Banking New York 4Q 2014 by The Warren Group

THE INDUSTRY MAGAZINE FOR FINANCIAL EXECUTIVES & PROFESSIONALS • FOURTH QUARTER 2014 • VOLUME 34

Winds

of Climate Change

TO AFFECT BANKS

Ready or Not, Here It Comes

+ INSIDE: Cyber Security More Reactive Than Proactive | Avoiding Regulatory Criticisms Produced in partnership with the Independent Bankers Association of New York State

BANKING NEW YORK Volume 34 | Fourth Quarter 2014

Winds

of Climate Change

TO AFFECT BANKS

Ready or Not, Here It Comes

04 FROM THE EDITOR

The Epidemic this Time

20 ONCE MORE INTO THE BREACH

06 PRESIDENT'S MESSAGE

Competition is One Thing, But ...

23 TECHNOLOGY The Tech-Savvy Board

08 PUBLIC AFFAIRS UPDATE New York State Report

24 BANK PROFILE

10 LOAN QUALITY Waging WARR on

Cyber Security Still More Reactive Than Proactive

Substandard Commercial Loans

12 BRANCHING OUT Alternate Branching Strategies

Sticking to the Plan

26 SELLING OUT Will My Bank Be Sold? 28 REGULATION Avoid Regulatory Criticism 30 SMALL CHANGE

CONTRIBUTING WRITERS THIS ISSUE Laura Alix, Linda Goodspeed, Steve Vuiker TWG STAFF Timothy Warren Jr. PRESIDENT David Lovins ACCOUNTING MANAGER Mark DiSerio CEO & PUBLISHER

SALES DIRECTOR OF BUSINESS MEDIA

George Chateauneuf GROUP SALES MANAGER

Richard Ofsthun ADVERTISING ACCOUNT MANAGERS

Bob Holzhacker, Mike Lydon, Claire Merritt

EDITORIAL EDITORIAL DIRECTOR

Cassidy Norton Murphy CUSTOM PUBLICATIONS EDITOR

Christina P. O’Neill ASSOCIATE EDITOR

Anna Sims CREATIVE/MARKETING DIRECTOR OF MARKETING & CREATIVE SERVICES

John Bottini DESIGN PRODUCTION MANAGER

Scott Ellison GRAPHIC DESIGNERS

Amanda Martocchio, Tom Agostino & Tyler Grazio

©2014 The Warren Group Inc. All rights reserved. The Warren Group is a trademark of The Warren Group Inc. No part of this publication may be reproduced in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without written permission from the publisher. Advertising, editorial and production inquiries should be directed to: The Warren Group, 280 Summer Street, Boston, MA 02210 www.thewarrengroup.com

CORRECTION:

In the last issue of Banking New York, a caption on page 18 incorrectly identified the location of an Abe Stark billboard. It was on the scoreboard of Ebbets Field in Brooklyn, not Dodger Stadium.

LETTER FROM THE EDITOR | By Christina P. O’Neill

The Epidemic this Time

s this issue went to press, the stock market was getting battered, losing a year’s worth of gains, while first-time applications for unemployment benefits were at a 14-year low. The job scene apparently prompted Fed Chief Janet Yellen to take a road trip to get regional input on job outlooks. She emphasized a concern about income inequality around the country. Meanwhile, the news was all about the social and cultural disruptions of the Ebola epidemic. There’s an interesting parallel between these two items – the U.S. health system initially proclaimed that Ebola would not come to U.S. shores. But that was before U.S.-based health care workers who had been exposed to contagious individuals became infected themselves. Most staggeringly, there was the mid-October disclosure that there were only about 10 Ebola-appropriate beds in the entire country, in the world’s richest economy. Apparently we thought it was someone else’s problem. Yellen’s comments about income inequality bring to light a longer term epidemic of falling-behind that continues to drag on the greater economy. Too many people in the lowest economic 40 percent have lost purchasing

power that they’ll never regain. They become the targets of bottom-feeding financial enterprises including rent-to-own, payday loans and car title loans. Their economic vitality directly affects the people just a bit better off, and so on. When they become better off, they bump their well-being down the chain. If not, they don’t. Let’s compare the thousands of deaths in West Africa with the economic fortunes of those in our own country at the bottom. Healthy adults bump their good fortune down the chain to their kids, either positively through asset building or through the ability to care for the kids until they mature. Western culture has always considered foreign epidemics as someone else’s problem. Now, with a global economy, it’s our problem as well. For those thousands of people stateside who are experiencing financial death, there’s little chance of a rebirth. The consequences are not as immediately threatening, but nonetheless there. ■ Christina P. O’Neill Editor, Banking New York, The Warren Group

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PRESIDENT’S MESSAGE | By John Witkowski

Competition is One Thing, But … Don’t Worsen an Uneven Playing Field Community banks, long the cornerstone of economic development in many of New York’s communities, are sandwiched between mega banks and credit unions. The expanded regulatory environment for banks rewards the size and scale of mega banks, while the credit unions compete based on their exemption from state and federal taxes. The credit unions are aggressively pursuing expanded powers to become more like community banks, without the taxes.

recent example of this strategy is provided by Gov. Andrew Cuomo’s signing of A.9037-A, legislation which authorized financial institutions to conduct savings promotions prize giveaways linked to savings accounts. Since community banks are prohibited by federal law from engaging in such programs, this will provide an unfair advantage to credit unions, which do not pay taxes, over local, taxJohn Witkowski paying community banks. Credit unions will be able to award prizes to members for savings. The Legislature also passed another bill this year (A.9408/S.7112) that now awaits the governor’s action. We strongly urge him to veto this bill, as he vetoed similar legislation last year. The proposal would significantly expand state chartered credit unions’ membership fields, far beyond federal government’s qualifications and the “common bond” definition that has traditionally been used to determine membership in a credit union. The result would be that there would be an extremely minimal chance that an applicant for credit union membership would be denied. Signature of this bill would effectively enable credit unions to accept members without any significant barrier or threshold. This is a dramatic change from the original credit union concept. Let’s remember that the credit union charter was granted by Congress to serve the needs of individuals of modest means who share a common bond. Credit unions have increased their 6 | Banking New York

membership by more than 2 million in the last two years. In New York State, credit unions have 5,011,000 members – close to one-quarter of the state’s entire population. New Yorkers are obviously not under-served by credit unions. Clearly, this new expansion is directed at expanding credit unions’ market share without expanding their tax burden. This proposal would further exacerbate the already unfair marketplace, and provide tax-exempt credit unions an even greater competitive advantage over local community banks that pay their fair share of taxes. Credit unions already pay no federal, state or local income taxes, virtually no sales tax and no MTA mobility tax – all of which banks pay as a cost of doing business. The new proposal would allow credit unions to grow beyond their historic mission and operate even more like taxpaying community banks – but without accepting the responsibility of paying taxes, or documenting that they are following the community reinvestment requirements mandated on banks by the CRA rules. There is no public policy rationale for this expansion. It is simply based on the desire of credit unions to become even more competitive with community banks, and it is particularly designed to assist large credit unions that want the ability to expand their membership bases without significant restrictions. The bill currently under consideration would also allow credit unions to expand their investment powers as well, with the unilateral authority of the superintendent of financial services. There is no such precedent for this continued on page 8 

IBANYS Board of Directors Officers Chairman Christopher Dowd Ballston Spa National Bank, Ballston Spa Vice Chairman John Buhrmaster First National Bank of Scotia, Scotia Treasurer/Secretary Doug Manditch Empire National Bank, Islandia Immediate Past Chairman Gregory Hartz Tompkins Trust Company, Ithaca Directors Thomas Amell Pioneer Savings Bank, Troy Ronald Bentley Chemung Canal Trust Company, Elmira R. Michael Briggs USNY Bank, Geneva Brenda Copeland Steuben Trust, Hornell Randy Crapser Bank of Richmondville, Cobleskill Ronald Denniston First National Bank of Dryden, Dryden Robert Fisher Tioga State Bank, Spencer E. Peter Forrestel Bank of Akron, Akron Stephen Gobel First National Bank of Groton, Groton Richard Koelbl Alden State Bank, Alden Paul Mello Solvay Bank, Solvay David Nasca Evans Bank, N.A., Hamburg G. William Ryan Cayuga Lake National Bank, Union Springs Glenn Sutherland Catskill Hudson Bank, Monticello Kathleen Whelehan Upstate National Bank, Rochester IBANYS STAFF John J. Witkowski President & Chief Executive Officer Stephen W. Rice VP Government Relations & Communications William Y. Crowell, III Legislative Counsel Linda Gregware Director of Administration & Membership Services

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PUBLIC AFFAIRS UPDATE | By Stephen W. Rice

New York State Report Forty years ago, a group of local independent community bankers from throughout New York State formed the Independent Bankers Association of New York State (IBANYS). Why? To ensure New York’s smaller banks had a strong, unified voice and presence in Albany on legislative and regulatory matters, and have an organization of their own, where they could build relationships and share experiences and ideas.

ince 1974, IBANYS has taken our mission to heart: Representing the interests of community banks and their commitment to meeting the financial needs of their customers and communities. Our locally-based ownership allows us to stay close to the economic pulse of New York’s Stephen W. Rice cities, towns and villages. With locally-set policies, we are inextricably linked to our communities. As providers of financial services and active participants in civic affairs, we are integral to their future. Indeed, when Gov. Andrew Cuomo unveiled the New York State Department of Financial Services’ landmark Community Banking Study last year, he said: “Community banks represent a strong economic engine that drives growth in New York and their performance is re-

markable. Small business is the engine of job growth and most small business loans come not from the big national banks, but from community banks.” We’ve had a great deal of success together over the years, most recently a major victory in Albany that will reform the way community banks are taxed, and result in significant bottom line savings. Yet, we still have much to do. In 1958, New York’s community banks endorsed a document entitled, “Independent Bankers Credo.” In part, it states: “By the faith that is in us in American Independent Banking, and by our faith in the role it plays in American economy, we look forward to the challenge of the future confidently.” At IBANYS, we think that says it well. We want to “bridge the gap” and bring together community banks from upstate regions and their colleagues from the NYC/ LI area to network, share ideas and conduct business wherever possible. We want all New York community banks to take

full advantage of our government relations presence and reputation in Albany, and our extensive list of educational programs, conferences and webinars. We’re very proud that our IBANYS’ incoming Vice Chairman John Buhrmaster also chairs the Independent Community Bankers of America, which represents community banks all across the nation. Buhrmaster, president of 1st National Bank of Scotia, recently wrote: “It’s our independent community banks that are our nation’s legacy. It’s something no other country in this world has. Our financial system is unique. And it’s this independence through community banks that keeps our financial system strong – even through tough economic times.” We couldn’t agree more! ■ Steve Rice coordinates government relations and communications for the Independent Bankers Association of New York State. He has worked in the New York banking industry and New York state government for more than three decades.

PRESIDENT’S MESSAGE | continued from page 6

with respect to other financial institutions. Indeed, the superintendent himself has never requested this authority. Appropriate investments for financial institutions have always been subject to the legislative process. This bill would allow expanded investment in real estate for branches and other operations, while the financial services industry in general is undergoing a transformation of branches through consolidation and integrating technology. In releasing the state’s Community 8 | Banking New York

Bank Study last year, Cuomo said, “Community banks represent a strong economic engine that drives growth in New York and their performance is remarkable. Small business is the engine of job growth and most small business loans come not from the big national banks, but from community banks.” We hope Cuomo remembers those words, and respectfully urge him to consider the consequences of this proposal and veto A.9408/S.7112. Community banks feed local economies through

commercial and residential loans. Credit unions don’t replace community banks in the financial services marketplace. Competition is one thing, but realignment of powers to make an already uneven playing field even more so is the wrong choice for New York, its communities and its taxpayers. ■ John Witkowski is president and CEO of the Independent Bankers Association of New York State. He may be reached at johnw@ibanys.net or (518) 436-4646.

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LOAN QUALITY | By Bo Singh

Waging WARR on Substandard Commercial Loans One of the best ways to monitor the quality of your portfolio is by using the Weighted Average Risk Rating (WARR). The WARR is expressed in bank’s normal risk rating. It is calculated by multiplying each loan’s exposure times the assigned risk rating, summing all these weighted calculations for loans being analyzed, and then dividing this total by the sum of exposure of all loans being analyzed.

he WARR is much better than using the “average risk rating” in that it takes into account the size of the loan. For example, the $3,000,000 substandard loan is going to have much higher impact on your portfolio quality than a $30,000 substandard loan.

STRATIFICATION OF LOANS REVIEWED BY LOAN TYPE BALANCE

PERCENT

WARR

BALANCE

2014

PERCENT

WARR

BALANCE

2013

PERCENT

WARR

2012

Commercial & Industrial Loans

$40,326,794

44.82%

4.21

$46,187,101.48

50.31%

4.17

$36,448,444.68

48.35%

3.73

CREM-Commercial Real Estate Mortgage

$46,078,429

51.22%

4.80

$40,868,140

44.51%

4.39

$31,902,211.36

42.32%

4.58

Construction

$2,163,948

2.41%

5.00

$2,219,163

2.42%

5.00

$2,370,977.85

3.15%

5.00

Letters of Credit

$1,396,722

1.55%

4.00

$2,534,724

2.76%

4.00

$4,666,782.44

6.19%

3.95

TOTALS

$89,965,893

100%

4.52

$91,809,128.48

100%

4.28

$75,388,416.33

100%

4.16

HOW TO USE THE WARR

The WARR should be tracked on an ongoing basis to determine if portfolio quality is remaining the same, improving, or deteriorating. This information, in turn, can be used to make credit risk management decisions such as continuing to grow, or temporarily curtailing, lending in a particular portfolio. Below are some ways to use the WARR. The table above shows WARR for different type of loans within the bank’s portfolio. This bank is operating with 5 Pass ratings, with 5 being its Pass/Watch category. As can be seen, the bank’s overall portfolio risk is increasing, as the bank’s WARR has increased from 4.16 in 2012 (close to its 4 risk rating), to 4.28 in 2013, and now 4.52 in 2013. The board should set a risk tolerance limit on an overall acceptable WARR for the portfolio. In our company’s experience, a satisfactory WARR is around 50 basis points below the bank’s Pass/Watch risk rating. You can also tell that the CREM and the Construction portfolio is showing heightened risk with an overall WARR of 4.80 and 5.00, respectively. 10 | Banking New York

Policy Exceptions POLICY EXCEPTIONS

TOTAL EXPOSURE

WEIGHTED AVERAGE RISK RATING (WARR)

Total Loans Reviewed

$89,965,893

4.52

Loans Approved With Policy Exceptions

$35,350,375

4.54

Percent Approved with Policy Exceptions

39.29%

TOTALS

$89,965,893

100%

What does all this mean? This should give you enough information to determine what type of new loan you should approve. For example, approving a new $3 million CREM loan that is rated 5-Pass/Watch is probably inadvisable as that will only increase your portfolio risk. However, a $3 million CREM loan that is rated 4 should be welcomed, as that will help you improve your portfolio risk. You can also do the above exercise by looking at loans by various NAICS code

to see which industry is giving you most problems. The table on the right shows WARR for loans originated in different years. The bank’s WARR is 4.71, close to their 5-Pass/Watch category, for their new loan production in 2014. This means their new loans are increasing their portfolio risk. Monitoring the Bo Singh WARR can assist in you controlling the quality of your new loan production. Finally, you can use the WARR to monitor if your policy exceptions are actually increasing your portfolio risk … or not. The table on the previous page shows that out of the entire portfolio, just over 39 percent of the loans were approved as an exception. However, these loans approved with an exception have a WARR of 4.54, compared to the entire portfolio WARR of 4.52, so these loans are not really adding to the risk. Our company routinely uses the WARR to determine the overall quality of the portfolio during loan reviews. ■

Recently Approved Loans YEAR ORIGINATED

TOTAL

WEIGHTED AVERAGE RISK RATING

2014 YTD

$6,296,154

4.71

2013

$24,087,867

4.34

2012

$19,368,219

4.66

2011

$22,888,075

4.77

2010

$14,655,362

3.73

2009

$9,189,386

4.97

2008

$13,503,921

4.15

2007 & Before

$19,951,375

4.89

Bo Singh is president of T. Gschwender & Associates Inc., a diversified consulting company serving financial institutions for 30 years. Contact them at info@tgschwender-assoc.com.

Get Introduced To Your Best Prospects. And start building stronger business relationships today! New York is the banking and finance capital of the country, and one of the largest financial centers in the world. Its institutions host an impressive amount of deposits, assets, wealth and, as a result, power. Banking New York magazine is a highly focused publication for the array of executives and managers within every bank in New York state. You have the unique opportunity to promote your products, services and solutions within the pages of New York’s own banking publication. Banking New York has been educating bankers since 2007. Now in the second year partnership with the Independent Bankers Association of New York (IBANYS), the magazine’s reach and coverage is more expansive than ever before. Questions? To learn more about Banking New York or to customize a marketing program unique to your business needs, call 800-356-8805 ext. 307 or email advertising@thewarrengroup.com.

Fourth Quarter 2014 | 11

BRANCHING OUT | By Trent Fleming

Alternate Branching Strategies Cost-Effective Enhancements of Your Geographic Footprint Traditional branch traffic is diminishing as customers opt for electronic delivery channels. Yet, there are options for community banks to use technology to better serve businesses and consumers, while minimizing brick and mortar investment.

ATM and Cash Vault Services

ATMs with cash and check deposit functions: Increasingly popular in areas with low-volume demand for check or small cash deposits. Twenty-four hour availability is important. The detailed receipt, containing images of checks deposited, and listing the cash denominations deposited, increase customer confidence. Empty-envelope fraud is eliminated. Siting must be done with care, but when deployed well, they improve customer satisfaction and reduce bank deposit-handling costs. Remote ATM balancing: Allows bank personnel to balance ATMs from a central location. In conjunction with ATM cash service by an armored courier, it precludes the need for bank personnel to visit the ATM. Electronic vaulting: Electronic vaults are placed at a customer’s location, typically in a retail environment. They function as a secure cash vault, and a cash recycler to dispense change as needed. Electronic vaults are connected 12 | Banking New York

to the bank, and provisional credit can be given for deposits made into the device, offering security and convenience. They’re typically served by armored car. When used in conjunction with Remote Deposit Capture, they minimize business customers’ trips to the bank. Cash dispensers at the teller line: Similar to electronic vaults, they work in conjunction with a teller platform system, and automate the process of handling cash at the teller line. In high risk environments, they can be placed through a secure wall. In newer branch facilities, they can be placed at a desk, eliminating the need for the bank associate to walk to a teller window or vault in order to help a customer with a cash transaction. Mobile Services

Mobile banking: Essentially an extension of existing Internet banking functions to hand-held devices. Features customers already enjoy must be made available on the mobile device.

The bank’s website must also render well on a mobile device, so that customers can quickly find basic information (contacts, hours and locations) via a mobile device. Most choose to offer three flavors of mobile banking: Apple, Android and Text. Others add Blackberry or Windows-specific apps, while some choose to simply add an enhanced browser functionality that works adequately on any Internet browser device. What to watch for: responsive technology. Essentially, the customer points, via a shortcut, to the mobile website, and the mobile banking solution then configures itself optimally for the specific device. Expanded mobile banking functionality to watch for includes mobile bill pay, mobile capture, and mobile chat. More on these, below: • Mobile capture: Check-image capture and deposit can eliminate the need to for bank trips. While consumer check deposits have decreased, business applications remain for those businesses delivering services or goods in the field, and which often find latency in deposit due to the schedules of their service or delivery drivers. As with any newer technology, it is necessary to carefully evaluate the true value versus the initial thoughts. • Mobile bill pay: Consumers want to do more on handheld devices. Bill pay may give banks an opportunity to reclaim customer activity from billers. Apps that allow a customer to snap a picture of a bill and set it up for recurring use, give customers control over how and when a bill is paid. • Mobile chat: Younger consumers prefer secure text messaging to phone or email communication for customer-service issues. Look for this option from your mobile banking provider soon, as well as chat (if you don’t already have it) for your traditional website and Internet banking solution.

• Mobile wallet and payments: The digital wallet has great potential to enhance a customer’s payment experience. While ongoing card fraud is driving the U.S. toward a chip and PIN technology, advances in mobile payment solutions may be overtaking the chip card as the best longterm solution. In my view, a digital wallet will consist of a secure application, provided by and managed by a bank, that allows a customer to input a variety of payment methods, along with clear guidelines about payment preferences (when to finance, when to pay directly, what type of rewards to earn). Upon checking out at the merchant, and likely using NFC technology for communicating with a checkout device (although bar codes have been used for this purpose) the app will make the optimum payment decision for the customer.

accounts with appropriate compliance measures, at a much lower cost than via in-person methods. Online loan applications can be useful for complex applications, including mortgages and commercial loans. Customers are able to enter significant information at their convenience from their home or office, then meet with a banker to complete the application process. Consumer loans such as auto, credit and even personal loans, can be almost completely automated. Video Conferencing

The ability to offer face to face customer service via video conferencing has many advantages. At a teller line, a single teller can work multiple customers from a single location. For more general customer service, a customer can interact with a bank employee from an ATM, a kiosk in a branch, or from home. Sometimes the face to face environment is desirable for more complicated customer issues; video conferencing supported from a call center environment can support this. Finally, the implementation of video conferencing will have benefits for internal bank use as well, as a way to conduct more productive meetings without travel time and disruption.

Remote Deposit Capture

For higher volume businesses with an average of 50 or more checks per day, this technology allows scanning deposits and transmit electronically to the bank. In conjunction with electronic vaulting, RDC can virtually eliminate the need for bank trips. RDC also offers excellent recordkeeping, including easy access to electronic images of the deposit, the assurance that the deposit is balanced and accurate prior to transmission (no more adjustments) and may improve cash flow by offering longer daily deposit windows. The RDC software allows the bank to establish appropriate activity limits for a business, based on their deposit history, effectively controlling fraud, accidental duplicate deposit, and other such issues. Online account opening: Modern identification and authentication techniques allow bankers to apply the same level of care to online account opening as they do to in-person events. Existing customers can easily open additional accounts; and banks can acquire new

Configuration Solutions

Here are suggestions on how to deploy a remote location that allows the bank to support a new area with minimal investment in traditional brick and mortar facilities. For locations at which commercial banking relationships will be a focus, a physical office is more important. • Scenario: A modern, drive-up facility featuring a deposit-taking ATM. Messaging that emphasizes ease of banking, from online account opening to mobile banking, also aids market visibility. Depending on the safety and convenience of the location, a two-sided facility with walk-up and drive-up ATMs could also be helpful. Depending

on your decisions around online lending applications, you may possible be able to effectively serve such an area without further investment. • Scenario: Establish presence and focus on commercial account relationships. A facility as described above is also a good starting point. Also add a physical office, which can be a suitably-appointed storefront, so that your calling officer in the market has a location to office out of and meet clients. When properly marketed, your other commercial and consumer product lines and delivery channels will very effectively complement the physical presence, allowing you to grow your business. • Scenario: A suitably-appointed banking facility, available for purchase, gives you a tremendous head start, as it is designed for the things you wish to do. Priorities are ATM services and consumer and commercial presence. Do not create a traditional branch model. Instead, leveraging the technologies discussed, the facility can serve as a base for commercial banking officers, a location to serve retail customers, and a focal point in the community for your branding. The office location will help determine the optimum ATM location, whether in the office or elsewhere that has better visibility and traffic flow - in the community. Associates who staff this facility should be well rounded and able to address all of a customer’s banking needs, from deposits to loans and beyond. Markets are different, but it is these differences that offer you the diversification that you are looking for. Each situation has to be evaluated in light of the criteria suggested above. ■ Trent Fleming is a consultant to the banking industry and helps clients analyze specific situations and formulate appropriate strategies. He can be reached at trent@trentfleming.com. Fourth Quarter 2014 | 13

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Winds

of Climate Change

TO AFFECT BANKS

By Steve Viuker

massive report published earlier this year by Boston Common Asset Management (BCAM) takes banks to task regarding their concerns about climate change. The report states: “Climate change is fundamentally altering the landscape in which banks operate. More than any other industry, the banking industry’s assets are widely distributed across sectors and markets, making it vulnerable to economic and political uncertainty caused by climate change. Through its lending portfolio, a bank’s total carbon footprint is significantly larger than that of its own operational activities. And yet, banks display little attention to the impacts of their lending, underwriting, and ownership activities.” “We believe that the banking industry has not successfully integrated climate change risk into its long-term strategic planning or understood the implications of this game-changing phenomenon for its business operations,” Lauren Compere of BCAM told Banking New York. “The banking industry needs to develop new financial models to foster its own long-term well-being and to help other businesses achieve sustainable growth. To achieve this level of leadership, banks must come to a more comprehensive understanding of their own environmental impact. They must accurately assess risk levels in their lending models and develop strategic management plans that consider climate change and its implications for credit and risk assessments.” However, there are some positive aspects to the report. Many financial institutions, both public and private, and national governments have implemented policies that aim to curtail financing for high-emissions projects. HSBC’s Energy Sector Policy stipulates that it will not provide financial services to new coal-fired power plants whose carbon intensity exceeds 850 grams of carbon dioxide per kilowatt hour in developing countries and 550 grams of

16 | Banking New York

Ready or Not, Here It Comes

carbon dioxide per kilowatt hour in developed countries. The Co-operative Bank’s Ethical Policy states that it “will not finance any business whose core activity contributes to global climate change via the extraction or production of fossil fuels (oil, coal and gas),” with an extension to the distribution of those fuels that have a higher global warming impact (e.g. tar sands and certain biofuels). Credit Suisse states that it will not provide financing to mountaintop removal mining projects or to mining projects that dispose of tailings in riverine or shallow sea environments. The Overseas Private Investment Corporation (OPIC) has set a goal to reduce portfolio emissions of greenhouse gases by 30 percent by 2018 and 50 percent by 2023. Wells Fargo uses carbon “shadow pricing” to help it more accurately calculate the true cost of high- carbon investments. Below are specific overviews from the report for various sectors of the banking industry.

GLOBAL WARMING, GLOBAL REACH China’s Industrial Bank has said that it incorporates environmental issues into its overall strategic planning. It has developed a green credit implementation plan with dedicated departments, training and public advocacy. Many governments have withdrawn support for public financing of new coal plants built abroad, including Denmark, Finland, Iceland, Norway, Sweden, the United Kingdom and the United States. They have all committed to ending public financing for coal, although exceptions for “rare circumstances” are allowed. Recently in The Guardian, World Bank President Jim Yong Kim said, “there were four areas where the bank could continued on page 18 

Fourth Quarter 2014 | 17

WINDS OF CLIMATE CHANGE TO AFFECT BANKS | continued from page 16

REPUTATIONAL RISKS Increasing consumer awareness of banks’ role in financing high-carbon projects may heighten consumers’ scrutiny of the industry. Organizations like Rainforest Action Network, Energy Action Coalition, Earth Quaker Action Team and BankTrack are already leading grassroots protest movements to oppose lending to the coal industry. The campaigns are global and multigenerational, cutting across economic, cultural and social divides. Protest targets to date include Bank of America, HSBC, PNC Financial and the Royal Bank of Scotland. Although most banks have not yet begun to take significant action, they are becoming more aware of these kinds of reputational risks. Of the 94 financial sector respondents to the CDP’s questionnaire for the Global 500 Climate Change Report 2013, more than half viewed reputation and changing consumer behavior related to climate change as presenting significant risks and opportunities.

LEGAL RISKS History has shown, from asbestos to tobacco, that public health concerns went unaddressed for decades, and dramatic shifts in regulation occurred as a result of changes first in scientific consensus, and then in public sentiment. When assessing high carbon investments, it is helpful for banks and investors to consider the experience of the tobacco industry. Through 1998’s Master Settlement Agreement, U.S. states successfully extracted $207.5 billion from the tobacco industry for damages caused by its products. If a legal precedent is established by this settlement, then we can perhaps expect states to seek to have their costs of adapting to climate change paid for by high-carbon industries.

INVESTMENT BANKING The adoption of new technologies will be a boon to primary markets, while secondary ones may profit from climate change regulations, which will provide the necessary infrastructure required for carbon trading markets to function. Innovative financing structures can help advance the market for renewable power and fuels, as they have done in the past for markets like housing. New business opportunities related to renewable energy (wind, solar, biomass) will develop and global trading in a variety of new climate-related markets is likely to increase. Among the examples provided in the reports are IPOs for renewable energy companies, development of weather derivatives, emission trading services and the provision of climate change management consulting. New markets are also expected for green funds and other sustainability-oriented investments.

18 | Banking New York

help specifically in the fight against global warming: Finding a stable price for carbon; removing fuel subsidies; investing in cleaner cities; and developing climate-smart agriculture.” Improved access to clean water and sanitation was vital, as he predicted that tension over resources would result from inaction over global warming. “The water issue is critically related to climate change. People say that carbon is the currency of climate change. Water is the teeth. Fights over water and food are going to be the most significant direct impacts of climate change in the next five to 10 years. There’s just no question about it. So getting serious about access to clean water [and] access to sanitation is a very important project. Water and sanitation has not had the same kind of champion that global health, and even education, have had,” Kim told The Guardian. A new World Bank Group study looks at a series of climate-smart development project scenarios, including landfills in Brazil, and for the first time on a large scale adds up how government actions can boost economic performance and benefit lives, jobs, crops, energy and GDP – as well as emissions reductions to combat climate change. It provides concrete data to help policymakers understand the broader potential of climate-smart development investments. “Climate change poses a severe risk to global economic stability, but it doesn’t have to be like this,” said Kim. “At the World Bank Group, we believe it’s possible to reduce emissions and deliver jobs and economic opportunity, while also cutting health care and energy costs. This report provides powerful evidence in support of that view.” The report, “Climate-Smart Development: Adding Up the Benefits of Actions that Help Build Prosperity, End Poverty and Combat Climate Change,” focuses on five large countries – Brazil, China, India, Mexico and the United States – plus the European Union. It examines the benefits of all six implementing three sets of policies on clean transportation, energy efficiency in industry and energy efficiency in buildings. This report introduces a new macroeconomic modeling framework that can incorporate these considerations, providing a more holistic analysis of the co-benefits of development investments. The new modeling tools: • Measure the multiple benefits of reducing emissions of several pollutants. • Can be used to better design and analyze policies and projects. • Provide a rationale for combining climate action with sustainable development. This report utilizes the new framework in seven simulated case studies – three dealing with sector policies and four focused on project level interventions – to calculate the many benefits of air pollution reduction. The sector policies include regulations, taxes and incentives to stimulate a shift to clean transportation; improved industrial energy efficiency; and more energy efficient buildings and appliances. ■

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ONCE MORE INTO THE BREACH | By Steve Viuker

Cyber Security Still More Reactive Than Proactive Latest Data Breaches Mine Customers’ Information

P Morgan Chase and numerous other financial entities were hit with a cyber breach, discovered in July and disclosed in August, at which time the bank estimated that 1 million accounts had been compromised. In early October, the scope of the breach was made public, and an estimated 76 million households and 7 million small businesses were affected. The attack was more serious than was apparent at first. Financial information was not compromised and there had been no breach of login information such as account or Social Security numbers, passwords or dates of birth. But the names, email addresses, phone numbers and addresses of account holders were exposed. In August, Bloomberg reported that the attack on JP Morgan had been linked to Russian hackers, who FBI sources said had been able to extract 20 | Banking New York

“gigabytes of sensitive data.” Recently, Jamie Dimon, JP Morgan CEO, told shareholders the bank would employ 1,000 people to oversee its systems. Andrew Bagrin, CEO and founder of My Digital Shield, explained: “The first step of avoidance is awareness. You need to know where you stand today and what your security posture is.” Security audits can take many forms, from an elaborate, extremely expensive security audit “that will give you an extreme amount of detail and keep you busy for a year.” The second step is to evaluate and take action on the information to improve the institution’s security. Because of the variety of security solutions and its ever-changing nature, institutions which lack a dedicated security staff should choose solutions that do not require continuous maintenance and management – “otherwise you will be

out of date and no longer secure very quickly,” he said. (Bagrin pointed to a 30-second test on www.shieldtest.com as a first step.) Lloyd’s of London CEO Inga Beale expects the market for cyber insurance to surge. “Cyber is a new risk and it is a concern,” Beale said in an interview with Bloomberg Television. “Lloyd’s is at the heart of cyber attacks, providing coverage right now. It’s going to grow dramatically with all the high-profile hacking incidents.” Beale’s comments echo that of Tom Ridge, the first U.S. homeland security chief under President George W. Bush. His new insurance company has teamed up with five syndicates at Lloyd’s including Brit Plc (BRIT) and Aegis London. Marsh & McLennan Cos. estimates that the U.S. cyber insurance market could double this year to $2 billion in gross written premiums

from an estimated $1 billion in 2013. In Europe, the market is estimated to be less than $150 million, rising by 50 percent to 100 percent annually. “Traditional liability policies do not address cyber/privacy exposure,” said Robert Muenzberg vice president of sales at McGrath Insurance Group Inc. “The industries most impacted by the threat of cyber/privacy liability are financial services, health care and retail, but all businesses that handle any personally identifiable information or financial information of others, and that are active on the Internet, have potential exposure to cyber-liability.” Richard McGrath, principal at McGrath Insurance, noted that data theft is not the only cyber-risk that businesses should prepare for. Heavy reliance on technology for business and personal use exposes businesses of all sizes to cyberthreat risk. “Experts in the field believe that cyber threats are just as serious, and possibly more dangerous, than other catastrophic events,” he said. Cyber risk is a reality, and just like any risk, businesses must find a way of managing this new exposure, he said. “By developing policies and procedures to identify and address the vulnerabilities in your system, you are preparing for what all businesses inevitably will face: a cyber security breach.” Brian Lozada, director of information security, Abacus Group said the Chase breach “didn’t surprise me. It was a matter of time. These recent events are raising an awareness that cyber needs to be brought to the table on an executive level. Obviously, Russia isn’t going to admit they were involved. But they had the motive and they used cyber to get their message across. This was about the sanctions

KMART IS NEW TARGET

Cyber-security begins at the point of sale. Any weak links there will have repercussions for the business’ bank. We’ve seen this happen at Target, Supervalu, Kmart and most recently, Home Depot. Sears Holdings Corp. said that a data breach at its Kmart stores that started in September may have compromised some customers’ credit and debit cards. The data theft at Kmart is the latest in a string of hacks at big retailers. Sears was unable to provide the number of affected cards, but it said that based on its investigation so far, it believes no personal information, debit card PINs, email addresses or Social Security numbers were obtained by the hackers. And there’s no evidence that Kmart.com shoppers were affected. It said Kmart was able to remove the malicious software from its systems. Sears said Kmart is working with federal law enforcement authorities and banking partners as it investigates the breach. It is also deploying software to protect customers’ information. Dr. David Bailey, chief technology officer at BAE Systems, gives the following guidelines for businesses:

IDENTIFY AND QUANTIFY YOUR CYBER RISKS Get a picture of why someone would want to attack you. What would they gain? What would the impact be on your business? Basing an assessment on scenarios derived from real threat intelligence is a good way to engage the whole organization in understanding its cyber risk

DEFINE YOUR ROADMAP Armed with an understanding of the level of security you need in each area and with an understanding of what stage your business is at in each of the three areas above, develop a roadmap for enhancing your security monitoring. Set clear objectives and map the steps, costs, and timescales and, most importantly, work out how you will measure progress along the way.

WORK OUT WHAT YOU NEED Effective detection, good intelligence, and robust investigation are three essential aspects to cyber security. Each aspect should be invested in, proportionately for your business. Getting the right balance is key. Too much of what you do not need in one area will be a waste of money and not enough in another area will leave your business exposed. Be clear on how much of each aspect you need, how you will realize the benefits and budget accordingly.

CONSIDER AND SELECT YOUR DELIVERY APPROACH When looking at monitoring, each business faces the same question – should you develop your own security operations, outsource to specialists or look at a hybrid model? The right answer will be different for every business but the overall business process needs to work end to end regardless of whether the elements are internal or external.

continued on page 22 

Fourth Quarter 2014 | 21

ONCE MORE INTO THE BREACH | continued from page 21

regarding Ukraine.” “The $250 million that Chase will spend on cyber security is a major commitment, but how they allocate it is the next step,” said Lozada. “Any industry that is processing or storing consumer information is a target. Information is leverage. You need to identify your sensitive assets and all your third parties that have connec-

tions into your network or that you share sensitive information with. Target had their HVAC contractor have their credentials compromised and used to access the network.” Russell Stern, CEO of Solarflare, saw firsthand what Chase is up against. “Last month, I attended the Chase tech summit in Menlo Park. Cybersecurity for most financial in-

TD BANK IN MULTI-STATE DATA BREACH SETTLEMENT TD Bank N.A. has agreed to an $850,000, multi-state settlement regarding a 2012 data breach in which 1.4 million files of 260,000 customers were compromised. New York state, in which 31,407 customers were affected, will receive $114,106.11 under the settlement. New York State Attorney General Eric Schneiderman’s office announced the agreement on Oct. 15. Schneiderman was one of nine state attorneys general who conducted the investigation over the course of a year and a half. The investigation included a review of the company’s policies and procedures. The settlement requires TD Bank to reform its data security practices to prevent future incidents. It requires that the bank notify state residents of any future security breaches or other compromises of personal information in a timely manner. The breach occurred in 2012, when the bank reported the loss of unencrypted backup tapes in Massachusetts. The tapes included 1,800 different file types that had been accumulated over a period of eight to 10 years. Under the agreement, no backup tapes are to be transported unless they are encrypted and all security protocols are complied with. Schneiderman’s office also stated that TD Bank will review on a bi-annual basis their existing internal policies regarding the collection, storage and transfer of consumers’ personal information and will make changes to better protect such information. TD Bank will also institute further training for its employees. 22 | Banking New York

stitutions seems to have an endless budget. The challenge for the banks is the evolution of cyber threats moving from hackers being disruptive to state-sponsored terrorist threats. The most attacks are generated from China and the United States is the number one receiver. The second country of origin is the United States and the second receiver is China.” Indeed, as Banking New York went to press, Reuters reported that the FBI warned U.S. businesses that hackers it believes to be backed by the Chinese government have recently launched attacks on U.S. companies. The document said that the agency recently obtained information regarding “a group of Chinese Government affiliated cyber actors who routinely steal high-value information from U.S. commercial and government networks through cyber espionage.” FBI spokesperson Josh Campell said, “The FBI has recently observed online intrusions that we attribute to Chinese government affiliated actors. Private sector security firms have also identified similar intrusions and have released defensive information related to those intrusions.” “As for Chase, they just hired someone from the intelligence industry to head up cyber security,” said Stern. “To me, that is a sign to look at this differently than in the past. Chase was hit, in part, because of what they represent. But that doesn’t mean Bank of America or the other institutions aren’t in danger. Security devices tend to focus on perimeter security. A firewall is an example. It is like a security guard. Once you get past the guard, everything in the environment is open. If I can assemble a threat, I can get data out. At Solarflare, we can take security elements and drop them into every server in the environment. We are able to distribute security policy at every end point. This is like a war. You need layers of defense protecting you.” ■

TECHNOLOGY | By Jack Vonder Heide

The Tech-Savvy Board: Helping Directors Understand Technology

irector responsibility for IT risk and strategy has become more consequential as customers migrate to electronic delivery channels. New laws, guidance and regulations require a higher level of board focus on the IT area. At the same time, many directors still classify themselves as technology novices. Technology is a continuum. People tend to develop a high degree of familiarity and expertise with technologies that were pervasive in their formative years. If a bank board is comprised of directors of varying ages, each member will generally bring a set of skills and a frame of mind that is characteristic of his or her generation. A 75-year-old director, for example, may have no idea how to use an iPhone. However, the same director would easily be able to drive a stick shift car. Ask this director how Wi-Fi works and you will get a blank stare. But if you ask how a Hi-Fi worked, you will get a detailed explanation of proper warmup procedures, changing defective tubes, etc. Most bank directors I have worked with have the natural ability to understand technology, but many feel overwhelmed by the rapid pace of change and the increasing level of personal responsibility they must assume for an area with which they don’t feel fully comfortable. There are several steps that boards can take to improve the technical competence of directors and help them make better informed decisions. First, recruit an outside director who has a deep understanding of technology. An ideal candidate would be a C-level executive who is currently working in the field – one who oversees

the IT area of a well-respected large or middle-market company. A publicly traded organization, is best because the executive will have some familiarity with regulatory issues. Second, form a board-level technology committee. This group would be chaired by the tech-savvy director and would include two or three other directors, plus key C-level officers from the technology, risk management, operations and business development areas of the bank. Third, ask each board member to identify the specific technology areas that they would like to understand better. Then provide one-on-one or small group training. Some board members are visual learners who like examples, while others learn better by reading. It is important to discern how each person learns best and provide them with the type of instruction that will help them absorb and retain the information. A good strategy for older directors is to explain technical topics in nontechnical terms. I once worked with a board that was considering a proposal for increased bandwidth. Two of the directors could not grasp the concept until I said, “Imagine that that you are driving your car on Interstate 94 and all of a sudden traffic is reduced from four lanes to one lane.” There was an aha moment, and the bank got more bandwidth. Fourth, have a technology-focused presentation at every board meeting and at every board retreat. Some of these presentations should focus on current issues like cybercrime, system upgrades, etc. while others address longer range strategic issues. Fifth, decide what type of bank

you are when it comes to technology. Do you want to be on the bleeding edge, where you will enjoy an early lead over your competitors by being the first bank in town to introduce something new? Do you want to be a quick follower that observes what other banks are doing, and then copies those new technologies that seem to be working for them? Do you want to be a straggler and wait until the last possible minute to give your customers what every other bank offers? Finally, prioritize technology initiatives that enhance the customer experience and improve the bank’s bottom line. Every bank has limited resources, and getting a double return on investment is a goal worth pushing hard for. A tech-savvy board is a successful board. ■

Jack Vonder Heide is president of Technology Briefing Centers Inc.

Fourth Quarter 2014 | 23

BANK PROFILE | By Linda Goodspeed

Sticking to the Plan National Bank of Coxsackie Expands into Capitol Region

James W. Warren President and CEO 24 | Banking New York

ince 1852, the National Bank of Coxsackie (NBC) has been serving the banking needs of the small, tight-knit towns and hamlets of the Catskills. But that history is about to expand. As part of a three-year strategic plan, NBC is expanding northward to bring the “hometown banking” it is known for to the greater Albany region. In July 2014, the bank opened its eighth branch office in Glenmont, one of the fastest-growing suburbs in the Capitol region. “Out of all the areas surrounding Albany, Glenmont has had about a 9 percent population growth over the last 10years,” noted Nicole Nazi, NBC’s marketing communications officer. The National Bank of Coxsackie is an independent, locally owned, commercial bank with total assets of about $245 million. Like many small community banks, NBC is challenged to find a

balance between offering all the banking products and technological perks of a larger bank, keeping up with an ever increasing regulatory burden and maintaining that “hometown” feel. “We’re a community bank,” said James W. Warren, president and CEO since 1996. “We know our customers.” “Literally,” added longtime board member Donald Persico, owner of Persico Oil Co. in Ravena. “I don’t think we have a customer that someone in the bank does not know, either socially or business-wise.”

LOOKING FOR GROWTH NBC offers a wide array of products, ranging from student banking options to IRAs, CDs and Christmas clubs. It handles all personal banking needs, business banking, mortgages, home equities and lines of credit, auto loans, land loans, commercial and other loans. It has online banking, mobile banking and has an app

for smartphones and banking via text messages. Warren said growing the bank’s loan portfolio was behind the Glenmont expansion. “We have a loan-to-deposit ratio of about 50 percent,” Warren said. “We’re making every effort to increase our loan portfolio. It’s the central element of our strategic plan. Almost all of our peers have loan-to-deposit ratios up around 70 percent. That’s where we want to be.” Hindering that strategy has been low loan demand and tighter underwriting guidelines. “The ‘character loan’ is going away,” Warren said. “Lending today is driven by cash flow, collateral. It’s not wrong. But there’s always been an art to lending. The character element to lending has diminished the last five years. Some small businesses are not showing strong financial statements. Those folks are going to be left behind. Regulators are just not receptive to permitting those kinds of loans.” He said press reports that banks are not lending are “baloney.” “We’re more than happy to lend,” he said. He said slow loan growth is more a combination of customers “not qualifying and not asking.” To date, Persico said the Glenmont branch has exceeded expectations – “there’s a huge amount of building and construction activity in the Albany area. It’s the right location for us.”

sackie to Cairo, a town of 6,000 about 40 minutes south of Albany. The bank also has branches in Greenville, Ravena and Athens. “Our growth is coming from our new branches,” Warren said. “Mature branches are not growing. We believe we need to expand our physical footprint. We’re in no rush, but we’re looking around for the right opportunities.” Beyond competition and regulation, Warren said another challenge facing all banks, particularly smaller ones, is staffing. The bank recently hired a new CFO, and “it took us quite a good time to find someone,” he said. The bank has 70 employees, all of whom answer their own phones. “We’ve made a quiet commitment to always answer the telephone,” Warren said. “I don’t like automated answering systems.” The bank even ran a series of radio ads featuring employees answering

the telephone in person. It’s all part of that “hometown” commitment. So is its involvement in its communities. “NBC has been an incredible supporter of the community and local events over the last number of years,” said Sylvia Hasenkopf, a local historian and vice president of the Cairo Historical Society. She said the bank is even a member of the historical society. Beyond financial support, NBC also encourages branch managers to join the local Rotary and other service organizations, and its employees to donate time to help out on fundraisers and volunteer activities. “NBC’s approach to community giving is not based on a yearly cycle. It’s based on great ideas and their desire to support the community,” Hasenkopf said. “It’s neat when you see a large organization like that invested In the community and events and people.” ■

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MOVING IN AND MOVING UP In November 2012, NBC opened a branch in Middleburgh, a small farming hamlet of about 2,000, after one of the town’s two banks closed and did not come back. NBC bought the shuttered Berkshire Bank branch and moved in. “It’s a small community, similar to our other branches,” Persico said. “The growth there has been tremendous.” Prior to Middleburgh, NBC’s last previous expansion was in 2006, when it moved its headquarters from Cox-

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Fourth Quarter 2014 | 25

SELLING OUT | By Mary Buffett

Will My Bank be Sold? What to Watch for if CEO is Ready to Retire

want my surgeons and my pilots to have a touch of grey. The same applies to bank CEOs. However, every banker will age and eventually retire. The question that many customers and investors often ask is this: Does a bank CEO’s age suggest that his or her financial institution may be quietly readied for sale? Mary Buffett Since the economy rebounded from the 2008 financial meltdown, larger banks are looking to expand again. As bank regulations were relaxed during the mid-1980s, a number of mid-sized and larger banks went on a spending 26 | Banking New York

spree. Within a decade, our banking institutions went through a period of great consolidation. Many great financial brands found themselves in the dustbin of history. Today, it’s the same old story. Smaller and regional banks position themselves as counterpoints to the mega banks. They will give customers the time, care and feeding that larger banks cannot offer. In many cases, the CEO is only a phone call away. When these smaller banks are purchased, customers are often the last to know. Bank staff might know that there are acquisition rumors in the air but they often discover an ownership change once senior management inks the new agreement. Healthy bank mergers are back.

Many of the mergers that took place during the meltdown were designed to find healthy homes for failed institutions. They were more like shotgun marriages than traditional mergers, because the policy goal was to keep the American banking system afloat. Between 2008 and today, the general populace has forgotten how close the American economy came to total collapse. But also since then, things have improved dramatically.

WHY ACQUIRE? Why do smaller community and larger regional banks remain delicious acquisition targets? It’s all about attracting business customers, the most profitable piece of any banking portfolio. Larger

bank brands might conclude that it’s cheaper to purchase a bank (and its customers) than growing business clients organically. That’s also why when healthy community banks are sold, it’s often for far more than book value. Just because a community bank CEO may be eyeing retirement, it does not necessarily mean that anybody is putting the “For Sale” sign in the window. However, there might be several clues that investors, staff and customers might wish to ponder if they think that a particular institution might be up for sale in the near term. Here are some red flags that should resonate with staff, investors and customers alike. Look at the gene pool. If the financial institution is family-owned or family-controlled, take a good look at the gene pool. Is there a family member who is being groomed to be the next generation of bank leadership? If the senior leadership team is in their 60s and seeking a soft and smooth exit, they should have designated an heir apparent to carry on the family business. When the third generation of any family institution comes onto the scene, they are often tossed and turned by the inevitable family dynamics that cuts across several generations. If the next generation has been assigned to the bank’s foundation (which gives away money as opposed to making it), it is a signal that the family’s genetic predisposition for banking has petered out. If the next generation of leadership is not family, look closer still. Thanks to LinkedIn, you can look at the successor’s background

Wise companies engaged for the long term will have a constant rotation within their C-level suites. and determine whether that person is a short-term or long-term player. Based on what we have seen with recent community and regional bank acquisitions, that person will be richly rewarded. Look at the senior management team. If they are a closely held or family controlled institution, look at the ages of the entire senior management team. Time takes its toll on everybody and we all are put out to pasture at some point. Wise companies engaged for the long term will have a constant rotation within their C-level suites. If the senior management team of a financial institution continues to age without any new blood added into the mix, it is a sure sign that its long-term prospects might be very limited. How is the bank organized? If the bank has an environment where the percentage of shares is highly concentrated within a few shareholders, it’s likely to be organized as an S corporation. If so, it is a sure red flag for a future sale. Unlike a traditional corporation, S corporations pass the taxable profits and losses directly back to the shareholders (as opposed to the corporation’s bottom line). By law, the timeline of an S corp has a beginning, middle and an end. When it matures, often after a 10year period, the shareholders have some very big decisions to make. They could renew the S corporation

structure, alter it or simply sell. After surviving on the dangerous rapids of the last couple of years, the idea of a happy and wealthy retirement might be completely irresistible. Finally, look at the bank’s product offering. Smaller community and regional banks often have an incomplete portfolio of customer and commercial products when compared to large banks. Smart Realtors will “stage” a house to prepare it for sale by adding a number of features that will attract a top flight buyer. It is no different within the world of banking. If senior management is making a concerted effort to quickly add a number of new programs and products, it could mean that they are trying to complete against the big boys. However, it could also mean that the bank is being “staged” for a future sale. Smaller community banks and other regional institutions became quite profitable as a result of the 2008 banking collapse. Average balances within these institutions are often 50 percent higher than what you find in the larger mega banks. Because banking programs offer so many hooks that make it harder to steal away business clients, it becomes far easier to buy the entire bank. In a nutshell, that is what is driving the endless waves of bank acquisitions, not solely the age of retirement potential of a CEO. ■

Mary Buffet is an author, international speaker, entrepreneur and political and environmental activist. Her website is marybuffet.com.

Fourth Quarter 2014 | 27

REGULATION | By Stephen Brown Klinger

Avoid Regulatory Criticism ALM Assumptions Made Simple lar) will be a particular focal point [of examinations].” As noted earlier, there are four elements necessary to develop proper ALM assumptions: historic experience, customer loyalty, economic projections, and industry benchmark data.

HISTORIC EXPERIENCE

any community banks develop their asset liability management (ALM) modeling assumptions based on four measures: the bank’s historic experience, current customer loyalty, economic projections, and industry benchmark data. Before discussing best practices, the need to develop accurate modeling assumptions starts with the fact that the banking industry is currently flush with funding. The FDIC’s Statistics on Depository Institutions Report shows that between 2007 and 2012 total domestic deposits grew from $6.9 trillion to $9.4 trillion, of which $2.1 trillion was in money market deposit accounts. With this “bubble” comes additional liquidity and interest rate risk for the industry when rates begin to rise. FinPro research reveals that total interest expense tripled during the last rate rise (2004 to 2007). It is vital for planning purposes that a bank makes strategic decisions about how to handle interest rate risk and liquidity when rates rise, incorporate those plans into its modeling assumptions, stress test 28 | Banking New York

the results in different economic scenarios, and then reassess its plan. In addition to internal reasons, regulators are scrutinizing the process for developing modeling assumptions with increasing frequency. The FDIC’s FIL-46-2013 “Managing Sensitivity to Market Risk in a Challenging Interest Rate Environment” and the OCC’s “Fall 2013 Semiannual Risk Perspective” provide key pieces of insight as to regulators’ concerns in the face of rising rates: • Declines in net interest income • Deposit run-off • Constrained loan growth • Extension risk of MBS portfolios • Reliance on long-duration fixedincome securities for liquidity • Net unrealized losses on securities The forward projections of these items are directly impacted by a bank’s modeling assumptions. In fact, the OCC states “The adequacy of interest rate stress scenarios and the appropriate support for key modeling assumptions (non-maturity deposits in particu-

It is often said that understanding history is the best way to predict the future, and bank regulators wholeheartedly agree. For establishing decay rate assumptions this means analyzing three to five years of account level experience and then aggregating the flow of funds to the product level at which you model. A beta value study is a little trickier. It involves basic statistics and necessitates product pricing data back to 2006 in order to capture the last rate move (2000 to capture the last three). These two analyses are the first building blocks in developing assumptions designed to project the future. However, the connection must be drawn between the bank’s experience and the bank’s current customer base based on customer loyalty factors.

CUSTOMER LOYALTY The difference between “core deposits” and customer loyalty is one of the common ALCO misunderstandings. The following conversation demonstrates this point best: Bank: “We do not have hot money deposits. The majority of our deposits are core, our customers are extremely loyal and will not move in rising rates.” The Regulator: “But your products are paying 45 bps over the competition?” Bank: “Well, our loyal customers are very price-sophisticated.”

Yes. No. Maybe? Regulators define a core deposit as deposits under $250,000, but in the real world this in only one component of customer behavior. In the example above it is impossible to describe the customers’ price elasticity without further analysis. The only thing the bank has demonstrated is that its customers are acquaintances who are sophisticated enough to shop for the best rate in town, not a good situation. In order to develop a proper beta value strategy for rising rates the bank must stratify its deposit accounts based on six loyalty factors: customer relationship, price, geography, tenure, frequency of use, and size. Scoring these loyalty factors will generate a propensity to renew score which indicates the true loyalty of each account. The key is that this is based on current customer data. When overlaid with the bank’s historic information, this positions banks with best knowledge to develop funding strategies that build value. Some industry leaders and academics still say, “core deposits drive franchise value.” Do not fall into the “core deposit” trap. Customer loyalty builds franchise value.

Do not fall into the “core deposit” trap. Customer loyalty builds franchise value. changes to the balance sheet with the bank’s strategic plan (dynamic modeling) creates a larger separation between the most likely actual depiction of the bank’s future interest rate risk and what is captured in ALM modeling. What this means is that banks must match their strategic planning balance sheet with their ALM model and overlay different practical projections of economic scenarios (adjusting for interest rates, new business projections, and subsequent effects on ALM assumptions) as stress tests to the base case. Only then will management, the board, and regulators get a depiction of the bank’s interest rate risk that is actually useful for planning purposes.

INDUSTRY BENCHMARK DATA The concept of benchmarking a bank’s assumptions and results to industry benchmarks is a straightforward concept. However, of the four steps it is the most commonly overlooked. While assumptions must be bank specific based on historic studies and future projections, the ability to benchmark against industry values is a powerful tool to ensure the reasonableness of non-maturity deposit decay rates, price sensitivity (beta values), and loan prepayment speeds. Different risk thresholds or assumptions may be more appropriate given the institution’s strategic plan, but in those circumstances it makes it even more important to see the forest

ECONOMIC PROJECTIONS Stress testing is an important and evolving component of asset liability management. While still mandated by some regulatory agencies, instantaneous parallel rate shocks on static balance sheets will soon become a thing of the past. Why? Rates have never risen by more than 200 bps in a parallel manner across the entire yield curve, especially overnight. Nor will they ever in the future. Additionally, not matching future

from the trees in order to prepare a justification for the difference. Additionally, market intelligence on product benchmarks is extremely valuable in supporting ALM assumptions at new institutions or new products where historic information is unavailable. The increased regulatory focus on banks’ interest rate risk has fueled an increase in matters requiring board attention (MRBA) regarding ALM assumptions. In fact, the FDIC’s Supervisory Insights publication of summer 2014 notes it as the fastest growing area for MRBAs among bank’s rated “1” and “2.” Common language includes: • “Develop and document non-maturity deposit assumptions based on a historical analysis of the bank’s customer base and create reports quantifying rollover risk.” • “Document support for key bank specific assumptions utilized in quarterly IRR modeling.” “Enhance the ALM policy to better define required modeling scenarios and their associated risk limits.” • “Reasonable EVE sensitivity … Risk limits must be adequately supported.” A simple way to avoid these criticisms is to make sure your institution has properly addressed each of the four areas: historic experience, customer loyalty, economic projections, and industry benchmark data. ■

Stephen Brown Klinger is director at FinPro Inc. Contact him at (908)-604-9336 or sbrownklinger@finpro.us.

Fourth Quarter 2014 | 29

SMALL CHANGE | News Roundup

SEND US YOUR NEWS! SUBMIT NEWS FROM YOUR BANK TO CHRISTINA O’NEILL, EDITOR, AT CONEILL@THEWARRENGROUP.COM

KEYBANK

Gary Quenneville

Richard Gold

Alan Braden

Keybank is organizing its New York state operations into a consolidated upstate region. The bank announced the change on Sept. 22. Gary Quenneville, a western New York KeyBank executive who oversaw an earlier consolidation, heads the New York operations for the bank. Previously, KeyBank was organized into separate upstate regions: The Western New York Region, which included the Buffalo and Rochester markets, and the Eastern New York Region, which included Syracuse, Albany and the Hudson Valley. The regions had separate presidents leading them. Hugh Donlon, who had been the Capital Region market president since June 2013, is leaving KeyBank. Donlon had replaced Jeff Stone as the Capital Region’s top KeyBank executive in that earlier consolidation. Stone is now senior vice president for Kinderhook Bank. Quenneville is KeyBank’s regional sales executive for Western New York. The combined New York operation includes more than 3,000 employees and 232 branches in 40 upstate counties. KeyBank, formerly headquartered in downtown Albany, is now headquartered in Cleveland, Ohio.

perintendent, Contingency Air Staging Facility; career counselor and senior enlisted leader and manager, Command Medical Inspections. As director of the Community College of the Air Force Medical Service Course, Braden managed a $33 million dollar budget and supervised 55 staff members. After training with CLO Max Pickard, Braden will service CCB’s commercial loan customers in the western and northern Chautauqua County and Southern Erie County areas. Cattaraugus County Bank has also appointed Deborah Fargo as risk, compliance, CRA, security and BSA officer. She joined the bank in 2007 and previously held the position of commercial credit analyst. She has been a supervisor in the Volunteer Income Tax Assistance Program since 2008. She is a member of the Institute of Management Accountants. The bank has also promoted Stephanie Brown to assistant vice president, Randolph branch manager, business development and lending. She joined the bank six years ago, and has served in several positions and in several locations. She most recently served as commercial loan processor and then executive administrative assistant to the CEO, COO and most recently also to the bank’s new president.

M&T BANK

STERLING NATIONAL BANK

Richard S. Gold was named a vice chairman of Buffalo-based M&T Bank and chief risk officer of M&T Bank Corp. and M&T Bank. He succeeds current CRO Donald K. Truslow, who announced his retirement, although he will continue at M&T Bank on a part-time basis. Gold has more than 25 years of experience at M&T. He has served on M&T’s Management Committee for seven years and heads its Office of Regulatory Projects. He has led M&T Bank’s retail banking division, and most recently the mortgage and business banking divisions.

Sterling National Bank has expanded its sales team for its New York Metro market this year, in New York City, Westchester County, Long Island and New Jersey. The most recent new hires, announced in October, include Ellen Weber, named as senior managing director. She previously served as regional executive and market president at Capital One. She has more than 25 years of commercial banking experience focusing in the areas of health care, professional services and commercial real estate. Stephen Weiss was named senior managing director. He was previously senior client manager at Bank of America. He has particular expertise in the areas of investments, commercial lending and treasury management solutions. Munesh Verma was named managing director; he was previously a vice president within the commercial banking group at HSBC Bank, where he advised middle market enterprises and high-net-worth families. ■

CATTARAUGUS COUNTY BANK Little Valley-based Cattaraugus County Bank has appointed Alan Braden to its management team as vice president, business development and commercial loan officer. He has served nearly 20 years with the U.S. Air Force where he held many positions, including director, Community College of the Air Force; su30 | Banking New York

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