makes $1.5 million per year in income from its current activities and has 3 million shares outstanding, or an earnings per share (EPS) of 50 cents. At a typical price/earnings ratio of 10, the bank’s stock should be trading at around $10 per share. If the bank were to create an SBA department and generate the additional $700,000 in pre-tax profits, the after tax affect would be an increase in income of $455,000 or $1.96 million in total profit. This would boost the banks EPS to 65 cents and should move the stock price up to $6.50, which will certainly make your board and shareholders happy.

Other Benefits of SBA Lending
Beyond enhancing profitability and mitigating risk, many banks use SBA lending as a tool to provide better loan structuring for their loan clients. So what are some common ways to utilize the SBA 7(a) guaranty?

Some loans may be better suited to being structured as SBA loans and they may be eligible for refinancing. Converting existing conventional loans or lines of credit by refinancing them into SBA guaranteed loans is one way to improve your portfolio and generate fee income. Banks are allowed to refinance their own debt, but it is important to note that the loan needs to have stayed current within 30 days for the last 36 months. If not, SBA would consider the lender to be putting itself in a preferential position.

We recently had a client refinance a mini-storage loan they had on their books that was coming up for renewal. Their regulator had criticized the bank for having a concentration in mini-storage loans. We completed the refinance of this mini-storage loan for approximately $1.6 million and sold the $1.2 million guaranteed portion for a premium in excess of $133,000.

Many times banks have good clients that need financing for equipment the bank doesn’t feel comfortable relying on as collateral. Some examples of this might be food processing and bottling equipment, car washes, MRI machines or unique manufacturing equipment. However, the SBA guaranty can mitigate the risk of taking unique assets as a form of collateral.

Smaller banks can also use the SBA 7(a) guaranty program as a way to provide funding beyond their legal lending limit. Since the guaranteed portion of an SBA loan is excluded from calculating this limit, it frees up the ability to make more loans to a quality customer.

Conclusion
It is clear that creating an SBA lending group can increase your bank’s profitability and provides some significant advantages. All community banks are looking for new ways to better serve their clients and increase profits. SBA lending provides an opportunity to accomplish both of those objectives and potentially improve the bank’s stock price at the same time.

Building An M&A Blueprint



Scale is driving buyers and sellers today, with acquirers seeking growth and sellers seeing scale as an obstacle. Christopher Olsen of Olsen Palmer outlines how both buyers and sellers can plan for a successful deal, and explains how even banks focusing on organic growth strategies will be impacted by consolidation.

  • Scale and M&A
  • A Buyer’s Plan
  • A Seller’s Plan
  • Impact on Organic Growth Strategies

What’s More Important—Size or Profitability?


scale-12-9-15.pngDoes size matter in banking? Many senior bank executives and directors plainly think that it does, based on the results of Bank Director’s 2016 Bank M&A Survey. Sixty-seven percent of the survey respondents said they believe their banks need to grow significantly larger to stay competitive in today’s more highly concentrated marketplace, and about a third of them say their institutions need to get to at least $1 billion in assets.

I struggle with this logic because there is nothing that is necessarily magical about size per se—and particularly a specific number like $1 billion—that makes it more likely that a bank will be able to attain an acceptable level of profitability. The argument you frequently hear is that scale helps you spread your compliance costs—which have gone up precipitously in recent years—over a larger base. It also makes it easier to afford the kind of technological investments that are necessary to stay competitive in a marketplace where consumers and small businesses are using digital and mobile channels in increasing numbers. Both rationales have some basis in fact, but I wonder how many boards of directors have actually put their banks up for sale solely because they couldn’t afford the costs of regulatory compliance and/or technology upgrades. I think not very many.

One of banking’s most persistent problems in recent years has been a low interest rate environment that has compressed net interest margins across the industry and made it difficult to grow both top line revenue and bottom line profits. And herein, I believe, lays the rationale for many of the acquisitions that we have seen in recent years. Perhaps by getting bigger, many CEOs and their boards think they can become more profitable—but that doesn’t just happen ipso facto. Almost always, there’s vital post-acquisition work that needs to be done, such as cutting duplicate administrative costs, rationalizing overlapping branch networks, or deploying one of the merger partners’ expertise in a particular area to the other partners’ untapped market.

Gaining scale can increase a bank’s profits in an absolute sense, but not necessarily its profitability. Profit is the actual amount of earnings that a bank makes for a particular reporting period, while its profitability is what it makes relative to its asset base (return on assets) or market capitalization (return on equity). I believe that profitability is the better yardstick with which to judge the effectiveness of a management team and board of directors because it measures how well they did with what they had to work with. And behind every successful acquisition is, I believe, a strategy for how to increase the combined bank’s profitability rather than its absolute profits.

I really don’t consider doing an acquisition to be a “strategy” per se. An M&A transaction is exactly that—a transaction. This might seem like an overly nuanced point, but “strategy” is what the acquirer intends to do with its prize after the deal closes. How does the acquirer use its new, larger platform to increase its profitability? In fact, I would go so far as to say that if the acquirer’s ROA and (if it is a public company) ROE don’t improve materially within 18 months of the deal’s closing date, than the acquisition has probably failed to live up to its potential even if the bank’s net income is higher. 

Strategy is so important, in fact, that many highly successful banks avoid the M&A game altogether and focus all of their efforts on organic growth, which is rarely achieved and sustained without a well-conceived plan for how to make it happen. I don’t discount the fact that regulatory compliance and technology costs have gone up significantly in recent years, but growth through acquisition needs to be done with a larger purpose behind it than just getting bigger.

Improving Branch Profitability: We Ask the Experts


The reports of the impending death of the bank branch over the last several decades have been greatly exaggerated, but that doesn’t mean that plenty of banks couldn’t use a reboot when it comes to the profitability of individual bank branches. Bank Director asked bank consultants the number one thing they think banks should do to make branches more profitable. Many said that banks should start with a data-driven analysis of individual branch profitability.

What’s the no. 1 thing banks should do to improve the profitability of their branches?

Grinstead-Andy.pngBank management must make data-driven decisions. Consumer and small business trends have changed the role of the branch, and bankers have four main moves to consider as they adapt their branch networks to stay in step with those trends: which branches to close, which to move, which to reconfigure and new markets to consider. Branch footprint changes are emotional and may have brand impact and regulatory implications. It is absolutely essential to build a quantifiable model to inform these decisions. This model should be comprised of key performance indicators, including revenue per branch, revenue per FTE and transaction deposits per branch, along with segment, saturation and growth projections for each branch. This allows management to evaluate the franchise as a whole and determine a stacked rank for each branch.  Franchise value is management’s responsibility and that requires making many forward thinking and tough decisions based on solid data.

—Andy Grinstead, senior vice president, Bank Intelligence Solutions, Fiserv

Cady-Joseph.pngWith branch traffic down significantly, costs up per transaction and branches serving fewer people, banks would be best served by building robust online and mobile banking delivery channels to better meet the shifting needs of their customers, especially on the retail side. Rather than focusing on branch profitability, they should focus instead on bank profitability by transitioning customers from branches to electronic delivery through active incentives and education programs. Online/mobile banking is more beneficial to both banks (lowest cost delivery) and their customers (faster, easier and more convenient). By reducing the necessary number of branches, the fewer remaining offices should become more profitable through reduced facility and staffing costs.

—Joseph H. Cady, managing partner, CS Consulting Group LLC 

McCormick-Jim.pngOur new analysis of bank networks has identified highly skewed branch performance. Fifty percent of the branches operated by most banks have less than their “fair share,” measured by the deposits they have captured relative to competitors in each micro-market. More disconcerting is that in 70 percent of branches, the situation is getting worse. Shoring up the performance of such laggard branches has tremendous profitability upside, with a typical impact of 20 percent to 30 percent in retail banking revenues and even higher profit upside.  

Consequently, banks should determine the fair share ranking of each branch and address the causes of below-parity performance. Typical causes are: branch manager quality, training of branch personnel related to the needs of important segments such as affluent and small business, service quality and relationship-oriented performance.  It is important to note that if a bank operates some branches with high fair share, this provides the empirical evidence that the bank’s products are sufficient to accomplish this outcome if the bank’s personnel are performing.

—Jim McCormick, president, First Manhattan Consulting Group

Gilbert-Collyn.pngOn average, branch operating costs comprise 50 percent to 60 percent of a bank’s overall expense base. Given the change in customer preferences, and lower foot traffic in the branches, rethinking branch utilization strategies should be a top consideration of bank executives today. The overall improvement in branch profitability should be targeted to reducing branch real estate. This reduction can come through consolidating or closing locations, and shrinking overall branch square footage. Shift customer transaction activity from human interaction to self-serve terminals or kiosks (similar to the process adopted by the airlines), and create regional and mobile concierge banking services, minimizing full time equivalent needs in the branch. Reallocate branch overhead expenses into more online services and targeted ad campaigns so as to preserve and promote “the brand” that is often created by the physical locations. 

—Collyn Gilbert, analyst, Keefe, Bruyette & Woods

Kilgore-Toby.pngTo both drive branch profitability and position the bank for the digital future, unlock the value potential by bringing branch-based sales and customer engagement into the data age. Drive a focus on purposeful growth, directed through actionable analytics and fueled by an appropriately aligned incentive system. This means pulling together both internal and external data to better understand potential and existing customers, applying predictive analytics to understand likely needs, and using those insights to drive outreach and selling efforts. This also involves tailoring growth strategies (covering the array of loan and deposit products for both retail and small business) that reflect the characteristics of the local markets served at the branch level. Also, to be sustainable, incentive programs need to be sufficient to generate and maintain focus. We have seen significant value generation through the deployment of analytics-based growth strategies (e.g., customer acquisition rate improvement of 30 percent and up-sell or cross-sell increase of more than 20 percent).

—Toby Kilgore, a principal with Deloitte Consulting

Technology: Driver of Profitability or a Big Expense?


How does technology play a role in a bank’s growth and profitability? When asked to rank the importance of certain factors as drivers of their bank’s organic growth plans—culture and people, technology, unique products and services, and brand—technology placed second for 74 attendees who participated in an on-site audience poll at Bank Director’s Acquire or Be Acquired, held in Scottsdale, Arizona, in January, and the Bank Board Training Forum, last week in Nashville, Tennessee. The responses came mostly from bank directors, chairmen and CEOs.

In terms of importance to the organic growth of your bank, rank the following:

  Overall Rank Score*
Culture/people 1 235
Technology 2 157
Unique products/services 3 136
Brand 4 135

*Score is a weighted calculation, with items ranked as first receiving a higher value, or weight, of 4, second weighted as 3, etc… The score is the sum of all weighted values. Source: Bank Director

Technology continues to change the way customers interact with their banks. Respondents were also asked about their biggest fear—an open response about what keeps them up at night—and 10 percent cite non-bank competition. One of the speakers at the Bank Board Training Forum mentioned that Staples plans to begin offering small business loans. The Apples, Googles and retailers of the world are an increasing concern for bank boards, but will a focus on short-term profitability impede a director’s ability to take a long view of the business?

“Technology can move from an expense to a competitive advantage, if you do it right,” says George McGourty, president of the financial services group at Computer Services Inc. Big banks used to have the advantage with a significantly larger branch footprint, but technology can erase this advantage.

Looking at profitability for your bank in 2015, what do you believe will have the most positive impact?

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Looking at profitability for your bank in 2015, what do you believe will have the most negative impact?

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Sixty-nine percent of survey participants see loan growth as the factor with the most positive impact on the profitability of their financial institution, while no one cites technological innovations. Yet the right use of technology—and the right partnerships—can expand a community bank’s reach and help drive demand. Titan Bank, a $79.4 million asset bank based in Mineral Wells, Texas, partners with San Francisco-based peer-to-peer online lenders Prosper Marketplace and Lending Club to make small business loans, according to a spokesperson at the bank. These relationships help expand the bank’s reach beyond its local markets. (In addition to its Mineral Wells headquarters, the bank has a branch in nearby Graford, Texas, and a loan production office in Dallas, about 90 miles away.)

For Bethesda, Maryland’s Congressional Bank, with $446 million in assets, Lending Club helps the bank diversify its loan portfolio through the purchase of unsecured consumer loans, according to Jeffrey Lipson, the bank’s president and CEO. In February 2015, Lending Club partnered with BancAlliance, giving members of the Chevy Chase, Maryland-based lending platform—roughly 200 community banks—access to Lending Club’s expanded market for consumer loans.

Another technological opportunity is the use of data analytics. Too few banks take advantage of personal financial management tools and even for those that do, few effectively use the valuable customer data it provides, says Bradley Leimer, senior vice president and head of innovation at Santander Bank, N.A., the U.S. subsidiary of Banco Santander, S.A., headquartered in Madrid, Spain. Leimer just joined Santander in September 2014: He previously served as vice president of digital strategy at Richmond, California-based Mechanics Bank, with $3.4 billion in assets, from January 2010 to September 2014. During his tenure, almost 40 percent of Mechanics Bank’s customers used personal financial management tools, with the majority aggregating financial data from external accounts. The bank was able to use that information to target offers to its customers. “There’s money to be had in looking at the data that your customers provide you,” he says.

One-quarter of those polled in Bank Director’s survey view cybersecurity as their biggest fear. Do concerns about cybersecurity turn technology, in the minds of these board members and CEOs, into a potentially disastrous threat? Technology helps fuel growth, but it’s also a big expense. Finding technology’s place in a profitable bank isn’t easy. But bankers that view technology simply as an expense item, and not a way to grow, may find it difficult to get ahead. “If they look at [technology] clearly as an expense, I think they’re going to make some bad strategic decisions,” says McGourty.

Year in Review: Big Profits, but Big Regulatory Fines, Too


1-9-15-Naomi.pngThe banking industry has never seen it so good. Or has it? Bank earnings have returned to record levels, and average return on equity (ROE) is about what is has been historically. At the same time, regulatory fines are huge and banks are contending with increased regulation like never before. Digitization is providing new opportunities for some banks to cut costs and please customers, and yet the surge in technology startup companies poses special challenges for banks. Because of this, management consulting firm McKinsey & Co. concludes in its 2014 annual review that “those banks that have articulated and executed a regulation-savvy, customer-centric strategy are collecting all the surplus value in the industry.”

Improved Profitability
One of the most impressive trends has been the industry’s return to profitability following the financial crisis six years ago. In 2013, U.S. banks above $10 billion in assets made $114 billion in profits, second only to the record year that was 2007, according to McKinsey.Year-end earnings for the largest banks will be released in the next few weeks, but 2014 is shaping up to top $100 billion in earnings again, says Fritz Nauck, senior partner at McKinsey. Improved credit quality and cost cutting were major drivers of the increased profits. Where is this cost cutting coming from? Many banks are cutting branches. Since 2011, U.S. banks have downsized the industry’s branch network by nearly 5 percent. In 2013 alone, that amounted to 1,300 branches, according to McKinsey.“Should that continue, that will drive future earnings and ROE,’’ Nauck says.

Banks now are close to an historical average ROE of 10 percent, calculated since 1980.

U.S. and Canadian banks are doing better than their European counterparts. The ROE for U.S. and Canadian banks went from 8.4 percent in 2012 to 9.3 percent in 2013 and 9.9 percent in the first half of 2014. For comparison’s sake, Western European banks had an ROE in 2013 of only 2 percent. Credit quality is better in the U.S. than in Europe, plus banks trimmed operating expenses and added capital earlier in the financial crisis than European banks, Nauck says.

Increased Regulation
Fines and settlements, however, have put a damper on the banking world’s profitability, both in Europe and North America, with many of those settlements relating to the financial crisis. The top 15 European banks and top 25 U.S. banks paid $60 billion in fines and settlements combined in the first half of 2014, according to McKinsey. From 2010 to 2014, those banks have paid about $165 billion in fines and settlements, and some of that involves regulators stepping up enforcement in areas not relating to the crisis, including money laundering rules, McKinsey says. Without those fines, the banking industry would have been significantly more profitable. In addition, increased regulation is taking more staff time and more hours out of the executive management team. McKinsey estimates that senior executives spend about 20 to 25 percent of their time on regulatory matters.

Driven to Digitization
The trend toward digitization—connecting with customers through apps and websites as well as automation of transactions and personalization of products and services—is transforming banking. McKinsey estimates that there are now more than 12,000 financial technology startups in existence. Fintech companies such as PayPal were first interested in transactions but many of them are now moving into new areas, including lending.

Interestingly, McKinsey sees fintech companies as more of an opportunity than a threat, because banks can set up joint ventures and sometimes acquire them to deepen and broaden their offerings for customers, just like Spanish bank BBVA did when it acquired the innovative online banking startup Simple in 2014.

Banks that have well defined strategies and execute them effectively are outperforming others, McKinsey says. But as the past year has made clear, banks must respond well to enhanced regulation and have a digital strategy in place to be successful.

Customer Analytics: Solving the Checking Account Profitability Quandary


6-11-14-SC.pngWhat are banks to do when zero percent of customers will gladly pay fees for their basic checking products, yet 100 percent of banks need more fee income, and an average of 43 percent of checking customers aren’t profitable? Simply slap a new fee on an existing product, especially one that’s been free? Sounds easy, but this just ticks off customers, especially the most profitable ones.

It is this Catch 22 situation that led StrategyCorps to create a customizable BaZing consumer checking solution that delivers customer-friendly fee income, fixes unprofitable accounts and protects the profitable ones. As a bonus, it also better connects with the mobile/online financial lifestyles of consumers. Here’s how it works.

Using BaZing’s analytical tool (called CheckingScore), we determine the profitability of each customer’s total householded relationship based on total deposit accounts, loans and fee income. Each customer gets a score based on profitability. With this financial foundation, the bank can then begin tailoring the BaZing-related checking product to the bank’s needs and deciding its place in the checking line-up.

This involves building exactly what the bank’s BaZing product will be, given specific market realities (such as fee income needs, competition, brand identity, marketing resources, current state of mobile and online platforms).

6-11-14-SC3.pngStrategyCorps and the bank determine which traditional banking benefits are necessary to combine with precisely chosen non-traditional benefits, like discounts with local merchants (including the bank’s small business customers) or cell phone insurance, which consumers have already shown a willingness to pay for. These benefits are delivered with a mobile application and online for a reasonable monthly fee of $6. The most profitable customers are provided these non-traditional benefits for free as a reward for being the most loyal and productive customers.

BaZing’s list of available non-traditional benefits revolve around two premises: (1) saving customers money when they spend it, especially with local merchants and (2) protecting customers when something unexpected happens in everyday activities.

Plus, due to StrategyCorps’ purchasing power, the price of a bundle of several of these benefits in the checking account is typically less than the price of just one benefit sold on a stand-alone basis.

There are nearly 200 banks today with the BaZing solution out of thousands of banks facing the fee income and profitability quandary described above.

6-11-14-SC2.pngFirst Financial Bank in Abilene, Texas employed BaZing to simplify and standardize active and grandfathered accounts. The bank had more than 120 different deposit accounts due to acquisitions and its corporate structure, which were slimmed down to eight accounts across ten banks in its holding company. The bank also used BaZing to upgrade its value-based checking account (Wow! Checking). This allowed customers to save their hard-earned money with local community merchants (including nearly 200 small business customers), while generating substantial new customer-friendly fee income.

Lakeland Bank in Oak Ridge, New Jersey customized BaZing as Elite Checking to improve consumer checking profitability, with incentives for customers to increase their debit card usage. It also provided the bank with a competitive advantage in the crowded New Jersey/New York City metro market with a checking account that aligned perfectly with their brand identity.

The game-changing innovation of BaZing can be summed up in its typical financial results for a bank:

  • Unprofitable checking accounts (about 43 percent of all accounts) can be fixed by generating nearly $75 per year per account in customer-acceptable fee income. This is usually a fee income lift of 250 percent+ over existing levels.
  • Super profitable checking accounts (about 15 percent of all accounts) can be protected and retention increased by providing BaZing’s benefits as a reward for their loyal patronage.
  • When unconditional free checking is offered (a rarity these days), new checking customers will choose the fee-based BaZing-related account 30 percent of the time, and they will chose it more than 50 percent of the time when totally free checking isn’t offered.
  • The consolidation of grandfathered accounts into a simplified active account line-up saves tens of thousands of dollars annually in costs related to maintaining, managing and servicing these grandfathered accounts.

Strategically, BaZing engages customers differently, so they remember the bank when they’re not in the branches (average annual branch visits per customer is three) by going beyond basic banking.