Three Steps to Building a Commercial Card Business In-House

As the economy recovers from the impact of the Covid-19 pandemic, community banks will need to evaluate how to best serve their small and medium business (SMB) customers.

These companies will be seeking to ramp up hiring, restart operations or return to pre-pandemic levels of service. Many SMBs will turn to credit cards to help fund necessary changes — but too many community banks may miss out on this spending because they do not have a strong in-house commercial card business.

According to call reports from the Federal Deposit Insurance Corp., community banks make up half of all term loans to small businesses, yet four out of five have no credit card loans. At the same time, Accenture reports that commercial payments made via credit card are expected to grow 12% each year from 2019 to 2024. This is a significant strategic opportunity for community bankers to capitalize on the increased growth of cards and payments. Community bankers can use commercial cards to quickly capitalize on this growth and strengthen the relationships with existing SMB customers while boosting their local communities. Commercial credit cards can also be a sticky product banks can use to retain new Paycheck Protection Program loan customers.

Comparing Credit Card Program
Many community banks offer a branded business credit card program through the increasingly-outdated agent bank model. The agent bank model divorces the bank from their customer relationship, as well as any ability to provide local decisioning and servicing to their customers. Additionally, the community banks carry the risk of the credit lines they have guaranteed. In comparison, banks can launch an in-house credit card program within 90 days with modern technology and a partnership with the right provider. These programs require little to no upfront investment and don’t need additional human resources on the bank’s payroll.

Community banks can leverage new technology platforms that are substantially cheaper than previous programs, enabling issuers to launch products faster. The technology allows bank leaders to effortlessly update and modify products that cater to their customer’s changing needs. Technology can also lower customer acquisition and service costs through digital channels, especially when it comes to onboarding and self-service resources.

More importantly in agent bank models, the community bank does not underwrite, fund or keep the credit card balances on its books. It has little or no say in the issuing bank’s decisions to cancel a card; if it guarantees the loan, it takes all the risk but receives no incremental reward or revenue. The bank earns a small referral fee, but that is a fraction of the total return on assets it can earn by owning the loans and capturing the lucrative issuer interchange.

Bringing credit card business in-house allows for an enhanced user experience and improved customer retention. Community banks can use their unique insight to their SMB customers to craft personalized and tailored products, such as fleet cards, physical cards, ghost cards for preferred vendors or virtual cards for AP invoices. An in-house corporate credit card program gives banks complete access to customer data and total control over the user experience. They can also set their own update and product development timelines to better serve the changing needs of their customers.

Three Steps to Start an In-House Program
The first step to starting an in-house credit card program to build out the program’s strategy, including goals and parameters for credit underwriting. The underwriting strategy will establish score cutoffs, debt-to-income ratios, relationship values and other criteria so automated decisions reflect the policies and priorities of the bank. It is important to consider the relationship value of a customer, as it provides an edge in decision making for improved risk, better engagement and higher return. If a bank selects a seasoned technology partner, that partner may be able to provide a champion strategy and best practices from their experience.

Next, community banks should establish a long-term financial plan designed to meet its strategic objectives while addressing risk management criteria, including credit, collection and fraud exposures. It is important that bank leaders evaluate potential partners to ensure proper fraud protections and security. Some card platform providers will even share in the responsibility for fraud-related financial losses to help mitigate the risk for the bank.

The third step is to understand and establish support needs. These days, a strong account issuer program limits the bank’s need for dedicated personnel to operate or manage the portfolio. Many providers also offer resources to handle accounting and settlement, risk management, technology infrastructure, product development, compliance and customer service functions. The bank can work with partners to build the right mix of in-house and provided support, and align its compensation systems to provide the best balance of profitability and support.

Building an in-house corporate credit card program is an important strategic priority for every community bank, increasing its franchise value and ensuring its business is ready for the future.

Evaluating Your Technology Relationship

 

It’s tough to find a technology provider that puts your bank’s needs first. Yet given the pace of change, it’s becoming crucial that banks consider external solutions to meet their strategic goals — from improving the digital experience to building internal efficiencies. In this video, six technology experts share their views on what makes for a strong partnership.

Hear from these finalists from the 2021 Best of FinXTech Awards:

  • Dan O’Malley, Numerated
  • Nicky Senyard, Fintel Connect
  • Zack Nagelberg, Derivative Path
  • Doug Brown, NCR Corp.
  • Joe Ehrhardt, Teslar Software
  • Jessica Caballero, DefenseStorm

To learn more about the methodology behind the Best of FinXTech Awards, click here.

If you’re a bank executive or director who wants to learn more about the FinXTech Connect platform, click here. If you represent a technology company that is currently working with financial institutions, click here to submit your company for consideration.

The Three Pillars for Success in Peer Mergers

Recent trends indicate that many bankers are considering adding significant scale by targeting peer institutions for outright acquisition.

These transactions, which we call “peer mergers,” are comparable to so-called “merger of equals,” except that the management team, operational structure and culture of the acquiring institution will mostly remain the same for the combined institution. This avoids the most obvious difficulty with successfully executing a merger of equals: combining two institutions without one side of the equation feeling “less equal” than the other. Peer mergers still carry plenty of their own risks, but keeping the management team and operational structure mostly intact is appealing and can greatly reduce the need to cut redundancies post-merger by eliminating them at the outset. Here are three key concepts to keep in mind when considering such a merger.

Choose a Good Strategic Fit

Why are we doing this deal? Will we be solving challenges or creating new ones? Is the combined institution greater than the sum of its parts?
Choosing to do a peer merger may be as straightforward as needing to add scale. However, banks desiring scale to fortify their balance sheet and gain operational and regulatory efficiencies may find that the wrong partner creates more headaches than it solves. Long-term solutions may be more difficult to manage at a larger combined institution, especially if there is a significant clash in cultures. In most cases, identifying a target needs to be about more than just scale. Does the merger gain entry into high-growth markets, meaningfully diversify credit risk, add complementary products and teams, or create significant synergies and efficiencies? Does your bank need to merge in order to accomplish those goals, or are there simpler, cleaner alternatives?

Get Ahead of Challenges

What are the challenges posed by the merger? How can those challenges be addressed? How quickly can those challenges be overcome?
We always recommend to our clients to be as proactive as possible about identifying and solving issues as early as they can in the acquisition negotiation process. This is even more true in a peer merger, where the consequences of a miscalculation are amplified by the transaction’s scale. The merger agreement doesn’t need to be signed to start this process. In fact, addressing issues prior to execution may very well reveal even deeper problems than due diligence would have otherwise shown, and allow for solutions or protections to be negotiated into the merger agreement. Especially try to hammer out the compensation of the potentially retained management personnel as early as possible; you don’t want to find out post-signing that key personnel aren’t as keen on staying with the combined institution as you’d thought — especially if that would trigger change in control payments.

Look Down the Road

What are our long-term strategic goals, and how does the merger get us closer to them? What will the combined institution look like 3 to 5 years from now? How does this benefit our shareholders?
Forecasting what the combined institution will look like in the long term involves much more than looking at pro formas and financial projections. Will your operational structure be able to handle the combined institution’s business volume at closing? Will it be able to five years down the road without a difficult and expensive overhaul? Will you be operating in your target markets, or will further geographic growth be needed and how will you achieve it? Will you cross asset size thresholds that trigger more onerous regulatory oversight in the near future?

Another important consideration is the impact on your shareholders — both the old and the new. Consider how you will give your shareholders the ability to cash out their investments. Will you conduct stock buybacks? Is a public listing on the table? Do you give target shareholders the opportunity to cash out at closing?

Both the potential benefits and risks of a typical merger are magnified in a peer merger, due to the scale of the transaction. With extensive strategic and operational foresight and careful navigation of the potential pitfalls, peer mergers offer a way to quickly add scale and supercharge your bank.

Finding Opportunities in 2021

Will deal volume pick up pace in 2021? Despite credit concerns and negotiation hurdles, Stinson LLP Partner Adam Maier predicts a stronger appetite for deals — but adds that potential acquirers will have to be aggressive in pursuing targets that align with their strategic goals.

  • Predictions for 2021
  • Capital Considerations
  • Regulatory Hurdles to Growth

Use Compensation Plans to Tackle a Talent Shortage


Can you believe it’s been 10 years since the global financial crisis? As you’ll no doubt recall, what was originally a localized mortgage crisis spiraled into a full-blown liquidity crisis and economic recession. As a result, Congress passed unprecedented regulatory reform, largely in the form of the Dodd-Frank Act, the impact of which is still being felt today.

Significant executive compensation and corporate governance regulatory requirements now require the full attention of senior management and directors. At the same time, shareholders continue to apply pressure on management to deliver strong financial performance. These challenges often seem overwhelming, while the industry also faces a shortage of the talent needed to deliver higher performance. As members of the Baby Boomer generation retire over the coming years, banks are challenged to fill key positions.

Today, many banks are just trading people, particularly among lenders with sizable portfolios. Many would argue the war for talent is more intense than ever. According to Bank Director’s 2017 Compensation Survey, retaining key talent is a top concern.

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To address this challenge, many banks have expanded their compensation program to include nonqualified benefit plans as well as link a significant portion of total compensation to the achievement of the bank’s strategic goals. Boards are focusing more on strategy, and providing incentives to satisfy both the bank’s year-to-year budget and its long-term strategic plan.

For example, if the strategic plan indicates an expectation that the bank will significantly increase its market share over a three-year period, compared to competition, then executive compensation should be based in part upon achieving that goal.

Achieving Strategic Goals
There are other compensation programs available to help a bank retain talented employees.

According to Federal Deposit Insurance Corp. call report data and internal company research, nonqualified plans, such as supplemental executive retirement plans (SERPs) and deferred compensation plans, are widely used and are particularly important in community banks, where equity or equity-related plans such as stock options, restricted stock, phantom stock and stock appreciation plans are typically not used. These plans can enhance retirement benefits, and can be powerful tools to attract and retain key employees. “Forfeiture” provisions (also called “golden handcuffs”) encourage employees to stay with their present bank instead of leaving to work for a competitor.

SERPs
SERPs can restore benefits lost under qualified plans because of Internal Revenue Code limits. Regulatory rules restrict the amount that can be contributed to tax-deferred plans, like a 401(k). A common rule of thumb is that retirees will need 70 to 80 percent of their final pre-retirement income to maintain their standard of living during retirement. Highly compensated employees may only be able to replace 30 to 50 percent of their salary with qualified plans, creating a retirement income gap.

retirement-income-gap.png

To offset this gap, banks often pay annual benefits for 10 to 20 years after the individual retires, with 15 years being the most common. SERPs can have lengthy vesting schedules, particularly where the bank wishes to reinforce retention of executive talent.

Deferred Compensation Plans
We have also seen an increasing number of banks implement performance-based deferred compensation plans in lieu of stock plans. Defined as either a specific dollar amount or percentage of salary, bank contributions may be based on the achievement of measurable results such as loan growth, increased profitability and reduced problem assets. Typically, the annual contributions vest over 3 to 5 years, but could be longer.

While deferred compensation plans have historically been linked to retirement benefits, we see younger officers are often finding more value in cash distributions that occur before retirement age.

To attract and retain millennials in particular, more employers are expanding their benefit programs by offering a resource to help employees pay off their student loans. According to a survey commissioned by the communications firm Padilla, more than 63 percent of millennials have $10,000 or more in student debt. Deferred compensation plans can also be extended to millennials to help pay for a child’s college tuition or purchase a home. Because these shorter-term deferred compensation plans do not pay out if the officer leaves the bank, it provides a strong incentive for the officer to stay longer term.

Banks must compete with all types of organizations for talent, and future success depends on their ability to attract and retain key executives. The use of nonqualified plans, when properly chosen and correctly designed, can make a major impact on enhancing long-term shareholder value.

Insurance services provided by Equias Alliance, LLC, a subsidiary of NFP Corp. (NFP). Services offered through Kestra Investment Services, LLC (Kestra IS), member of FINRA/SIPC. Kestra IS is not affiliated with Equias Alliance, LLC or NFP.

How a Board Can Become a Strategic Asset



Issues like cybersecurity, digital transformation and future business models now require the attention of not just management teams, but also bank boards. As directors engage more deeply in these issues, Bill Fisher of Diligent explains how they can enhance the effectiveness of the board to be a true strategic asset to the bank.

  • The Board’s Role as a Strategic Asset
  • Enhancing Board Effectiveness
  • Addressing Board Skills

Talent Strategies for Family-Owned Banks



How strong and transparent is the bank’s succession plan? Are employees being developed to achieve strategic goals? Joshua Juergensen, principal at CliftonLarsonAllen, shares how community bank boards and management teams should strategically approach talent development.

  • Tackling Succession Concerns
  • Outlining a Career Path
  • Developing a Strategic Vision

Merger of Equals: Does 1 + 1 = 3?


merger-9-12-16.pngGiven today’s burdensome regulatory environment and complex business climate, many banks are evaluating different strategic alternatives as a means to grow. Mergers of equals (MOEs) are not always at the forefront of discussions when bank executives consider strategic alternatives, due to the social and cultural issues that can present roadblocks throughout the negotiation process.

It is vital to the success of a MOE that both parties come to terms on these issues early in the process to minimize the execution risk. When both parties of a MOE develop and align the structure of the transaction as well as the vision of the combined entity, MOEs can be executed successfully.

Historically, these issues have hindered MOE activity. Since 1990, MOEs have made up only 2.43 percent of total M&A transactions, reaching their peak (by number of deals) in 1998 before dropping off with the entire M&A market during the 2008 financial crisis. We are now seeing a resurgence in MOEs. As of Aug. 30, 2016, there have been seven MOEs this year making up 4.41 percent of total M&A activity in the community banking space. The banking industry has become increasingly more competitive in recent years, underscored by net interest margin compression as well as increased regulatory and compliance expenses. MOEs serve as an excellent alternative to cut costs, increase earnings, and gain size and scale.

In our eyes, successful MOEs cannot be forced; they are a marriage that must develop naturally between two institutions and their executives that have an amicable past with one another. They are most successful when the two banks’ philosophies and strategic visions align. While not every bank may be a fit for a MOE partner, we recommend that executives give consideration to merger opportunities, as a well-executed MOE can significantly enhance shareholder value.

MOEs present a significant opportunity to gain immediate size and scale that otherwise may not be achievable through small bank acquisitions. Achieving this size and scale will have a direct impact on the bottom line as the increasing regulatory burden can be spread across the firm while generating cost savings through the reduction of repetitive back office staff, overlapping branches, data processing contracts, and marketing expenses. Moreover, this will further enhance shareholder value through the pooling of talent and increased earnings stream generated by the bank, ultimately providing an opportunity for a higher takeout multiple in the event of a sale of the combined enterprise.

The market performance of MOE parties has reflected the positive impact that MOEs can have. When comparing the stock performance since January 2010 of both the accounting acquirer and accounting target (a merger of equals always has, for accounting purposes, an acquirer and a target), on average they have both outperformed their peers, beating the SNL US Bank & Thrift index three months after the announcement by 1.9 percent and 3.7 percent, respectively. Moreover, the pro forma bank has outperformed the SNL US Bank & Thrift index at both one- and two-year time frames after the mergers have closed; the average stock price change of the pro forma bank one-year post closing is 15.9 percent compared to 8.9 percent for the SNL US Bank & Thrift index and over two years is 22.0 percent compared to 13.3 percent.

Additionally, the combined enterprise has also performed well financially. The average pro forma bank has increased both return on average assets (ROAA) and return on average equity (ROAE) one and two years after the transaction closing.

Average Pro Forma Bank Before and After a Merger of Equals

merger-graph.png

Source: S&P 500 Market Intelligence
Note: ROAA and ROAE for acquirer and target are as of the quarter prior to transaction announcement. Includes select MOE transactions from 1/1/2010 to 8/28/2016 in which the accounting buyer is publicly traded; includes 12 transactions. Transactions in which ROAA and/or ROAE are not available for specific time periods are excluded from average ROAA and/or ROAE calculations.

When a MOE is well executed it can bolster earnings, gain scale, increase efficiency and improve products and practices, ultimately creating a stronger combined institution. In these cases, the whole is greater than the sum-of-the-parts and 1 + 1 = 3.

How to Completely Change Your Future


strategic-planning.pngIs the regulatory burden getting you down? Does your market offer slow to no growth? Are your shareholders increasingly fed up with that?

It might be time to buy a bank or sell to a competitor with better prospects for growth.

Banks face some very significant challenges in the years ahead. The sharply increased cost of regulatory compliance might lead some to seek a buyer; I have seen others respond by trying to get bigger through acquisitions in order to spread the costs over a wider base.

Quite a few banks have already made difficult decisions such as these. For instance, one of last summer’s notable bank dealsCIT Group’s purchase of Pasadena, California–based OneWest Bank — was struck in part because of the costs of regulation. Likewise, the board of Michigan–based Citizens Republic Bancorp sat down with its CEO a few years ago and seriously considered its strategic options for the future, with the end result being a sale to Ohio–based FirstMerit Corp. It wasn’t that Citizens didn’t have a future. The conclusion was that the future was better paired with a larger organization.

In last month’s column, Will Nonbanks Impact Bank M&A?, I looked at how Lending Club and Prosper, two online lending marketplaces that offer loans to consumers and small business funded by private investors and institutional money, present significant challenges to those looking to expand their lending portfolios. With Lending Club announcing on July 14 that its marketplace is available to investors in Arkansas, Iowa and Oklahoma, I have to assume that officers and directors in those and other states are considering how to either fend off such threats — or potentially partner with them to gain access to new lending opportunities.

With competition coming from both the top of the market and from non-traditional players, it is imperative for community banks to focus on improving efficiencies and enhancing organic growth prospects. Those with the best prospects? The 550 or so banks between $1 billion and $10 billion in assets — and within this niche, banks with bold, creative and disciplined CEOs. Banks in this range have both the size to compete technologically and the scale to begin to afford the regulatory compliance burden.

While transforming a franchise through organic growth is desirable and potentially less risky, I continue to see better growth prospects from acquisitions in many parts of the country.

Earlier this year, at Bank Director’s Acquire or Be Acquired conference in Phoenix, KPMG’s Hugh Kelly offered that with growth opportunities available through M&A, many sellers will be motivated by getting out from regulatory burdens. At a minimum, regulators expect a bank’s strategic planning process to consider the following questions:

  • Where are we now?
  • Where do we want to be?
  • How do we get there?
  • How do we measure our progress?
  • What adjustments are necessary to meet our goals?

If you don’t have satisfactory answers to those questions, your bank might consider a sale to a bank with solid growth prospects. As John Gorman and Eric Luse with the Washington, D.C.–based Luse Gorman law firm shared at the same conference, “increased regulatory and compliance costs have changed the banking business in a fundamental way.” As the two note, this has squeezed profitability, particularly for smaller banks, and pressure to consolidate and achieve economics of scale has increased.

However, many deals are delayed for regulatory reasons.

While many point to the potential for nonbanks, such as the Lending Clubs and Prospers of the financial world, to steal marketshare, regulatory risk is probably the greatest obstacle to completing an M&A deal, and ironically, may be the very thing driving it.

What New Directors Are You Adding to Your Board?


board-effectiveness-7-17-15.pngWhat types of new directors are banks adding to their boards? The following are responses from DirectorCorps-member banks, a diverse bunch of publicly traded and private banks ranging in asset size from less than $100 million to $10 billion. While hardly a scientific poll, the responses show that banks are looking for specific expertise that helps them accomplish their strategic goals. For small institutions, that primarily means adding board members who can bring business to the bank as well as knowledge about their communities. It may also mean mergers and acquisition expertise or financial acumen. Interestingly enough, no one said they had recently added a risk expert or a technology expert, types that some of the larger banks are increasingly adding to their boards.

Here is what we asked:

Q. If you have added new directors to the board in the past two years, what skills or backgrounds do they have and how are they different from the skills or backgrounds of existing members? Please write 2-3 sentences, telling why these skills are now important to your bank.

When we started our bank in 2000, our board was composed almost entirely of successful entrepreneurs. Our board is still strongly entrepreneurial in nature but as the bank has grown, we have added new members with more corporate executive level experience to enhance our perspective on the issues and opportunities facing a more complex and growing organization. Going forward, we may need to add member(s) who meet the regulatory requirements of a “financial expert” to give our audit committee greater depth and to provide for future succession as audit committee chairman.

—Director of a publicly traded bank with more than $1 billion in assets

Our bank added two new directors in 2014. Their respective skill sets and backgrounds further broadened our board’s capabilities in two key areas: expanding our community development efforts and the growth of our business banking enterprise. One director is the executive director at one of our community’s largest nonprofits; the other is the chief executive of a well-known business with significant ties to the local and regional business communities. In both cases, they have contributed to these areas and others in the short period they’ve been with us.

—CEO of a privately owned bank with more than $1 billion in assets

We added a new director last fall [who] is from one of our newer and potentially large marketing areas. He is a lawyer with a background in banking law and bank M&A. These are two areas where we have no board member with expertise. While we have acquired banks in the past, we don’t have anyone with his kind of expertise.

—Director of publicly traded bank with more than $2 billion in assets

Our last two directors are at the top of their respective professions.  They are well connected in the business community which is good for new business development at our bank. Our board has a business development culture. The new directors bring additional prospects to the table.

—Director of publicly traded bank with more than $1 billion in assets