Many community bankers and their boards are entering the post-pandemic world blindfolded. The pandemic had an uneven impact on industries within their geographic footprints, and there is no historical precedent for how recovery will take shape. Government intervention has propped up many small businesses, disguising their paths forward.
Federal Reserve monetary policies have hindered the pro forma clarity required for bank management and boards to create and evaluate strategic plans. Yet these plans are more vital than ever, especially as M&A activity increases.
“The pandemic and challenging economic conditions could contribute to renewed consolidation and merger activity in the near term, particularly for banks already facing significant earnings pressure from low interest rates and a potential increase in credit losses,” the FDIC warned in its 2021 risk review.
Bank management and their boards must be able to understand shareholder value in the expected bearish economic and financial markets that will accompany increased M&A activity. They need to understand how much their bank is worth at any time, and what market trends and economic scenarios will affect that valuation.
As the Office of the Comptroller of the Currency noted in its November 2020 Director’s Book, “information requirements should evolve as the bank grows in size and complexity and as the bank’s environment or strategic goals change.”
Clearly, the economic environment has changed. Legacy financial statements that rely on loan categories instead of industries will not serve bank management or boards of directors well in assessing risks and opportunities. Forecasting loan growth and credit quality will depend on industry behavior.
This is an extraordinary opportunity for bank management to exploit the knowledge of their directors and get them truly involved in the strategic direction of their banks. Most community bank directors are not bankers, but local industry leaders. Their expertise can be vital when historical and pro forma information is directly and accurately linked to industry segments.
Innovation is essential when it comes to providing boards with the critical information they need to fulfill their fiduciary duties. Bank CEOs must reinvent their strategic planning processes, finding ways to give their boards an ever-changing snapshot of the bank, its earnings potential, its risks, and its opportunities.
If bank management does not change how it views strategic planning, and what kind of data to provide the board, the bank will remain in the dark, missing unique opportunities for growth that its competitors will seize.
The OCC recommends that boards consider these types of questions as part of their oversight of strategic planning:
- Where are we now? Where do we want to be and how do we get there? And how do we measure our progress along the way?
- Is our plan consistent with the bank’s risk appetite, capital plan, and liquidity requirements? The OCC advises banks to use stress testing to “adjust strategies, and appropriately plan for and maintain adequate capital levels.” Done right, stress testing can show banks the real-word risk as certain industries contract due to pandemic shifts and Fed actions.
- Has management performed a “retrospective review” of M&A deals to see if they actually performed as predicted? (A recent McKinsey & Company review found that 70 percent of recent bank acquisitions failed to create value for the buyer.)
By linking loan-level data to industry performance within a bank’s footprint, banks can increase their forecasting capability, especially if they incorporate national and regional growth scenarios. This can provide a blueprint of how, when, and where to grow—answering the key questions that regulators expect in a strategic plan. Such information is also vital to ensure that any merger or acquisition is successful.
By Kamal Mustafa, Invictus Group Chairman
A version of this article was first published by Bank Director.
