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Merger Concerns and Loosening Credit Standards

In this episode of The Purposeful Banker, we talk about the ever-popular commercial banking trend of mergers. Is there perhaps a downside to adding scale? Also, after banks tightened standards in 2020, how far is the pendulum swinging now toward looser credit standards? 


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Jim Young: Hi and welcome to The Purposeful Banker, the podcast brought to you by PrecisionLender. We discuss the big topics on the minds of today's best bankers. I'm your host, Jim Young, Director of Content at PrecisionLender, and I'm joined again today by Dallas Wells, our EVP of Strategy. Today, we're going to do something a little bit different. Typically we take one major topic and talk it into submission, but today, perhaps just because we couldn't decide which topic to choose, perhaps because it felt like both merited presence in this podcast, we're going to discuss two subjects, bank mergers and loosening credit standards.
Dallas, let's start off with bank mergers and The Financial Brand article, Jim Marous, who has been a guest on this podcast, and his articles have been frequently used on this podcast. His piece on bank mergers with the title Banking Mergers: Bigger Isn't Always Better. So, it's giving away a little bit right there in the title as to where Jim's going to go with this. But I'm curious, this is not a new topic, certainly not on this podcast, so why do you think Marous is revisiting it now?
Dallas Wells: Well, I think the pace has picked up a little bit, if you just look at total merger numbers. Picked up a little bit over the last couple of months. But I think more importantly, the size has really increased. So these are big headline names and well recognized industry names that are pairing up in bigger sizes than before. So it feels like a little bit more of an industry shift and there are more total industry assets at stake, bigger operating budgets, bigger branch footprints. These simply just have more repercussions than a couple of smaller community banks pairing up and combining geographies essentially.
Jim Young: Right. Okay. We've talked on the show about scale advantages that big banks have when it comes to tech and what they can do and the armies of developers they can throw at something and the amount of money they can throw at something. We've talked about this not just for community, but for regional banks about the squeeze they feel on this. So all of that lends itself to, well, yeah, this seems like the way things would go. And Marous does acknowledge some of that, but what are his reservations about what's happening?
Dallas Wells: Well, I think what it boils down to is he's not sure or sees at least no evidence of the fact that the scale helps. So you're taking two large regional banks that already spend a ton of money on technology and are each individually eyeball deep in their own digital transformations. And just because you marry them together, it doesn't necessarily change the trajectory. And especially considering that one of those two leadership teams, even than these branded as mergers of equals, one of those two leadership teams is going to take the helm of the new combined bank and largely continue on the strategy that they were on before. So with more scale, with more head, count, more operations, more locations, all that stuff, but it doesn't necessarily speed up anything. It doesn't necessarily add new projects. At least we haven't seen that.
So, that's been the marketing spin to more than a few of these mergers. We're going to combine forces, and this bigger platform will allow us to really invest in the bank of the future. And what happens is the age old merger playbook, which is, hey, we can squeeze some efficiencies out of this, and that's what the street actually sees and tends to measure them on is, all right, how much cost savings can you bring out of the new combined entity and how quick can you do that? And that is sometimes directly at odds with building the bank of the future with a bigger technology budget marketing spend that went with it. So, two divergent goals at play here.
Jim Young: Yeah. I'm curious too. He makes this comment, I'm not sure which bank it's directed at, where he says, basically, "If you merge financial insititutions, and it takes over 18 months to get that institution to a single brand, how can we really expect them to quickly transform digital customer experience?" And that gets me back to the whole thing we've always used about turning an aircraft carrier. Is it possible here that even if putting aside, and we'll get back to the Wall Street stuff later on, of how you're doing this merger, even if you say yes, and you really is about digital customer experience, is there a case that the scale actually works against you when it comes to this transformation?
Dallas Wells: Well, I think everybody has that experience of the larger the company, just the more layers of stuff there are to deal with, and it's just harder to move quickly. And when you add on top of that all the messy human realities of going through a merger, maybe it's possible that someday the two banks get to a place where they get faster, but maybe that's even not a realistic goal because it feels like they first have to get back to the speed at which they were already running. We've been right near the finish line with banks in our history as a software company selling to banks. We've been right at the finish line with a bank that's a prospect, and they announce an acquisition and it's like, well, everything's on hold. It's a universal nobody's to buy anything or make any decisions until we get sorted out how this is going to work.
And that's the tongue in cheek point that Jim is making there, which is changing the branding takes a year and a half. We've seen some of our projects take two years before they come back around. And okay, we're ready to get back to, now, where were we on that? And you've got brand new team and a whole new process and you essentially start over. So you go back to the beginning of the process. So it is a big delay in a lot of things, as you figure out who's running which group, what are the budgets going to be? How are decisions going to be made? What is the strategy? Those things take a lot of time to sort out.
So, I think this is a valid point that this article makes, which is forget the scale, forget the number of zeros involved in some of these. Just the sheer fact that you are emerging is a distraction from anything digital that was already in flight, much less all this brand new stuff that you see for the future. So long-term, who knows how these actually work out, but in the short term, there's no way to argue that this speeds up anything. It just plain doesn't.
Jim Young: Right. Right. Well then Marous gets into this point of you can talk about getting rid of legacy systems, but it's not going to essentially do you any good if you've got legacy leadership. And I took his point here, but I was curious about, is it the leadership that's the issue that's operating in an old school system of banking when we're trying to talk about new school digital transformation, or is it a little bit of what you were getting at, which is that Wall Street has these expectations that are about what can you get from me value wise for the next quarter? And it feels like, to me, transformation and innovation is often about saying, We're just going to do some short-term pain for long-term gain, and Wall Street doesn't really seem to be big about short-term pain. I guess I wonder when it comes to that, how much that affects your ability to do a merger maybe the way you'd really like to.
Dallas Wells: Yeah. Bank management teams are stuck in a really tough spot here. I think your question there really summarizes the essence of the struggle here when it comes to transforming a bank. It's not that nobody knows how to do it or what to do or what it would take. It's that the Street, or sometimes even the private investors are saying, "Look, you've got to modernize. You've got to become that bank of the future. You have to meet customers where they are now, but by the way, make sure you crank out acceptable growth next quarter from the prior quarter. Don't disrupt any of the existing business."
And that's kind of technology disruption in a nutshell, is it's really hard for the incumbents to keep up because they do have that core business to protect, to make sure it's profitable, that the investors actually have invested in and have expectations around the returns from that business.
So to start diverting some of those core cash flows and earnings into these investments, and they are that, and they are some short-term disruption and pain and earnings going away in some cases to bet on the future. That takes some gumption from a management team and a really clear mandate from their investors that it's okay and a really clear, well articulated strategy. And that's the part that maybe these mergers do help with it. It does those things of resetting expectations a little bit and saying, "Hey, the reason we did this is, yes, we can get more efficient, but we don't just want to get back on the quarterly treadmill." It is so that we can do something maybe drastically different because we feel like that's what we need to do to compete long-term.
So it's maybe a little bit unfair to poke at the leadership teams and say they're not good enough. He even had a quote in there of, "Maybe the best thing they could do is step down." Some of those experienced leaders have the reputations and the history of performance behind them. It's going to take those reputations and those histories and those good names to make this happen. So I don't know that that's actually the right answer. It's just going to be that it does have to be well articulated, and I think those trade-offs have to be clear. There is no free lunch. You do have to invest to make some of this stuff happen, and that's the part that we are seeing some management teams able to do that and they will differentiate themselves.
So there are some banks that have the leadership teams that can pull this off and are willing to do the hard work, maybe at the tail end of a career to take another flier, another leap of faith that this is the right answer and others that aren't, and they're the ones that maybe are just going to sell and not be the leadership team that survives. So I think that's part of what you're seeing in the pace picking up here and part of the point Jim is making is, hey, if you're going to partner up with somebody at least be clear, are you hitching yourself to the right wagon? Or are you confident, if you're on the other end of that, that you do have the leadership team that can take those brave and necessary steps to do true transformation to what's next for this industry?
Jim Young: Yeah. Yeah. I guess I'm left wondering a little bit, based off of all the difficulties we've just outlined there. We spent time on previous podcasts talking about all the difficulties again of when you don't have scale and you don't have that sort of thing and maybe you don't have the ability to pursue a project in the back room with 60 developers that doesn't really actually affect your bottom line, but could be a good long-term thing to pursue. But then I'm also wondering now, maybe if you all are a bit smaller, a bit more nimble and maybe a bit more free from Wall Street expectations, maybe you can say, "Yeah, we're going to bite the bullet and we're going to go this direction," because A, maybe you're a leader of a smaller institution and you've got more clout, or B, you just don't have so many different things pulling on you from the outside.
Dallas Wells: There certainly is some need for scale. And I think the question is just, well, how much is really enough? The very largest banks in the U.S. each individually have bigger engineering teams than Microsoft does. So at some point, that's no longer an excuse, that you don't have the tech budget or the engineering and developer talent to actually build the next new thing. You absolutely do. It's how much of that talent and how much of those budget dollars feed and care for everything legacy, systems, processes. And that's what Jim is digging at here, is it's not just about scale. You've got scale in these deals that we're talking about. So the community banks, yeah, they have zero developers, much less five that they could pull aside and do some skunkworks. But these regional banks that are doing these multi-billion dollar mergers, they all have dev teams maybe bigger than ours and we're building the solutions that they're buying.
So it's about choosing some of those allocation of resources between old and new. To get it out of the banking thing, what we're really talking about here is Blockbuster Video. They protected the old franchise and the earnings and cash being thrown off of it, all the way down the slide to being swallowed by Netflix, et cetera. Bankers don't want to be caught in that, but they also don't think they're quite there yet. So that's the turning point that Jim is asking if the industry is at, is are we there where this should maybe be a little more urgent and you should ignore some of those quarterly earnings expectations to do what is right?
Jim Young: Right. Got you. Okay. Let's turn to, I guess this topic wouldn't be here. It's just not going to be the full second half of this thing, but it's something I just wanted to touch on here, which was a article that appeared in S&P late last week saying US banks loosen credit standards as they look for loan growth. That's not a super shocking sort of thing, but I was just struck by this because we talk about the pendulum of how things swing back and forth from tightening and not doing as many deals to loosen and trying to do more deals and that sort of thing. Is this just a matter of the pandemic? We talked about tightening last year and now it's, okay, things look a little bit better. So it's time to loosen up.
Dallas Wells: I think that's exactly what it is. It is the pendulum swinging. Two interesting things here. So first of all in this article, they do a good job of laying out ... The way this stuff gets reported is, it's changed since last time. And since last time, are you a little looser than you were before? So you're catching a whole bunch of banks that were very much on the sidelines saying, "All right, we're not fully on the sidelines. We have a toe on the field now." And it shows us this giant loosening of standards from that stand still. We saw a similar effect after the financial crisis, where banks were tiptoeing back in, but the percentage changes were huge. This article lays out really well the fact that we're still not back to the easiness of credit standards from before the pandemic.
So in other words, things got tight and they've loosened up a little bit from that really tight spot, but they're not yet back where they were. The pendulum got pulled really far in one direction, and it's now in the process of swinging back, but it's not even yet back to even. So the second point there is that I think there's a lot more of this to come. We just recently had a meeting with our client advisory board, so some of our top clients sitting down with us and talking product roadmap and industry issues. And the number one thing for every single one of them pretty much universally was where do we go for loan demand? So, what that tells us is that those standards will loosen. Of course, none of them think they're going to be the ones to loosen the standards. It'll be everybody else, but that's how this works. So eventually to keep pace, everyone will get a little looser.
Already in the syndicated loan markets, those standards have been loosening quite a bit pretty quickly. We're starting to see that in the bilateral markets as well. And I think more of that to come as summertime comes, as another earning season comes around and there's still lackluster growth, what you'll see is executive teams start to really push the envelope and push expectations on their frontline teams to deliver. So we will see probably the pendulum swing, like it typically does, past that starting point to make up for lost time or lost expectations along the way.
Jim Young: We've talked a little bit in the past about, to be fair, a little bit of a pendulum swing is kind of a pejorative phrase and a little bit of a negative slant in terms of an inefficiency. You're going a little too far in this direction, and then you swing a little bit too far back in that direction. And I guess in this situation though, thinking through the pandemic and what you just described, it seems to me to be either understandable or logical on this, or do you have any concerns that again banks are being a little too reactive?
Dallas Wells: No, I don't think they're necessarily being too reactive. This will be a test of their ... We talked agility in terms of technology. This is a test of their ability to be agile in terms of strategy. And I think it was necessary to be able to quickly stop, assess what the potential damage and potential risks really were, and then when it looks like things are at least to an acceptable level of risk, you plug the apparatus back in. That's not easy to do in short timeframes and at scale. So I think it's been the proper reaction. There will be losses that come out of this. There will be some bad deals that get put on the books that got put on because they were a stretch. Banks were stretching for growth. And one really interesting thing, again, as we talk to our clients and they're measuring by business units, some of their business units, the small business banking areas with PPP production, if you include that, that they did over the last year, they did like five years worth of typical production in a year.
So what they're really wondering is how much future demand did we really just pull forward into PPP because it was super favorable terms and essentially in many cases, government grants. So are we going to add way too much risk if we expect loan generation to just go back to a normal pace when we just did the next five years worth all at once? Maybe there's not that much to be had. If you put capital out there and you put capital out there at easy terms, somebody will use it and they'll use it on stupid projects. So there are some losses coming, and I think banks need to be conscious of that.
And that's the strategy discussion that we're having with clients now is, what is the right place on that risk tolerance scale? How loose do we get with standards? How aggressive do we get with pricing? Because we have all this liquidity sitting around, we have all this need to re-engage earnings and there's not real what feels like viable loan growth out there to drive those things. So either what do we do instead, or how hard do we chase it? That's the big question. And no easy answer to it.
Jim Young: You don't think that you could just get on an earnings call and explain that to investors and say, "Listen"-
Dallas Wells: It seems reasonable, right?
Jim Young: Yes. Everything you just said makes total sense to me. Like, hey guys, just cool it on our loan growth for a couple of years and then we'll be back to normal.
Dallas Wells: Yeah. Give us a couple of years, and then all will be well. Yeah, I don't think that would be received too well. I mean, that's the conundrum.
Jim Young: But then you could just spend that time doing your digital transformation. And see, we just tied it all into a nice bow.
Dallas Wells: Yeah. I'm not sure why this is such a struggle. It seems so easy.
Jim Young: So clear to me. All right. Well, thanks Dallas, for coming on and tackling not just one but two topics on this week's podcast.
Dallas Wells: Yeah. I'll send you double the usual invoice. So, appreciate it.
Jim Young: And thanks so much for listening. And now for a few friendly reminders. You want to listen to more podcasts, check out more of our content, you can visit the resource page at, or head over to our homepage to learn more about the company behind the content. If you like what you've been hearing, please make sure to subscribe to the feed in Apple Podcasts, Google Play, or Stitcher. We love to get ratings and feedback on any of those platforms. Until next time, this is Jim Young for Dallas Wells, and you've been listening to The Purposeful Banker.