Industry Insights

July 8, 2019
Enterprise Risk Management for the Boardroom
By L. Randy Marsicano, NCRM, CRISC, Professional Services Senior Manager, WolfPAC Solutions

Have you ever felt challenged while preparing for an ERM program presentation? Ever had one go badly?

Enterprise Risk Management, by definition, is a process itself, so the reporting of your program’s results by default is also considered a process. Your success in reporting engaging and simplified results has less to do with which report you choose to present than it does with better understanding your audience and how they consume data. Wouldn’t it be great if, during your preparation, you understood how to build a “reporting” narrative tailored to your audience’s consumption of information, in an organized and engaging manner? To do so, you’ll have to start by getting past some of the common myths surrounding ERM presentations.

Myth #1: All Communication is the Same
Imagine your car suddenly makes a funny noise. When you make an appointment with your mechanic, you describe the situation in great detail and participate in a mutual negotiation of what needs to be fixed, the timeline and acceptable payment terms. Now imagine updating your spouse on the car situation. Will you go into that same level of detail? Probably not. You may simply state that you had an issue, weighed out the potential solutions, agreed on a price and ask for a ride home! Take this scenario one step further – imagine explaining the same situation to your boss. Wouldn’t you simply say “My car is in the shop, I’m working from home today and am available on my cell if you need me”?

The same situation is described, but presented very differently depending on the audience and how they consume information. If you can get your head around that, you may also agree that you communicate ERM program results differently with the first line of defense, second line of defense and your board.

Myth #2: All People are the Same
In 1924, lawyer and psychologist William Moulton studied the concepts of will and a person’s sense of power, and their effect on personality and human behavior. Through this research, the DISC profile emerged. Today, we can benefit from understanding different personality types and how they consume information. At a high level, four DISC traits have been identified, each with their own communication style:

- Dominance (sometimes called the Eagle): A direct and results-oriented personality, this profile consumes information quickly and at a high level, without delving into details.
- Influence (sometimes called the Parakeet): With an outgoing, high-spirited and lively personality, this profile consumes high-level information but prefers a more personal approach.
- Steadiness (sometimes called the Dove): Known as having a calm and sensitive personality, this profile methodically consumes information and may desire direct involvement.
- Conscientiousness (sometimes called the Owl): As a reserved and analytical personality, this profile consumes logical and detailed information.

Understanding people’s specific personality types is important, because the right information presented the wrong way may distract from your message.

Myth #3: One Report Does it All
In helping people prepare for ERM boardroom presentations, I notice that some individuals simply ask which reports to print. Although the value of reports should not be dismissed, they are only a supporting player. According to the RMA Governance and Policies Workbook, “risk reports shouldn’t create paper, they should create dialogue. Information reported without context can be extremely dangerous.”

Providing constructive dialogue on ERM programs is essentially telling a good story – complete with a beginning, a middle and an end (or rather, with a process, results and conclusion):

- Process: This includes the period considered, what was covered and who participated
- Results: What did we learn, what are the threats to the business, are appropriate controls in place and are we safe?
- Conclusion: Lessons learned and action plans

Myth #4: You Can Put This Together Quickly
We all have a friend who waits until Christmas Eve to shop for gifts. But preparing a relevant, succinct and effective presentation is not the same as Christmas shopping – it takes time, and must be done over time. Discerning people will see right through a quickly pieced-together presentation.

Now that we have dispelled some of the myths around ERM programs, here is some simple yet effective advice for presenting your ERM program:

1. Start early. Begin by writing down the basic framework and key messages. Seek to understand early what information may be missing, and put together a plan to get it.

2. Make sure you understand how your audience consumes information. If you don’t have the opportunity ahead of time, be ready to quickly determine which trait you are talking to and adjust accordingly. When there is more than one personality in the audience, communicate to the highest ranking person in the room – most likely an “Eagle”. If the highest ranking person is not an Eagle, but someone of influence is, you may still need to start communicating in “Eagle-ease,” but quickly get to areas of detail to accommodate the other styles. Parakeets, Owls, and Doves tend to have more patience than an Eagle.

3. Craft your story. Your presentation should start with the process, or how you got there. This will lay the groundwork and help your audience understand what it is they’re looking at. Results should be communicated with the appropriate detail, but be prepared to drill down into some of the higher-risk areas if asked. Always end with lessons learned and next steps, which can include how results will be used, remediation put in place and linkages to strategic programs.

A well-structured and communicated program shows value not only in the effort, but in the presenter as well. Good luck!

Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not necessarily reflect the official policy or position of the Financial Managers Society.

About the Author

Randy Marsicano is a Senior Manager of Professional Services in the WolfPAC Solutions Group, overseeing all Enterprise Risk Management Advisory Services. He has nearly 30 years of experience designing and implementing risk management, vendor management, technology and operational management programs, and works closely with community institutions to create and improve their ERM programs and drive costs down.

June 17, 2019
CECL Status Check: How Prepared is Your Financial Institution?
By Rick Martin, Product Manager, Financial & Risk Management Solutions, Fiserv

It’s already clear that the effect of CECL – the Financial Accounting Standards Board’s (FASB) Current Expected Credit Loss standard – will be far-reaching. The CECL accounting standard, which requires banks and credit unions to record expected losses whenever they make a new loan (at the time of origination or purchase), is scheduled to go into effect as follows:

- Q1 2020 (March 31) for SEC-filing public organizations
- Q1 2021 (March 31) for non-SEC-filing public organizations
- Q1 2022 (March 31) for non-public business entities
- Q1 2022 (March 31) for credit unions

Despite these fast-approaching effective dates, many financial institutions do not have the historical data in place to calculate life-of-loan losses as required by this new credit loss model. Consequently, it may come as no surprise that financial institutions are working at a breakneck pace to prepare themselves for CECL. As financial institutions ramp up to this new standard, considering these following seven tasks will not only help them ensure they have the right data (and enough of it), but also save time and money down the road.

Driving CECL Implementation by Committee
By now, financial institutions should have implementation committees in place, with responsibilities assigned along the three main categories: operational, credit and compliance. These committees should include senior leaders from finance, accounting, lending, risk, operations/IT, compliance and retail.

Beyond the essential to-do lists, institutions should assign responsibility for integrating systems and processes across the organization and re-evaluating growth strategies.

Selecting a Methodology
Financial institutions have a great deal of flexibility when it comes to selecting a methodology for evaluating expected credit loss. In fact, the only requirement is to choose a method that is appropriate and practical – one that can reasonably estimate the expected collectability of financial assets and be applied consistently over time. The right choice depends on the type and size of loans issued by the institution (for instance, car loans versus mortgages) and other internal and external factors. In other words, different methods for different asset groups.

Compiling the Data
Compiling all of the data necessary to comply with CECL often represents the most challenging, time-consuming aspect of the process. For financial institutions, gathering the right historical data is a staggering task.

Begin by learning what data is required for CECL compliance and compare it to existing data to identify gaps. How will missing data be acquired to fill the gaps? Define how data from external or internal sources can be used. Look to external or aggregated sources from peer institutions. Institutions can also extrapolate through historical analysis of data within their organization. Determining how to put processes in place to capture the necessary data going forward is paramount.

Applying Economic Forecasts to Loans
Moving from the incurred-loss model to an expected-loss model will force financial institutions to consider how to apply economic forecasts to the valuation and protection of loan portfolios. Economic forecasts can provide valuable insight into future performance. For instance, unemployment rates could indicate shortfalls on car loan repayments or other short-term loans, while regional growth factors could positively affect repayment/refinancing of home loans, mortgages and longer-term loans.

Once the external data best suited to a loan portfolio has been assessed and gathered, forecasts can be developed to provide an advanced look at loan performance and reserve requirements.

Storing and Managing Data
Data management, retention and storage should also be considered when adapting to CECL standards, and many institutions are assessing their IT systems and planning investments to meet current and future requirements. Going forward, they’ll also need to put the right systems in place to gather data, and develop governance strategies to ensure its retention. By combining data from financial accounting and risk management systems, it can be managed and analyzed in a meaningful way.

Gaining a Strategic Advantage
Fortunately, all of this data preparation can provide a competitive advantage for financial institutions. CECL requirements mark the first time this much data has been aggregated at the individual financial instrument level. And once that history – that instrument-level data – is captured, good things can happen. It can reveal valuable insights and trends that can help the institution improve decision-making around credit risk, interest rates and profitability.

For instance, look at demand for different types of loans over time, or other key factors. Data can be pooled and correlated by collateral or type – including mortgages, auto loans, credit cards and more – and further segmented by cost center, loan officer, FICO score or geography. Practical analysis of such a historical amount of instrument-level data provides a solid foundation for financial institutions to understand their markets and metrics. This includes how portfolios behave and where potential opportunities lie.

As it facilitates risk analysis into interest rates, liquidity, credit, market and regulatory capital, additional data for loans and credit helps forecast and reduce losses. In addition to generating more accurate budget projections, using this data to inform strategic decisions can help lead to lower overall risk and better managed return for every stakeholder, including borrowers.

Making Technology Do the Work for You
Making progress on CECL implementation is more urgent than ever considering the fast-approaching deadline. The best bet for financial institutions to meet the deadline and be positioned to strategically leverage all of that required data is to turn to a consultative vendor with the right CECL technology. Utilizing these resources can have a financial institution up and running with a CECL solution in as little as two months.

Consider these five factors when investigating CECL technologies: data management; methodology; reporting; technology integration; and strategic guidance and expertise. Having the right solution not only ensures compliance and minimizes reserve requirements, but also provides insight into data for strategic value over the long term.

Regardless of the ultimate choice, it is crucial for institutions to accelerate their implementation plans so they can approach the coming deadline with confidence.

Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not necessarily reflect the official policy or position of the Financial Managers Society.

About the Author

Rick Martin is a product manager in the Financial & Risk Management Solutions division at Fiserv. He has more than twenty years of experience in banking and financial technology, and educates financial institutions on ensuring compliance with CECL and other standards and regulations.

May 20, 2019
White Paper:
Pricing and Elasticity in Financial Institutions: What happens when pricing changes?

By Matthew E. Speed, Vice President, Ceto and Associates

Summary: The financial services industry employs several methods of making pricing decisions on its products and services. While there is not an agreed-upon industry best practice for how products and services are priced, pricing inefficiencies cause a detrimental effect on income. Furthermore, various regulations in the industry significantly impact pricing strategy and must be taken into consideration.

“The single most important decision in evaluating a business is pricing power,” Warren Buffet, CEO Berkshire Hathaway1. “If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by 10%, then you’ve got a terrible business.”

The above statement is true regardless of the industry, which is why it is often quoted. The financial services industry, specifically banks and credit unions, have struggled over the last several decades with pricing. As the industry grew more competitive, giving everything away became commonplace. This “strategy” worked during times of higher interest rates and less regulation around fee income, which is why new banks opened at a rate of over 100 institutions per year from 2000 to 20072.

Read More >

May 6, 2019
The Road to Higher Profits
By Alec Hollis, Director, ALM Strategy Group, ALM First Financial Advisors, LLC

Banks want to achieve above-average profitability. Profitable growth is a critical element to success as an organization. Long-run commercial viability occurs when an organization delivers value to its constituents in a profitable and sustainable manner. But how do banks get that way? Are there distinguishing characteristics of high-profit banks?

The year 2018 was a blockbuster one for the banking industry, thanks in large part to the Tax Cuts and Jobs Act (TCJA). The industry earned $236.7 billion in 2018, a whopping 44.1% improvement over the $164.3 billion in 2017, and return on assets (ROA) was 1.35% – its highest point in over seven years. According to the FDIC’s Quarterly Banking Profile, the 44.1% increase in full-year net income would have only been an estimated 13.5% given a normalized tax rate.

Drawing conclusions from the FDIC’s published data, it’s clear that asset size is a factor to profitability. Medium and larger banks have a much higher profit advantage over smaller banks. For example, banks under $100 million in assets have a ROA disadvantage of 33 basis points (bps) to the industry’s 1.35%, much of which can be attributed to scale that results in greater efficiency. However, the discussion of size and performance recalls the chicken-and-egg conundrum; or as statisticians would put it, correlation does not imply causation.

The effectiveness of an institution’s management team shapes its performance, and hence its size. Growth for the sake of growth is no substitute for profits. The wrong incentives related to growth could lead to uncontrolled increases in operating expenses and a loss of a competitive advantage. Rather, management teams should focus on delivering value in a profitable manner. Growth then becomes a natural byproduct, which can bring scale and further improvements in efficiency.

To view performance outside of the traditional confines of asset size, we created a bank screener to profile high-profit banks. To start, we filtered out the largest of banks, removing banks above $20 billion in assets and other unrepresentative specialty banks.

From there, our high-profit benchmark (HPB) contains banks with the following criteria:
- ROA and ROE higher than the industry in four out of the past five years
- A higher ROA today than five years ago
- Non-performing assets not greater than 1.20% of assets (double the industry’s aggregated figure)

Of the 5,406 institutions reporting according to the FDIC, 575 banks were included in the HPB, representing about 11% of the total number of banks. These are institutions without excessive credit losses and a strong track record of performance over the past five years. The asset size distribution is very similar to the broader industry, indicating high-profit banks across all asset sizes are represented. However, the skew is more towards the larger side, as the average asset size is $873 million in the HPB compared to $670 million on average for banks less than $20 billion in assets. In our findings, the factors these high-profit banks share are expense control, leverage and balance sheet structure.

How High-Profit Banks Do It
Expense control is one factor that leads to higher profits, and arguably the most important one. Operating overhead stands out as the most statistically significant factor in profitability, as HPBs posted 2.57% of average assets in non-interest costs and a 50.38% efficiency ratio – both significantly lower than the numbers of their similarly-sized peers. HPBs also have lower interest costs and higher net interest margins (NIMs). On the other hand, non-interest income and fee income don’t seem to be key factors; HPBs seem to earn less in these diversified sources of income relative to larger banks. Overall, HPBs outpaced the broad industry by a wide margin last year, generating a 1.81% ROA and 16.03% ROE.

Leverage also stands out, but more so when comparing to banks on the smaller side. Larger banks tend to make better use of economically cheaper debt relative to high-cost owners’ capital. Interestingly, HPBs have higher capital ratios than the broader industry – including the largest banks – but risk-based capital ratios are about the same. This indicates HPBs are more likely to utilize risk-based capital, which leads us to the next point.

Balance sheet structure influences performance, at least for the time being when credit performance is strong. Loan-to-deposit and loan-to-asset ratios are significantly higher than the broader industry. HPBs also have higher deposit-to-asset ratios, perhaps giving them a cost of funds advantage.

Ultimately, profitability is a result of many factors. Market forces are certainly a big part of this discussion – once again, think back to 2018’s tax tailwind. A bank’s financial statement performance, however, suffers from the drawback that it is not risk-adjusted. That is the purpose of asset-liability management (ALM) – to increase profits by reducing risks that may adversely impact profitability. Should market forces move unfavorably, efficient, well-run banks will be the best positioned to survive.

Figure 1: The Index of High-Profit Banks Compared to the FDIC's Compiled Data

Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not necessarily reflect the official policy or position of the Financial Managers Society.

About the Author

As a Director for the ALM Strategy Group at ALM First Financial Advisors, Alec Hollis performs asset liability management strategy research for financial institutions, implements firm-wide ALM modeling procedures and assists in the execution of client balance sheet hedging programs.

April 22, 2019
The Growing Push for Financial Literacy
By Robert Segal, CEO, Atlantic Capital Strategies, Inc.

The Massachusetts legislature approved a bill in January that requires state education officials to establish financial literacy standards for students in kindergarten through grade 12. The goal is to train students in skills that will help them become financially self-supporting adults, with topics that include understanding loans, renting or buying a home, saving for college and investing for retirement.

“Financial institutions have said that when they interact with young customers, they’re seeing a lot of young people not fully grasping everything from what credit cards are to compound interest to just general costs once they’re out of high school and college,” said Massachusetts State Senator Jamie Eldridge, who sponsored an original version of the bill.

Also in January, New Jersey Acting Governor Sheila Oliver signed a law that requires the state Board of Education to include financial literacy instruction in the curriculum for students in grades six through eight in public schools across the state. The new law says the lessons should equip students with tools for “sound financial decision-making,” with content covering budgeting, savings, credit, debt, insurance and investments.

“Financial responsibility is an important acquired and learned life skill, and with the increasing financial challenges millennials face, it is a skill that must be a necessary part of our educational curriculum,” said Oliver.

John Pelletier, director of the Center for Financial Literacy at Champlain College in Vermont, reported that only five states received an “A” grade for providing the appropriate financial education for students. He further noted that studies continue to show that financial literacy is linked to positive outcomes like wealth accumulation, retirement planning and avoiding high-cost alternative financial behavior like payday lending and paying interest on credit card balances. Conversely, he says, financial illiteracy was partly to blame for the Great Recession, and that in order to minimize the impact of any future recession or financial crisis, Americans must be educated in personal finance.

The Center asserts that high schoolers are the prime candidates for financial education for the following reasons:

- The number of financial decisions an individual must make continues to increase, and the complexity of financial products continues to grow;
- Many students do not understand that one of the most important financial decisions they will make in their lives is choosing whether they should go to college after high school;
- Most college students borrow to finance their education, yet they often do so without fully understanding how much debt is appropriate for their education;
- Children are not learning about personal finance at home, with a 2017 T. Rowe Price survey noting that 69% of parents are reluctant to discuss financial matters with their children;
- Employee pension plans are disappearing and being replaced by defined contribution retirement programs, which impose greater responsibilities on young adults to save and invest.

It seems most Americans would agree with the study’s conclusions. The National Foundation for Credit Counseling’s (NFCC) “2017 Consumer Financial Literacy Survey” reports that 42% of adults gave themselves grades C, D or F with regard to their personal finance knowledge; 27% have not saved anything for retirement; 32% have no savings; 60% do not have a budget; and 22% do not pay their bills on time.

In a 2015 report, the FINRA Investor Education Foundation revealed that vast improvement in credit behavior resulted from state-mandated personal finance education. The study evaluated the effect on credit scores and delinquencies over a three-year period in the states of Georgia, Idaho and Texas. Individuals in school during the third year following the inception of the program showed greater benefits from personal finance instruction, with credit scores increasing by 10.89 points in Georgia, 16.19 points in Idaho and 31.71 points in Texas, while ninety-day-plus delinquencies dropped nearly 2% in all three states by the third year. FINRA found that if a rigorous financial education program is carefully implemented, it can improve the credit scores and lower the probability of delinquency for young adults.

The data suggest that financial literacy is more than just a “feel-good” exercise. According to most research, consumers who understand the basics of personal finance are more profitable for the banks and credit unions that provide them with financial education. Individuals who participate in these programs tend to be open to advice from that institution and generally say they’re likely to bring business to them.

The FDIC has shown that partnerships with non-profit organizations and local government agencies are key components in outreach efforts. The FDIC stresses that a well-executed strategy is mutually beneficial to banks, their community partners and consumers. Across the nation, a number of depository institutions work with established groups from the local community to provide financial education. This builds trust and, in turn, educates consumers about the benefits of using banking services and the lasting advantages that a banking relationship offers in gaining access to other financial products.

Promising opportunities exist for banks that are considering developing continuing, sustainable relationships with consumers. Financial institutions not yet participating may wish to explore partnering with various state agencies and/or non-profit organizations in to order to support their customer base and ensure the long-term viability of their communities.

Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not necessarily reflect the official policy or position of the Financial Managers Society.

About the Author

Robert Segal is the founder and CEO of Atlantic Capital Strategies, Inc., which provides investment advisory services for financial institutions. He has over 35 years of experience in the banking industry, having worked in several community banks with roles in mortgage banking sales, trading and ALM. Bob is also currently a Director-at-Large on the FMS Board of Directors.

April 8, 2019
Is Your Shadow IT Compromising Your Growth and Compliance?
By Joe Galletta, Sales Manager – Americas, ClusterSeven

With the financial crisis behind us and the much-debated rollback of some Dodd-Frank Act regulations underway, the focus of many financial institutions has finally shifted from managing compliance to managing the business. Issues such as cost management, optimizing business performance and the need for innovation have once again come to the fore.

The emphasis now is firmly on building the business across areas such as portfolio management, risk management and product development. Central to these goals are the models banks use to manage their business, and the technology they use to deliver the output of these models – typically spreadsheets, databases and visualization tools.

Regulators are “on the case”
Of course, the wide and varied use of models – together with the tools, calculators and the technology infrastructure that supports them – brings its own challenges. Unmonitored and uncontrolled, models can themselves pose risk factors that regulators are increasingly noting. The Current Expected Credit Losses (CECL) accounting standard is one such example where model management is a fundamental requirement for which institutions need to demonstrate full control and transparency. The FDIC too has its model risk management framework for financial institutions with assets over $1 billion, affecting around 700 banks in the U.S.

Hence, while financial institutions are keen to focus on developing and driving the business forward, effective compliance management remains an imperative. And judging by historical events, compliance appears to be a moving goal post.

Shadow IT a risk
Shadow IT (e.g., databases, development environments, management information systems and spreadsheets) today is extensively used to manage numerous business processes, in parallel with and integrated with corporate IT applications. In fact, these applications, especially spreadsheets, are often the preferred business and regulatory compliance modelling tool due to their ease of use and flexibility. They are powerful enough to run complex calculations and are easy to connect so that data seamlessly flows between the various models, tools and calculators, as well as the processes they support. Perhaps this is why these applications often start as a tactical fix for a business issue, and eventually become so embedded into a business-critical process that they can’t be easily removed.

Regulators are increasingly recognizing the importance of shadow IT to key business processes at banks and credit unions. There is nothing wrong with this as such, but it does mean that institutions need to have suitable visibility and controls in place. Without these controls, there’s no getting away from the operational, regulatory and reputational risks the unfettered use of these tools pose.

For example, a fat-fingered data entry can cause outcomes to be skewed. A lack of version control means that there can be multiple versions of the same file or spreadsheet in use at the same time, which can seriously impair decision-making and critical reporting. This can be exacerbated if these applications are linked to other applications, replicating the same problems across the business almost instantaneously. From a compliance standpoint, such situations can cause inadvertent misreporting, resulting in severe regulatory fines. Recently, a regulator in the UK imposed a $37 million fine on UBS for a decade of transaction misreporting errors, serving as a reminder of the potential risks involved – and a fine like this doesn’t begin to quantify the reputational risk involved.

From a business perspective, the impact can be equally serious. Poor quality information can lead to missed opportunities, or give an unrealistic view of potential returns on an investment. It can also expose an institution to contractual breaches or other issues that drive reputational risk.

A risk-sensitive approach to managing shadow IT
These shadow IT challenges can be overcome by taking a risk management led approach to its usage. At its core, it requires establishing a framework for “business as usual” shadow IT management, which should include:

Creating a comprehensive inventory of the shadow IT tools and processes is an obvious place to start.

2. Risk-based tiering
Not all the tools and processes will be equally materially important to the business. Based on a defined criteria and the institution’s appetite for risk, tiering the shadow IT processes and models helps identify the ones that pose the most operational, regulatory, compliance and reputational risk to the business.

3.Understanding the data connections
Especially for high-risk processes, identifying and understanding the data linkages and lineages across the landscape is crucial to ensuring data quality and accuracy – and thereby integrity – of the processes and models.

4.Managing and monitoring
Based on a shadow IT user policy, the business-critical models and processes can then be monitored and managed for version and change control, as well as review, approvals and authorizations, to ensure that the data is accurate and can hold up to scrutiny at all times.

Institutions often resort to manual processes to govern their shadow IT estate, but despite the best will in the world, they’re fighting a losing battle due to the vast expanse and complexity involved. Achieving full transparency for an estate (to the stringent requirements of auditors and regulators) that is complex and grows organically due to lack of controls is next to impossible to achieve manually.

Therefore, automation is often the preferred solution for taking care of everything end-to-end. From scanning the IT infrastructure to locate the spreadsheets and other files to exposing the underlying data sources and relationships across the landscape to risk-checking the critical files and models, automation can help to provide continuous monitoring and control without being a drain on resources. In doing so, it also presents a reliable and demonstrable way to assure stakeholders – including senior management, auditors and regulators – that the institution’s shadow IT is subject to the same level of scrutiny that its enterprise IT is.

Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not necessarily reflect the official policy or position of the Financial Managers Society.

About the Author

Joe Galletta has over three decades of experience in business development and partner management, with extensive work with financial services organizations, banks, asset managers and insurers.

March 25, 2019
Banking M&A 2019: The What and the Why
By Neil Dhar, Partner and Head of Financial Services, PwC

In all of 2017, there were $33 billion in announced deals among U.S. banking and capital markets firms. After six weeks in 2019, we had already passed that level.

What’s going on?

There are many factors that underlie any given transaction. But there are also some broad themes at work in the market, and we expect them to continue for the foreseeable future. Whether you’re a would-be acquirer or a potential target, this is a good time to review some trends and consider how they might apply to your own institution. In fact, two recently announced transactions – the $28 billion proposed merger between BB&T Corporation and SunTrust Banks, and the $3.6 billion combination of Chemical Financial Corporation and TCF Financial Corporation – say a lot about where the industry may be heading.

Innovation and digital capabilities
For several years now, the largest U.S. banks have grown significantly faster than their regional competitors. We believe this trend is due to two factors: a sustained push to develop strong digital capabilities at scale, and more successful, better-funded marketing efforts. Some of the strongest customer growth in retail is being driven by millennials and older, wealthier clients; PwC analysis shows that both of these groups tend to be especially responsive to digital and marketing strengths.

Between 2011 and 2014, the biggest U.S. banks accounted for nearly two-thirds of deposit growth and virtually all the net growth in debit cards, which is a good proxy for consumer checking accounts. Given their scale, these players can significantly out-invest other banks in brand marketing, data analytics and digital products and services. The converse is also true: financial institutions that don’t, or can’t, invest to achieve digital capabilities at scale are finding themselves at an ever-greater disadvantage. With both of these deals, the banks involved cited their desires to invest in innovation and digital capabilities as a strategic reason for the deals.

Favorable deal economics
Higher-priced deals typically require aggressive synergy and growth targets to create attractive returns. Our research has shown that more than 50% of banks fail to achieve their growth-adjusted cost synergy targets. However, recent deals referred to as “mergers of equals” (MOEs) have found a sweet spot, where both sides structure a deal with book value multiples and targets that might reward all stakeholders.

Recent transactions are setting a new standard for attractive bank deals. In 2018, bank transactions averaged above 1.8x a target’s tangible book value (TBV), and as high as 3.2x. At around 1.7x, the BB&T-SunTrust and Chemical-TCF mergers represent great prices for strong organizations. These deals appear to have been priced reasonably, and this increases their chances of generating the desired return on investment.

Further, when banks link up, they typically announce that they will see synergies (cost savings) ranging from 10-45% of the acquired bank’s non-interest expense. Our experience with bank integration shows that synergy targets in the 20-30% range tend to be conservatively achievable. Synergies greater than 30% usually require rationalizations of branch networks, products and operations that are far more ambitious, and therefore harder to accomplish. In the first transaction, the banks have announced a target of 29% of SunTrust’s non-interest expense. In the second, they are aiming for 18% of TCF’s non-interest expense. We believe that if other banks can create deals with relatively low TBV multiples and achievable synergy targets, we are likely to see many more similar transactions in the market.

Regional, digital tie-ups
MOEs traditionally bring together complementary strengths, such as uniting a strong commercial bank with a strong community bank franchise, distinctive product sets or adjacent territory. If both firms in a transaction can effectively distribute their combined product portfolios across their combined geographies, they may boost top-line revenue. Digital capabilities may provide an additional path to these kinds of synergies: the new variable in bank M&A.

Receptive investors
The total number of U.S. banking deals has remained relatively flat for awhile. Despite equity markets getting increasingly skittish, shareholders have reacted well to these transactions; the MOE deals have traded up on announcement. With such optimistic responses from investors, we’re likely to see more of these types of transactions in the year ahead.

No deal is a slam dunk. Integration issues associated with change management, data and technology can limit the payoff from a deal that looks good on paper. These challenges may be harder for MOEs relative to outright acquisitions, because the two firms often have comparable processes and teams. Leveraging the best of both cultures, choosing what to preserve, aligning and retraining everyone to follow a new operating model and a set of desired behaviors, thinking through location strategy, transparency around how people and communities will be affected: these all require work. But when MOE deals are integrated properly, there can be winners on both sides of the transaction – as well as shareholders, customers and employees.

We expect the trend toward M&A in the community and regional banking sector to continue. Consolidation is a strong path forward for many banks in the sector, especially those that are beginning to invest in customer-focused digital transformation. The BB&T-SunTrust and Chemical-TCF mergers suggest that fairly priced deals with reasonable synergy targets will nearly always attract interest, especially when shareholders believe that the integration is achievable.

Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not necessarily reflect the official policy or position of the Financial Managers Society.

About the Author

Neil Dhar is an experienced partner at PwC who currently serves as the head of PwC’s financial services business, which includes all matters (consulting, tax and audit services) associated with the asset & wealth management, banking & capital markets and insurance sectors. Functionally, he is a seasoned deal consulting professional with over 20+ years of experience advising on over 200 transactions representing billions in transaction value and/or capital.

Have a topic you want to share? 

We’d love to hear from you:
Mark Loehrke
Editor and Director, Publications and Research
Direct: 312-630-3421