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Where Have All the De Novos Gone?

Barriers to entry, reasons to overcome them, and why it's important for the industry

In 2005, the FDIC reviewed 299 applications to start new banks (237 were approved). From 2009 to 2016, they approved just five. Meanwhile, the U.S. economy in general has recovered from the financial crisis of 2008 and subsequent recession, with employment levels back to their 2005 numbers and housing markets back to booming. So, where have all the de novos gone? "It's a combination of factors," said Attorney James Sheriff, partner at Reinhart Boerner Van Deuren, s.c. "It's not a simple, easy answer." The credit crisis alone did not cause the current dearth in de novos, but its lingering effects have created several barriers to entry that discourage the formation of new banks. "This didn't go from a lot to a few; it went from a whole bunch to nearly none. That's very telling," said Andy Guzikowski, Attorney and Shareholder at von Briesen & Roper, s.c. "It's all related to barriers to entry, both real and perceived."

Barriers to Entry

Compliance | One obvious headwind to starting up a bank is the current regulatory environment, which is far more onerous than it was a decade ago. "Practically speaking, the regulatory environment is much more complex with regard to de novo banks," said Tim Kosiek, CPA, partner at Baker Tilly Virchow Krause, LLP. "There's still overlay from the credit crisis and recession." Unfortunately for de novos—which are almost always small community banks, at least at first—community banks shoulder a disproportionate regulatory load in today's industry, and the costs of that add up quickly. "Community banks in particular need to spend more time and money on compliance than they ever have before," Sheriff explained. There have been recent indications, however, that the federal regulatory agencies are willing to compromise in order to foster new banks. "The regulators are always collaborative, very willing to meet and spend time and provide resources to answer questions," said Pete Wilder, attorney and shareholder at Godfrey & Kahn, S.C. He pointed out that the FDIC has been holding meetings on how to encourage de novo activity and has updated its manuals for applications. 

Capital | Another commonly cited barrier to entry is today's higher capital requirements. "The capital requirements today are significantly greater than they were 20 years ago," said Mark Koehl, partner at Wipfli LLP. "That's certainly a big hurdle." In the de novo heydays of the late 1980s and early 1990s, a group of investors could start a bank for $6M. Today, most estimates hover around $15-$20M. However, that number can vary depending on the new bank's specific circumstances. "There is a lot of misinformation out there related to capital," Wilder explained. "The regulators don't take a one-size-fits-all approach." He says DFI and FDIC both determine capital requirements based on the new bank's intended market, products and services, and growth strategy.

ROI | The general decline in bank profitability since the crisis is another barrier to entry for potential new banks; it means lower returns for investors. "The returns available in the banking business are measurably reduced compared to what they were prior to the credit crisis," said Kosiek. "We're in a measurably different landscape when it comes to economic reward for entering the industry." He also pointed out that the amount of time it takes for a de novo to reach "critical mass" and begin generating returns for its investors is much longer today than it used to be—7-10 years instead of 5-7. The current prolonged low interest rate environment compounds this problem, lengthening the time it takes for a nascent bank to become profitable. "Investors hope a bank will become profitable within two years, and with the interest rate environment we're in it's difficult for investors to see banks making money," Sheriff explained. This less-than-appealing timeline plus the current regulatory environment makes purchasing a bank much more attractive to investors than starting one from scratch. "It's much easier for a group of people who want to start a bank to buy a bank than to form a new one," said Sheriff. "It's faster, and the process of getting approval is far less complicated. You also don't have to go find talent, in many cases."

Talent | The cost of talent is another factor that gives potential de novos pause. "There's still a bit of malaise from the crisis, where the entrepreneurial spirit has been dampened," said Wilder. That lack of leadership combined with the higher prices commanded by experienced compliance and lending professionals makes building a staff difficult. "There's a notably lower supply of high-quality bank talent on the marketplace in comparison to what you had 10-20 years ago," said Kosiek. "There are just fewer people out there who think banking is the right place for their career."

Competition | Finally, the competitive environment in the financial services industry is wider and more complex than it used to be, for a variety of factors. First, small businesses no longer feel underserved when local banks merge with larger institutions, according to Koehl. "Many larger institutions have done a good job serving communities, and fintech companies are also helping to fill in the gaps," he explained. "In addition, millennial business owners don't necessarily want the same level of relationship development." The more relaxed regulatory environment and exciting startup culture makes investing in fintech companies more attractive to most investors than a de novo community bank. "There are other options within the banking industry and within the financial services industry that are more appealing to the investor and a better answer for customers and business owners," said Kosiek.

Impact on the Industry

Wisconsin is fortunate to have a diverse, thriving financial services industry, so the Badger State hasn't been as heavily affected by the national lack of de novo activity as states with fewer banks. However, underserved markets are typically where de novo activity happens, so they are the first to feel the impact when it doesn't. "Most important is the availability of credit to rural areas," Guzikowski explained. "Larger banks can achieve that true community contact, character-based lending if they have the right people, but that's specifically what de novos and community banks are designed to do." In rural states like Wisconsin, merger activity without de novo activity often results in fewer financing options for businesses and consumers outside of metropolitan areas. "If the current trend continues without the ability to encourage de novos in the future, we're at risk of having a good chunk of our state where the local economy suffers because of a lack of community bank presence," said Koehl. 

The lack of new banks also impacts M&A activity. "It deprives the industry of new opportunities for growth," Guzikowski said, explaining that many investors consider growing through acquisition and then selling a bank to be a good exit strategy. The lack of de novos means there are fewer acquisitions to be made, making that strategy more difficult. Instead, many investors see purchasing an existing bank as a better opportunity. "If you're interested in the banking industry from the investor standpoint, dropping your money into a de novo is not as appealing as investing in an existing franchise, enhancing it and getting ready for acquisition by a larger enterprise," said Kosiek. According to Koehl, another major factor is that acquired banks used to have younger management teams who wanted to stay in the industry and did so by starting their own bank. "Today, there's still a lot of M&A, but it's often with banks with older management teams who are looking for an exit strategy," he explained. 

Finally, startups—in any industry—are the most likely source of excitement and innovation. "Traditionally new banks have more innovative ideas," said Sheriff. "They're looking to make a statement." New entrants to the market can prevent other banks from stagnating. "For the industry overall, having a few new banks pop up here and there means there's more room for new ideas, new products, and more creativity and excitement in the industry," said Wilder. 

Looking Forward

While de novos have been rare over the past decade, there are signs the tide is turning. In the final quarter of 2016, the FDIC approved two new bank charters. In April 2016, FDIC Chairman Martin Gruenberg announced the reduction of the period of heightened scrutiny for newly chartered institutions from seven years to three, the same level it was before the financial crisis. Since then, FDIC has published a handbook for prospective de novo applicants and held outreach meetings on the topic. Other federal regulators are taking steps to reduce some of the friction in the de novo process, as well. "The OCC in particular has recognized that new banks are the lifeblood of a robust banking industry," said Guzikowski. Acting Comptroller of the Currency Keith Noreika has gone so far as to suggest the OCC be granted authority to approve de novo applications. Considering these ongoing efforts, Guzikowski suggests the next step is test cases. "With the easing of the interest rate environment, what the regulators need now are more applications so they can start putting some of their initiatives into practice," he explained.

In combination with this (slightly) softening regulatory environment, Wisconsin's robust, steady economy could be fertile ground for new banks. "Our economy tends to be pretty stable compared to the big swings you see on the coasts, so it's a good environment for banking," said Wilder. Since 1990, Wisconsin has had 33 de novos and only three of them failed, while on average the new banks turned a profit within six quarters. The recently announced Foxconn development planned for the southeastern corner of the state also brightens prospects for potential new banks. "If all that comes to fruition, it could be an opportunity," said Koehl. "Community banks, whether they're in existence today or a de novo, they're always driven by how their local economy is doing. So, if you have a vibrant economy in a local market that doesn't have a community bank, that's an opportunity for a de novo."

Baker Tilly Virchow Krause, LLP and Wipfli LLP are WBA Silver Associate Members. 
Godfrey & Kahn, s.c. and von Briesen & Roper, s.c. are WBA Bronze Associate Members.

 

By, Amber Seitz

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Community Banks Leveraging Technology

Three Wisconsin institutions prove you don't need to be big to benefit from technology

The banking industry is undergoing a period of massive change in many areas (technology, compliance, competition, etc.), but one of the most significant has been in progress for over a decade. Over the past ten to fifteen years, banks have been gradually replacing in-person, customer-facing operations with technology—account opening and loan applications, for example. The concept of using technology to augment human relationships is relatively new to banking, but Wisconsin Banker interviewed three Wisconsin banks who have done so successfully, each in a unique way. 

Customer Convenience – Digital Channels
Waterloo-based Farmers & Merchants State Bank has offered online mortgage applications since May 2008 and added a mobile banking app five years ago, and they've seen results. "In the last five years we've gone from $95 million to $153 million in loans serviced for the secondary market, largely due to the online applications," said Executive Vice President & CFO William Hogan, CPA. After an initial lag in adoption rates, Chief Marketing Officer and Bank Manager Kim Abraham says marketing helped the online applications grow in popularity, but customers are also becoming more accustomed to doing things online. "Their comfort level with technology changed," she explained. Hogan notes that the product also markets itself through referrals, since customers who love the convenience of being able to start their application anytime often recommend it to others. 

Internally, the bank decided to implement the online mortgage application product (which includes HELOCs) as a tactic to build their secondary market servicing portfolio. However, it also enhanced the perception of the bank and their products and services in the community. "We recognized that this was a way for us to not only be seen as a small town community bank with big banks products and competitive rates, but also as viable option and player in the surrounding communities and Madison market," said Abraham. 

The bank's mobile app has also been impactful, partly due to steady increase in users of the mobile deposit feature. "We were one of the early adopters of mobile deposit capture," Hogan said (the bank launched the product in June 2013). "There's been a steady adoption of that." One of the reasons usage of the bank's app continues to grow is the periodic additions of new features, such as mobile bill pay. "We're constantly looking at the mobile app and adding to it," Hogan explained. He knew the bank needed to invest in mobile the day he walked around the office and saw everyone with a smartphone. "It's just the way to go," he said. The bank's goal with each of these tools was to make connecting with customers easier. "Customer convenience is one of the primary drivers behind our technology," said Abraham. 

Speedy Service – Compliance Concierge
Mayville Savings Bank was one of the first institutions to use FIPCO's Compliance Concierge loan origination and deposit account opening software suite when it launched in 2012, but they've been using software for lending for many years. "We are trying to follow technology as fast as it's moving," said Loan Processor LaRue Wills, who also sits on the FIPCO Users Committee. "Our small little community bank wants to be able to offer what larger regionals are offering their customers." Being fast adopters of software has increased speed-of-service for the bank's customers and internal efficiencies, as well as allowing the bank to offer mortgage products it previously could not. 

One of Wills' favorite features of Compliance Concierge is an upgrade the bank purchased: a credit reporting interface with Factual Data. "It makes it so nice to be able to take an application, do a credit report and have all the information fill in automatically," she said. The software also allows bank staff to offer faster service. "The time-saving for customers is excellent," Wills said. "Customers can walk into the bank and get taken care of in an hour." Leveraging the software to its full capacity has also helped the bank operate more efficiently, according to Wills. "If a customer wants to get a loan and switch their deposit account to us, it's much easier now for all of that to go into one system," she explained. "Banks that only have the deposit side or only the loan side don't know what they're missing."

The bank's decision to invest in technology like online banking and Compliance Concierge has also enabled it to offer fixed-rate mortgage loans, a product they previously were not able to offer their customers. "We are a small community bank with only one branch, we're as small as they come," said Wills. "Now we're able to offer our customers fixed-rate loans and that's due to the convenience of having Compliance Concierge be able to upload the required information for selling them on the secondary market directly to the bank we use. Before, we couldn't help a customer who would only do a fixed-rate loan. Now we can serve them."

Full-Service Machines – QwikBank ATMs
Two years ago, Superior Savings Bank decided to consolidate some of its branch locations to improve efficiencies—branch transactions had been steadily declining due to the popularity of the bank's electronic services. "Management and the board felt the need to replace two of the bank's high-cost branch offices with a solution that would provide customers with similar convenience," President Dawn Staples explained. Four months after closing a branch in the Walmart Supercenter on the west side of Superior, the bank installed its first QwikBank ATM just across the parking lot. Shortly after that, a second QwikBank ATM was installed on the east side of Superior. "The main goal was to mirror the services provided when the bank had three staffed locations in Superior," Staples said. "In addition to making cost-free ATM access available to its debit card customers, the bank wished to provide the ability for them to deposit cash and checks at locations in addition to the main office in the downtown."

The QwikBank ATMs have several features, including typical ATM functions like cash withdrawal and checking balances, but one of the most popular is a transaction previously only available in the teller line. "Our favorite feature of these full-service ATMs is the customers' ability to deposit cash and checks into their accounts with immediate availability," said Staples. "This essentially enables the bank's customers to cash a check at the ATM." To promote this new way for customers to interact with the bank, the main office tellers have undertaken a continuous customer education process, which Staples says has been successful. "The reaction of the bank's customers has been very positive," she said. "The key is getting the word out about the QwikBank locations and capabilities." 

Ultimately, the QwikBank ATMs are just one more tool in the bank's technology repertoire. "For a small bank, Superior Savings Bank has capably matched its larger competitors in providing electronic banking solutions," said Staples. "In addition to the full-service ATMs, we offer internet banking, bill pay, mobile banking and remote deposit capture." That comprehensive approach to technology has helped the bank set itself apart in the communities it serves. 

FIPCO is a wholly owned WBA subsidiary.

 

By, Amber Seitz

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Channel Surfing: Banks Adapt to Shifting Customer Preferences with Multiple Delivery Channels

When it comes to delivery channels, the quantity over quality strategy is ineffective, Gallup research shows. In studies and surveys conducted from 2013-2016, Gallup has found that some banks have focused on aggressively expanding the number of channels they offer their customers without first researching how to choose the channels that best fit their customers and their overall strategic goals. Channel satisfaction is the key to increasing engagement and deepening the bank's relationship with its customers, and the key to channel satisfaction is identifying how and where your customers want to interact with you. 

The list of channel options for product delivery and marketing seems endless—but rather than having 500 channels and nothing good on, a strategic channel approach can effectively engage your audience. When the focus shifts from individual channels to the overall customer experience, it can be easier to identify where to focus. In general, channels can be classified as either traditional or digital and used for product delivery or marketing. Wisconsin Banker interviewed four experts to highlight current popular channels for banks to consider. 

Branches
"Branches are not dead, they're just changing from transaction centers to sales centers," said Mark Arnold, president of On the Mark Strategies. The bank branch is still a key channel because customers still want to know their banker and value the experience they have with the bank—regardless of whether that experience is online or in person, according to Sara Baker, vice president, Ladysmith Federal Savings & Loan. "Customers still demand that high-touch personal service from their community bank," said Baker. "Balancing the digital versus human touch relationships with our customers is key to the future of community banking."

Interactive Teller Machines
"Interactive teller—or video teller—machines are something every bank should study," said Jay Coakley, president of Coakley Strategic Solutions, LLC. "You can reduce delivery cost and provide great customer service, especially in a small community, by utilizing employees in one location to service customers in another location. It's great technology." These machines can help banks maintain strong service relationships even in locations where a full-scale branch is inefficient or prohibitively expensive to operate. 

Core Processors
Banks should consider the delivery channels offered through their core vendor, according to Jim Pannos, president and principal of the Pannos Marketing Agency. "Many of our clients are getting involved with their core processors to get their most recent release because there are so many more capabilities within the newer core processing platforms," he explained. 

Email 
"Don't forget the power of email," said Arnold. "Email is still a great channel to use to deliver products and services. Think about how scalable they are and how they look on mobile." For example, with the growing number of emails viewed on mobile phones, the format needs to be designed to allow readers to scroll through content easily.

Content marketing
In all digital marketing, but email especially, good content is a critical component. "Consumers today really want content and not sales pitches," said Arnold. "It's what you're saying as opposed to how you're saying it." Banks can position themselves as expert advisors by offering useful information to their customers through blogs, their website and emailed newsletters. However, Arnold cautions against too much verbosity: "People are consuming more information than they ever have before, but in smaller bites. Information you send out needs to be digestible," he said. 

Online
Technology that allows customers to access answers when the bank's doors aren't open will become increasingly important, according to Pannos. "Your bank doesn't have to be open 24 hours, but people are focused on accessing at their leisure versus when the bank is open," he said. The convenience of online banking appeals to many customers who previously performed transactions in the branch. "Consumers are not increasing the number of transactions each month," Coakley said of the growth in online and mobile transactions. "They're just interacting with the bank in a way that's more convenient for them."

Mobile
"Mobile has the strongest trend line," said Coakley. "From the studies we've done, mobile banking's trend line is going up at a steep increase while online, in-branch and phone systems are declining." However, it is important that the bank dedicate enough resources to their mobile app to make it both functional and intuitive or many customers will not adopt it as a preferred channel. "Customers expect a bank's mobile app to be vibrant, easy-to-use, and fast," Pannos explained. 

P2P Payments
Person-to-person payment applications like Vimeo are becoming the preferred tool for younger consumers, which makes these types of delivery channels a potential market for banks that choose to target younger customers. "Usage of [these apps] isn't going to shrink," said Pannos. "Banks should be aware of that as they're looking at their technology and how they're going to serve the millennial generation and Gen Z. They're looking to those types of platforms as currency."

Remote Deposit Capture
This service allows customers to deposit checks via their mobile phones by simply snapping a picture of it, and while it's becoming very popular, banks should be cautious. "It's a great service, but it can be costly, especially for smaller banks," said Pannos. Due to the diminishing number of checks being written across the industry, he advises banks to assess the overall market demand and competition for the product, as well as examine their own customer base demographics to ensure the product will assist in the bank's overall customer satisfaction and retention. 

Before Diving In…

So which channel(s) should your bank invest in? There are four main areas to consider when investigating a channel strategy upgrade: your customer base, cost, marketing and training. "It's important for banks to understand their market and their customer base," said Baker, pointing out that customer demands for a bank in metropolitan Milwaukee will be very different from those at a bank in rural northern Wisconsin. "Just because the bank down the street offers a certain product doesn't mean your bank needs to offer that same product. Ask your customers what they want before diving in." Coakley recommends defining not only what the bank's current customers want for delivery channels, but also the preferences of the bank's targeted future customers. "It's about what your current customers want and what your future customers want, and those can be two vastly different answers," he said.

While upgrading or purchasing new delivery channels can be costly, banks need to consider their options from all angles. For example, purchasing new video tellers may reduce branch overhead expenses enough to offset the initial cost. "Investing in new technology and solutions can overall reduce the cost of operations, so this is important to look at too," said Baker. Intentionally migrating your customers to digital channels can also lead to staffing changes. "Long-term reduction in FTEs pays for the new technology," Coakley explained.

Additionally, the bank must plan to market any new channels in order to optimize usage rates. "You may have great products and technology, but if you don't communicate that to your customers and your community, they won't adopt it," said Coakley. A review of the bank's current marketing channel strategies is also essential. "The very first thing every bank needs to do is conduct a marketing audit," said Arnold. "You need to look at each of your channels and how successful they are, then come back with strategic and tactical recommendations for changes." Finally, as with any major operational or product changes, the bank must offer training to its staff. "Banks need to invest in their staff, training them on ways to provide quality customer experiences at all touchpoints," Baker advised. 

Whether your bank has three delivery channels or 30, it's important that your customer experience is consistent across them. "Rather than thinking about just one channel, think about the experience," Arnold advised. So, when a customer visits a branch they experience the same level of service and style of messaging as when they visit your mobile app or website. "That's the challenge that banks face today," said Pannos. "You have to be old-fashioned in some aspects and cutting-edge in others." Because consumer preferences are so capricious, it's essential for banks to constantly reevaluate their channel strategy and adapt to what they learn. "Customers will continue to crave whatever technology is available which offers them convenience and a personal experience," said Baker. "As the technology evolves, banks too need to evolve."

By, Amber Seitz

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Bank Boards: Yesterday, Today and Tomorrow

The banking industry is undergoing a prolonged period of tremendous change. In fact, many experts say that constant change is the new normal. As the guiding hand and governing body, bank boards must also adapt and adjust their focus in order to lead their institutions to success in today's volatile environment, all without losing sight of their primary responsibilities. Read on for a look at how directors and boards have changed in recent years, and for perspective on what your bank's board may need to transform into in the near future. 

Who's Sitting Around the Table?

Twenty or 30 years ago, the banking industry was much more straightforward than it is today, and was reasonably stable as well. That placed fewer demands on directors, in general. "As long as the board members were representative of the bank's market and were helpful in generating new business and making lending decisions they contributed to the success of the bank," said Cass Bettinger, president, Cass Bettinger and Associates. Often chosen for their community status or ongoing business with the bank, directors on historical bank boards often mirrored the bank's product mix, which facilitated their role as brand ambassadors, according to Julia Johnson, senior manager, Wipfli LLP. "However, those historical boards may not have had a thorough understanding of banking, and how banks serve as an intermediary of cash," she explained. "They put a lot of faith, confidence and trust in senior management to prudently manage the bank and ensure regulatory compliance." 

Walk into a bank boardroom in 1985 and you'd find a collection of businessmen, lawyers, accountants and community leaders, individuals with backgrounds in either business or finance. New directors were often selected based on their commercial relationship with the bank, their connections to the local business community, or because they (or their family) owned a large share of the bank's stock. According to Philip K. Smith, president, Gerrish McCreary Smith Consultants and Attorneys, the director role used to be viewed as a passive one with little impact on the overall success of the institution. "Historically the makeup of the board of a successful bank was identical to the makeup of the boards of unsuccessful banks," he said. "The focus of those kinds of boards was loan approval, dividend payments and general oversight." 

Walk into that same boardroom today, and you'll still find a collection of businessmen, lawyers, accountants and community leaders, but they may look very different. As with historical boards, today's directors are individuals with business acumen, and may also be representatives of large shareholders. "A good business background is helpful, and those people often end up leading discussions and have significant input," said John Knight, partner, Boardman & Clark llp. However, today's economic and regulatory environment has forced a move toward selecting directors to fill in gaps in expertise on the board, rather than business community or shareholder representation. "That has promoted much more diversity in the board in terms of gender, race, age and ethnicity," explained Smith. "Those go out the window when the question is 'what does the bank need?' rather than 'who should sit on the board?'." According to Knight, the composition of bank boards is transitioning slowly, especially at community banks. "It's quite different between community banks and regional or national banks," he said. "If I see a change, it's modest and gradual. This is not abrupt." Still, Johnson says not only is increased diversity necessary to bring in expertise, but it will also have an overall positive impact on the institution. "When you look at what needs to shift in terms of the composition of the board, we need to have more diversity on the board," she said. "While backgrounds may remain consistent, the diversity of individual experiences and perspectives contribute to the strength of the board by creating a rich and robust platform for discussion. Specifically, there will be greater representation of women and individuals of different ages on the board." 

Same Board, Shifted Focus

While the individuals sitting around the table and their backgrounds are not much different, the expectations placed on them and their approach to their role has shifted dramatically. "Traditionally, the board has looked to the CEO to be the primary strategist for the organization and that their role was simply to look at the strategic plan and approve it," Bettinger explained. "The biggest single change in responsibilities for board directors is that they now must be responsible for being actively engaged in the strategic planning process and understanding what it means." According to Knight, the law regarding directors' responsibilities has not changed appreciably, but the application of it has broadened as expectations from regulators rise. "In general terms, their fiduciary duties haven't really changed," he said. "But the regulators in particular expect more of directors." Those expectations mean directors can no longer be passive sources of commercial loan contacts. "In the past, directors could serve in a more passive capacity," Johnson said. "Today, the regulatory environment doesn't allow for that." 

Just as regulatory expectations for bank directors have transformed their role, so have market and economic influences. "Banks now have to be constantly reassessing their business model and changing it," said Bettinger. "The bank needs directors who have certain skillsets that will help the bank succeed in a changing marketplace." The ideal combination of skillsets will vary by institution, depending on the bank's strategic goals. "The board needs to know who the bank is and who they want to be in the future," Smith explained. "You identify new members by understanding the kind of bank you're trying to become and then reaching out to those people." For example, if the strategic plan forecasts growth through M&A activity, the board should have at least a couple directors with experience in that arena. That's why Johnson advocates not filling the board to capacity at all times. "I like to see banks that don't keep their board at full capacity, but leave a couple seats vacant as permitted by the bank's bylaws," she said. "This gives the bank flexibility to bring in new board members who have a particular expertise and/or enables the bank to create an overlap between a new director and an experienced director who may be stepping off the board." That provides the board with crucial responsiveness if a critical unmet need is identified.

With this shift away from more ceremonial boards to knowledge-based, strategic, active boards, the recruitment and training of board members is transforming as well. "It's a requirement that the board not micromanage but be much more active than historical boards," said Smith. "That changes the dynamic, even as you're recruiting people." Smith says the board must also take an active role in its own succession planning. "Directors must help recruit new board members," he said. "The board should consider itself a body independent of management and therefore participate in recruitment." The process for identifying potential successors should be familiar to the board, because it's the same one they use within the bank. "Look at the strategic plan and then do a board composition analysis, on the basis of knowledge, skills and abilities, and identify where you have gaps," said Johnson. "It's the same thing you do at the bank level. The key is to be intentional and proactive." Active recruitment also requires directors to understand and articulate why serving on the board is valuable. "In today's world, if you want somebody who's really good to come on your board, you need to have a winning value proposition for them," Bettinger explained. "You want them to feel that going on your board will be a great thing for them to do for the community and their business." 

Training: Not Just for New Directors
Offering regular education and training opportunities is one of the best ways bank executives can equip their directors (and therefore their bank) for success. After all, most directors will not have built-in understanding of the banking industry, and that is an important component of their fiduciary duty. Board education and training is a highly diverse process that varies greatly from board to board. The key is that it should not be a one-and-done onboarding session. "All board members of all banks ought to have some type of minimum requirement for continuing education every year," Smith advised. Bettinger recommends specifying the education and development each individual director needs and incorporating it into a written plan. This not only provides specific training for each board member, it's more efficient, too. "You don't want to spend money to send your entire board off to training that only a quarter of them need," Bettinger explained. "It's much more cost-effective to be individualized in your director education by identifying what specific education that each director needs that's most important." Another approach, specific to the onboarding process, is to provide one-to-one guidance. "You might even assign a mentor for a period of time," Johnson suggested. "Partner a new director with a seasoned director who can respond to questions."

Looking Forward

So, what will you see walking into a bank boardroom in 2030? "I'm already seeing more independent directors with specific expertise and experience that are relevant to the development and execution of strategy," said Bettinger. "A prime example is the crucial role that digital technologies increasingly play in developing, promoting and reinforcing winning customer value propositions; measuring and managing relationship profitability and loyalty; efficiency enhancement; and more effectively managing all categories of risk." With signs indicating that mergers and acquisitions will continue to rise, Johnson predicts the resulting larger banks will have boards focused on those unique challenges. "On the one hand, I think bank boards will need to be more savvy and more skilled in merger and acquisition activity," she said. "On the other side, as the asset size of the banks grows and regulatory pressures increase, they'll need to be increasingly more sophisticated in terms of the banking industry and the applicability of those regulations to their financial institution in order to mitigate risk and liability, to ensure safety and soundness." Increased regulatory pressure will be met with increasing pressure from technological changes, as well. "It's my opinion that it will result in more board turnover because directors will need to constantly stay on top of new threats that didn't exist before," Smith said. "The industry is changing so rapidly it will require a more engaged, nimble board with a much younger average age that is able to monitor technology." Just as we've seen over the past two decades, as the industry becomes more complex, the board will shoulder more responsibility to be informed. "The complexity of banking is much greater now than it's ever been," said Knight. "That requires more well-informed, better educated directors, just to deal with the complexity of it.

By, Amber Seitz

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Building a Better Budget

Accurate forecasts and transparency are keys to achieving bank financial goals

With 2017 just around the corner, many banks are deep into their annual budgeting process. However, projecting loan growth and interest rates is not as simple as it used to be, operational costs continue to rise, and interest margins continue to shrink… along with the budget's margin for error. "The cost of operations has continued to increase, and margins are shrinking. The challenge is how to manage and balance those out," said Scot Thompson, president/CEO of Denmark State Bank. Thompson participated in a recent national event hosted by the Conference of State Bank Supervisors and the Federal Reserve, and he says the message on interest rates was clear. "They said this is the new normal," he said. "The question is: what are we going to do today to make sure we can survive tomorrow?"

Despite the variables that will change the budgeting process from bank to bank, the key to generating a successful, actionable budget is combining accurate forecasting and transparency. 

Forecasting

The exact process for forecasting and establishing budget goals often varies by bank asset size. Larger banks ($5-$10B) tend to have a planning and budgeting committee led by the CFO and consisting of the major department heads. At smaller institutions, the CEO or president will be much more involved in the budgeting process. "The key, no matter what your size, is to involve the people in the major categories you're looking at, both income and expense," said Kevin Schalk, partner – Financial Services Practice at Baker Tilly. "These budgets become the goals for those departments, so it's imperative to involve the heads of those departments so you have buy-in on their goals." 

After establishing the budget-creation team, the next step is for management to determine which process works best for their institution. According to Marc Gall, vice president at BOK Financial Institution Advisors, there are two general methods used to generate a bank budget. "One takes the approach of using the strategic plan as a starting point to build the budget and the other is to start fresh with each budget," he said. "So, you can either start with broad numbers and work through it top-down, or you can start with all the pieces and figure out how to put them together." The primary risk with the top-down approach is the potential difficulty in getting buy-in from the staff responsible for achieving the goals set down in the budget if they were not involved in creating those goals. 

Another important step in accurate forecasting is to incorporate trend analysis in order to ensure accurate, achievable budget goals. "There are many times the bank will start with identifying the desire to grow the bank by X percent, but those goals might be too aggressive relative to what they've been able to accomplish historically," Gall explained. He recommends spending more time on the areas where, historically, the bank has the largest variance from previous projections, including interest rates. In addition to creating achievable goals, accurate forecasting also helps with risk management. "The ability to forecast is a guide to mitigate any significant unforeseen issues," Schalk explained. 

Transparency

The second key to building a successful budget is executing it throughout the year, a task which requires buy-in from everyone in the bank. "Everyone needs to have an awareness of looking for efficiencies and looking out for the best interests of the bank," Thompson explained. Frequent, transparent communication of the goals laid out in the budget is the best way to encourage that united effort. "You have to communicate those goals and get buy-in from everyone who is affected," said Schalk. "You need to be transparent and give updates on a quarterly or even monthly basis." That transparency also extends to how compensation and bonuses are tied to achieving budgetary goals. For instance, Gall noted that sometimes a bank may have two mutually exclusive goals – such as ROA and asset growth – so identifying the priority of each goal is critical. "Make sure the compensation structure and bonus goals are truly tied to the results the bank wants to get," he cautioned.

Transparency with staff at every level of the institution is also important, particularly when it comes to the importance of reducing non-interest expenses. "Invite the line staff to come up with ways to do something more efficiently and reduce cost," Gall advised. "Those small changes can have a large impact when taken in aggregate." As with transparency around compensation, all staff need to understand the specific goals of the institution to avoid concentrating on competing initiatives. For example, Schalk cautions against letting intense focus on income generation or expense reduction misdirect the bank. "You don't want to encourage a mix of products that is not in line with what the bank wants on the balance sheet," he said. "On the expense side, reduce repetitive processes versus reducing a person so you don't lose expertise." 

Once management has crafted a well-forecasted budget and communicated its goals throughout the institution, the final key to achieving those goals is frequent recalibration. "Variance to budget reporting is important," said Gall. "Look at those lines early in the year, because if you end up being way off budget early, it'll only get worse as time goes on without it being addressed." Thompson says that's why they reforecast every month. "There are variables that come up that will positively or negatively impact your year-end," he explained. "That's why we look at it on a monthly basis, so we can see where we're heading and take corrective actions throughout the year to have a better result." No matter how carefully planned and well-articulated, the bank's budget should never be so rigid it doesn't allow for adjustments. "In the past, budgets were more of a guide than set in stone, and that's even truer today with all the uncertainty," Schalk explained. 

Ultimately, the budget is a tool for management to use in achieving the bank's longer-term strategic goals. "The budget is a one-year focus that is a component of the strategic plan, which is usually a multi-year vision," said Gall. "However, just like strategic planning, it is important to be flexible. There may be many paths to achieve a single goal." Thompson urged bankers to keep in mind the goal of a budget: to make the organization stronger and better, even if that means making substantive changes. "Bankers like myself really need to look at why we would wait for another bank to buy us to do something that makes long-term sense for the bank," he said. "Is it something we could be doing ourselves right now?

A Bigger Piece of the Pie: Budgeting for Technology Expenses

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One of the biggest challenges banks face during the budgeting process is projecting technology costs. Current estimates from industry experts project 10 to 20 percent increases over what banks are currently spending, but there are a host of variables that can significantly impact that number. "It's a challenge to figure out what you're spending on all aspects of technology," said Gall, citing examples such as core conversions and adding new systems. "You need to make some very broad estimates if you're embarking on something new," he said. 

Part of the challenge with projecting technology costs is the variance between what customers see and what the bank needs to invest in on the back-end. Schalk explained that technology is divided into two components: customer-facing and behind-the-scenes. "The larger spend I see is the non-customer-facing pieces like cybersecurity and risk management," he said. "Some smaller institutions may be able to avoid the higher-end customer-facing pieces, but absolutely need the risk and cybersecurity platforms."

One way to bring costs down is to determine the right timing for your institution – not every bank needs to buy technology as soon as it is released into the market. "Technology is needed, but you have to balance it out," said Thompson, pointing out that new technology becomes less expensive as it works its way through the market. "The timing of when it's right for you as a bank will be different."

By, Amber Seitz

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Innovation and Identity: How to Embrace Change Without Changing Who You Are

Hint: It's not all about technology

Sometimes change is driven by a fundamental shift in the industry (think ATMs, internet banking, or today's pairing of cloud storage and mobile devices). Other times it is born from necessity, as banks fight to stay profitable in a persistent low-rate, high-regulation environment. The one certainty is change itself. The challenge for banks is to transform in a way that fits their identity rather than jump to extremes – so pump the brakes on buying that fintech startup. The best way to innovate without losing your identity is to foster a culture of innovation grounded in the bank's strategic goals, both with regard to internal processes and customer-facing technology.

Hone Internal Processes

Innovation, to have the greatest positive impact, must permeate the institution. That requires support from the top: the board of directors and CEO. "It starts with the CEO and the board including innovation discussions in their strategic planning," said David Peterson, CSO and Founder of i7Strategies. "Then, they can form a cross-functional group in the bank to work on specific innovative ideas." That cross-functional group should involve representatives from all areas of the bank. "Innovation, like serving customers, is really the job of all areas of the bank," explained Bob Giltner, Chairman, RCGILTNER Services, Inc. "Some banks establish committees or define a specific person to spearhead the effort as a way to build buy-in for the organization across functions." It's also a good strategy to look outside the bank for ideas. Jack Vonder Heide, president of Technology Briefing Centers, Inc. recommends designating a high-level bank employee as the primary researcher, and when they find an article about a bank in another state doing something innovative, to call that bank up. "They're happy to share that information as long as you're not a direct competitor," he pointed out. 

Whether an individual or a team is in charge of innovation at the institution, the first step is evaluating and updating the bank's processes. "Innovation should be directed to both customer-facing and internal operations," Peterson explained. This kind of procedural innovation involves identifying processes and procedures that occur simply because they've always occurred and streamlining them as much as possible. Giltner recommends constructing a process map for each of the bank's service processes for products and deliver channels. That typically involves placing the delivery of the product on one end of a whiteboard and the need for the product on the other end, and then filling in all of the execution steps in the middle. For example, on one side you have a customer using their checking account, and on the other a customer requesting information about the types of checking accounts the bank offers. "Innovation looks at the entire process and asks where improvements can happen," Giltner said. "Look for areas of greatest friction." Procedural innovation should be an enterprise-wide effort, too. "Banks should start encouraging innovation internally," Peterson advised. "Ask your employees to be innovative, no matter what their role is."

"Innovation does not have to use new technology," Giltner said. "Innovation can be accomplished simply by defining new processes or organizational structure." For example, before the mid-1980s, the idea of "giving away" checking accounts was anathema in banking. Later, free checking became one of the most popular methods banks use to begin relationships with new customers. "That was a huge delivery and customer service innovation that was not technologically driven at all," Giltner explained.

Team Up for Technology

When it comes to the more visible side of innovation (technology), banks have more of an upper hand in the market than many think. "If you step back for a minute and look at the data banks have, they know where and when people spend their money," said David Furnace, CEO of Haberfeld Associates. "That's an incredibly valuable data asset." That data, combined with the pre-established trusted relationship with customers, means banks are in a good position to partner with technology vendors. "The key thing banks need to see is that they have competitive advantages in fintech with a lower cost of funds and established customer relationships in comparison to non-banks," said Giltner. In other words, banks have already developed the client networks and compliance processes that lie beneath the technology and allow the industry to function.

On the other hand, fintech companies and technology vendors have the expertise and products to unlock bank data and leverage it to deepen customer relationships. "This will be an area where banks can partner with technology vendors in the future in order to leverage all of that data and make it actionable," said Furnace. If management determines that adding or updating technology to the bank's offerings is the right strategic direction to move in, partnering is a viable option. "What fintechs do is create 'shiny objects' for consumers, but because they themselves are not banks, they still have to work with banks in order to facilitate transactions," Peterson explained. "So banks can effectively compete by educating their customers on the types of services they offer, and then partnering to offer customers those shiny bits while still keeping their accounts with the bank." 

There are a wide range of benefits for banks that choose to partner with fintech companies rather than go it alone. "The rewards for community banks to focus on this and partner are very substantial," Vonder Heide explained. "You're making it possible for very small or new businesses to do business with your bank in a profitable way." Furnace says lending is also an area of opportunity for these partnerships. "Scale is difficult to achieve for some community banks, and deploying technology can allow for that scale." 

Of course, banks must weigh the risks with the rewards of all potential partnerships, particularly regulatory risk. "You have to put it together in a way that passes regulatory muster," Vonder Heide cautioned. "You also need to have a process for vetting your partners, especially considering most of them are very new." For most Wisconsin banks, however, the benefits of establishing a partnership with a fintech company outweigh the risks because of the sheer volume of resources required to initiate technological innovation solo. "Many community banks don't have the resources to go out and invent new technologies," said Furnace. "What they have is a trusted relationship with their customers." 

Take a Focused Approach

Those established customer relationships are the bedrock of community banking, and true innovation requires an approach focused on that identity. The first step in determining your bank's unique innovation ID is to define your appetite for change. "The first thing that the board of directors needs to do is decide what kind of a bank they want to be in terms of innovation," Vonder Heide advised. That means identifying where on the spectrum of innovation and implementation the bank should be. Do you want to be the first institution in town with every new product or feature? Do you want to be a fast follower, learning from other institutions' mistakes? Or do you want to hold off on change until your customers demand it? "Once you decide what type of bank you want to be, that will drive everything else," said Vonder Heide.

Next, management must determine which potential innovations to implement, because in today's banking environment no one has a lot of room to experiment. "It's tough for community banks in a time of zero interest rates, always increasing regulatory pressure and expenses," said Furnace. "It's important to choose wisely, but there are absolutely innovations that can make community banks more profitable." Winnowing down the list of possibilities should revolve around the bank's stakeholders. "Innovation should be focused on where it can make the biggest impact on the bank's stakeholders: customers, employees and shareholders," Giltner said. "Ideas should be prioritized based on the ratings of value for these stakeholders." 

To maximize value for shareholders, return on the investment must be part of the decision-making process when selecting ideas to implement. "It's trite but it's true: it has to be ROI," said Furnace. "The world of innovation is so broad, at the end of the day it has to contribute to your bottom line." To incorporate the customer perspective, Vonder Heide recommends forming an advisory group consisting of customers to help vet new ideas. "A lot of community banks make the mistake of introducing technology initiatives based on what they hear or observe from other banks," he said. "Your customer base is where you should go for technology initiatives."

Finally, don't assume cost when you're narrowing down your list of ideas to implement. Many impactful changes are also cost-effective. "The biggest fallacy right now is that innovation is a high-cost effort," said Peterson. "Particularly with branch transformation, innovation doesn't have to be expensive." It can be as simple as redecorating a branch office or removing a duplicative step from a back-office process. The most critical component of identity-centric innovation is to remember you probably won't get it 100 percent right on the first try. "You can't just decide you're going to innovate and suddenly be good at it," said Peterson. "In order to have perfected innovation in the coming years, you need to start now."

By, Amber Seitz

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Holiday Budgeting Tips

'Tis the season for holiday shopping. Black Friday is just around the corner, not to mention the gifts, family meals and decorations all put a strain on your wallet. Creating a holiday budget and sticking to it can help keep you on track. Here are some budgeting tips for the busiest shopping season of the year.

Make a List and Check it Twice
Creating an effective holiday budget means including everything you plan to spend. Budget for decorating, new outfits you plan to buy, food estimates, and travel costs alongside the gifts on your expense list. Be sure to include any money you plan to receive, too. Does grandma give you $50 every year like clockwork? Include that in your calculations. Will you be buying a joint gift and then receiving cash from the others going in on it? Include that, too. The best budgets encompass all of the spending and saving you do throughout the holidays, not just how much you spend on gifts. If you're not sure where to start, look up what you spent last year as a good jumping-off point.

Keep Track
The most important key to remember with your budget is to not forget about it after you create it. Keep track of all the purchases you make, especially ones made with cash, and adjust your budget if need be. It is a good idea to hold a weekly "reckoning" meeting, especially if you're not the only one making the purchases for the year. Sit down and check your real spending against your planned spending (the budget). If you've gone over in one area, these meetings give you the chance to adjust by lowering the amount set aside for another area to make up the difference. That way you'll keep your overall spending on track.

Save your Budget
After the holidays, don't throw away this year's holiday budget. Save it and use it as a model for next year's shopping. Make notes of where you deviated from the original budget, so that next year's is more accurate. You can also use the gift lists from year to year. If you know well in advance what items you want to buy, you can shop for them during the season when they're cheapest, rather than during the holidays.

Setting and sticking with a holiday budget will help you enter the New Year without any added financial stress, making the holidays that much more enjoyable

By, Amber Seitz

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