The Choice Facing Every Bank

Has your executive team been approached by leaders of another bank interested in an acquisition? It likely means your bank is doing something right. But, now what?

Many CEOs’ visceral response to being asked to consider a deal is to say, “Thanks, but no thanks” and continue running the bank. While this may be the correct response, this overture is a chance for leadership to objectively revisit the bank’s strategic alternatives to determine the best option for its shareholders and other stakeholders.

Stay the Course
Boards must objectively identify where their bank is in its life cycle — be it turn-around, growth or stability — and what will be needed to successfully compete at the next stage. Ultimately, they must determine if the bank can drive more long-term shareholder value staying independent than it could with a partner. They must also weigh the risk of remaining independent against the potential reward.

Directors should prepare five-year projections, ideally with the help of a financial advisor, that assume the bank continues to operate independently. They should forecast growth and profitability that reasonably reflect current marketplace dynamics and company strategy, and are generally consistent with past performance. Consider opportunities to lower funding costs, consolidate or sell unprofitable branches, add lines of business, or achieve economies of scale through acquisitions or organic growth. However, be cognizant of market headwinds: low interest rate environment, slower projected loan growth, increasing cost of technology and cybersecurity, regulatory burden, competition, demographic trends, upcoming presidential election and so on. The board should also consider organizational issues such as succession planning — a major issue for many community banks. How do these factors impact the future performance of your institution? Will your bank be able to meet shareholder expectations?

Merge with Peer
Peer mergers have been a hot topic of late. The bank space has seen several high-profile transactions: the merger between BB&T Corp. and SunTrust Banks to form Truist Financial Corp.; Memphis, Tennessee-based First Horizon National Corp. and Lafayette, Louisiana-based IBERIABANK Corp.; Columbia, South Carolina-based South State Corp. and Winter Haven, Florida-based CenterState Bank Corp.; and McKinney, Texas-based Independent Bank Group and Dallas-based Texas Capital Bancshares.

The opportunity to double assets while achieving economies of scale can drive significant shareholder value. But these transactions can be tough to nail down because both parties must be willing to compromise on key negotiation topics. Which side selects the chairman? The CEO? How will the board be split? Where will the company be headquartered? What will be the name of the future bank?

Peer mergers can be risky propositions for banks, as cultures don’t always match and integration can take several years. However, the transaction can be a windfall for shareholders in the long run.

Sell
A decision to sell almost always generates the greatest immediate value for shareholders. Boards must ascertain if now is the right time, or if the bank can do better on its own.

Whether or not selling creates the highest long-term value for shareholders depends on several factors. One factor is the consideration mix, if any, between stock and cash. Cash gives shareholders the flexibility to invest and diversify the net proceeds as they see fit, but capital gains will be taxed immediately. Stock consideration is generally a tax-free exchange, when structured correctly, but it is paramount to select the right partner. Look for a bank with a strong management team and board, a proven track record of building shareholder value and a plan to continue to do so. That partner may not offer you the highest price today, but will most likely deliver a better return to shareholders in the long run, compared to other potential acquirers. Furthermore, a partner that is likely to sell in the near-term could provide a double-dip — a potential homerun for your shareholders.

It is crucial to consider what impact a sale would have on other stakeholders, like employees and the community. Prepare your bank to sell, well in advance of any conversations with potential acquirers. Avoid signing new IT contracts with material termination costs; it is an opportune time to sell when core processing contracts are nearing expiration. In addition, review existing employment agreements and consider establishing a severance plan to protect employees ahead of time.

Being approached by a potential acquirer gives your bank an opportunity to objectively reflect on its strategy and potentially adjust it. Even if your bank hasn’t been contacted by a potential acquirer, the board should still review the bank’s strategic alternatives annually, at a minimum, and determine the best path forward.

Four Interesting Insights from Two Very Interesting Bankers

The greatest benefit of being a writer is that you get to talk with lots of interesting people. It’s a constant education. Particularly if you appreciate the opportunity and structure your conversations accordingly.

My style is to conduct broad interviews across a range of topics, whether all the topics are germane to the piece I’m working on at the moment or not. This has helped me construct a mental model of banking, but it also means that a lot of material is left on the cutting room floor, so to speak.

With this in mind, I decided to revisit some of the conversations I’ve had with bankers over the past few months to share the most interesting insights.

Foremost among these is a series of conversations with Robert and Patrick Gaughen, the CEO and president, respectively, of Hingham Institution for Savings, a $2.6 billion bank based in the Boston metropolitan area.

Since the Gaughens gained control of Hingham in 1993, following a two-year proxy contest with its former managers, it has generated a total shareholder return of more than 5,400%, according to my math. That’s more than double the total return of other well-run banks like JPMorgan Chase & Co. and PNC Financial Services Group.

One thing that strikes you when talking with the Gaughens is the depth and sophistication of their banking philosophy. All bankers understand banking. But some understand it on a deeper level than others — that’s the Gaughens.

They approach the industry as investors, or capital allocators, instead of bankers. This seems to be a product of the fact that both Robert Gaughen and his father — Patrick’s grandfather — practiced law before becoming de facto bankers in order to protect investments they had made in banks.

This may seem like a vacuous nuance, but it isn’t. It’s always tempting to subordinate the process of capital allocation to operational processes. After all, if your operations aren’t profitable, you won’t have excess capital to allocate.

What true capital allocators appreciate, however, is that the distinction between capital allocation and operations is nebulous. Everything can be viewed through the prism of capital allocation — from how many employees you hire to which technologies you implement to whether you increase your dividend or repurchase stock.

In this respect, capital allocation is less of a mechanical process than it is a mindset, concentrating one’s attention on measuring the return on each incremental decision.

Another interesting insight that came up in our conversations is the importance of studying other industries. Not only the importance of doing so, I should say, but why it’s so important to do so.

The drive to constantly learn is something that many people preach, but few people practice. This is an element of leadership that can’t be overstated. It serves as the common denominator underlying the performance of the most successful CEOs in banking.

It’s well known that banking is an acutely competitive and commoditized industry, and that those characteristics compress profit margins. But there are two other forces that lead to a lack of differentiation as well.

As Patrick points out, high consultant reuse and an overbearing regulatory schema contribute to a high degree of homogeneity in terms of the way banks are run. The net result is that studying other banks can be less fruitful than one might think.

This isn’t to say that a mastery of banking isn’t critical — it is. But after accumulating a critical mass of knowledge about best practices within banking, the incremental return from intermittently studying other industries, it seems, will exceed the return of concentrating exclusively on banking.

The final point that both Gaughens stress relates to the importance of skin in the game, or executive and director ownership of stock. In their case, their immediate and extended family owns upwards of 40% of Hingham’s outstanding stock. This provides a powerful incentive to care not only about the return on their capital, but also the return of their capital.

Many companies talk about the mystical benefits of alignment between executives and shareholders, as well as having employees that act like owners. But there is simply no substitute for having actual skin in the game. It hones one’s appreciation for the virtues of extraordinary banking, from efficiency to risk management to disciplined growth.

None of this is to say that the Gaughens have everything figured out; they would be the first to admit they don’t. But their philosophy and approach to banking is not only unique, but also tried and true.

Using Succession Planning to Unlock Compensation Challenges

compensation-9-16-19.pngSuccession planning could be the key solution boards can use to address their biggest compensation challenges.

Succession planning is one of the most critical tasks for a bank’s board of directors, right up there with attracting talented executives and compensating them. But many boards miss the opportunity of allowing succession planning to drive talent retention and compensation. Banks can address two major challenges with one well-crafted plan.

Ideally, succession planning is an ongoing discussion between executive management and board members. Proper planning encourages banks to assess their current talent base for various positions and identify opportunities or shortfalls.

It’s not a static one-and-done project either. Directors should be aware of the problems that succession planning attempts to solve: preparing future leaders, filling any talent voids, attracting and retaining key talent, strategically disbursing training funds and ultimately, improving shareholder value.

About a third of respondents in the Bank Director’s 2019 Compensation Survey reported that “succession planning for the CEO and/or executives” was one of the biggest challenges facing their banks. More popular challenges included “tying compensation to performance,” “managing compensation and benefit costs,” and “recruiting commercial lenders.”

But in our experience, these priorities are out of order. Developing a strategic succession planning process can actually drive solutions to the other three compensation challenges.

There are several approaches boards can use to formulate a successful succession plan. But they should start by assessing the critical roles in the bank, the projected departure dates of those individuals, and information and guidance about the skills needed for each position.

Boards should be mindful that the current leaders’ skill sets may be less relevant or evolve in the future. Susan Rogers, organizational change expert and president of People Pinnacle, said succession planning should consider what skills the role may require in the future, based on a company’s strategic direction and trends in the industry and market.

The skills and experiences that got you where you are today likely won’t get you where you need to go in the future. We need to prepare future leaders for what’s ahead rather than what’s behind,” she said.

Once a board has identified potential successors, it can now design compensation plans that align their roles and training plans with incentives to remain with the organization. Nonqualified benefit plans, such as deferred compensation programs, can be effective tools for attracting and retaining key bank performers.

According to the American Bankers Association 2018 Compensation and Benefits Survey, 64% of respondents offered a nonqualified deferred compensation plan for top management. Their design flexibility means they can focus on both longer-term deferrals to provide retirement income or shorter-term deferrals for interim financial needs.

Plans with provisions that link benefits to the long-term success of the bank can help increase performance and shareholder value. Bank contributions can be at the board’s discretion or follow defined performance goals, and can either be a specific dollar amount or a percentage of an executive’s salary. Succession and training goals can also be incorporated into the plan’s award parameters.

Such plans can be very attractive to key employees, particularly the young and high performing. For example, assume that the bank contributes 8% of a $125,000 salary for a 37-year-old employee annually until age 65. At age 65, the participant could have an account balance equal to $1,470,000 (assuming a crediting rate equal to the bank’s return on assets (8%), with an annual payment of $130,000 per year for 15 years).

This same participant could also use a portion of the benefit to pay for college expenses for two children, paid for with in-service distributions from the nonqualified plan. Assume there are two children, ages three and seven, and the employee wants $25,000 a year to be distributed for each child for four years. These annual $25,000 distributions would be paid out when the employee was between ages 49 and 56. The remaining portion would be available for retirement and provide an annual benefit of $83,000 for 15 years, beginning at age 65.

Boards could use a plan like this in lieu of stock plans that have similar time horizons. This type of arrangement can be more enticing to younger leaders looking at shorter, more mid-term financial needs than a long-term incentive plan.

And many banks already have defined benefit-type supplemental retirement plans to recruit, retain, and reward key executives. These plans are very popular with executives who are 45 and older, because they provide specific monthly distributions at retirement age.

It is important that boards craft meaningful compensation plans that reward older and younger executives, especially when they are vital to the bank’s overall succession planning efforts and future success.

How Subchapter S Issues Could Snag a Sale


acquisitions-5-2-19.pngNearly 2,000 banks in the U.S. have elected Subchapter S tax treatment as a way of enhancing shareholder value since 1997, the first year they were permitted to make the election. Consequently, many banks have more than 20 years of operating history as an S corporation.

However, this history is presenting increasingly frequent challenges during acquisition due diligence. Acquirers of S corporations are placing greater emphasis on due diligence to ensure that the target made a valid initial Subchapter S election and continuously maintained eligibility since the election. Common issues arising during due diligence typically fall into two categories:

  • Failure to maintain stock transfer and shareholder records with sufficient specificity to demonstrate continuous eligibility as an S corporation.
  • Failure by certain trust shareholders to timely make required Qualified Subchapter S Trust (QSST) or Electing Small Business Trust (ESBT) elections.

A target’s inability to affirmatively demonstrate its initial or continuing eligibility as an S corporation creates a risk for the acquirer. The target’s S election could be disregarded after the deal closes, subjecting the acquirer to corporate-level tax liability with respect to the target for all prior periods that are within the statute of limitations. This risk assessment may impact the purchase price or the willingness of the buyer to proceed with the transaction. In addition, the target could become exposed to corporate tax liability, depending on the extent of the compliance issues revealed during due diligence, unless remediated.

Accordingly, it is important for S corporation banks to ensure that their elections are continuously maintained and that they retain appropriate documentation to demonstrate compliance. An S corporation bank should retain all records associated with the initial election, including all shareholder consents and IRS election forms. S corporation banks should also maintain detailed stock transfer records to enable the substantiation of continuous shareholder eligibility.

Prior to registering a stock transfer to a trust, S corporation banks should request and retain copies of all governing trust instruments, as well as any required IRS elections.

It is also advisable to have the bank’s legal counsel review these trust instruments to confirm eligibility status and any required elections. Banks that are relying on the family aggregation rules to stay below the 100 shareholder limitation should also keep records supporting the family aggregation analysis.

While S corporation banks have realized significant economic benefits through the elimination of double taxation of corporate earnings, maintaining strong recordkeeping practices is a critical element in protecting and maximizing franchise value, especially during an acquisition. Any S corporation bank that is contemplating selling in the foreseeable future should consider conducting a preemptive review of its Subchapter S compliance and take any steps necessary to remediate adverse findings or secure missing documentation prior to exploring a sale.

A Better Way to Value Deposit-Driven Deals


deposits-4-1-19.pngThere’s no doubt that the focus these days on acquisitions centers around deposits. When surveyed at the 2019 Acquire or Be Acquired conference, 71 percent of attendees said that a target’s deposit base was the most important factor in making the decision to acquire. This suggests that targets with excess liquidity (low loan-to-deposit ratios) will be highly valued in the market going forward.

This strategic objective is out of whack with traditional deal valuation metrics.

The two primary traditional deal metrics are tangible book value (TBV) payback period and earnings per share (EPS) accretion. Investors expect every deal to meet the benchmarks of a low TBV payback period (ideally less than three years) and be accretive to EPS, according to a presentation from Keefe Bruyette & Woods President and CEO Tom Michaud.

These are earnings-based metrics, and targets with low loan-to-deposit ratios have lower earnings because they have larger securities portfolios relative to loans. Therefore, traditional consolidation modeling will undervalue those targets with longer payback periods and lower accretion. Potential acquirers will struggle to justify competitive prices for these highly valued targets.

Why are deals that clearly create shareholder value by strengthening the buyer’s deposit base not reflected by the deal metrics du jour? Because those metrics are flawed. How can you justify a deposit-driven deal to an investor base that is focused on TBV payback and EPS accretion? By abandoning traditional valuation methods and using forward-looking, common sense analytics that capture the true value of an acquisition.

Traditional consolidation methodology projects the buyer and seller independently, then combines them with some purchase accounting and cost savings adjustments. Maybe the analyst will increase consolidated loan growth generated from the excess deposits acquired. This methodology does not capture the true value of the acquired deposits.

The intelligent acquirer should first project its own financials under realistic scenarios, given current market trends. Industry deposit growth has already begun to slow, and the big banks are taking more and more market share. If the bank were to grow loans organically, it must be determined:

  • How much of the funding would come from core deposits and how much would require brokered deposits or other borrowings like Federal Home Loan Bank advances and repurchase agreements? This change in funding mix will drive up incremental interest expense.
  • How many of the bank’s existing depositors will shift their funds from low cost checking and savings accounts to higher cost CDs to capture higher market rates? This process will increase the bank’s existing cost of funds.
  • What will happen to my deposit rates when my competitors start advertising higher rates in a desperate play to attract deposits? This will put more pressure on the bank’s existing cost of funds.
  • How many of my existing loans will reprice at higher rates and help overcome increasing funding costs? Invictus’ BankGenome™ intelligence system suggests that, while the average fixed/floating mix for all banks in the US is 60/40, the percentage of floating rate loans actually repricing at higher rates in the next 12 months is much lower because the weighted average time between loan reset dates is more than six quarters.

Standalone projections for the buyer must adequately reflect the risks inherent in the current operating environment. These risks will affect a bank’s bottom line and, therefore, shareholder value. This process will create a true baseline against which to measure the impact of the acquisition. Management must educate its investors on the flaws in legacy analytics, so they can understand a deal’s true value.

In the acquisition scenario, the bank is acquiring loan growth with existing core deposit funding attached. And if the target has excess deposits, the acquirer can deploy those funds into additional loans grown organically without the funding risks due to current market trends. The cost differential between the organic growth and acquisition scenarios creates real, tangible savings. These savings translate to higher incremental earnings from the acquisition, which alleviate TBV payback periods and EPS accretion issues. Traditional deal metrics may be used as guideposts in evaluating an acquisition, but a misguided reliance on them can obscure the true strategic and financial shareholder value created in a transaction.

Every target should be analyzed in depth, with prices customized to the acquirer’s unique balance sheet and footprint. Don’t pass on a great deal because of flawed traditional methodologies.

How Analytics and Automation Can Improve Shareholder Value


automation-2-8-19.pngAdvanced data science technologies like artificial intelligence (AI), machine learning and robotic process automation are delivering significant benefits to many banks.

As part of their mandate to protect shareholder value and improve financial performance, bank directors can play an important role in the adoption of these promising new technologies.

Technology’s expanding influence
With fintech companies generating new competitive pressures, most traditional banks have recognized the need to adopt some new techniques to meet changing customer habits and expectations. Declines in branch traffic and increased online and mobile banking are the most obvious of these trends.

Yet, as important as service delivery methods are, they are in a sense only the top layer of bigger changes that technology is bringing to the industry. New data-intensive tools such as AI, machine learning and robotic process automation can bring benefits to nearly all areas of a bank, from operations to sales and marketing to risk and compliance.

Advanced data analytics can also empower banks to develop deeper insights and make better, more informed strategic decisions about their customers, products and service offerings.

The power of advanced analytics
Historically, business data systems simply recorded and reported what happened regarding a customer, an account, or certain business metrics. The goal was to help managers understand what had happened and develop strategies for improving performance.

Today’s business intelligence systems advance this to predictive analysis – suggesting what is likely to happen in the future based on what has been observed so far. The most advanced systems go even further to prescriptive analysis – recommending or implementing actions that increase or decrease the likelihood of something happening.

For example, AI systems can be programmed to identify certain customer characteristics or transaction patterns, which can be used for customer segmentation. Based on these patterns, a bank can then build predictive models about those customer segments’ likely actions or behaviors – such as closing an account or paying off a loan early.

Machine learning employs algorithms to predict the significance of these customer patterns and prescribe an appropriate response. With accurate segmentation models, a bank can tailor marketing, sales, cross-selling and customer retention strategies more precisely aligned to each customer.

Automating these identification, prediction, and prescription functions frees up humans to perform other tasks. Moreover, today’s advanced analytics speed up the process and can recognize patterns and relationships that would go undetected by a human observer.

Industry leaders are using these tools to achieve benefits in a range of bank functions, such as improving the effectiveness of marketing and compliance functions. Many large banks already use predictive modeling to simplify stress testing and capital planning forecasts. AI and machine learning technology also can enhance branch operations, improve loan processing speeds and approval rates and other analytical functions.

Getting the data house in order
While most banks today are relatively mature in terms of their IT infrastructures and new software applications, the same levels of scrutiny and control often are not applied to data itself. This is where data governance becomes crucially important – and where bank directors can play an important role.

Data governance is not just an IT problem. Rather, it is an organization-wide issue – and the essential foundation for any advanced analytics capabilities. As they work to protect and build shareholder value, directors should stay current on data governance standards and best practices, and make sure effective data governance processes, systems and controls are in place.

AI, machine learning, and robotic process automation are no panacea, and banks must guard against potential pitfalls when implementing new technology. Nevertheless, the biggest risk most banks face today is not the risk of moving too quickly – it’s the risk of inertia. Getting started can seem overwhelming, but the first step toward automation can go a long way toward taking advantage of powerful competitive advantages this technology can deliver.

Enhancing Shareholder Value



Bank stocks have taken a dive in late 2018, and bank boards play a key role in the strategic decisions driving shareholder value. Scott Sommer and Steve Williams of Cornerstone Advisors explain the issues impacting shareholder value in 2019, including technology.

  • Bank stock trends
  • Focus on fintech
  • Board decisions

How to Build Shareholder Value When Economic Growth Slows


shareholder-12-4-18.pngBanking has been on an impressive run since the end of the 2009 recession. Now, as the industry finds itself with sky-high valuations, the market is wondering what banks can do for an encore.

Whatever comes next must be defined by a clear strategy for building shareholder value. That’s because the next 12-18 months are likely to show some level of marketplace pullback. A recent Wall Street Journal article reported that the U.S. economy has likely peaked and that we should expect slower growth on both the consumer and business sides. This means that formulating a strategic plan is increasingly vital.

These six ideas offer some places to start:

1) Balance CRE exposure with C&I growth
One of the commercial growth engines has been the commercial real estate space. But as the demand cycle begins to flatten, many small and mid-size banks are refocusing their attention on the commercial and industrial loan sector. Although it’s a slower, relationship-oriented build, there is an opportunity for a more sustainable, mutually beneficial relationship that could span several years. As a result, we expect continued demand for high-performing C&I lenders over the next 18-24 months who can drive the right kind of volume for the banks.

2) Bolster non-interest income businesses
Non-interest income has always been a big topic. But the banking industry needs to go beyond simply focusing on service-fee opportunities. That can mean creating new businesses around payments, treasury management and areas of wealth management. It can also include non-traditional businesses like insurance, which can offer a nice annuity-based income stream.

3) Play hard in the talent wars
Nearly 60 percent of employers struggle to fill job vacancies within 12 weeks—and by 2030, the global talent shortage could reach upwards of 85 million people. For banks, this means emphasizing three basic strategies that go beyond monetary compensation: a) Develop and enhance career development and retention programs; b) create an emotional bond between employees and the bank itself; and c) involve human-resource executives in formulating deliberate talent-search strategies.

4) Ensure value realization in a pricey M&A market
Banks need a clearly defined strategy around managing mergers and acquisitions. Where will banks find targets and opportunities? Whether the strategy is opportunistic or deliberately acquisitive, banks must create a structured playbook that more than earns back the premium paid by the acquirer.

5) Develop a deliberate deposit strategy
There is no single answer to the deposit funding challenge facing most banks today. But here are areas worth exploring: a) Make sure retail checking and money market products are positioned to retain loyal checking customers; b) bolster treasury management solution capabilities and develop industry niches to grow specialty deposits; and c) align sales team goals and incentives to reflect the priority of deposit growth and retention. The key is putting together a detailed funding plan–and executing a deposit strategy that balances deposit growth with overall cost of funds in 2019.

6) Execute on the channel delivery shift
Make plans to keep moving into a digital world and navigate the world of tech. This really comes down to ensuring a significant return on your channel investments. When making any investments in delivery channels—whether brick-and-mortar, contact centers or a digital strategy—they have to be looked at in three areas. How much will the investment help with customer acquisition? How much will it help to retain profitable clients? And what is the cost?

Building a great strategic plan is actually creating a great story—for the board, for investors, for the employee base and for prospective talent. Then, when looking at financial rigor and value, embrace the idea of relentless execution with milestones, key performance indicators and focus. Success is derived not just from the plan, but also from the notion that everybody has their fingerprints on it by the time the process is done.

No matter the focus over the next three to five years, break it down into its basic parts, create a story and execute on it. Because in the end, success comes down to relentless execution.

You’ll Never Guess Where BB&T Gets Its Big Ideas


strategy-10-19-18.pngIt is well worth any banker’s time to read the vision, mission and purpose statements of BB&T, the eighth biggest commercial bank in the United States.

They will sound at first like similar statements from any other bank, but what makes BB&T’s unique is the inspiration behind them.

They weren’t drawn up with the help of consultants or survey data; they are grounded instead in the writings of philosophers—classical thinkers as well as modern proponents of capitalism.

“The philosophers that influenced me the most are Aristotle, Thomas Aquinas, John Locke, and Ayn Rand,” writes John Allison, the chairman and CEO of BB&T from 1989 to 2008, in his 2014 book, The Leadership Crisis and the Free Market Cure.

BB&T has published an entire pamphlet outlining its culture, encapsulated in its vision, mission and purpose statements, which reduce to one key objective: “Our ultimate purpose is to create superior long-term economic rewards for our shareholders.”

The $223-billion bank based in Winston-Salem, North Carolina, doesn’t just talk the talk; it walks the walk. It ranks in the 98th percentile among publicly traded banks in terms of the total amount of shareholder value it has created during its time as a public entity.

Yet, there’s a nuance to BB&T’s philosophy on creating value that’s easy to overlook. It doesn’t talk about “maximizing” long-term economic rewards for shareholders; it talks instead about “optimizing” those rewards.

Why the difference?

As Allison writes in his book:

When free market economists and finance theorists refer to maximizing shareholders’ returns, they imply a long-term context. In the real world, maximizing tends to be a short-term concept. BB&T’s mission also focuses on ‘creating a safe and sound investment,’ The goal with this wording is to communicate to potential purchasers of the company’s stock that we are in the game for the long-term and will not take inordinate risk even if that risk could maximize short-term returns.

In no industry is a long-term view more important than banking. Banks, as a group, use more leverage than companies in any other industry, typically borrowing $10 for every $1 worth of capital.

This is by design, of course, as a principal purpose of banking is to leverage society’s capital to fuel economic growth—a point Bank of America’s chairman and CEO, Brian Moynihan, made in a recent interview with Bank Director:

[B]anks came up to help people borrow money, which helps economies grow faster. If you’re constrained to only your equity, you only have so much money to spend. But if you borrow against it, now you can spend more. That’s the magic of leverage in terms of accelerating progress.

But there is a downside to all that leverage—it makes banks vulnerable to economic cycles, explaining why more than 17,000 banks have failed since the Civil War.

Bankers are prone to the same impulses that, at the top of a cycle, cause real estate developers to break ground on skyscrapers, retailers to over-invest in inventory and technology entrepreneurs to believe that traditional rules of economics no longer apply.

The difference is that, thanks to leverage, there’s less margin for error in banking than there is in other industries. A mere 10 percent decline in the value of a typical bank’s assets will render it insolvent.

This is one reason BB&T chose the words of its mission statement so carefully in terms of “optimizing” as opposed to “maximizing” shareholder value.

Another reason is that shareholders aren’t a bank’s only constituency—there are also clients, employees and communities. A bank that doesn’t tend to all four is like a table with only three legs.

It’s by optimizing returns among multiple constituencies, in other words, that a bank can maximize the returns to anyone of them. And if a bank does that through multiple cycles, the outcome is even better.

The net result at BB&T, writes Allison, is that “we operate our business in a long-term context by adding value to our clients, employees, and communities and in that context create superior rewards for shareholders.”

In short, while Aristotle, Thomas Aquinas, John Locke and Ayn Rand may seem like an unlikely source for inspiration in banking, if BB&T’s success is any indication, it’s safe to say they were onto something.

One Risk in M&A You Maybe Have Not Considered


core-provider-9-25-18.pngThe vast majority of middle-market community banks and credit unions will at some point explore acquiring or being acquired because M&As are one of the quickest and most effective ways a bank can scale up, expand reach, and grow. Unfortunately, many of these banks have no choice but to watch lucrative opportunities pass them by because they unwittingly agreed to grossly unfair and inequitable terms in their core and IT contracts.

Financial institutions constantly assess risk from nearly every conceivable perspective to protect shareholder value, but far too many realize too late that hidden astronomical M&A termination fees and other hidden contractual penalties render a deal totally unfeasible. Over and over again, blindsided banks are hobbled by stifled growth.

Simply stated, core and IT suppliers punish banks with excessive termination, de-conversion and conversion fees because they can get away with it. Suppliers also sneak in large clawbacks for discounts awarded in the past as an added pain for measure. Banks fall for it because they don’t know better.

Bank deals are complex procedures with the possibility of extraordinary payoff or extraordinary peril. Terms regarding potential M&As are buried deep within the pages of lengthy and convoluted core and IT supplier contracts. Suppliers are betting that arduous language within these five- to seven-year agreements deter bankers from looking too closely or fully comprehending terms and conditions they contain. Many banks are not thinking about a merger or acquisition when they originally signed those contracts. The suppliers’ bets pay off, and banks either lose the deal or are forced to pay in spades.

Termination fees core and IT suppliers secure for themselves in most contracts with community banks and credit unions border on unconscionable. Banks find themselves saddled with the prospect of paying 50, 80, or even 100 percent of the amount due to the core provider based on what would have been paid if the institution remained with that supplier for the life of the contract.

And these fees apply even if the financial institution they’re merging with or acquiring has the same core IT supplier. Even in cases where the core has virtually nothing to lose in the deal, they still demand a fat check for their “pains.” These fees are so high they can easily kill a potential deal before it even reaches the negotiating table — and they often do.

Banks Have Defendable Rights
A contract isn’t a contract unless there’s some cost for exiting it early. But there’s fair and then there’s fleecing — and let’s just say core and IT suppliers wield a pretty big pair of shears.

The reality is that more than half of all states will not tolerate these termination fees in court, provided they’re challenged by institutions. The maximum amount of liquidated damages a supplier is entitled to legally — provided they can rationalize how they were harmed — is the discounted value of remaining net profit. This might not be more than 18 to 22 percent of remaining contract value, or about one year on a five-year deal. That’s nowhere close to what is often claimed by core suppliers.

But you have to know your rights before you can demand they be respected, and a wealth of knowledge regarding the most favorable core and IT contract terms available can’t be acquired overnight. It’s taken many years for Paladin to amass proprietary core and IT supplier contract data.

Secure Fair Terms Now to Protect Deals Later
By updating your contracts before a transaction, you can speed the M&A process, protect your institution and shareholders, and prevent unforeseen deal risks. But you’ll need to come armed and ready for battle. Core and IT suppliers have enjoyed decades of manipulating the system to their advantage. Going it alone in your next contract negotiation will likely result in ending up with more of the same hidden and unfair terms. That’s how good these guys are at getting what they want from the community banks they call their “partners.”

There are experts with a proven track record of going toe-to-toe with core and IT suppliers and coming out ahead for community financial institutions. Time and again, we’ve approached the table with our clients, advocated for a fair deal, and walked away with terms that make sense for both parties — not just the suppliers.