October/November 2016 Banking Exchange

Competitive intelligence for bankers

October/November 2016 bankingexchange.com

CORE SYSTEMS AT A CROSSROADS

Pressure points grow as banks need to do more and do it fast

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/Contents October/November 2016

16 Core systems at a crossroads Bankers grow increasingly restive about core-vendor relationships. Key players cite “gripes� and 5 ways to improve things.

By Lisa Valentine, senior contributing editor

22 Cover image: Shutterstock/Mark Agnor

Rethinking leadership Three critical factors will define effective leadership going forward

By Alan Kaplan, Kaplan Partners

October/November 2016

BANKING EXCHANGE

1

/ contents / 4 On the Web Fair-lending scrutiny for business lending; What a blockchain world would look like

8

6 Like it or Not Be careful what you pay for. Five takeaways from the Wells Fargo mess

Promises don’t equal experience; Why GDP could be wrong; “Bankers aren’t retailers,” and more on Wells Fargo

Chairman & President Arthur J. McGinnis, Jr.

12 Seven Questions Forget fintech, Chip Mahan and his Live Oak Bank may be the bigger threat

26 Risk Adjusted Multifamily loans are in regulators’ spotlight. How banks are dealing with it

28 Bank Tech One year in, observers see opportunities for EMV cards beyond fraud avoidance

Why you shouldn’t put off complying with BSA/AML customer due diligence rules

34 Idea Exchange Bank tries out hybrid equity crowdfunding

30

It may be time to share specialized talent Subscription Information: Banking Exchange Magazine (Print ISSN 2377-2913, Digital ISSN 2377-2921) is published February/March, April/May, June/ July, August/September, October/November, December/January by Simmons-Boardman Publishing Corp., 55 Broad Street, 26th Floor, New York, NY 10004 Pricing: Qualified individuals in the banking industry may request a free subscription (see below). Non-qualified subscription print or digital version: 1 year, financial institution $67; other business $93; foreign $508. 2 year, financial institution $114; other business $155; foreign $950. Single Copies: $35 each. Subscriptions must be paid for in U.S. funds.

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White papers and more from our partners

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Executive Editor & Digital Content Manager Steve Cocheo scocheo@sbpub.com

Director, National Sales Robert Vitriol bvitriol@sbpub.com

33 Industry Resources

2

Editor & Publisher William Streeter bstreeter@sbpub.com

Contributing Editors Ashley Bray, John Byrne, Nancy Castiglione, Dan Fisher, Jeff Gerrish, John Ginovsky, Lucy Griffin, Mike Moebs, Ed O’Leary, Melanie Scarborough, Lisa Valentine

30 Compliance Watch

36 Counterintuitive

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8 Threads

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Oct. 2016-Nov. 2016, Vol. 2, No. 5

Circulation Director Maureen Cooney mcooney@sbpub.com Marketing Manager Erica Hayes ehayes@sbpub.com Editorial Advisory Board Jo Ann Barefoot, Jo Ann Barefoot Group, LLC Ken Burgess, FirstCapital Bank of Texas, N.A. Steve Ellis, Wells Fargo & Co Mark Erhardt, Fifth Third Bank Joshua Guttau, TS Bank Jane Haskin, First Bethany Bank Trey Maust, Lewis & Clark Bank Earl McVicker, Central Bank and Trust Co. Chris Nichols, CenterState Bank of Florida, N.A. Dan O’Malley, Eastern Bank Dan Soto, Ally Bank McCall Wilson, Bank of Fayette County

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/ ON THE WEB / Popular stories on

bankingexchange.com

Fair lending scrutiny for business lending coming

What would a blockchain world look like?

3 things banks can learn from Pokémon Go

Bankers can expect to see some movement from CFPB on a fresh aspect of fair lending: credit for small businesses, women-owned businesses, and minority-owned businesses. Read more at tinyurl. com/businessfairlending

What if blockchains remake work, life, and play the way the compass changed seafaring, internal combustion engines changed transportation, or penicillin changed medicine? Two experts examine implications. Read more at tinyurl.com/block2020

You may not play Pokémon Go—but think how many of your customers may be playing it. Professor Pikachu—one of the game’s creatures, above—has lessons about the world of smart devices. Read more at tinyurl.com/BankPokemon

What other banks can learn from Wells Fargo Repercussions of the Wells Fargo sales scandal will be felt for months.

But once you get past the latest revelations, what can other banks do?

Our bloggers and other experts have been examining the case from many angles. Find them at www.bankingexchange.com/blogs On Twitter: #WellsFargoLessons

Subscribe to our free weekly newsletters, Tech Exchange and Editors Exchange at bankingexchange.com/newsletters

@BankingExchange

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October/November 2016

To suggest topics, new blog subjects, and other web ideas, contact Steve Cocheo, digital content manager, scocheo@sbpub.com, 212-620-7219

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to find out how your company can partner with Banking exchange, please contact: Director - NatioNal SaleS Robert D. Vitriol • bvitriol@sbpub.com • 212-620-7242 Month 2015

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/ like it or not /

What can we learn from this mess?

T

he wave of outrage over the Wells Fargo scandal may have spent itself as you read this, or it may continue for months. Nobody should be surprised at the public outcry nor, certainly, the political reaction. Considering that the story was broken by the Los Angeles Times in 2013, there’s more than a whiff of politics in the air regarding the timing of the settlement. And what an incredibly inviting target Wells is for the anti-bank crowd. Those folks haven’t wasted the opportunity, despite the fact that this is one bank and the scope of the misdeed is hardly in the same league as what happened in 2007-2008.

Don’t take that as defending what happened at Wells. The bank stumbled badly, whatever the ultimate cause. Over one million customers were affected by accounts created without their knowledge or permission. The problem was known about for years and attempts were made to correct it. But still it went on.

Fraud was committed, customer trust was breached, and it is a scandal.

The result is a venerable institution dragged through the mud, a black eye for banking (which doesn’t need another one), and a stigma now carried by the tens of thousands of Wells Fargo employees who do their jobs well and properly.

Last but not least, as sure as the sun rises and sets, this will lead to dozens of proposed new rules and regulations—some of which may eventually be enacted and added to the current crushing total.

So what can we learn from this? See if you agree with the following.

1. Integrity first. As a leader, be clear in your mind about whether you are going to run a business (or a department) based on integrity. Even if this is truly your intent, be on guard to the pressures to stray from that due to the demands to “do more.” Business is tough and demanding, and goals are part of it. But just as we’ve seen in big-time sports, you can do it the right way, or you can cheat.

2. Constantly check. Recognize that the same pressures apply to all members of an organization—to varying degrees, naturally, depending on their positions.

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October/November 2016

Never assume that people who work for you understand that you expect them to do the right thing. And never assume that even if they do understand it, they will always do it. Question and check frequently. Ask yourself: “Do I know what’s happening in the trenches? Is the chain of communication functioning and encouraged?”

3. Be careful what you pay for. When it comes to incentives, whatever you reward is what you will get. For some people, money will always trump best practices, rules, laws, and principles.

Dangle too much in front of them—or, conversely (as seems to have been the case in parts of Wells’ retail operation), set unrealistic goals and bully people into making them—and you w ill get unacceptable behavior.

4. Sell, but do it right. Cross selling is not a “worst practice.” There are countless examples, both in and out of banking, where customers benefit from buying something additional to what they originally wanted. They can say “no.” But of course, there is potential for abuse here if the mix of incentives and goals is not in balance and closely monitored, including listening to customer complaints. It’s not enough to simply say, “We only sell customers something they want.” Wells Fargo’s management missed the mark here.

5. Take responsibility. The culture within too many businesses today, large and small, does not encourage responsibility—rather, it fosters covering up and def lecting blame. This is a cancer that extends well beyond the business world.

At least within one’s own sphere, changing that should be the highest priority.

Doing the right thing may get you, or people working for you, fired (there have been reports of this happening at Wells), may prompt ridicule, or cost you a bonus.

It can take true courage. But consider the alternative. Turning a blind eye to wrongdoing or doing too little, too late eventually catches up with you, and the results will be far worse.

[Read what our bloggers have been saying about the Wells affair on BankingExchange.com and in Threads, p. 10.]

BILL STREETER, Editor & Publisher bstreeter@sbpub.com C

M

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/ THREADS

EXPERIENCE ON THEIR MINDS Banks up their focus on how they’re doing with customers

By Ashley Bray, contributing editor

T

here’s a saying: “People won’t remember what you said or did; they’ll remember how you made them feel.” And banks are taking it to heart.

“I would say, in the last three to four years, the focus on customer experience has increased dramatically,” says Lance Kessler, president of Lance Kessler & Associates, a marketing consulting and training firm in Mechanicsburg, Pa. Customer experience is far from a new concept; however, the increased attention is noticeable.

“There’s a higher bar now than there’s ever been,” says Kevin Tynan, senior vice-president for marketing at $835 million-assets Liberty Bank for Savings in Chicago. “Today, marketing requires us to not just engage, but to fulfill the needs of people and customers in more impactful ways than we’ve done before.

We’ve got to listen better and give more than lip service.”

The folks at Stone Mantel, a brand and innovation insights company, refer to this distinction as “Promise Making and Promise Keeping.”

“Some banks do really strong brand work and a nice job of shaping the promises they make to the market, but those are short-lived and suspect without an experience strategy that ensures those promises are kept,” points out Martie Woods, lead strategist, Thought Leadership, at Stone Mantel, in an email.

Kessler says that there are three considerations when building a customer experience: How do you create real value for the customer in that experience; how do you make sure that the value you’re creating differentiates you in the marketplace; and how do you consistently deliver the experience no matter what touch point customers use?

But just how can a bank be sure it’s providing a superior customer experience? Suggestions include examining customer retention and acquisition figures as well as getting customer input and feedback. Mining other data—like transaction times (to evaluate wait times) and the amount of time spent on website pages—can be helpful, too.

“It’s a matter of setting up benchmarks to identify points in the customer

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interaction that aren’t working or roadblocks in the customer’s journey,” says Liberty Banks’ Tynan.

Kessler breaks down the tactics for measuring customer experience into four key strategies: 1. Strategic improvement analysis.

“We start by identifying variables based on the customer’s feedback, and what the customer says is important and not important,” says Kessler.

These variables are then narrowed down to five or six and annually measured to see if the bank is meeting all the variables and which ones the bank still needs to work on.

2. Customer retention. Segmenting customers into categories—like existing customers, new customers, and high-priority customers (those with the greatest revenue-generation potential)—can help a bank identify which customers it is losing and why, and then allow the bank to develop action plans to get the retention rate back.

3. Mystery shopping. Designed to measure whether or not a desired experience is actually being delivered, an

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October/November 2016

anonymous person goes into the bank, poses as a customer or a prospective customer, and then rates his experience at the bank.

4. Net promoter score. Customers are asked how likely they are to recommend a product or business on a scale from zero to ten. Those who answer zero to six are categorized as detractors; seven to eight as passive; and nine to ten as promoters. The percent that answered nine to ten minus the percent that answered zero to six equals the net promoter score, which is a reflection of customer loyalty.

Both Liberty Bank for Savings and $24.6 billion-assets Commerce Bank in Kansas City, Mo., cite surveying their customers—whether in person, online, or over the phone—after recent transactions as an effective measure.

Commerce Bank also surveys customers about new products and solutions.

“Whenever we’re considering new solutions to offer to our customers, we go out and ask them: ‘Will this solution work for you? Is this the way you would like to be able to interact with the bank or solve a financial problem that you’re having?’” explains Cindi Tetrault, senior vice-president and director of omnichannel delivery. “Then we’re able to take that feedback and tweak our offering.”

A longer version of this article appears on bankingexchange.com at tinyurl.com/bankexperience

“We must not just engage customers, but fulfill their needs in more impactful ways.

We’ve got to listen better and give more than lip service” — Kevin Tynan, Liberty Bank for Savings

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October/November 2016

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/ THREADS /

Could the GDP Be Wrong?

An alternative indicator explains why By Ashley Bray, contributing editor

I

s the Great Recession really over?

Generally speaking, the start or end of a recession is defined by two consecutive quarters of GDP decline or growth. Economists also study other leading indicators, such as the stock market, as well as lagging indicators, like the unemployment rate. Going by GDP numbers, the last recession started in December 2007 and ended in June 2009.

Mike Moebs, economist and CEO of Moebs Services in Lake Forest, Ill., a company providing research, consulting, and training for banks and the government, is introducing a new indicator in 2017—Transaction Account Metrics (TAM). He believes these metrics show, from the consumer’s point of view, that the Great Recession never ended. “If consumption drives over 70% of the economy, then measuring the consumer’s checking account balance would measure the consumers’ activity,” he states.

TA M is built on average checking account balances in the Federal Reserves’ Flow of Funds Report, Z1, and the one million checking accounts Moebs tracks (it is not a statistical sampling). Although the accounts tracked a re consumer checking accounts, the data will include some embedded small business checking balances because some businesses represent themselves as consumers.

The information the company has tracked covers the early 1990s up until today, and Moebs believes it’s a good indicator of the state of the economy and consumer activity. “There are very few

$7,000

Average Consumer Checking Balance

$6,000 $5,000 $4,000 $3,000 $2,000

Avg. since early 1990s

$1,000 $-

2007 2008 2009 2010

2011

2012 2013

2014

2015 2016

Source: Federal Reserve & Moebs Services

consumers who are going to be dealing day-to-day with ordinary things in life that don’t have some type of transaction account,” he says.

From the TAM data, Moebs has found that the average checking account balance since the early 1990s is about $2,000. In good times, the balances are lower—for example, $700 in 2007, right before the recession hit.

“The consumer has enough confidence that they don’t have that much money in their checking account. We also find that in good times, there will be more errors, overdrafts, that are made,” says Moebs.

“There is greater activity, greater volume when the balance is low.”

However, in bad economic times, the balance rises, and it is currently at an alltime high of $6,535. With these higher balances, there is less activity. “Overall, I think what this is saying is we’re

still in a recession. The consumer isn’t back,” says Moebs, adding there won’t be a turnaround until there is a reduction in checking account balances, which likely won’t occur until the Fed raises interest rates and gets money stock back to normal levels. Once this happens, banks will begin to see money leave the accounts.

Now, $1.8 tr i l lion is in check ing accounts, with about one-third ($694.1 billion) contributed by consumers. Moebs says 40% of that money will remain stable, but 60% ($414.1 billion) will move from checking accounts to other deposits or be used to pay down debts, etc.

This movement is a ways off as the Fed has been slow to raise rates. This also means that to consumers, the recession will continue. “We’re going to have to see three or four quarters of reduction in these consumer DDA balances before we can truly say the recession is over,” says Moebs.

Takeaway from Wells Fargo: Bankers aren’t retailers

A

fter the government’s $185 million settlement with Wells Fargo on Sept. 8 for faking account openings to up sales, U.K. fintech expert Chris Skinner addressed it on his blog, The Finanser. Here’s an edited excerpt: In the 2000s, U.K. banks became hard-core retail banks. They hired people from big retailers like Asda, now part of Walmart, and told staff to get out there and sell. In the last decade,

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BANKING EXCHANGE

U.K. banks sold payment protection insurance. If you borrow from the bank and lose your job, PPI will cover loan repayments until you find work. Result: Millions got PPI without knowing what it was; some because staff ticked the box without telling them; others because staff filled in applications and signed for customers after they left the branch.

When the U.K. complaints authority saw a swarm of angry customers, it

October/November 2016

acted, stating that these activities were illegal and banks must pay back all premiums with interest if customers asked.

That was in 2011, and, so far, that decision has cost U.K. banks $50 billion.

Is this America’s PPI moment? I hope not. But remember, retail banking is not retailing. One lives with high risks whilst the other does not; mixing the two is dangerous. Read the blog at tinyurl. com/SkinnerWellsblog

catching the “Wells Problem” Paying close attention to complaints may help By Lucy Griffin, contributing editor

W

ells Fargo has been subjected to the largest civil money pena lt y t hat t he Consumer Financial Protection Bureau has imposed.

The bank’s compliance, audit, and monitoring programs had all the necessary pieces in place. But the activity—unauthorized accounts—is almost impossible to detect through monitoring and auditing. Perhaps the most significant fact in the case is that Wells found the problem.

But it didn’t come fast enough.

It’s a fairly safe bet examiners would not have found the problem for the same reason auditors would not. Why? Because the documentation looks okay. The consent orders require Wells to do a better job auditing, without specifying how.

Bottom line: There are few techniques that would expose the problem explicitly.

This type of misbehavior is most likely revealed in complaints. At Wells, when the unauthorized activity resulted in overdrafts—consumers didn’t know funds were moved out of their accounts to establish new ones—consumers complained.

Consumers complain to banks and regulators. With regulators involved, banks lose control of solutions, so they must find problems early by keeping tabs on complaints. Complaints analysis over time reveals patterns where problems may exist. But the Wells case brings up a critical question: Can you afford to wait?

When a customer complains he did not open an account, the complaint should be vetted at a policy level and the bank

should resolve the consumer’s problem.

Customer dissatisfaction may be an early indicator of a UDAAP problem. If customers don’t like a new product or procedure, pay attention. Read the full article at tinyurl.com/complaintpatterns

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/ Seven Questions /

The “unbanker”

Forget fintech, you should worry about Chip Mahan. His Live Oak Bank may be the bigger threat By Bill Streeter, editor & publisher

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BANKING EXCHANGE

personal liquidity in Live Oak stock.

The following interview has been distilled from a 50-minute conversation and edited for clarity.

Q1. What’s the philosophy behind Live Oak Bank and its business model?

Our thought wa s to f unda ment a lly “reverse-engineer” the way you think about a bank. A normal bank operates in a geographic territory.

We said, “Why don’t we lift the geographic restrictions, and why don’t we be smart about it?” Let’s make government-guaranteed loans so we don’t take on as much risk. The SBA allows you

October/November 2016

to lend to 1,100 industries. Let’s get the data about a particular industry, and then hire a domain expert who has actually operated in that industry. One of our verticals is funeral home operators.

Jerry Pullins is the former CEO of Service Corp. International in Houston, the largest consolidator of funeral homes in the world. Jerry knows something about what it takes to operate a funeral home.

So we hire folks like Jerry or put them on our board, and ask them to make an investment with their own money in our bank. Then we have these experts sit down with the credit folks and design the credit box. We release the credit box

Photograph © George Diebold/Blend

“W

atch out for the f intechs” has been the drumbeat for a couple of years from industry pundits. These nimble nonbanks, the refrain goes, aren’t hampered like banks, don’t act like banks, have loads of venture capital, and have technolog y that can turn on a dime.

Much of that is true.

But in a ll business “revolutions,” there’s always a shakeout. And we’ve seen that recently with some fintech highf liers brought low, along with increased interest in partnering with previously “irrelevant banks.”

But perhaps a more potent threat is when you have a competitor led by someone with banking experience who has an unconventional, creative mind, where the entity operates within the system as a regulated bank, but is unlike any bank you know. That describes Live Oak Bank and its chairman and CEO, James S. “Chip” Mahan III. Mahan started Live Oak eight years ago along with its bank software subsidiary nCino (recently spun off). Bankers of a little longer tenure will recall that Mahan and his brother-in-law, data security expert Michael McChesney, formed Security First Network Bank, the first internet bank, in 1993. Mahan had worked for several banks before that, including Wachovia, and was CEO of Cardinal Bancshares, Lexington, Ky. Mahan also created and led bank technology company S1 Corp.

L ive Oa k Ba n k at pr e sent i s t he second-largest Small Business Administration lender in the country, lending to 13 distinct industry groups. Mahan has plans, however, to take the model beyond SBA loans, as you will read.

Live Oak’s assets are nearly $1.4 billion. It has one physical branch and an impressive headquar ters campus in Wilmington, N.C., where its 400 employees enjoy the amenities of a tech startup and quite a bit more. Mahan does everything possible for them. He wants them to be happy, work hard, and stick. Key employees are asked to invest half their

to the sales people and say to them, “Go out there in all 50 states and find us good loans.” We have three airplanes to help them do that.

SBA allows you to lend up to $5 million. Our average loan is $1 million—75% guaranteed by the U.S. government. We sell the $750,000 guaranteed portion of the loan in the secondary market, and achieve, on average, a $75,000 gain on sale. So if I go out and spend $4,000 an hour on a private plane visiting ten sites in two and a half days, and those ten sites all average a million dollars in loans, you can do the math.

Those planes are flying branches. Most banks build a branch and hope somebody comes to it. We “build a branch” and go see the customer—for both loan generation and follow up. We make the supposition that if you’re not sending us a current financial statement to compare to your agreed-upon budget, there’s something wrong. And we’re going to go see you. In all likelihood, we’ll end up helping you with your business.

I can’t tell you how many websites we helped set up for veterinarians at our own expense, because if I’ve got a vet that goes down, the paper is worthless.

There are no assets there.

Q2. Do you require an investment from every employee?

Mainly from the senior lenders and the domain experts. I will ask a lending candidate, “How much money do you have in the bank?” He might say, “Well, I’ve got $100,000.” So I respond, “Okay, I’ll take half.” It’s not the dollar amount, but the percentage of what they’ve accumulated in their life. They need to be partners.

The candidate may say, “You really want me to drain 50% of my liquidity and buy Live Oak stock [a private company for its first seven years]?”

“Yes, I do,” I tell him. “It’s like owning your own car versus renting. We’re all in this together. I’ll give you options, and they vest this way: 10% a year for each of the first five years, and 25% a year for years six and seven.”

I explain that we’ve got a bank that’s grown to 400 employees, a software company that has 265 employees, and a brand new trust department. “I think I can keep you interested for the rest of your life. But if this is really all about you, you should work for somebody else.”

I’ve had experience with software companies. People work a year or two and want their options to vest on the way to lunch. I didn’t want to do that this time.

I wanted to approach it completely differently. We all know about the threelegged stool—shareholders, customers, employees. I thought, what if we really, really, really spoiled our folks? And so we pay 100% of their health care. We have a 6% 401(k) match. We built a $3.5 million restaurant for employees here at our

“You really want me to drain 50% of my liquidity and buy Live Oak stock?” headquarters, and we built a $1.5 million gym and an outdoor track around the lake next to our building. Our three airplanes get lenders and domain experts home at night from visiting clients.

We have virtually no turnover. Each of the past two years, we’ve been voted the best bank to work for in America. And still, every day I try to figure out a way to throw another log [employee perk] on the fire. Some of this stuff people say is stupid, but every time we do it, profits get better.

Until we went public and raised all this money, we had 30%-35% return on equity and 4% return on average assets.

Q3. How many verticals do you have?

How do you choose them?

We now have 13. We started with veterinarians and added dentists, death care, hotels, poultry, government contracting, self storage, family entertainment centers, insurance agencies, independent pharmacies, investment advisors, and

renewable energy. Up until a couple of years ago, truth be told, it was just me waking up in the middle of the night with an idea for a new vertical.

Now we have “Seal Team Six.” Three of our best and brightest are responsible for trying to find three or four new verticals a year. We have five data scientists here to help them analyze payment data, D&B data, SBA data, and a lot more.

Sometimes, we just back into one. For example, I was in New York for a Fox Business News interview, and a guy who was in the investment management business says to me, “I went to your website, and you’re missing the boat. No bank will lend money to registered investment advisors because there’s no collateral.

But there’s a lot of recurring income. You ought to look at it.”

So I did and ended up hiring the only lender Charles Schwab had, and now we’re doing a couple hundred million dollars in loans to RIAs. There are about 58,000 of them. When one of them wants to sell out to a younger guy, we’ll lend the buyer the money. He gets a 1% management fee on maybe a $1 billion book of business. That’s a pretty good business.

Q4. Live Oak Bank is highly capitalized (Tier 1 of 11.12% at midyear). Is that a response to regulatory pressure or by choice?

When I owned Cardinal Bancshares in Kentucky [the parent of Security First Network Bank], Nick Adams of Wellington Asset Management was an investor.

After chatting with him about my plans for nCino and Live Oak, I sold him 24.9% of the bank. On a handshake, I agreed to take the company public sometime in the next five to seven years.

We took the company public a year ago and raised about $90 million. Sixty million of that is still sitting in a checking account at the holding company to support our growth.

Last year, we did $1.15 billion of originations. We told the Street that we’ll do $1.3 billion to $1.45 billion this year, and we’ll probably do better than that.

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/ Seven Questions / We’ve got a tiger by the tail here.

I learned from S1 that raising capital when you don’t need it is smart. At Live Oak, we have over $200 million of capital at the bank and holding company. Our loan losses this year are under 30 basis points, and total nonperformers are $2.5 million. And that’s for the unguaranteed paper alone.

The reason earnings have been relat ively f lat i s t hat we keep a dd i ng construction loans. Let’s take two of our newest verticals: self storage and hotels.

We’ve got 10-12 people in each division, and we make a self storage loan for $2 million. It will take two and a half years to monetize that because the borrower has to build the storage building and then lease it up. Between self storage and hotels, we have about $800 million worth of construction loans tied up, representing $60 million in profits.

Analysts that take the time to understand this don’t really care if we monetize it today or two years from now.

It’s a little bit like Jeff Bezos and Amazon. I’m certainly not trying to compare myself to him, but he didn’t care about quarterly results; he knew what he was building for the long term.

So we think we know where we’re going, and that others will have a difficult time keeping up with us. But you would not want to go in and out of our stock on a quarterly basis.

Q5. You rolled out a new e-lending initiative earlier this year. Is it your version of marketplace lending?

No. Historically, we have not been interested in a loan under $350,000. The average government-guaranteed loan has 150 documents, so it’s going to take just as much effort and time to do a $350,000 loan as a $5 million loan.

But we figured out how to use nCino’s technology to get all that data in one place for the customer—not just internally. So when a borrower goes to our website and drags and drops a document, it will say, “Hey, Bill, you’re 19% complete. When you get me these documents, I’m going to get you an approval, or not, in 24 hours.”

Once approved, of course, all you care about is getting the money. And here’s what that takes. You get your lawyer, or your paralegal, on the phone w ith our para lega l. A nd they ’ ll say, “We’ve got to have this appraisal, this 14

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environmental—whatever it is—to get you the money.”

We said, “Why don’t we go down-market inside our verticals where we would automate a bunch of this stuff?” So again, our data scientists jumped in there, and we partnered with about 18 separate companies to do it.

But we’re not marketplace lenders.

I affectionately call a lot of those guys charlatans because at the end of the day, it’s not really going to work, right? And we’re beginning to see that now.

Let me ask you this: Do you know any business that can be run well when you don’t know your cost of goods sold?

With a lot of these fintech lenders, it isn’t their money. So they’ve got to rely

“With a lot of fintech lenders, it isn’t their money. Being regulated by FDIC, the state, the SEC, and the Fed is not fun.

But I know what my cost of funds are” on the capital markets—hedge funds— and we know hedge funds are here today, gone tomorrow.

Being regulated by FDIC, the state of North Carolina, the Securities and Exchange Commission, the SBA, and the Federal Reserve Board is not fun.

But I know what my cost of funds are because we’re a bank.

Q6. What about the other side of the balance sheet: Where do you get your deposits, and how will that change when you roll out your new online banking platform?

Just think of us as an Ally Bank model.

We have about $400-$500 million in local deposits in our Wilmington, N.C., branch, but otherwise it’s the full faith and credit of the U.S. government at higher interest rates gathered in an efficient fashion—some brokered, but mostly online.

It occurred to us that we do lending business with about 900 veterinarians, and there are 80,000 veterinarians in this country. There are 23,000 independent pharmacies, and we do lending

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business with 500. Every one of them has a checking account, but certainly not every one needs money, right?

So let’s take a next-generation online platform with a clear user interface with remote deposit capture tightly integrated into bill pay. And say we give away merchant services tightly integrated into Checkfree, so you can do financial forecasting and benchmarking. And we offer that inside our 13 verticals. A lot of big banks thrive on these merchant fees because they’ve got to support a branch infrastructure. Not us. We’re testing this package today, and it will be operational in the next three months.

Q7. So how do you see the future unfolding for banking overall? Is the industry at a turning point not seen historically, or is that overstating it?

No, I think that’s understating it, and here’s why.

Brian Moynihan used to be the general counsel at Fleet, and Fleet was an investor when we raised $300 million at S1. I think the world of Brian Moynihan. And I felt so sorry for him when [this summer,] on the front page of the Wall Street Journal, he announced that he was going to take another $5 billion worth of cost in the next 24 months out of Bank of America and lay off thousands of employees.

He has to.

Because if you go back—and I have done this—and look at the top ten banks in this country over the last five years with interest rates what they are, and margins that have been squeezed, these are declining revenue model businesses.

A nd I don’t c a r e i f you a r e r u n ning a bank or a chicken company or a funeral home; if you’re running a declining revenue business, you’ve got to fire somebody. So who wants to work there?

Brain drain.

I’d rather invest in a utility than in a declining revenue business where you’re investing in a blind pool of credit risk that’s leveraged ten to one.

And when are we going to have the next cycle of downturn from a credit quality standpoint? We know it’s coming, right?

So it’s a crappy business, unless you can do something a wee bit different. And that’s what we try to do here.

We’ve been growing our business in excess of 30% a year for a long time. I do not have any trouble attracting and retaining talent.

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CORE AT A

CROSSROADS

By Lisa Valentine, senior contributing editor

Like a good marriage, both partners need to give a bit to build a strong relationship

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here are rumblings that community bankers—especially those in long-term relationships with their core banking providers—are feeling less than satisfied with the status quo. Among the bankers’ list of complaints are a lack of transparency into pricing; contract terms that appear to protect the core banking providers’ interests at the banks’ expense; a lack of product innovation; and an increasing sense that banks—or more specifically, their data—are being held hostage.

Is this perception of unfavorable treatment from core banking providers spot-on? Are core providers taking advantage of banks? Or, has the industry changed so much and gotten so complex that it’s natural that bankers’ relationships with their core providers will need to change as well?

Or, is the truth somewhere in between?

The answer, of course, depends on whom you ask. Bankers are feeling increasing competitive and regulatory pressures, causing them to rethink their technology strategies. There’s a crop of consultants who specialize in core banking contract negotiations, and some have built their businesses, in part, on an adversarial relationship between core providers and banks. In addition, as publicly held companies, the largest of the core providers obviously have a responsibility to return shareholder value. They are just doing what they need to do to satisfy their shareholders.

But it’s even more complicated than banks and core providers simply trying to get the best deal in an evolving business and regulatory environment, and consultants trying to drum up business. Add in fintech and new web-based core banking and ancillary systems providers, such as Nimbus Banking and Mambu. These new systems boast the features and functions that bankers are clamoring for, such as real-time posting of transactions, cloud-hosted solutions, and open architectures that allow bankers to more easily use best-of-breed solutions from other third-party providers. They also offer attractive pricing schemes that are often less expensive.

Shutterstock/dotshock

Multiple add-ons under contract Another reason for the increasing frustration is that the relationships between bankers and core banking providers have grown much more complex in the last ten years or so. Banks used to rely on their core banking providers solely for transaction processing. It was, and still is, a mission-critical function for banks—and the core banking systems perform transaction processing and the associated functions admirably.

Today, many ancillary systems swirl around the core banking systems. Online and mobile banking and bill pay are just several systems that require close integration with the core banking systems. The core providers now offer these ancillary systems, and it’s not unusual for a bank to contract with a core banking vendor for 20, or even 30, add-on systems. As a result, the contracts have become exponentially more complicated, and the October/November 2016

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relationships more intertwined.

It’s little wonder that banker unease is reverberating throughout the industry. “The relationship between core bank providers and banks has dramatically changed,” says Don Free, research vicepresident with Gartner. “But vendors don’t seem to understand that.”

Although complaining can feel cathartic, it rarely changes the situation. With that in mind, Banking Exchange spoke with consultants, bankers, core banking vendors—as well as interviewees who spoke off the record—to get a sense of the biggest gripes bankers have with their core banking providers. Instead of simply complaining about the state of the union, however, we also asked interviewees to share their recommendations for improving the banker/vendor relationship. First, let’s walk through the gripes.

Gripe #1: A Lack of Innovation

It’s not the lack of core provider innovation that is frustrating, according to Christy Baker, chief operations officer 18

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“The relationship between core providers and banks has dramatically changed” — Don Free, Gartner of TS Banking Group, Treynor, Iowa, “It’s that the pace of innovation is slow.”

The bank has used the Fiserv Provision core banking platform since 2004. Baker acknowledges that a large company like Fiserv is less likely to be as nimble as a smaller or startup company, adding, “It’s a big ship to turn.”

Brad Smith, managing director of technolog y solutions at Cornerstone Advisors, often hears bank CEOs express frustration that their core banking provider is unable to deliver products that the bank needs to compete. “The big three core providers aren’t in the innovation business,” contends Smith. “They

October/November 2016

are in the business of maximizing their assets. Vendors continue to support legacy systems and upgrade them just to keep up with regulatory requirements, but won’t sunset them because they are cash cows. Bankers feel stuck.”

Smith’s colleague Bob Roth, managing director, agrees: “There are a few core banking products that have gotten very stale. Since these are not the vendor’s f lagship product, they are not investing development dollars into them.”

Steve Powless, CEO of core provider CSI, concurs that there is a feeling among banks that vendors are not providing timely and substantive enhancements to their products. These community banks believe that their ability to compete is compromised by lagging technolog y, notes Powless.

All the vendors who spoke with us (all the top five were given the opportunity) acknowledged the tension, but said they try to work as partners with the banks.

But it is a juggling act for the core vendors, says Stephen Greer, analyst in Celent’s banking group. The biggest

Shutterstock/phive

/ core crossroads /

core banking vendors have been growing by acquisition, and are now having to expend internal resources to integrate their own products rather than focus on developing new systems that take advantage of technolog ies like open architecture and the cloud. “The core banking vendors are upgrading the systems they currently have, but those systems will never be as modern as those provided by startup vendors,” says Greer.

Community bankers often feel that their requests for innovation also fall on deaf ears. Says Greer, “Due to their smaller size, community banks are less likely than large institutions to get attention from their core provider.”

In addition to systems that don’t provide community banks with features and functions that allow them to compete with large financial institutions, the age of these systems has bankers worried.

“Regulators are expressing concern that community banks are at risk by running a system that is 30 years old,” says Greer.

Gripe #2: The High Cost of Leaving

Some version of this stor y was often repeated by those interviewed for this ar ticle: A small communit y bank is acquired by a larger community bank.

Each bank uses a different core system provider, so the decision is made to convert the smaller bank to the larger bank’s core banking system. The smaller bank is two years into a five-year core contract.

The termination clause for the smaller bank to exit the contract is 100% of the contract value.

That’s absurd, according to Aaron Silva, CEO of Paladin fs, which negotiates with technology vendors on behalf of banks. “There are big crimes in the contracts themselves,” he says. “The vendors are getting away with it because they can.” He notes that only 4% of banks switch core banking providers in any given year, but the statistic is misleading. “Banks don’t stay with their vendor because they are happy; they stay due to the financial penalties in their contracts.”

“Banks can’t afford to leave, and vendors know it,” continues Silva. “It’s an oligopoly.” He wants to change that.

“Bankers should be able to leave if they are not satisfied,” says Silva. “This will give the vendors an incentive to provide competitive technology.”

Paladin fs, along with Pillsbury LLP,

a law f irm that is heavily involved in IT contract negotiations, launched the Golden Contract Coalition (GCC) earlier this year. Financial institutions pay a $5,000 membership fee for the right to license a standard contract, and according to Silva, the remaining fees are paid by vendors.

Silva’s vision is that “unionized” banks in the coalition will refuse to do business with vendors that don’t adhere to the golden contract standard. GCC then negotiates the pricing for each contract based on the economics of each bank.

So far, 165 banks—ranging in size from $200 million to $15 billion in assets— have signed on as members, representing $1.5 billion in total contract revenue, maintains Silva.

Dan Fisher, president and CEO of the Copper River Group and author of the Beyond the Bank blog on bankingexcha nge.c om, i s a not her c ont ra c t negotiator who cautions bankers about termination clauses: “It’s dangerous not to read these contracts carefully. Banks that decide to leave their vendor early get a huge surprise on what de-conversion costs. Some vendors definitely gouge their departing customers.”

“These contracts are always eye-opening and sometimes alarming,” Fisher adds. Before signing any contract—but particularly any contract for more than three years—Fisher warns bankers to ensure they have a favorable exit clause.

Gripe #3: Not Playing well with Others

Those banks that would prefer to select best-of-breed solutions rather than purchase all the products they need from a single vendor often run into integration issues. Integration between the core banking system and an ancillary system, such as mobile remote deposit capture, is either nonexistent or available for a fee.

“Bankers are frustrated because they sometimes have to pay their core banking vendor to access their own data after they’ve just spent money on an ancillary system,” adds Smith. “Some of these core vendors say that they are open, but banks have to pay enormous fees to connect with other systems.”

The lack of integration is especially frustrating as banks work to improve the customer experience with digital interfaces. “Vendors can simply refuse to integrate,” says Stessa Cohen, Gartner

Signs your core system is at risk

F

or bankers concerned that their core banking systems may not be getting the development dollars they should, here are some telltale signs that their vendors may not be prioritizing upgrades or enhancements: • Lower sales: Year-over-year sales of the core system your bank uses are trending downward over a multi-year period, especially important when the product is marketed to Tier 2 to Tier 4 banks.

• Poor design or architecture: Use of proprietary integration, and the product has no discernible or credible road map to adopt serviceorientated architecture.

• Operating system, hardware, and database dependency: The core banking market is moving to operating system, hardware, and database neutral systems.

• Decreased customer satisfaction: Product support is lagging, resulting in lower customer retention.

Source: Core Banking Renewal: Criteria that Matter for Successful Selection, Gartner

research director. “It’s an old-fashioned way of doing business.”

In addition to integration woes, Fisher warns banks about exclusivity clauses for ancillary products that forbid the bank from even buying a third-party product.

5 WAYS TO IMPROVE The following recommendations can help banks improve their relationships with their core providers and take back some control over what many feel are unfair business practices.

Recommendation 1:

Get more involved with the vendor “We hear a lot of complaints, but we don’t see our bank clients getting very involved in the vendor user groups,” says Cornerstone’s Roth. That’s a mistake. He notes that the large core banking vendors all do a good job of promoting their user groups

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as a way for bankers to provide feedback, but few bank executives take advantage of these opportunities.

But Roth acknowledges that somet i me s t he f o c u s of t he u s e r g r oup meetings becomes more of a “lovefest” or product showcase rather than an opportunity to have a serious discussion about what the vendor can do to improve or help the bank meet its strategic goals.

Part of the problem is that the attendees at the user group meetings often lack the big-picture viewpoint.

“The vendor’s day-to-day contact at the bank is happy w ith the relationship bec ause the core system is not broken, but the bank CEO and CFO are not happy,” maintains Roth. “There is a real disconnect.”

Pete Graves, CIO for Independent Bank, Ionia, Mich., believes in being involved. “We like to be front and center with our vendors, especially with FIS, our core provider.” He also participates in a peer group that talks about a variety of issues, including challenges with core providers. TS Banking Group’s Christy Baker sits on several advisory board councils for Fiserv and will often raise her hand to be 20

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a beta for a new product or release.

Stacey Zengel, president of Jack Henry Banking, also believes that more communication is better for both the vendor and the banker. “Our industry is dependent on banks being in business. We are really joined at the hip. It’s helpful if a bank has a clear strategy that they can share with us,” says Zengel.

Eric Edwards, head of account management for D&H’s Enterprise Solutions Group, adds to that point: “Banks need to be open so we can help them execute on their strategy and get more value out of our products and services.”

Recommendation 2: Get better at negotiating Even though the core banking contract is likely the largest dollar contract a bank will ever sign, “it’s surprising how few banks negotiate these contracts,” says Brad Smith.

However, it is not just price that is up for negotiation. Fisher advises bankers to keep their contracts as short term as possible. For example, he recommends only three years for renewals.

“I’ve seen banks sign eight-to-ten year

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deals without a way to get out of the contract. The longer the contract, the more termination options the community bank should have,” points out Fisher.

Bankers also should scrutinize the price increases written into the contract, according to Fisher, since some can result in double-digit increases.

“Shame on the vendor, but community banks need to step up their diligence.

Bankers should not assume that they will be getting a good deal from their vendor,” says Fisher.

Core banking vendors negotiate contracts ever y day, while bankers may negotiate a core banking contract once every five to seven years. Guess who has the upper hand based on experience?

Hiring a consultant to negotiate a contract can be a good move, and there are very good consultants out there, says CSI’s Powless.

When negotiating contracts, Gartner’s Free points out that while training, implementation, and other resourcerelated costs are not candidates for negotiating since they are directly related to time and materials, maintenance fees as well as customization requirements

Shutterstock/PHOTOCREO Michal Bednarek

/ core crossroads /

that are regulation related are negotiable.

For example, development efforts for regulation-related customization can often be shared by the vendor by up to 50%, according to Free.

Recommendation #3: Squeeze more out of the current core system “Banks need to take responsibility for getting the most value out of their existing core systems,” says Cornerstone’s Smith. “This is not just a failure of the vendors. In 25 years, I’ve never seen a bank that has gotten the maximum value from their core system.”

For e x a mple , b a n k s shou ld t a ke advantage of the training of fered by vendors—even if that means paying for it. In addition, banks need to stay up to date on the vendors’ latest releases and system enhancements.

CSI’s Powless agrees with Smith. As the core systems have grown more complex, they often have tremendous capabilities that the bank is not leveraging. “Invest in the education to learn how to use the system. There may be features that you don’t even know about,” says Powless.

Recommendation #4: Understand what you need Core banking systems are a key enabler of digital bank transformation—and should be treated as such. “A flexible core banking system is a significant contributor to a bank’s ability to respond quickly to changing market conditions, including compliance and changing regulations,” says Gartner’s Free.

While functionality of the core system will always be important, many bankers are increasingly concerned about the architecture of the system and whether or not it’s open. Explains Free: “Banks recognize that a distributed approach is the desired end state.”

If a bank does decide to consider switching core providers, it’s important to look under the hood and scrutinize the core banking vendors’ integration partners. “Vendor products with proprietary integration methods, absent a standards basis or alignment, are a high-risk choice for the long term, carrying much higherthan-average integration costs for future technology projects,” says Free.

Specifically, core banking solutions should provide f lexibility that includes application connectivity and data integration, workflow, and component-based,

service-oriented-architecture-compliant architectures, he notes, adding that there are differences in core banking SOA strategies.

According to Free, how the core vendor provides real-time enablement also is important. Look for systems that leverage database design and enable real-time posting of future-dated transactions.

Recommendation #5: Focus on vendor performance management The regulators and examiners have been pushing the banks to improve their vendor management in the past several years. However, vendor management connotes a risk-based approach. Smith, for example, would like to see banks shift to a vendor performance management focus. The difference is that while vendor management typically includes

“I’ve seen more banks willing to convert in the past 18 months than I’ve seen in the past 18 years” — Dan Fisher, Copper River Group a yearly vendor assessment, a perform a nc e m a n a g ement appr oa c h i s a continuous process that focuses on maximizing vendor relationships and return on investment of technology spend.

“Vendor performance management requires ongoing discussions between the bank and the vendor,” explains Smith.

It also requires accountability on both sides. “Build contracts that hold the vendor and yourself accountable,” he advises.

“Commit to staying up to date on releases and training. Employ processes and discipline to make the relationship with your core banking provider more productive.”

Will Bankers Vote With Their Wallets?

Jack Henry & Associates, FIS, and Fiserv dominate the core banking provider market. Silva says that the big three have 85% of the under $1 billion market, and 93% of the above $1 billion market.

However, by the end of 2019, 25% of

retail banks will use startup providers to replace legacy online and mobile banking systems, predicts Gartner’s Cohen in the Market Guide for Open Unified Digital Banking Platforms. “Vendors should be thinking about whether or not they want to be relevant in a few years,” cautions Cohen.

Don Free agrees that a change is the air—although it won’t happen overnight.

“There will be alternatives to the big three core vendors. It’s only a matter of time until vendors’ solid base of long-term customers starts crumbling.” He points to Mambu, which is installed in 30 countries and runs on Amazon web services, an increasingly attractive approach.

While there are several core banking providers new to the market, including Mambu, that are getting attention, these vendors have an uphill climb to gain momentum and market share. “The sales and implementation cycle for core systems is long, so it will take a long time before these new entrants gain critical mass,” says Smith.

The other challenge for new entrants is passing regulatory muster. “With all the regulatory focus on vendor management, the bar has been set high for banks choosing to go with an upstart vendor,” adds Smith.

Cohen agrees that the risk of an untested vendor—perhaps one headquartered internationally, without hundreds of bank customers—is a regulatory risk, although she points out that smaller bankers are increasingly willing to take on that risk.

Copper River Group’s Fisher says he sees more banks willing to ditch their long-time core providers. “I’ve seen more banks willing to convert in the past 18 months than I’ve seen in the past 18 years,” he contends. “I see interest in banks with younger management teams who aren’t intimidated by technology and who recognize the need for technology to stay competitive.”

Another reason that bankers may be willing to switch is a lack of trust, especially if in a competitive bid process, the bank discovers it may have been paying too much.

“The last thing a core vendor wants a customer to do is to go through a competitive bid process,” explains Fisher. “If they feel taken advantage of, they lose trust in the vendor and may decide to leave.”

In other words, it’s true that ignorance can be bliss, but it all depends on which side of the contract negotiation table you are sitting at.

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Meet THE NEW BANK EXECUTIVE

Bill Alatriste

By Alan Kaplan, Kaplan Partners

22

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October/November 2016

The requirements for effective leadership have changed

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oday ’s ba n k lea der is under greater pressure than at any time since the financial crisis.

While the crisis itself was a hot mess, the Great Recession’s aftermath has likely altered the course of the industry for decades to come. The two most vital ingredients today for a bank’s longterm autonomy are capital and talent.

Without them, a bank’s future survival becomes much more of an uphill climb.

Much has been w ritten about the tangible banking skills and technical proficiency that have become necessities for leaders today. The shopping list includes regulatory relations, balance sheet management, capital strateg y, commercial credit, investor relations, r isk ma nagement , technolog y, a nd strategic planning. These are all now considered table stakes for bank leader s a nd CEO c ont ender s. The re a l challenges, however, lie in development of key leadership competencies for institutional success. We will focus here on three intangible but particularly important areas of emphasis in the human capital arena: cultural agility, workforce f lexibility, and talent-centricity. There are others, but these three are critical for the future bank leader’s success.

Shutterstock/HerrBullermann

Cultural Agility & Adaptability

Let’s face it: While middle-aged, white men still dominate the C-suite in banking, the growth markets—and new and future employees—do not fit this profile.

Here are a few points to consider: • Women constitute a majority of bank employees in many institutions, with rising penetration into senior management.

• Nonwhite children are now a majority of births in this country.

• More new businesses are started by women and minority members of our communities than by white males.

What does this say about a bank’s future opportunities for growth? It says that bank leaders and line personnel need to develop a true appreciation for the varied needs of different customer constituencies. It says that products may need to be tailored to better take

advantage of specif ic market opportunities. A nd it says that employees will likely need additional training to be in a position to serve a wider array of customers.

Bank leaders need to lead this charge by exemplifying cultural agility; that is, the ability to be comfortable with and make others comfortable with a relationship. It takes training to be able to meet differing customer types at their comfort levels, rather than expecting potential clients or prospective employees to relate to leaders in leaders’ ways.

Cultural agility also involves helping workers understand how people from different backgrounds think and operate, so that a wide range can coexist and work constructively within the bank.

After all, future team members will be just as diverse as future customers, and those growing customer segments want to work with people who understand their needs and business concerns.

Today’s, and surely tomorrow’s, new bank leaders need to possess a level of personal adaptability and cultural agility that allows them to model interactions with a multitude of constituents.

Workforce Flexibility Much continues to be written about the multigenerational workforce. We see many companies where there are three or even four generations hanging around the (virtual) water cooler. Minimally, that typically includes baby boomers (roughly ages 54 to 70), Generation Xers (roughly 33 to 53), and the still younger millennials. Each segment of this working population looks through a different lens. Understanding the priorities and drivers of each, and how to mesh them effectively, is critical to enhancing team performance and the bank’s bottom line.

As an example of generational differences when it comes to banking, studies show that only 38% of millennials have used a bank facility beyond a simple ATM transaction.

One recent statistic f rom Ga llup states that of the four current workforce generations, millennials are notably the least engaged, with only 29% feeling

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connected to their employers. Furthermore, according to research from private equity f irm Kleiner Perkins Cauf ield & Byers and Independent Community Bankers of America, the rising millennial generation seeks meaningful work; high pay; a sense of accomplishment; training and development; and f lexibility—in that order. Yet the same generation is known for being empathetic, humanitarian, environmental, and generally caring. How do banks connect w ith these future leaders to attract and keep them in the fold?

Here’s where I believe banks hold a hidden advantage over many other fields.

There is no industry that is more community minded than banking. No business sector supports local organizations with time and money the way banks do. Yet too often, we take this proud and locally minded behavior for granted when we should be shouting it from the rooftops, especially when recruiting up-and-coming talent on campus or elsewhere. This is how banks can win the hearts and minds of the next generation of potential leaders. Use this “community advantage” to the fullest extent possible when 24

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promoting the organization—whether to potential hires or potential customers. And it is incumbent on bank leaders of today to lead by example, which most

“The variable on the success of a bank’s strategy is always execution.

Execution comes down to people.

Don’t skimp” ­ Alan Kaplan, — Kaplan Partners do, in highlighting the bank’s community commitments and its employees’ good work in the community.

At the same time, banks need to make sure they have refreshed the traditional time lines of career advancement that former bankers like me grew up with.

October/November 2016

While some veteran bankers may disdain the up-and-comer who expects rewards and recognition much faster than previously provided, they need to accept that times are different. Changes in the banking industry—particularly driven by technology—have made previous rules of engagement as obsolete as the passbook account. I’ve heard veteran bankers lament: “It took me 20 years to make vice-president; why does she think it should happen in five?” Expectations need to shift a bit on both sides.

Today’s recent college graduates, in addition to being tech savvy, are typically driven to succeed, anxious to collaborate, and want to work for a company that gives back to the community. Again, this plays to banking’s strengths. We are a technology-enabled, team-oriented, community minded industry. We need to reinforce that “this is not your grandfather’s bank” in our recruiting messages and performance feedback. This creates opportunities for the bank to compete for talent and become known as a “destination employer,” and for the industry as a whole to be perceived as leading edge rather than over-the-hill.

Shutterstock/Cube29

/ Leadership /

talent centricity

The banking industry’s ongoing challenges are occurring at a time when the industry’s crop of potential leaders is actually shrinking. Despite the continued consolidation of the industry—we’re now losing several hundred banks annually to mergers—the ranks of folks who can lead a bank in today’s climate is not keeping pace with retiring CEOs. The other great talent shortage lies in the quest for trained commercial lending professionals. In the past few months alone, I’ve been asked by bank clients from Maine to Connecticut to Ohio about my thoughts on the shortage of quality lenders in the market. The answer is simply that the shortage persists and will not get better anytime soon. It’s not a regional issue; it’s national.

By way of example, back in the mid1980s when I served as a management trainee learning to underwrite corporate loans at First Pennsylvania Bank in Philadelphia, there were 10 to 12 banks in town with formal credit training programs. These banks—some of which had multiple classes annually—turned out hundreds of hungry, young lenders eager to deploy their newfound credit skills.

Today, programs are smaller, stealthy (out of fear of poaching), and more onthe-job than classroom oriented. True, some large banks like Wells Fargo and PNC continue to offer commercial training programs, but the nature of those programs has changed dramatically.

This means that bank leaders who can attract talent to their organizations will have a distinct advantage. In the battle for new loans in crowded markets—which many still are—the banks w ith more and better lenders on the street will win. The tools and products are important, as is the credit approval process, but the supply of lenders will continue to lag the demand for talented producers. It’s the same in the battle for technology talent. Remember, stars have the most options as to where they will deploy their talents. Plus, stars want to work with stars and other “A” players.

Unless it’s a crisis move, “A” players will choose an opportunity where they are working with or for a well-known company, and where they feel they are best set up for success.

One of the added complexities for many banks, particularly community banks, revolves around the dynamics

of compensation, especially for senior officers and revenue drivers. Too many banks continue to lament the cost of talent, rather than accept the rules of supply and demand.

Here’s my view: If you can attract a star lender to your bank—especially a strong producer—pay the market rate for the talent, even if it upsets your compensation chart. Why? Because a true star player generates an annuity stream of new business, and a “B” player simply does not. The lesser performer, while almost always less expensive, is never cheap enough relative to the ROI of the more proven player.

With regard to executive leadership, the same principles apply. Top talent wants to work with other top performers, and a bank CEO who can attract top players—whether directly or via a third party—gains a competitive edge. High growth banks, such as New York’s Signature Bank and Sterling Bank, have not only benefitted from an influx of veteran talent, but the attraction of top talent is a core business strategy.

Banks that choose to play it safe with regard to talent—whether in the executive ranks; in key areas like technology and customer experience; or in the hiring of revenue generators—do run the risk of being penny-wise and poundfoolish. We are living in an industry time of “go big or go home” when it comes to human capital. The variable on the success of a bank’s strategy is always the execution, and execution always comes down to people. Don’t skimp on getting as many difference-makers on the team as possible.

The future of banking remains bright, despite the challenges facing bank leaders today. The difference between banks that are able to grow and remain independent a nd t hose t hat a ren’t may unexpectedly come down to their leaders’ “soft” skills—how banks adapt to changing employee and customer markets; navigate the different workplace expectations of up-and-comers; and approach the talent market overall. Failing to shift focus to these factors may come at a very high price.

Alan J. Kaplan (alan@KaplanPartners.com) is founder and CEO of Kaplan Partners, a Philadelphia-based, retained executive search and talent advisory firm.

Adopt a skillbased board

W

hile the evolution of the requirements needed for bank leaders today will continue, the same can be said for bank directors. Boards are under more scrutiny than ever from governance ac t i v is t s, shareholder s, Wall Street analysts, activist investors, and community leaders. Even mutual saving banks and privately held institutions face more scrutiny from regulators and key constituents.

E xpec tations for direc tor per formance have never been higher.

Community banks in particular tend to have long-tenured board members.

Continuity can be good, provided director skill sets are relevant and the board does not become too close to the CEO, compromising objectivity. However, many bank boards have begun to focus more on the collective skills represented around the board table, and have started to use a skills-based approach when making retention and recruiting decisions.

There are skills that nearly all boards need more of. First is technology, from risk management and grow th perspectives. There also is high demand for directors with strategic planning, marketing/branding, human capital, or prior CEO experience.

The real place for improvement, however, is often in how the board behaves. Research shows that how a board operates is critical to determining if it is a truly valuable strategic asset. Director willingness to discuss vital issues—such as strategy, CEO succession, transactions, and risk—is important for institutional success.

Also key is diversity of thought, perspectives, and experiences. Move beyond a “stale, pale, and male” board.

Today’s bank director needs to be a subject matter expert in an important area, but also a collaborative, communicative, engaged partner. The more willing a board is to tackle the toughest business issues, and encourage and respec t divergent views, the more likely the bank will succeed.

October/November 2016

BANKING EXCHANGE

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/ Risk Adjusted /

EYE ON MULTIFAMILY RISK

As regulators highlight multifamily lending growth, banks balance demand with risk management By Steve Cocheo, executive editor working in multifamily in the Northeast.

For bank lenders, multifamily is often a relationship business, entailing more services than just lending. “They know the players—not just the brokers,” says DePaolo. “Like they say about the races, ‘You need to know the jockey’.” But then there are also the racing officials.

Agencies press vigilance

S

ignature Bank President and CEO Joe DePaolo grew up in a five-story walk-up in the Bronx.

The New York City lender says there was never a vacancy in the building.

The landlord always had a waiting list.

New York City’s f ive boroughs represent the largest multifamily rental market in the United States. Growing up, DePaolo learned an important lesson about that market, which $36.5 billionassets Signature serves: “There’s never enough housing, at least for low-to-moderate and middle-class households. And there’s always a need for multifamily.”

Nationally, a bit over one-third of housing stock consists of rentals of all kinds.

Many heads, fewer roofs

Nationally, rental housing vacancies have been declining, with quarterly blips, since 2009—a good thing for landlords and their lenders. The second quarter closed at a vacancy rate of 6.7% versus second-quarter 2009’s 10.6%. Regionally, the second quarter saw vacancies lowest in the Northeast (5.2%) and the West (4.9%), and highest in the South (8.9%) followed by the Midwest (7.3%). In its second-quarter Multifamily Investment Outlook, advisory firm Jones Lang LaSalle IP, Inc., points out that a longstanding, post-crisis “homeownership 26

BANKING EXCHANGE

bottleneck” is helping to maintain a stable and strong rental pool. This plus factors such as many millennials’ preference for urban lifestyles drive demand.

“Renter-occupied household formations have surpassed owner-occupied household formations for the past nine years running,” writes Jones Lang analyst Michael Morrone. He reports as well that sales of multifamily buildings may exceed 2015’s record-setting pace.

New apa r tment unit s under construction in New York are adding to the inventory there, as is the case in many other markets currently, as a combination of demographic and societal trends drive increased demand for rental housing.

Signature Bank doesn’t have a stake in the many projects around the city now.

The bank does not do construction loans.

And “we’re not in the high-end rental market at all,” DePaolo explains. Signature prefers deals with proven cash flow, and that is something that established buildings, often with rent-controlled units, provide. Rent-controlled tenant populations are considered more stable than others, and there is also a built-in rent increase when units change hands.

One of the pluses Signature has is its veteran multifamily lending team, which has worked for the bank for nine years, and had extensive experience before that

October/November 2016

Regulators have been warning banks about increasing commercial real estate exposure, including multifamily lending, in multiple ways. Last December, federal regulators issued their “Statement on Prudent Risk Management for Commercial Real Estate Lending.” The document contained no new rules or guidance, but reminded bankers of all that the agencies have already issued.

Earlier this year in its Semiannual Risk Perspective for the spr ing, the Comptroller’s Office acknowledged that multifamily, while growing, remains a small share of total lending. However, OCC repor ted that multifamily ha s become a significant concentration—25% or more of capital—and a fast-growing loan category for more than one in seven banks with loan growth of 10% or more.

OCC noted that growth is strongest for banks between $1 billion and $10 billion. Federal Reserve figures indicate that banks and savings institutions hold 35% of outstanding multifamily debt, the remainder largely held by governmentsponsored enterprises (43%), though GSEs have been slowing involvement.

In July, FDIC’s Northeast regional office held a teleconference for its banks on CRE and multifamily trends, covering patterns seen in real estate reports and FDIC statistics, as well as concerns for the future and a review of best practices. FDIC officials showed how New York region multifamily construction is swelling the supply, and pointed out how national figures compiled by CoStar Portfolio Strategy indicate that new units under construction are anticipated to exceed the market’s expected rate of absorption. FDIC warned that

multifamily may be approaching supply-demand equilibrium, which could weaken prices, and that vacancy rates could rise.

Cream rises

For his part, DePaolo notes that seasoned, deeply committed multifamily lenders like Signature engage in a deeper level of analysis and stress testing than newer players. Experience, prudence— and regulatory expectations for heavily involved lenders—drive this.

In August, Keefe, Bruyette & Woods, recapping a community bank investor conference, noted how officers from nor theastern lenders had spoken of the regulatory pressure. “The consensus among management teams seemed to be that many of the more established multifamily and CRE underwriters have highly tested operations and detailed underwriting practices, which should allow them to take advantage of growth opportunities as certain other competitors may be pressured to pull back.”

Some pullback has been occurring already. There is speculation that some lenders, rather than devote more funds to stress testing and other controls, are voluntarily slowing down. More evidence came in the July Federal Reserve Board’s Senior Loan Officer Opinion Survey on Bank Lending Practices. Overall, domestic bankers indicated that standards for all types of CRE loans have tightened, and more banks reported tightening than loosening. In multifamily lending, the survey indicated that 42.9% of domestic banks reporting had tightened, 47.1% had held steady, and 5.7% had tightened considerably; 4.3% had eased somewhat, and none had eased considerably.

Lenders address risk

Among banks presenting at the KBW conference, several have strong concentrations in multifamily, and they addressed regulatory issues and risk.

At $6 billion-assets Flushing Financial Corp., also in New York City, 42% of current originations are multifamily loans.

John Buran, president and CEO, said understanding the market necessitates “peeling back” what’s going on. He noted that Flushing Financial is not involved in the market-rent-based segment of multifamily. Buran said this activity seems to be concerning regulators. Flushing Financial concentrates, he said, on the rent-regulated market, where rents average $1,300-$1,500, versus the $3,000 range for market-rent properties. “We see the rent-regulated market as very stable going forward,” he said.

On the West Coast, $7.5 billion-assets Opus Bank makes multifamily loans in California (70% of its multifamily portfolio), Washington, Arizona, and Oregon.

“Opus underwrites multifamily loans at a ‘stressed’ underwriting rate that is higher than the start-rate of the loans,” according to the bank, “which provides greater protection to the loan’s debt service coverage.”

The start-rate is the f loor for the hybrid fixed-floating loans. (More on this later.)

Beyond credit risk

An interesting point that Opus brought up is that multifamily loans can qualify for 50% risk weighting, which permits a bank to hold less capital against qualifying loans. Opus noted that multifamily

loans have two sources of repayment—the property’s cash f low and recourse to the borrower, as guarantor for the property.

At present, 44% of the bank’s multifamily loans qualify for that treatment.

A nother factor is rate risk. While Opus, a relat ively young ba n k , ha s become the major West Coast multifamily lender, Michael Allison, Opus copresident and president of its commercial bank, told the KBW conference that the bank has increased its emphasis on C&I loans. Multifamily credit, he said, is the bank’s lowest-yielding asset, and the bank has been growing business loans to enhance the bank’s yield. This is in spite of a loan structure that includes a f loating-rate element.

At Opus, multifamily loans begin for a three- or five-year period at a fixed rate.

Then the loan rate shifts to a f loating rate indexed to LIBOR. Generally, final maturity runs ten or 15 years.

Signature Bank’s DePaolo reports a similar strategy—increasing C&I lending to increase diversity and to increase the portion of its loan portfolio that carries floating rates.

In a sense, today’s search for yield may drive the shift that regulators have been urging through exams and jawboning.

Price appreciation is expected to ease Price growth, year-over-year percent 20

Actual Forecast

1

15

0.9

10

0.8

5

0.7 0.6

0

0.5

-5

0.4

-10

-20

0.3

Multifamily (apartment) Office Retail Industrial

-15 Recession

0.2 0.1

-25

0

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Source: CoStar Portfolio Strategies. Data as of March 31, 2016.

Note: Price growth is based on CoStar constant quality sales index.

October/November 2016

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/ BANK TECH /

What’s next for EMV?

Observers see opportunities beyond fraud avoidance

By John Ginovsky, contributing editor

W

ith chip cards passing the tipping point in consumer possession and merchant awareness, industry analysts are considering what more can be achieved with EMV. Possibi lit ie s bei ng c ont emplat ed include collecting new data from consumers as they use their chip cards, and applying big data/analytics and other technologies and plugging those results into ways to boost back-office functions, customer loyalty programs, and more.

Ed McKinley, writing in Transaction

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Trends, the official publication of the Electronic Transactions Association, comments on the state of EMV adoption, and hints at what else may be done.

“Most of the merchants in the middle—think of reg iona l super market chains or pizza parlors with five locations scattered around town—have neither the resources of the big players nor the simplicity of the small players,” McKinley notes. “As a result, medium-sized players have been caught unprepared for chip cards.” Notably, he adds: “[These medium-sized players] haven’t been able

October/November 2016

to integrate transactions with their loyalty program, inventory control, payroll, and employee scheduling.” The point being that transaction data could be used for more than fraud control.

Te c h n av io h a s g i v e n t h i s a lo t o f thought and has come up with a report specif ying three trends for the EMV poi nt of sa le (POS) t er m i na l ma r ket through 2020. In short, they are: • A shift toward cloud-based solutions.

“Several large retailers and small and medium-sized enterprises in the United States are expected to migrate to software-as-a-ser v ice in the cloud from back-end processes,” the report says.

An example of such a service, it adds, is First Data’s Clover Station POS solution, “which delivers benefits, such as inventory management, secure transactions, and increased customer loyalty.”

• Big data management. “Large amounts of data and its functioning will require highly compatible POS solutions that w ill work ef f iciently w ith the information present in the cloud, such as demographics, payment preferences, and customer buying behavior to fuel market analytics (pre-marketing and post-sales marketing).” This, the repor t notes, would encourage more customer visits in stores by providing loyalty points, self-checkout systems, and new mechanisms, such as visual identification along with voice recognition and biometrics.

• Effective information management.

“Companies need to gather businessrelated information, such as sales data pertaining to individual segments or sales data pertaining to the demography of customers to remain competitive in the market. . . . Inventory management, analytical tools, sales reports, and receipts management are some of the services provided by the leading vendors.”

Gemalto, a manufacturer of payments cards, points to a number of possibilities that could enhance the EMV experience.

These include: • Contactless EMV. Whether card-based, embedded in a wearable device, or within a smartphone, the security protection of

the chip also could be combined with a muc h q u ic k e r t r a n s a c t ion p a c e .

• Wearable EMV. Issued pre-personalized and tied to a user’s account, this could provide a medium to reach a large market of users valuing convenience and speed.

• Securing all payment channels.

E M V secur it y c a n be coupled w it h tokenization technolog y to pro t e c t a g a i n s t c r o s s - c h a n ne l f r a ud , i nc lud i ng c a r d-not-pr e s ent f r a ud .

• New card designs. Issuers could achieve differentiation through new and unusual card features, such as new core colors, ecosustainable materials, transparent or translucent plastics, holographic images, metal card bodies, and customer-designed cards.

In a repor t issued in July, Mercator Advisory Group predicts the EMV percentage of total card-present credit volume will go from 43% this year to 100% by 2021.

“Consumers have grown much more comfortable with chip cards over the last 12 months,” maintains Alex Johnson, direc tor of Merc ator Adv isor y Group’s Credit Advisory Service. “This has thrown the ongoing challenges in activating merchant POS terminals into sharper relief. How merchants, acquirers, and the card network resolve these challenges will shape the next 12 months of the U.S. EMV migration.”

Fraud down and shifting Of course, the original EMV objective of curbing fraud still remains front and center.

Mastercard estimates that counterfeit fraud at EMV-equipped merchants decreased by 27% in January 2016 as compared with January 2015. To put this in perspective, an Aite Group study finds that counterfeit card fraud accounts for 45% of fraud, while allowing that the EMV chip is very effective against this type of fraud.

The issuers’ perspective paints a different picture. According to a widely cited study by LexisNexis, issuers directly lose $10.9 billion to card fraud each year,

driven mainly by credit cards. Among the key findings: “Issuers’ opinions are mixed about some aspects of the effect that EMV will have on fraud. The majority of issuers agree that EMV will result in increased card-not-present fraud losses, while driving a reduction in fraud at POS. Despite the EMV rollout, counterfeit card fraud is the fraud type issuers believe is most likely to increase as criminals rush to misuse magnetic-stripe cards before that opportunity ends.”

The report notes that significant investment in fraud mitigation was planned for 2016. Specifically, 78% of issuers said

Future EMV technology may be contactless or wearable, and collect data in the cloud to boost back-office functions and sales they would invest in additional tools, such as dynamic and static knowledgebased authentication methods.

Hard to justify PIN One could conclude from this that the chip card-adoption road will be bumpy in the near term—at least until the last of the mag cards go away. A side issue that has arisen—and has not been resolved— is the current requirement in the United States for chip-and-signature cards versus chip-and-PIN cards, which are used in other countries and generally favored by merchants.

Aite Group looked into this recently, exploring the relative costs for installing chip-and-PIN systems and the estimated fraud such an investment would deter.

Taking many factors into consideration, Aite concludes that issuer costs to switch to a chip-and-PIN system would reach more than $2.6 billion, which would result in a five-year fraud-avoidance benefit of about $850 million.

“With very little incremental risk for

merchants and significant expense and implementation challenge for the payment ecosystem, it is difficult to justify a mandate to implement PIN as a credit card verif ication method,” says Thad Peterson, senior analyst at Aite.

Removing speed bumps Another issue that has beset the EMV rollout has been its perceived slowness—both in getting merchants’ POS terminals certified and in getting customer transactions processed. Both Mastercard and Visa recently announced plans and policies designed to speed up the certification process that had produced bottlenecks to EMV adoption.

G enera lly spea k ing, these prov ided streamlined testing requirements for acquirers and value-added resellers, as well as additional resources to speed things up. Visa estimates that the new processes could reduce subsequent testing by acquirers by up to 80%.

“Visa recognizes the importance of having the industry help merchants get their chip terminal solutions up and running quickly, so that everyone, especially consumers, can benefit from the powerful security protection of chip technology,” says Oliver Jenkyn, group executive, North America, for Visa.

To address the need to speed up transactions, earlier this year, Visa introduced Quick Chip for EMV in which customers dip their cards into a terminal and then remove them, even as the transaction processes behind the scenes. In addition, Mastercard introduced a process called M/Chip Fast, in which the chip only needs to be inserted long enough for security sequences to be established for the given transaction.

Of course, the EMV migration is still ongoing, making what comes next a matter of speculation. Several milestones still need to be reached. The liability shift for ATMs will take effect this October for Mastercard and in October 2017 for Visa. The liability shift for automated fuel dispensers will occur in October 2017 for both card companies.

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/ Compliance Watch /

KNOW YOUR (REAL) CUSTOMER Don’t put off complying with BSA/AML customer due diligence rules By Steve Cocheo, executive editor

opening accounts with the bank.

Ali adds that bankers need to move faster than they seem to be. Many say they are waiting for changes to core systems and related IT from the core vendors, Ali says, but she has heard that in this area, the vendors are waiting for the banks to tell them what they want.

In “compliance years,” the mid-2018 date is not far away, and Ali says changes are significant enough that banks should aim to complete work in time for a few months of tweaking before going live.

From advice to demand

F

ans of 1960s television may know the “Control Voice” used to open episodes of the original The Outer Limits series. This included the warning about your television: “We will control the horizontal. We will control the vertical. We can roll the image, make it f lutter. We can change the focus to a soft blur or sharpen it to crystal clarity.”

You don’t have to be a sci-fi fan to know that bankers assigned to BSA/AML compliance have been working in something of a “soft blur” that is being sharpened to crystal clarity by new regulations.

“Customer Due Diligence Requirements,” issued by the Financial Crimes Enforcement Net work (FinCEN) in

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May, has become known as the “beneficial ownership rule,” but there’s much more to it than that important section.

And in the “sharpening,” there’s been some new soft blur added, according to Maleka Ali, director of consulting at Banker’s Toolbox.

Ali says the regulation—effective July 2016, but with an “applicability date” of May 11, 2018—will sharpen compliance responsibilities in the BSA/AML area overall, because it turns much that used to be the subject of regulatory guidance, and expectations of best practices, into a more definitive set of requirements. This applies broadly, and specifically, in the area of beneficial ownership of companies

October/November 2016

In part, the government seeks greater ef f icacy in institutions’ compliance efforts, but it also seeks to level the playing field among institutions. While most banks—a recent rule change now makes it “all banks”—have been expected to maintain an anti-money laundering program, there’s been a great deal of leeway in what satisfied that requirement.

This included identification of beneficial ownership of customer companies.

This is def ined by the international Financial Action Task Force as “the natural person[s] who ultimately controls a customer and/or the natural person on whose behalf a transaction is being conducted. It also includes those persons who exercise ultimate effective control over a legal person or arrangement.”

Some banks have extensive processes for identif y ing customers, including drawing on database searches. And some other countries maintain registries of beneficial ownership of corporations— something the United States doesn’t have. Indeed, in the mutual-review process among member nations that FATF runs, the United States has been criticized for not having a requirement that its banks routinely look past the legal entities owning customer companies to the beneficial ownership.

(The new rule has exemptions, including traded, publicly held companies.

“Legal entity,” for this regulation’s purposes, includes a corporation, limited liability company, or other entity created

through filing with a secretary of state, a general partnership, and similar structures. Not covered: sole proprietorships, unincorporated associations, or natural persons opening their own accounts.)

FinCEN is working to get financial transparency across the board, according to Carlos Garcia-Pavia, director of market planning at LexisNexis Risk Solutions. He predicts that along the way, regulatory expectations may clash: “There’s a fine line between transparency and the privacy statutes.” That is also, for the time being, a blurry area.

Change of attitude Imposing such a requirement can mean a big change. “Many banks don’t even ask what kind of business a company is in,” says Ali, believe it or not, let alone about beneficial ownership that isn’t explicitly identified voluntarily or in the person of the individual opening the loan, deposit, or other account.

Ali knows of one bank where a conscientious compliance officer tried to require gathering business-line data. The commercial banking function utterly rebuffed the attempt as interference with customer relationships. Now, Ali says, much more will be expected from banks that have been lax.

“In some institutions, it’s going to require changing their mindset,” says Ali. FinCEN’s former director, Jennifer Shasky Calvery, now a senior financial crime prevention official at HSBC, spoke t o t he industr y about developing a “culture of compliance” throughout organizations, and Ali sees the new rules as strong encouragement to do so.

Hearings held by FinCEN revealed a wide and diverse spectrum in how banks handled the beneficial ownership issue pre-regulation. In the preamble to the new rules, FinCEN states both specifically and generally that such variation “can promote an uneven playing field across and within financial sectors.”

Continuing, FinCEN says: “Financial institutions have noted that unclear CDD [Customer Due Diligence] expectations

can result in inconsistent regulator y examinations, potentially causing them to devote their limited resources to managing derivative legal risk rather than fundamental illicit finance risk. Private sector representatives have also noted that inconsistent expectations can effectively discourage best practices, because financial institutions with robust compliance procedures may believe that they risk losing customers to other institutions with more lax procedures. Greater consistency across the financial system addresses this competitive inequality.”

According to Ali, it’s not unusual for bankers at institutions with stringent CDD programs to complain about customers who walk because their officers are asking too many questions.

Schematic of changes The reg ulation turns g uidance into explicit regulation, overall, expanding on the former, in turn. The four formal elements are customer identification and verification; beneficial ownership identification and verification; understanding the nature and purpose of customer relationships in order to frame a customer risk profile; and ongoing monitoring for reporting suspicious transactions, and maintaining and updating customer records with a risk-based approach. Yet the law enforcement community’s desire for ownership data makes the lowest common denominator an unsatisfactory choice. Taken as a whole, the regulation amps up customer identification program expectations and more.

“This is ‘know your customer’,” observed attorney Robert Rowe, summarizing the new rules. Rowe is vice-president and associate chief counsel, regulatory compliance, at the American Bankers Association, and spoke on the regulations during the group’s June Regulatory Compliance Conference. The regulation will explicitly require risk-based processes for understanding “the nature and purpose of customer relationships for the purpose of developing a customer risk profile,” according to the preamble.

Ali says that the industry should have had a pretty good idea of what FinCEN had in mind. Regulatory agreements and penalties over recent years took banks to task for incomplete and ineffective BSA/AML programs, if not worse. After six years under interagency guidance, FinCEN saw the need to tighten up and make explicit demands. One of those involves beneficial ownership.

Who’s behind the company?

Federal reg-speak can make fireworks seem dull, but the section of the rule’s preamble describing the consequences of not having a benef icial ownership requirement to date surpasses the usual regulatory prose: “This [lack of a mandate] enables criminals, kleptocrats, and others looking to hide ill-gotten proceeds to access the financial system anonymously. The beneficial ownership requirement will address this weakness and provide information that will assist law enforcement in financial investigations, help prevent evasion of targeted financial sanctions, improve the ability of financial institutions to assess risk, facilitate tax compliance, and advance U.S. compliance with international standards and commitments.”

What banks must do, once the requirement s become ef fec t ive in 2018, is identify and verify through customerprov ided document ation who the beneficial owners are of all covered types of legal entity customers opening any kind of new account. Banks can use a model form provided in FinCEN’s rule or devise their own. Beneficial ownership is defined in the rule for purposes of determining what falls under the regs.

The key element is that the customer must certify to the truth of the information provided. In fact, so long as the bank has no reason to doubt the information provided, and the documents used for verification appear to be valid, it can accept the information as given. Institutions are expected to use the records as they would other information obtained through their customer identification

October/November 2016

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31

/ compliance Watch / program, including identifying whether the beneficial owner falls under sanctions and f lagging transactions for aggregation for currency transaction reporting.

One blurry spot, notes Ali of Banker’s Toolbox, is when an account that preexists the new regulation should be subject to its identification and certification of beneficial ownership. The regulation says retroactive compliance is not required unless something arises in the course of “ongoing monitoring” that indicates the need to obtain ownership data on an existing customer relationship.

Ali says it’s unclear what the triggers would be under normal, ongoing monitoring, absent a definitive red f lag, such as an event like a change of ownership that the bank learns of or a huge inf lux of cash, which may indicate an ownership change. What examiners will be satisfied by remains to be seen, she says.

“I lie, and he certifies to it” In its preamble, FinCEN says that the stif fened requirement s w ill lea d to knowledge about customers that is “a critical aspect of combating all forms of illicit financial activity, from terrorist financing and sanctions evasion to more traditional financial crimes, including money laundering, fraud, and tax evasion.”

FinCEN explains that abuse of legal entities to hide ownership that wants to stay hidden poses multiple threats.

“Criminals have exploited the anonymity that use of legal entities can provide,” FinCEN points out in the preamble, and cites several major law enforcement cases where organized crime, drug traffickers, and others have hidden behind anonymous companies.

A nd that leads to a “dumb” question that one may ask: If someone is a criminal or even a terrorist, why would they have any qualms about lying when they certify? Is a drug kingpin going to lose sleep over the form that his minion executed fraudulently—likely under someone’s instructions?

In answer, one is reminded of how Al Capone was taken down, ultimately.

When you put aside the drama and gunplay of Robert Stack or Kevin Costner playing “G-man” Eliot Ness, Capone got sent up not for bootlegging, racketeering, or murder, but for income tax evasion.

Yes, banks must labor to get customer information that they can ascertain, to the best of their ability, is correct. But 32

BANKING EXCHANGE

as Ali points out, even with revised policies, procedures, and systems in place or coming, new accounts staff members aren’t lawyers or trained investigators, and could collect false information from the party opening the account that can’t be detected. “They can still lie,” says Ali. “How is a new accounts representative—maybe a part-timer or a college student—going to know whether someone is lying to them?”

The FinCEN preamble explains that law enforcement agencies consulted in the course of developing the rules indicated that even when ownership isn’t honestly identif ied, getting ver if ied

“If someone is a criminal or even a terrorist, why would they have any qualms about lying when they certify? Is a drug kingpin going to lose sleep over the form his minion executed fraudulently?” data on even the “straw men” can help.

The preamble states that “at a minimum they may have information that can aid law enforcement in identifying the true beneficial owner(s).”

The preamble goes on to add, “false beneficial ownership information is of significant use to prosecutors in demonstrating consciousness of guilt, as well as for impeachment purposes at trial. And law enforcement also noted the likely deterrent effect that a categorical collection and verification requirement would have on illicit actors, by making it more difficult for them to maintain anonymity while opening accounts.”

Legislation introduced by the Treasury Department earlier this year would require disclosure of beneficial ownership information and establishment of centralized records regarding ownership at the Treasury. Such legislation has been introduced in previous congresses.

Getting in gear In their joint presentation at ABA’s Regulatory Compliance Conference in June, Ali and ABA’s Rowe outlined the steps

October/November 2016

that banks need to begin taking as soon as possible in order to comply with the FinCEN regulation. Ali expanded on this in a subsequent interview.

Training is a top priority, according to Ali. She says that it’s unfair to expect frontline staff to handle expanded CDD without additional training. From this f lows the need to develop and finalize related policies and procedures for staff to be trained in.

Ali points out that training is not just a matter of compliance, but also of customer relations. Ba nk s must f ind a tactful way for their staff members to ask prospective customers for information that those customers may consider to be conf idential. Consider how the structuring of cash deposits began as an evasion of regulatory reporting, prompting aggregation requirements.

Beyond the need to get outside vendors on board, banks need to coordinate not only compliance needs but practical needs with IT. The federal form, or the bank’s alternative to it, could be a piece of paper in a file drawer, never to be seen or consulted again.

According to Ali, banks must devise a way for t he benef icia l ow ner ship information to make it into automated systems so staff members can access the data and make use of it.

Given such concerns, Ali says that a broadly based task force is necessary to get the job done right and on schedule.

The team needs to include compliance (and BSA/AML if it is a separate function at the bank); system administration; business department heads; form administrators; training; and even marketing, which may need to get involved with the disclosure language.

In the end, communication will be essential, Ali points out. “If the bank’s sales people don’t see this as a priority,” she maintains, that’s bad. “They can’t just see this as just another annoyance from the compliance people that they have to comply with.”

Ali sees this as demanding “tone from the top”—board-level expectations. If a bank winds up with a regulatory penalty from FinCEN, that will certainly reach up to the board, both economically and in terms of reputational damage.

Overall, experts stress urgency. “Two years from introduction to comply sounds like a long time with this rule,” said ABA’s Rowe. “It’s not.”

Industry Resources Banking Exchange partners with companies that work with banks to provide useful information, data, and analysis in the form of webinars and white papers. The webinars are all conducted live, but are available for viewing on-demand for six months on bankingexchange.com. The white papers run for up to six months on the website as well.

Below are the sponsored white papers and webinars currently on bankingexchange.com. You can learn more by using the shortened web address below each item. Or, on the site, click on the “Industry Resources” tab at the top of the home page.

White Papers Financial Institution Profitability Measurement and Reporting Paper explores funds transfer pricing, RAROC, and other components of profitability management framework.

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How Electronic Signatures Enable Remote Account Openings Learn about the benefits of digital onboarding across multiple channels using electronic signature technology.

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New Network Models for the Digital Age of Banking

Mobile Account Opening: Solving the Convenience-Risk Conundrum Mobile dominates consumer interactions with banks—except account opening, because of fraud and usability concerns. The solution lies in mobile’s unique capabilities.

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Branch Transformation Survival Guide

Mobile Account Opening: Solving the Convenience-Risk Conundrum A Mercator Advisory Group Research Brief Sponsored by Mitek

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On-Demand Webinars Digital Account Opening—New Path to Profitability

Win Over Millennials: Are All Your Bases Covered?

Mobile account opening will surge. Find out how banks can make it seamless for the customer and safe for the bank.

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An expert on millennials addresses which products millennials want and where they go to find them.

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Branch Banking Reimagined

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A panel including a senior retail banker and a tech expert explore changing role of the branch.

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Get answers to questions regarding the ongoing management of EMV card programs, as well as new opportunities.

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October/November 2016

BANKING EXCHANGE

33

/ Idea Exchange /

BUILD “BANKABILITY” Equity crowdfunding opens new doors for West Coast bank By Bill Streeter, editor & publisher

former community banker Kim Kaselionis, has completed two other hybrid financing transactions with community financial institutions in California.

The details . . .

A

simple press announcement in September ref lected several current banking trends: the need for growth, the need to differentiate, and increased interest of fintech companies to work with banks.

Fresno First Bank, an 11-year-old bank with just over $300 million in assets, serves primarily businesses and business owners in California’s Central Valley.

The bank is a big SBA lender. Like many banks, it has been exploring options to help it break out of the pack. As CFO Steve Canfield explains, Fresno First goes after the same business customers as everyone else—typically, established businesses that are safe and steady. There are two problems with this, he says: Banks “beat themselves up” on loan rates and terms; and these companies are not usually fast growing, which limits growth prospects.

Hybrid equity/loan combo With an eye on the large pool of businesses that ra nge f rom st a r t ups to those with about $25 million in annual revenue, the bank struck a deal with three-year-old fintech company Breakaway Funding, LLC. The deal enables the 34

BANKING EXCHANGE

bank to offer “hybrid crowdfunding.”

Crowdfunding comes in many varieties, including donations, debt, and equity.

Breakaway’s model combines equity crowdfunding with financial institution lending in a trademarked platform called Community Capital Marketplace.

As described on Breakaway’s website (www.breakawayfunding.com), the platform matches investors with businesses requiring capital and helps position those companies for funding by traditional community banks. According to the site: “This hybrid ecosystem provides investors with new opportunities; companies with new sources of capital; and financial institutions with a steady stream of qualified business. . . .”

“It’s an opportunity to bank people who traditional banks, including ourselves, would not bank,” explains Canfield. He says nobody in the bank’s market area is doing this, which addresses the need for differentiation.

The arrangement, which does not require the bank to make loans, is the first hybrid crowdfunding deal Breakaway has done in which a bank commits to a program. The company, founded by

October/November 2016

Here’s how it works at Fresno First: Companies that raise a minimum of 10% equity capital through Breakaway’s program may be eligible for bank financing through one of several loan programs, including SBA 7a and 504 and a state program for small businesses.

Canfield says the bank still looks at traditional metrics and may decide not to lend. However, when things come together, the equity component allows the bank to make a traditional loan at an earlier stage in a company’s lifecycle.

The company may be only two- or threeyears-old and in a pre-profit stage.

The hybrid equity/loan arrangement can be attractive to young companies where owners want to minimize dilution, Canfield says. For example, they may opt to raise just $250,000 in crowdfunded equity and borrow $250,000, versus using only equity for the full amount.

Other details: The bank requires a minimum equity contribution of 10%; the minimum loan size is $250,000 with terms ranging from one to ten years; and real estate loans are acceptable.

The bank has made a $10 million loan portfolio commitment as part of the arrangement with Breakaway. If the program is successful, the bank will consider upping the commitment, Canfield says.

Regulators were consulted prior to launching the program and were generally encouraging. “They don’t want anything to weaken the bank, but they like that this program is fostering new businesses and helping to serve underserved communities,” says Canfield.

Canf ield adds that refer ra ls f low between the two companies. In the past, he says, when they couldn’t bank a company, they would refer it to var ious government programs. “Now we refer them to Breakaway. Then, maybe in a year, they will be bankable for us.”

/ Ad index /

INTERACTIVE index of advertisers Welcome to Banking Exchange’s Interactive Service Center. This section has been created to allow you to interact with the advertisers who appear in this issue and to gain information on the products and services offered in the following pages of the magazine.

Company Phone

Fax

e-mail address web site address

Appraisal Institute

888-7JOINAI

Comcast Business

888-317-9627

CPI Card Group

307-248-0255

312-335-4400

620-694-1150

aiservice@appraisalinstitute.org

page

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C2

business.comcast.com/financial-services C4

klawton@cpicardgroup.com

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Cummins Allison

847-299-9550

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C3

D+H

800-815-5592

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BDR@dh.com

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DCI (Data Center Inc)

620-694-6800

620-694-1150

info@datacenterinc.com

www.datacenterinc.com

7

Temenos

610-232-2800

610-232-2801

usainfo@temenos.com

www.temenos.com

11

The Advertisers Index is an editorial feature maintained for the convenience of readers.

It is not part of the advertiser contract and Banking Exchange assumes no responsibility for the correctness.

Advertising Sales

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Classified Advertising Jeanine Acquart (212) 620-7211 Fax (212) 633-1165 jacquart@sbpub.com

Display Advertising Robert D. Vitriol (212) 620-7242 Fax (212) 633-1165 bvitriol@sbpub.com

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October/November 2016

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BANKING EXCHANGE

35

/ CounterIntuitive /

SHARING FOR SURVIVAL

Time may be here for community banks to team up—to remain independent By Steve Cocheo, executive editor

I

nev itably when community banks merge, key reasons include rising technology and compliance costs, and the ability to find increasingly specialized talent. An alternative may lie in sharing resources with other banks.

Many vendors can sell banks expertise, advice, and services, but often bankers want some degree of ownership in their resources, points out Shane Deal, deputy commissioner of financial institutions in Minnesota’s Department of Commerce.

Deal helped produce a white paper recently published by the Conference of State Bank Supervisors, Shared Resource Arrangements: An Alternative to Consolidation. It is a state regulatory companion to a 2015 Comptroller’s Off ice paper, An Opportunity for Community Banks: Working Together Collaboratively.

Collaboration isn’t new, but with the stakes rising higher, CSBS staff and regulatory members have found rising interest.

“Banks are looking for ways to collaborate to stay independent,” say Jim Cooper, CSBS senior vice-president of policy.

O ver the years, many communit y bankers have shied away from collaboration. Often, the reason is fear that if two organizations sharing a specialist both face a “fire,” a tug-of-war will result. Cooper and Deal stress the need for having the right partner. “It’s a real issue,” says Cooper. “We’ve heard about it, especially in cases where collaboration didn’t work.”

The CSBS white paper contains small case studies on how collaboration can work—through contractual agreements, jointly owned operating subsidiaries, and nonprofit entities. This practice can help community banks compete with larger banks with deeper benches and resources, and, sometimes, better locations.

Deal says attracting a good BSA/AML specialist can be diff icult for a rural bank. Attractive salaries can be harder for a small institution to offer, and persuading an expert to relocate may be diff icult. Yet, says Deal of his state’s many small, rural institutions, “those banks are the lifeblood of those communities,” and they need expertise.

36

BANKING EXCHANGE

Among the success stories in the CSBS white paper: • Sharing expertise and capacity. A small bank lacked a chief information off icer. A larger bank had excess IT capacity. The larger bank now provides expertise and capacity to the small one for a fee, and is looking to add partners.

• Sharing IT ownership—and income.

Four community banks banded together to share ownership in a data processing provider. To avoid operational risk, one bank houses the main IT center and another houses the backup facility. The center also serves other institutions, making money for the four partners.

• Sharing a compliance team. For over a decade, four community banks with a small degree of common ownership have shared a compliance team. Team members take advantage of remote work capabilities. One bank reported it saves $30,000 annually compared to similar banks that don’t collaborate.

Neither white paper represent s a

October/November 2016

regulatory free pass for individual collaborative arrangements. CSBS and OCC urge that bankers wishing to collaborate discuss ideas with their regulators. Regulators also emphasize the importance of addressing third-party vendor risks, and collaborative efforts come under that concern. Due diligence is key, says Deal.

Among the other regulatory issues discussed by the CSBS white paper are the identification of shared employees who work with customers; establishment of policies and controls; and the consideration of federal- and state-level employment laws.

The white paper notes that FDIC often looks to OCC rules on activities and investments permissible for national banks.

Also, antitrust laws must be considered, bringing in Federal Trade Commission and Department of Justice guidance.

Such matters may influence who makes a suitable and compliant partner.

For the independence-minded banker, collaboration may be the answer.

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