Bank Director’s 2019 Bank M&A Survey finds that many banks see themselves as prospective acquirers. However, as a result of a recent wave of industry optimism—fueled by strong loan demand and regulatory relief—fewer banks may want to sell in 2019. So how can buyers position themselves to win in a more competitive M&A marketplace? Rick Childs, a partner at survey sponsor Crowe LLP, shares how a strong strategy is key to success. He also provides his outlook for the banking environment in 2019.
- Advice for Prospective Acquirers
- Expectations for Bank M&A in 2019
In accordance with applicable professional standards, some firm services may not be available to attest clients. © 2019 Crowe LLP, an independent member of Crowe Global. crowe.com/disclosure
M&T Bank Corp.—the $117 billion asset bank holding company headquartered in Buffalo, New York—is well-known for its disciplined approach to M&A, a strategy that has served the big regional bank well through the 18 whole-bank acquisitions it has made since 1987.
Its most recent deal, which closed in November 2015, was also its biggest—the purchase of Hudson City Bancorp, a Paramus, New Jersey-based regional thrift that expanded M&T’s reach in New Jersey, Connecticut and parts of New York City, adding $37 billion in assets and $18 billion in deposits.
Given M&T’s three decades of successful deals, Bank Director interviewed M&T Chief Financial Officer Darren King to explore the bank’s philosophy around M&A. He says three values drive its M&A strategy.
The first—and perhaps most important value—is patience. Put simply, if a deal doesn’t align with M&T’s strategy, it won’t happen.
“We’ve never been a bank that’s been interested in growth just for growth’s sake,” says King. M&T is laser-focused on getting a return on the dollars invested, whether that’s for an acquisition, an investment in technology or any other investment made to grow and improve the business.
“Our job is to provide our shareholders with a better-than-average return on their investment,” says King. That focus on returns—rather than chasing growth—yields the discipline the bank needs to execute on its strategy.
Part of that patience means the bank will wait for the right partner—one that is committed to the long-term success of the deal. This is the second value that drives dealmaking at M&T.
“One of the places that helps you earn that return [on investment] is the price that you pay,” says King. Committed partners tend to hold to a more long-term view on that point. “Our hope is that anyone who is a willing partner—which is precondition for us for the combination—would like to be paid in our stock, and therefore the price [paid] isn’t necessarily a reflection of the value that would be created for both [entities’] shareholders by putting the two organizations together.” A lower price in a successful transaction will have a positive impact on M&T’s stock—which benefits the seller as a stockholder.
Having so-called skin in the game by taking stock in the transaction also represents a commitment from the seller that the acquired bank’s management team will stay on board to ensure the future success of the merged entity—and raise the value of the stock.
“They don’t want someone to sell their bank to M&T, and go away and retire,” says Brian Klock, a managing director at Keefe, Bruyette and Woods, who covers M&T. “They want to have those local managers and executives that will make a difference and be the M&T leader in that market, so they want those executives to stay around. If they take M&T stock and don’t take as big a price, that’s a commitment from the bank that’s selling to them.”
The final value for M&T is its consideration for the size and location of the target.
“We’re cautious not to go too big, because then it increases the risk,” says King. Integrating a large deal can get out of hand if a bank bites off more than it can chew. But a deal can’t be too small either, he says, because some of the risks related to integration and conversion aren’t scalable. “If you’re going to take on that risk, it needs to be worth the trip,” King says.
M&T also prefers in-market deals or locations in contiguous markets, where its brand is well known.
Outsiders may see M&T as a bank focused on price, but that’s not the case, says King. “If you look at our history, people would describe us as focused on price, and we buy troubled assets,” he says.
Economic downturns tend to yield troubled franchises with strong long-term potential. Having the discipline to focus on long-term returns—not just price—puts M&T in a position to take advantage of opportunities in the marketplace. M&T scooped up four banks—totaling more than $10 billion in assets—from late 2007 through August 2009. It gained another $10.8 billion through its acquisition of Wilmington Trust in May 2011.
It’s often said the best deal is the one you don’t make. By making deals that adhere to three key M&A virtues—patience, focusing on in-market targets that are the right size, and finding a committed partner—M&T’s disciplined approach has served it well.
Benchmarking key performance indicators (KPIs) can help you more fully understand your bank’s financial condition and operating results, as well as the true value in a potential M&A market.
The success of your M&A strategy – whether buy, sell or stay – measurably increases with a sound grasp of the metrics that drive shareholder value.
KPIs as M&A drivers
KPIs can help you to identify important strengths in your target organization and your own institution. This can help determine the areas you could strengthen in an acquisition, or understand where your bank’s value lies within a merger. You can also learn about your organization’s, or your target institution’s, primary challenges and how this might impact the transaction.
These metrics can also help the organization evaluate the success of the transaction after completion. Have the key performance indicators drastically changed? Was that change different from the anticipated adjustment from the combination of the two entities? Understanding the metrics, and some of the forces impacting them, can be a strong foundation for successful M&A transactions.
Q3 2018 KPI observations
Community banks throughout the U.S. used the strong economy and relatively stable interest rate environment to maintain steady operations throughout the third quarter of 2018.
Baker Tilly’s banking industry key performance indicator (KPI) report reflected almost no change in comparison to the same benchmarks for the second quarter of 2018. Earnings, credit quality and capital adequacy benchmarks all remained essentially the same. This consistency appears to reflect a more stable economic environment, disciplined management of credit pricing and quality, notwithstanding a continued highly competitive environment, and the early stages of a move to higher interest rates.
If there is anything to take away from the relatively unchanged KPIs over the first nine months of 2018, it is that community bankers have diligently pursued the opportunities emerging from the strong economy.
Loan growth, reflected in the comparison of the loan-to-deposits ratios each quarter, has been somewhat subdued. Potential drivers of this include increasing liquidity pressures arising from changes in interest rates, early stages of the potential for a downward credit cycle and the uncertainty of the November midterm elections. These factors kept many community bankers focused on internal matters such as compliance and technology during the second and third quarters of 2018.
Many banks continued to assess consolidation opportunities on both the buy and sell side. Until the recent series of market declines, bank equity currency remained quite strong, supporting a continued active consolidation of the industry, at price points that, on average, exceed 1.5 – 1.7 times book value.
We expect more of the same consistency in the KPIs as we have seen throughout 2018. It does not appear there will be any significant shifts in either direction arising from changes in economic policy. However, the pace of deregulation may subside due to the change in leadership in the U.S. House of Representatives.
If equity markets rebound following the midterms and the Federal Reserve pauses its increase of interest rates, we may see a re-acceleration of the consolidation of community banks, especially those with assets of $500 million or less. Other than an increased emphasis on securing and maintaining low cost deposits, we anticipate community banks to maintain a steady course into early 2019.
To maintain a competitive advantage over peers, two areas of strategic focus we have seen increase include enhancing the customer experience and attracting and retaining the right talent. Specifically, many banks are focused on digital transformation and technological efficiencies as well as human capital management to attract the right talent, including diverse talent, to be able to achieve the strategic priorities.
Companies are clearly emphasizing the importance of these two strategic priorities, but how you measure success is challenging. And, do you incentivize management based on progress? The goal for boards is to have executives focus on objectives that will ultimately drive performance and long-term shareholder value.
Some organizations are beginning to align incentive-based compensation with these strategic priorities; however, objective measurement of progress or success may often require a subjective judgement.
Customer experience and engagement: The banking industry runs on relationships and maintaining these connections, which is shifting as customer demand for new and faster technology evolves. While ensuring customer security is still important, the focus once on customer service has now shifted to the customer experience. To measure this, we often see a portion of the total incentive tied to customer engagement, typically measured through surveys, customer retention, or strategic technological or digital initiatives.
Two examples of companies that utilize customer-centric metrics include American Express and Unum Group. Both weight customer experience and satisfaction as standalone metrics in the annual incentive plan. Citigroup uses a scorecard to assess top management performance and compensation, 30 percent of which is tied to non-financial objectives.
Digital Transformation: The changes in the banking industry have increased the demand for tech talent to implement digital strategies, particularly those involved in improving the customer experience. Banks need to decide whether they will rely on internal talent and resources to develop proprietary new technologies, or if they will go outside the industry to find talent. In recruiting this talent, financial services firms find themselves in competition with tech companies that can provide significant equity opportunities and may have less-traditional work arrangements.
Financial services companies must be creative in attracting this talent with perks like open offices, flexible work arrangements and separate pay structures for niche talent. Goldman Sachs’ dress code, and JP Morgan Chase & Co.’s relocation of its tech team to a more modern, open-floor office are examples.
Diversity and Inclusion: Driving some of these strategic priorities are talent issues that have been a hot topic in the boardroom. Studies have shown a diverse workforce provides for more diverse thinking, and a better performing organization. We are seeing some organizations incorporate improvements in diversity and inclusion in their incentive plan metrics:
- Prudential Financial: Performance shares include a diversity and inclusion modifier (+/- 10 pp). Executives at the senior vice president level and above will be subject to a performance objective to improve the representation of diverse persons among senior management through 2020.
- Citigroup: 18-member operating committee will be measured on the progress of raising the percentages of women and African Americans in management positions by 2021.
- American Express: Has had talent retention and diversity representation goals as part of the annual incentive plan since 2013.
- Old National Bancorp: Has included diversity and inclusion targets in the annual incentive plan as a negative modifier since 2016.
The use of a modifier for Prudential Financial and Old National Bancorp may be due to the amount of influence an executive may have over the goal. Regardless of the weighting, inclusion of these metrics is a signal about the importance of the issue.
When boards are considering which strategic metrics to incentivize executives, the focus should be on management’s priorities, such as innovation, security, employee satisfaction or employee diversity. The key is attracting, hiring and retaining the right people who will align with the company’s strategic priorities. That is what differentiates one company from the next and those with a competitive edge.
Human capital is likely the most expensive resource a bank has, and we all know our people are important in a customer-facing business, so why not be strategic with it? Almost every business has a written strategic plan that states profitability goals, growth goals, three-year plans, etc. However, when it comes to compensation, fewer than four in 10 banks (38 percent of the 103 banks surveyed in our 2016 Compensation Trends Survey) have a formal, written compensation philosophy.
The Compensation Philosophy
Most organizations start the strategic compensation discussion with the development of a compensation philosophy. This document, often only a page or two, primarily identifies a few key items, including what the bank is trying to accomplish with its compensation programs; what compensation programs does the bank have available to our employees; who qualifies for these programs and why; and where does the bank want to position ourselves versus market? The compensation philosophy statement should be a living document that is reviewed annually and is adjusted as necessary to support business strategy changes.
Strategic Salary Planning
Banks that are strategic with compensation will also generally have a clearly defined salary grade structure, accurate and up-to-date job descriptions, utilize external market data for position benchmarking, and a salary increase matrix for annual adjustments. The annual salary increase process should be strategic, based on individual performance, foster internal equity, and fit within the overall budget of the organization. Many banks utilize a salary increase matrix to assist with determining annual raises. The matrix focuses on providing the largest increases to employees who are exceeding expectations and are positioned low in their salary grade. The days of giving everyone the same percent of salary raise are gone.
Once you have the salary component figured out, the next step is incentive-based pay. This can take the form of annual cash incentives and/or equity-based incentives. The type of incentive a bank utilizes will often vary depending on the company structure—like whether it is public or private—and position level. As an example, executives may be eligible for a cash and equity incentive plan, but staff may only be eligible for cash incentives. The key to using strategic compensation is to make sure your incentive plans are based on performance and are motivating and rewarding key positions.
In today’s banking world, there is a lot of talk about incentive plans being “risky” and maybe even “evil” (example: Wells Fargo retail incentives). We disagree with this sentiment. Banks are still in the business of being profitable, and incentive plans have their place to help drive behaviors and reward performance. The key is to have a balanced approach between profitability and strategic goals.
Benefits and Perquisites
Benefits and perquisites are total compensation components that often apply primarily to executives. The broad-based benefit programs like 401(k) plans and health insurance programs have not experienced unique banking-focused changes in recent years. However, executive benefits such as salary continuation plans, change-in-control/severance plans, employment agreements and perquisites (auto allowances, country clubs, etc.) have seen reductions. These programs are still prevalent but there has been an increased focus on the business reasoning and validation behind such programs.
Executive benefits can provide some of the best retention vehicles in compensation if you have an executive leadership team you want to keep in place long-term. It is critical to ensure the benefit or perquisite is serving an appropriate business purpose.
The most successful banks are those who can appropriately balance their profitability needs with good culture, communication, and strategic compensation programs. Banks need to be financially successful to help the communities they serve. Ensuring that your compensation programs are strategically supporting the overall goals of your organization and linked to performance is essential. Make sure you are getting your “bang for the buck” with your compensation dollars being spent.
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 years, I’ve shared one of my favorite proverbs when talking about the value of high-performing teams: to go fast, go alone; to go far, go together. Now, as we prepare to welcome nearly 200 people to the Four Seasons Chicago for our annual Bank Board Training Forum, this mindset once again comes front and center.
In many ways, banks may appear to be on solid footing. Unfortunately, evolving cyber risks, the battle for deposits and pressures to effectively leverage technology make clear that banking leaders have challenges aplenty. Given the industry’s rapid pace of change, one would be forgiven to think the best course of action would be to go fast at certain challenges. However, at the board level, navigating an industry marked by both consolidation and emerging threats demands coordinated, strategic planning.
Our efforts in the days ahead aim to provide finely tailored insight to help a bank’s board go further, together.
This annual forum caters to an exclusive audience of bank CEOs, chairmen and members of the board. It is a delight to have Katherine Quinn, vice chairman and chief administrative officer, from U.S. Bancorp, as our keynote speaker. U.S. Bancorp has the highest debt rating among all banks and consistently leads its peer group in terms of profitability, efficiency and innovation. Bank Director Executive Editor John Maxfield will have a one-on-one conversation with Quinn and cover everything from the qualities of good leadership to diversity to the Super Bowl.
Following her remarks, we explore strategic issues like building franchise value, creating a vibrant culture and preparing for the unexpected. Against the backdrop of this year’s agenda, there are five elements that characterize the boards at many high-performing banks today. Some are specific to the individual director; others, to the team as a whole.
#1: The Board Sees Tomorrow’s Challenges as Today’s Opportunities
Despite offering similar products and services, a small number of banks consistently outperform others in the industry. One reason: their boards realize we’re in a period of significant change, where the basic premise of “what is a bank” is under considerable scrutiny. Rather than cower, they’ve set a clear vision for what they want to be and hold their team accountable to concepts such as efficiency, discipline and the smart allocation of capital.
#2: Each Board Member Embraces a Learner’s Mindset
Great leaders aren’t afraid to get up from their desks and explore the unknown. Brian Moynihan, the chairman and CEO of Bank of America, recently told Maxfield that “reading is a bit of a shorthand for a broader type of curiosity. The reason I attend conferences is to listen to other people, to pick up what they’re talking and thinking about… it’s about being willing to listen to people, think about what they say. It’s about being curious and trying to learn… The minute you quit being educated formally your brain power starts to shrink unless you educate yourself informally.”
You can read more from Bank Director’s exclusive conversation with Moynihan in the upcoming 4th quarter issue of Bank Director magazine.
#3: The Board Prizes Efficiency
In simplest terms, an efficiently run bank earns more money. This allows it to write better loans, to suffer less during downturns in a credit cycle, to position it to buy less-prudent peers at a discount all while gaining economies of scale.
#4: Each Board Member Stays Disciplined
While discipline applies to many issues, those with a laser focus on building franchise value truly understand what their bank is worth now — and might be in the future. Each independent director prizes a culture of prudence, one that applies to everything from underwriting loans to third-party relationships.
#5: The Board Adheres to a People-Products-Performance Approach
Smart boards don’t pay lip service to this mindset. Collectively, they understand their institution needs to (a) have the right people, (b) strategically set expectations around core concepts of how the bank makes money, approaches credit, structures loans, attracts deposits and prices its products in order to (c) perform on an appropriate and repeatable level.
Looking ahead, a sixth pillar could emerge for leading institutions; namely, diversity of talent. Now, I’m not talking diversity for the sake of diversity. I’m looking at getting the best people with different backgrounds, experiences and talents into the bank’s leadership ranks. Unfortunately, while many talk the talk on diversity, far fewer walk the walk. For instance, a recent New York Times piece that revealed female executives generally still lack the same opportunities to move up the ranks and there are still simply fewer women in the upper management pipeline at most companies.
At Bank Director, we believe ambitious bank boards see the call for greater diversity as a true opportunity to create a competitive advantage. This aligns with Bank Director’s 2018 Compensation Survey, where 87 percent of bank CEOs, executives and directors surveyed believe a diverse board has a positive impact on the performance of the bank. Yet, just 5 percent of CEOs above $1 billion in assets are female, 77 percent don’t have a single diverse member on their board and only 20 percent have a woman on the board.
So as we prepare to explore the strong board, strong bank concept in Chicago, keep in mind one last adage from Henry Ford: if all you ever do is all you’ve ever done, then all you’ll ever get is all you’ve ever got.
As rising short-term interest rates flatten the yield curve, the resulting squeeze in bank margins is leading executives to look in every nook and cranny seeking cost savings. But as bank management teams tenaciously put some vendor relationships under a microscope, why do the bond portfolio and investment management processes typically escape scrutiny?
Bankers often and instinctively evaluate the performance of a securities portfolio by considering investment returns in comparison to an appropriate benchmark. But hidden in the overall yield are many expenses associated with managing the bond portfolio. Because transaction execution costs are not visible as an expense “line item,” financial institutions often overlook these when it comes time to tighten the expense belt. Even when the portfolio catches the eye of senior management, the idea of bringing in an independent party to assist is rarely considered. While most banks see no issue with leveraging an outside partner’s expertise on items considered “new” and “non-core” (such as loan review, derivatives and hedging), they see managing the investment portfolio as “core” and are therefore naturally reluctant to consider working with an outside partner.
With the potential for significant savings, here are some reasons to keep investment portfolio management as a “core” function, while also working with an outside party to gain efficiency:
- Same Side of the Table – Regardless of your desire to keep the investment management process in-house, the numerous and diverse responsibilities shouldered by the individual carrying the dual titles of chief financial officer and treasurer make it essential to lean on someone for help. When the time comes to deploy cash generated from maturing securities and prepayments, the path of least resistance for the CFO is to depend upon the broker who is selling the bonds to assist in an advisory capacity. While brokers can provide valuable assistance with security selection and analysis, their compensation is difficult to quantify, as it is built into the bonds purchased as an undisclosed mark-up to the price. Rather than sitting across the table from you when it comes time to transact, the independent investment advisor sits on your side of the table, is accountable only to you, and is compensated in a clear and direct fashion. By overseeing the execution process for the purchase and sale of securities, the independent investment advisor can free up valuable time for the CFO, while ensuring that compensation for the brokers involved is reasonable, consistent and improves security yields. The advisor can also help establish a process for quantifying average annual transaction costs for the portfolio based on projected turnover and expected growth.
- Retain Strategic Control – Involving an independent investment advisor in the investment management process may feel like a sacrifice of control if the advisor works in a discretionary capacity. However, finding a non-discretionary advisor enables you to cede control of time-consuming, tactical tasks, while holding on to important strategic decisions such as asset allocation, duration and credit profile. Retaining an independent investment advisor on a non-discretionary basis alleviates concerns that a core function is being “outsourced.” Instead, the relationship can be viewed as a partnership that provides the bank with increased operating leverage, while leaving you in complete control of the process.
- Equipping Resource – Through daily interactions with a variety of clients and trading partners, the independent investment advisor brings a unique vantage point on the fixed-income markets that benefits you when it comes time to execute a bond purchase or sale. The breadth of experience of the advisor can also be leveraged to strengthen the skills of the internal team at the bank. As you grow, you may identify an employee you would like to groom to take on more treasury responsibilities. The advisor can serve as an educating coach, teaching best practices while performing advisory duties until the time comes to gradually hand over the reins to the new treasurer. This also relieves the CFO from finding time to be the employee’s exclusive mentor.
Whether out of concerns about pushing a core function out of the bank, or perhaps due to sheer oversight, many banks have not yet taken a close look at the investment management process as a potential source of earnings improvement. By partnering with an independent investment advisor on a non-discretionary basis, banks invite a resource to their side of the table while remaining in the strategic driver’s seat for all investment decisions. This can lead to meaningful savings, thanks to new-found price transparency, and can liberate the CFO to focus on other critical priorities.
A tight labor market could be big risk if your bank lacks the talent to fuel its future. How can bank boards and management teams manage this risk? In this video, Julia Johnson of Wipfli shares why your bank should conduct a human resources review and provides tips to help banks tackle the talent challenge.
- Four HR Areas Bank Leaders Should Be Watching
- How Boards Can Better Understand HR Portfolio Risk
- The Impact of Today’s Economic Environment