Hazy Outlook for Bank M&A in 2023

The bank M&A landscape in 2023 will likely be affected by several factors, including concerns about credit quality and turmoil in the stock market, says Rick Childs, partner at Crowe LLP. While sellers will naturally want to get the best price possible, rising interest rates and weak bank stock valuations will impact what buyers are willing to pay. Bankers that do engage in dealmaking will need to exercise careful due diligence to understand a seller’s core deposits and credit risk. Concern about the national economy could prompt bankers to look more closely at in-market M&A, when possible. 

Topics include: 

  • Credit Quality 
  • Customer Communication 
  • Staff Retention
  • Impact of Stock Valuations 

The 2023 Bank M&A Survey examines current growth strategies, including expectations for acquirers and what might drive a bank to sell, and provides an outlook on economic and regulatory matters. The survey results are also explored in the 1st quarter 2023 issue of Bank Director magazine.

Detect and Prevent Check Fraud in Real Time

Financial institutions are engaged in a never-ending battle to stay a step ahead of fraudsters that are clever and nimble enough to continuously exploit their organization or system weaknesses.

Many banks focus on combating digital fraud given the rapid digital developments in the financial services industry. However, fraudsters continue to leverage digital and physical channels to commit check fraud. In fact, checks serve as the payment method most impacted by fraud activity; 66% of payments professionals reported check fraud activity in 2020, according to the 2021 Association for Financial Professionals Payments Fraud and Control Survey.

Banks encounter check fraud in many ways, including counterfeits, forgeries, alterations, serial numbers, stop payments and check kiting. Technological advances have made it easier for fraudsters to create realistic counterfeit and fictitious checks, as well as false identification that can be used to defraud financial institutions nationwide.

Digital banking provides customers with many conveniences but also leaves banks vulnerable to risk. Perpetrators are no longer required to show their faces at physical branches or ATMs to deposit fake checks. However, 49% of fraud occurs in over-the-counter transactions, according to a recent ABA Deposit Account Fraud Survey Report.

Fortunately for financial institutions, there are three key tools they can use to combat check fraud.

The first is leveraging transaction analysis, which is the process of examining bank transactions to look for unusual and suspicious activity or other issues. This key component scrutinizes debits and credits contained in deposits and withdrawals to identify suspicious items, such as duplicate check numbers and out-of-range check numbers and amounts. It also applies tests at the account and entity level, measuring things such as account velocity, account volume and deposits or withdrawals of unusual amounts.

The second tool is check stock validation, which analyzes presented check images against historical reference check images to authenticate the check stock. This can help institutions identify counterfeit in-clearing and over-the-counter checks quicker and more effectively. accurately and reliably than visual inspections. Check stock verification leverages technology to spot aberrations that the human eye cannot detect. It also reduces the number of manual verifications and decreases false positives through digital check image analysis. This improves the check fraud detection process and alleviates the burden on in-house anti-fraud teams.

A third tool is signature verification, which uses machine learning algorithms and sophisticated decision trees to provide a detailed analysis of check signatures. This results in efficient evaluation of suspect in-clearing and over-the-counter checks and increased confidence levels for acceptance and return decisions.

Banks can improve on their ability to detect fraud by combining software innovations such as decision tree/multiple variable analysis, image analysis and machine learning predictive analytics. Data topology, which is a way to classify and manage real-world data scenarios, will increase over time, which allows banks to include contextual information and negative historical analytics. In turn, these outcomes detect transactional fraud and suspicious activity, reducing false negatives and enabling a financial institution to make better and faster fraud-related decisions.

Automation software performs fraud risk scoring on deposits and withdrawals, using specific detection algorithms for each type of check such as on-us, transit, treasury checks and local government checks. The software applies transaction and image analysis on each item in the deposit, along with a configurable scorecard that calculates the risk for the parties involved in the transaction. Today, software can analyze more than 60 parameters covering the conductor, beneficiary, issuing account, and items to produce a single fraud score. This calculated fraud score provides the bank with an appropriate interdiction message — including a hold recommendation that gives the bank the option to accept the deposit, covering the fraud and other collectability risks by holding the fund.

Fraudsters become more innovative every year, targeting vulnerable victims to execute their plans and schemes. Even though check use is increasingly uncommon, fraudsters still utilize checks as a convenient medium to exploit banks and their customers. But banks can mitigate risk and reduce fraud loss efficiently. Used together, tools like transaction analysis, check stock validation and signature verification enable banks to prevent check fraud. Providing a safer banking experience protects the financial institution from fraudulent risks, strengthens the customer experience and earns trust.

Three Ways to Increase Shareholder Value

shareholder-5-3-17.pngWith the Federal Reserve due to raise interest rates again this year and an administration focused on domestic issues and reducing regulation, community bank stocks are in high demand. The OTCQX Banks Index, a benchmark for community banks traded on the OTCQX market, gained 30 percent in the past 12 months, compared to 15 percent for the S&P 500. How can community banks leverage this positive trend and deliver greater value to their shareholders?

First, achieve a fair valuation for your shares. Fair market value is the price at which a person is willing to buy a company’s stock on the open market. Determining fair market value for a publicly traded stock is relatively straightforward and can be done by, for example, taking the average of the highest and lowest selling prices for the stock that day.

Figuring out fair market value for a stock that is not traded on a public market is a little more complex. For privately held community banks, this typically requires the chief financial officer to call around to multiple investors to negotiate prices in bilateral transactions. Not only is this process opaque and inefficient, but it generally doesn’t yield the highest value for shareholders.

For a publicly traded community bank, achieving fair market value is also a factor of the market on which it is traded and how much information it makes available to investors. A bank that trades on an established public market like OTCQX or OTCQB is helping maximize the value of its shares by providing transparent pricing, access to liquidity and convenient access to its news and financial disclosure.

Second, reduce the risk of owning your securities. Community banks can also maximize shareholder value by reducing the risk of trading their securities. A privately-held bank that trades its stock out of a desk drawer opens itself up to additional risks related to pricing, holding and clearing its securities. In contrast, a bank that trades on an established public market reduces risk for shareholders by allowing them to freely get into and out of its stock.

Public market standards can also help lower shareholder risks. In the OTC markets, the top two markets—OTCQX and OTCQB—have verification processes which allow banks to demonstrate to shareholders that they have met certain standards and that there are risk controls around their securities. In contrast, there is no such verification process for companies on the bottom Pink market, which increases the risks—and costs—of owning these securities.

Third, embrace technology. As community banks struggle to replace an aging shareholder base, technology will play a key role in attracting and retaining a new generation of millennial investors. Millennials, aged 18 to 34 years old, get most of their news online and on their phones, so banks need to embrace technology to make sure their financials and news are widely disseminated.

Trading on an established public market like OTCQX and OTCQB can help community banks ensure their news and disclosure is seen by broker-dealers and investors wherever they analyze, value or trade its securities. OTC Markets Group also works with Edgar Online to provide non-Securities and Exchange Commission reporting banks conversion and distribution of their fundamental data in XBRL format, so it can be more easily consumed and analyzed by investors.

With community bank stocks receiving positive attention, now is the time for banks to capitalize on market demand. Think about your shareholders and what’s important to them. Whether your bank has $100 million in assets or $3 billion, your shareholders should be treated like customers and you need to put their needs first.

Is there a Sweet Spot for Bank Stock Pricing?

stock-valuation-7-8-15.pngWhat drives bank stock valuations? Is it asset size, growth, profitability—or a combination of factors acting in concert? Keefe Bruyette & Woods Managing Director Jeffrey Wishner presented an extensive study recently at the Crowe Horwath Bank Growth & Profitability Conference in San Diego in which he examined how a variety of factors influenced the stock prices of 381 publicly held banks traded on the Nasdaq or NYSE exchanges during the first quarter of 2015.

For starters, size would seem to have a positive impact on valuations—although it is by no means a linear relationship. Wishner divided the universe of public banks into seven asset size categories, beginning with institutions having $500 million in assets or less, and ending with $50 billion in assets and above. Banks in the $5 billion to $10 billion category traded on average 1.8 times their tangible book value (TBV) in the first quarter of this year, which was the highest of any of the asset groupings. Interestingly, banks in the $10 billion to $50 billion and $50 billion and above categories had lower price-to-TBV (P/TBV) ratios—1.69x and 1.56x on average, respectively—an indication that the benefits of size dissipate as banks grow larger.

Wishner also looked at the impact that profitability had on stock prices.  Banks that had a return on average assets (ROAA) of 1 percent or better traded on average 1.59 times TBV in the first quarter. Those that had lower ROAAs had correspondingly lower P/TBV ratios. The same relationship was observed with return on tangible common equity (ROTCE): Banks that had a ROTCE of 10 percent or better traded at 1.6 times TBV while those institutions below that mark all had lower valuations.

As one might expect, banks that had solid loan growth also tended to have higher stock prices. Those that grew loans by at least 10 percent also had P/TBV ratios on average of 1.55x, while those that had lower loan growth also had lower P/TBV ratios. Loan growth became even more powerful when combined with higher efficiency, which only makes sense since more of the economic benefits are falling to the bottom line. Banks whose five-year loan compound annual growth rate (CAGR) was 10 percent or better, and also had an efficiency ratio of 60 percent or lower, traded on average 1.9 times their TBV.

Strong loan growth combined with a high ROAA produced the highest returns of all. Banks that had a five-year loan CAGR of 10 percent or higher, and a ROAA of at least 1 percent, had a median P/TBV ratio of 2.09x.

Wishner’s study uncovered some other interesting findings as well. Commercial real estate has accounted for a significant percentage of commercial loan growth in recent years, but too much of a good thing can depress valuations. Banks that had between 25 percent and 50 percent of their loans in commercial real estate traded at 1.61 times TBV, but banks that had higher concentrations also had significantly lower P/TBV ratios. Capital is another factor where having too much can negatively impact a bank’s stock price. Institutions whose ratio of tangible common equity (TCE) to tangible assets ranged between 6 and 8 percent had a P/TBV of 1.58x. Bump the TCE ratio up to a range of 8 to 10 percent and the P/TBV ratio drops to 1.4x. Increase it to 10 percent or greater and the P/TBV ratio plummets to 1.2x. Why? The higher the TCE ratio, the less leverage the bank has—which in turn drives down return on equity.

Although the banking industry tends to be obsessed with growth, it’s not what investors value the most. “The market values efficiency and profitability a little more than growth,” says Wishner.

It would be possible from Wishner’s study to construct the ideal bank from a valuation perspective. That would be a bank with assets of $5 billion to $10 billion, with strong loan growth, high efficiency, enough commercial real estate exposure to help drive profitability but not so much that it distorts the bank’s risk profile, and a TCE ratio of between 6 percent and 8 percent. Any bank that has these characteristics occupies a sweet spot in the bank stock market and should enjoy a higher valuation than many of its peers.