Many community bankers and their boards are entering the post-pandemic world blindfolded. The pandemic had an uneven impact on industries within their geographic footprints, and there is no historical precedent for how recovery will take shape. Government intervention propped up many small businesses, disguising their paths forward.
Federal Reserve monetary policies have hindered the pro forma clarity that bank management and boards require to create and evaluate strategic plans. Yet these plans are more vital than ever, especially as M&A activity increases.
“The pandemic and challenging economic conditions could contribute to renewed consolidation and merger activity in the near term, particularly for banks already facing significant earnings pressure from low interest rates and a potential increase in credit losses,” the Federal Deposit Insurance Corp. warned in its 2021 risk review.
Bank management and boards must be able to understand shareholder value in the expected bearish economy, along with the financial markets that will accompany increased M&A activity. They need to understand how much their bank is worth at any time, and what market trends and economic scenarios will affect that valuation.
As the Office of the Comptroller of the Currency noted in its November 2020 Director’s Book, “information requirements should evolve as the bank grows in size and complexity and as the bank’s environment or strategic goals change.”
Clearly, the economic environment has changed. Legacy financial statements that rely on loan categories instead of industries will not serve bank management or boards of directors well in assessing risks and opportunities. Forecasting loan growth and credit quality will depend on industry behavior.
This is an extraordinary opportunity for bank management to exploit the knowledge of their directors and get them truly involved in the strategic direction of their banks. Most community bank directors are not bankers, but local industry leaders. Their expertise can be vital to directly and accurately link historical and pro forma information to industry segments.
Innovation is essential when it comes to providing boards with the critical information they need to fulfill their fiduciary duties. Bank CEOs must reinvent their strategic planning processes, finding ways to give their boards an ever-changing snapshot of the bank, its earnings potential, its risks and its opportunities. If bank management teams do not change how they view strategic planning, and what kind of data to provide the board, directors will remain in the dark and miss unique opportunities for growth that the bank’s competitors will seize.
The OCC recommends that boards consider these types of questions as part of their oversight of strategic planning:
Where are we now? Where do we want to be, and how do we get there? And how do we measure our progress along the way?
Is our plan consistent with the bank’s risk appetite, capital plan and liquidity requirements? The OCC advises banks to use stress testing to “adjust strategies, and appropriately plan for and maintain adequate capital levels.” Done right, stress testing can show banks the real-word risk as certain industries contract due to pandemic shifts and Fed actions.
Has management performed a “retrospective review” of M&A deals to see if they actually performed as predicted? A recent McKinsey & Co. review found that 70% of recentbank acquisitions failed to create value for the buyer.
Linking loan-level data to industry performance within a bank’s footprint allows banks to increase their forecasting capability, especially if they incorporate national and regional growth scenarios. This can provide a blueprint of how, when and where to grow — answering the key questions that regulators expect in a strategic plan. Such information is also vital to ensure that any merger or acquisition is successful.
Culture is fundamental to the success of the deal, so it’s top of mind for bank leadership teams working with Richard Hall, managing director for banking and financial services at BKM Marketing. In this video, he explains why transparent, candid communication is key to retaining customers and employees, and shares his advice for post-pandemic strategic planning.
While the health and safety of one’s constituents takes top billing, keeping a business relevant — and viable — during these times should top the shortlist of any board’s agenda.
And while nobody has a compass to navigate these times, we at least have the means to aggregate an incredible amount of information and insight, vis-a-vis BankBEYOND.
With many fatigued from virtual conferences, we challenged ourselves to bring concise, novel ideas to a hugely influential audience. We followed Steve Jobs’ principle of design, working backward from the user’s experience to present board-level issues in new ways on BankDirector.com.
Our North Star in crafting the BankBEYOND agenda and experience: Respecting viewers’ time while surfacing issues that are both specific and relevant to their interests and responsibilities. Hence, our focus on issues that are strategic, risky and potentially expensive.
Since March, the industry has witnessed — and undergone — a rapid evolution of financial services. As a result, officers and directors must now assess the potential of their bank’s business in a post Covid-19 world. Growing a bank prudently and profitably took center stage at our Acquire or Be Acquired Conference in January; today, I suspect many boards and executives today emphasize efficiency to protect their franchise’s value. Indeed, a 50% efficiency ratio used to be the stretch goal for many banks; now, that might be closer to 35%.
Banks across the country are grappling with the tough choices they will need to make to rapidly bring those ratios down while delivering consistent service across physical and digital channels. We appreciate how so many institutions quickly embraced new technologies to solve specific business challenges, like the rollout of the Small Business Administration’s Paycheck Protection Program. In recent merger announcements, the drive to leverage technologies proved a primary catalyst for striking a deal. In fact, that’s where many efficiency gains come from.
However, boards realize that many of these technology additions can be expensive, which is why economies of scale becomes critical. We have seen how mergers can become the most expeditious way to generate meaningful economies of scale. But of course, much of the bank space is stuck in neutral at the moment when it comes to bank M&A.
We know that BankBEYOND’s audience has the responsibility for finding answers, rather than identifying barriers. We are tackling issues like:
Setting high-priority, short-term goals;
Keeping optimism and a sense of purpose alive; and
Weaving the best of the past eight months into everything the bank does going forward.
These are only three of the topics we’ll address with the help of various advisors and executives. Unlike a digital conference, with specific dates and watch times, we release families of videos and presentations at 8 a.m. CST. Beginning Monday, Nov. 9, we explore strategic and governance issues. The next day, we add information geared to the audit committee and risk committee. We conclude on Wednesday, Nov. 11, by sharing content developed for the compensation and nominating/governance committees.
BankBEYOND tees up the topics that allow for proactive — not reactive — change. By placing a premium on complex issues that all directors must address, we strengthen the knowledge of a bank’s board. And we rarely find a strong board at anything but a strong bank.
Looming new capital rules are an opportunity for banks to improve strategic planning and data management as they strengthen their compliance and reporting processes.
The coronavirus pandemic has delayed deadlines for complying with the latest round of capital guidelines dictated by Basel IV. Still, financial institutions should not lose sight of the importance of preparing for Basel IV, the difficulties it will create along the way and the ways they can leverage it as a potential asset. Compliance and implementation may be a significant expenditure for your bank. Starting now will lengthen your institution’s path to greater productivity and profitability to become a better bank, not just a more compliant one.
Making Basel IV For Business Where there is a will — along with the right tools — there’s a way to leverage the work required to comply with Basel IV for other commercial objectives. The new capital rules emphasize using forward-looking analysis, a holistic, collaborative organizational structure and data management capabilities for compliance and reporting purposes. These tools can all be leveraged for strategic planning and other commercial objectives, reducing or controlling long-term expenses while enhancing efficiency.
Central to this approach, however, is adopting the right attitude and approach. Executives should view Basel IV compliance as a potential asset, not just a liability, and be willing to make changes to the structure of operations and supporting data management systems.
A Familiar Approach Basel IV is not a monolithic set of edicts; instead, it’s a package of regulatory regimens through which the Basel Committee on Banking Supervision’s guidelines will be put into practice. These measures are actually the final version of the Basel III guidelines issued in 2010 but were seen as such an expansion of what came before as to be thought of as an entirely new program. It contains elements that encourage and even require banks to act in ways that enhance business practices, not just compliance.
One element is the mandate for a holistic, collaborative approach to compliance. All functions within an institution must work in concert with one another, to create a data-driven, dynamic, three-dimensional view of the world. Another point of emphasis is the importance of prospective thinking: anticipating events from a range of alternatives, instead of accumulating and analyzing data that shows only the present state of play.
“What now?” to “What if?” Banks can use Basel’s compliance and reporting data for business intelligence and strategic planning. Compliance efforts that have been satisfactorily implemented and disseminated allow executives to create dynamic simulations displaying prospective outcomes under a range of scenarios.
The possibilities of leveraging Basel IV for business extends to the individual deal level. Calculations and analysis used for compliance can be easily repurposed to forecast the rewards and risks of a deal under a range of financial and economic scenarios whose probabilities themselves can be approximated. And because a firm’s risk models already will have been vetted in meeting Basel IV compliance standards, bankers can be confident that the results produced in the deal evaluation will be robust and reliable.
Another big-picture use of Basel IV for business is balance sheet optimization: forecasting the best balance sheet size for a given risk appetite. This can show the board opportunities that increase risk slightly but obtain far more profit, or sacrifice a bit of income to substantially reduce risk.
To turn Basel IV’s potential for business into practice requires openness and communication from senior executives to the key personnel who will have to work together to bring the plan to fruition. It will mean adopting a mindset that considers each decision, from the details of individual deals to strategic planning, along with its likely impact. Staff must also be supported by similarly structured data management architecture.
The emphasis on forward-looking analysis and a holistic, collaborative organizational structure for compliance and reporting purposes, supported by data management capabilities designed along the same lines, can be leveraged for strategic planning and other commercial objectives. Success in streamlining operations and maximizing productivity and profit potential, and any edge gained over the competition, can reap especially great long-term rewards when achieved at times like these. Leaders of financial institutions have a lot on their minds these days, but there is a persuasive case to be made right now for seizing the opportunity presented by Basel IV for business.
challenge facing many community banks this new decade has nothing to do with public
policy, the yield curve, regulation or technology.
growing number of banks face an aging shareholder base, concentrated ownership and
limited liquidity. This can lead to shareholder succession impositions when
large shareholders want to exit their ownership position or an estate
settlement creates a liquidity need.
Community banks have always been owned by local centers of influence, passed down through generations and thought of as both a financial investment and philanthropic participation in the community. But the societal aspect of bank ownership is not the same as the current ownership cedes to the younger generation, many of whom have moved away from home and see banking as an increasingly more digital experience.
and securities regulations do not make the situation easier. There are
parameters around a bank’s ability to issue stock in the local community to
attract new shareholders. Banks are cautious of giving unknown investors a seat
at the table, particularly institutional or activist owners, as they may only
hold the stock for a defined, shorter period before seeking liquidity
themselves. The bank itself can sometimes be a source of liquidity to repurchase
stock from shareholders, but regulatory capital ratios may limit that capacity.
Some advice for banks struggling with these issues includes the following:
Treat shareholder succession as a business initiative: Identifying
issues before they occur, or a capital need before it becomes urgent, increases
a bank’s flexibility. Boards should discuss shareholder liquidity issues, as some
large owners may be sitting around the board table.
Investor relations is not just for large and liquid banks: Local
banks are often owned by members of the local community. The legacy of family ownership
is emotional, and large owners often do not want to “upset the apple cart” and force
the bank to sell. Many may not realize that how they treat their position could
impact the bank’s future. Some may not be open to discussing the issue, but
others might appreciate the opportunity.
Address long-term liquidity in strategic planning: Under what
conditions would the bank consider listing on a more liquid exchange, commencing
a traditional public offering, or raising subordinated debt as a way to address
shareholder succession? The owners of many closely held banks are wary of
incurring dilution to their ownership stake but want to remain independent, which
limits their options. For smaller banks, even upgrading to a slightly more
liquid trading medium such as OTC Market Group’s OTCQX Banks market, may open the
doors to investors that understand smaller, less-liquid situations and have capital
to put to work.
Plan for shareholder liquidity as you would for balance
sheet liquidity: It is helpful that directors and executives understand the
bank’s capacity to repurchase shares, as the bank itself is often the first
line of defense for an immediate liquidity need. Small bank holding company
regulation gives community banks flexibility to leverage their capital
structure by issuing debt at the holding company, which can be injected into
the bank subsidiary as common equity. Creating an employee stock ownership plan
or dividend reinvestment plan may help to manage and retain capital and
dividend policy can also be critical.
The right answer is usually a combination of all of the
There is no silver bullet for addressing shareholder liquidity in a smaller,
more closely held bank; all of the discussed initiatives will play a part. Many
banks get caught flat-footed after the fact, either faced with an estate
settlement or a family with a large position seeking liquidity. Dealing with an
urgent liquidity need, often in tight timing, limits the bank’s flexibility and
If a merger or sale is the right alternative, control that
Some shareholders looking to exit may find the premium in a sale attractive
relative to the desire of others for independence. It’s a worthwhile exercise
for boards and executives to understand the bank’s value in a sale, as well as likely
partners, even if a sale is only a remote possibility. This allows your bank to
identify preferred partners and ascertain their ability to pay a competitive
valuation independent of any urging from shareholders. Highlight those strategic
alternatives to the board on a regular basis. If an urgent shareholder need forces
the bank to seek a partner, your bank has already begun addressing these issues
and building those relationships.
succession issues can drive change and create uncertainty, risk and opportunity
at community banks. Careful analysis and planning can help lead to a desired
outcome for all involved.
The country’s most advanced bank is run by the industry’s smartest CEO.
Co-founder Richard Fairbank is a relentless strategist who has guided Capital One Financial Corp. on an amazing, 25-year journey that began as a novel approach to designing and marketing credit cards.
Today, Capital One—the 8th largest U.S. commercial bank with $373.2 billion in assets—has transformed itself into a highly advanced fintech company with national aspirations.
The driving force behind this protean evolution has been the 68-year-old Fairbank, an intensely private man who rarely gives interviews to the press. One investor who has known him for years—Tom Brown, CEO of the hedge fund Second Curve Capital—says that Fairbank “has become reclusive, even with me.”
Brown has invested in Capital One on and off over the years, including now. He has tremendous respect for Fairbank’s acumen and considers him to be “by far, the best strategic thinker in financial services.”
I interviewed Fairbank once, in 2006, for Bank Director magazine. It was clear even then that he approaches strategy like Sun Tzu approaches war. “A strategy must begin by identifying where the market is going,” Fairbank said. “What’s the endgame and how is the company going to win?”
Fairbank said most companies are too timid in their strategic planning, and think that “it’s a bold move to change 10 percent from where they are.” Instead, he said companies should focus on how their markets are changing, how fast they’re changing, and when that transformation will be complete.
The goal is to anticipate disruptive change, rather than chase it.
“It creates a much greater sense of urgency and allows the company to make bold moves from a position of strength,” he said.
This aggressive approach to strategy can be seen throughout the company’s history, beginning in 1988 when Fairbank and a former colleague, Nigel Morris, convinced Richmond, Virginia-based Signet Financial Corp. to start a credit card division using a new, data-driven methodology. The unit grew so big so fast that it dwarfed Signet itself and was spun off in 1994 as Capital One.
The company’s evolution since then has been driven by a series of strategic acquisitions, beginning in 2005 when it bought Hibernia Corp., a regional bank headquartered in New Orleans. Back then, Capital One relied on Wall Street for its funding, and Fairbank worried that a major economic event could abruptly turn off the spigot. He sought the safety of insured deposits, which led not only to the Hibernia deal but additional regional bank acquisitions in 2006 and 2008.
Brown says those strategic moves probably insured the company’s survival when the capital markets froze up during the financial crisis. “If they hadn’t bought those banks, there are some people like myself who don’t think Capital One would be around today,” he says.
As Capital One’s credit card business continued to grow, Fairbank wanted to apply its successful data-driven strategy to other consumer loan products that were beginning to consolidate nationally. Over the last 20 years, it has become one of the largest auto lenders in the country. It has also developed a significant commercial lending business with specialties like multifamily real estate and health care.
Capital One is in the midst of another transformation, to a national digital consumer bank. The company acquired the digital banking platform ING Direct in 2011 for $9 billion and rebranded it Capital One 360. Office locations have fallen from 1,000 in 2010 to around 500, according to Sandler O’Neill, as the company refocuses its consumer banking strategy on digital.
When Fairbank assembled his regional banking franchise in the early 2000s, the U.S. deposit market was highly fragmented. In recent years, the deposit market has begun to consolidate and Capital One is well positioned to take advantage of that with its digital platform.
Today, technology is the big driver behind Capital One’s transformation. The company has moved much of its data and software development to the cloud and rebuilt its core technology platform. Indeed, it could be described as a technology company that offers financial services, including insured deposit products.
“We’ve seen enormous change in our culture and our society, but the change that took place at Capital One’s first 25 years will pale in comparison to the quarter-century that’s about to unfold,” Fairbank wrote in his 2018 shareholders letter. “And we are well positioned to thrive as technology changes everything.”
At Capital One, driving change is Fairbank’s primary job.
Every bank director has heard it: You can outsource a service, but you cannot outsource the responsibility.
That sounds clear enough, but how does a board know what its role should be when an opportunity to partner with a financial technology firm, or fintech, arises? The board’s role is oversight and guidance, not day-to-day management. But oversight is not passive. So what does board oversight look like in the evolving world of bank and fintech relationships?
Consider a bank that is reviewing a proposal from a fintech. Management believes that this is a great opportunity for the institution, and presents it to the board for approval. What is the board’s role here? The board’s involvement must be flexible enough that it can react to these situations, but it should also consider some essential inquiries, such as:
Does the proposal match up with the bank’s strategic plan? The board is responsible for the strategic direction of the bank. Directors should consider if the proposal is an appropriate project for the size, resources and initiatives of the bank. They must also think about whether the proposal aligns with the bank’s strategic plan. If the proposal does not match up with the strategic plan, they may also want to consider if it is material enough that the strategic plan should be amended.
What are the risks? The board is responsible for ensuring that an effective risk management program is in place at the bank, which includes the ability to fully assess risks and establish controls and oversight to mitigate those risks. It should assess the fintech proposal through its risk management process
Management should provide the board with a comprehensive risk assessment of the proposed relationship that thoroughly outlines how each identified risk will be mitigated. The board should look at that assessment critically. Was it prepared by competent and experienced personnel? Does it appear to be thorough? Does it focus on IT risks or other narrow issues, or take into account all of the compliance issues? Does it include state laws, which is especially important if the bank is state-chartered? How does the assessment address concerns about privacy and cybersecurity? What does it say about reputation risk?
Is there a negotiated contract that addresses all of the risks? The board is responsible for ensuring that all third-party relationships are documented in negotiated contracts that protect the interests of the bank. The board needs to ensure that appropriate legal counsel is engaged to negotiate the arrangement, depending on the riskiness of a proposed fintech relationship. Counsel should have a thorough understanding of the legal issues involved in the proposed program and the applicable regulatory guidelines for third-party contracts.
The actual contract negotiation should be done by management. However, the board could consider requiring a summary of the important contract provisions or a presentation by management or legal counsel about the terms, depending on the level of risk involved and materiality to the bank.
How will the board know if the program is performing? The board should receive ongoing reports relating to monitoring of the program and the fintech. These reports should be sufficient for the board to establish that the program is compliant with law, operates in accordance with the contract and meets the strategic objectives of the bank. If the program is not performing, the board should know whether appropriate action is underway to either facilitate performance or terminate the program.
A bank’s board cannot outsource its responsibility for outsourced services, even if a fintech partner seems to have a fantastic product. The board must ask enough questions to be certain that management has engaged in appropriate due diligence, identified the risks and determined how to mitigate those risks through the contract and oversight. The implementation of all of those steps is up to management. But one role in particular rests with the board: ensuring that the relationship with the fintech partner furthers the strategic goals of the bank.
You can’t drive a car to a new destination without a roadmap, and a board can’t conduct a productive meeting—and ultimately, effectively oversee the organization—without a well-thought agenda that keeps meetings focused on discussing what’s important, and helping the board stay proactive on the potential opportunities and threats facing their bank. What’s placed on that agenda, and when it’s discussed, differs a bit from bank to bank. But there are several issues that should be on every agenda, and some that should be addressed regularly, albeit less frequently.
At every meeting Bank board agendas don’t differ from a standard corporate agenda in many respects. There should be a call to order, review and approval of minutes from the previous meeting, and a review of reports.
For a bank, every meeting should include a review of financial reports, with the chief financial officer on hand to address questions and discuss items in detail. Directors will also want to review loan reports, at which point the board will typically hear from the senior loan officer. Reports from the committee chairs should also be heard at every board meeting.
New business will include updates on strategic initiatives, including milestones and progress. Actions taken by the bank to address regulatory concerns should also be addressed, though how frequently this item appears on the agenda will depend on how much hot water the bank is in with its examiners. Trends impacting the growth and financial performance of the bank should also be discussed.
Old business should also be addressed in the agenda, and it’s an area often overlooked by banks, according to Bob Brown, a managing director at Kaplan Partners and board member at $84 million asset County Savings Bank in Essington, Pennsylvania. He previously spent 40 years at PwC. If management was instructed to take a certain action, or the board decided it would circle back to an issue, those matters shouldn’t be dropped.
Regular items to address Risk, cybersecurity and technology are top concerns for bank boards, but directors are split on how often these topics need to be discussed by the full board. Twenty-six percent of respondents to Bank Director’s 2018 Risk Survey said their board discusses cybersecurity at every meeting, compared to 37 percent who do so quarterly. Half of the respondents to the 2018 Technology Survey said their board discusses technology at every meeting, compared to 37 percent who cover the topic quarterly.
The board should discuss management and incentive compensation semiannually, advises Brown. And don’t forget the auditors: Internal auditors should address the board semiannually, and external auditors annually.
Board education should be woven into the agenda at least quarterly, and should cover a variety of topics relevant to directors’ level of expertise as well as any ongoing regulatory, economic or competitive concerns. Regularly bringing in outside experts can also stimulate productive dialogue among board members.
Every year, the board should review board and committee charters, as well as key policies and loan loss reserves. The makeup of the board should also be assessed annually, using a board matrix or evaluation, or both. A board matrix is a grid that lists all the directors on one axis, and the skill sets and attributes needed on the board on the other. This check-the-box-style exercise can be an easy way to identify gaps where additional expertise is needed.
Strategic planning should occur annually and will drive the agenda by setting the priorities that the board will want to follow up on throughout the year. “That then drives what senior management does,” says Jim McAlpin, a partner and leader of the financial services client service group at the law firm Bryan Cave Leighton Paisner. Does the bank need to renew its contract with its core vendor, or seek another solution? Does it make sense to build a new branch? These decisions should be fueled by the strategic plan. “It’s good to take stock, set direction and plan, and then over the course of the next year refer back to that plan and refer back to the priorities when engaging with the CEO,” he says.
McAlpin recommends that strategic planning take place off site if possible, with the board spending a half day or day talking about the bank’s strategic direction.
The board chairman—or the lead director, if the chairman is not independent—often develops the agenda, with input from the chief executive. Committee chairmen should also weigh in to ensure those areas are addressed. Individual directors should feel welcome to contribute to the agenda, and there should be room to speak up during meetings. “A good agenda should include a line item in which the chair asks if there are any additional matters the directors think should be addressed,” says McAlpin.
An annual discussion that sets the agenda for the year—tied to the strategic planning session—can help boards better drive what’s on the agenda, says Brown. The governance and nominating committee can then take that conversation and finetune the scope of the board’s agenda for the year, with input from the board before it’s finalized.
Getting the right input It’s important to hear from other members of the management team and ask questions directly of the heads of the respective areas of the organization, rather than relying on one source—the CEO—for that information. Ideally, the board should hear from the CFO at every board meeting to address financial matters. The heads of legal, compliance, human resources and information technology should also be available to address their areas of expertise, when needed. McAlpin recommends asking open-ended questions to gain their perspectives and address any of the board’s concerns. “If I were a board member, I’d rather [their answers] be unfiltered,” rather than through the CEO, he says.
Brown also recommends that the board hear from business line leaders at least annually, to better understand these important areas of the business.
Aside from better understanding the bank, it’s important for the board to understand the depth of the management team. “Perhaps the most important role a board has is selecting and evaluating the CEO,” says Brown. “Succession planning is a key responsibility, and understanding the management team’s depth, strengths and weaknesses of management team members, and having the chance to see them in action … is really important.”
Independent directors should also make time to discuss issues without management present, in an executive session, advises Brown.
Facilitating effective discussions The board agenda will structure the discussion, but it’s on the board to ensure those discussions are fruitful. First and foremost, materials should be provided in advance, so directors have time to prepare.
Remote participation has become more common as technological solutions like web conferencing make this option easier and can be a good way to attract younger candidates with diverse backgrounds, who may still be building their careers, to the board, says Dottie Schindlinger, vice president at Diligent. But make sure discussions are secure. Don’t reuse the same conference call number and passcode every time—this can easily be accessed by a disgruntled ex-employee, for example, who then gains access to sensitive conversations. And directors shouldn’t use their personal emails to discuss board matters. Web portals, such as that offered by Diligent, can help boards store and access information, and communicate safely.
Remote attendance can have its disadvantages, and there are always directors who tend to dominate a discussion. An effective facilitator—usually the chairman or lead director—will overcome these hurdles and ensure everyone’s voice is heard. Pointed, open-ended questions can help engage introverted board members. Making sure one director speaks at a time cuts out crosstalk and helps remote directors understand what’s discussed.
McAlpin emphasizes that it’s important to have an actual discussion—not just directors passively listening to what the CEO has to say, or other members of management, or the committee chairs. And this underscores the need to assemble a strong board. “Some of the most effective CEOs, I’ve found, are those who purposefully build a strong board—a board consisting of board members with a range of strong experience, good insight and a willingness to share feedback and make suggestions,” he says.
Strategic planning is one of the most important roles of a financial institution’s board of directors. Since the 2008 financial crisis, financial institution boards have dealt with the emergence of fintechs as a primary consideration in developing their strategic plans. A few large financial institutions have opted to build fintech capabilities, but the majority of financial institutions have determined that the best strategy is either to invest in or partner with a fintech firm through an outsourcing process.
On July 31, 2018, the Office of the Comptroller of the Currency announced it would begin accepting applications filed by fintech firms for “special purpose” federal bank charters. While not unexpected given the conversations around this topic in recent years, the announcement garnered immediate and passionate responses from the interested constituents. Whichever strategy has been adopted and implemented in their firm, financial institution boards should consider the impact a “special purpose national bank charter” may have on their relationship with a fintech firm, or how newly chartered fintechs may change their strategic plan.
First: Re-evaluate Your Strategy Financial institution boards should first consider if their strategy should change based on an assumption that fintech firms would become chartered special purpose banks. Applying the standard SWOT (strengths, weaknesses, opportunities, threats) approach to their strategic planning, the board might determine that what once was a strength for a financial institution (direct access to customers, ability to accept deposits) could become a threat as chartered fintechs obtain bank powers, while weaknesses (stricter regulatory oversight and related infrastructure expense) become strengths or opportunities. This shift in the playing field for fintech and financial firms should become a basis for deciding if the build, invest or partner strategy is still the best fit for the financial institution.
Second: Evaluate Your Options Whether the board determines that their current strategy is appropriate or needs to be reconsidered, their decision will be influenced by the ability to and cost of change. The board should review the existing relationships that are in place and determine the feasibility of changing strategy. While building may be the best answer, the cost of building fintech expertise may not be a valid strategic option, given the expertise required and the size of investment. Likewise, finding a new vendor or outsourcing partner may be relatively easy, but exiting a current contract may be difficult or costly if there isn’t a valid contractual reason for termination.
Third: Focus on Execution In their review of options the board should have been exposed to any shortcomings or important factors in executing the adopted strategy. Once the strategic approach has been decided, the basis of that decision must be taken into account in the execution. The possibility of a fintech firm obtaining a bank charter should be the cornerstone of execution. Directors should ask themselves whether getting a bank charter should be a basis for terminating a financial institution’s relationship with a fintech firm. If so, the terms should be clearly stated including financial outcomes and operational details. For example, any fintech investments or contracts should make it clear the financial institution will maintain the customer relationships and the related data. In addition, the arrangement should have appropriate non-solicitation and non-competition clauses to protect the financial institution in the event the fintech becomes a competitor. If the fintech firm can terminate the relationship, the financial institution should ensure there is an adequate conversion process that will allow it to pursue a different strategy or to migrate to a new strategic partner with minimal interruption to its customers.
It is not expected that fintech firms will rush to obtain charters or that charters will be granted to fintech firms in the near future. Significant barriers still remain for fintech firms to obtain charters. The application, review and examination process for obtaining a new (or de novo) charter is arduous and time consuming. In addition, newly chartered special purpose banks would need to build extensive regulatory infrastructure and would be subject to additional oversight and supervision during their early existence. Nevertheless, the OCC’s announcement will provide fintech firms with additional strategic options and a foothold for bringing further disruption to the financial services industry. Financial institution boards should be prepared to strategically respond to that challenge.
For many bank boards of directors and senior management teams, an acquisition will be the most important deal they ever make. Unfortunately, even experienced acquirers make mistakes that can have a negative—and sometimes even disastrous—impact on the outcome. And they are all avoidable.
Be Able To Say Why One of the most common missteps is to pull the trigger on a deal without having a clear rationale for why a particular acquisition target—as opposed to other possible candidates—is the best strategic fit. “Some acquirers tend to be more opportunistic and try to assess on the fly whether or not the deal is a good fit, as opposed to knowing before hand that they really want to acquire institutions that have certain parameters,” says Rick Childs, a partner at the consulting firm Crowe LLP. “It may be that they make a certain level of money, or do a certain type of lending, or operate in a desirable geography.”
In almost every instance, doing no deal is better than doing the wrong deal. Says Childs: “My dad used to tell me a long time ago, when I would say that something was on sale, ‘Son, a bargain isn’t a bargain if you don’t need it,’ which is to say if it doesn’t really fit, you’re better to walk away from that and focus on… opportunities that would really advance your cause as an organization and produce the returns you need for your shareholders.”
Cultural Compatibility Having a well-developed a well-defined set of criteria in advance enables the acquirer to then assess critical elements such as the target’s culture—which is important because misaligned cultures can lead to significant problems after the deal has closed and the banks need to be integrated. “I find that many times buyers don’t take the time to learn whether the organizations are compatible,” says Gary Bronstein, a partner at the law firm Kilpatrick Townsend. “And this is especially important when the seller will become a significant part of the merged organization. Too often, says Bronstein, buyers fail to focus on this issue until the integration process begins. “And it becomes [apparent] that perhaps the cultures of the two organizations in terms of how hard they work, how customers are treated, what the philosophies are in terms of how they operate, might not be compatible and it makes it very difficult to integrate under those circumstances.”
Clear, Consistent Communication Bronstein also finds that acquirers sometimes fail to place a high enough emphasis on the importance on effective and honest communication with people at the acquired bank. “That is particularly [true] among CEOs of the two organizations,” he says. “I’ve seen many deals fall apart or deteriorate pretty quickly due to bad communication, or lack of thoughtful communication.” Candor is an especially important element of the communication process, Bronstein says. “I’ve seen situations where a buyer CEO will say one thing but then do another thing, and that just alienates people in the process. And it’s critically important to develop a… rapport early, because if things deteriorate early it’s hard to get back,” he cautions.
Consider The People Many acquirers also tend to wait too long to make critical people decisions that can impact the outcome of a merger. Bronstein divides these important people decisions into three categories. “Category number one is, who do you need long term, and [in] what positions?” he explains. “Who do I need for this larger organization, and what positions can I spot them in? The second category is, who do I need short term to get me through the transition? The common timeline for transition is the technology conversion, which will usually happen somewhere between three and six months after the transaction is closed. And the final thing is, who are the people that are closest to the customers that I really need to lock up with a non-compete so they don’t go next door and compete with me?”
Childs also stresses the importance of communicating these important personnel decisions throughout both organizations. Staffers at either bank who ultimately will not be part of the combined organization once the integration process has been completed should be informed “as quickly and as compassionately as you can,” he says. It’s equally important that employees who will be going forward with the new bank know that their jobs are secure. “Uncertainty breeds angst and anxiety that is going to affect how people treat their day-to-day job, and taking that away and reassuring them is really job number one for the CEO and the management teams.”