The Bank Spot

Views, muse and the occasional brilliant insight about banks and banking

BB&T’s Open Road for Bank Acquisitions

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Noticeably absent from the bank merger and acquisition market in recent years has been the large bank buyers that historically have driven the industry’s consolidation over the past three decades. There is a good reason for that. The 2007-2009 financial crisis had a truly profound impact on both the substance and philosophy of how the banking industry was regulated, and very large institutions are now viewed much more critically (if not suspiciously) by the bank regulatory agencies in Washington.

The landmark Dodd-Frank Act of 2010 established an important $50 billion threshold above which all bank holding companies must comply with tougher capital, liquidity and leverage requirements than banks below the limit. Members of the $50 billion-plus club also must undergo annual stress tests that are either self-administered under strict regulatory guidelines, or in the case of much larger banks that have been designated by the Federal Reserve Board as Systemically Important Financial Institutions – or SIFIs – are administered by the Fed itself. Eight very large U.S. banks have been designated as SIFIs and they also have to meet an even tougher set of capital, liquidity and leverage requirements than the smaller members of the $50 billion-plus club.

Not only have the regulations themselves become more demanding for large banks, they have also been held on a much shorter leash by their supervisory agency. For years I been hearing stories of how since the crisis banks are expected to run all major strategic decisions by their primary regulator before enacting them, and this includes acquisitions. I think it’s fair to say that for those banks $50 billion and above, the regulators have wanted them to comply with the capital and liquidity requirements, and go through a couple of rounds of stress testing, before they started to green light acquisitions again.

Three of the four largest U.S. banks — JPMorgan Chase & Co., Bank of America Corp. and Wells Fargo & Co. — are precluded from acquiring a domestic retail bank because they all have deposit market shares in excess of 10% and are prohibited by law from increasing that further through another acquisition. But I have the sense that virtually all banks above the $50 billion threshold have been discouraged if not prohibited from making acquisitions by their primary regulators. There have been a few deals since the end of the financial crisis where $50 billion-plus banks were the acquirers, but they have been an exception to the rule. Bank M&A activity in recent years has been characterized by small and midsized institutions acquiring each other rather than by very large banks devouring much smaller ones.

However, an exception to that exception is BB&T Corp., a $210 billion asset bank headquartered in Winston-Salem, North Carolina. Historically an active acquirer, BB&T has never been completely out of the M&A game, even during the financial crisis. It bought the remains of two banks that had been taken over by the Federal Deposit Insurance Corp. in 2008 and 2009, and some of the assets of a third bank that had fallen on hard times in 2010. Since September 2014, BB&T has done three healthy bank acquisitions deals in rapid succession, starting with $1.9 billion asset Bank of Kentucky Financial Corp. in Crestview Hills, Kentucky. In November of last year, BB&T also acquired $18.6 billion asset Susquehanna Bancshares in Lititz, Pennsylvania for $2.5 billion, and in August it bought $9.6 billion National Penn Bancshares in Allentown, Pennsylvania for $1.8 billion.

Long gone are the days when a CEO would place a courtesy call to the bank’s primary regulator and say it would be announcing a deal in the morning. Bank M&A is a very different ballgame nowadays — as we explained in Bank Director magazine’s first quarter issue and the regulators expect their banks to consult with them on their M&A plans, including proposed acquisitions. So when a large bank like BB&T is able to do three deals — bang, bang, bang — in just under a year, you have to wonder what it knows that others don’t.

I would say that BB&T has several things going in its favor. First, at $210 billion it is not yet so large that it poses a systemic risk to the U.S. economy should it get into trouble, and these three acquisitions have been a fraction of its size. Second, the bank meets or exceeds all of the new capital requirements for large U.S. banks. Third, it obviously has a strong regulatory compliance track record — and we know this simply because it has been able to do these deals. Even well capitalized banks with a serious compliance issue won’t be allowed to acquire. Fourth, and this might be BB&T’s secret sauce, the bank has brought its primary regulator – the FDIC – into the sanctum of its deliberations on M&A strategy.

Kelly King

In an interview for the cover story of Bank Director’s first quarter issue, BB&T CEO Kelly King explained how they go about this. “We on at least a quarterly basis sit down with [the FDIC and] share with them what our plans are, long-term, short-term and talk to them about issues and challenges,” King said. “We have a full and complete dialogue that is non-transaction based. They know what our strategies are. They know what types of M&A plans we have. They know the kind of candidates that we’re considering. And so when [an acquisition] actually comes along it’s simply a matter of filling in the blanks.”

BB&T also places considerable emphasis on organic growth and it tends to look for smaller deals that give it more market share in specific locations rather than large transformational deals that entail much more risk. The Bank of Kentucky acquisition strengthens its position in the greater Cincinnati, Ohio market, while the two Pennsylvania deals now makes it the second largest bank in that state.

I would expect BB&T to pursue this strategy of relatively small and very targeted acquisitions for the foreseeable future. The fact that King works with BB&T’s regulators rather keeping them in the dark should give him an open road to keep doing deals.

A Horse Designed by Committee is a…what?

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There’s an old saying attributed to novelist Franz Kafka that a camel is a horse designed by a committee, and that’s an apt description of how this country’s financial system is regulated. There are four prudential agencies that are responsible for regulating insured depository institutions for safety and soundness: The Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp. and the Federal Reserve regulate banks and thrifts, while the National Credit Union Administration watches over federally chartered credit unions. The Consumer Financial Protection Bureau, which was created by the Dodd-Frank Act and just celebrated its fourth birthday, polices the retail financial services market. And the Securities and Exchange Commission and Commodity Futures Trading Commission cover the broad capital, futures and derivative markets.

And there you have it – a system of regulation by committee.

This is not a rational approach to regulation for such a massive, and massively important industry as financial services, and it certainly is not how one would design the system today if starting from scratch. And that is exactly what former Fed Chairman Paul Volcker is proposing to do – to start over. Volcker and two former treasury secretaries, Timothy Geithner and Henry M. Paulson Jr., have stated publicly the view that regulation by committee was a significant enabling factor behind the 2007-2009 financial crisis. For example, unregulated nonbank mortgage origination companies helped drive the subprime mortgage lending boom by engaging in many of the now-discredited practices, like negative amortizing home loans and loans that did not require income verification, that ultimately led to the market’s noisy collapse.

The Dodd-Frank Act attempted to address many of the weaknesses in the financial regulatory structure, including the fact that the banking industry was undercapitalized. It created the CFPB, which does extend some measure of regulatory oversight to nonbank financial companies, at least in terms of the products they sell and how they sell them. And it eliminated the Office of Thrift Supervision, which was seen as a weak sister among the regulatory agencies that were overseeing insured depository institutions.

But DFA did very little to rationalize and simplify the regulatory framework. In fact, the law made things even more complicated. While it did sack the OTS, it also begat the CFPB which shares its oversight function with the FDIC, OCC and Federal Reserve. The CFPB makes the rules and supervises banks and thrifts over $10 billion in assets while the other agencies are responsible for consumer compliance at institutions under $10 billion, so there is still great duplication of effort. And it also created the Financial Stability Oversight Council, whose job is to identify and monitor systemic risks in the economy as they arise from large financial institutions. There are 10 voting members on the council including all of the aforementioned agencies, so basically it’s the same cast of characters meeting — yes! — in committee.

There have been countless proposals over many decades to reform the system, and the most recent one came from Volcker himself, who formed the Volcker Alliance in 2013 in hopes of bringing order to chaos. The Alliance, which is comprised of a star-studded cast of Washington worthies including former FDIC Chairman Sheila Bair and former Sen. Bill Bradley, released an ambitious proposal in April that would truly be a sweeping reform of the financial regulatory structure if ever enacted.

At the risk of significant oversimplification, because this is an expansive proposal, the Volcker plan would create a new super agency to assume the prudential supervisory duties of the OCC, FDIC, Federal Reserve, SEC and CFTC. The Financial Stability Oversight Council – or FSOC, which always reminds me of “sock it to ‘em’” — would have its responsibilities for systemic regulation greatly expanded. And the SEC and CFTC would be merged.

There has been little if any action on the Alliance blueprint since it was released four months ago, and I would be truly surprised if anything ever comes of it. Financial regulatory reform is a tough sell in Washington because it is complicated, because it doesn’t have great political sizzle, and because the regulatory agencies themselves fight like wildcats to preserve their turf. Elizabeth Warren, the Democratic senator from Massachusetts, has introduced legislation to reinstate certain Glass-Steagall Act provisions that would re-separate some commercial and investment banking activities. But I am not aware of anyone in Congress who has stepped forward to champion the Volcker proposal.

In truth, the best opportunity to reform the regulatory framework would have been just after the financial crisis, when Congress was focused on the passage of Dodd-Frank. Six years later, no one in Congress is talking about the financial crisis except, perhaps, for Warren. The next presidential campaign cycle is in full swing and Congress seems much more interested in debating the Iran nuclear deal, or trying to defund the Affordable Care Act and Planned Parenthood, or preserve the right to fly the Confederate battle flag in national cemeteries than regulatory reform.

I am reminded of the famous quote that then-Defense Secretary Donald Rumsfeld uttered during the Iraq War. “You go to war with the army you have. They’re not the army you might want or wish to have at a later time.” I strongly suspect that when the next financial crisis hits, we will go to “war” with the committee system we have today and not the better system we might want.

What Will Become of The Banking Industry’s Battleships?

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Lael Brainard, a member of the Federal Reserve Board of Governors, gave a speech earlier this month in which she reported on the efforts of the various bank regulatory agencies to drive the final nails in the coffin of the unofficial government policy known as Too Big to Fail. Brainard intended her remarks to be a progress report, but as I read her speech I couldn’t help but wonder if she hadn’t made the argument — unintentionally, I’m sure – for why some of the largest U.S. banks are using a business model that is trending towards obsolescence or, at the very least, economic unsustainability. And in their efforts to reduce the systemic risk that megabanks pose to the U.S. economy, the regulators and the U.S. Congress may be accelerating that process.

Much has been written about the government’s efforts to prop up ailing banks during the 2007-2008 financial crisis, a rescue mission that was very unpopular with the general public but was probably necessary to restore confidence in the country’s banking system. Banking and finance are the heart of the body economic. Lose the heart and the body dies. The policy of Too Big to Fail starts with the premise that some banks are so large and systemically important that their failure could end up doing great harm to the economy. At various times over the past 30 years or so, this thinking has led to government intervention when large banks have stumbled and the feds have had to bail them out. Critics have long argued that bankers will have little reason to be prudent if they know that Uncle Sam will rescue them if everything goes south.

One of the principal objectives of the landmark Dodd-Frank Act of 2010, which was enacted in direct response to the financial crisis, was to end the policy of Too Big to Fail. One way in which DFA sought to do that was to focus on those banks whose failure would pose a serious threat to the economy and then require them to meet a much tougher set of requirements than the rest of the industry. There are 30 high-risk institutions around the world that have been designated as Global Systemically Important Banks (GSIBs) by the Financial Stability Board, an international body comprised of senior policymakers, central bankers and regulators from the G20 countries, and eight of them are in the United States. This is an exclusive club that no bank wants to belong to, and the U.S. members are JPMorgan Chase & Co., Bank of America Corp., Citigroup, Wells Fargo & Co., Goldman Sachs, Morgan Stanley, Bank of New York Mellon Corp. and State Street Corp.

Dodd-Frank imposes on these eight GSIBs a combination of capitalization, assessment and policy requirements that in theory should make them stronger and, consequently, less likely to fail during an economic crisis. Brainard, who served as the U.S. Treasury Department’s undersecretary for international affairs before being appointed to the board of governors in June 2014, offered an assessment of what has been accomplished to date. I would summarize her report this way:

  1. The GSIBs are required to meet several separate capitalization requirements that will be phased in through 2019, and once fully implemented these institutions will have double the capital they held in 2007.
  2. Since 2009, large U.S. banks and certain U.S. subsidiaries of foreign banks have been required to undergo annual stress testing under the Comprehensive Capital Analysis and Review program, and for these institutions – including the GSIBs – their mandated capital levels are not a static target but in fact could rise even higher depending on economic conditions.
  3. GSIBs are required to meet a 5% leverage ratio regardless of their other capital ratios, which means their Tier 1 Capital must total at least 5% of their consolidated assets, including all off-balance sheet exposures.
  4. Beginning in January 2017, banks with $250 billion in assets or greater will be required hold a significantly larger percentage of high-quality liquid assets as a buffer against funding disruptions during times of economic stress. The eight GSIBs also have to go through a more stringent annual liquidity assessment by the Federal Reserve.

Once fully implemented, these changes will theoretically make the eight GSIBs stronger, but whether investors will want to support them at that point could be another matter. The 3rd Quarter issue of Bank Director magazine, which will be available in early August, will feature our annual Bank Performance Scorecard, which is a ranking of the 300 largest publicly owned U.S. banks. We divide the banks into three asset categories: $50 billion and above, $5 billion to $50 billion and $1 billion to $5 billion. Included in the metrics that we use to determine the ranking are return on average assets (ROAA) and return on average equity (ROAE). The average ROAA for seven of the GSIBs in 2014 (Goldman Sachs did not report an ROAA last year) was 0.79%, which is substandard to say the least. Throw out Wells, which earned 1.33%, and the average dips to 0.70%. The average ROAE for all eight banks last year was 8.30%. Exclude Goldman, State Street and Wells, all of which earned 10% or better in 2014, and the ROAE for the remaining five GSIBs was just 6.58%. And this was five years into the recovery of the U.S. economy!

To be fair, the profitability of some of these GSIBs last year was negatively impacted by restructurings or multi-billion dollar legal settlements with the regulators for past sins. But what happens in 2019 when all of the heightened capital requirements have kicked in? My guess is that their investment returns will still lag the rest of the industry, as they did in 2014. Capital is a double edged sword. It makes you safer but too much of it can depress your equity returns. The regulators are most concerned about the economy and the U.S. taxpayer, but publicly owned banks have shareholders and they expected to be rewarded.

Jamie Dimon, the chairman and CEO of JPMorgan, has defended his bank’s business model, which is to be all things to all people (or at least pretty damn near). JPMorgan has a major investment bank, a very large corporate bank, a significant branch banking franchise scattered throughout the United States that operates under the Chase brand, and a big presence in national consumer product businesses like home mortgages and credit cards. Citigroup and Bank of America are more similar than dissimilar to JPMorgan in this regard. With an ROAA of 1.33% and ROAE of 11.72% in 2014, Wells is an outlier – at least for now.

Will this universal banking model be economically sustainable when JPMorgan, Bank of America, Citigroup and perhaps even Wells Fargo must bear the full weight of the heightened capital requirements in 2019? Remember also that the GSIB’s compliance costs are astronomical because of all the new regulations that have gone into effect since the financial crisis, and because they are under the constant watch of the regulators.

The evolution of the GSIBs to a more rigorous regulatory structure has occurred while another industry trend of potentially great significance has been unfolding. The 3rd Quarter issue of Bank Director will also contain a 20-page special section, entitled “The Fintech Revolution,” that explores how the emergence of financial technology companies like Lending Club and Kabbage is beginning to redefine the delivery of consumer and small business loans at a cost that most traditional banks can’t begin to match.

It will be interesting to see how the universal banks respond to the growing competition of fintech companies, which focus on many of the same product categories. The development of this alternative lending market could turn out to be a sideshow since the fintech industry needs to demonstrate that it has staying power through at least one full economic cycle, but it highlights one of the universal banks’ most pronounced weaknesses, which is a reliance on expensive brick-and-mortar distribution, which drives up their costs compared to their fintech competitors.

Here is how all of this comes together for me. First, the high capital requirements and elevated compliance costs are a constant headwind that all of the GSIBs – and particularly JPMorgan, Citi and Bank of America – will struggle against, forcing them to extract an extra measure of profitability from their business models just to compensate for that. Secondly, fintech companies are beginning to change how consumer and small business lending is done in the United States. This change is driven to a large extent by the increasing comfort level that a wide demographic cross-section of Americans have with doing financial transactions online and with their smart phones. I suspect that the universal banks will have a difficult time adapting their branch-based systems to this emerging phenomenon, and might have to accelerate their own shift to digital and mobile distribution while deemphasizing the branch.

It may take years before these factors have their full impact on the universal megabanks, but I think the long arc of history is moving away from them.

Students of naval history know that World War II signaled the beginning of the end of the battleship as the dominant weapon system at sea. Magnificent vessels like the USS Missouri, which represented the height of battleship design when she was commissioned in June 1944, were surpassed by submarines, which relied on stealth, and the aircraft carrier, which projected American air power throughout the Pacific Theater. The Missouri continued in service until her decommissioning in 1992, but she had been built for an era that no longer existed. The photo at the top of this post shows her being towed back to her berth in Pearl Harbor after undergoing maintenance and preservation repairs in 2009. Today she is a floating museum. I wonder if some of our largest banks will suffer a similar fate.

Banking in the Age of Innovation. Uh-Oh…

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I believe there is a strand of conventional thinking (I hesitate to call it wisdom) that considers banking to be a highly regulated industry offering little opportunity to innovate. I would agree that JPMorgan Chase & Co. would be restricted from, say, buying Google because of prohibitions built into the Bank Holding Co. Act of 1956 that forbid banks from engaging in non-banking activities. (Of course, with a market capitalization of approximately $362 billion, Google would be more likely to acquire JPMorgan, whose market cap is a mere $243 billion.) The definition of what constitutes a “non-banking activity” has been stretched down through the years by subsequent federal legislation (banks are permitted to own securities firms and insurance companies, for example), but clearly a community bank would not be permitted to acquire a local car dealership because it wanted the inside track on offering auto loans to the dealership’s customers.

Building a Culture of Innovation

But there are still plenty of opportunities to experiment within banking’s permissible range of activities. Earlier this month my colleague at Bank Director magazine, managing editor Naomi Snyder, wrote about Wells Fargo & Co.’s Startup Accelerator program in which the big San Francisco-based bank makes investments of up to $500,000 in early stage technology companies that are developing ideas Wells Fargo might eventually want to incorporate into one of its own businesses. In addition to the funding, companies that have been accepted into the program are mentored by one of Wells Fargo’s many business units for six months. In effect, the business unit is a product development guinea pig. Wells also takes a small investment stake in the companies, although Bank Holding Company Act restrictions limit these to less than 5%.

In September of last year, I wrote about a program at Bank of New York Mellon Corp. where the bank also tries to encourage innovation, but in this case among its own workforce. In 2009, the company established a pilot program to review ideas submitted by its 10,000 employees. That first year the bank received over 1,000 ideas that generated about $165 million in pretax profit. The program has grown even larger since then – it now includes several elimination rounds with the finalists traveling to the company’s New York headquarters to make a five-minute pitch to a panel of judges. The winners receive both a cash award and the opportunity to leave their current jobs and join a company-run incubator where they get the chance to develop their idea to operational readiness. Since 2009, the program has generated over 13,000 innovation ideas.

Of course, Wells Fargo and Bank of New York Mellon are large organizations with enough resources to spend freely on this kind of activity. Or at least, that’s probably the excuse that many smaller institutions would use to explain why they don’t have the time or money to innovate. Except that they do, on an appropriate scale. I’ll point to one area that is exploding with innovation right now – mobile banking. The cellular phone could very well end up having an even greater impact on banking than the Internet did a couple of decades ago. In January 2014, the usage of all mobile devices exceeded personal computer usage over the Internet for the first time. Many financial technology companies are using smart phone apps to crowd into the payments space and peel off market share from traditional banks that have been slow to embrace the mobile revolution.

Can you guess which U.S. bank was the first to offer mobile phone picture bill pay? The answer is First Financial Bankshares Inc. in Abilene, Texas. With $5.8 billion in assets, First Financial is not exactly a small community bank – but it’s not $1.7 trillion asset Wells Fargo, either. At Bank Director’s recent Bank Board Growth & Innovation Conference in New Orleans, Dave DeFazio, a partner at the consulting firm StrategyCorps, gave a fascinating presentation on how banks can increase customer usage and build loyalty by including a wide range of popular consumer apps in their basic mobile banking offering. This struck me as a no-brainer because it doesn’t cost much and puts the bank at the front edge of the most important development in retail and small business banking over the last 20 years.

I wrote in my last blog – “Beware the Fintech Raptors” – about the emerging financial technology companies (hence the term fintech) that are beginning to challenge traditional banks in many of their core lending and payments markets. Innovation is to these companies what flight is to a raptor: It’s what they were born to do. Traditional banks need to pay attention to what these new fintech companies are up to and find ways of competing with them in the innovation arms race. There is still value in a bank charter, but that value could decline over time if traditional banks allow themselves to become the equivalent of an Internet dial-up service in this new Age of Innovation.

Beware the Fintech Raptors

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What exactly is a bank nowadays?

Those of us who are closely connected to the banking industry might be tempted to say that a bank is an entity that has a charter from either its state of domicile, or in the case of a national bank, from the federal government. A bank also offers deposit insurance through the Federal Deposit Insurance Corp., and is supervised by a combination of state and federal bank regulatory agencies if it has a state charter, or by the feds if it has a national charter.

To many traditionalists, that is a bank. And yet I would argue that the distinction between a bank and a nonbank has become increasingly meaningless. This is not a new phenomenon. The financial service marketplace in the United States has been has crowded with nonbank companies that have competed fiercely with traditional banks for decades. But we seem to be in a particularly fecund period now. Empowered by advances in technology and data analysis, and funded by institutional investors who think they might offer a better play on growth in the U.S. economy than traditional banks, we’re seeing the emergence of a new class of financial technology – or fintech – companies that are taking dead aim at the consumer and small business lending markets that have been banking industry staples for decades.

I wrote about the larcenous designs that nonbank competitors like Apple, Google, Walmart (through a joint venture with American Express) and Amazon have on the payments system in the Fourth Quarter 2014 issue of Bank Director magazine. But that is only half of the story. The payment system is important to banks because it ties the customer at least nominally to the traditional banking system, and is still a source of revenue (albeit a declining source) for most banks. And yet the threat that an emerging array of fintech companies like the Lending Club and Kabbage pose to traditional bank lenders could end up being just as serious because lending is still the activity whereby most banks make most of their money.

Halle Benett, a managing director and head of diversified financials investment banking at Keefe, Bruyette & Woods Inc., did an excellent job at Bank Director’s recent Chair/CEO Peer Exchange event of describing how the market for fintech lenders has exploded in recent years. These companies generally have a significant pricing advantage over traditional lenders because their Internet-only distribution strategy allows them to operate at much lower costs, and also because like many private-equity funded startups in the technology space they are more concerned about revenue growth than profitability at this stage of their development.

Will the likes of the Lending Club and Kabbage put traditional banks out of business? I don’t think so, any more than Facebook or Apple is likely to with their personal payments initiatives. But traditional banks do face the risk of continued market share loss in the near term as fintech companies swoop in and pick off some of their best customers. I live in what might be best described as a rural suburb near the Blue Ridge Mountains in Virginia, and there is a breeding pair of Cooper’s Hawks that live in the neighborhood. Unlike the falcon at the top of this post, which dives upon its prey from great height at terrific speed, a Cooper’s Hawk hunts its prey (mostly other birds) by hiding amongst the trees and strikes quickly and stealthily. I know they have been hunting in my yard when I find a pile of feathers (and nothing else) on the ground. Regardless of how they hunt, all raptors have the same endgame in mind. And when fintech companies snatch a potential bank customer, they don’t even leave the feathers behind.

I think the emergence of these new fintech companies has greater significance than just their potential to steal market share from traditional banks. I see them as harbingers of things to come. For a growing number of borrowers, they are redefining the meaning of customer service. We have seen this trend play out in other aspects of retail financial services for decades now (think ATM, online and mobile distribution) and more recently in small business banking (think mobile-enabled remote deposit capture), where the definition of “good service” is a well-priced product delivered through efficient and reliable technology rather than a smiling face on the opposite side of the counter, or kiosk.

Traditional banks, and particularly community banks that have placed most of their chips on the small business customer, tend to think of face-to-face customer service as their killer app because people still want the opportunity to bank with other people, or so the argument goes. But the world is full of examples where technology-enabled user interfaces have gained traction even when a “people interface” is available (think self-checkout machines at the supermarket). Applying for a $50,000 small business loan should be more arduous than, say, buying a book on Amazon, but the growth of the fintech lenders suggests that many potential bank customers see the two processes (buying a business loan from Kabbage versus a book from Amazon) as roughly equivalent.

It seems to me that the trend towards greater acceptance of (and perhaps even a preference for) technology as the centerpiece of the customer service relationship will only continue, particularly as millennials – the first generation that we can truly say are cradle technologists – become a greater force in the U.S. economy. Face-to-face customer service will still have its place in the world of banking, but traditional banks had better wake up and realize just how fast technology is reshaping their industry.

Raptors are pitiless predators. I suspect that many fintech companies are, too.

Ciao.

Desert Sunrise

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The financial crisis occurred six years ago and yet we often talk about it as if it was just yesterday, which I think is an indication of just how profound that experience was for the banking industry. Of course, the legacy of the crisis lives on in the corpus of the Dodd-Frank Act and its progeny, including the Consumer Financial Protection Bureau; in the higher capital requirements that all banks must meet today under both Dodd-Frank and the Basel III agreement; and a much tougher supervisory environment. The crisis is long past, but the industry has been changed because it, perhaps permanently.

And yet the environment today is also different, and better, than it was a few years ago. That point was very apparent to me at Bank Director’s Acquire or Be Acquired Conference, which took place this week in Scottsdale, Arizona. Compared to, say, even three years ago I could feel a marked sense of optimism among the 800 or so attendees that life had returned to something that was at least predictable. I wouldn’t say back to normal because (forgive me for using an overworked phrase) there is now a new normal and it includes all of the aforementioned changes. The environment might not be all that most bankers would like it to be, but at least it has achieved a level of stability so they know what to expect. The industry’s margin pressure is still quite significant, and that has had a significant impact on revenue growth and profitability, but the U.S. economy continues on an upward slope even if it’s not quite as linear as everyone would like, so the business climate should keep getting better.  And while the industry’s regulatory burden has greatly increased as a result of Dodd-Frank and other regulatory initiatives, for the most part we now know what those changes are.

Knowing is always better than not knowing, even if what you do know doesn’t make you entirely happy. And most bankers have a pretty good sense of what to expect over the next couple of years.

I believe that an important outcome of this renewed sense of optimism will be a more vigorous merger and acquisition market in 2015. Not that last year was bad: There were 288 healthy bank acquisitions in 2014, according to SNL Financial, compared to 224 deals in 2013. But I think the combination of continued economic growth, generally favorable asset quality, a more positive regulatory view of acquisitions (as I explained in my January 27 post in this Spot) and continued margin pressure (which unfortunately does not look like it will change any time soon) will all be catalysts for a lot of M&A activity this year. Acquiring another bank is probably the best growth strategy that most institutions have today, and a stable environment gives them the confidence to take that risk.

If I came away from the Arizona desert with one lasting impression, it was that things that weren’t possible a few years ago are possible today. I love sunrises because I am a morning person, and one of the things I like about the morning is the feeling that anything is possible.

Maybe this is banking’s desert sunrise.

Ciao.

How Regulators Have Changed the Bank M&A Market

A lot of the talk at the 2015 Acquire or Be Acquired conference has been about the strong impact that the federal bank regulatory agencies continue to have on the mergers and acquisitions market. The regulators became a lot tougher pretty much across the board after the financial crisis, which probably isn’t surprising under the circumstances since lax supervision was often cited as one of the causes of the crisis in the first place. In an interview I did recently for Bank Director magazine, Camden Fine, president of the Independent Community Bankers of America, told me that safety and soundness examinations in most areas of the country have become a little less strenuous for banks, which makes sense since the industry has now largely recovered.

The regulators are also approving acquisitions at a faster pace than they had been a few years ago, but they are still taking an approach that has no precedent in my 30-plus years of experience covering the banking and financial services industry. Only clean banks with an excellent regulatory compliance record can reasonable expect that their merger application with whatever federal banking agency serves as their prudential supervisor will be approved without any complications. The regulators are paying especially close attention to any deficiencies in an institution’s Bank Secrecy Act compliance program, but it’s safe to assume that any major regulatory violation will require remediation before the bank involved will be allowed to do an acquisition. This applies to sellers as well as buyers, since a seller with a significant problem might find that the agencies won’t allow any potential acquirers to bid for them. As one speaker put it today, they don’t want the problem bank poisoning the healthy bank.

But even clean banks need to take the extra step of communicating their M&A intentions to their primary regulator and maintaining a steady dialogue about their plans. This includes any new markets and potential merger partners the bank has identified, as well as any changes to the bank’s business plan from a possible acquisition. If it’s a transformational deal that would significantly increase the bank’s size or take it into new business lines, the regulators will want to make sure that the current management team is capable of handling those challenges.

There was a time when banks were reluctant to communicate their acquisition plans to their regulators because they didn’t consider them trustworthy enough not to leek the news to the outside world. But it’s now a fact of life that the regulators expect full disclosure of a bank’s M&A plans, and there’s really no other choice but to bring them inside the tent.

Ciao from the desert.