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BankBosun Podcast | Banking Risk Management | Banking Executive Podcast

BankBosun is a biweekly syndicated audio program that provides the multi-tasking bank C-suite officers ideas and solutions from key executives from all types of businesses operating in the banking ecosystem. BankBosun provides relevant ideas and solutions clearly, concisely and credibly to better enable them to navigate risk and discover reward. Kelly Coughlin is a CPA and CEO of BankBosun, a management consulting firm helping bank C Level Officers navigate risk and discover reward. He is the host of the syndicated audio podcast, BankBosun.com. Kelly brings over 25 years of experience with companies like PWC, Lloyds Bank, and Merrill Lynch. On the podcast Kelly interviews key executives in the banking ecosystem to provide bank C suite officers, risk management, technology, and investment ideas and solutions to help them navigate risks and discover rewards. Kelly earned his undergraduate degree (BA) from Gonzaga University and a master’s degree in business administration (MBA) from Olin Graduate School of Business at Babson College in Wellesley, MA. Kelly lives in Edina, MN.
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Dec 29, 2016

Kelly Coughlin:

The Chinese have a phrase. If you want to kill the tiger, masquerade yourself as a swine. He who poses as a fool is not a fool. The best way to be well received by all is to clothe yourself in the skin of the dumbest of brutes.

Announcer:

Kelly Coughlin, CEO of BankBosun, a management consulting firm helping banks C-level offices, navigate risks, and discover reward. He’s the host of the syndicated audio podcast bankbosun.com.  Kelly brings over 25 years of experience with companies like PWC, Lloyd’s Bank, and Merrill Lynch.  On the podcast Kelly interviews key executives in the banking ecosystem to provide bank C-suite offices risk management, technology, and investment ideas and solutions to help them navigate risks and discovery reward.  Now your host, Kelly Coughlin. 

Greetings. This is Kelly Coughlin, CEO and program host of Bank Bosun, helping banks C-Suite executives manage risk, regulation, and revenue in a sea of threats and opportunities. You know, 100 years ago the risk environment of the banking world was much different than it is today. The Federal Reserve System was established only a little over 100 years ago in 1913. There were about 26,000 banks back then compared to about 7,000 today. In fact, Citibank only had about $1 billion in assets back then compared to $2.6 trillion today. And the risk profile of bad guys – criminals - was much different, too. Charles Ponzi was launching his famous scheme to turn a profit by manipulating international reply coupon systems in which he'd buy stamps in one country, and then sell them for profit in another. He defrauded investors of about $20 million, $220 million in today’s funds, and destroyed six banks in the process. And then in 1925, the famous Victor Lustig convinced a bunch of investors to give him funds to purchase the Eiffel Tower for scrap metal. He even convinced Al Capone to invest $50,000 in another bogus scheme. Lustig returned the funds to Capone, who was so impressed with him that he let him keep $5,000 of the original $50,000. Of course, that was Lustig’s plan all along. That's all he was looking for.

Today’s criminals, however, are different. Yes, we still have bank robbers. The FBI reports that U.S. has about 5,000 per year. But the bigger risk today is in the cyber security and social engineering area. Cyber security, of course, is new. We didn't have computers or Internet 100 years ago. Technically, though, social engineering is not new. The definition of social engineering is the clever manipulation of the natural human tendency to trust, but the tactics and methods used today are much different than in the days of Ponzi and Lustig and Jessie James. These methods involve strange names like dumpster diving, email phishing, vishing, pretexting, baiting, and piggybacking, just to name a few.

My guest today is a recognized expert in today’s version of social engineering. His name is Kyle Konopasek, and he works in the Business and Technology Risk Services Group of CBIZ MHM.

The stated mission of CBIZ is to help clients prosper by providing them with professional business and individual services to better manage their finances and employees. To accomplish that, CBIZ has three operating practice groups, one of which is Business Services, and that's where Kyle operates out of, in their Kansas City office. The specific mission of Kyle, however, is to assist clients in the internal control areas related to information security, cyber security, vendor management, and of course social engineering. Kyle has a BS in accounting at Rockhurst. He is a certified internal auditor. He lives in the great city of Kansas City, home of some of the best barbeque in the country. So, I want to start off with the most important thing and get that out of the way. Kyle, what is your favorite barbeque restaurant in Kansas City?

Kyle Konopasek:

That's kind of a loaded question, Kelly. I actually had Joe’s KC Barbeque today for lunch. Used to be known as Oklahoma Joe’s. Don’t understand why they changed that iconic name to Joe’s KC, but it's still pretty darn good. But you know what? There's a smaller, a little bit lesser-known barbeque restaurant in town called Smokehouse Barbeque, and that's actually my favorite.

Kelly Coughlin:

Smokehouse Barbeque? Where is that located?

Kyle Konopasek:

Well, they've got just a few locations around town. They've got one up in Gladstone, Missouri, one out in Independence, Missouri, and then there's another one over in South Overland Park, Kansas.

Kelly Coughlin:

Okay. I'll have to give that a go. Well, now that we've got the important things out of the way, let's get down to business here. First of all, did I get your bio correct, and was there anything that I said in my introduction that was either wrong or you disagreed with?

Kyle Konopasek:

Not at all, Kelly.

Kelly Coughlin:

Why don’t you tell me what your definition of social engineering is? I think I took my definition frankly from a Power Point that you had, but is there anything you wanted to elaborate on in terms of the definition of social engineering? Especially related to the cyber security world.

Kyle Konopasek:

Yeah. Kelly, you did mention the technical definition of social engineering earlier. However, we can elaborate on what social engineering is and what that means a little bit further. In some of the speaking engagements that I have with some of my clients and various organizations around the country, we usually talk about what our children do to us. If you think about it, even just a small child, a toddler, a three- or four-year-old, take them to the grocery store, you push them in the cart through the grocery store. Oh, Mommy, Daddy, I want this. Mommy, Daddy, I want that. Well, you tell them no a few times, and then they begin to find other ways to try and manipulate Mom and Dad into how to get that item that they want. We start performing acts of social engineering, every one of us, very early on in life without really understanding what it is. And I think that's very important to distinguish, because social engineering, as you stated, is not new at all.

In fact, we all do it without really understanding or comprehending that it is social engineering that we're doing. We may not necessarily be trying to manipulate one another for bad intent, but we often use different shades of social engineering, if you will, to try and get certain things that we want. And quite frankly, social engineering is ancient in its methodologies. The Trojan, with the whole Trojan horse scenario, that's really social engineering. Hollywood loves to depict examples of social engineering in its movies. Just to name a couple of better-known social engineering oriented movies, Catch Me If You Can, with Leonardo DiCaprio, about the story of Frank Abagnale. Sneakers, with Robert Redford. Those are both excellent movies that depict in every facet, different types of social engineering.

Now, when we talk about social engineering, sometimes, people get confused as to how that relates to cyber security. Cyber security and social engineering are very tightly linked together. However, we like to take it up one more level when we think about the two. We think of this large bubble called information security, and within that large bubble of information security, there are other bubbles floating around inside, one of which is social engineering. Another one is cyber security. Another one is vendor management, and you can continue to break it down into subsets of bubbles within the information security bubble. So, that's important to point out, that they are related, but they're not one and the same. For example, email phishing is one type of social engineering that is widely understood, but many people still describe that actively as a cyber security breech or a cyber security issue. You can definitely blur the lines between those two, and there is a gray space there. But email phishing at its heart belongs to social engineering.

Kelly Coughlin:

What are the main motivations for social engineering attacks? Is it always financial gain? Or on the other side of is it harm? Or is it a competitive advantage? Or do we get personal vendettas or that part of it, too?

Kyle Konopasek:

In the business world, Kelly, really all of those are examples that you mentioned of motivators for performing an act of social engineering. Social engineering is essentially a grouping of attack vectors that an attacker can use to attempt to not necessarily defraud an organization, but start to build a dossier of information about that organization for the purpose of executing a much larger attack. And when I say a larger attack, it can be in terms of dollars or it can simply be in terms of volume of information obtained. For an example, email phishing might be a starter for a social engineering attack to build that larger dossier of information. The attacker would be hoping that perhaps yourself of myself would be willing to click on a link in an email to take us to a website that was built to mock a website that maybe we're familiar with or maybe that we would typically trust. In reality, they're wanting to get one piece of information from us. The attacker wants to have login credential information to our networks, our systems, within the workplace.

They don’t really care what other information we provide, but sometimes we provide additional information that they don’t really ask for but help them to build that case. For instance, if I then provide them with a user name and a password or other types of login credentials to a network or a system, they obviously can then use that information to assist them in hacking into that system. The word hacking from an information security perspective or cyber security perspective is somewhat clouded by the fact that social engineering methods and techniques are many times one of the leading methods used to get to a “cyber attack” to “hack” into a system. There aren't that many individuals that are literally sitting there in front of their laptop computer, trying to brute force hack their way into a network. Social engineering is a much easier way, because what we're looking to do is just very easily and inconspicuously have the victim, or one of the victims, provide us the information that we need to do our bad work, to do the attack. And from that perspective, social engineering is very useful to a more intelligent attacker. And that's quite honestly, why so many foreign entities are using social engineering to get sensitive information.

Kelly Coughlin:

Give me some examples of that. Keep in mind, the audience is community and regional banks. What are some of the techniques? What are some examples that you've seen where this manipulation occurs successfully?

Kyle Konopasek:

Well, email phishing is the low-hanging fruit in terms of an example for a social engineering attack. Many of us have seen that on a personal level as well. But yes, vishing, starting with the letter V, vishing is a legitimate social engineering attack method. And vishing is the telephone equivalent of email phishing. It's simply picking up the phone and perhaps pretending to be someone with a help desk or with, perhaps it's an outsourced company that the financial institution has engaged with, that caller is hoping that the person that picks up that phone is going to feel pressure to provide them an answer that they're asking for. It might be that they're going to try and elicit an attack based on patch management, for example. Maybe I work for a third-party data management company and I call XYZ Community Bank and I call Sally. And Sally answers and I tell her, Hi, I'm Kyle with ABC Data Management Services. We see that your desktop computer didn't have the patches updated on it last week. All the other terminals did. We can take care of that patch for you right now if you just provide us with your user name and password for your desktop computer. That way, you don’t have to mess with it and you’ll be able to continue doing your work.

Kelly, it's something as simple as that. While the broader population might scoff at that scenario and think that it's not possible, the social engineering attackers needs one person, and you'd be surprised that many, many times, people fall for those attacks because a, again remember the true definition of social engineering, the natural tendency, the manipulation of the natural tendency to trust one another. They don’t want to inconvenience another human being from doing their job, or what's perceived to be them just doing their job. They want to do something that's helpful to them. So, therefore, the pressure is enough to where they just provide the information and hope that their day can go on without any further interruption, and that that person that in perception, is on the other end of the phone, trying to get information is truly trying to help them out. That's one example.

Kelly Coughlin:

Well, I've never had that kind of luck, because if I get a bounced email from like a CFO or a CEO and I try to call secretary and say, hey, what's Joe’s email? I got a bounced one. And they won't even give that to me. So, I'm not a very good hacker, I suppose. I'm going to do a quiz for you, Kyle, since you started showing off on some of these terms. We're going to play Jeopardy! with Kyle. Dumpster diving.

Kyle Konopasek:

Dumpster diving is literally me and/or my crew, our staff, getting into the large metal dumpster out in the parking lot behind the financial institution, in the middle of the night, usually. This is one of the more intriguing services that we provide. And again, keep in mind as I describe, social engineering is about getting tidbits of information through different attack vectors and building that dossier of information. In a dumpster dive, going out in the middle of the night with the rubber gloves on—yes, Kelly, I carry latex gloves with me at all times, and I travel a lot. The TSA hasn’t said anything yet, but one day they will.

Kelly Coughlin:

What are you diving into the dumpsters for?

Kyle Konopasek:

We're actually getting in the dumpsters and looking for things like social security numbers, bank account numbers, anything like that. And you might say, well, what financial institution’s putting that kind of information in the trash? A lot of them. We have had so many clients over the years where this is the first test that they fail. When they ask us to come in and perform social engineering testing, this is the first one they fail. And many of them fail it miserably.

Kelly Coughlin:

You're diving in as your internal audit function.

Kyle Konopasek:

Absolutely. Kelly, you know, one of the things that, from a dumpster diving perspective that I think is really important to stress is that documentation as simple as a phone listing for the organization or an email listing for an organization, because they have a whole listing of people they can call to try and perform vishing on. Or even a vacation schedule for an executive or senior management person, because then they know that person’s gone for that period of time. In addition to that obvious personally identifiable information like social security number, account number, it's that other often overlooked information that becomes valuable. And let me tell you, just shredding that information and then putting it in a trash bag and putting it in the dumpster’s not good enough. We have taken shredded material from a dumpster, laid it out on our conference room table and taped it back together, and we have found full listings of user names and passwords that employees have kept over the years for access to not only their own systems and networks, but for some of their customers’ trust accounts. We've tested those, and they've been active. The amount of information that's out there is absolutely astonishing to me, and how easy it is to come across in a dumpster is even more terrifying to me, just as a human being.

Kelly Coughlin:

That's amazing. All right. So, next question. What is phishing?

Kyle Konopasek:

Phishing with a P. Kelly, that generally, when it's mentioned by itself, refers to email phishing, and that is essentially, you're receiving that unknown email or that unexpected email in your inbox that looks like it might be from someone that you would expect, but upon further inspection, if you really look, like if you hover your cursor over the link to the website that it wants to take you to, if you look at the URL address, it's actually going to take you somewhere else, which would be typically a website that was built specifically to look like XYZ Community Bank’s website. Vishing is the telephone equivalent of email phishing. Same thing, except that I'm picking up the phone and I'm calling you, trying to extract as much information out of you as I can. Maybe it's just to find out if Kelly’s out of town for the next two weeks.

Kelly Coughlin:

What is pretexting?

Kyle Konopasek:

Pretexting, that's the Hollywood that we like. The Hollywood version of social engineering is where we are basically disguising ourselves to walk in face-to-face and try and gain access to a secured area of a financial institution, whether it be the vault or the telephone closet or the server closet or the surveillance system. You would amazed at how easy it is to gain access to secured areas of financial institutions through pretexting.

Kelly Coughlin:

What is baiting, B-A-I-T-I-N-G?

Kyle Konopasek:

Baiting is when you would take a USB thumb drive or a CD, and you would pretend to put information on that media. If you're a true attacker, what you would put on that media would be some type of a virus or malware, but the key behind the baiting piece is that you write on the cover of the CD, it says, Bank Bosun 2016 annual bonuses. Or maybe you put the USB thumb drive in an envelope and you write something conspicuous on the outside that might get someone’s attention, and then you leave that item in a conspicuous place, in a hallway or on the corner of a desk or a conference room table, because what you're hoping is that a curious eye is going to catch that and say, oh, I want to know what so-and-so’s making. Well, that put that item in their CD drive or their USB port, and once they open up that file, bang. That virus has been installed, and they don’t know it. But in reality, there's nothing on there. So, that's all we're trying to do with baiting, is get that virus on there so they can then phone home and tell us all the information. Maybe it's a keystroke logger so we can user names and passwords that are put into that terminal.

Kelly Coughlin:

Wow. What is piggybacking?

Kyle Konopasek:

Today would be a good day to do piggybacking, Kelly. It's about 18 degrees here in Kansas City. Maybe I want to go piggyback into a multi-tenant building. Smaller organizations with a few employees are not as easy to perform this test with, but if there are more than 50 or so employees, it's generally possible. Basically, take a cold day like today, have a heavy backpack over one arm and maybe have a box of donuts or something or a coffee in the other hand. And then, you're trying to watch for someone to come in through a secured exterior door, as an example. What you're wanting them to do is just hold that door open for you, because your hands are full. It's cold. They don’t want to leave you out in the cold and make you get our your keycard to badge your way in. This can happen inside, as well. Again, the more employees, the better, because they don’t necessarily know all the faces, and they're more willing to trust strangers.

Kelly Coughlin:

Okay. Now, the trick question. What’s the difference between phone phishing and vishing?

Kyle Konopasek:

No difference whatsoever, Kelly.

Kelly Coughlin:

That was the trick question. Good job. All right. I give you 100% on that. Where are the biggest human vulnerabilities? Is it new employees? Is it the older employees that, presumably are less tech savvy? Or are they the younger, heavy tech users that are certainly more tech savvy, but because they use it more? Or is it kind of the third-party consultants that are working inside a bank? Do they create more vulnerabilities?

Kyle Konopasek:

Based on statistics that we know of, anyway, new employees are the number one weakness for falling for social engineering attack. The reason why they don’t want to do anything to disrupt the culture of their brand-new employer. They don’t necessarily know everyone. They don’t necessarily know if the person sitting next to them is a person of importance or not. May or may not be. They're more likely to both fall for email phishing, vishing, and occasionally face-to-face social engineering attacks, just from the perspective of not understanding the culture, not being completely versed to all of the policies. And also just wanting to please everyone. As a new employee, you want to be a pleaser. You want to come across as positive and liked and all those good things. From that perspective, new employees are the number one threat. After that, it's third-party service providers. It might not necessarily be your auditor that's coming in once a year, but think about all the other vendors that are engaged to do business with the financial institution. It's not necessarily just IT vendors, either.

That's the other issue that we run across is that so many organizations want to focus on all of the vendors that they use to outsource IT to. It might be a data center, but it could also be a payroll company. Payroll companies have access to a lot of information. Let's not forget about the sensitive information of our own employees. It's not just our customers, but also our employees. So, we need to be cognizant to that as well. New employees and third-party service providers are the top two most likely to fall for a social engineering attack. The way that someone outside the organization would find out that there's new employees that have been hired on? Dumpster diving. There might be some on boarding information that got in the trash and shouldn't have been. You can kind of start to see how all of these different types of social engineering attacks work together to build that bigger dossier of information for a larger type of attack. I think it's important for all employers of all sizes to have some form of consistent and periodic information security training. If those employers are providing that training, then it is appropriate to test those employees. And when we do social engineering testing, we have to be very clear, because we are not testing to identify the bad eggs within the employee group. That is not the point. Social engineering testing, or any types of test on information security, is designed to identify weaknesses in the culture, in the policies, the procedures that are performed. The employees are just the vessels by which those items are implemented and executed.

Email phishing tests. Those are an easy one, fairly expensive for an organization. They can even be done internally by the organization. Spending $25 on a domain name, a website domain name that looks similar to a financial institution’s actual domain name and then setting up a fake website. An example of a good fake website to use in an email phishing campaign would be from HR, or if there's some type of HR function. Send out an email to a group of employees that says, good afternoon. We have just implemented a new human resource information system, and we want to make sure that all of our vacation accrual balances are up to date. Why would we choose vacation accrual balances? Well, because it's something that is impactful to the employee as an individual. They want to make sure they get their vacation time.

That email phish is going to go out with a link to that fake website, and what we're trying to see is if those employees actually click that link and then, do they actually go to that website and enter in their user name and password that we've requested so they can get to that fake website. Well, they're doing it in the hopes that they can make sure their vacation accrual’s correct. We just want to see if they're following policy. And again, if they fail, and nine times out of 10, they do fail, it's not a poor reflection on that individual unless they fail that same test 15 times. It's more a reflection on the level of effort and quality of the information security training that management has provided to those employees.

Kelly Coughlin:

Now, I assume that you guys at CBIZ MHM have engagements where you’ll do training, testing there, too, if that's called for?

Kyle Konopasek:

Yes, absolutely. From the training perspective, we actually partner with a company in Minneapolis named InteProIQ. They do a lot of online information security training for organizations of all sizes. Then, we come in and test how employees react after having that training. Sometimes, it's valuable to do a test before the training and after so that you can then compare to see if there's been improvement in the employee base in terms of how they handled those types of attacks, breach efforts. Then, kind of the third leg of that is cyber security insurance. CBIZ Property and Casualty does provide cyber security insurance, and that's also a key component. If an organization performs social engineering testing and jumps through other certain hoops, many times, they can get a discount on their cyber security insurance if they've demonstrated that they have gone through tests of controls and that they have validation that controls work.

Kelly Coughlin:

Why don’t we wrap it up? What's your favorite dumpster diving story? Where you were in a dumpster and you're thinking, what the heck have I done with my career? What am I doing in a dumpster?

Kyle Konopasek:

Well, Kelly, honestly, our CBIZ office here in Kansas City has about 400 people that work in our office space. In our financial service division where I am, there's about 150 to 200 people, so, I think that just to kind of give scope to the workplace. Now, most of the people on our financial services division are traditional audit and traditional tax CPAs. I am not, obviously. From this phone conversation, you've learned that. However, when we talk to our internal management about some of the services we offer and we mention dumpster diving, we just get these cold, blank stares, because they're wondering how in the world is a CPA firm paying us to go out and get in our clients’ dumpsters? And do our clients actually value that? Well, they absolutely do, and the reason why is because we're in harm’s way, Kelly.

We've found ourselves in large dumpsters that, come to find out, are actually big trash compactors. And then once we learn that, we do everything we can to scramble out of that dumpster as quickly as possible. We've been in that situation before. Fortunately, those trash compactors have not turned on, but those are the types of stories and little details that sometimes we don’t tell management about. Another dumpster diving story that we've kind of run across is that in speaking with local law enforcement, they actually encourage us to carry handguns, because some of the different areas, not just Kansas City, but all across the country that we do this work, they're not in the best areas. And we're also doing it late at night. Do we carry handguns? Absolutely not.

Kelly Coughlin:

Well, you haven’t seen any dead bodies in the dumpster, have you?

Kyle Konopasek:

No. We have not seen any dead bodies in the dumpster. We found some deer parts during hunting season.

Kelly Coughlin:

All right. That's just, that's terrific. I really appreciate your time on this. How can people get ahold of you? CBIZ has got, I don't know, 1,000 offices, I can't remember the number, all over the country. Are they best just to contact one of the local offices and then they get directed to you? Or do you want them to call you?

Kyle Konopasek:

You know, it's best if they just call me directly, because our Kansas City office is the primary location for this particular type of service. My direct number is (816) 945-5512, and I can certainly be reached by email. My CBIZ email address is my first initial K, and my full last name spelled out, Konopasek, which is K-O-N-O-P-A-S-E-K at CBIZ.com

Kelly Coughlin:

That's excellent. All right, Kyle. You're the man. I really enjoyed it. Thank you for your time.

Kyle Konopasek:

Kelly, thank you very much.

Announcer:

We want to thank you for listening to the syndicated audio program bankbosun.com.  The audio content is produced and syndicated by Seth Green, Market Domination with the help of Kevin Boyle.  Video content is produced by The Guildmaster Studio, Keenan Bobson Boyle.  Voice introduction is me, Karim Kronfil. The program is hosted by Kelly Coughlin.  If you like this program, please tell us. If you don’t, please tell us how we can improve it.  Now, some disclaimers.  Kelly is licensed with the Minnesota State Board of Accountancy as a Certified Public Accountant.  The views expressed here are solely those of Kelly Coughlin and his guests in their private capacity and do not in any way, represent the views of any other agent, principal, employer, employee, lender, or supplier.

Dec 24, 2016

Kelly Coughlin:

Two horses were carrying two loads. The front horse went well, but the rear horse was lazy. The men began to pile the rear horse's load on the front horse. When they had transferred it all, the rear horse found it easygoing and he said to the front horse, "Toil and sweat. The more you try, the more you have to suffer." When they reached the tavern, the owner said, "Why should I feed two horses when one horse carries all? I'd better give the one all the food it wants and cut the throat of the other." And so he did.

Fables - Leo Tolstoy.

Narrator:

Kelly Coughlin is CEO of BankBosun, a management consultant firm, helping banks see level offices, navigate risk, and discover reward. He's the host of this indicated audio podcast, BankBosun.com. Kelly brings over 25 years of experience with companies like PWC, Lloyd's Bank, and Merrill Lynch. On the podcast, Kelly interviews key executives in the banking ecosystem; provides banks' C-Suite officers, risk management, technology, and investment ideas, and solutions to help them navigate risks and discover reward. Now your host, Kelly Coughlin.

 Kelly Coughlin:

Good morning, everybody. This is Kelly Coughlin, CEO of BankBosun. Helping bank C-Suite executives navigate risk and discover reward. Competing for and retaining high quality executive and senior management talent, requires a combination of a good fit between a company and the people in the following three areas. I call them the Three C's: Culture, Capabilities, and Compensation. Today is related to compensation.

Certainly, base cash salary, cash incentive compensations are the easy components. When you get into additional forms of compensation that begin to address the unique needs of both the company and the individual - and these needs could be tax planning from both the employer and employee perspective; cash management - again, from both perspectives in terms of cash disbursement needs and cash receipt needs, and long-term legacy in the state needs. You begin to get into a more complex world that requires the expertise of professionals to help create structure and implement suitable plans.

Frequently, these are referred to as non-qualified benefit plans and they address the needs of both the employers and the employees. In the previous podcast, I interviewed David Shoemaker, President of Equias Alliance, who talked about how banks can create non-qualified benefit plans to help the bank recruit and retain executives. And then they fund these plans with bank owned life insurers. Today I'm going to interview Greg Ochalek Greg is the National Director of Non-qualified Benefits Consulting at CBIZ Retirement Plan Services. He has over 25 years' of experience in the consulting expertise with Fortune 1000 companies.

The mission of CBIZ is to help the clients prosper by providing them with the professional business and individual services, products, and solutions to better manage their finances and employees. And to accomplish this, CBIZ has three operating practice groups. One of which is employee services and that's where Greg operates out of. Greg has got a degree in economics. He used to work at Arthur Andersen. I'm going to let Greg pick it up from there. Greg, are you on the line?

Greg Ochalek:

Yes I am, Kelly. Good morning.

Kelly Coughlin:

You're up in Cleveland. How's the weather today?

Greg Ochalek:

Well, that's another story. We're having some big storms up here, but it's pretty typical being this close to Lake Erie. Getting all that lake effect weather. We've actually had some huge car pileups on our shore way and that's something we're dealing with now.

Kelly Coughlin:

Greg, anything else you want to add to the short bio I presented there?

Greg Ochalek:

Sure. To correct it, I've been specializing in non-qualified executive benefits for over 25 years. I got my start and training at Arthur Andersen in their Los Angeles office, when I was asked to be a member of the Charter Executive Financial Planning team. Part of the Executive Financial Planning led me into dealing with the non-qualified benefits that were made available to the executive group. It was during that time at Arthur Andersen that I really started to focus on it and actually became the west coast specialist for Arthur Andersen for a number of years while I was there.

We helped clients in the design of non-qualified plans. We consulted with them on accounting issues, tax issues. We helped our clients in analyzing different funding strategies to consider what would be best for a particular company. The administration of non-qualified plans is a lot different than administration for qualified plans, so we had to become familiar with the different types of administrators who are in the marketplace, so that we could recommend the best type of administration for our clients based on their need.

For the past few years I've been working with CBIZ for two years, as an outside resource to them for their plan and for plans of their clients. It was just in April of this year that I was asked to come inside of CBIZ, be part of the team and I accepted the position as National Director of their Non-Qualified Benefits Consulting firms. That's where I am today and it's been a lot of fun.

Kelly Coughlin:

Great. Well, let's get right into it here. Is there a typical company profile, bank profile, that you think they should begin to look at some sort of non-qualified benefit plan? Is there a profile based on assets, or business lines, or revenue size? Is there anything that strikes you as being kind of a trigger point that a bank would look at?

Greg Ochalek:

I think it's a very good question. The answer really is, that a bank is still a corporation or a business that has similar needs as companies in other industries. As it applies to non-qualified benefit plans, specifically volunteering deferral plans and supplemental executive retirement plans, banks really are not any different than other companies and other industries. These types of plans are really suited for mostly public companies or at least companies that are for-profit companies, that are paying taxes, because the benefits of the non-qualified plans really is heavily weighted for tax benefits.

If you're a company that's not paying taxes, then a lot of these qualified plans may not be as suitable for those types of companies. We like to deal with banks and companies that have at least ten to 15 highly compensated or management people that would be considered participants for the plan.

Kelly Coughlin:

Okay. Why public companies?

Greg Ochalek:

Because public companies are owned by a wide variety of shareholders. The corporation really is an entity that stands on its own. When you have companies that are privately owned, you may have only one or two owners of those companies and a lot of times, those companies are set up as pass-through entities so, all the tax benefits, the deferred tax savings, would end up flowing into individual tax returns. And it's a heavier burden for companies that are private, that are owned by a few people, to carry those deferred tax savings over a period of time. As opposed to a corporation that have a long life ahead and can carry the burden of deferring their tax savings.

Kelly Coughlin:

Okay. So I'm going to summarize what I heard you say. No, there's no typical bank in terms of assets, business revenues, but ideally, profitable. Ideally, it's not a sub S bank, but a C corporation that's held by more than the executive management of the company.

Greg Ochalek:

Yeah, that's correct. Let me clarify one point on non-qualified plans. That is that when a non-qualified plan is put together and participants are deferring dollars into the plan, or if the company is promising to pay a benefit in the future, that benefit or those monies that are being deferred, are not taxed currently to the planned participant. At the same time, the company does not get a tax deduction like it does with a qualified plan.

An example is, a 401(k) plan, people can defer money into it but the company gets a tax deduction in the current year. In a non-qualified plan, the company does not get that tax deduction, it defers that tax savings into the future and that's what I was referring to.

Kelly Coughlin:

What is your business model there at CBIZ? What's your business process? How does it work?

Greg Ochalek:

Well, first of all, I'd like to discuss the events that would trigger a reason why people would create these plans for their bank and for their company. That usually is when you have a company or a bank that you may be losing some of your key people to your competitors, or if you are going to be increasing your executive talent internally and you're trying to attract key talent into your company. These types of plans are very good for doing that because there are benefits that could help them personally, financially. It's just a way of helping them manage their compensation to benefit their families and them personally.

Also, there are companies that have discrimination testing issues with their qualified plan. Where a plan participant may not be able to put in the full amount into the qualified plans because of the discrimination testing issues, or you may have executives that are putting the maximum they can into their 401(k) plans and they have other dollars that they'd like to put away on a deferred basis. It's these reasons that are the main triggers for putting these plans in.

Now, when companies identify these events and are looking for solutions, that's when we can step in and help them. The way that we're set up as a company and what our platform is, is that we really try to have an unbiased approach to designing these plans and recommending things for our clients. We have what we call an open architecture platform. The open architecture performs on two levels. The first level is with the plan administrator of the non-qualified plan we have eight, nine, maybe ten different administrators that we work with across the country.

Now, each of those administrators have designed their platforms for certain markets. Depending on the size of the bank; where it is in the country; what it's trying to achieve one administrator might be better than another. We actually help our clients select a plan administrator and going through an interviewing process to determine which would be the best plan administrator.

Kelly Coughlin:

In the interest of full disclosure, the company I do work with, Equias Alliance, could potentially be one of those administrators.

Greg Ochalek:

Yes, absolutely. Especially in certain areas more than others. Equias has a great reputation in the BOLI market and accessing those types of investing products. We would work with Equias for those types of situations. Part of our platform is to help banks and companies go through an investment analysis, so that they would have the information, be able to make a decision on whether they should even fund these plans at all. Some companies have these plans and they go unfunded. Most companies will actually fund the plans, but they have to make a decision what they're going to fund using managed funds or using a tax advantaged vehicle like a bank owned, or a corporate owned life insurance policy to provide benefits for the company or the bank.

We help them with that process. And with that process there's various insurance companies that provide these types of polices or managed investments. We're very agnostic as to which company they use, but we have access to all of them and can help a bank or a company decide which of those products may be the best to help fund in on a qualified plan.

Kelly Coughlin:

Right. To summarize that, you helped the company fine-tune their needs requirements and then secondly, you helped them fulfill that need with - you say you're agnostic, but you have your open architecture, that is limited to high quality providers. You don’t open it to everybody, but you've done some due diligence and vetting of the providers that you will recommend to fulfill that need. Correct?

Greg Ochalek:

Yeah, that's absolutely correct. But I also want to just make a point that before we do those two things, is that we do a lot of consulting in the design of plan with the different features that are available, so that the planned design meets the objectives of the company. This whole thing starts with clarifying: What is the company trying to accomplish? Who are they trying to attract? Who are they trying to retain… or other objectives that the company may have by offering these benefits to their select group of management or highly compensated people? So that's where it starts. Then part of the process is the administration and then part of it is the funding and security, and that's what we had just talked about.

Kelly Coughlin:

Right. If I use the metaphor of building a house. You help them design the blueprint for the house, the architectural part of it, so you're like, what do you need? You want granite counter-tops, do you want this type of wood? Windows? You help them on the design and then you create the blueprint based on what they told you they need. Then you get the OK on that, and then you go out and get it fulfilled with subs and that sort of thing. Is that how you look at it?

Greg Ochalek:

I've never heard that analogy. It's a good analogy. I like that. I think to understand the power of non-qualified plans, why they attract key talent and attain key talent – and that goes all the way back to the beginning of studying non-qualified plans and how they work within corporations or banks.

Kelly Coughlin:

Greg, why don’t you talk for just a couple minutes about the difference between corporate owned life insurance and bank owned life insurance.

Greg Ochalek:

There's a funding vehicle the banks use called bank owned life insurance or BOLI. I think that it's fair to define really what BOLI is and I think there's a couple definitions. You've got bank owned life insurance that most banks are very familiar with, that they use to fund a wide variety of employee benefits. The bank owned life insurance by OCC regulations, they really have to be put in place to help the bank finance these benefits. You're really talking about benefits that would include post-retirement benefits, perhaps financial planning, maybe legal benefits, disability, other group benefits.

The typical BOLI type of product that banks are familiar with, they'll invest in that type of a product in addition to other things in their investment portfolio, to help pay for those benefits. They usually purchase it in single blocks of premium and it's designed as a modified endowment contract, which is a variation of a life insurance contract according to the Internal Revenue Regulations on Life Insurance. But then there is a different type of BOLI that is sometimes referred to as COLI, which stands for Corporate Owned Life Insurance, which is designed differently and would be more specific of a funding vehicle for the types of plans I discussed today.

Those are actually non-modified endowment contracts and the banks would be funding those with deferrals that they're getting from executives, or money that's coming from their operations that they're contributing to individual executives. Those premium payments into that type of a funding vehicle are paid on an annual basis. And the tax advantages are different between a modified endowment contract or what something would be referred to as a MEC compared to a non-MEC In most of the work that we do to fund non-qualified plans, we use the non-MEC approach.

Part of our business is working with companies like Equias to help place the other type of BOLI that I originally discussed, which would be the modified endowment contracts. We work very closely with a company like Equias and yourself, Kelly. But I do want to make the distinction that the funding vehicle for the types of non-qualified plans that I'm talking about and that we've talked about today are different. And it takes a different type of expertise and CBIZ provides that expertise to help companies make the right decision on how to fund these types of plans.

One of my very first clients was a cornerstone client of Arthur Andersen and as the person in charge of all the financial planning for the executives, I had to go in and understand all the non-qualified plans. Then when it came to retire, I got to see the benefits that the non-qualified plans provided for these executives. The one thing that just was startling, that jumped out, was that the participants were the executives that utilized the non-qualified plans to the maximum were actually retiring on incredible sums of money and in this case it was about $1.2 to $1.4 million a year for 15 years. I was struck to see how these non-qualified benefits were able to provide such a large amount of supplemental income in their retirement, in addition to the other benefits that the companies had.

Now, I compared that with those executives that did not participate in the non-qualified plans and those executives were retiring on $240,000 a year for 15 years. So you can see that the huge difference in how the non-qualified benefit plans affected the lives of the executives that took advantage of it. It helped them financially. They were able to help their children buy homes; set up education trusts for their grandchildren. It helped them socially with things that they wanted to do for their community. I saw them be philanthropic to the community and participating, things like their church, museums, other charities that they wanted to participate in.

That's really where I got sold and why I dedicated my whole career to non-qualified plans because of the difference that participating in these plans can affect peoples' lives. It was a good thing to see. That's one of my favorite stories to tell because it's very meaningful. Just another quick story. We had a bank in the Midwest that has been having some of their people being taken away by other banks in the area, just through competition. And this particular bank not only needed to keep their executives, but they were trying to add to them. They came to us, CBIZ, and talked to us about looking at their compensation package and the one thing that we did talk about was to add a non-qualified deferred compensation plan and possibly a supplemental executive retirement plan.

Then we helped them design a plan to keep it within their budgets, but to give their executives a way to defer dollars in addition to the monies that they were putting into the qualified plan. Then we helped promote that plan with their executives, so that they knew that their company was concerned about them personally and not just professionally. And then there was a group of people that they really wanted to keep around, so we created a plan through a supplemental executive retirement approach. That really was a way to put golden handcuffs on these people, so the bank had set aside funds into an account. The account could be managed by the executive. The executive could go online and see the value of that account.

But then that account would vest at certain points in their career. They saw that if they stayed with a bank, that they had this huge benefit that was waiting for them. If they left the bank, they would leave it on the table and have to walk away from it.

Kelly Coughlin:

That's great. You've been doing this a long time. You must like your job. What is it about your job that you like? Why do you like it? What gets you up in the morning? What makes you smile when you work?

Greg Ochalek:

Well, Kelly, I am very fortunate that I am able to deal with different types of companies and different industries, different sizes. I get to work with some incredibly talented people that are clients. I work with people in the C-Suite. Get a chance to observe CEOs to see how their minds work and how they take a look at these things. The CFOs who look at the economics of these plans, to be able to wrap their minds around it very quickly. That's fascinating to me. I've worked with some creative human resource people that really see the benefits of these plans. And that's all stimulating as far as working with all these people and learning about different industries and different companies.

I think that even beyond that, when I see executives that have worked in their career and are getting ready to unwind, and take things a little bit slower, the benefits that these non-qualified plans provide to them and their families really takes them up a notch or two, as to where they are and what they can do with their families and retirement. And that's just very satisfying for me. Those are the reasons why this has just been a lot of fun for 25 years.

Kelly Coughlin:

That's true. I like to hear people who like their job. How do people get a hold of you? I know that CBIZ has over 100 offices and 4,400 associates or so. If a company wants to explore this, should they talk to one of these associates or offices, or can they just get on the phone and call you?

Greg Ochalek:

Probably the best thing to do would be to contact me directly. We have offices all around the country. I actually travel quite a bit to our clients. My email is GOCHALEK @CBIZ, which is C-B-I-Z.com. My direct line is area code (440) 591-8581.

Kelly Coughlin:

Okay, that's great. We'll post up your notes, so listeners can access that and get the written form of that as well. I want to finish with either one of your favorite quotes, or sayings, or a funny thing you've done in your career to add some levity to a very exciting interview on non-qualified plans.

Greg Ochalek:

In light of the political season we just went through, I think the first thing that comes to my mind is that, “We're here to help your bank be great again.”

Kelly Coughlin:

Oh, good one. All right, we'll leave it at that. Thanks for your time, Greg. I appreciate it. We'll be in touch soon.

Greg Ochalek:

Thanks, Kelly. It's been a pleasure. Thank you very much.

Narrator:

We want to thank you for listening to this indicated audio program, BankBosun.com. The audio content is produced and syndicated by Seth Greene, market domination with the help of Kevin Boyle. Video content is produced by the The Guildmaster Studio, Keenan Bobson Boyle. Voice introduction is me, Karim Kronfil. We want to thank you for listening to the syndicated audio program bankbosun.com.  The audio content is produced and syndicated by Seth Green, market domination with the help of Kevin Boyle.  Video content is produced by The Guildmaster Studio, Keenan Bobson Boyle.  Voice introduction is me, Karim Kronfil. The program is hosted by Kelly Coughlin.  If you like this program, please tell us. If you don’t, please tell us how we can improve it.  Now, some disclaimers.  Kelly is licensed with the Minnesota State Board of Accountancy as a Certified Public Accountant.  The views expressed here are solely those of Kelly Coughlin and his guests in their private capacity and do not in any way, represent the views of any other agent, principal, employer, employee, vendor, or supplier.

Dec 24, 2016

Kelly: My next guest lives in a town that was originally called "Mudsock" in Indiana because people would get off the train, step in a watery mess, and end up with a mud-covered sock.

Greetings! This is Kelly Coughlin.

Voiceover:      Kelly Coughlin is CEO of BankBosun, a management consulting firm helping bank C-Level Officers navigate risk and discover reward. He is the host of the syndicated audio podcast, BankBosun.com. Kelly brings over 25 years of experience with companies like PWC, Lloyds Bank, and Merrill Lynch. On the podcast, Kelly interviews key executives in the banking ecosystem to provide bank C-Suite officers risk management, technology, and investment ideas and solutions to help them navigate risks and discover rewards. And now, your host, Kelly Coughlin.

Kelly:             Greetings, this is Kelly Coughlin. I'm the CEO of BankBosun and program host. Today, I'm going to interview Todd Andritsch, a very smart and successful former bank executive, who’s working in the bank-owned life insurance and nonqualified benefit plans industry. He's a board member and principal at Equias Alliance.

Todd brings over 12 years of experience in designing customized benefit and BOLI programs. His prior experience includes 17 years in the banking industry. He earned his undergraduate degree from Drake University. And an MBA from DePaul University. I think that means he lived in Des Moines and Chicago. Todd lives in the Fishers, Indiana which is, I believe, a suburb of Indianapolis, Indiana.

We're going to start out with "Let's Play Fishers, Indiana Trivia". I haven't rehearsed these with Todd, so I'm going to throw him a couple curveballs. Todd, are you on the line there?

Todd:              I'm here and ready.

Kelly:             Now, you can confirm we did not rehearse this, correct?

Todd:              Absolutely. I'm interested here what you come up with them and see what these questions are.

Kelly:             Okay. What was the previous name of Fishers?

Todd:              Could be one of two answers. I think the real answer is Fishers Switch, which was named after the switching station in Fishers at the train line. But it's also known as Mudsocks. It's one of the areas because the horses in the area had mudlines about a foot up their feet because it was just muddy and is known as the Mudsocks area. So I'm not sure what answer, but those are two common answers.

Kelly:             Fishers Switch is what I had in mind. Okay, here's question number 2. What do you Todd think the population of Fishers was in 1963, about 50 years ago?

Todd:              Since the first neighborhood had not been platted in any, at all Fishers, it was all country, I would say less than probably 500.

Kelly:             Good one. It was 350.

Todd:              The neighborhood that I live in was the first platted neighborhood and that was platted in 1970 so you were well before that.

Kelly:             That's great. Now it’s 65,000. That's a pretty affluent suburb, isn't it?

Todd:              I don't know about affluent, but it's been rated as one of the best places to live in the country by numerous organizations over the years just based on income levels, affordable housing, high quality education, education levels…. So it's a good place to live and raise a family.

Kelly:             Yeah, that's great. So I covered little bit on your education. Do you want to pick up your business background a little bit and maybe talk about some family, living, married, number of kids, that kind of stuff.

Todd:              Sure. Yeah, well you mentioned 17 years in banking in Chicago on the commercial lending side, both as a business development person as well as a manager of commercial lending unit and then went to actually work for a company, that was a friend of mine was their lead banker called Clark Consulting. So that kind of got me into the industry and that Clark Consulting was also based in Barrington, Illinois, which is where I lived at that time. So I was familiar with the company. Just made a change and got out of banking. For number of reasons it was a good move for me. Five kids today and been raising them here in Fishers and ages range from 22 down to about 10. So it’s kind of spread across age ranges there.

Kelly:             Yeah that’s great. So that's how you went from banking directly into Clark, which was in the BOLI business, correct?

Todd:              Correct. It was almost a predecessor company to Equias Alliance now. BOLI, nonqualified benefit plans, so always working with banks across the country. My emphasis was really in the Midwest; Midwestern banks and just developing relationships with those banks and bankers and trying to help them achieve their objectives. 

Kelly:             Alright. That's great. Now one thing we did talk about is kind of getting into the difference between general account, separate account, and hybrid portfolios. There was a conference that you and I were at and you gave a brief talk on the hybrid portfolio and I was kind of focusing more on just the general account and you said to me, “ Well, Kelly, you’ve got to keep your eyes open, because the hybrid is something to look out for.” So I’m wondering if you could just talk for a couple of minutes on what’s the general account portfolio; what’s separate account portfolio; but then give a little more attention to the uniqueness of the hybrid portfolio. Some of the features of it, and some of the benefits, and in which markets they are most beneficial and which markets they're not so attractive.

Todd:              Sure. As you mentioned, there’s three different general types of bank owned life insurance. I think of it as a three-column chart. On the left side of the chart is the oldest type of product, the General Account Product. The General Account Product means that you’re an unsecured creditor of the insurance carrier when you give them the bank’s money. In return, you get some basic guarantees. The guarantees include, a guaranteed minimum interest rate, interest default protection and no mark-to-market asset which is a book value guarantee by the carrier. General Account is simple, safe and weighted 100% from risk based capital purposes. But the down side is that you’re an unsecured creditor of that carrier, so the carrier’s credit rating and financial strength is very important. That was the left chart on the column, now let’s describe the right chart of that column. It’s a BOLI product kown as Variable Separate Account. Variable Separate Account is typically a bigger bank product and as such is more complex than the other products. The reason it’s a “bigger bank” product, and I’m putting that in quotes “bigger bank” and that has some variants in it, there’s no set hard line as to what “bigger bank” means. But it’s a bigger bank product because the minimum purchase amounts are typically much larger, as well as the complexity of the product.

It’s a literal security, so that product is a security, it’s covered by securities law, in addition to insurance laws. So, you end up getting into much more documentation and complexity, as I said. It can be a good product for bigger banks, but you also have to have a staff that’s willing to and capable of administering it. So, just having more moving parts makes it more complex.

Kelly:             So, with that in mind, what are some of the advantages of the separate accounts?

Todd:              Well the advantages of Variable Separate Accounts, include separate asset protection, which is off the carrier’s balance sheet and often time lower expenses due to the bigger dollar amounts. There’s also possibly a lower risk based capital rating. These products are more flexible, allowing the bank to change investment philosophies over time, but there’s no guarantees. And again, it’s much more complex than the other forms.

Kelly:             When you use the term a big bank product what do you mean by that…a big bank product?

Todd:              Well, that's a good question. And I would put it not to necessarily on asset size but more of a complexity of the institution. But typically, I don't see that variable separate account product in a bank that’s less than billion and a half to two billion dollars. At that point, they're typically getting enough accounting staff and financial management staff to monitor and manage that type of asset. So, that's a general rule but it's really based more on complexity in institution that it is on size of institution.

Kelly:             And now the Hybrid Account, how does that fit into this chart?

Todd:              So far, what we’ve described is the left and the right columns of that chart. Those two columns. But what’s left is the combination of the two in the middle, which is the hybrid. Which makes sense, a hybrid between the General Account and the Variable Separate Account. This product is called a Hybrid Separate Account, thus the hybrid name. It’s what falls between the two and brings the best of both of those other products to the middle and together. What it does is it brings the simplicity and guarantees of the General Account from the left-hand product into the hybrid, which includes the guarantees such as the guaranteed minimum crediting rate, investment default protection and book value guarantees and it is 100% risk rated. But, the hybrid also has many and most of the advantages of the Variable Separate Account in this middle column on the chart and that’s the separate asset protection and much of the flexibility to investment philosophies and changes in investments over time.

The advantages here are you are getting the guarantees of the general account, you're getting the much of the flexibility and the separate account collateral effectively…it’s not collateral but it’s effectively what it is, backing you up from the separate account side. And you do get the opportunity to move between funds and pick the right fund and investment management philosophy to fit the bank's balance sheet needs overtime. But as I said, it’s because of the guarantees from the carrier backing it up it still is a 100% risk weighted. But it does provide much more flexibility with the simplicity like a general account. 

Kelly:             And who assumes the balance sheet risk on those assets?

Todd:              It’s part of the carriers guarantees and part of what they’re bringing similar to the general account. If market interest rates change, which obviously we continue to see quite a bit in the market and the interest rates are a big deal today and will continue to be. But if rates rise, what happens to value of those bonds on that carriers balance sheet? Well they’ll decline a bit. But that’s not the bank's issue. The guaranteed book value that the carrier is guaranteeing, that investment risk in that mark to market risk, is the carrier's risk, not the individual bank owner of this hybrid separate account BOLI policy. 

Kelly:             From what I’m hearing from you, there are advantages in the general account, and there are advantages for big banks in the separate account. So this is kind of right in between there. Is that what I'm hearing you say?

Todd:              Yes, it’s bringing advantages on both sides into the middle in that chart description I had before. A typical hybrid will have at least two, maybe three or four, different investment philosophies you can choose from and again you can have that flex with the needs of the bank’s balance sheet over time. Do you want only a government fund, where you want absolute credit protection and have a very conservative portfolio or would you rather get more aggressive and move into more of a Lehmann aggregate type of approach; or even further maybe even a small equity upside within that BOLI portfolio. All of those are available within hybrid type of products. It just depends on what you are trying to look for in terms of your risk profile and appetite on the bank’s balance sheet, and you got the opportunity to move in and out of those over time.

Kelly:             Okay. Well, there must be a cost of having that kind of flexibility. Would it be safe in assuming that the expense ratios are a little higher in the hybrid vs. the general account?

Todd:              In general, they are very similar. There is a cost difference

between the hybrid and the general account. One of the major differences is the carriers have to have some type of payment to the other general account that’s the best way to put it up to pay for the guarantee they’re providing to the hybrid fund. And often times, it’s about a 10 basis point cost. There’s a couple of carriers actually have it literally at 10 basis point. But that's the payment from that hybrid account to the actual carrier for those guarantees backing it up. But really the yield differences over time are more driven by less the costs there than it is kind of what the market rates are; and what’s being invested in; and where new money is flowing in. It’s driving more kind of the yields that are obtained. But the cost of insurance, cost of investment management, really there's no difference there at all between those different types of funds.

Kelly:             Aren't the underlying assets or securities that the insurance investment team invest in...aren’t they going to be pretty much the same?

Todd:              Pretty much. All the funds are going to be bank eligible BOLI assets because they’re investing for banks in this bank-owned life insurance policies. They're very much similar. But does the general account products necessarily have as much governments in it? In dollar amount it might, but the hybrid fund could have a government only fund, where that’s all that the banks want to be and that’s a very conservative government fund. So it could have a particular fund may have a higher emphasis on one thing or another, depending on what the investment objectives are of that fund. And therefore, that’s why it fits the balance sheet and the risk management profile of the bank depeding on what the needs are over time in the hybrid a little bit differently and you could just match that a little bit closer to what the bank’s needs are. If your investment portfolio really doesn’t have much governments, but you want to have that in the BOLI fund, you can manage the risk profile, the bank's balance sheet overall differently and use that as a piece of the puzzle.

Kelly:             What's going on now in the market? Is hybrid an attractive alternative now? Is general account where all the money's going or is hybrid still an attractive investment for banks these days?

Todd:              It’s a good question. And the answer to that really depends on market timing and kind of when you're looking. Today, you're right, there’s really, in the last year there’s been very little variable separate account, the big bank products as I described it earlier, really kind of new purchases being done.

General account has been getting a majority of new business, about twice that of the hybrid separate accounts today. And that’s really just based on yield. As the hybrid separate accounts are smaller portfolios, new money going in is being bought at new money rates. So there isn’t as much as a block of an existing insurance and cash value out there to kind of leverage off of older investments as there is in general account.

So general account as of June of 2016 had almost $70 billion in cash value and to put that in perspective in terms of the hybrid separate account, there’s about $17 billion as of the end of June in hybrid separate accounts. So new money going in is going to dilute an existing portfolio less in a larger portfolio, which is the general account.

So, the bulk of the growth has been in general accounts over the last year or two, but there's still is a good amount of money going into the hybrid separate accounts and really the reasons that I went through before: collateral protection, diversification, and diversifying carriers as well product types is still putting a lot of money into hybrid separate account.

As a rate environment changes and long term rates increase, I think you’ll see that flip back to what it was a couple of years ago and probably more going into hybrid separate account than into general account. I think it’s just an issue of what the rate environment is doing right now and kind of where most money is going today. But I think that will change with new money rates over time.

Kelly:             Okay. You had mentioned early on in the podcast that separate accounts tended to be kind of big bank product. Is there a certain type of bank profile that you think is appropriate for the hybrid or is it mainly the internal culture of the bank and the appetite for control that you think influences that?

Todd:              Yeah, I'm not sure it’s an asset size, or charter type or anything like that...that's going to dictate a hybrid separate account purchase versus another type. I think it’s going to get to what are yields, that credit protection or lack thereof, offset buy an enhanced yield. I think it’s going to get to that risk reward trade-off that bankers are used to making every single day as banks aren’t in the risk avoidance business; they’re in a risk mitigation business.

Are we taking on a risk and are we getting paid for it? That’s a risk mitigation business in trying to figure out how to get their money back in a safe and sound way. That's the same thing in BOLI. There is advantages and disadvantages to the different structures, having assets backing you up and having flexibility on a product with carrier guarantees is better than not having those things. But what is the return trade off?

In today's environment, as I mentioned many banks are saying that return trade off isn't worthwhile. I’m better off going with general account and giving up some of those additional protections. But as rates rise, I think we'll start seeing a different mix in the market. So it's about whether those things are helping mitigate risks internally. Is flexibility good and important? Is the asset protection backing up off-balance sheet of that carrier important? Those things, if the answer to those is yes, hybrid product is absolutely the way to go and depending on market timing, it’s going to be a little below, at, or higher than that general account equivalent.

Kelly:             Great. Based on your background, you are at your core primarily a banker and secondarily you are an insurance guy. When you look at BOLI, do you think banks allocate assets  to BOLI for investment reasons or insurance reasons? Or some look at it as it’s a loan to insurance company. What's your perspective on that and when you work with a bank, do you emphasize one or the other, or do you stick with…it’s an insurance product? 

Todd:              Banks are allowed to own or have an assignment of life insurance for three reasons and three reasons only: First is key man coverage on key officers and executives and that’s a temporary need. The executive or the officer leaves the bank, you have to get rid of the policy.

Second is an assignment of a policy for a loan. Got a loan; it doesn’t have enough collateral, not good enough, something's going to happen when you're relying on the individual in terms of repayment you're going to have an assignment, a policy pays off or it moves to another bank, you let go of that assignment.

The third and only other reason that a bank can own or hold a life insurance policy is to offset and recover benefit liabilities it’s all per the regulators. So what banks do is they buy life insurance on a group of executives or directors. The enhanced yields on those policies that's available is really recovering existing benefit expense. It could be pension costs. It could be 401(k) match. It could be health care costs. It could be other nonqualified type plans. It’s for recovering those benefit liabilities and expense.

So while we're talking about some investment aspects here, the reason their bank buys is to offset and recover those benefit liabilities. That is the business purpose. That’s why it’s there. And it’s the only, effectively permanent need. If you and I are both insured at a bank and we leave, our seats and positions are replaced by somebody else. Those benefit expenses continue. So that’s the only effectively permanent need that the bank has and reason to keep that life insurance on the book is to support those benefit liabilities.

And that's really what it revolves around with these banks and again it’s a risk mitigation tool. Benefit expenses are rising. Banks want to keep key employees and have benefit programs that do that. So in order to do that they have to pay for it. One way to mitigate those expenses and keep them down is to have bank-owned life insurance on the books to help pay for those things, because the only difference between Bank A and Bank B isn’t the color of their green money. It’s no different. The difference is the people and how they’re serving their clients. There’s obviously other marketing differences. But it really gets down to the people. Keeping, attracting, retaining, rewarding your key people is important. So then how do you pay for those programs? Bank-owned life insurance is a way to help support those. Because they’re really the only permanent need, and the reason you can own it is to offset and recover those benefit liabilities.

Kelly:             You seem pretty passionate about this business. Was that your reason to get into it, to help these banks better compete?

Todd:              Yeah, that's the tool. My motivation for getting into this business and anything I do, it's just working with people and continue to develop relationships. Having strong relationships with people you like working with, and developing that bond and trust over time. Whether that would have been in my commercial lending days, or today in this arena, it's about helping people achieve their objectives and then building those relationships. So helping someone with their retirement programs and be able to live comfortably in retirement; helping a bank maintain its profitability by keeping key people; growing the institution by adding new people; that all gets down to compensation and keeping people and the way they pay for it. So bank-owned life insurance and nonqualified benefits are just tools to help build and maintain relationships and help the organization have the tools to grow internally and grow itself and that's just the tool I’m bringing to the table that I can help them with.

Kelly:             Great. What type of banks should contact you? I know you’ve got a geographical focus clearly in Indiana, what other states do you work? What profile do you look for? Do you want to help banks that have BOLI on the books from other providers, and then you enhance their reporting or servicing? Who do you want to work with? Who should be contacting you?

Todd:              Primarily focus: Indiana, Michigan, Ohio, Kentucky, are my cores states and I got a couple people helping me with that, that are employed by me but again, building those relationships. But again, size of the bank, the charter type, irrelevant. We work with banks from $30 million in assets to over $15 billion, a wide range. And what we do for those different institutions varies, but really, any and all of the above.

Look, we’d love to help banks that have BOLI right now, maintain those portfolios and become a little more efficient with that, maybe enhance yields slightly, if they’ve got it already. We help with M&A activities in terms of reviewing a target’s nonqualified plans and BOLI portfolio and how it can be rolled into existing client. It could be a bank that’s never had any of the above, but it wants to explore it and understand how to retain a key employee and to grow their business and/or just to become more profitable. Any or all of those, again these are just tools to help banks achieve their objectives.

Each bank's objectives are a little bit different and vary. There is no one size fits all. It’s about getting in and understanding the people, understanding the board, understanding what makes the institution tick, what their objectives are, and then structuring something around that.

Just like bankers know that a loan is not a loan is not a loan. A line of credit is not the same as a term loan is not the same as mortgage. They have different needs. They have different objectives, and different ways to structure to make sure that it achieves their clients' objectives. That's the same thing with BOLI and nonqualified benefit plans. And that’s why we talked about hybrid vs. general account. We can go and structure around the particular needs to help the individual bank regardless of size or geographic location achieve their objectives and to help them drive down that course they want to go on.

Kelly:             That's great. Sounds like you like what you do.

Todd:              I do. It's fun helping people. And no matter what business you're in, and that's what I do and that's what I enjoy.

Kelly:             That's great. All right. Now, I gave you a heads up. I was going to ask you either your favorite quote or the dumbest thing you’ve done or said in your career. And I’ll let you know that your business partner, Glenn, answered the dumbest thing by giving a summary of a presentation he made with his zipper down. So, that was pretty dumb, so you might be able to top that.

Todd:              Mine isn’t necessarily what I’ve done in my career, but probably the dumbest thing I ever said was "Sure, I'll go skydiving with you.” As I'm holding on to the strut of the plane thinking, I can hold on to this thing and land, but then letting go and having a whole different type of reaction. So dumbest thing I ever said was "Sure, I'll go skydiving with you". Favorite quote? Yeah, I thought about that one a little bit and yeah, it varies and shifts over time, but I think right now it would probably be a quote from the Bible. Proverbs 27:17. “As iron sharpens iron, so one man sharpens another.” I've been thinking about that one a lot recently and I think it applies to not only our faith but all our personal relationships as well as business.

Kelly:             That's a good one. Read it again.

Todd:              Proverbs 27:17. “As iron sharpens iron, so one man sharpens another.”

Kelly:             That's quite good. I’ve never heard that. Very good.

Todd:              As we deal with other people, and challenge each other and question each other. And the more we challenge each other, the sharper we get and the better we get. So, I really like that one.

Kelly:             Well, that's all I have, Todd. Is there anything else you want to sign off with or shall we conclude this?

Todd:              No, thank you. That was great, appreciate the time.

Kelly:             Thank you very much. Keep sharpening your iron. We'll be in touch soon. Thank you.

Voiceover:      We want to thank you for listening to the syndicated audio program, BankBosun.com The audio content is produced and syndicated by Seth Greene, Market Domination, with the help of Kevin Boyle.

Video content is produced by The Guildmaster Studio, Keenan Bobson Boyle. The voice introduction is me, Karim Kronfli. The program is hosted by Kelly Coughlin.

If you like this program, please tell us. If you don’t, please tell us how we can improve it. And now, some disclaimers.

Kelly is licensed with the Minnesota State Board of Accountancy as a Certified Public Accountant.  The views expressed here are solely those of Kelly Coughlin and his guests in their private capacity and do not in any way represent the views of any other agent, principal, employer, employee, vendor or supplier.

Dec 24, 2016

Kelly: This is Part 2 of my interview with Glenn Blackwood, who was a member of the “Killer Bees”. This wasn’t the much feared Africanized bees, rather it was the equally feared defense of the Miami Dolphins in the early 80s.

 Greetings! This is Kelly Coughlin.

 Voiceover:      Kelly Coughlin is CEO of BankBosun, a management consulting firm helping bank C-Level Officers navigate risk and discover reward. He is the host of the syndicated audio podcast, BankBosun.com. Kelly brings over 25 years of experience with companies like PWC, Lloyds Bank, and Merrill Lynch. On the podcast, Kelly interviews key executives in the banking ecosystem to provide bank C-Suite officers, risk management, technology, and investment ideas and solutions to help them navigate risks and discover rewards. And now, your host, Kelly Coughlin.

Kelly:             Hello! This is Kelly Coughlin, CEO of BankBosun and program host. This is the second in a two-part interview series with Glenn Blackwood, a former NFL safety for 10 years with the Miami Dolphins and a current 25-year executive, board member and principal in the bank-owned life insurance industry with Equias Alliance.

In Part 1, I talked with Glenn about some of his experiences in the NFL and how his ability to face competition, sometimes quiet fearfully enabled him to have quite a successful career in the NFL and with the Dolphins and ultimately in business.

Glenn was coached by Don Shula, who instilled two things in his players: competition and integrity. Glenn said that Shula instilled in them the concept that winning wasn’t the only thing but winning with integrity was the only thing. And because of this, Glenn has become a very successful businessman.

I think Lombardi said, “Winning isn’t everything. It’s the only thing.” Well, that might work well on the gridiron but in the boardroom, integrity is equally important and as fierce a competitor as Glenn was and is now; he is equally fierce in his adherence to good business ethics and a high level of integrity.

In Part 2, we will talk about how Glenn works in the bank-owned life insurance business and why he is so successful with his clients and why his clients truly like working with him.

So Glenn, what’s your approach to helping community banks compete and succeed in this environment where risk, regulation and revenue creation can be so challenging?

Glenn:            Glad to be visiting with you. So the community bank has a niche that it fills in the ecosystem of banking, and I think the biggest battle with community banks is the regulatory environment they are having to deal with. They don’t have the scale that the big guys have to absorb it and it is a very difficult task for a community bank and this is just listening to all of my clients. And as you mentioned, I’ve worked probably 150 community banks in the southeast. And I stay in very, very close touch with those banks and it’s a common thing that their biggest battle right now is the regulatory burden that’s on them and the cost that it hits on them on an ongoing basis. And it’s very hard to get return to the shareholders, and I think that’s the biggest challenge they face.

Our goal and the way I’ve looked at it is I want to be an ally to them in helping them be able to be as successful as they can and one of the ways we do that – there are two primary ways.

One is helping them manage benefit expense. That’s the BOLI asset. And then, understanding when you put that on your balance sheet, there’s a lot more that goes into that than just sticking an asset on your balance sheet, which most bankers fully understand because there’s a regulatory issue, an accounting issue, a legal issue, etc.

And the other piece of it is helping them to put in programs that allows them to retain, reward and ultimately retire their key executives. They’re called top hat or deferred compensation SERP plans, things like that. And they’re there for a reason. A lot of people say, “Oh that’s just another perk for these highly paid executives.”

But the reality is, it’s not another perk. It’s getting them to a level playing field due to the restrictions that are imposed upon what’s deemed to be highly compensated, which is anybody making over, basically $120,000. They can’t put enough aside in their retirement plans due to these ERISA and IRS limitations on both social security and qualified plans.

So allowing them to have a meaningful retirement benefit that’s commensurate with what they’re doing for everybody else in the rank and file. One banker called it, it’s good parenting. And then the other piece of it is that you use those programs to retain those executives. Because they’re non-qualified, you can structure the vesting in a way that allows you to say, “Look, if you stay here Mr. or Mrs. Executive until a certain date, then you get this benefit, but if you leave, you leave it behind.”

So now, you’re doing something that’s balancing the playing field for them in benefits, but you’re also hooking them to the bank so that if they walk away, then they’re going to walk away from that benefit then there is economic pain for that. And that usually provides the deterrent for them going to greener pastures.

Kelly:             Curious about in a bank-owned life insurance business, you mentioned there’s a lot of moving parts there, and that’s what you liked about it. You’ve got the legal part; you’ve got the accounting part; you got the insurance part; you got the investment part; you got all sorts of components there. But simplifying the message in a sales process has got to be critical to any sort of complex financial sale. What’s your approach to simplifying the sales message? Not trying to be the smartest guy in the room, but trying to be the guy that simplifies the message, because I know you’re good at it. I’ve heard you. I’ve heard you talk, so I know you’re quite good at that.

Glenn:            I think the main thing for me is I want to be honest, especially if I’m working with a board. I want to be honest about what I’m laying out for them and I want to, I call it bringing all the skeletons out of the closet. I want to bring all the bones out. I want to lay it out there so they can understand their risk and understand the benefits that come with it as well. And then also understand what does it entail on an ongoing basis with these programs and whether you’re just putting BOLI in or whether you’re putting  BOLI and benefits in.

There’s a lot of hair that comes on that stuff and you got to identify what that is and show them how those risks can be managed. I try to condense it down at the end of the day, if I’m speaking with a comp committee or board, what’s the benefit to the bank; what’s the benefit to the executive team and then what are the risks that they’re going to need to address as they put these programs in place.

Understanding that we are going to shepherd them through this process. We’re going to work with their accounting firm. We’re going to work with their legal counsel. We’re going to help them document it all from a regulatory standpoint. Which by the way is very important, the words that I used there “help them,” document it. There’s a lot a people out there that says, “Look, we’ll do all your regulatory documentation for you.” And that’s not a good answer. The good answer is, We’ll “assist you” through that process. We’re good at it. We know what you need to have answered.

But their bank needs to have their fingerprint all over that documentation. The regulators don’t want to know that we know what you did. They want to know that the bank knows what it did. And so, it’s really critical to let them know, we’re going to shepherd them through that process and make sure it’s done in a way that they’re not going to have criticism from their examiners.

And I can tell you that one of the things when you look back at our company, we’ve operated under the endorsement of the American Bankers Association and a number of states banking associations down in – Florida, South Carolina, Virginia, Texas, Tennessee and so on and so forth, California.

But with all of that and part of the reason that we’ve able to get those endorsements is that we are extremely thorough in what we do from a documentation and expertise standpoint. And I always look back, I had a bank that I was working with and they basically said, “Why should we work with you?”

I looked at this man and I said, “I’m going to give you four numbers and I’m going to tell you here’s why you should work with me.” And I said, “Number one is 26, number two is 150, number three is 99.9 and number four is 46. And here is what those numbers mean.”

I said, “The first one is 26 and that’s the number of years I’ve worked in this industry in the region that you’re in… in the South East; 26 years I’ve worked down here. Number two is 150. That’s the number of banks that I’ve worked with. You don’t work with that number of banks and have done a shoddy job; there’s consistency there. Number three, 99.9; that’s the persistency I’ve had with the clients that I’ve had. We don’t lose clients. We don’t lose them because we’re very good at what we do and we pay attention to details. And then, the least and the last thing, the number 46. That was the number BOLI consultants that I’ve watched over my 26 years come and go out of this business.

And that’s the reality. That’s not to be a knock on anybody else. It’s just the reality that you look for people that are committed long-term, to being able to not only take care of you but that long-term track record speaks to consistency and the knowledge of the market and knowledge of the product. So that’s kind of what I communicate with our banks. Let you understand what the benefit is to you, what your risks are and what we’re going to do to walk alongside you to make sure we manage those so that you don’t have a headache on an ongoing basis.

And I think our track records speaks for itself and we engage the CPA’s. We engage the attorneys, because we know what we’re doing is valuable and we know that working with them in partnership as advisors to the bank is going to make it a seamless process. So that’s basically what I do.  

Kelly:             You guys won a few games down in Miami. I did a rough count before this interview. You won about 114 games and lost 58. You were 11 times in the playoffs, and went to the Super Bowl twice. So guys you knew how to win. How did that help you in this business?

Glenn:            One of the things that we were talking about earlier and I look back, I think why did you all win a lot down in Miami. And one of the things was that we were prepared. We were very well-prepared for the game. That speaks to our overall organization and primarily Don Shula preparing us. We were very well-prepared for the game. And then once you got past that team-wise, I had to look at it individually and I had to know what my responsibility was in the process.

But for me, I also had to know the responsibilities of others. As I talked about earlier, I had to know about the linebackers and linemen and the cornerbacks were doing and then coordinate all of that. And it’s the same process working with a bank. I’ve got to understand what the challenges are that the accounting firms have in working with their bank clients and the legal counsel; and the CFO having to do the regulatory documentation and the board, making sure they’ve asked all the right questions.

And that’s another thing, we try to ask questions for them. We want to turn over every rock so that they don’t have anything exposed. And then do what you say you’ll do. If you tell somebody you’re going to do something, then do it. And that’s the way our whole operation runs. We’re going to do what we say we’re going to do.

And if we can’t get there because sometimes glitches come up, communicate with the bank immediately, let them know the time frame. And then the last thing, and this was Coach Shula’s mantra, was you operate with integrity.

I remember for almost nine years in a row and we were the least penalized team in the NFL, and we were the least penalized because Coach Shula said, “You don’t just do it. You do it right, and you do it the right way. And winning isn’t the only thing. Winning with integrity is what matters.”

And I believe that’s the same way that we’ve operated as a company and certainly in my operation down here in the Southeast. I’ve always told my kids, “You never go wrong by doing right. And that’s the way we try and operate.”

Kelly:             Glenn, what type of bank should contact you? What do you look for? Where is your sweet spot with banks? I know you’ve got a geographic focus down in Florida.

Glenn:            Kind of that southeast quadrant.. typically, that bank that’s got a regional focus and has some programs in place that either retain or reward their key executives or that they want to make sure that they’re putting BOLI assets on their balance sheet in a way that’s not going to be a headache for them on a go-forward basis.

Kelly:             I then asked Glenn, what was the dumbest thing he’s ever done in his business career, recall in Part 1 he talked about his worst play…whiffed on tight end who went in for the score. So I asked him in his business career what was the dumbest thing he’s ever done and we’re going to finish with that.

Glenn:            This was kind of stupid. I was doing a board meeting for a bank and I was doing the presentation and it was back on a projector back then because we didn’t have the equipment, the technology we have now. And I had a chair right there, I put my foot up on the chair, and I got finished with the presentation.

I walked out and there was a rest room right to the left and I needed to use the restroom so I went in the rest room. And as I was preparing to go to the rest room, I realized I didn’t have to unzip my zipper and I thought, “Oh my gosh! It must have been down during the whole board presentation.”

And so, the head of the comp. committee came out, which was a lady, a very nice lady, very pleasant, and she said, “Great job on everything! You answered our questions, blah-blah-blah, and I said, “Nancy, can I ask you a question? Was my zipper down during that presentation?” She said, “The whole embarrassing moment,” but we still got the deal done.

Kelly:             Very good job! Well that is terrific! I think with that, we’ll sign off. Glenn, I want to thank you again for your time and I look forward to talking to you again.

Glenn:            It is my pleasure. Thank you.

Kelly:             Okay. Great.

Voiceover:     We want to thank you for listening to the syndicated audio program, BankBosun.com The audio content is produced and syndicated by Seth Greene, Market Domination, with the help of Kevin Boyle.

Video content is produced by The Guildmaster Studio, Keenan Bobson Boyle. The voice introduction is me, Karim Kronfli. The program is hosted by Kelly Coughlin.

If you like this program, please tell us. If you don’t, please tell us how we can improve it. And now, some disclaimers.

Kelly is licensed with the Minnesota State Board of Accountancy as a Certified Public Accountant.  The views expressed here are solely those of Kelly Coughlin and his guests in their private capacity and do not in any way represent the views of any other agent, principal, employer, employee, vendor or supplier.

Nov 17, 2016

Hello, this is Kelly Coughlin, CEO and Program of BankBosun. Oysters open completely when the moon is full and when the crab sees one, it throws a piece of stone or seaweed into it and the oyster cannot close again so that it serves the crab for meat. Such is the fate of him, who opens his mouth too much and thereby puts himself at the mercy of the listener.

 

Announcer:

Kelly Coughlin, is CEO of BankBosun, a management consulting firm helping banks C-level offices, navigate risks, and discover reward. He’s the host of the syndicated audio podcast bankbosun.com.  Kelly brings over 25 years of experience with companies like PWC, Lloyd’s Bank, and Merrill Lynch.  On the podcast Kelly interviews key executives in the banking ecosystem to provide bank C-suite offices risk management, technology, and investment ideas and solutions to help them navigate risks and discovery reward.  And now your host, Kelly Coughlin. 

 

Kelly Coughlin:

This podcast is a continuation of a series of interviews of key executives from community and regional banks throughout the US. Community banks play a key and critical role in ensuring that a community has a healthy social and economic ecosystem. This podcast series is being produced to help celebrate and encourage community banking throughout the US.

 

I grew up in the great state of Kansas. My great-grandfather ran a coal mine in Osage, Kansas and was one of the first employers of former slaves who moved to Kansas after emancipation. So, even though I spent most of my adult years out of Kansas, I raised my four daughters in Minnesota, I have a fondness for the state of Kansas.

 

In addition to Business, County and Finance, I studied the classics in college; Greek and Roman history and the language the Roman’s spoke, Latin. I always had an infinity for Latin, even in high school. And, I think it might have something to do with coming from Kansas. No, we didn’t speak Latin in Kansas, but our state motto is a great Latin phrase that in my mind captures the real spirit of the Midwest and perhaps all of us living in America. Facing adversity, challenge and the opportunity that doesn’t come easy, but through hard work. The motto is: Ad astra per aspera – To the stars with adversity.

 

I remember hearing this motto as a very young kid. This motto has always stuck with me and in many ways, has defined me. So, what does this have to do with this podcast? Well, my guest today is the CEO of a bank located in the heart of Kansas, actually about two hours from the dead center of the Country, with a Latin name that comes from the state motto. I’m taking to Kyle Campbell, CEO of Astra Bank in Abilene, Kansas. Kyle, did get all of that right?

 

Kyle Campbell:

You did, and thanks for having me.

 

Kelly Coughlin:

So, let’s talk about the bank name. Does it come from the State motto, or was that just coincidental?

 

Kyle Campbell:

Well, it does from the state motto and you’re exactly correct in the background on that. Where that came from is where our charter located, we’re actuallyabout ten miles south of the Kansas/Nebraska border. And, while there are a lot of similarities that mid-western residents share, they’re also intensely loyal to the state in which they reside. So, we knew any sort of name that was blatantly attributable to the state of Kansas may not be well-received if we ever had an expansion opportunity in Nebraska. So, we looked at the state motto, which you talked about, and thought that Astra Bank would be a great nod to being a Kansas chartered bank. But also, would not preclude us from having opportunity to go into the state of Nebraska, which turned out to be a great move because we actually had an opportunity to move into the state of Nebraska and we do have a location there.

 

Kelly Coughlin:

Excellent. Tell me a little bit more about the founders, early history, etc.

 

Kyle Campbell:

Well, the interesting part about Astra Bank is that we actually started in a community that we no longer serve. It started as Peoples State Bank in Courtland, Kansas, in north central Kansas. And the integration of my family into that, was my grandfather went to work for Peoples State Bank which was chartered in 1911. He went to work for them shortly after that and he started work in May of 1929. As a student of history, you know he picked a great time to enter banking. As he puts it, he made it in time just for the big bank holiday that happened later in 1929. That really influenced a lot of his early views on banking. What came out of that was, throughout Kansas and a lot of the country there were a lot of bank failures that happened in 1929, and one of the neighboring communities was left without a bank. But the two banks that were in Courtland, Kansas both survived the great depression and what happened in 1929.

 

So, the city father of Scandia, Kansas, which was a community just seven miles to the east of Courtland, Kansas came over and a made a pitch to both banks trying to get one of the two of them to move over to Scandia. Well, Peoples State Bank decided they would move and they moved in 1939 to Scandia and renamed them Scandia State Bank. We’ve grown from there, through that point in time. My grandfather, over the course of the 50s, 60s and early 70s, gradually came to acquire ownership of the Scandia State Bank. My father, my grandfather’s son-in-law went to work in the bank in the 1970s and started there and is still active in our bank today.

And then, we’ve grown by acquisition, we acquired a bank in Belleville, Kansas which was ten miles to the east of Scandia. And then we’ve grown by acquisitions since then and we now have locations from central Kansas, north central Kansas, all the way up into south central Nebraska and now have eight locations overall.

 

Kelly Coughlin:

And you are running the show?

 

Kyle Campbell:

I am running the show.

 

Kelly Coughlin:

So, your grandfather passed and your father is still involved?

 

Kyle Campbell:

My father is still involved and still comes in on a regular basis. One of the things that he enjoys working with, is he enjoys managing a securities portfolio, which in this rate environment, trying to find somebody who enjoys that is a challenge. So, if I’ve got somebody who’s got an interest in it and enjoys doing that, it’s a good fit for us.

 

Kelly Coughlin:

Let’s talk about your background. You grew up in the Midwest where you’re raising your family?

 

Kyle Campbell:

I was raised in Scandia, Kansas. So, I spent most of my life actually living in a house in Scandia right next to the bank, so it was a really short commute for my dad. He just essentially walked next door and was at work. I grew up and had what I call a delayed childhood rebellion. In college, I decided I was going to major in Engineering and made the statement that I was never going to work in the family bank. You can see how well that proclamation worked for me.

 

Kelly Coughlin:

You went to school in Kansas? Did you say K State, is that where you went?

 

Kyle Campbell:

Yes, I went to school at Kansas State and majored in Chemical Engineering. After K State, then I went to Kansas City and I worked for Procter and Gamble and their manufacturing plant there for five and a half years as a Process and Project Engineer for them. And then, at that point in time, had some opportunities that came available to me in the company, took advantage of those and used it to get my MBA through Rockhurst University in Kansas City. Then came back into banking in 2002 and I’ve been working in the bank and in banking ever since.

 

 

 

Kelly Coughlin:

Right. That’s terrific. Let’s talk about your early customer market and the current customer market that the bank has. In the early years, what was the primary market for the bank during the first 50 years of operation?

 

Kyle Campbell:

Well, I think that in the first 50 years of operation, really the customer base was not a whole lot different that it was today. We have always been in a very agricultural oriented area in the state of Kansas. Our focus has been very much oriented towards agriculture, since our founding and also serving our community needs, which meant that in our case, our commercial credits looked like providing credit to Main Street merchants in our communities. Which, very often for us, were very small mom and pop shops that the types of services and stores that were needed in small communities to keep them growing and thriving.

 

Kelly Coughlin:

That has been pretty consistent throughout your entire operating history, correct?

 

Kyle Campbell:

That has been very consistent throughout our entire operation. In fact, if you look at the information that’s available on us today, you’ll still find that about 50 - 55% of our loan portfolio is still in either ag production or ag real estate credit.

 

Kelly Coughlin:

I read a book a while back, about five years ago, it was called The Worst Hard Time. It was the story of those who survived the American Dust Bowl. Was your bank around during that period?

 

Kyle Campbell:

Well, the bank started in 1911 and really our family history started with it in 1929.

 

Kelly Coughlin:

I think this was in ’35 though, so it would have been around during the Dust Bowl period then.

 

Kyle Campbell:

Right, right. So, I think realistically it was a very challenging time back then. As I mentioned earlier, a lot of that type of situation really was what influenced my grandfather’s view on banking and it’s still something that we keep very much mind with our DNA as to who we are at Astra Bank in that he wanted to run a bank that never went broke. He saw far too many go broke and he saw the impact that it had on the banks customers and on the communities that the bank served and he never wanted to subject his customers or his communities to that.

 

Kelly Coughlin:

Right. That does that mean that he was very, very cautious and careful about the loans that he did or patient about collection on the loans?

 

Kyle Campbell:

It meant both of those. He was very cautious about that because he didn’t want to, if he could avoid it, getting into collection situations. At the same point in time, what he also wanted to do, was to make sure that if he got into a situation where collection was needed, it meant that he had exhausted all opportunities and avenues to provide the customer a way to work through that difficult challenge.

 

Kelly Coughlin:

Yeah, because those were terrible times and I would imagine being a banker at that time, where you were close and integral to the community, it would have been very tough to kind of start squeezing people, squeezing your friends and people you go to church with, during those times.

 

Kyle Campbell:

Yes, and it’s one of those things that Mark Twain, I believe it was said, that history doesn’t repeat itself, but it very often rhymes. My dad was faced with a similar situation in the 1980s when agriculture faced another challenging set of years. I think it was a lot of the example that my grandfather set in place, that my father followed which was really prudent and conservative lending into that, that helped them avoid some really serious credit challenges. Also, looking at the example of patience and allowing the customers all of the opportunities that we could afford them to work through the challenges that the economic times presented.

 

Kelly Coughlin:

Yeah, right great. All right. Looking forward and what you’re faced with today as the third generation managing the bank, what do you see the biggest opportunities and then, consistent with that, would be what are the biggest threats that your bank faces or community or regional banking in Kansas is facing?

 

Kyle Campbell:

Well, I think the biggest opportunity that really faces a bank like Astra Bank and really banks that operate in some less densely populated areas of this country, is there is going to be a drive for consolidation, because of the scope and scale of services that banking customers expect today. That drives a certain inherent level of cost structure with it, which does require some scale.

 

So, I think that is an opportunity that is presented to banks like Astra Bank. Now, that situation may be a challenge for some banks that have found themselves in a position where they don’t know if they have the capacity to actually grow through that, but I think there are some interesting opportunities that I hear bankers looking at in terms of being cooperative with other banks that are facing similar situations. So, I think consolidation is a big opportunity that's out there. It may appear to be a threat to some.

 

Kelly Coughlin:

Well, are you guys on the acquiring side?

 

Kyle Campbell:

Yes. That's one of our strategies because we can see, as we look forward, there is the potential that we need to continue to grow the scale of our bank, just to continue to be able to serve the communities that we serve in an economical manner.

 

Kelly Coughlin:

Give me a brief profile of, what are you looking for?

 

Kyle Campbell:

There's some geographical constraints, because obviously, one of the things we know very well is, we know rural communities well. So, generally, we're looking in smaller communities. Not that there's anything wrong with larger communities, but generally, there's a different style of banking that’s present there. We've seen far too many banks that have thought that there isn't really any significant difference between banking in a rural area and banking in an urban area, and they've gone to urban areas and basically had it handed to them by banks that were already in those markets. Really, what we've come to realize is that the ag concentration that we talked about earlier, we certainly have that concentration, but part of what we feel like we know is, we know how to manage that risk that comes along with that concentration. There are other types of businesses that may be presented within less rural markets that we may as not be as well positioned to handle. We're comfortable with who we are, and so that's where we look to as we look to expand. Then, we're also looking to make sure that we're in communities that are significant in the areas that we're targeting, and also making sure that we've got acquisition targets that are of a certain size because really, when you go to acquire an institution, there's a certain base level of work that's required regardless of the size of the institution.

 

Kelly Coughlin:

Yes. Along with that opportunity goes the need to have adequate professional staff to help run the bank, whether it be the finance, operation side, executive management. That is a problem that plagues community banks in general, but when you're in the middle of western Kansas, it could be an even more significant challenge. How have you been able to deal with that? How do you get that done?

 

Kyle Campbell:

That is one of the areas that I have always kept an eye open for is, we're always looking for good quality staff. And if we find good quality people, we're looking for ways that we can integrate them into the team here at Astra Bank. We as bankers spend a lot of time looking at things that we can easily see on a piece of paper in terms of looking at an institution’s deposit portfolio or looking at its loan portfolio, securities portfolio, etc. But I have a spent a significant amount of time in each of the acquisitions that we've done looking at the people portfolio that comes along with it, and we've had some very excellent people who are in key positions of leadership with Astra Bank, who have come to us through the acquisition process.

 

 

Kelly Coughlin:

I would imagine, in this environment, where living in big cities comes with an element of risk that it really didn't have 15 years ago, living in a nice, quiet community in Kansas may appeal to many families just to get to a safer, quieter area. Have you observed that at all?

 

Kyle Campbell:

We have observed that, and we see that there is more of an interest, especially, I think technology is helping rural areas because there are a lot of career opportunities where you had to locate in a major metropolitan area to be physically present to do the job. Whereas today, with the advances of technology, it doesn't matter where you are as long as you can get access through the Internet to your employer and whatever source of work it is that they have for you. You can do your job from almost anywhere in the world. So, we have quite a few people in the communities that we serve, even though they live in rural parts of Kansas and Nebraska. They're actually working for employers in some of the country’s most major metropolitan areas.

 

Kelly Coughlin:

Well, for those of you who have never been to Abilene, Kansas, where Kyle is, I'm here to tell you, it's a very cool city. Kyle, why don’t you describe a little bit what you've got going on in Abilene from historical, cultural perspective?

 

Kyle Campbell:

Well, I would be obviously remiss if we were talking about the historical and cultural part of Abilene, if we didn't start with the most famous person to come from Abilene, Kansas. And that would be the 34th President of the United States, Dwight David Eisenhower. We are very fortunate here in that we have one of the Presidential libraries and boyhood homes of a United States President. So, that is a very big draw to what we have here, and it's very neat to have something from that scope and scale of a historical significance in our country here in the community of Abilene.

 

Kelly Coughlin:

Yeah, and I've been to that library. It's very cool. So, any of you listeners, I would encourage you to pay a visit to Abilene. Kyle, I'm curious, did your father or grandfather ever meet Eisenhower, or was he born and raised there and exited?

 

 

 

Kyle Campbell:

He was born and raised here, and then exited. There are a lot of people here still in Abilene that knew Eisenhower when he was alive, but I was from more of the north central part of the state. So, where I grew up is about an hour and 15 minutes away now. So, we were more out of the area, and even though my grandfather fought in WWII, he was under a different general, because he was over in the Pacific instead of being in the European theater.

 

Kelly Coughlin:

All right, that's terrific. Kyle, it sounds like you like what you're doing. You enjoy it?

 

Kyle Campbell:

It's great. I really enjoy it. In fact, I tell folks all the time that I think banking is about one of the best careers you could have, because where else do you get the opportunity to work with people on an individual basis and help them achieve their dreams?

 

Kelly Coughlin:

Yeah, and you guys are doing a terrific job there. I know that. Well, that's all I have, but I wanted to finish with one of your favorite quotes. Or the other option would be to tell us one of the stupidest things you've ever said or done in your career, but I'll give you the choice on that.

 

Kyle Campbell:

Well, I think I could actually share a brief story on both. As I tell folks since I have the opportunity to teach a couple of classes in banking from time to time and telling the students that I'm teaching there is no such thing as a dumb question. I remember my first bank meeting that I went to, and I sat down in the room with a bunch of people who were obviously much more experienced in banking than I was at the time. I was looking down through the agenda and there was an item later in the agenda that caught my attention, and actually, I was kind of excited to see what was going to happen there. I was really in for a big surprise, when we got to that part of the meeting, and I learned for the first time that in banking, OREO does not refer to a sandwich cookie. So, I was very disappointed to learn that we were talking about real estate that the bank had taken back on the liquidation because I thought we were getting close to a break time where we were going to have treats that were brought in. So, I thought we were going to have Oreos for snacks and really, we were talking about other real estate owned. So, that was kind of my first indoctrination. So, I always tell folks, don’t feel foolish if there's ever anything that you ask, because I've probably done maybe even worse assumptions.

 

Kelly Coughlin:

Yeah. Different sweet spot, right?

 

Kyle Campbell:

Yeah. I was going to say, I thought we were going to have a sweet spot and then we were talking about something that wasn’t nearly pleasant at all for anybody. One of the quotes that I often use in talking with folks, and I think it also works for banking, because part of what we need to do in our roles as bankers is really keeping a level head in how we assess situations and making sure that we're doing the best for our customers. When I was at Kansas State, I had the opportunity to be in a presentation that was made by the person, who at that point in time was the athletics director at the university, and his name was Max Urick. He made a statement that has stuck with me still to this day. His statement was, “Things are neither as bad as they seem nor as good as they seem. The truth is usually somewhere in between.” I found that statement to be very applicable in life, because there is times within the human emotions that we can get too high on the highs and too low on the lows, and realistically, we need to step back and take a very balanced view of the situations we're in. And I think that's one of the tremendous services that we can offer our customers as community bankers.

 

Kelly Coughlin:

Yeah, that's a great quote. I've heard derivations of that, but that's succinctly phrased. I like that. Thank you for sharing that. I appreciate that. Well, that's all I have. Anything else you wanted to add? Or should we sign off right now? I really appreciate your time.

 

Kyle Campbell:

Well, I want to thank you for inviting me as a guest. I've really enjoyed our time talking.

 

Kelly Coughlin:

Thanks a lot.

 

Announcer:

We want to thank you for listening to the syndicated audio program, BankBosun.com. The audio content is produced and syndicated by Seth Greene, market domination with the help of Kevin Boyle. Video content is produced by the Guildmaster Studio, Keenan Bobson Boyle. Voice introduction is me, Karim Kronfli. The program is hosted by Kelly Coughlin. If you like this program, please tell us. If you don’t, please tell us how we can improve it. Now, some disclaimers. Kelly is licensed with the Minnesota State Board of Accountancy as a Certified Public Accountant. The view expressed here are solely those of Kelly Coughlin and his guests in their private capacity, and do not in any way represent the views of any other agent, principal, employer, employee, vendor, or supplier.

Nov 7, 2016

Kelly Coughlin:

Greetings, this is Kelly Coughlin. The Blind Hen. A Hen who had lost her sight and was accustomed to scratching up the earth in search of food, although blind, still continued to scratch away most diligently.  Another sharp-sighted hen who spared her tender feet, never moved from her side and enjoyed, without scratching, the fruit of the other’s labor.  For as often as the blind hen scratched up a barley corn, her watchful companion devoured it. 

 

Announcer:

Kelly Coughlin, CEO of BankBosun, a management consulting firm helping banks C-level offices, navigate risks, and discover reward. He’s the host of the syndicated audio podcast bankbosun.com.  Kelly brings over 25 years of experience with companies like PWC, Lloyd’s Bank, and Merrill Lynch.  On the podcast Kelly interviews key executives in the banking ecosystem to provide bank C-suite offices risk management, technology, and investment ideas and solutions to help them navigate risks and discovery reward.  Now your host, Kelly Coughlin. 

 

Kelly Coughlin:

Greetings.  This is part two of my interview with Kris St. Martin, a bank cyber security expert at CBIZ.  In part two, we will talk more about what drives premium costs and once a bank experiences a cyber intrusion, then what are the actual types of costs the bank can insure and how to make sure these costs are recoverable in an insurance claim.  I finished part one by asking Kris about how a bank should go about determining the maximum claim liability.  Is it based on records, revenues, business lines, and ultimately, what can a bank do to manage and reduce the premium costs with good internal cyber risk management controls implemented and utilized at the bank.  Here is what Kris had to say about that in part two.

 

Kris St. Martin:

Because of the number of records, you can fairly well quantify the physical costs to deal with a breach. Those types of costs, if you’re hit with a breach, time really is of the essence.  You want to be able to get as much good, accurate information as to what happened, did it trigger your state data breach law as quickly as possible because if you go back to Target again, one of the things that they learned in the litigation and heavily criticized for reputation.  In fact, my family, we all have debit cards at our local bank and we have a Target about three blocks away.  So I always remember these dates, because it affected us.  They really came out public and our bank had offered debit cards two days before this special breach happened and they identified it because in early November.  So they took well over a month to month-and-a-half, to actually notify the world that there was a breach.  Looking at the costs, the cost part of a breach is going to be the initial forensics, legal consultation, so if initial forensics say this was indeed a breach, then you go to your legal representation, did this breach trigger the state’s data breach laws?  Everybody’s a little bit different.  They’re all state driven, but more similar than different.

 

The second part is you go to your attorney and you say here’s our data, here’s what happened, did that trigger the breach?  Well, these are expenses that are accumulating.  Then, if it does, you need to notify in writing and send compliance letter for all the people involved.  Then, you need to handle their calls and inquiries along the way.  They’re going to call in from that letter and either you do it in house or you set up a data center for that, train the people in the data center for those phones or your own employees, and then you need to offer one year of credit monitoring, and there’s a cost for that.  That’s kind of all your costs that are generally, somewhere, at least $30 per record and often times I’ve seen other studies saying going up to $100 per record.  That’s fairly quantifiable, based on how many records you have.  What’s much more tough on the limits is going to be, based on the data that’s been breach, who’s going to sue you and why, and what harm are they going to say you have caused. That becomes more much difficult to quantify.  Along those lines we deal with banks all over the country and as we’ve been renewing cyber policies, this has now become a regulator/board-driven type of thing. 

 

We’re routinely having banks come to us at renewal time and saying we want more liability just because of the unknowns out there.  So, what’ a good number?  It’s really hard to say.  There’s peer numbers that different services put out including Travelers puts out peer numbers for cyber liability.  We’ll throw our customers a couple of what their peers for the different pricings will be as a point of reference and then try to have a discussion on what type of information do you hold in the bank and how is it held, and start talking through kind of worse cast scenarios, if they lost some of that information, and who would be armed the most.  You try to massage the peer numbers from there, but like I think anything in risk and insurance, you really—you can’t necessarily observe for the absolute worst scenario, but you try and pick a number that will largely cover most of the occurrences along the way on a probability basis.

 

Kelly Coughlin:

Kris, you mentioned earlier that theft of funds gets covered by another type of risk mitigation tool and then you also mentioned that business interruption for a bank isn’t very high, because it’s not like there’s a bunch of transactions that come in if there’s interruption of service.  So what are the main costs drivers a bank can look at in determining how much coverage they need?

 

Kris St. Martin:

That’s a very good question and on the cyber side, certainly the number of records.  That’s going to be the biggest driver to look at on the cyber side.  We have banks that are also involved with card programs.  There can be other services that they provide very actively that involves the flow of personal information and vendor partner information.  That can provide another element of risk there versus the standard just checking and savings accounts and loans, and CDs type of business.  It could be a smaller bank that do very large wire transactions.  Another thing to look at is the size of transactions that you’re doing electronically.  There’s other banks that might be bigger that just do a series of very small transactions.  They may not need as big of a theft limit.  Those are things that underwriters as far as pricing a policy, are going to be looking at too; size of transactions, third-party vendors that you might be associated with, with special programs with the added element of risk of other people holding your data.

 

Kelly Coughlin:

When a bank experiences a breach, what are the costs that the bank has to absorb?  You mentioned the theft of funds, that’s covered by a bond.  There’s probably no business interruption costs or very minimal.  What costs normally accompany a cyber breach?

 

Kris St. Martin:

Well, in a cyber breach, let me kind of walk through what happens.  Somebody in IT is going to come to a CFO or some C-level executive and say, “Hey, something happened, we’re not quite sure what it is, but we’re concerned and we need to dig into this thing.”  The first thing you would do is try to go with an outside forensic partner who specializes in this type of thing and start digging it in with your IT group, and say, “Okay, exactly what was breached and is there a pretty high probability that all or some of our records are involved with that?  There’s a cost for that, for your forensics.  Once you get through that, you would bring that information to an attorney and I would highly recommend somebody who specializes in data breach law.  Say here’s the facts of what happened and how does that relate to our state’s data breach law, did it trigger that law, do we now have to go down the steps of notification and all the remedies that are built into that law.  There’s legal fees there.  Then, if the attorney says you did breach the law then you’re going to have to do a letter or a series of letters, emails, so on, out to your clients notifying them of a breach and then in there is going to be an offer of call us for more information.  Many times, it’s a separate call center service used.  There are those that specialize in data breach call centers and there’s an expense for that.  Also, most states, if not all, are going to require, if you did trigger a data breach law, that all of the people affected are going to be offered credit monitoring for one year and there’s a cost to the credit monitoring. 

 

This type of expense can be around $30 to $100 per record.  Banks may choose to do some sort of PR campaign, which often times happens with breaches in many industries.  There’s expenses of hey, we need to do some local newspaper advertisement.  We need to do some more letters to our clients.  We need to get on local TV or advertisements.  Basically, they put a message out there that this happened, we’re sorry, we’re on top of it, and we’re going to be better because of it.  Whatever your PR message is that you’re going to want to try and mitigate the damage under your brand.  Those are additional expenses that can come along the way before you even get to the liability side of who’s going to sue us. 

 

Kelly Coughlin:

Okay.  I’m going to list those again.  You’ve got: 1. A forensic partner; 2. Attorney costs; 3. Notification costs, notification of customers; 4. Maybe a call center; 5. Credit monitoring; 6. Reputation remediation. Are all of those insurable?

 

Kris St. Martin:

Yes and that’s part of making sure your insurance policy contains all that on the front side.  There’s really kind of a couple of ways that the breach expenses can be handled.  One that’s just more common is you’ve got a million dollar limit to handle A, B, C and D, and you’ve got to go out and find your partners, and you’re on your own, and we’ll reimburse you.  What we’re seeing is more and more of these insurance carriers providing some sort of data breach service as part of the policy and that’s been very well received in the banking world.  Now, you have to kind of wind through scenario again.  Instead of calling an outside forensics person, your first call under one of the policies that’s very common out there, is to call the insurance underwriter data breach manager and he assigns a case manager to it, and they start—that case manager stays with you through the whole time of the process.  They either have in-house services or they have third-party partners that they can immediately get you to.

 

The value of that versus a limit, one of the things, going back to the regulators, the regulators are all over the concept of what’s your—they’ve always been good on disaster recovery, the regulators, or at least asking what your disaster overall recovery plan for the bank. Now they’re getting all over where is your disaster recovery plan in the event of a data breach.  Again, you want to make quick access decisions and mitigate the reputational risks that you sat on this information, and get through it quickly and well-organized.  The regulators really like if you just do all those services under your limit then you better show them who your contracted third-party providers are going to be for those services, they’re lined up, they’re ready to go, they can work quickly, and you’ve thought through that whole process of who’s going to do that for you.  There are other policies that you call them and they start walking you through that, and provide a forensic person, they provide an attorney, they can help with the PR, all of that kind of built into the policy itself. 

 

Kelly Coughlin:

What advice would you give policy holders when completing their applications for cyber insurance?  Any unique tips, any special tips you’d give them?

 

Kris St. Martin:

Yeah, one very important is to be accurate.  Sometimes these things are onerous and they’re many pages long, but take the time to be very accurate, because if you put a number down, if they’re asking for a number or you answer something that you think, where that could come back to haunt you is at claim time.  They can pull up that application and say you answered it this way, we may not have even given you a policy.  What they’re going to do at claim time, they’re going to look and see if there’s anything, any speedbumps, that would take you out of getting the claim paid.  I’d also say be aware of warranty statements.  This is true, very true for cyber policies as well as all policies.  You need to be aware, often times in the applications themselves, they will say some statement like is there anybody in your organization aware of any circumstances that could lead to a claim under our coverage? If you have 500 employees, there’s no way you can say yes to that with any assurances and again, it could come back and haunt you at the claim investigation time.  So pay attention to warranty statements.  There are ways to modify those statements or eliminate them.  Then again, I mentioned this before, but pay attention to the thought behind the question on the application.  There are good reasons for asking for them and use that as maybe an excuse to go back and review your own procedures.

 

Kelly Coughlin:

Okay. I know you’ve been in this business a long time and you have a terrific reputation, so congratulations on that.  Is it fair to say that your objective is to help your bank clients get the coverage and not trying to help the insurance carrier avoid a claim?

 

Kris St. Martin:

Right.  Right.  What I always tell my clients is we’re going to sell the best, but accurate story to the insurance underwriter.  We’re not going to hide anything.  We’re going to give them accurate information and then they make their decision whether to insure or not.  From that point, when it comes to claim time, there’s two parts on the claim.  One is on the front end of it, when we give all the information to the insurance underwriter, they’re going to come back and say here’s our offer.  A good insurance agent, a producer out there, and there’s lots of great ones, you’re going to dive into that.  For example, we’ve developed a 40-point checklist with cyber over years of working with this.  We start, you know, producers should check a number of things in the offer so that when you do come to claim time, you don’t have these speedbumps.  Then there’s just a number of things that you can modify in the wording with the negotiation with the underwriter.  When it comes to claim time, whoever you’re working with for an agency, can be a great advocate for you on claim time.  You’re going to initially put the claim in as a customer copy or agent, but the agent should be in the loop the whole time, and aware of any objections that the claims adjuster is going to have, when it comes to the client. The agent has a really usual business dual role. They have a legal obligation both to the carrier and to the client, but they’re different obligations to each.  Claims is one where we really work with the client just to make sure they’re well advised on whether or not that’s a reasonable denial, if it’s a denial, or it might be something that they should talk to their attorney about and do a little bit more legal research on.

 

Kelly Coughlin:

Let’s talk about pricing a bit.  How flexible and negotiable are the terms of a cyber policy?

 

Kris St. Martin:

Like any policy, there are certain things that are just absolutely industry things.  But there are a number of things that are different and negotiable in a cyber contract.  Just a couple of quick examples, data breach on loss of information in one policy can be defined, for example, as electronic information loss.  What you want in the contract is paper information or electronic.  These things are negotiable with the carrier, often times.  A number of fine-print type of things.  Another example is some policies will pay on a ransom letter, for example, and then the definition will say we’ll pay out in US dollars.  Most ransom letters are requesting bitcoins.  Another dot that’s on our checklist is going to be make sure that the wording says US dollars or bitcoins that they can be paid out in.  Most of these types of things, the carriers are fairly flexible, but some cases, they’re not going to proactively do that.  They give you often times, the standard type of contract form and approval.  There’s room to be negotiating a premium.  We’re talking maybe 10% latitude, if it’s a good agent can build a case for the risk.  There’s some room in premiums, but a lot of room in the terms and conditions. 

 

Kelly Coughlin:

Back to that internal control continuum of one being nothing, five being great internal controls, is there negotiable room if the bank can build the case saying hey, look, our internal controls are four and five, you shouldn’t be pricing this at a three. Is that an area that’s negotiable?

 

Kris St. Martin:

Absolutely.  Absolutely.  It’s all claims related.  Example is like worker’s comp insurance, there’s a lot of loss prevention that carriers very proactively get involved with, with certain industries if there’s a lot of injuries.  If there’s a lot of claims in the cyber area, you can count on the carrier getting much more proactive in not only just asking the questions, but it might dig a whole lot deeper.

 

Kelly Coughlin:

One final question I have is, any tips, tricks, or traps when making a claim that we should be aware of?

 

Kris St. Martin:

Well, I’d say first when you’re looking at how claims are going to be handled, you want to do as much work as you can before you have a claim. We’re big proponents of things we’ve talked about here with procedures and all the preventive types of things.  In the insurance world, the preventive type of thing is one, make sure you pick a carrier that has a great reputation in the area of insurance that you’re talking about. That’s important because they’ve been there for a while and have a good claims paying history, and just a general reputation.  Secondarily in the prevention on the insurance side is make sure your policy is looked at by somebody who writes a lot of cyber insurance in this particular case, and knows the speedbumps that you’ve got to address, that are going to give you a problem at claims history.  Some of the wording, the definition, those types of things.  Lastly, you want to make sure that you have your agents intimately involved with that, because they’re going to be a strong advocate of you when it does come to claims time.

 

Kelly Coughlin:

Great.  That’s perfect. I will say, this podcast isn’t designed to be an infomercial for you or for CBIZ, but I am going to put a plug in, because I have some experience with you guys and some of your carriers, and I’ve been so impressed with how you are working with the community banking and regional banking market that I think the service is terrific.  I’m totally committed to helping banks manage this cyber risk because as I started it out, I think it’s a problem.  Community banks are in the crosshairs of these bad-guy cyber pirates and they need all the help they can get in preventing attacks and breaches. I applaud you for your great work.  I think I’ve finished the questions that I had, Kris.  Is there anything else you wanted to add that we didn’t get?

 

Kris St. Martin:

You know, only that another big topic out there is this third-party vendor. That’s probably a subject for a whole different thing that the regulators and just good business practice is really pushing hard down the road of okay, so your data processor is Fiserv, what do you really know about them?  Or your IT guy is XYZ, what do you really know about them, their procedures, their insurance?  It’s a whole other kind of layer to this that’s opening up as a third-party vendor that you as a business or bank are using.  Besides that, no, I just wanted to thank you a lot of the opportunity.  It was fun to do and really honored that you thought enough of us to pull us into one of your podcasts. 

 

Kelly Coughlin:

Well, yeah, I appreciate it.  I would like to follow up with another podcast on third-party vendors and the due diligence required.  Let’s put that on the calendar.  Kris, I really enjoyed it.  I wish you the best.  Keep up the good work.  Enjoyed talking to you.

 

Kris St. Martin:

Thanks, Kelly.  Thanks so much.  Talk to you soon.

 

Announcer:

We want to thank you for listening to the syndicated audio program bankbosun.com.  The audio content is produced and syndicated by Seth Green, market domination with the help of Kevin Boyle.  Video content is produced by The Guildmaster Studio, Keenan Bobson Boyle.  Voice introduction is me, Karim Kronfil. The program is hosted by Kelly Coughlin.  If you like this program, please tell us. If you don’t, please tell us how we can improve it.  Now, some disclaimers.  Kelly is licensed with the Minnesota State Board of Accountancy as a Certified Public Accountant.  The views expressed here are solely those of Kelly Coughlin and his guests in their private capacity and do not in any way, represent the views of any other agent, principal, employer, employee, lender, or supplier.

Nov 7, 2016

Kelly Coughlin:

Greetings, this is Kelly Coughlin. A pack of wolves lurked near the sheep at pasture, but the dogs kept them all at a respectful distance and the sheep grazed in perfect safety. But now, the wolves thought of a plan to trick the sheep.  “Why is there always this hostility between us,” they said.  “If it were not for those dogs who are always stirring up trouble, I’m sure we should get along beautifully.  Send them away and you will see what good friends we shall become.”  The sheep were easily fooled.  They persuaded the dogs to go away and that very evening, the wolves had the grandest feast of their lives. 

 

Announcer:

Kelly Coughlin, CEO of BankBosun, a management consulting firm helping banks C-level offices, navigate risks, and discover reward. He’s the host of the syndicated audio podcast bankbosun.com.  Kelly brings over 25 years of experience with companies like PWC, Lloyd’s Bank, and Merrill Lynch.  On the podcast Kelly interviews key executives in the banking ecosystem to provide bank C-suite offices risk management, technology, and investment ideas and solutions to help them navigate risks and discovery reward.  Now your host, Kelly Coughlin. 

 

Kelly Coughlin:

Hello everybody, this is Kelly Coughlin, CEO of BankBosun, helping C-suite bank executives navigate risks and discover reward.  Today is the first in a series of five podcasts on the subject of cyber security and banking.  Cyber hackers today rob banks much more sophisticated than the days of say Jesse James.  And certainly, they’re much more intelligent than Isaac Davis who committed the very first bank robbery in the US in the year 1798.  Davis robbed the Bank of Pennsylvania at Carpenters Hall in Philadelphia, PA.  He was apparently so stupid that he robbed the bank of over $162,000 and then deposited the funds in his own account at the same bank.  Not very smart. He got busted. 

 

Today’s cyber pirates aren’t that stupid.  They attack the bank’s web application.  They shut down their site for ransom with denial of service attacks. They skim credit and debit cards. They engage in privilege misuse, crime ware, just to name a few.  It’s a huge threat to banks. And the reason I’m putting so much attention and focus to it at BankBosun is the expectation is that more bad guy resources will be directed to community and regional banks in the future for two primary reasons.  Number one, the Willie Sutton factor.  When he was asked by the FBI, “Hey Willie, why do you rob banks?”  He replied, “Because that’s where the money is.”  Then, a second reason, insufficient resources to prevent and detect.  If lower net interest margins and higher regulatory burden weren’t enough, then the additional expense required for cyber security risk management is enough to put you over the top. 

 

So that leads me to my guest for today.  His name is Kris St. Martin.  He’s vice president bank services program direction for CBIZ with over 100 offices and 4,000 associates in most of the major metropolitan and suburban areas throughout the US.  CBIZ delivers financial and employee business services to many organizations of all sizes as well as individual clients by providing national expertise combined with highly personalized services.  CBIZ is a leader in cyber risk including cyber insurance, IT audit, penetration testing, mobile application assessment, digital forensics, cyber risk management, and Kris is a cyber insurance expert, and is a member of the CBIZ national cyber risk management team.  He has more than 23 years of direct bank experience and he’s held many positions in banking.  He’s been providing risk mitigation services since 2009.  So, with that introduction, Kris, are you on the line there?

 

Kris St. Martin:

I am.  Thank you very much for that introduction, Kelly. 

 

Kelly Coughlin:

Did I cover all the relevant points in your bio, Kris?

 

Kris St. Martin:

You were very, very thorough.

 

Kelly Coughlin:

Excellent, I like being thorough.  Now, I didn’t include any personal background in there.  Do you want to start off with telling us who you are, family, where you live, that sort of thing?

 

Kris St. Martin:

Sure, absolutely.  As you mentioned, I was in banking for over 20 years.  I live in Plymouth, Minnesota, a suburb just west of Minneapolis.  In my banking days, I was involved in community banking in Plymouth for 20 plus years.  I worked First Bank Systems, which later became US Bank.  I was very familiar with a regional bank becoming a large national bank.  Went to a very small community bank, worked there for four years in my hometown, opened up a branch for them for a couple of years, and then became part of the de novo bank experience in 1999.  We opened up the bank in 2000.  Lived in the same community, Plymouth, for 20 plus years.  Wife of almost 26 years.  Three kids, one is a wildland firefighter; one’s a senior at the University of Minnesota going on to the law school next year; and my daughter has graduated with a marketing degree recently, and works for a hotel chain in the twin city.

 

Kelly Coughlin:

That’s terrific.  Let’s dig right into it, Kris.  Subject today is cyber risk, cyber risk management in the banking ecosystem.  Let me just start out with a very general question here.  From your perspective, what are the cyber risks facing banks today?  What are the key risks that you see they face today?

 

Kris St. Martin:

Well, Kelly, you mentioned a number of them in your introduction and they include probably the largest frequency risk today is the ransomware by cyber extortion.  For the last few years, that was not as prevalent in the financial institution world, because financial institutions were deemed as a little better at backup than other industries such as retail and medical.  The very nature of those are locking up your information and if you haven’t backed up for a few days, that could be very, very costly. So they paused on the banking world for a couple of years, and now it’s getting hit very, very hard.  The other industries have tightened up on their backup procedures.  They tend to be smaller amounts; anywhere from $500 to $50,000.  They can be larger.  They tend to be quick hits, lock up your system.  Data breach is obviously a big one in the banking world, because obviously banks hold a great deal of data. Theft of money is always a big one. 

 

We’ve seen several cases recently where there was some type of hack leading up to obtaining passwords and wiring money out.  In addition to the types of things that are happening, banks are having to deal with, as you mentioned, the regulatory aspect of that.  The regulators are all over this topic and have great expectations when they’re coming in for exams.  Cyber insurance is part of that, where they really didn’t look at that too much in the last couple of years before that.  Now, they’re wanting to know what type of cyber coverage and all your cyber procedures are so it’s put a great deal of burden on them.  The reputation risk for having your information active is enormous to both your reputation, your brand, and litigation from a number of sources if you could have your data breached can be from clients who’ve had their data breached and it could be as more of like a class action if you had 50,000 records breached.  They could all ban together and sue, but it could also be if you’ve lost one really critical piece of data. 

 

Let’s say it was a critical business plan of one of your clients that you obtained in conjunction with a loan request.  Who knows what kind of harm that could cause, if that got in the hand of a competitor?  There’s also some litigation based on what is showing on social media.  Banks often encourage their employees to be on LinkedIn and other social medias to increase the bank’s presence.  There are other things that bankers are on that are not necessarily done with bank approval like Facebook.  So, somebody could be on Facebook and note on there, they’re an employee of XYZ bank and put something disparaging about one of the competitors on there.  It wasn’t necessarily a bank approved type of a thing, but they can be pulled into the litigation because of the reference to the bank.  So there’s a wide variety of cyber risk and financial risk for banks out there right now.

 

Kelly Coughlin:

Now that social media example, that isn’t part of cyber security risk. That’s more reputational risk, other financial risk, but a bank’s employee participating in Facebook for instance, that doesn’t open up risks for cyber-attack, correct?

 

Kris St. Martin:

Not from a cyber-attack, but it can be part of your cyber risk management program.  There’s great expectations from regulators that you are training your employees because there’s a financial risk that can come back to the bank.  So it’s part of your cyber risk management program at the bank not necessarily directly from a hacker. 

 

 

 

 

Kelly Coughlin:

Okay.  You guys are in the business of helping banks insure the risk.  In the event of a cyber-attack, they buy an insurance policy that covers their financial risk in the event of some sort of cyber-attack, correct?

 

Kris St. Martin:

Yeah. 

 

Kelly Coughlin:

Now, is it fair to say that four years ago cyber risk management was more or less a footnote of a P&C policy or an E&O, D&O type policy?

 

Kris St. Martin:

Right and there’s just only a few remnants of that.  So, for example, in your general liability policy there were many areas in there that could have provided coverage 10 years ago under what’s happening in today’s environment.  Over the years, the carriers have been excluding on your D&O policies, directors and officers liability policies, your professional services policies as well as your general liability policies, anything that’s related to cyber risk.  So today, most directors and officers policies and general liabilities policies exclude anything related to cyber risk.  They push everything towards a cyber policy with only a few exceptions.  The exception to that is in their directors and officers policy, if you look at what happened to Target, the Target breach about three or four years ago, after the smoke cleared the directors and officers were sued for lack of oversight of the cyber risk management program.  That’s where kind of a cyber-related type of thing can still be pulled into a D&O policy, but specifically if officers and directors are named based on decisions made by those directors and officers.  The D&O policy is not going to pay for anything that’s related to your expenses associated with the breach.  In the case of theft of money through hackers, where there is a theft of money, that’s treated under a crime bond policy. So the other exception is if you had a hacker come in, obtain codes to malware or whatever they use, eventually wire money out that’s not retrievable, that actual cash loss, whether it’s the bank or your client, is treated and handled under the bond.  So those are kind of the two remaining policies where there is some related coverage. 

 

Kelly Coughlin:

Okay, but business interruption, for instance, let’s say it’s denial of service, which is business interruption, would that be specifically excluded from the other P&C policy that would cover interruption from fire or water, that sort of thing?  Is that specifically excluded? 

 

Kris St. Martin:

Yes and with other causes of business interruption, that is included in your traditional package policies.  That has historically been part of those policies, but with a cyber interruption, again, those policies now exclude the business interruption reimbursement and pushed it back to the cyber policy.  If you’re a retailer selling products online and your website goes down for three weeks, it’s very easy to document the lost sales based on a history there.  In the banking world, your primary revenue is going to be your net interest margin, so your loan income is still coming in regardless if your system is down or not.  So the classic business interruption policy is going to pay for the lost income. It’s good to have it in your policy because you never know, but there’s not a lot of claims in there in the banking world because it’s difficult to demonstrate you actually lost income.

 

Kelly Coughlin:

Yeah, I suppose it’s mainly reputational damage, if people go to the site and they can’t access it, and the media gets wind of it, then that’s more harmful than loss of any sales on any given day, correct?

 

Kris St. Martin:

Yes, that is correct.

 

Kelly Coughlin:

So this is a whole new policy that banks now have to include in their portfolio of insurance policies.  That’s good for you in that it’s another policy that you can earn fees on.  Bad for them, it’s another policy that they have to pay fees on, but that’s the brave new world.  Is it fair to say that regulators today are looking for and demanding specific policies related to cyber insurance? 

 

Kris St. Martin:

Yeah, it’s interesting from the regulators.  They will come in and they will look at your insurance policies, but there’s very little that they absolutely require on insurance.  The way the regulations are written under there is you don’t necessarily have to have insurance, but you’ve got to convince us that you have a way of self-insuring, or what your plan is.  A bank that’s extremely well capitalized can go in without any insurance policies if they want and say we’re going to self-insure for those.  That’s not very common. So the regulators would come in, they don’t require it, but they will look through the insurance policies and it could be a critical comment, if you didn’t have insurance.  When the regulators come in and look at the cyber program and IT in general right now, the insurances went from low business access loss to a very important part of your cyber risk management and how your IT exam is going to come out.  Again, it’s not a requirement, but it’s going to fall into how you’re rated and the components of the rating for that whole area.  They know that if you do have a cyber breach and you’re making decisions, and you need to make fairly timely decisions, because the harm for not acting quickly exponentially get worse.  Not only financially and reputation wise, so it’s good to know that you would have an insurance available to help you make good, accurate, quick, timely decisions and not make bad decisions based on we don’t have a funding mechanism outside of our own capital.  It’s a very distinct part of that exam, but not required.

 

Kelly Coughlin:

Okay.  If I go back to my consulting days of internal controls, you’ve got three categories of controls; prevention, detection, and correction.  Insurance has been more or less in the correction category.  It’s a way to make people whole, make the company whole.  It really doesn’t prevent and detect things.  Those are internal controls that the company has to adopt and use insurance on the correction side.  As part of the insurance underwriting process, is there any sort of work or effort being done by insurance carriers that helps banks on the prevention and detection side in terms of adopting best practices among the industry?  Do they give discounts in premiums if they have best practices, or not?

 

Kris St. Martin:

I think it’s fairly early on in that world with carriers right now, but if you look at an application from a carrier and try to say okay, why are they asking that, a lot of it gets at the best practices that they’re asking.  They’re going down that path and by the way Kelly, the cyber policies today are not viably priced as of yet in the banking industry.  If you’re a community bank under let’s say a half billion, you can probably get a $3 million limit cyber policy.  Now, there’s going to be different bells and whistles there, but you can probably get something in that range for $8 to $12,000 in that range, for $3 million.  We’ve got small little banks that they’re buying them for million dollar coverage for $3,000.  They’re a pretty good robust policy.  Where underwriters are looking at pricing, they can fairly quantify, if a data breach happens based on a number of records, personal data records that you have, there’s different published amounts of somewhere around $30 per record is going to be what your cost is out of pocket.  They can fairly well quantify the costs to immediately get through the data breach part of it and the carriers are fairly comfortable with the pricing on that.  Where it really gets difficult, is more on the liability side; who’s going to end up suing you; what regulatory body is going to put a fine on you; and that is a really ever-evolving market. 

 

As an example, going back to the critical piece of data, if you lost somebody’s business plan, it gets into the wrong hands, that’s hard to quantify.  It all depends on the circumstances.  It could be a half-million dollar lawsuit, it can be a $10 million lawsuit.  So that’s evolving.  Getting back to kind of your question on the underwriting, the first two things that a cyber underwriter will look at in the big picture of things is number of records that you have.  Records are generally defined on the consumer side, if there’s a social security number associated with a name of loss, that’s automatically going to qualify as triggering a data breach for that particular record.  So you look at the number of records both personal and business, that you hold, and that will be on the application and that will be probably the biggest thing that will set the pricing.  A bank may have 100,000 accounts, either accounts that are closed or current ones, but they may have 25,000 individual individuals who opened all of those accounts.  So the number of records would be the individuals with their social security number and how many of those do you have at the bank.  Historically, if you are retaining that information in current accounts, that’s the primary driver with the cost of cyber insurance right now. 

 

They’re going to look at the annual revenue of the company just to give them a scope of the size and breadth of the company.  It’s not perfect, but it gives them an idea of obviously a bigger company versus a smaller organization, because it’s got more things going.  They have more contracts.  They have more data.  In general, more stuff going on that could potentially fall into the cyber world.  Then, you look at a typical application and look at some of the questions that they’re asking.  Some of them would be maybe a complete take out of hey, we don’t want to write this policy.  Some of them are going to be a little much less alarming, if you had answered no. But if you look at it, there’s a reason they’re asking those questions.  It’s the overall risk to the insurance company.  Same thing for the bank. 

 

For example, one question that’s on many applications and I’ll read one, “Does the applicant restrict employee access to personally identify information on a business need to know basis?”  That’s a pretty general question and most banks are going to say, yes, we make sure, we try to make sure that people can have access to different areas on the computer network based on what they need it for, kind of a need to know type.  That question, I think most banks are going to say yes to that.  Who wouldn’t say that?  But they always want you to kind of think that through and really go back and review that.  Hopefully, if I’m looking at that, not only am I going to say well yeah, but hopefully that causes you to go back and really review that because they’re asking that for a very good reason.  There’s claims history behind those questions.

 

Kelly Coughlin:

Back to my prevention, detection, correction internal control model. On the prevention and detection internal controls, what I think I hear you say, let’s say we have a continuum of one being no internal controls and five being terrific internal controls.  In the underwriting process, if the bank comes in at a one or a two, they’re going to get rejected.  If the bank comes in at a four or a five, they’ll get accepted, but they’re not going to get any discounts. They’re not going to get rewarded for their superior internal control structure, but they’ll get accepted.  So if they’re a 3, 4, 5, then they get lumped in terms of the same pricing, but they won’t get rejected.

 

Kris St. Martin:

Yeah, I think that’s a fair statement.  What will happen over time as there is more and more claims history with these carriers, they’re going to be able to get even more defined on that type of thought process.  If they know that, in my example that I talked about under being able to restrict your employees to only certain applications within your system. If that became more and more of a claim problem for carriers, they’re probably going to dig deeper into that and actually ask more and more questions beyond that and have you document that and also base the pricing on that more and more.  So yes, there is definitely some underwriting based on your current procedures in place.  I think just based on where claims are going, there’s going to be more and more of that.

 

Kelly Coughlin:

What’s your expectation in terms of likelihood on the pricing part?  Do you think they’re going to increase or decrease, or stay the same over the next 12 months and then even farther out from that?

 

Kris St. Martin:

Yeah, I think it’s going to be a little bit like the hurricane effect in general P&C insurance.  Whenever there’s a big hurricane, that’s going to affect everybody’s homeowner policy for a couple of years.  Everybody will see the cost of premiums will spread out a little bit.  I think you’re going to see that in cyber.  Right now, there are a number of claims out there, but it’s not to the point where I don’t think that the premiums the carriers are changing isn’t supporting it.  The carriers are a profit business like anybody else. They try not to pay out more than 50% of what they charge in premiums on claims, kind of a rule of thumb and then the other 50% is profit and paying for the rest of your operation. When you see that pay out starting to exceed that kind of industry percentage, that’s when you start seeing the premiums go up. That would just take enormous breaches or volume of community bank breaches, then it’s going to be all claims related. 

 

So, as of right now, based on what the pattern of claims are, it should be pretty steady, but with a caveat that it wouldn’t take much if there’s a couple of alarge financial institutions or a bunch of smaller ones, you’re starting to get into hundreds of millions of dollars of claims, that could push prices up in a hurry.  The other part to that is there’s also a future expectation of risk of what’s going on, they can push it up also.  Even if the claims haven’t quite hit yet, if there is a more and more devious way to harm banks than before and that comes out, and there’s a fear of that, you may see some underwriters starting to push the premiums up in anticipation of that.  They don’t have any reason to believe right now, based on what’s been happening, that we’re going to see premiums drastically increase in 12 months.

 

Kelly Coughlin:

Well, that’s it for part one of my interview with Kris St. Martin, a bank cyber security expert at CBIZ.  In part two, we’ll talk more about what drives premium costs and once a bank experiences a cyber intrusion then what are the actual types of costs the bank can insure, and how to make sure that these costs are recoverable in an insurance claim. 

 

Announcer:

We want to thank you for listening to the syndicated audio program bankbosun.com.  The audio content is produced and syndicated by Seth Green, market domination with the help of Kevin Boyle.  Video content is produced by The Guildmaster Studio, Keenan Bobson Boyle.  Voice introduction is me, Karim Kronfil. The program is hosted by Kelly Coughlin.  If you like this program, please tell us. If you don’t, please tell us how we can improve it.  Now, some disclaimers.  Kelly is licensed with the Minnesota State Board of Accountancy as a Certified Public Accountant.  The views expressed here are solely those of Kelly Coughlin and his guests in their private capacity and do not in any way, represent the views of any other agent, principal, employer, employee, lender, or supplier. 

Nov 3, 2016

Kelly: My next guest worked with his brother, and was so fierce and mean in his first career that some journalists called him and his brother the “Bruise Brothers”. He wasn't in the mafia. He was an NFL safety for the Miami Dolphins.

Greetings! This is Kelly Coughlin.

Voiceover:     Kelly Coughlin is CEO of BankBosun, a management consulting firm helping bank C-Level Officers navigate risk and discover reward. He is the host of the syndicated audio podcast, BankBosun.com. Kelly brings over 25 years of experience with companies like PWC, Lloyds Bank, and Merrill Lynch. On the podcast, Kelly interviews key executives in the banking ecosystem to provide bank C-Suite officers, risk management, technology, and investment ideas and solutions to help them navigate risks and discover rewards. And now, your host, Kelly Coughlin.

Kelly:             Hello! This is Kelly Coughlin. I am the CEO of BankBosun and program host. This is the first in a two-part interview series with a guest that I think is fascinating, interesting and frankly, he’s simply an enjoyable guy.

 

His name is Glenn Blackwood. And he is a Board Member and Principal of Equias Alliance, a bank-owned life insurance and nonqualified benefits consultant for regional and community banks.

 

What makes Glenn more fascinating and interesting than your average BOLI guy is Glenn is a former NFL athlete with the Miami Dolphins. And for all you bankers out there, who of you never reenacted the 5 seconds left, game on the line, opponent in the red zone, pass thrown your way, interception, game over, you win…

 

Well, this guy has been there, done that. And you all hear that not all games ended this way. You will win some and lose some, and learning to deal with that was part of being a professional athlete.

 

You know, in my mind, competition is the common denominator between sports and business. Certainly, professional sports are a business industry in and of themselves, but I am talking about the competition on the field of play in sports - the gridiron; and the competition on the field of play in business - the boardroom.

 

So what can be learned from professional sports about competing more effectively in business? And more specifically, what can our bank clients learn from professional sports and a professional athlete who knows business? That’s the purpose of this podcast.

 

Glenn has over 25 years of experience in the bank-owned life insurance and nonqualified benefit plans consulting and has worked with hundreds of banks in the design and construction of cost-effective solutions, to help banks compete and retain good talent. But before that, he was with the Miami Dolphins for about 10 years and I think he played middle linebacker for the Dolphins. Glenn, did I get that one right?

 

Glenn:            You got everything right except position. If I had played middle linebacker, I’d have gotten killed.

 

Kelly:             Oh that’s right, you played safety.

Glenn:            Yes, I played safety.

 

Kelly:             All right. Great. Glenn, welcome! How are you doing?

 

Glenn:            Thank you. I am doing fine. Glad to be visiting with you.

 

Kelly:             Great! Thanks for coming on board. Glenn, I don't want to try to summarize your background, because you know yourself better than I know you. Just give us a summary of education, business background, family, where you living, how many kids?

 

Glenn:            My wife and I have been married for 34 years and we have 4 children and 4 grandchildren. I grew up in Texas and I grew in a football family. My dad played running back at Baylor in the late ‘40s. And then, I had two brothers and one sister.

 

My sister was a very good athlete as well. She played tennis and actually was one of the top tennis players in the city of San Antonio where we grew up.

I’m the youngest of the four and my oldest brother Lyle played at TCU and went on and played in the NFL with a variety of teams, and actually ended up playing with me down in Miami for his last 5 years, which was really a kick.

 

Then I have another brother Mike, who was probably the best athlete of all of us, but he was just smaller than Lyle and I were. He was a tremendous baseball player, basketball player, golfer, football player, and he played at TCU and then primarily due to size restraint, he wasn’t able to play in the NFL.

 

I did really well academically in high school so back then there wasn’t as much educational counseling it’s kind of like, well, if you did really good in grades you went into med, you became a doctor.

 

And then I ended up going to the University of Texas out of my high school. Darrell Royal was kind enough to offer me a scholarship and there is a long story there, which I won’t bore you with. I was not his early on pick, because I was kind of small as well. And they ended up taking a chance on me and I think it worked out for them and certainly worked out for me.

 

I ended up starting three years there at the University of Texas. I was captain the last year of my playing there.

 

So I was in pre-med at the University of Texas. Actually, had completed those or was right in the process of completing, when the Dolphins drafted me. And the dean at one of the, I think it was the University of Texas Dental School, said "Look, you can come back and go to school anytime, but how many people get a chance to play in the NFL?"

 

So I really appreciated him having the candor because a lot of academic guys don’t really value the sports side. He was really a balanced guy and he said, “Go try the NFL. And you can always come back and go to school.”

 

And I was drafted by the Miami Dolphins in the 8th round and I ended up.

So after 10 years in NFL, I wasn’t going to go back and try to redo that, and ended up playing 10 years for the Dolphins. And started my career there and ended my career there. I actually had nine seasons. I played in my last year but I was on injured reserve with a knee injury, which ultimately ended my career. So it was a good run.

 

Kelly:             Those were Don Shula years, I’m thinking, right?

 

Glenn:            That would be correct. That was 1979. I was drafted and I retired in April of 1989. I had all my years with coach Shula and that was a great experience from a standpoint of playing for a coach who had a grasp of the game and all phases of the game, as well as how to manage a football team. The head coach has to do a lot of stuff and Shula was probably as good at it as anybody I've ever seen.

 

Kelly:             And let’s see, Bob Griese would have been the quarterback in those years?

 

Glenn:            Actually, Griese was there the first two years I came to the Dolphins and then after that, we had a little stub period and then we drafted this kid out of Pittsburgh named Dan Marino and that was the end of that.

 

Kelly:             And that was the end of that. So you had, what, four years with Marino at the helm?

 

Glenn:            Danny came in at '83. So I actually had five years of playing with Danny.

 

Kelly:             Five years, yeah.

 

Glenn:            There is a great story there. He came up to my brother was in the locker room and my brother had been playing at that time for like 12 years, kind of the seasoned veteran. And here is the rookie Marino at his first start and Danny tells the story during his Hall of Fame speech.

 

My brother walked up to him and said, "Danny, look just relax. You are a great football player. You’ve got a great arm. You are going to be great in this league. Don't be nervous. Don't go out there with any anxiety. But just remember our whole season is riding on your shoulders."

 

Marino said, “Thanks a lot!” And he properly went out threw for a 356 yard game and so began the career of Dan Marino and probably one of the most amazing releases I’ve ever seen by a quarterback. He was so quick release. People say, “Oh, what it’s like playing with Danny?” And I’d said, “Well, you know I watched him from the sidelines so I was glad I wasn’t playing against him. But I practiced against him every day. And he made me a better football player because his release was so quick that you had to get a jump. You couldn't play around with him. You couldn’t give him any space because he could get that ball going with accuracy and velocity quicker than anybody I’ve ever seen.

 

Kelly:             I always have this incredible amount of respect for defensive players - safeties and cornerbacks - when they are in a situation where they know the game is on the line and then it’s the safety and the cornerback facing a really good quarterback and a really good receiver and there you are getting ready for the play. What’s that like? How do you get your mind in the game, where you’re not thinking "Oh my God! If I blow this, I’m done." Right? How do you get yourself prepared for that?

 

Glenn:            Well, I think part of it is that you realize that you are playing against professionals that are really good at what they do. So you’re going to get beaten some. And if you don't have a healthy understanding of that, then you’ll be a basket case in the NFL. There are those individual NFL players that are so talented…they relish that opportunity because they know they’re that good and they’re going to be able to rise to the occasion.

 

Most of the players in the NFL are really good athletes, but they are not of that ilk where they are just going to dominate every time. So it’s nerve racking and it is exhilarating when you rise to the occasion, and it’s a gut punch when you don’t. And I’ve been beat for touchdowns and I’ve intercepted passes as they were going in for touchdowns and I’ve stopped the play. And as they said in the Wide World of Sports, the thrill of victory and the agony of defeat. And it’s painful. But if you don't realize that that’s very much the way life is. You’re going to have some moments of exhilaration in life and you are going to have some pain parts in life as well. If you don't negotiate that well, then it can make for a tough time.

 

Most guys who have a difficult time with that don't last as long in the game, because they can't handle the pressure. I really felt like I prepared extremely well for a game. I had knowledge of my opponents. I knew what they liked to do. I knew what they like to do in certain downs and distances. And so I could it whittle it down.

 

I remember there was a play where we were playing with the Jets one time and they had a really good tight end, almost like a receiver guy a guy named Jerome Barkum, and I knew what pass route they were going to run. They ran it against me and Richard Todd threw the ball, completed it ind the end zone for touchdown. I knew exactly what they were going to run. I was just playing against a really talented receiver and a quarterback who put the ball in a place where only he could catch it.

 

Kelly:             Do you get in situations or have you seen players in situations where the fear factor of getting burned it almost creates a paralysis and they get so consumed by failing that they are almost slow to react cause they are so consumed by that?

 

Glenn:            There is no doubt you see that. You see it all the time. And that’s happened to me. Everybody has those moments where you know you say, “I don't want to be the weak link in this defense or this offense.” So absolutely, that happens. And I think some guys can live through that and come out on the back side and learn from it, and they mature and they grow through things. And then others, they never get a handle on it. And I think it hinders their career.

 

Look, I watched a lot of guys that were much better athletes than me, come into training camp every year and for some reason you know I was able to keep my job for you know ten years. A large part of it was because I really prepared a lot for the games and I had a good knowledge of the game, and I could coordinate our defense really well. The other part of it was that you kind of grow into that knowing that you’ve got to realize that you are going to have times where you make the play and there’s going to be times where it doesn’t work out the way you wanted to.

 

And that’s the game of football. You are playing with really good players on the other side of the line and that their job is to make you look bad, to beat you. They are good athletes. So sometimes you win, sometimes you lose. Fortunately, down in Miami, we won a little bit more than we lost and that was good.

 

Kelly:             Ever been in that situation where there is just mismatch, you are making the wrong reads and then, they are picking on you?

 

Glenn:            Very seldom I saw myself in that position because I was not reading things right. It usually was just physical talent. I wasn’t the biggest, fastest guy out there. You are going to get in those situations – and sometimes the quarterbacks see it and sometimes they don't.

 

Kelly:             So after the NFL, you decided you wanted to get in to the bank-owned life insurance business. How did you end up picking this industry?

 

Glenn:            You know the reason I got into the business is that – it’s a long story but I will make it very short. I ran into a former adversary of mine in the NFL, a guy named Wally Hilgenberg. And Wally played linebacker for the Minnesota Vikings…and played sixteen years in the NFL. And he and a few other gentlemen had started this business and they called the company Bank Compensation Strategies. And that company placed the first BOLI product on a bank in Bloomington, Minnesota back in 1982. And it was kind of a quid pro quo. It was an insurance policy purchase to hedge a SERP or deferred compensation expense.

 

And that’s the way this whole business really got started. And Wally and I ran into each other at a fishing tournament..I’ve got a name for it but I won’t say it on this…but it’s basically the old guys fishing tournament..former retired guys from the NFL we were fishing down in Louisiana and I happened to sit next to Wally on a bus going to the fishing tournament. And he and I got to talking.

 

And I had prepared for after football by going to a university down in Miami and studying for a couple of years. I had worked in an investment banking firm because I knew they’d kick me out of football one day. And that’s probably the one thing if I could say for most athletes, especially professional athletes is you’ve got to prepare for the day they tell you you're not good enough anymore. Because it will happen. And when it does, the severing of that cord, of that tie is swift, and it’s brutal, and it’s fast and it’s painful.

 

If you are not economically prepared and educationally or vocationally prepared, it’s a very tough transition. Fortunately, I had done that and Wally and I got to talking and he said we’ve got this program where he had this BOLI asset and the benefit needs. And he explained it to me and what I saw in it, was I saw there were three real focused needs of expertise.

 

You had to have some sense mathematically. You had to have accounting grasp. You had to have a legal grasp, because there were agreements involved. And then, you had to understand the regulatory piece of it. And I loved the multitasking and juggling all those balls. That was very similar to what I did on the football field, because I ran our defense for most of the years I was playing down there in Miami.

 

And so, I had to know what the line backers were doing. I didn’t play their position but I had to know what they were doing, what their challenges were, and our defensive line, our corners. And then I had to when the offense came up and showed us a different formation, I had to change our defense and put us in the right one. I love Bill Arnsparger, my defense coordinator, who was one of the greatest defense coordinators in the NFL and he sat me down on the bleachers one time and said before I was going into my first start, where I was running the defense, and he said, “Glenn. I can only guess right half of time. You have to put the right defense the other half.”

 

And first of all, Bill was understating his capabilities, because he didn’t guess, number 1. He was well prepared. And most of the time, he gave us the right defense. But he gave me that freedom, to move and change if I saw something I didn’t like.

 

And I loved that ability, the need to understand all the different pieces of how a defense works together. And it is the same way in this business. You got to understand the legal, the accounting, the regulatory. And I love being able to juggle those balls and being able to put everything together and explain to a bank and a bank board how this works, how we can put it in, how it works from an accounting perspective, and tax and balance sheet and income statement, and then what we do to take care of them to caretake for them on an ongoing basis. I looked at it and I thought this is a good fit for my skill set and Wally wanted somebody in Florida and I said I think I found the right guy for you, and that's me.

 

Kelly:             Did you ever have to play up in Metropolitan Stadium in the winter?

 

Glenn:            I played in the Met Stadium but not in the winter. And by the time I played up there in the winter, we had a dome. But I did play in the Packers in the teens and I played in New England and Chicago and New York.

 

Kelly:             How tough was it from Miami because half your games were down or more than half of your games were down in the southern climate, right? But how tough was that?

 

Glenn:            It was hard because you had to adjust to the cold weather really, it hardens everything and it makes it harder to catch the ball. One of things coach Shula used to say is don’t overdress and he’d be yelling in the locker room, don’t overdress. His point out of that was you can be warm, you can put on enough stuff to get you warm, but you can't function. You had to get that balance of layering that allowed you to maintain some form of body heat but also be able to move fluidly in your uniform, etc. I think, actually, while it was tough on us, I think it was much harder for the northern teams in November to come down to Miami and play in 80 degree weather and it’s humid. I’ve watched teams literally just melt right before us because they just couldn't handle it in the second half.

 

Kelly:             Really? What about the Mile High Stadium? Did you ever must have played there?

 

Glenn:            We did play at Mile High Stadium. That just really wasn't a lot  of problem either for me. The lack of altitude was offset by the lack of humidity…and so you didn’t sweat a lot out there. It was invigorating…I loved playing in that. The worst place I ever played from a physical standpoint of trying to be able to breathe was when we played the Rams out in Anaheim one year and they had a stage four smog alert. It was a one o'clock game; they had to turn the lights on in the stadium. There was so much smog. My lungs burned for about 2 days after that game.

 

Kelly:             Let's finish with the dumbest thing you have ever done or said in your situation?

 

Glenn:            I remember one time I was so, we had a fourth and one the Buffalo Bills were going into our endzone. They had kind of a strong set towards me and I was a strong safety and I really wasn’t that big a guy, so my adrenaline was flowing and I thought this guy was going to try and kill me. And they’re going to try to run right over me. It was kind of what you talked earlier, where there’s a little bit of fear there and I didn't want to be the weak link in the defense. So I was geared up and as soon as the ball was snapped, I took off to run into that flanker, he just turned sideways and I whiffed on him and he was a tight end flanker, it was a real tight set. They ran a play action pass and you know when I whiffed on him, I basically stumbled and the guy I was supposed to be covering ran right into the end zone and they threw him a little pass for a touchdown.

 

Kelly:             Well, that finishes Part 1 of my interview with Glenn Blackwood. I started the podcast saying Glenn was fascinating, interesting and simply a good guy, and I think that came out in this interview. I personally just love hearing his war stories of the NFL.

 

In Part 2, we will talk more about his second career in business and focusing on his expertise in the bank-owned life insurance business. And true to his form, he is competing and winning in this business just like he did with the Miami Dolphins. Thanks.

 

Voiceover:     We want to thank you for listening to the syndicated audio program, BankBosun.com. The audio content is produced and syndicated by Seth Greene, Market Domination, with the help of Kevin Boyle.

 

Video content is produced by The Guildmaster Studio, Keenan Bobson Boyle. The voice introduction is me, Karim Kronfli. The program is hosted by Kelly Coughlin.

 

If you like this program, please tell us. If you don’t, please tell us how we can improve it. And now, some disclaimers. Kelly is licensed with the Minnesota State Board of Accountancy as a Certified Public Accountant.  The views expressed here are solely those of Kelly Coughlin and his guests in their private capacity and do not in any other way represent the views of any other agent, principal, employer, employee, vendor or supplier.

Sep 26, 2016

 

Kelly:

Hello, this is Kelly Coughlin, CEO of BankBosun. Today we're going to launch a series of podcasts on community banks and the role they have played in our history and the future. Community banks are critical to a community's social and economic ecosystem. I use the term ecosystem carefully and intentionally to describe a system of inter-connected elements formed by the interaction of a community with their environment, and in terms of a social and economic community, in my mind community banks are critical members of that ecosystem.

That brings me to this podcast series, in which we're going to focus on community banks. In this series we're talking to a number of executives who are leaders in community banking, and I'm asking them to make community banks more fun and interesting. I think I used the term “humanize” community banks. The community bank has been around a long time. From the Revolutionary War in Massachusetts to the Santa Fe Trail in Kansas; expansions and contractions, recessions and depressions, community banks have seen it all. With that in mind, I have one of those leaders, Sammie Dixon, CEO of Prime Meridian Bank in Tallahassee, Florida. He's not been around since the Revolutionary War, I don't think, but he has seen a lot. Sammie, are you on the line there?

Sammie:

I am.

Kelly:

Have you been around since the Revolutionary War, Sammie?

Sammie:

No, I barely made the '60s.

Kelly:

Barely made the '60s, excellent.  Sammie, I wanted to talk to you because when I look at your bio and some of the community involvement…I looked at all the involvement that you guys have…and I counted nearly 50 organizations, whether it be the Treehouse of Florida, Toys for Tots, Young Actors Theatre, Good News Outreach, Holy Comforter School, Lee's Place, Opening Nights. I'm not sure what Opening Nights is but..., you've got Florida Tax Watch. You've got over 50 organizations that you guys support one way or another. Talk to me about that.

Sammie:

Well, Kelly, there was a famous banker here in town by the name of Godfrey Smith, that always stated that a healthy community makes a healthy bank. And if you take care of the community, then the bank will be taken care of, if you're providing good service and charging good, honest rates, paying people good rates, and just making sure that the well-being of each individual client and the community as a whole is taken care of.

Kelly:

Kind of jumping forward here, what happens in a community when a community bank ends up getting acquired by a national bank or a large regional bank? Does that go away do you think?

Sammie:

It does to some extent. You've got someone outside of the individual community that really doesn't understand what's important, making decisions or providing budgets to the local leadership of that regional or money center bank. And they cannot react as quickly to the needs of the community. Whereas your community banks are able to really provide a nimble outlook. And by that I mean that if there's something happening that needs to be taken care of. The decision can be made within 5 minutes and let's get the problem squared away, from supporting one of the individual not-for-profits that are providing services to our community to the hospitals, the school system. It's having that ability to make a decision on the ground floor.

Kelly:

That's a segue into maybe the bigger picture here. That dynamic doesn't just relate to non-profit involvement, but it gets at the for-profit activities that a bank is involved in. When you're not part of that community, you can't respond as quickly, whether it be granting a commercial loan or that sort of thing. Talk about that a little bit. How is that impacted?

Sammie:

Every business is nothing more than a story with substance behind it. Having people and having the executive leadership having the opportunity to not only listen and hear the story, but live it. You get to see what they do each and every day and you're able to make decisions and make judgments in extending credit; what type of depository services they need; and there's nothing about a story that fits in a box. Every one of them is different. Every individual character, if you want to say, within the story is different. Having that ability to take the time, sit down, understand what the story is and where it's going, gives us an opportunity to make very quick and rational decisions that helps each individual business that then helps the community.

Kelly:

You mentioned story. What's your story? What's Prime Meridian's story?

Sammie:

Well, Prime Meridian Bank is a newer bank, one of the last in the state of Florida to get chartered. We opened our doors February 4th, 2008. We initially capitalized with about $12.9 million dollars. We have now since grown in excess of $275 million, over the last 8 years. We decided to start the bank, myself and Chris Jensen, and we thought we could provide service to our clientele, and decisions that would help them move more prudently and faster.

Kelly:

You saw a need specifically in the Tallahassee market?

Sammie:

We did. We thought that we could provide service and compete with everybody in town. We didn't have a group of people come together and say, "Let's start a bank." We put our story together and put our model together, and went to individual business leaders within town, here in Tallahassee and said, "We're going to start a bank we'd like you to be a part of," and that was the genesis of Prime Meridian Bank.

Kelly:

Was there a lot of consolidation and acquisitions that had gone on prior to that, and so that kind of created this market opportunity for you guys?

Sammie:

No. You had several community banks here in town already, most of your southeastern regional banks and your money center bank. We just thought there was an opportunity for us to come in and provide a little different level of service that would make us a profitable entity and serve Tallahassee very well.

Kelly:

Let's talk about the name Prime Meridian. You do know that you're not on the Prime Meridian? You do know that you're 84 degrees west, right?

Sammie:

I do, but the Prime Meridian for all metes and bounds in the state of Florida is here in Tallahassee.

Kelly:

Oh, got it.

Sammie:

If you look at the Prime Meridian, what is it? It's a starting point of the metes and bounds here for the state of Florida, and starting point of time, or the starting point of a new financial institution. The Meridian line is an unwavering line going over the Earth. We're unwavering in our outlook and care of our shareholder's money, but more importantly, our clients.

Kelly:

The Brits claimed Greenwich was the Prime Meridian. They don't own that, so you'd redefine Tallahassee to be the Prime Meridian.

Sammie:

At least for a new financial institution.

Kelly:

Very good. Continue with the evolution of the bank and the challenges you've faced in the past, as you went from de novo Bank? You didn't acquire another bank, right?

Sammie:

Right. Several things that we're proud of through the evolution of our company. Number one, which goes back to the quality of our team. When we started our bank, the average startup cost was about $800,000. The day that we opened the doors and took the write-off to capital for the expenses, we wrote off $395,000. That goes to the knowledge and expertise of our team of not having to hire a lot of consultants, and understanding each and every thing that we did. Going on to 2012, four years after we opened, we looked around with the team that we had, and realized that we could do our own data items processing. Instead of having a service bureau that was processing our checks, we decided we would do it ourselves. That added an immediate $8,500 a month to the bottom line.

Kelly:

Wow.

Sammie:

That same year, we also became cumulatively profitable. That was pretty exciting for us. And then in December 11th of 2013, we became an effective SEC registered company and then started listing our stock in 2015 on the OTCQX. So those are some of the things that we have done and we're very, very proud of. Dealing with the SEC, we went through a full review, when we filed our S1, our initial going public document. Our comment letter back from the SEC was simply 2 1/2 pages, which goes to say just how good our team is, and how detailed we are in each and every thing that we do.

Kelly:

Yeah. I know access to capital has been good once you go public, but it's quite a task to a) go public, and b) maintain that. The requirements are immense as you know. Was it worth it, do you think?

Sammie:

Absolutely. We went public for 3 reasons. Number one is we could raise our capital the way that we wanted to. We didn't have to worry about an accredited offering or anything of that nature. Number two is we're looking to grow the company and grow outside of the Tallahassee MSA, and if we do that we want to have a currency that we can use.

In order to have your stock act as a currency, you've got to have a market for it, and the only way to do that was to be an SEC registered trading company. Then number three, when we decided to do it, our bank is still very clean. We do not have many non-performings or any crazy things on the books. It would never be easier to go through and do it. And we look at it like these days, with capital, you can't say, "Okay, we're going to go buy someone or do something. Now let's go get approval and say, 'Okay, if you give us approval we'll get the capital.'" You've got to have capital already on hand. There's no more just in time capital. And the same way we look at it is there's no just in time human capital.

Kelly:

Let's talk about human capital for a minute. How challenging is it for you to compete for new talent and retain existing talent with the compensation structure that community banks have to deal with?

Sammie:

Well, Kelly, that's been one of our strong points. When we started the bank in 2008, we were the new kids on the block. Nobody knew us. All we had was a story. It was nothing but air. So going out and getting the top absolute talent was difficult. People had their banks, things were going well. So we decided that we would start building our own bankers. And being here in Tallahassee and having Florida State and FAMU and TCC here, gave us the opportunity to go get a lot of talented younger folks to bring in, that had the capacity, train them, educate them.

And one thing that we've done is we've been very transparent with our team. Up until we went public, we went through our financials with our entire team once a month.

Now that we're a publicly traded company, we do it once a quarter. But giving them the exposure, I cannot give them experience, but giving them the exposure to what we're doing, why we're doing it, and how we're doing it, is as important as finding experienced people. And our entire culture is surrounded by a one-word question and that's “why”. Any teller, relationship manager, operations person, whoever, can ask me or anybody in the bank why are we doing something. And that causes two things. Number one, the hardest thing to get people to do is think. If they're asking you questions, then they're thinking. And if you answer their questions: Why did we go public? Why did we raise capital? Why are we looking to acquire banks? What does that mean to the bottom line?

Now, all of the sudden you've created an inclusive ecosystem, as you say, that people can buy-in. The biggest thing people want is to be a part of something, and what we've afforded a lot of folks to do is come in and be a part of building something from the foundation up. And constantly giving them that transparency of what we're doing and why we're doing it, is very, very inclusive. And we listen. I can't tell a teller how to make a teller line more efficient. So if I can't listen to what they're doing like I ask them to listen to me and do what I say. If we don't have a partnership there, we're not going to get any better. That's the number one. Number two, if someone asks me a question. Why are we doing this? and I can't answer it, then I might need to rethink what I'm doing. Does that make sense?

Kelly:

It certainly does. Have you used non-qualified benefit plans as part of that overall compensation structure? This is not a pitch for that. I was just curious if you'd ever talked about that.

Sammie:

Yes. We're in the process of looking at our entire compensation structure now, and figuring out how to better enhance it to a) retain, b) attract, and c) incentivize.

Kelly:

So say another side of say the balance sheet, since we're talking about that, municipal bonds. Anything that you've seen change here since the 2008 Dodd-Frank and all this other stuff of municipal bond rating agencies? Have you guys had to modify any of your practices on that?

Sammie:

We're using a third party right now to monitor our municipal portfolio. So in the old days of just buying bonds and putting them on the books, we actually have a quarterly review of all of our municipalities.

Kelly:

So you've had to upgrade that since the regulatory changes?

Sammie:

We have. And I don't think it's all that bad from the standpoint that you look at a lot of municipalities out there that are having weakness due to the down-turn, and the one thing that we have made the decision from day one, is we take risk, and there's risk in everything you do, but we take the real risk in our loan portfolio. We do not want any risk in our investment portfolio. We're looking at it as simply a hedge against interest rates, and also as just a liquidity source.

Kelly:

Well then you better load up with bank-owned life insurance. You've got about 50% of your financial assets in muni’s and I like the lower balance sheet risk that BOLI offers. That’s another discuss with you and Glenn. What's the future look like for community banking in general, threats that you see, opportunities? For example, 80% of millennials haven't even walked into a bank before.

Sammie:

Let's stop right there for a second and talk about the millennials for a minute. Number one, I talked about how we hire and what we do. The average age of our bank is 38. The average age of our management team is 41. As far as dealing with millennials and all, one thing most people have forgotten is most millennials have yet to start a company. A lot of them, due to the recession, still live with their parents. So therefore, they really haven't needed to walk into a bank. Now a lot of the millennials that we have found, and we talk with, and we do this a lot. They want to be a part of something. And they're much more community driven and doing something for the greater good. Once you are able to show them from a teammate standpoint what we're doing, they buy in.

Once they actually need something other than just a regular checking account, i.e. buy their first house; buy a business or trying to finance the start of a business, they need to sit down and talk with someone who understands the market. And we have found, we've been very successful with millennials. Now we're not out there with everything online, rocket mortgage and things of that nature. We're finding a lot of success dealing with the millennials. What that comes back to is we generally don't get them until they need something. And every individual, every household is nothing different than a story too. Where's your income coming from? Is it going to be sustainable? Can you afford whatever asset you're trying to purchase?

That has been very, very beneficial to us. As far as whether or not banks are going to be here, I've talked with bankers that go back to the '60s that said the community bank's not going to be around much longer. Well, as long as you have people, there's a certain segment of the population that wants to talk with people, when it comes to their financial situation. Coming up from a small town in south Georgia, and growing up the 3 most important people in the town was your doctor, your preacher, and your banker; your health care, your faith care, and your financial care. And you generally didn't do that via an email. I truly believe that there will always be a place for the community bank. Now with the regulations and thought process out there, there's going to be fewer and fewer community banks due to the fact that what we're required to do.

We're operating in most cases from an asset-liability standpoint, overall balance sheet management standpoint, like a larger bank. However, we don't have the economies of scale to do it. So we have to be more innovative and more nimble. And that goes right down to talking with your regulators on a consistent basis to understanding what the rules are. If you're going to form a hospital, or if you're going to start a power company, there's regulations you have to abide by. As a community banker, you had better understand the rules and abide by them or find something else to do. That's just the approach that we've taken. And it creates a lot less heartache and stress, when you come at it from that standpoint, versus saying, "The regulators are going to kill me." Regardless what they're going to do, they're going to do it. So you better find out or figure a way to cope with it.

Kelly:

Great. What's the biggest threat, other than let's say cyber-security risk, which probably keeps you up at night…other than that, what's the biggest risk or fear that you have, say for the next 10 years?

Sammie:

As we expand, finding the human capital, finding the talent, the teammates.

Kelly:

Really?

Sammie:

The human capital.

Kelly:

So in Tallahassee or in some of your outlying branches? You have access to plenty of talent there, right?

Sammie:

There is a good supply, and it's just finding the right people that believe in what we believe in. Our culture is the most important aspect of what we do each and every day, and I go back to the question “why”. If you're questioning why we're doing something, some people look at that as somewhat of a negative. We look at it as a positive, because if you cannot explain what's going on, and you cannot understand it, then the “how” really doesn't matter.

Kelly:

What's the biggest opportunity that you see? What gets you up every morning after you've had a sleepless night worrying about cyber-security risks? What gets you going?

Sammie:

The opportunity to grow, to build our franchise here within Tallahassee; the opportunities outside of Tallahassee. Within our investor presentation, we show that we don't want to go any further north than Macon, south of Ocala, east of the Atlantic and west of the eastern border of the state of Mississippi. That is south Alabama, south Georgia, and north Florida. The opportunities to be there are endless. And that is something to get excited about and get out of bed every day, and figuring out a new challenge to go build upon.

Kelly:

That's great. All right. In closing, I always like to ask either your favorite quote and/or the stupidest thing you've done in your business career.

Sammie:

I will give you my favorite quote, and it's on our boardroom wall, and it is by a retired General, Eric Shinseki, who has been re-retired. The quote is, "If you do not like change, you are going to like irrelevance even less." Shinseki is the most recent former head of the VA. He's pretty irrelevant right now.

Kelly:

I would say so. Alright. Very good. Anything else you want to add Sammie, or should we sign it off?

Sammie:

You tell me. Thank you.

Kelly:

I think we're good. Thank you very much for your time. It was a pleasure talking to you. I wish you well, Sammie. Stay safe! And that’s it for my interview with Sammie Dixon from Prime Meridian Bank in Tallahassee, Florida. Thank you.

Sep 19, 2016

This is Kelly Coughlin. There is a little known secret about how to use your bank owned life insurance asset to pay your cyber security costs, muni bond analytics expenses and other risk and insurance expenses. Listen to this two-minute audio podcast and then call me if you it gets your attention. Two minutes could generate thousands of dollars in expense reductions for your bank.

Kelly Coughlin is a CPA and CEO of BankBosun, a management consulting firm helping bank C Level Officers navigate risk and discover reward. He is the host of the syndicated audio podcast, BankBosun.com. Kelly brings over 25 years of experience with companies like PWC, Lloyds Bank, and Merrill Lynch. On the podcast Kelly interviews key executives in the banking ecosystem to provide bank C suite officers, risk management, technology, and investment ideas and solutions to help them navigate risks and discover rewards. And now your host, Kelly Coughlin.

Greetings, my name is Kelly Coughlin. I’m a CPA and the CEO of BankBosun, a risk management company located in Minneapolis, MN. We are writing a research report for publication in a banking journal this coming October comparing the use of bank owned life insurance (BOLI) in two US regions: the Midwest and the Northeast. The data shows there is a significant variance between these two regions and we are trying to dig into it a bit to understand and explain it. The major distinction is some banks tend to use the asset more as an investment that competes with other balance sheet financial assets like municipal bonds for example, others tend to use it a more of a risk management funding tool for their nonqualified benefit plans or benefit plans in general. Some even tend to look at it more as a commercial loan...a loan to a AA credit insurance company.

Some banks end up with it on their books through an acquisition and are stuck with it…others look at it as a terrific asset that they can’t get enough of… some like the Other Non-Interest Income classification versus interest income. Some don’t care about that. So far I have talked to about 50 bankers personally. And I really have enjoyed it. I have learned a lot. And I want to talk to about a hundred more.

I have a handful of other related questions that will only take a couple minutes. We will be sending you a copy of the report no charge of course so you can see how your peers in the northeast and Midwest are using this non-traditional asset.

Additionally, I also wanted to point out we have a risk management program that allows you to utilize your BOLI insurance asset to pay for some of your cyber security risk expenses, muni bond analytics and other risk management expenses the bank has. You keep the insurance policy and investment terms in place, but you modify the servicing and reporting terms. Not only does this cost you nothing, you actually reduce your expenses and increase profits by thousands of dollars.. potentially.

Frankly, the only one who kind of loses in the deal is your agent that is “servicing” your BOLI now. So if you want to first and foremost take care of him/her, fine. No worries. I understand that. But if you feel it is more important to take care of the bank and more specifically, the bank’s financial statements, then you might want to talk to me about this. It can be done fairly easily. And our servicing and quarterly and annual board and regulatory reporting is best in the business…so you actually get a win there.

Again, my name is Kelly Coughlin. I’m a CPA and the CEO of BankBosun. I can be contacted at 612-232-6640. My email address is: kellycoughlin@bankbosun.com

Thank a lot, goodbye.

We want to thank you for listening to the syndicated audio program, BankBosun.com The audio content is produced and syndicated by Seth Greene, Market Domination;  with the help of Kevin Boyle. Video content is produced by The Guildmaster Studio, Keenan Bobson Boyle.

Aug 17, 2016

Three Drivers of Bank Enterprise Value: Cash Flow, Risk, and Growth

Kelly Coughlin: Good morning, everybody. I'm excited for our podcast today. This is Kelly Coughlin, CEO of BankBosun. This is the second in a series of five podcasts that cover bank valuation, and enterprise value creation. At the end of the day, as CEOs and CFOs of our community banks, our fiduciary duty, is to our owners, shareholders, and all stakeholders. The best way to demonstrate that duty, in my mind, is to create value for our enterprise.

Now, certainly, the obvious way to create value is to increase revenues, profits, and free cash flow. Having a discussion on that, in my mind, is kind of disingenuous. Of course that creates value. On another podcast series, we'll talk about tactical ecosystem marketing, where we'll discuss some new strategies to help you cost-effectively increase relationships and customers, and revenues and profits.

Today, we're going to talk to a bank valuation expert, Jay Wilson. He's a Chartered Financial Analyst, at Mercer Capital's Depository Institutions practice. Jay is involved in the valuation of banks, thrifts, and credit unions for multi-purposes, so, without further ado, I'm going to let Jay talk about himself and give us a brief introduction. Jay, are you there?

Jay Wilson: Thanks for having me today.

Kelly Coughlin: Jay, welcome aboard. Thanks for taking your time out. Jay, let's start with a brief summary of your business background, education, where you live, family, kids, hobbies, and then, and then a minute or two on Mercer Capital, your employer. Does that work for you?



Jay Wilson: Jumping right in, into my educational background, I have a Economics and International Studies degrees from Rhodes College, a smaller liberal-arts school here in Memphis, which is where Mercer Capital is headquartered and I'm located. Mercer Capital is a valuation and advisory consulting firm. We have offices in Dallas, Nashville, Memphis. We do work in a variety of industries. We tend to segment our practice by industry specialization. Our largest industry concentration is financial institutions. We would define that fairly broadly.

That would include banks, insurance companies, wealth managers, broker dealers, specialty lenders, some non-bank financial companies as well. In terms of my time here, I'm focused in the financial services industry, to do some work for banks, insurance, wealth managers, as well as financial technology companies. Technology's become an increasing part of the financial services industry, so we've seen some opportunities there, as well.

Kelly Coughlin: That's terrific. Let's get into the meat of the matter here today, on bank valuation. Jay, I thought we'd start with valuation metrics. Give us some ideas on the, let's just say, the top five baseline metrics that you might look at in defining a bank value. Is it asset-based, deposit-based, customer-based, revenues, that sort of thing. What are the things that you kind of look at to find that value?

Jay Wilson: In terms of valuation, the three kind of key elements tend to be cash flow, risk, and growth. You can drill in on those and go to great lengths to come up with assumptions and different elements around those, around those three elements, but at the end of the day, those kind of three broad things tend to define valuation.

By its own nature, it's more forward-looking than backward-looking, so when you're thinking about those three elements, cash flow, risk, and growth, you're kind of thinking about those in the future. However, to get a good estimate of those, you tend to use historical performance and how those have performed over time, to give you some idea of how those might look going forward. Like anything else, any predictions of future inputs depends on, those future assumptions depends on the quality of the input.

Finally, I think valuation is a range concept, so oftentimes in our engagements, we'll come up with a point estimate of this little particular value for the bank or the stock, on more of a range type concept.

Kelly Coughlin: Have you seen any changes in trends over the past couple years in these baseline metrics?

Jay Wilson: You can think about return on assets, in terms of measuring the productivity of the assets deployed at the bank, or return on equity, how productively the bank may invested its capital. I think those kind of top-line metrics have certainly turned it up the last few years, coming off the depths of the financial crisis, but we haven't seen them get back to where they were, sort of, pre financial crisis.

If you look at the 90's and the early 2000's for the median baseline measures for the community banks, you will find that a significant proportion of them were in the ten to fifteen percent range on return on equity. Now, you're more in the six to ten percent range, and a significant proportion of the community bank pool is operating in that zero to ten percent, kind of, return on equity range. Although we've seen things improve, relative to the depths of the financial crisis, we haven't seen the profitability metrics kind of get back to where they were, and I think there's a couple things kind of driving that.

Certainly the interest rate environment is difficult, difficult for net interest margins. Then you've also got a lot of compliant, regulatory sort of operating costs, trending up across the industry. Offsetting those two trends, you have credit costs have improved, but not enough to offset the larger trends there.

Kelly Coughlin: A lot of companies today derive significant value from digital assets, like contacts, relationships, email addresses. Email addresses alone seem to derive significant value. Facebook because they've got connectivity with nearly every human being on the planet, they've got a $350 billion market cap, some say it's going to go to a trillion. I don't know if that's true.

Jay Wilson: Right.

Kelly Coughlin: In the community bank market segment, do you see any value accruing to this kind of asset?

Jay Wilson: I think that's a great question. In some ways, for the community banks, there's a good opportunity there. They still are one of those primary figures in terms of the financial relationship or provider to a lot of their customer base. Over time, if they can leverage that relationship and effectively compete as things sort of transition to the digital format, then they may have more opportunity to provide better services, more efficiently, at lower costs, and also, offer more services.

Think about your smaller community bank, for example, in a rural location. They may have banked a particular family in the community for a long time, and have a relationship with the younger people in the family. If that person goes off to college or work in a different city, they may not be able to continue to bank that customer. While it's difficult for the smaller banks to compete with the physical footprint of a lot of the larger banks, there may be some opportunities to compete effectively through some of the digital platforms.

Kelly Coughlin: Great. Let's switch gears here for a minute, and talk about Net Interest Income versus Other Non-Interest Income.

Jay Wilson: Certainly.

Kelly Coughlin: Do you have any thoughts on whether a bank can fetch a higher valuation multiple if they have an increase in Other Non-Interest Income? Do you think that affects it? Certainly, the income affects valuation, but in terms of a premium, is a higher value placed on a bank that, that isn't reliant completely upon interest and net interest?

Jay Wilson: That's a question a lot of our clients have tasked us with from time to time, as they look at different opportunities in the non-interest income area, whether it be in a trust company, or an insurance agency, or different things like that. I would say it does depend on what type service line, or what type non-interest income they're looking to add.

Banks that tend to have higher levels of non-interest income as a proportion of their total revenues, they do tend to have higher valuation multiples. Especially those where the source of non-interest income is something that is a recurring or consistent potential revenue stream over time. That would be in the forms of dividends, or additional earnings, or something that could be transferred to a buyer in a sales type situation.

I definitely think you've honed in on a key issue, and an area where there is an opportunity for a lot of banks to increase their potential valuation, and their multiple. There does seem to be some evidence of that, the publicly traded banks, banks that you look at out there.

Kelly Coughlin: Do you use the term in valuations these days…do you use the term 'quality of earnings' at all, anymore?

Jay Wilson: I think there are certainly some areas where people really dig in on quality of earnings (particularly in an M&A type scenario, where the buyer may want to look at something like a quality of earnings type report).

Kelly Coughlin: I guess in the banking world, it's kind of like the quality of earnings analysis would dive into the underlying credit.

Jay Wilson: Where a bank would differ from some other industries, the balance sheet, really is the driver of a lot of the income statement. Any quality of earnings type analysis would be focused on 1) the credit condition, and how comfortable the buyer or potential investor would be with the underwriting, 2) how proactively the management team has been in sort of dealing with problem credit, 3) your assessment of risk profile in that area.

Kelly Coughlin: Let's switch to financial technology. Banking and technology kind of intersect more and more these days. Of course, that opens up the whole cyber security risk element as well. Do you see any trends going on in the FinTech world impacting the community bank industry in the next few years?

Jay Wilson: You've seen an increasing number of startups in tech, whether in payment, online lending, or different solutions and offerings that can help banks with clients. I definitely think that's a growing area where you're going to see a lot of activity.

I think it sort of remains to be seen how that will transpire over time, in terms of whether that's more of a disruptive threat to a lot of the banking business models, or whether banks are able to leverage some of the solution, things that people come up with in that arena.

Kelly Coughlin: Is there anything that you wanted to add, or should we hit with some of the more easy, fun stuff, like the dumbest thing you've ever said in your career and your favorite quote? Anything you want to add?

Jay Wilson: My favorite quote is from Bill Gates. "We always overestimate the change that will occur in the next two years, and underestimate the change that will occur in the next ten. Don't let yourself be lulled into inaction." I like that quote, because I think I've seen that play out in my career.

Kelly Coughlin: That's a good quote. All right. Dumbest thing you've done in your career. Do you have anything that comes to mind? Done or said?

Jay Wilson: Early in my career, I was more hesitant to either reach out if I had a difficult question on a valuation, or something with a client.

Kelly Coughlin: Early in your career, you're kind of hesitant to show a weakness, or a perceived weakness, by asking a dumb question, right?

Jay Wilson: Right.

Kelly Coughlin: Then, worried that they'll think, "Oh, God, why'd we hire this guy?" Right?

Jay Wilson: Yeah, exactly. We have had a few new hires start, and I’m trying to let them know that I can be a resource for them, and there are no dumb questions, so that hopefully they can accelerate that learning process faster than I did.

Kelly Coughlin: Yeah. One of my favorite quote is, "He who asks a question is a fool for a second. He who never asks a question, is a fool all his life."

Jay Wilson: Yeah, that's a good one, and I'll have to remember that.

Kelly Coughlin: We've all worked with people that think they have the answers to everything, and those guys, they are the fools, aren’t they?

Jay Wilson: That's right.

Kelly Coughlin: That's great. Jay, I appreciate your time. That's terrific. How can bankers get ahold of you if they need to?

Jay Wilson: We have a lot of resources on our website, mercercapital.com. We actually put out quite a bit of content. We have a bank watch publication that covers trends in the banking sector, valuation trends for the public banks, as well as for the private banks in the form of M&A transaction announcements. If you want to get signed up for that, they can just email me, wilsonj@mercercapital.com. You can all find my contact information, or feel free to give me a call, 901-685-2120.

Kelly Coughlin: Jay, thanks for your time. We appreciate it, and we'll be in touch, okay?

Jay Wilson: Thanks as well, Kelly. Enjoyed it. Have a good day.






 

Jul 20, 2016

Introduction: Kelly Coughlin is CEO of BankBosun, a management consulting firm helping bank C-Level Officers navigate risk and discover reward. He is the host of the syndicated audio podcast, BankBosun.com. Kelly brings over 25 years of experience with companies like PWC, Lloyds Bank, and Merrill Lynch. On the podcast Kelly interviews key executives in the banking ecosystem to provide bank C-Suite officers, risk management, technology, and investment ideas and solutions to help them navigate risks and discover rewards.

 

And now your host, Kelly Coughlin.

Kelly Coughlin:

Greetings, this is Kelly Coughlin. I'm the program host of the syndicated, biweekly podcast, 'BankBosun.com: Helping Community Banks' C-Suite Officers Navigate Risk and Discover Reward.' As most of you know, we like to focus on three primary categories here, the three 'R's, Risk, Regulation, and Revenue Creation. I think just about all the critical things a bank does can be captured in one or more of these three categories, Risk, Regulation, Revenue Creation. Nowhere else does the results of how a bank does with these three categories, than in the valuation of that bank.

 

 

I think Jack Welch, in the eighties, first made popular the notion of shareholder value. He didn't create this concept, but he sure popularized it. I think, since then, we've kind of expanded it to include more than just shareholders, but stakeholders, and stakeholders might include all range of people and enterprises, ranging from suppliers to entire community ecosystems. At its core, we still get back the valuation, the equity value of the enterprise. With that in mind, I'm going to introduce George Thompson, a forty-year, seasoned vet in the bank deal business. George is managing director of The Capital Corporation. George, are you there?

 

George Thompson:

Good morning, Kelly. How are you?

 

Kelly Coughlin:

I'm fine, thanks for joining us today. George, rather than me kind of get into summarizing your background, education, etc, can you give us a minute on who George Thompson is, and why you're the seasoned vet in the banking valuation deal business?

 

George Thompson:

I would be pleased to do so. Kelly, I graduated from the University of Missouri in Columbia, in 1976. Accountancy was my major. I went to work for one of the large accounting firms in Kansas City right out of college, and three years later, joined an individual out of Arthur Anderson, that was wanting to build a CPA practice specifically for community banks in the Midwest. I joined him in 1979, and we built that firm for the next twenty years, ended up selling it when H&R Block and RSM McGladrey were doing their accounting from roll-ups. In about the year 2000, we sold that accounting firm and it merged into RSM McGladrey here in the Midwest.

 

 

Since that time, I've been in banking and investment banking, right now, managing director, as you said, with The Capital Corporation. About 85-90 percent of our business is sell-side work. In other words, we work with the sellers of financial institutions, although we do work a little bit with buyers, and will contract with banks to go find them a bank to acquire. Appreciate the invitation to talk about the things that kind of drive value in banking.

 

Kelly Coughlin:

George, how many deals have you been in the middle of?

 

George Thompson:

Our firm, all we work with is banks. We do not do investment banking for small businesses. We do only banks. We have been involved, either whole-bank or branch transactions, over the past fifteen years, with approximately 125 to 140 whole-banks to branch transactions. Probably about seven and a half billion in assets changed hands during those transactions.

 

Kelly Coughlin:

Right. I want to go immediately to net interest income versus other income, non-interest income.

 

George Thompson:

Okay.

 

Kelly Coughlin:

You know, the goal here is to come away with some ideas on, how can, if I'm a CEO or a board member, how can I increase the value of my bank? Now, the obvious things are, well, increase revenues and profits and free cash flow. But I need something better than those things. So I want to go to net interest income and Other Income. Because net interest income, other than getting more quantity, more assets, and more loans, there's a price. You're kind of stuck with the yields that are in the market, right? Other income gives more variability, I should say. My question to you is, in terms of valuation can a bank fetch a higher multiple in valuation, whether that be based on assets or revenues or free cash flow or earnings through an increase in non-interest income versus net interest income. Is there any difference in that?

 

George Thompson:

The answer is yes. I can talk about a couple of specifics. We are working with a bank right now, that has built a program that they refer to as a contract services division, but it is a community bank that has built ties to the servicing, not making credit card loans, but has ties to the credit card industry. And as they service the debt that's on the outside, they are the servicer, they are the administrator. They do not hold the debt, so they do not have the credit risk, but they have built substantial contracts, for revenues. It is recurring revenue, and it has substantially increased what our asking price, and what we expect to get in the marketplace, when we ultimately can get a transaction done.

 

 

We have seen other banks that have built substantial mortgage generation machines and divisions, that, it's harder to sell and get a full value for a mortgage division, from the standpoint of, buyers look at those mortgage divisions as more transactional-based, not quite as recurring. Now, if you do it year after year after year, there is value there, but it's not the value that, perhaps, someone would pay for a truly recurring revenue.

 

Kelly Coughlin:

Right, so it's this other income, this non-interest income, is it fair to say that the quality of earnings, I don't know if you use quality, in earnings, is higher in other income? I guess it depends on the permanence, and how long it's been on the books, et cetera, but

 

 

George Thompson:

 

It’s the recurring nature and, you know, can a buyer look at that potential selling bank, and are they willing to pay a multiple of that because they believe it will be recurring for year after year after year? Or is it transactional-based, to where, you know, if there's a downturn in the economy or change in interest rates, I think right now, everybody's waiting, as far as, I mentioned mortgage producing machines are revenue generators, if interest rates go back up, which is kind of anticipated now for a few years, some of that mortgage revenue is going to drop, and buyers anticipate that, so they will pay less of a premium with that.

 

Kelly Coughlin:

Yeah, I guess, part of, in full disclosure, part of my reason to get right to that, is that, I was at one of these, you know, bank conferences, and there was, I'm not going to mention who it was, but this broker who's in the business of kind of promoting municipal bonds, made the argument that bankers might have to extend duration a little bit to get the yield they need to fetch here.

 

 

I asked him, offline, I said, "Well," in full disclosure, I'm in the, I work through independent consulting work with Equias Alliance, and we are in the bank-owned life insurance business, and I said, "Well, wouldn't the recurring nature of bank-owned life insurance, more predictable, recurring, et cetera, other non-interest income, wouldn't that be better for the bank's valuation?" He said, "No, I prefer that interest income." When I go back to my Cooper's days of doing some bank valuation work, I thought that other income would increase the value, but ...

 

George Thompson:

It does. There's no doubt that it does. Now, we do not see BOLI being, in any way, a detriment to get a deal done. At the same time, we do not see BOLI being anything that will drive a transaction price higher. I'm involved in a transaction right now that will be announced within the next couple of weeks, whereas the seller, I believe, probably has six to ten million of BOLI already on their books. The buyer is not worried about that, is not concerned about that, welcomes that earning asset as we move forward. In that case, the BOLI certainly, I wouldn't say it helped driving price, but they like the, the buyer likes the earnings off that BOLI, that's for sure.

 

Kelly Coughlin:

Now, this wasn't mean to be a shameless plug for BOLI, but it's one of those things that did come into my mind, and as I'm looking at banks that hold muni bonds versus BOLI, and I just wanted to kind of get that clarified with you. Let's go to another question I have. When you see a deal, what do acquirers like to see, or not see, in terms of locking up staff, how they're dealing with high-producing staff or low-producing staff, I mean, what are you seeing out there in terms of staff like that?

 

George Thompson:

Our buyers, especially in, size matters in this relationship, but as the buyers get larger, as the sellers get larger, normally, you have a group of people, or a handful of people, that are really helping drive earnings and drive the revenue of the seller, which is what the buyer's interested in acquiring. They'll want those revenue streams and customer contacts to continue. We often see that that definitely comes into play with a buyer and a seller, where they want to try to lock up that staff, whether it be with some type of employment agreements. We have seen transactions where the buyer has pretty much made it a demand, as a part of the contract, that one, two, three, four people, sign employment agreements before they're willing to put their name on a contract to pay a real high price. They want to make sure those people are locked up.

 

 

Now, it's very difficult to get a pure non-compete. You can certainly get a non-solicitation. We've seen agreements like that, for sure. A lot of our transactions are community banks based, here in Midwestern states, and oftentimes, the primary seller, one of the largest shareholders, if not the single shareholder family, is the president and CEO. Many times, the buyers will, whether they hire them full-time, and we are seeing that more, where some of the bankers are looking ahead, asking themselves, "Who is my buyer? Where are the buyers? Perhaps I should sell this bank now, I'm sixty years old. I would have waited til sixty-five or sixty-eight, but if I sell it now and work three to five more years for the new buyer, one, I get my price, two, I get to keep working, and kind of lock in the liquidity, and not have to worry about it. I can kind of turn that over to a new buyer.

 

 

We are seeing that a little bit more often, where the president, CEO, primary seller, does get locked into employment agreements, non-compete agreements, non-solicitation agreements. The buyers want those people locked down.

 

Kelly Coughlin:

Yeah. That goes, probably, in terms of the food chain, it goes down to the producing professionals, the credit guys, and the guys that are doing deals.

 

George Thompson:

Once in a while, you'll see a COO or CFO that falls into that fold, but many times, it is the chief lending officer, the major loan producers, that are bringing the revenue to the table.

 

Kelly Coughlin:

Right, right. How does the cyber security risk, it's one of those big, contingent risks, and potential contingent liabilities out there, any trends, anything that you're seeing going on there, on how they deal with the cyber security risk?

 

George Thompson:

The buyer certainly comes in and looks at what kind of auditing processes, what programs, what compliance, you know, what does the seller have in place that has been protecting cyber security? What programs do they have that's monitoring it, you know, every second, every minute of every day, to protect the customer data and protect the bank from an intrusion? That certainly is a piece of the puzzle when a buyer is doing its due diligence.

 

Kelly Coughlin:

Yeah. Are you finding, on the deals that you're working on, do they typically hire an outside consulting firm to help on that? That isn't the kind of expertise that you'd normally get on an accounting due diligence team.

 

George Thompson:

The inside people for the buyer, you know, the operations people, will get out the audits, get out the contracts, get out the intrusion tests, and really review that hard. They may pursue it, if they see something, you know, "Why didn't you do this, this, this, and this?" We have not seen them go hire, at this point, outside technology companies to come in, during due diligence, and do intrusion testing, or testing of those. They're pretty much relying on what the bank has been doing to satisfy the regulatory agencies.

 

Kelly Coughlin:

Okay. Good. Have you seen any deals collapse because of cyber security?

 

George Thompson:

We have not, in our practice.

 

Kelly Coughlin:

Okay. What are the top five things a bank can do to increase enterprise value for a sale? Looking forward a year. They meet with their board, they say, "Okay, we're going to position this for sale a year from now. Or, two years from now." Other than the obvious, increase revenues, profits, and cash flow, what could a bank do?

 

George Thompson:

Yeah, and let's be honest, Kelly, there are many times that banks are sold and they didn't look out one, two, or three years in advance. I'll touch on a couple of things where the pricing could have been helped. My first comment to anybody that contacts me about selling their bank is asset quality. It seems common sense, but oftentimes, bankers that are wanting to sell, they may be trying to put the smallest amount possible, and we're not, we don't want them to put excess bad debt reserves, or allowance for loan lease losses in their financial statements, but make sure that bad debt reserve is adequate, that you've taken the marks on any problem loans you have, that you've taken the marks on your other real estate owned, or OREO. Just, fewer items to be argued by a potential buyer, with respect to asset quality, will help pricing, will help things go much smoother.

 

 

Tied to that is loan file documentation. We've actually seen a couple of transactions within the last year, where the buyers got into the loan review, and had some significant issues, and one of them was one-rated bank. Some significant issues with the loan file documentation, and the lack, in their mind, that the regulators had kind of, let that seller kind of glide along, just because they'd had very few loan losses, had kept giving them one ratings. Their loan file documentation was very poor, so I suggest sellers, or potential sellers, to clean up loan files, and make sure that all the docs are there.

 

Kelly Coughlin:

Low-cost activity, too.

 

George Thompson:

It is. It's something that, you know, you probably have the personnel to go through loan files, dig through them, "We don't have this tax return, we don't have this credit report," you know. "We don't have this debt service coverage calculations." Seems like common sense, but there's, oftentimes, a lot of that loan file documentation just, it doesn't get done, or loan file memos.

 

 

Vendor contracts, Kelly. We have seen vendor contracts come up and bite sellers. You know, maybe they didn't think about that contract, that seven-year contract they signed three years ago, and now they're ready to sell their bank. "Oh, by the way, you have a four-year penalty to pay off the core processor, or the ATM company, or the debit card company." Sometimes, those penalties can be substantial. As some of these groups are aging, the stockholder groups, the ownership groups, the management groups, if selling your bank is something that you're thinking about doing, frankly, any time in the next three to five years, you need to be thinking about that when you sign any of these vendor contracts, because these penalties can have a significant bite on the amount of premium you get.

 

 

Branch networking. We are seeing people worry more about the viability of some Midwestern towns, Midwestern communities. At the same time, we're seeing people that love to be in the, in county seat towns, and will continue to pay good premiums for locations that are in county seats, that are stable, growing, but there are some real communities that, you know, are losing population, may not be in a county seat, and it really is impacting the premiums that are paid by buyers in some of the communities that really aren't showing future viability. I guess ...

 

Kelly Coughlin:

Are you saying they should be looking at closing those down, in an advance anticipation of the sale?

 

George Thompson:

The answer is, that question should be asked, you know. If you're, let's say you're in a small town, and over the last decade, that small branch has just steadily dropped in deposits and loans. You know, maybe you're down managing it now, with two or three people, and you don't want to close it, you don't want to let people go as far as their jobs, but if a potential buyer walks in and looks at that, and says, "Well, they're just leaving it for me to close," it will cost you, when you go to sell the institution, if the buyer has to be the one that has to be the bad guy, that maybe is taking a banking service away from a community, or from other people. They're going to take that into account when they're calculating what they're willing to pay you.

 

Kelly Coughlin:

Yeah, I guess they take the political hit, don't they, if they have to do it?

 

George Thompson:

That's exactly right. Probably the last thing we touched on, is employment issues, a little bit, but, you know, it goes without saying that a buyer certainly wants key management to stay, they don't want to be the bad guy, firing poor performers. Many times, if there are some poor performers, the buyer will ask the seller to take care of those people before closing, so that the buyer isn't perceived as completely the bad guy.

 

 

Tied to the employment issues, unless a buyer has some long-term contracts or long-term deferred compensation contracts, if the seller has those and the buyer doesn't, many times the buyer will ask the seller to get those paid off, and pay off those employees, those long-term, let's say, deferred compensation arrangements. Because it's pretty tough for a buyer to bring home, and say, "Well, we've got three or four people, in the bank we just bought, that have long-term deferred compensation arrangements, but we don't have it here, and we're not going to give them to you, our current set of employees." Sometimes, not always, but sometimes, those deferred compensation arrangements can come into play between buyers and sellers.

 

Kelly Coughlin:

This would be, like, non-qualified benefit plans, you're saying?

 

George Thompson:

It would be. It would be.

 

Kelly Coughlin:

You're saying, those can be considered somewhat negative, depending upon the culture of the acquiring bank.

 

George Thompson:

If the buyer has them, and the seller has them, it can be okay. If the buyer doesn't have them, and the seller does, normally the buyer is not going to take in those long-term deferred compensation arrangements, and have things, employee benefits for new people, that they're not even giving to their current people.

 

Kelly Coughlin:

Right. I know, we at Equias, we like those things, because they help, the non-qualified deferred plans, because they help the bank compete and retain good talent, and, of course, we use the bank-owned life insurance as a way to, kind of, fund those things. It doesn't have a significant impact on their cash flow, but ...

 

George Thompson:

Well, and, you know, a bank has to, you're trying to protect somebody, and you may have had that in place for somebody for ten or fifteen years. It probably did what it was set up to do at the time, which was help you keep that person. Now, if you're in the position, after that ten or fifteen year period, you've protected the people, you provided for them, now they're going to get, maybe, an early payout, then it's up to the buyer to make arrangements to keep that person if they're making the seller cash out that deferred compensation arrangement. I'm like you, Kelly, I've seen it used very positively, many times, in a lot of banks, whether it's deferred director's fees, deferred compensation arrangements with key lending and financial officers. Don't take my comments that they're bad, complication in a deal.

 

Kelly Coughlin:

They're a complication. Right. Got it. Okay. All right. Anything else you wanted to add? That covers most of my questions on this kind of high-level overview of valuations. One of the things I ask you to do is, be prepared to tell me, give me either your favorite quote, or, what I prefer is, George, tell us one of the stupidest things you either said or did in your business career.

 

George Thompson:

You know, I try to never be too stupid, but, you know, going back, a saying I had, and it goes back to high school, and if you found my 1972 yearbook from my high school graduation, what it stated under my name was, "Lead, follow, or get out of the way." I've tried to live that as I've, kind of, been in my professional career. Now, what I gave them, back in 1972, to put in my yearbook, was, "Lead, follow, or get the hell out the way." In rural America, in a little religious farm town, they wouldn't put the H-word in the high school annual, but they wouldn't use the H-word in the high school annual in 1972.

 

Kelly Coughlin:

That's good. You didn't need that on your record, anyway. But now it will be on your record, so there it goes.

 

George Thompson:

Yeah, it's out there now, isn't it?

 

Kelly Coughlin:

It's out there now. All right, George, I appreciate it. Thanks for your time, and we'll get this posted, and published, and syndicated on iTunes and Google Play Store, and there you have it.

 

George Thompson:

Kelly, thanks so much for allowing me to be part of the podcast today.

 

Kelly Coughlin:

Okay. Thanks, George.

 

 


 

We want to thank you for listening to the syndicated audio program, BankBosun.com The audio content is produced by Kelly Coughlin, Chief Executive Officer of BankBosun, LLC;  and syndicated by Seth Greene, Market Domination LLC, with the help of Kevin Boyle.

Video content is produced by The Guildmaster Studio, Keenan Bobson Boyle. The voice introduction is me, Karim Kronfli. The program is hosted by Kelly Coughlin.

If you like this program, please tell us. If you don’t, please tell us how we can improve it. Now, some disclaimers.

Kelly is licensed with the Minnesota State Board of Accountancy as a Certified Public Accountant.   Kelly provides bank owned life insurance portfolio and nonqualified benefit services to banks across the United States.  The views expressed here are solely those of Kelly Coughlin and his guests in their private capacity and do not in any other way represent the views of any other agent, principal, employer, employee, vendor or supplier of Kelly Coughlin.

 

Jun 18, 2016

Introduction: Kelly Coughlin is CEO of BankBosun, a management consulting firm helping bank C-Level Officers navigate risk and discover reward. He is the host of the syndicated audio podcast, BankBosun.com. Kelly brings over 25 years of experience with companies like PWC, Lloyds Bank, and Merrill Lynch. On the podcast Kelly interviews key executives in the banking ecosystem to provide bank C-Suite officers, risk management, technology, and investment ideas and solutions to help them navigate risks and discover rewards.

 

And now your host, Kelly Coughlin.

 

Kelly:
Good morning. This is Kelly Coughlin. I've got David Shoemaker on the line. We’re going to do a podcast with David. He's the President of Equias Alliance.

 
David:
Good morning.

 
Kelly:
Good morning David. How you doing?

 
David:
I am well.

 
Kelly:
Just to kind of lay the foundation here I thought we’d talk very briefly about my relationship with David and Equias. As David knows, I'm a CPA. I've been in the investment and banking ecosystem for many years and as part of a consulting gig about a year and a half ago I came across the BOLI industry, the bank owned life insurance industry, and then Equias Alliance. I decided at that time, after looking at this asset class, that this is a space I wanted to get into. And I looked at the competitors, once I decided I liked the product, and decided who are the competitors, Equias, in my mind, rose above everybody else out there.

 
 
It wasn’t just me that thought that. I believe American Bankers Association selected Equias as their endorsed vendor. I think another dozen or state banking associations also selected them. Is that a fair statement?

 
David:
Ten of them.

 
Kelly:
Ten, clearly they emerged in my mind and in other’s mind as the key player out there. I met with David and I found him to be a key player in the industry, so I thought I'd do a podcast disclosing that I have an independent consultant relationship with David’s company, Equias. I thought we’d do a podcast and talk about first of all just give us a brief background on who you are, how you got into this space, some background and then we’ll talk about the product generally and how you got into this space and what your take is on that. You want to kick it off with some brief bio on who you are?

 
David:
I graduated from the University of Tennessee, Knoxville with a Bachelor of Science in Business Administration, with a major in accounting, then worked for Deloitte Touche for nine years and an investment banking firm for three years. Then, while I was in investment banking, one of my clients was looking at an insurance product and asked me to help evaluate it knowing that I was a CPA technical type.

 
 
I liked what I saw, but what I didn’t like was that, it had a four percent front-end load charge. I thought it was a good asset class, but if we could get rid of the load charge we could make it very viable for banks to want to use as an asset class. I've been in bank owned life insurance and nonqualified differed comp for the last twenty-seven years now. I've worked with hundreds of banks over that period of time. I live in Memphis. I have a wife and six children. There’s a lot to do on a daily basis just keeping up with the family.

 
Kelly:
All right, taking from your statement that you saw what was going in the market, the four percent front-end load. Let's elaborate on that because my understanding based on discussion with others including yourself is that you were one of the early pioneers of crafting the product offering as it is right now. What was the need in the market at that time? Give us a general year when that was. Then, where was the gap in products available and the products needed by the bank? What did you see at that time?

 
David:
The year was 1989. There were several products available in the market, but they all had loads of between two and four percent. That means if you purchased a million dollars of BOLI asset and you had even a two percent load that was a $20,000 initial reduction of your cash value. You’d have to reduce your earnings and capital by $20,000 per million. I saw that as a hindrance to banks wanting to buy that asset.

 
 
So my partner at the time, who was an attorney, and I decided we could go to insurance carriers and see if they could provide a product that had no-loads which would be more viable for a bank. During that process we found that there's more to it than we’d initially understood. The carriers have to pay a premium tax to the state which generally averages about two percent. Then the federal government has a tax called the DAC or Deferred Acquisition Cost tax that effectively costs around a point and a quarter.

 
 
Carriers at time were not comfortable with essentially front ending that asset to give a hundred percent credit after they paid the taxes because they would potentially lose the money if the policy didn’t remain on the books. It took a fair amount of discussion and a fair amount of time, but my partner and I were able to convince four carriers to do no-load contracts.

 
 
At that time, I guess there were two other firms that we knew of in the business. They were Bank Compensation Strategies who pioneered the business and then there was Benmark. They were the primary players in, it wasn’t called BOLI then, the bank owned life insurance market. The need for it was to find a product that was viable to banks that didn’t have these loads charges and the idea behind it, back in that day, was primarily to fund nonqualified, deferred compensation plans for management and Boards of banks.

 
Kelly:
That was the primary need for the product, not as an investment per se, but to help fund the nonqualified benefit portion.

 
David:
Yes, to maybe take it a step further. There were not really any regs back until 1991 that were clear as to what a bank could purchase and couldn’t purchase. They could not buy life insurance as an investment asset. They could buy it to fund specific needs. A nonqualified, deferred comp plan was widely considered to be one of those specific items that could be funded with life insurance. It was not clear at the time that you could buy life insurance to informally fund health care and 401K and other retirement benefits and group life benefits and so forth.

 
 
Even in the first regs that were issued in 1991, bank reg; I think it’s called BC249, essentially said that you can’t buy life insurance as an investment. You can buy it to offset the cost of certain benefit plans. Even then it wasn’t clear whether that covered health care and 401Ks and things like that, so the initial design of bank owned life insurance was primarily for the purpose of nonqualified deferred compensation plans.

 
Kelly:
The regs specifically prohibited it as an alternative investment asset class. Is that mainly because of that front-end charge and regulators didn’t want to see the hit to capital?

 
David:
That was not the reason. They just viewed life insurance as not a normal asset for a bank from an investment standpoint. It was for specific purposes, but not considered to be an investment in the same terms as Treasury’s and agencies and municipal bonds.

 
Kelly:
Now, that has changed since those early years correct that regulatory perspective?

 
David:
Technically no, in 1996 there was a guidance issued under OCC96-51 which specifically gave authority for a bank to buy life insurance to informally fund retirement benefits and health care. So even today you can't buy life insurance purely as an investment. You have to purchase it from a regulatory standpoint to offset and/or recover the cost of employee benefit plans.

 
 
For instance, if a bank had no employee benefit plans; if they weren’t providing health care or 401K’s or retirement plans or nonqualified plans, they really could not buy life insurance and hold onto it until the death of the insured because they would not have a valid reason under the regs to buy that life insurance.

 
Kelly:
They could only buy like Key Man life insurance.

 
David:
They could buy the Key Man, but when that Key Man would leave the bank they’d have to surrender the policy because there was no need for it once that key man left.

 
Kelly:
A bank does not have to have a nonqualified benefit plan. It could just have any sort of benefit plan. It could be health insurance. It could be 401K, any sort of benefit, correct?

 
David:
That's correct, as long as they're providing employee benefits. From experience, if a bank provides health care coverage typically the cost of health care in today’s market is so high that health care alone is enough to justify buying bank owned life insurance generally up to twenty-five percent of capital.

 
Kelly:
Right, so do you see BOLI as primarily an alternative asset class or an insurance product with investment benefits or does it kind of depend on what the needs of the bank are?

 
David:
I would say it depends on the needs of the bank. I'd say it probably leans more toward the alternative asset class in that you look at the features of bank owned life insurance as a tool to produce earnings that would help the bottom line and help recover employee benefit expenses. BOLI has features that are attractive from that standpoint.

 
Kelly:
As an alternative asset class, and I know you and I've had this discussion offline a couple times, if you consider the investment features as an alternative asset class what asset class does BOLI compete against best or worst I suppose? Where do you think, if you were a bank and they liked the features and benefits of BOLI and they need as a replacement. What asset do you think it replaces best MUNI’s, agencies, loans? As I see it, it could be a loan to an insurance company. Where do you see it?

 
David:
It's hard to say that BOLI replaces any particular investment because the features are different than all the other asset classes that are traditional for a bank. If you go down that path and talk about, for instance, BOLI versus MUNI’s there is some common characteristics in that they both have income that's not taxable that helps produce generally higher returns than most taxable asset classes.

 
 
There are a lot of differences in those two asset classes, for instance, MUNI’s generally have a fixed rate interest rate, whereas BOLI is an adjustable interest rate. The credit quality of both are high. The BOLI carriers tend to be large, very well-known, highly rated carriers, so very strong credit quality. BOLI has no mark to market in the asset, that in reporting periods whereas municipal bonds generally have to do a mark to market of capital through the OTTI adjustment. BOLI essentially doesn’t have a diminution of value when rates rise whereas municipal bonds could.

 
 
Now, from the value of municipal bonds relative to BOLI is that it's always tax-free rather than tax deferred. BOLI’s tax deferred technically, but if held until death its tax free. If you surrender a BOLI contract before maturity, before the person dies, you have a tax liability for the gain plus an extra ten percent for the it’s called a modified endowment contract penalty. BOLI effectively has minimal liquidity from the standpoint of once you buy it you intend to hold it until death, because you don’t want to incur the tax liability.

 
 
Whereas a municipal bond if you decided to sell that you would still retain all the income that you've earned to that point tax free. Sometimes banks put municipal bonds in the hold to maturity buckets so they can't really sell the bond; it becomes an illiquid asset for them as well. There's some pros and cons to each, but BOLI does hold up well generally considering the pros and cons of it to any of the asset classes.

 
Kelly:
But, especially MUNI’s.

 
David:
Yes, I think from that standpoint rather than one versus the other it might be some combination of the two for diversification.

 
Kelly:
From my perspective, I see MUNI yields to get higher yield you have to extend duration, so you look at the risk of extending duration versus investing some assets in bank owned life insurance. I've only been doing this for a year now. It’s seems that like half the banks have BOLI on the balance sheet and half don’t.

 
 
From my perspective, it's kind of a CPA, risk manager, investment person I don’t really see why a bank wouldn’t max out their twenty-five percent of net capital. Now, that sounds pretty self-serving I know, but in your experience what's the single biggest reason for a bank to not include BOLI in its assets class, because there certainly is a reasonable amount of bias and hesitancy for Boards and CFO’s to get BOLI. What's the single biggest reason that you see for a bank to not include it in their asset class?

 
David:
The stats on BOLI are that sixty percent of the banks across the country have BOLI and forty percent don’t. For banks over a hundred million it's about two-thirds that have BOLI and one-third that don’t. It’s fairly common for banks above one hundred million to have an investment in bank owned life insurance. For those that don’t, it generally falls into one of two to three reasons.

 
 
Probably the most prevalent is a bank that has high loan demand. The bank wants to make loans to its local market because that helps build franchise value. If they have high loan demands, say their loan to deposit ratio is over a hundred percent, they may not have the liquidity to hold BOLI at the current time. All their attention and all their liquidity is going into making loans. While BOLI competes with loans well on the yield side, the tax equivalent yield side, banks tend to want to have loans for building the franchise value versus owning bank owned life insurance. If they have the option, they're going it put it into loans rather than BOLI assuming they feel comfortable with the credit quality of those loans. That's probably the biggest reason.

 
 
Number two is that some banks don’t fully understand the asset, haven’t taken the time to fully understand it. The pros and cons and features of BOLI is not traditional with a lot of banks. There's this uncertainty about something that's not traditional. They may think “We haven’t done that before and I don’t want to take the time to learn pros and cons.” Maybe they’ve had a presentation and it wasn’t presented in a way that made it clear what the pros and cons are. They maybe saw it as too much of a sales push instead of laying out all the pros and all the cons kind of thing.

 
 
Keep in mind that for BOLI to be approved by a bank it generally requires a hundred percent agreement, meaning you must have the CFO of the bank, the CEO of the bank and usually everybody on the Board to be in unison that they want to buy BOLI. You can have one person dissent out of ten, for instance, and that could keep it from happening.

 
Kelly:
Why is unanimity required?

 
David:
It’s not required. It's just generally the way it is. First off, if you don’t have the CEO and CFO on board it probably won't go to the Board. You need both of them. The Board, they normally just don’t want BOLI to be something that causes dissention among the Board members. That's not always the case, but typically they need all Board members or at least eighty to ninety percent approval before they would invest in the asset. I haven’t really run into it, but I don’t think you’ll see BOLI being approved on a five to four vote.

 
Kelly:
Yeah, but that would be true with just about any asset class. Let's say the bank wanted to, the CFO proposed extending duration. Don’t you think that unanimity would be expected or the same standard would be expected for that decision to extend municipal bond duration versus like in a BOLI decision?

 
David:
Yes, I would think so. On investments they have their investment policy that's been approved by the Board and that decision would have to be made within the investment policy about extending duration. Yes, I would think you would need a very high approval rate of the Board members before you would change the investment the policy to do something that effectively increases the risk.

 
Kelly:
Do you see BOLI as being subject to…say within the scope of the banks investment policy in your experience?

 
David:
No, BOLI has its own policy. One of the requirements under the regs is that you have to have a BOLI policy before you can purchase it. You would establish a bank owned life insurance policy; in a sense it's an investment policy for BOLI all to its own. It explains within the policy the bank’s view of BOLI; the percentage of capital that the bank would be willing to purchase; the percent to any one carrier; the due diligence that would be done before purchase; carrier selection; vendor selection. How would they go about deciding which carriers, which vendors and so forth? That all has to be documented in a policy before the bank can even go about purchasing a BOLI product.

 
Kelly:
The bank either includes that as a chapter within the investment policy or they have it as its own separate investment policy.

 
David:
I have pretty much only seen it as its own separate policy. If they include it within the investment policy it would be its own chapter. It's fairly lengthy. It's usually ten - fifteen pages of policy all to itself.

 
Kelly:
How has the industry changed since the early years?

 
David:
In the early years, I guess from a salesperson’s standpoint the hard part was to get a bank to talk to you about BOLI because it just wasn’t common and owning life insurance as an asset was not normal. It was outside the box and a lot of bankers didn’t want to discuss doing something that was outside the box. The biggest hurdle was getting the audience.

 
 
Today, most banks know about BOLI so they've heard about it and they have had many, many sales calls about it. Other banks they know have purchased it, so they understand at least the term and what it is. Now, there are just a whole lot of sales calls from insurance sales folks asking about BOLI. They're aware of it. It's just very, very competitive and maybe difficult for the bankers to understand the difference in firm A versus firm B.

 
 
The other way that's changed, when I started doing this the only products available were what's called general account products where the carrier provides a universal life insurance product or some whole life products that have an interest rate or dividend rate. Then the main risk to the bank was a carrier’s credit whether the carrier would be able to pay the claim later. Today, you have not only general account which are still very popular, but since then there's been a lot of purchases of what is called hybrid separate account products and also variable separate account products.

 
 
Variable separate account products are where the assets are segregated from creditors somewhat like a mutual fund. The bank can choose to invest the money within a particular investment bucket; although, for a bank it as to be eligible investments unless it's used as a hedge against a deferred comp plan. Those have some higher risk features, a little bit more moving parts. They have a stable value wrap sold by a registered product or private placement memorandum and so they're more complicated. Most community banks shy away from those because of the complications and the mark to market within the portfolio.

 
 
Then, there's a hybrid separate account product that has features very much like a general account. It has an added credit enhancement that if the carrier were to ever become insolvent the assets within the separate account by legal definitions are segregated from creditors of the insurance carrier so that those assets would only be available to the policy holders. These new asset classes have been pretty popular and have essentially enhanced the options for banks to buy bank owned life insurance.

 
Kelly:
The first generation of BOLI was the general account, no-load product and then the second generation would be some of these the hybrid accounts and some of these more sophisticated product structures. But the core concept was the same, right?

 
David:
That's correct, basically similar structure from a standpoint of no loads, no surrender charges, single premium, just a difference in the chassis if you will.

 
Kelly:
Right, the risk sharing to a certain extent, right, because was the separate account available back then in the early years?

 
David:
You could buy a separate account that was called variable universal life. It was a shelf product, but banks really didn’t buy it then because you had mark to market. Say it was all in a bond fund but the interest rates went up and the value of the bond fund went down five percent you’d have to take an immediate mark to market on your balance sheet and income statement. That was not very attractive to a buyer. If you're a bank you don’t want that kind of volatility on your income statement.

 
Kelly:
Even though that's the nature of a municipal bond portfolio, they have to mark those.

 
David:
A municipal bond portfolio they mark to market, but not through the income statement. They mark to market through the capital account.

 
Kelly:
Right.

 
David:
It doesn’t flow through income.

 
Kelly:
Right.

 
David:
Whereas if you were to do the same thing in a variable universal life insurance contract and have that mark to market risk you’d have to mark that through your income statement because the cash value is changing.

 
Kelly:
One of the things that I noticed about Equias, again this sounds somewhat self-serving, but I’ll say it anyway. This relates to the industry changes. When I see Equias, it just seems to be a highly professional organization. I think eighteen consultants and thirty some support personnel and I believe seven CPAs and a bunch of attorneys, MBA’s that kind of thing. It just seems that one of the things that appears to have happened with Equias having emerged as the key player is the element of professional consulting capabilities versus I would suspect in the early years, and currently, many of potentially our competitors, it's mainly a bunch of insurance guys, right, trying to sell product?  I would think in the early years that's what it was all about, insurance guys trying to sell insurance to a new market…banks.

 
David:
Yes, there was a lot of that. The business model that Equias developed was this is not an area that banks have a lot of expertise in and that they need support services so that they can spend a minimal amount of their time dealing with the technical stuff and don’t have to pay a lot to CPA firms and law firms to help them through the process.

 
 
We set up the firm with the idea that we could provide those services at costs that are competitive with anybody in the marketplace. Through volume we could provide more services and all the technical services that a bank would need, but do it in a very cost effective way. That’s where we actually have eight CPAs and two attorneys and a former OCC regulator, former bankers, bank directors, and a former head of the BOLI area for one of the major insurance carriers.

 
 
We've staffed our firm with very, very experienced, competent, technical people including the consultants are all very experienced, so that we could be a real asset to the banks. It'd be hard for our competitors to match our knowledge and experience and to duplicate what we can do.

 
Kelly:
One of the things that got my attention was I think you're one of the few that has a SOC 1, Type 2 audit. Not many insurance “agencies” have that kind of thing going on. That was a good plus in my mind with you guys.

 
David:
Yeah, it covers our implementation process, as well as our administration process, and covers not only the BOLI side of it, but covers the nonqualified benefits side. We’ve set up internal controls when we established the company and we followed those controls. We've been able to go through the audit process very efficiently and effectively.

 
Kelly:
I’ll probably be criticized for this being an infomercial for Equias, but what the heck. That's what we can do. All right let's finish with one final thing. I’ll give you the choice. This is a question I ask every guest either your favorite quote or, what I like the best, is tell us what one of the stupidest things you’ve said or done in your business career.

 
David:
One of the early days in my career I remember having gone to this bank to explain BOLI and the nonqualified plans probably for the seventh or eighth time. Some of the Board members were wearing out with me coming back almost it seemed like every month. One of the Board members, who was an attorney, when I came back this time she just looked and “Oh no, not you again.” I said, “Yeah.” She said, “Look, if I vote for this, does that mean you won't come back and you'll leave us alone?” I said, ‘You’ve got my word on that.” I guess in that case persistence paid off.

 
Kelly:
It's good, yeah.

 
David:
It wasn’t one of those real positive “I'm glad to see you” kind of moments.

 
Kelly:
That's right; you got the deal done though.

 
David:
Yeah, I was able to get it done through persistence, not through the sales process really.

 
Kelly:
Yeah, that's good. All right, David, thanks for your time. I appreciate it.

 

We want to thank you for listening to the syndicated audio program, BankBosun.com The audio content is produced by Kelly Coughlin, Chief Executive Officer of BankBosun, LLC;  and syndicated by Seth Greene, Market Domination LLC, with the help of Kevin Boyle.

Video content is produced by The Guildmaster Studio, Keenan Bobson Boyle. The voice introduction is me, Karim Kronfli. The program is hosted by Kelly Coughlin.

If you like this program, please tell us. If you don’t, please tell us how we can improve it. Now, some disclaimers.

Kelly is licensed with the Minnesota State Board of Accountancy as a Certified Public Accountant.   Kelly provides bank owned life insurance portfolio and nonqualified benefit services to banks across the United States.  The views expressed here are solely those of Kelly Coughlin and his guests in their private capacity and do not in any other way represent the views of any other agent, principal, employer, employee, vendor or supplier of Kelly Coughlin.

 

May 27, 2016

Sun Tzu Helps a Bank Defeat Its Competition

by Kelly Coughlin, BankBosun CEO,

 

Kelly Coughlin is CEO of BankBosun, a management consulting firm helping bank C-Level Officers navigate risk and discover reward. He is the host of the syndicated audio podcast, BankBosun.com. Kelly brings over 25 years of experience with companies like PWC, Lloyds Bank, and Merrill Lynch. On the podcast Kelly interviews key executives in the banking ecosystem to provide bank C-Suite officers, risk management, technology, and investment ideas and solutions to help them navigate risks and discover rewards. And now your host, Kelly Coughlin.

Hi this is Kelly Coughlin. I am the CEO and program host of BankBosun. Today, I am not going to have a guest today but I’m going to introduce a screen play that I wrote, it’s titled: How Sun Tzu and a Harvard Professor Helped a Community Bank Crush its Competition.

Here is the Play Summary: The play tells about how the board of directors and shareholders of a community bank, frustrated by an ongoing loss in revenues to big banks, financial advisors and non-bank competitors, threatened Joe, the bank CEO,  to turn it around or the board will sell, merge or close the bank.

Let me start by introducing the setting: It is 2016. Main Street Community Bank is a middle market bank with $ 1billion in net capital. The bank’s board, CEO and CFO lose sleep over the Three Rs: Risk, Revenue and Regulation. His Big Bank Competitors compete against them on product and price. And they can pay their execs more compensation. The big banks drive regulatory change, partly because of their own major screw ups, and partly because of their access to and, influence of, the regulatory and legislative banking ecosystem; and partly, and perhaps simply, because they have more money to spend to buy influence and effect change.

Joe also competes with non-bank financial companies who compete on technology and mobile access making them very attractive to the millennial market.  

His wealth management and trust areas compete for deposits and investments with financial advisors, CPAs, independent brokers and wire-house brokers.

It’s a dismal setting and many are projecting and predicting that the community banking ecosystem will no longer survive, dying a slow death like travel agencies, video rental companies, and bookstores.

The board tell Joe to either fix it or they will either sell, merge or close the bank.

Let me next introduce the characters: Joe, CEO, Main Street Community Bank. Joe is accountable to his board of directors, his investor/shareholders, regulators; directly to his CFO and other officers; and indirectly to every employee at the firm. And of course, he is accountable to all current and prospective customers, both business and individuals. He gets pressure to hire and retain professionals, and even more pressure to keep tight controls on expenses.

The next main character is Sun Tzu. Sun Tzu was an ancient Chinese military general, strategist and philosopher, who is believed to have written the famous “The Art of War”.

The third main character is Michael Porter. One of the many business case studies I read in business school at Babson College in Massachusetts was written in March 1979 by Michael Porter, a very smart Harvard University professor, titled, How Competitive Forces Shape Strategy. And another one was written in January 2008, The Five Competitive Forces that Shape Strategy. I would encourage all banks C-Suite execs to read these articles. Contact me if you have any trouble locating them.

And finally, the fourth main character is me, Kelly Coughlin. I am a CPA and the CEO of BankBosun. I’m also an independent consultant for Equias Alliance. I have been working in the banking ecosystem since I was 23 years old. And that was over 20 years ago….alot over 20 years ago…ok, it was over 30 years ago. I have had senior and executive experience at PWC, Merrill Lynch, Lloyds Bank and was CEO of a financial technology and investment company for over12 years.

The Three Act Play:

The classic way to tell a story…or write a screen play… going all the way back to Aristotle I think, is to have a beginning, middle and end…or in screenplay vernacular, the Setup, the Confrontation and the Resolution.

So with that in mind, here is Act 1, The Beginning, The Setup:

  • Joe’s banks is losing customers, revenues and profits.
  • It’s not attracting millennials who are using their phone, devices and the internet.
  • It’s not attracting high net worth wealth management clients, who are using big banks, brokers and accountants.
  • It’s not attracting institutional clients of pensions and endowments, who are using independent financial advisors.
  • It’s losing loans to credit unions and non-bank financial companies.

Joe knows that if he continues to try to compete for customers on the existing playing field, because of their capital, regulatory and human resource constraints, he will lose.

Joe knows he needs a change in his business strategy and create new tactics to implement that strategy or he will fail.

 

Act 2, The Confrontation

Act 2 is where the playwright demonstrates a loss so painful, a failure so great, that the protagonist (Joe) must confront his reality and status quo and either continue in this miserable, wretched state or change his state and condition.

In my Act 2, change in business strategy and tactics” is the change is the confrontation. And for my play, I introduce Sun Tzu and Michael Porter.

In act 2, we have Sun Tzu meeting with Joe and sharing his ancient wisdom with ideas like:

  • You must subdue your enemy without fighting.
  • Know your enemy and know yourself and you can fight a hundred battles without disaster.
  • He will win who knows when to fight and when not to fight.
  • Attack your enemy where he is unprepared, appear where you are not expected.
  • The greatest victory is that which requires no battle.
  • If you wait by the river long enough, the bodies of your enemies will float by. I’m not really sure how relevant that one is…but for some reason I like it…

But two of my favorites are:

  • Strategy without tactics is the slowest route to victory. Tactics without strategy is the noise before defeat.

 

I’m going to repeat that:

  • Strategy without tactics is the slowest route to victory. Tactics without strategy is the noise before defeat.

And here’s my second favorite:

  • Avoid your competitors' strengths; and attack their weaknesses.

So the idea here is the advice and wisdom of Sun Tzu leads Joe to think clearer and more strategic about confronting his dilemma, which requires him to confront his enemy and his competition. And to avoid his enemy’s strengths and attack their weakness and change the field of battle to a location and venue where his enemy cannot effectively compete.

And then to help our protagonist identify where this field of battle is, I introduce Michael Porter with his brilliant Five Force Analysis. These forces are:

  • Threat of new entrants
  • 2nd of the Five Forces: Bargaining power of suppliers, in banking the key suppliers in my mind are human resources…the competition to retain and recruit talent
  • Bargaining power of customers. Customers certainly can drive fee income. If customers know they are key, they will demand lower fees or lower interest on loans; higher interest on deposits.
  • Direct rivals: these are other community banks that compete head on with Joe’s bank. They are most likely banks that are stuck in the old business model paradigm, that is, they haven’t met Sun Tzu, Michael Porter, or Kelly Coughlin. But these rivals ironically are NOT the most significant competitor of Joe.
  • And that leads to the fifth and final force. Substitutes. This is the biggest competitive threat. These include big banks, and other substitute providers like non-bank financial companies, internet banks, phone banks for deposits and loans; and for wealth management and trust, CPAs, brokers and financial advisors

Joe is introduced to Michael Porter, who helps him bank understand that his real competitive advantage exists in three primary areas: 1) location: he has a physical presence in his customers’ local community; 2) security: he has brand image of safety, permanence and security; and 3) service: a live person, not simply a phone contact or email contact, but a live person with whom he can speak. And while his direct rivals, other community banks in his footprint, are certainly direct competitive threats because they also share his competitive advantages; his biggest threat are other substitute competitors – big banks, internet financial companies, who do not share that competitive advantage.

Joe now begins to see his wisdom. But he fears he does not have the budget to spend on fancy and sophisticated consulting ideas.

And now we introduce our final character, Kelly Coughlin, CEO, BankBosun, that’s me. I introduce Tactical Ecosystem Marketing for Community Banks.

Kelly explains that the terms tactics and strategy are often confused. Strategy is the overall plan; tactics are the actual means used to gain an objective, the end goal. Strategy helps you understand the question “What is our goal and objective? What are we trying to accomplish?” Tactics help you answer the question, “How are we going to accomplish our goal and objective?”

Kelly describes how Tactical Ecosystem Marketing is a cost effective marketing tactic that requires Joe to do a couple basic things compete effectively with his direct rivals and substitutes on a playing field they simply cannot or will not compete:

  • Identify the ecosystem. These are business owners, accountants, lawyers and other center of influence in the bank’s footprint including customers.
  • Create multi-media content including audio podcasts to promote his role and importance in the community’s ecosystem and among its members and learn of his target customers’ individual and collective needs, and their product and service features and benefits.
  • Establish Joe as a community leader who is interested not simply in earning fees from members in the ecosystem, rather, equally interested in helping the ecosystem thrive.

 

Finally, Act 3: The Resolution

  • Joe meets with Kelly
  • Kelly shows Joe how he can accomplish these within a budget that his board will approve and possibly at no cost to the bank at all.
  • They create a plan to write 24 articles on some of the bank’s activities, leveraging some of the work the bank’s credit officers and investment team is already creating.
  • Kelly helps Joe create a plan to do 24 podcasts over the next 12 months and syndicate them in iTunes and Google.
  • They interview the CEOs of some of Joe’s big target customers to help better understand their needs and challenges.
  • They create some fun and entertaining videos that explain the benefits of community banking versus non-bank financials for millennials.

Joe’s bank is now thriving and he is recapturing market share. And most important of all Joe’s kids think that their dad is the smartest, coolest, most sophisticated dad in the world. Why? Because Joe’s on iTunes and Google Playstore. And they’re not. And Joe’s board of directors loves him. That’s it for now. Thanks for listening.

We want to thank you for listening to the syndicated audio program, BankBosun.com The audio content is produced by Kelly Coughlin, Chief Executive Officer of BankBosun, LLC;  and syndicated by Seth Greene, Market Domination LLC, with the help of Kevin Boyle.

Video content is produced by The Guildmaster Studio, Keenan Bobson Boyle. The voice introduction is me, Karim Kronfli. The program is hosted by Kelly Coughlin.

If you like this program, please tell us. If you don’t, please tell us how we can improve it. Now, some disclaimers.

Kelly is licensed with the Minnesota State Board of Accountancy as a Certified Public Accountant.   Kelly provides bank owned life insurance portfolio and nonqualified benefit services to banks across the United States.  The views expressed here are solely those of Kelly Coughlin and his guests in their private capacity and do not in any other way represent the views of any other agent, principal, employer, employee, vendor or supplier.

 

 

May 6, 2016

Kelly interviews Peter Weinstock, Partner, Hunton & Williams, Dallas Office. They talk about bank M&A deals and minority shareholder actions to gain control of bank management. Peter Weinstock’s practice focuses on corporate and regulatory representation of financial institutions. He is Practice Group Leader of the Financial Institutions Section and has counseled institutions on more than 150 M&A transactions, as well as provided representation on securities offerings and capital planning.

 

Kelly Coughlin is CEO of BankBosun, a management consulting firm helping bank C-Level Officers navigate risk and discover reward. He is the host of the syndicated audio podcast, BankBosun.com. Kelly brings over 25 years of experience with companies like PWC, Lloyds Bank, and Merrill Lynch. On the podcast Kelly interviews key executives in the banking ecosystem to provide bank C-Suite officers, risk management, technology, and investment ideas and solutions to help them navigate risks and discover rewards. And now your host, Kelly Coughlin.

Kelly: Hi, this is Kelly Coughln from the BankBosun. Hope everybody’s doing fine. I’m going to do an interview today with a deal guy. He’s with a law firm in Dallas, Texas. We’re going to talk about the types of deals that are getting done. Are they P&A deals? Are they stock deals? There are distressed deals out there, there are strategic ones, and what is he saying in terms of M&A activity in the banking sector. With that, we’ll get Peter Weinstock on the phone, from Hunton & Williams.

Let’s talk about deals, Peter. I have kind of a basic question on general trends. In bad banking economies, it seems that we have a lot of P&A deals, where I think the seller is normally the FDIC, correct?

Peter: Right.

Kelly: We must have had a lot of those in 2008, 2009, possibly up to 2010.

Peter: Yeah, I agree. For really almost a four, four and a half year period, there were more deals sold by the FDIC than there were private sector M&A transactions.

Kelly: Then today, better economy, better banking environment, we don’t see many of those, correct?

Peter: Very few.

Kelly: Would you say that the number of P&A deals is a leading indicator, lagging indicator of economic conditions of banks in general?

Peter: Yeah, it’s certainly a lagging indicator, just like capital as a protection is a lagging indicator because what tends to happen is asset quality issues or concentration levels or interest rate risk, some of those other factors, the metrics indicating those issues are becoming problematic kick in long before capital starts declining and capital starts declining generally long before or moderately before problem banks are looking to sell or the FDIC takes over. The number of P&A transactions, which again, we’re down to very few, are more reflective of the fact that the economy seemed to turn sometime in 2012 and we’ve had now three full years of, even though it’s not a great recovery, we’ve had some recovery.

Kelly: How many P&A deals have we seen in three years?

Peter: I think we’re only up to two so far this year, where we were, in 2009 through 2011, we were having dozens and in one of those years over one hundred bank deals.

Kelly: The two this year, are they in, say, oil patch regions that are struggling economically or somewhere else?

Peter: That’s an outstanding question because the answer is, it’s not. That’s not to say that the oil patch or the commodity price areas are not under stress. Certainly, the ag economy is under some stress, but again, it gets back to your first question about lagging indicators. The banks that are failing now are banks that have been circling around the drain for a long time now. They’ve been shrinking to maintain capital ratios, but they can’t get recapitalized because of the legacy assets that they have from the downturn, so we still have a significant number of banks that are undercapitalized and unless something happens, they could fail because they have elevated problem asset levels and those problem asset levels are what would bring them down. At December 31 there were 78 banks that were still somewhere undercapitalized or only adequately capitalized, which is down from, at one point, the problem bank list was over 600, but the 78 institutions that are adequately capitalized or worst, as of year end, are ones that are suffering from the last downturn, rather than the next one.

Kelly: All right, you mentioned 78 that are undercapitalized. What’s the metric that you use?

Peter: These are banks that are not well capitalized, so they’re adequately capitalized or lower, which is they have to have a leverage ratio of 5% in order to be well capitalized. Then you have the Basel III metrics. Right now, you’re talking about a total risk-based capital ratio of under 10% and total leverage ratio of under 5% to be adequately capitalized or, in that case, undercapitalized. It’s not an incredibly high bar that they’re not able to chin, so these 78, you would think that they would be able to recapitalize themselves, but the big challenge that they have is their elevated asset quality levels.

Kelly: You have these 78 banks. Are brokers out there, investment bankers out there trying to get them to sell? You guys probably don’t do that. Lawyers don’t hustle for business like that, I don’t think, right? You’re not making cold calls?

Peter: We’re purist, man. We would never do such a thing. I’m sure that all 78 of them have been shaking the trees and have talked to anyone and everyone who they think could be an avenue for capital and for addressing their problems, but at some point, if you’ve got capital of 5 million but you have problem assets of 15 or 20 million, at some point the numbers don’t make sense for an investor and that’s why these institutions are still on the list, some of them.

Kelly: Let’s talk about the good side of the market, not the problem areas. Let’s say last year, you being a proxy for the market, how many deals were related to distressed banks and how many were for strategic acquisition reasons or market expansion?

Peter: I would tell you the vast majority of them were strategic and few were problem bank acquisitions. What I mean by strategic isn’t necessarily that the seller was in great shape and they sold for a very high price. What we’re seeing is a number of sellers are kind of giving up the ghost because in this interest rate environment, with anemic loan demand, very competitive loan pricing, there are sellers that look at their compliance costs and their IT costs and their personnel costs and they’re saying, “We’re not big enough to do a deal. We’re not big enough to survive on our own and make our shareholders a fair return, so we need to look at doing something else.”

The something else is not necessarily selling for cash and going on down the road. One of the biggest trend lines we’ve seen in the last two, three years, is the willingness of sellers to take illiquid stock, stock from a privately owned financial institution.

Kelly: In the acquiring company.

Peter: To take illiquid stock from an acquiring company, that’s another community bank like they may be, sellers are much more willing to do that than they ever have been before in my 30+ year career. I think the biggest driver of that is that on the operational standpoint, the challenges of being a bank are such that skill matters and then on the shareholder valuation standpoint, I think they recognize that this may not be the greatest pricing time to sell out, so they look at doing some kind of strategic combination to be part of a bigger, more profitable organization, even though the stock is illiquid.

Kelly: Let’s say, in those situations where you’ve got a reasonably healthy bank, they see that if they don’t do something they might be in part of the 78 again, but they might go down that way, so they’re proactive. As a part of that, they have to lock up some of their good producers, right? Their good credit officers and those things. One of the thing we do in our business is help with non-qualified plan benefits to try to use that as a way to lock in good senior management. Do you see much of that going on as part of the deal criteria?

Peter: It surprises me that more banks that are potential sales candidates don’t do more. In community bank America, it almost doesn’t matter how big you are, you’re a potential target. I’ll give you an example. One of my clients is a $5 billion bank in California and they merged with an $8 billion bank in December, they announced it. The reason is because our client, that’s $5 billion, felt that they needed to get bigger in order to compete. The $8 billion bank felt like they needed to be bigger to compete, so now they’re going to be $13 billion. If you’re not an $8 or a $5 billion bank, if you’re smaller than that, you might say to yourself, I don’t need to be bigger to survive, but my efficiency ratio sure as heck would improve if we got bigger. I would tell you that almost every bank is a candidate to be sold, they’re a candidate to buy and they’re a candidate to be sold.

KPMG did a survey in 2014 and it indicated that over 50% of the banks thought they would engage in an acquisition, but 3% of banks thought they would sell. The numbers wound up in 2015 being something like 4.4% of all the banks sold. Every bank out there, it seems, is thinking about doing an acquisition, but every bank and community bank America is a potential candidate.

A long way around to your question is because the banks are all potential merger candidates, then they really should look at putting in place protections for their employees and really locking them up, but when they’re doing that, they also need to think about not hurting shareholder value. The way you could hurt shareholder value is you provide some kind of agreement, let’s say a change in control agreement, that provides on a change in control the employee gets paid if they leave the bank. Now we hurt shareholder value because the buyer knows that they could lose that person because there’s an incentive for that person to leave. Really, it takes somebody like you to think through not just how to protect the person, not just how to lock them up, but also to do it in a way where it creates or at least preserves shareholder value because the buyer is not looking at that contract and saying that that contract harms me because I’m going to lose a valuable producer.

Your question is a good one and I would even go further and I’d say what exists gets paid. If people want agreements to be in place, they need to put them in place because if they exist they’ll get paid, where if you wait until a potential acquisition, then what’s going to happen is the acquirer is going to say, “You can do that, but if you do that it comes out of the shareholder’s purchase price,” and I don’t think you want to be negotiating those types of agreements with another person with their elbows on the table.

Kelly: I’ve got a lot of experience in other financial sectors like financial advisors and broker dealers and the common theme with them is you’ve got much more highly paid execs, but the notion that the assets go down in the elevator every day. It’s more or less the same thing with many banks and not locking them up one way or another in an acquisition, it always kind of surprises me.

Let’s talk about surprises in an acquisition landmines. It seems to me that when we’re talking about banks that are not a huge footprint, a community bank that’s got 1 to 15 branches, isn’t it a fair statement to say that more of the acquirers or interested acquirers are going to be a current competitor of that bank and doesn’t that always present a bit of a due diligence challenge or problem, where you’re going to release sensitive, confidential information to your competitor?

Peter: That is absolutely correct that that’s a possibility. The reason for that is because most financial institution mergers are driven by cost savings. Where do you get the most cost savings? In a market deal or an adjoining market deal. It is very likely the party that can pay the most is going to be an existing competitor. That absolutely presents challenges in terms of protecting your employees and your confidential information. Obviously you’re going to negotiate the heck out of the non-disclosure agreement, if that’s likely buyer, if you’re the seller.

The other thing is you’re probably going to want to hold back on when you deliver information until there is an agreement on all of the relevant terms and then the due diligence becomes more in the way of confirming diligence than it does in terms of setting the price. You’ll release some key information, including whether there’s a termination fee as a result of the transaction on your data processing agreement, changing control agreements with employees, give all of that pricing type information, but you might hold back the loan review and the customer review until the deal is essentially set.

Kelly: The customer name is withheld until the deal is a little more mature.

Peter: We’ve also done it where you redact the customer names, but in an in-market deal it doesn’t take a lot of information for the buyer to know who that player is.

Kelly: Yeah, right. Back to my other question that we started on. Surprises?

Peter: I’d say the biggest surprise to buyers is that the seller’s compliance issues could infect them. I’ll give you an example. When MB Financial was acquiring Cole Taylor, Cole Taylor had a major compliance issue and the transaction was held up for about a year, while the regulators got comfortable with the resolution of that compliance issue.

Similarly there have been a number of red-lining cases and BSA cases where the compliance issues of the target have held up the deal. I think that’s a surprise for a number of buyers because if you’re engaged in a potential transaction, you’re locked into that transaction. You’ve agreed to try to get that deal closed. If you wind up with an extended regulatory approval time period, that could prevent you, preclude you from going after a deal that becomes available six months, a year later that might be a better deal for you.

Similarly for sellers, even in cash deal, if there’s a surprise that the buyer’s compliance issues can be such a hold up and what we’ve seen is we’ve seen AML, BSA, KYC issues that have held up approval of deals for two or three years in UDAP and some other consumer compliance issues that similarly have held up deals. As a seller, you have to perform some reverse due diligence, some extensive reverse due diligence on the buyer, even in the transaction that’s a cash deal. For a lot of sellers, that’s a surprise to them.

Kelly: Do regulators hold up the deal or does the buyer intentionally hold that up?

Peter: Generally it’s the regulators because from the buyer standpoint, they become aware of the issue and they adopt a plan of remediation for the issue. It’s one thing for a private sector party to get a handle on an issue and have a plan of remediation and feel good that they can implement it. It’s a whole other thing for an agent, say, to get their arms around it in a time frame that seems reasonable. The Federal Reserve has two analysts in Washington who handle compliance issues with regard to applications.

Kelly: The buyer would just haircut the valuation. At the end of the day it’s a contingent liability, right? They would just haircut the valuation on it.

Peter: If it’s a known risk and it’s one that they have presumably priced in. If it’s not a known risk and they become aware of it, then they may go back to the seller and say, “We’ve got all of these costs related to it, we need to reduce the price,” or if it’s significant enough, they could decide to walk the transaction.

Kelly: In terms of surprises, known compliance issues and I suppose the ‘know what you don’t know,’ whatever that term is. You know those issues, it’s the unknown compliance regulatory issues. Any ideas on pre-detecting, early detection of those things?

Peter: That’s really you just have to engage in some pretty thorough diligence of the other party to really understand where the risk areas are.

Kelly: I suppose you look at their internal controls and their timely filings or substantiation and all of those things on the control structure.

Peter: You do. Something that I like looking at as a starting point for diligence is nowadays banks have to do risk assessments. Seemingly a banker can’t walk out doing a five-page risk assessment. Those risk assessments are the other party’s self-confessing, if you will, where they see their own challenges or concerns. The beauty of that for the other party is that gives them a roadmap of things to look at in diligence.

Kelly: I was director of risk management for asset management subsidiaries of Lloyd’s Bank out of London, and this was many, many years ago. Regulatory issues and compliance back then just didn’t quite get the importance. They actually did in the UK, but things have ramped up in the US quite a bit, that it’s probably more on par with what it was with the British banks back then.

Peter: If you parachuted back, if you were Mr. Peabody and you got in the Wayback Machine and went back to 2000 and you had a full-time, dedicated BSA officer, and how many banks had full-time, dedicated compliance offer and how many banks had a full-time, dedicated risk officer, and how many banks had a full-time, dedicated IT person, and you compare those numbers to the way they are now, it’s just shocking. The bigger the acquisition, the more you want to look at areas that you might not want to spend the money on if you’re a smaller institution. In a bigger deal, you absolutely want to evaluate IT exposures and make sure that there have not been or in place potential breaches.

Kelly: Why don’t you give us parting thoughts you’d like to give. Speak to both buyers and sellers.

Peter: One thing we’re seeing for banks that may not want to be a seller is there is a lot more activism. We had six private banks in the fourth quarter that had proxy sites, tender offers. One even had a TRO, a temporary restraining order, filed against them. That’s continued in the first quarter of 2016. One thing is to put in place protections and recognize that your risks can be from your existing shareholder base or people who buy in. The world’s awash in money and people out there know if they could buy stock of a bank at eight-tenths of book or book and then wrestle control of the board and get control, then the bank on the sale might be worth book and a quarter or book and a half, book seven, where they could potentially even more than double their money, buy the stock and flipping it in a control situation. We’re seeing activism creeping down into the community bank, into the private bank sector, and that’s something clearly you want to watch.

Kelly: You’re not talking political and social activism. You’re talking about business acquisition, venture capital, investment activism.

Peter: Absolutely. We’re talking shareholder activism. Then just another thing that we’ve seen on the buyer’s side is buyers tend to be most focused targets who are of sale who sent them books. We talked about some of the compliance challenges of the application process. Just because somebody sends you a book and the book says, “We’re for sale,” doesn’t mean that they’re the greatest candidate for you to buy. What you want to be careful about is being locked up on a deal in the regulatory process that is somebody who doesn’t really move the needle for you. It’s got something that obviously is worthwhile, but maybe it’s really not consistent with your strategic focus. We’ve seen potential buyers almost shift their strategic focus just because an investment banker sends them a book on a potential target.

Kelly: Two good points. I always like to finish with two things: Your favorite quote and the stupidest thing you’ve either said or done in your business life.

Peter: There are a lot of the latter. Upon the former, I like the Warren Buffet quote, which it really resonates when you’re talking about shareholder activism. He said, “I prefer to manage my business for the shareholders who want to stay in and not the ones who want to get out.” I may be paraphrasing it, but that’s the thought. I like that quote a lot because that’s actually directors of the bank. Those are the people they have a duty to.

The second one is the stupidest thing I’ve ever done in my career?

Kelly: Yes.

Peter: One thing that I learned a long time ago not to do is something that’s emotionally gratifying because in business it almost always is a bad decision. Early on in my career I would get testy with regulators and that’s never a good strategy. Gray hair and maybe even the loss of hair and some experience, I’ve learned the wisdom of working together with regulators a lot more than trying to beat them up.

Kelly: Can you recall one that you said something to?

Peter: I remember when I was a third-year lawyer, I went to a meeting with the Federal Reserve and I’m not exactly sure what I said at the point, but this person with the Federal Reserve got up and it wasn’t quite Nikita Khrushchev banging his shoe on the table, but he was animated.

Kelly: All right, Peter. Thank you very much. I appreciate your time. I wish you the best.

We want to thank you for listening to the syndicated audio program, BankBosun.com The audio content is produced by Kelly Coughlin, Chief Executive Officer of BankBosun, LLC; and syndicated by Seth Greene, Market Domination LLC, with the help of Kevin Boyle.

Video content is produced by The Guildmaster Studio, Keenan Bobson Boyle. The voice introduction is me, Karim Kronfli. The program is hosted by Kelly Coughlin.

If you like this program, please tell us. If you don’t, please tell us how we can improve it. Now, some disclaimers.

   Kelly is licensed with the Minnesota State Board of Accountancy as a Certified Public Accountant.   Kelly provides bank owned life insurance portfolio and nonqualified benefit services to banks across the United States.  The views expressed here are solely those of Kelly Coughlin and his guests in their private capacity and do not in any other way represent the views of any other agent, principal, employer, employee, vendor or supplier of Kelly Coughlin.   
May 6, 2016

Kelly Coughlin interviews Wes Sierk, President and Co-Founder of Risk Management Advisors. Wes is the author of the book Taken Captive: The Secret to Capturing Your Piece of America’s Multi-Billion Dollar Insurance Industry. Wes is a recognized expert in using captive insurance strategies to manage and fund certain types of risk. Kelly Coughlin believes that such a strategy could be used to manage and fund cyber security risk. This is the first in a series of three podcasts covering captive insurance and cyber security risk management.

 

Kelly Coughlin is CEO of BankBosun, a management consulting firm helping bank C-Level Officers navigate risk and discover reward. He is the host of the syndicated audio podcast, BankBosun.com. Kelly brings over 25 years of experience with companies like PWC, Lloyds Bank, and Merrill Lynch. On the podcast Kelly interviews key executives in the banking ecosystem to provide bank C-Suite officers, risk management, technology, and investment ideas and solutions to help them navigate risks and discover rewards. And now your host, Kelly Coughlin.

Kelly: Hello this is Kelly Coughlin with the BankBosun. This is the podcast that’s the first in a series of three podcasts that are going to be related to using captive insurance strategy to manage and ensure cyber security risk and loss.

I’ve talked to many bankers over my 25-year career and I have observed in the past five years cyber security going from a concern of IT guys and techno geeks to top of mind attention and concern of CEOs, CFOs and boards of directors. In fact, I was at a conference in Kansas a while back, and a number of the sessions were on cyber security risk. I was thinking, “Well, should we go to that? Should we not go to that?” We talked to C-level execs. These sessions were all standing room only, completely filled with C-level execs.

It occurred to me that in this environment, we have potentially overpricing of all services related to the risk management of this risk including prevention, detection, hardware, software, consulting. I thought the subject of these 3 podcasts would be the transference of this risk. I think one of the areas that I detect as potentially being mis-priced is the cost of insurance, partly because the risk of loss is all over the map. We thought, “Let’s explore cyber security risk through a captive insurance enterprise.”

To help kick this series off, I am interviewing Wes Sierk, President and Cofounder of Risk Management Advisors. I came across Wes through a book that he wrote, exciting title called, Taken Captive. That sounds good so far. Here’s where it goes downhill: “The secret to capturing your piece of America’s multi-billion dollar insurance industry.”

I’m interviewing Wes remotely. He’s in Long Beach, California. Wes, you heard my introduction, and the reason you would be on this call, but let’s start with a couple of minutes on your background, how it would connect to bank cyber security risk management.

Wes: Well first of all thank you for having me on the show. I started out in the insurance business in 1993 in a division of Northwestern Mutual, which was a life insurance company called CCI, Compensation Consulting Inc. Mostly what we did there is qualified and non-qualified planning, retirement plans and deferred comp, things like that. I came across captive insurance companies in 2000. My first thought was, it was a perfect alternative to deferred comp. That’s how I got into it. My background is … I’m a researcher, so I started digging into why life insurance was all the same. It was you go to a life insurance company and you get a 45-year-old male, and you say, “How much is a million dollars of coverage?” The insurance company prints out that ledger. If you had ten agents going to the market, they would all come back with the same quote.

PNC is completely different. You actually have one broker who goes to the market for you and it’s much more of a negotiation, which leads into the pricing issues that you alluded to earlier in your call. My partner Jared and myself went on to form Risk Management Advisors in 2004 and all we’ve been doing since is just the design, implementation and management of captive insurance companies.

On a personal side, married for about 24 years, two kids, I coach baseball, and Risk Management Advisors has a Nascar team.

Kelly: Give us a definition in two sentences of captive insurance.

Wes: It’s an insurance company that a business sets up to insure their own risk. It’s pretty simple.

Kelly: It could be a bank?

Wes: Yes. Instead of them buying their general liability, their cyber, their property, all of their coverage from AIG, Zurich, Liberties of the world, they actually form their own licensed regulated insurance company and they pay those premiums to their own company. They deduct those premiums, just like they would by paying any other company.

Kelly: All right. In terms of primary motivations, my research shows that one, you’ve got access to cheap insurance rates because you’re paying them directly to your own carriers so to speak, right? You’ve got first dollar loss coverage, you can accelerate loss deductions, which appears to be a fancy term for you can over-fund the risk premium and build up tax deductible reserve. Are those the three core motivations to do this, or are there others? What’s the primary motivation to do this?

Wes: I think you hit the nail on the head. One thing it does give you, if you’re an insurance company, is it gives you access to the reinsurance marketplace.

Kelly: How much would a bank be saving? Are you talking 5% or are we talking 40%?

Wes: Well it depends on the kind of policies they’re writing and the amount of risk that they’re willing to take. One thing is, the reason why reinsurance is less expensive is because the insurance industry, insurance companies, have thousands of employees. I read somewhere that the insurance industry has three times as many employees as the US Post Office. They do a lot of the processing of paperwork and claims and things like that, so they have higher overhead. A re-insurer can get away with having 5% of the employees of an insurance company, because they only attach at a certain level whether that’s 50, 100, 250, a million, whatever. They’re not getting involved in the day-to-day operations of the insurance company and the day-to-day pay out of claims. That’s left to the insurance company level. We see, for regular insurances, I would say you could see a 30% savings over your traditional insurance.

Kelly: In the banking business we have what are called banker’s banks, and they provide banking services to banks. They don’t do anything directly with the public. So would a reinsurance company be an insurance company’s insurance company where they provide services only to another insurance company, so you cut out all of the sales process I suppose, the distribution expenses? Aren’t those the core things that are cut out plus the servicing part because they’re not dealing with million to 20 million dollar cases, they’re dealing with whatever the number is, 50 million or above, the larger ones?

Wes: You’re exactly right. Your analogy is very good. Where bankers have banker’s banks, this would be like an insurance company’s insurance company.

Kelly: If one were going to set up a captive, that entity would have to also sign up, unless they were going to absorb all of the risk themselves, which is unlikely. If they want to transfer or share some of that risk, they have to set up relationships with reinsurance companies, correct?

Wes: Correct, unless they want to take that risk themselves, which we don’t usually recommend the first couple of years.

Kelly: I suppose companies like you, this is not an infomercial for your group, but is that part of what you do, is you have these relationships and there’s probably some vetting process that you would go through to bring on a new captive client, I suppose, and introduce them and negotiate terms, etc with the reinsurance company. Is that one of the roles that your company provides?

Wes: Yes it is. Clients come to us because they want us to set up and manage their insurance company for them; deal with the departments insurance; do all of the regulatory filings and in most cases, not all cases but most cases; they’ll have us go and negotiate the reinsurance contracts for them. The good thing about reinsurance, reinsurance is always sold net of commissions, unlike an insurance policy where you pay an insurance agent, we’re just negotiating on behalf of the insurance company as a manager of the insurance company.

Kelly: That’s where the big savings comes from.

Wes: Yeah, there’s a lot of savings in that. I’m not going to begrudge brokers because brokers bring a tremendous amount of value to clients.

Kelly: There are a couple of ways to set these things up from what I can tell. You could set them up as a single parent captive or a group pooled collective type where you have a group of banks. You have a single bank, Bank A that decides, “We’re going to set this up.” It’s only one bank in there. Then you have a pooled or group approach where you have Banks A and B setting up the collective. They either do it alone or with others, like kind business I suppose, right? Is that a fair assessment?

Wes: Yeah, they either do it by themselves or they do it with other people. Then within the other people, there is many different ways they can do it.

Kelly: You know the context and setting that this call is about. It’s specific community banks, cyber security risk, captive insurance. If you had to Google this, those three terms would be in there. One other risk if you do it as a group or collective, let’s just say there are two banks in the collective – you have Bank A and B that are, let’s say they’re putting in an equal amount. Let’s say Bank A has great internal controls and risk management processes, Bank B has terrible ones. Bank B incurs all the loss and Bank A has insured it all. There part of the reason was to put in a bunch of excess premium perhaps, build up this reserve. Then you have Bank B eating up all the reserves. Is there a way that a bank can set up a hybrid of this where they could share say, the operating expenses, maybe consulting expenses, a number of things related to the entity? It could be another class of stock, something where the actual risk is only absorbed by the individual bank and ultimately a reinsurance carrier downstream.

Wes: There could be, but I wanted to go back to one point you made, which was Bank A has great internal controls and Bank B doesn’t. The issue with cyber security is many banks have good security or great security, but it’s also the luck of the draw. The person with bad security could be fine and the one with great internal controls could have that one in a million chance where somebody comes in and breaches their security or takes millions of dollars out of their company. Within the group captive there’s also cell companies. You can have a cell captive.

A cell captive is one where it basically looks at and smells like one large insurance company but each individual bank has its own cell, so they kind of wall off the assets and liabilities on a bank by bank or cell by cell limit. That could go a long way to protecting the bank. Then you go get one reinsurance treaty for all of the banks, and then you carve it off. You go get 100 million dollars of coverage and you carve it off at 5 million dollars per bank for twenty banks. The insurance companies like that because they know that if they’re writing 100 million dollars in coverage and they basically divided it at 5 million between twenty banks, they know their chance of loss is actually smaller. The frequency may be higher but the severity probably wouldn’t, and that’s where they get into the pricing. They’d much rather spread it 5 million over twenty banks, than one bank have a 20 or 25 million dollar claim.

Kelly: I accept your point that Bank A may have great controls and Bank B not, but Bank A could be hacked, right? I understand that’s a valid point, but I think in this environment what is going to happen is certainly you have the Top 10 banks, they’re the high-value targets of cyber criminals. They have the budget to always attempt to put up the adequate defenses to that. I fear what is going to happen is the less target-rich environments like community banks will, as the Top 10 banks for instance, get better at defense, then the smaller community banks are going to be the target and they don’t have the resources to fund that. It’s an expensive undertaking. where you’ve got hardware expenses, software, consulting, insurance, all of this stuff, and staff of course.

My thinking was that you set up this captive and you develop best practices. I’m going back to my PWC days in consulting, where in consulting business you’re always looking for best practices, but you develop best practices and you share the costs. You buy them properly, buy them at the right price, right terms, etc, and then you share the cost over twenty entities and not one community bank. The reality is these banks can’t afford to set up the high-level controls that a Top 10 bank can do it.

Wes: You’re exactly right. It’s the philosophy of build your ark before the flood comes. By creating their own insurance company and warehousing dollars today, because of the way the policies are written, they basically expire every 15 months. If they are the targets of cyber criminals three years from now, they would have already stockpiled a ton of money, so they can weather a claim if they have it and maybe not have to hit their reinsurance. To your point, we both know what’s happening in the cyber marketplace as far as the premium dollars in the traditional market. The reason why … it’s because insurance companies are doing the exact same thing. They’re charging exorbitant fees today because they don’t know how big this is going to be.

It reminds me of the old asbestos claims. Remember when asbestos started being a problem? All of the insurance companies started raising their rates dramatically. Then what happened was, a couple of smart insurance guys said, “You’re charging $700,000 for a million dollar general liability policy for asbestos, but if the people actually get hurt, it’s going to be a worker’s comp claim.” It’s not going to be a general liability claim, but the insurance company hadn’t thought that far ahead. They just wanted to get as many dollars in their coffers as they could in case they got hit. For cyber, you went to that conference … you’re exactly right. Five years ago it would have been just the IT people and you’d have fifteen people in the room. Now it’s actually the C-level. It’s CEO, CLO, CFO that are doing this.

Kelly: The board members are the ones that are saying, “Get to the conference. I want you there.” They’re telling their CEOs to get there.

Wes: It’s huge. It’s such a huge problem. I was just reading an FBI report on cyber crime. Their prediction is all businesses in the next five years will be spending at least 10% of their gross income on cyber for protections and hardware and software, and everything. You can’t even fathom that today, but it’s coming. Now we have passwords on top of passwords to get into password programs. They listed off that the FBI did a study and they went into the Apple iTunes store where people get the applications and they have all these password programs. 10 of the top 20 were programs that were sold that said, “Number one password protector.” They were sold and designed by organized crime, downloading these programs for their iPhone and their Androids, putting all their passwords in, all their banking information, and all that stuff was being directly fed to Russian organized crime. They don’t have to steal cartons of cigarettes anymore when they can make 20 to 30 million dollars in one financial transaction.

Kelly: Absolutely.

Wes: It’s staggering. I can see why these board members and CFOs and everyone else would be concerned about it. It’s a big issue. One of our clients was just hit with it.

Kelly: Let’s say we set up Newco captive insurance for community banks. You set up as part of this synthesis of best practices and captive insurance for cyber security. I’m going to throw in another term, “best practices.” I don’t necessarily think they’re into gouging. They just can’t efficiently price it because the risk parameters or the level of risk that they’re taking on an entity basis per entity, per insured, is all over the map. When you take in a company to join the captive … would you call them a shareholder?

Wes: Yes.

Kelly: Okay. When you take a shareholder, they have to adopt the best practices standards that the new captive insurance carrier says. Does that make sense, that would be part of the admission process?

Wes: I would say you definitely want to do that. Some insurance companies, it’s really a risk assessment for cyber preparedness. There are some insurance companies that have done a great job at this. In fact, one of them, these people developed this cyber preparedness company for Ace and Chub insurance company, as freelancers. They said, “Well we want this to make sure.” For them they realized that, “Hey, there’s a real market for this.” They basically bought company back for nothing. This was a few years ago. They’re like, “Well this isn’t going to be as big as we thought it was.” That’s all they do is analyze cyber preparedness. They give you a full report. We just had them come into ours because we have a lot of data in our stuff. We have a lot of HIPPA stuff because we run insurance companies for medical, for example. They gave us a whole big report of change this, change this, change this, and some stuff you’d never even think about. You’re like, “Whoa.” The cost to do it … I thought it was going to be very expensive but it was nothing on the scale of things.

Kelly: You just hope that they’re not owned by the Russian mob, right?

Wes: Yeah, exactly. Three of my clients had used them and the one that just got hit for cyber, their system was set up in such a way where they were instantly notified that this was happening. This was a server in Toronto. Instantly they had to switch the whole thing offline. They flew two of their internal programmers from here in California up to Toronto. They were back online in under 24 hours without an ounce of data. I’m like, “You know what? I’ve got to have your people come in and do this.” This is a company that does 100 million dollars in sales. I think everyone should be requiring this.

Kelly: I think there’s some really cool things you could do when you have many entities splitting the cost of this. I’m certainly set up best policies, procedures, all that kind of stuff. You could buy licenses. You get quantity discount, volume discounts there. There’s a lot of benefit to having a larger group in there. Even just the project team, these banks don’t have the resources to have a really good project team to do a good vendor search, for instance. That’s a costly undertaking in and of itself is, “Well what email provider should we do?” They just don’t have the resources free to do that. You threw out the 10% number. My goal would be to let’s set it up so the goal we could make that a 5% of revenue number, not 10.

Wes: Or 1%. What I was saying was, that was what the FBI’s projection of what people would be spending on their cyber stuff was. In my business, I can’t even fathom that. We spend all this money a year on hardware and software, and our business is X. If I were to extrapolate that out to say, “Well how much would we do if we did 10%?” There’s like, “There’s no way.” We could buy server hubs. We could buy everything. I guarantee you if you picked ten of your banks who listen to this, one of them is doing something great that the other nine aren’t, and so having a depository … You say, “Hey this was a great idea that this bank is doing and then you could take it over to the other one.”

Kelly: Yeah, but what happens, Wes, is that everybody is going to these conferences. They get the heck scared out of them, they come back and they talk to their IT guy and say, “You know I just went to a conference. We’ve got to start controlling this risk.” Then they look at it and realize that, “Oh this is going to cost $100,000? Oh I guess we can’t afford that.” There’s plenty of ideas out there. There are some great ideas and there is some not great ideas, but there’s loads of ideas.

Taking the idea and having the resources to actually implement is the big challenge. I believe that the captive program is a way to pull those things together buy cost-efficiently, do vendor searches efficiently. It all comes together there through that thing. Yeah, there are some tax benefits by throwing in higher premiums, that kind of thing. That’s great but I don’t think this is primarily a tax-driven … It just so happens that taxes will be favorable … favorable tax treatment. I really think it’s the cost-effective way to manage risk and to get best practices adopted in community banks throughout the country that otherwise just can’t quite afford it in their budget.

Wes: I was going to say, and you’re using double duty dollars. Right now if they buy cyber insurance from AIG, they’re not getting internal controls, they’re not getting all of this due diligence, they’re not having somebody come in. They pay them and then if there is a claim … They still on top of their premiums have to go out and do the best practices and do all of the stuff to make sure they’re secured vs. paying premiums to their own company.

Let’s say the insurance company takes 10% of all the premiums that it takes in from all the companies and then uses that to go in and install the best practices and stuff, so you’re actually using money that you would have just given to somebody else to now improve your overall business operation. We’ve had people do that with worker’s comp where, hey they can’t afford a safety guy and their worker’s comp rates have gone up, so they create their own worker’s comp company and now they use the money they were giving to Liberty and AIG and all these other companies to hire their own full-time safety person. That’s actually now just an expense of the insurance company vs them having to take money out of the bottom line of their company.

Kelly: One other thought that’s a great image that I have of you is set up this captive, you have fifty banks involved and you also fund a cyber security SWAT team comprised of Navy Seals and Rangers that are deployed in the event of some ransom war type deal, right? Then they get engaged, they’re ready to go, and then they go out and take them down.

Wes: Yeah, that’s a great idea.

Kelly: Otherwise it’s a call to the FBI and okay, they do great work, granted, but man it’d be nice to have our own team. That could be Phase 2 down the road. Anyway, let’s wrap it up. I really appreciate your time. Let me ask you this. Do you have a favorite quote?

Wes: Yeah, well I do but it’s a Ayn Rand in Atlas Shrugged they talked about Rearden Metal and it was going to be too expensive to rebuild these bridges for the trains using Rearden Metal because of the engineering. The quote was, “When men got structural steel, they didn’t use it to build steel copies of wooden bridges.”

Kelly: Good one.

Wes: I look at captives and things like that as you can use it as a powerful tool to do something in a completely different way. You don’t have to just use it for the same way you were always doing stuff. I would say that would be the first one that popped into my mind.

Kelly: What’s the stupidest thing you’ve ever done in your business career? Give people a laugh. Give people a chuckle here.

Wes: Oh, I have an album on my bookshelf. You know Bill Withers, “Lean on Me”?

Kelly: Lean on Me and “Use Me”.

Wes: I got an appointment. His wife called and wanted me to come talk about overall financial planning and stuff. I went to see him and I’m like, “I love your music. I love the movie and everything.” They’re just sitting there like uh-huh, uh-huh. The meeting didn’t go well and I left there. I had it confused with Stand by Me instead of Lean on Me. My dad found this Bill Withers album and he said, “Keep this on your bookshelf and any time you don’t know the answer, you won’t make a complete fool of yourself.”

Kelly: Oh that’s a great one! That’s very good, I love that one. All right, Wes. I appreciate your time. How can people contact you?

Wes: Yeah, my website is Risk Management Advisors. It’s riskMGMTadvisors.com and my email is WSIERK@riskMGMTadvisors.com. I create a website that’s not branded by us, but it’s captiveinsurance101.com and it just has general info on captives. You were kind enough to mention my book. The book is called Taken Captive and it’s just takencaptive.com

We want to thank you for listening to the syndicated audio program, BankBosun.com The audio content is produced by Kelly Coughlin, Chief Executive Officer of BankBosun, LLC; and syndicated by Seth Greene, Market Domination LLC, with the help of Kevin Boyle.

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   Kelly is licensed with the Minnesota State Board of Accountancy as a Certified Public Accountant.   Kelly provides bank owned life insurance portfolio and nonqualified benefit services to banks across the United States.  The views expressed here are solely those of Kelly Coughlin and his guests in their private capacity and do not in any other way represent the views of any other agent, principal, employer, employee, vendor or supplier of Kelly Coughlin.   
May 6, 2016

Kelly interviews Adam Mustafa, Invictus Consulting Group who talks about CECL and some of the challenges banks have in accounting for future credit loss.

 

elly Coughlin is CEO of BankBosun, a management consulting firm helping bank C-Level Officers navigate risk and discover reward. He is the host of the syndicated audio podcast, BankBosun.com. Kelly brings over 25 years of experience with companies like PWC, Lloyds Bank, and Merrill Lynch. On the podcast Kelly interviews key executives in the banking ecosystem to provide bank C-Suite officers, risk management, technology, and investment ideas and solutions to help them navigate risks and discover rewards. And now your host, Kelly Coughlin.

Kelly: Hi, this is Kelly Coughlin with the BankBosun. I’m going to do an interview today with Adam Mustafa, who’s one of the founders of a company called Invictus Group. There’s been so much discussion in the last couple months on this new CECL regulation that’s coming down the pike here this year some time that deals with how banks are supposed to be valuing and estimating their credit loss. I read a report that Invictus put together, a 2016 regulatory outlook. I actually did three blog posts on it, so you can go to the blog section and read those, as well, and then I’ve appended the Invictus report, as well. With that in mind, I’ll get Adam on the line. Adam, we’re going to talk about some things that are relevant to the bank industry. Why don’t you give us some background on yourself, on Invictus. I see a Mustafa name at the top of the letterhead. I assume that’s a family member.

Adam: Yes, my father and I co-founded the business, and like I tell everybody I’m the smarter, better looking version of him. I do all the work, and he gets to take all the credit. In all seriousness, we started the firm back in 2008 right after the financial crisis began. Today, our bread and butter is providing community banks with strategic advisory services that focus very heavily on using analytics to get an edge in terms of acquiring other banks, being able to analyze those banks and know those banks better than they know themselves, and using analytics also to customize their own capital requirements with their regulators in the face of increasing regulation and the implementation of Basel III.

Kelly: You were with Deloitte Touche for a while. It looked like a number of your other guys came from the banking or investment banking circles. What’s kind of been the genesis of the partners? You and your dad, where did you guys come from?

Adam: I’ve been very much an entrepreneur. I consider myself an entrepreneur first and foremost. I did work at Deloitte, and I was in their business evaluations group. I worked on Wall Street as a junior grunt earlier in my career. I’ve seen commercial banking and investment banking from a variety of different angles. My father’s background is far more impressive than mine. In many ways, a lot of the techniques we use today, my father learned from the great Walter Wriston at Citigroup. My father worked at Citibank in the late ’70s through the mid-’80s, where he was responsible for all mergers and acquisitions, including Citibank’s acquisitions of other financial institutions.

He is a disciple of Walter Wriston. Again, a lot of the techniques we use today were originated by Wriston, and we’ve just updated it for today’s times. That’s our background. We like to say we put the A back in ALCO. What we do is, on the one hand, innovative, because as soon as the 2008 crises occurred, the conventional techniques for analyzing banks all broke down. We’ve developed new analytics, but at the same time, they go back to the fundamentals of banking. You could trace their origins back to the ’60s and the ’70s when Walter Wriston was running Citibank.

Kelly: So now we get at the name Invictus and Invictus Group. Can I assume that it comes from the William Ernest Henley poem, “I am the master of my fate. I am the captain of my soul,” that type of Invictus, or is it another genesis?

Adam: Yes, sir. You hit the nail on the head. In many ways it was very much a metaphor for the times we were in, circa 2008, 2009, when we were in the depths of the financial crisis. Nobody knew exactly what was going to happen, but everybody knew that the industry was never going to be the same.

Kelly: Yeah, one of my favorite stanzas from that poem, it describes 2008 pretty well. It says, “In the fell clutch of circumstance, I have not winced nor cried aloud. Under the bludgeonings of chance, my head is bloody but unbowed.” It describes how many of us went through a very tough period. You also had some experience with the famous Jim Cramer. What was that like?

Adam: I was with him long enough to have a cup of coffee. I don’t even think he would remember my name, although he called me Ace for some odd reason. It was a great experience because he is obviously very well-known and very well respected. He’s got a method to his madness, so just being able to observe him, even though he didn’t know my name, to watch him go about his day, watch him go about his process, I learned a heck of a lot from him. I’d actually tell you what I learned was that I don’t want to be a stock picker because that job is not only very difficult but is very short-term oriented. It is very focused on what companies are going to report quarterly earnings better than what the analysts thought. It was very focused on what tomorrow’s economic indicators were. It was too short-term oriented for me. And so if nothing else, I learned that I wouldn’t make much of a stock picker.

Kelly: Let’s get right into it. I’ve known about you guys for a number of years, and I have great respect for the work that you do, but what got my attention I’d say most recently was this 2016 Regulatory Outlook. As I was pouring through that, it’s about a fifteen or twenty page report, most of which most CEOs and CFOs won’t read because it’s too long, I went through it and parsed it out into three components. One was a regulatory compliance cyber security thing. Part two was balance sheet risk management, and then part three, which was more board-level issues. Just briefly I want to skip to part two that got my attention. “Invictus research found seven hundred and fifty banks with commercial real estate concentrations above 250%. Regulatory guidance suggests banks have unhealthy concentrations.” That seems a lot.

Adam: Yeah, it’s very hypocritical when you think about it, because on the one hand, there is these concentration ratios that are essentially monitoring community banks, in terms of their exposure to commercial real estate, but at the end of the day, that’s what community banks are. They are commercial real estate lenders. That’s what nine out of ten of them do. In many cases, of course they’re going to have concentration ratios in that range. The regulators tend to use 300% as a threshold, and if a bank goes over 300%, that’s when they will examine them a lot more thoroughly, but that’s what community banks do. Community banks, they’re like any other for-profit business. They’re in business to make money, and they have to make loans to make money.

If you try to limit the number of loans they can make, then they won’t be able to make enough money, especially in this environment. And then on the other hand, if these ratios start to push them towards other forms of lending, such as C&I, then all of a sudden they don’t have expertise in C&I. It can be very dangerous making loans in areas where you don’t have an expertise in, and then the regulators will come after banks for venturing into lines of business where they may not have what they need from a skill set perspective. If they make too much of the loans that is their bread and butter, then they’re going to come under scrutiny, but if they try to diversify, they’ll come under scrutiny for getting into lines of business that they’re not familiar with. Community banks are in a very tough position.

That being said, I understand where the regulators are coming from. When you look at the carnage of the 2008 financial crisis, and you study banks that failed and got into heavy trouble, there was heavy concentration. The key is, let’s evaluate the spirit of what’s happening. The spirit of what’s happening is that regulators don’t want banks to fail, but at the same time, banks got to stick to their bread and butter. At the end of the day and we work with a lot of banks who are over that 300% threshold. At the end of the day, the regulators will be comfortable, and a community bank could have a concentration level at 500% to capital, but they have to demonstrate to the regulators that they have the toolkit from the perspective of risk management, capital management, and the sophistication to manage that type of risk.

Kelly: On this CECL business, what is the basic difference between from what banks are doing now in doing some sort of loan loss reserve? There seems to be this discussion on the life of the loan, and replacing and incurred loss approach with a lifetime expected loss estimate. It seems like, on origination, FASB and the regulators are going to say, “Okay, when you originate the loan, we want you to estimate how much you’re going to lose on this loan on origination.” When they do the loan, they’re not really expecting that they’re going to be losing on the life of the loan. Every credit they grant is estimated to be a good credit, so what is the difference here on the approach that they’re doing now, which is a basic allowance system possibly based on past results, versus this lifetime expected loss estimate?

Adam: The primary difference is that CECL is designed to be forward looking, whereas the current process for recording a loan loss reserve is backward looking. That’s the primary difference.

Kelly: Backward looking on their entire portfolio, not with that particular credit, but their overall portfolio, correct?

Adam: Yes. Let’s examine quickly how banks today calculate their loan loss reserve. It’s actually very simple, but you could then see how broken it is. By the way, I’m not advocating here for CECL, but the one thing I can tell you right now is the current way of calculating ALLL (Allowance for Loan and Lease Losses) is a joke. Let’s start with what banks do as first step. They take all of their high quality loans, they call them pass-rated loans, or loans that are currently doing fine, they put them into pools, and they will calculate how much they expect to lose off that pool, but that calculation is based off their historical loss experience. It’s backward looking from that perspective.

Then with the loans that are in trouble, they have to actually analyze those loans individually, and they will look at the collateral position of the loan. They’ll look at the borrower’s financials, and they will estimate using that data, which is also backward looking, how much reserve they need to have against those individual loans. Then you’ve got this third bucket. What CFOs will refer to is as is “qualitative factors”. Qualitative factors is the plug right now, the band aid that’s trying to bridge this gap of the ALLL being backward looking, and the idea that their own loss reserve should be forward looking. Essentially, these qualitative factors is like throwing darts at a board. The CFO or the chief credit officer will look at economic conditions locally and then add plus or minus 1, or 10, or 15% to these scorecards, and then they’ll try to use these score cards to pad their ALLL.

The irony is that this bucket, these qualitative factors, for most banks is actually representing 90 or 95% of their loan loss reserve. 90 or 95% of bank’s loan loss reserve today right now is based off throwing darts at a board. Frankly, that is not effective. The irony is, is that although studies have shown that CECL would hurt banks and would require banks to add to the reserve, we actually don’t see that. For strong, healthy banks, this bucket of qualitative factors is such a large component of their ALLL. We actually think CECL would help a lot of banks because it would demonstrate with more science and far less art how actually less risky those loans are, depending on where and when they were originated.

Kelly: Those qualitative factors that you mentioned, isn’t there a bit of an issue as to how that data is captured. Some of it is captured maybe in memory, some of it’s captured in a Word document, maybe it’s in Excel format. It’s not like there’s a standard input of this type of data, number one, and then number two, isn’t it true that much of that data is kind of subjective?

Adam: That’s exactly my point. It’s like throwing darts at a board. It’s highly subjective. It’s 99% art, 1% science at the most, and yet these qualitative factors, the number coming out of that bucket, is representing 90 to 95% of a bank’s loan loss reserve.

Kelly: Okay, but they’re still under the duty to try to compile that data, correct? That’ve got to collect it and compile, and then make some decisions based on that, right?

Adam: There’s not a lot of data, that’s the problem, for them to collect. Many of them are doing their best to try to collect local or national economic data and try to interpret that, but it is literally like throwing darts at a board. Therein lies the problem. This is why the FASB wants to replace how banks are calculating their loan loss reserves now and replace it with CECL. If you went back to 2008, and you studied what happened in the crisis, a lot of banks didn’t have enough in the reserve. When we’ve done this, if you study failed banks and you looked at their loan loss provisioning, you would see zero, zero, zero, zero, zero, and then a huge spike in one quarter, the quarter where the regulators showed up, and all of a sudden, the banks is under-capitalized and then two quarters later they fail. There was too much volatility. The ALLL itself is highly subjective, easy to manipulate, especially for larger, publicly traded banks. The current system for ALLL completely broke down in the financial crisis, which is why FASB proposed CECL.

Kelly: Wouldn’t it be true, though, that the qualitative factors that you mentioned that led to the ALLL analysis or result, those qualitative factors will help guide the CECL analysis, correct?

Adam: CECL’s going to replace that, because the regulators know, FASB knows that these qualitative factors are a joke. The qualitative factors right now is a band aid. FASB wants to improve the methodology for the reserve in instead of relying on these qualitative factors. They want to have a lot more science to the process. They want it to be far more forward looking. That’s why they want to implement CECL.

Kelly: I was under the impression, though, that some of those qualitative factors were part of the calculus of CECL, though.

Adam: The spirit of it, yes. The spirit of the qualitative factors right now in the ALLL is to basically say, “Yeah, we know when we calculate our loan loss reserve off our pooled loans and our individually impaired loans that that number’s not big enough because economic conditions could change, and economic conditions right now are fragile, albeit, we’re in this recovery driven by artificially low interest rates. We know enough to know the environment is fragile. We need to find a way to capture that in the loan loss reserve, so let’s come up with these qualitative factors to fulfill that. It’s not a great approach.

Kelly: The basic formula is something like probability of default, times exposure default, times loss of the given default, and that equals CECL. On that probability of default, therein lies the subjective element to that, correct?

Adam: Any forward looking model is going to be dependent on assumptions, and assumptions will vary in terms of how much art and science is contributing to them. The methodology you just described, it is one methodology that is being recommended for CECL compliance. It’s probably going to be the most used methodology. The key assumptions such as probability default and loss given default themselves will require some subjectivity or art to it, but there’s a lot more science that can be used in that process. That’s how we work with our clients.

Kelly: All right, so let’s move to the bigger picture here. Give us your take on this whole CECL thing. Is it a crisis? Is it something that CFO’s and CEOs and boards should put at the absolute top of the front burner? What’s your take on it?

Adam: I think CECL doesn’t need to be so complicated. I think there are vendors who stand to benefit from CECL, who are either subconsciously or consciously creating the perception that CECL’s going to be far more complicated than it really need to be.

Kelly: Both of us worked at Big 6 accounting firms in our early careers. I can picture, I was at PWC, and you were at Deloitte Touche? I mean these guys must be licking their chops at the size of some of these engagements, don’t you think, to get in there and help these banks out?

Adam: Yeah, absolutely. Take your typical community bank where it’s hard enough to make money in this environment. Our perspective on it A) this could increase my loan loss reserve, which is going to decrease my earnings and my capital, and B), the cost of putting the system in place for even doing that calculation’s going to cost me money now. From a community bank’s perspective, I completely understand the concern. That being said, let’s set the record straight. CECL hasn’t yet been passed. They’re talking about early half of this year where they’re going to make a final decision on it, although, they hinted at the end of last year it’s likely going to happen.

They also said there’s going to be a five year runway for compliance. So I don’t think community banks need to overreact to CECL. I think they need to develop a plan for CECL readiness, but I don’t think they need to rush into anything. I don’t think they need to panic about it. At the end of the day, CECL does not change the actual risk of a loan. If I make a loan to you today, the risk of that loan hasn’t gone up because of CECL. Maybe how I account for that risk has changed, but it doesn’t change the spirit of making loans. That all being said, here’s some things that community banks should be aware of. You know we talked about the life of the loan, but the other thing that community banks need to be aware of is the vintage of the loan matters.

If you have a properly built CECL model, what you will find is that the risk profile of loans made during the early part of a credit cycle will actually be very low, but if you’re making a lot of loans in the late part of a credit cycle, the risk could be very high. If you’ve got the system in place, you’ll be able to analyze that and not just have the accounting treatment reflect it, but more importantly, it will highlight your strategic decision-making, and it will help provide community banks with a sense of the risk/reward trade-off of making new loans in different environments. What we found is, the time to make new loans is in the early part of a credit cycle and not the second half of a credit cycle, and CECL will just bring that point to the surface, but it doesn’t change the actual risk profile of the loan itself.

Kelly: All right, let’s wrap it up. Do you have three to five takeaways you want to leave the bankers with?

Adam: I’m just going to leave you with one takeaway. It’s a quote that summarizes everything that we’re seeing in this environment, CECL being one aspect of it, which is, “The worst loans are made in the best of times.” The opposite of that is actually also true. A CECL model will quantify that point, but with or without CECL, that point holds true, and community banks, from a strategic planning perspective, really need to think hard about that.

Kelly: That’s a good one.

We want to thank you for listening to the syndicated audio program, BankBosun.com The audio content is produced by Kelly Coughlin, Chief Executive Officer of BankBosun, LLC; and syndicated by Seth Greene, Market Domination LLC, with the help of Kevin Boyle.

Video content is produced by The Guildmaster Studio, Keenan Bobson Boyle. The voice introduction is me, Karim Kronfli. The program is hosted by Kelly Coughlin.

If you like this program, please tell us. If you don’t, please tell us how we can improve it. Now, some disclaimers.

  Kelly is licensed with the Minnesota State Board of Accountancy as a Certified Public Accountant.   Kelly provides bank owned life insurance portfolio and nonqualified benefit services to banks across the United States.  The views expressed here are solely those of Kelly Coughlin and his guests in their private capacity and do not in any other way represent the views of any other agent, principal, employer, employee, vendor or supplier of Kelly Coughlin.  
May 6, 2016

Kelly Coughlin talks to Kevin Chiappetta, CFA, Financial Institution Management Associates Corporation about bank portfolio stress testing tools that are being utilized to help banks get prepared for the new FASB rule and CECL

 

Kelly Coughlin is CEO of BankBosun, a management consulting firm helping bank C-Level Officers navigate risk and discover reward. He is the host of the syndicated audio podcast, BankBosun.com. Kelly brings over 25 years of experience with companies like PWC, Lloyds Bank, and Merrill Lynch. On the podcast Kelly interviews key executives in the banking ecosystem to provide bank C-Suite officers, risk management, technology, and investment ideas and solutions to help them navigate risks and discover rewards. And now your host, Kelly Coughlin.

Kelly: Kevin, I came across FIMAC I think, at a conference in Wichita, where I met your CEO, Greg Donner. I think Greg made a presentation there that I thought was really interesting. Let’s just start out with a little bit of just brief background, Kevin, of who you are. Then we can do a deeper dive into what FIMAC does, and what you see going on in the market today.
Kevin: I appreciate the opportunity. Living in the Milwaukee area, my wife and I are the parents of two recently grown children. We’ve got one out of college, living overseas. We’ve got one who’s in college not too far from you, up in the St. Paul area.
Kelly: You came over from your executive director from a company called Balance Sheet Solutions.
Kevin: That’s correct.
Kelly: You guys are in the space of helping banks manage their balance sheet … Both their assets and liabilities. Correct?
Kevin: That is correct. We actually are two different approaches on that. We consider ourselves a technology company. We do provide the tools to do that. There are a number of them in the market place available at different price points. Different models which accomplish the tasks with slightly different variations, but we also are the consulting side of it. We use those tools to help the financial institution understand the risk that’s inherit in that, and use that risk information to make different decisions. We also want to be able to lend the expertise that we’ve been able to accumulate over the years. Both from bank CFO positions and other consulting firms to help them understand that information. Help them build that information better.
Having the technology is fantastic. It’s helpful, but understanding how to use that technology is really where we’re kind of moving forward with our firm, helping those institutions understand what all goes into using technology to make better decisions.
Kelly: The first point of entry is technology. Give them some tools. They start to use it, and they think that it probably triggers more questions than answers, so they need help implementing it. You’ve got a consulting area that helps the bank from that point.
Kevin: Precisely.
Kelly: What are some of the different business models out there to help the bank with their ALM?
Kevin: The most basic approach that we’ve seen is the technology side.
Here’s our model. Here’s what it cost to run it. We can help you move data in and out. Here are the results. We provide that series of results in a report, and you’re off on your own.
There is some benefit to that. Obviously, it tends to be more of a low-cost entry. For those who are well-versed in that type of thing, it might be advantageous. We can see all the way up to the full consulting as we’ve described it before.
We know that there are a number of competitors in the market space that provide that as well. We see some of this provided by firms who offer other product lines. Perhaps a broker dealer could offer something like that under a different feed-based arrangement, so we see a number of different ways to pay for that service. Whether you’re paying through a soft-dollar transaction type of thing that doesn’t show up on the income statement, or more on the straight feed base.
There are probably three or four different ways, I think, that we see financial institutions using this information. Where is it coming from? Who’s running it? When we start to compare the models themselves, we get into what type of random number generator is being used to create rate paths and some of the more geeky stuff that comes along with the rate models. We can start to split hairs as to one model comparison to the next.
I think the business side of it really breaks down into a model-only on the left-hand side, and on the right-hand side, the full-in consulting. Either you are or you’re not a full service on the consulting side. You’re just merely providing the service that brings the data in and pushes the reports out.
Kelly: You certainly have plenty of brokers that are trying to jam municipals and securities into the asset side. Right? That’s one component that is somewhat of a unique approach that you guys have.
Kevin: Without a doubt. We’ve run across some of those models. I don’t want to be overly disparaging. It really cuts back to something. We want to make sure as an organization that we separate duties. We do that in a lot of different areas. Those who are responsible for money coming in versus money coming out.
To the big duties, we try to make sure that we split the risk-taking and risk-measuring. When you start to combine those two duties you open up the opportunity for one to kind of crowd out the other. When you have advice that’s given on an overall risk-management standpoint for somebody who’s being compensated for selling you risk, it doesn’t take long to see that the opportunity to create more risk than you wanted to was there.
I’m sure there are very good people doing that modeling, but when it comes down to it at the end of the day. Whether I eat or not is dependent on you buying risk and adding it to your balance sheet.
The opportunity to create an environment that looks like you can absorb more risk is clearly there. Personally, I just don’t think that you’ve done enough effort to separate those two duties to make sure that conflict of interest is removed if you’re getting the information on your risk-management and acting on that from the same place. It creates too much room to create errors either willfully or otherwise.
Kelly: In other words, if you’re going to accept the business model where brokers drive the decisions, then you better have done your preparation and homework beforehand so that you know exactly what you need. Don’t let them decide which assets sit inside the bank’s portfolio at the inherit conflict. Is that a fair statement?
Kevin: Yeah. I think that’s a spot-on statement. Clearly, to create these risk reports it requires a certain amount of judgement to go into some of the assumptions. I don’t want to get overly technical but if you look at the liability side, it requires a certain amount of assumption. You need to understand the impact of that assumption has on the result. If my main motivation is to sell risk asset, I can make an organization look more or less risky depending on what is necessary. The opportunities exist for that to happen. Any time the opportunity for that conflict of interest opens itself up, it has risk managers and organizations who are responsible for managing that risk.
I think it’s imperative that we try to close off those opportunities. Whether or not you believe they’re there. The opportunity for it to be there and anybody with a suspecting eye is going to be drawn right to that, taking that opportunity for that risk-management problem off the table. It just goes a long way in proper governing.
Kelly: All right. Another approach, that I’ve seen in the marketing out there, might be to outsource it completely to another investment management firm where they will take on the entire function. They’ll take care of finding and executing the trade. Presumably, not with their own broker, I would imagine, but in theory they could. They could be a broker dealer, they could be an investment adviser, and run the trade. Do you see much of that going on?
Kevin: Yeah. We do see some of that. Some of my background comes from that particular business model, whether with or without the dealer side. It’s not too dissimilar from the role I described earlier on our consulting side, where we spend a great deal of time getting to know the organization and working along with them.
In essence, being an outsourced CFO, or finance division if you will, we create that role and play that role within the organization. Along the lines with that business line, however, it’s imperative that you don’t simply take it off their table and say, “Go focus on lending,” or “File your table reports and everything will be fine.” It’s imperative that you become part of the organization, provide the information, the education, and help them understand what’s going on with that decision-making process.
It might seem easy, say, in February now to come up with the reports from the year end, then tell them where they are and what they can do, but along about April, May when they need to answer for an exam a process , “ Where did those numbers come from? How did you make that decision process?” I can’t think of something that would go worse in that exam process than not being able to answer a question because you just don’t know what’s going on behind the numbers that created that decision. However, we approach that.
If you don’t include management in the decision-making process, I think later on there’s going to be some difficult conversations you’re going to be having.
Kelly: Why don’t we talk about what’s going on with this new FASB ruling, the current expected credit loss that is coming out here? I believe it’s going to come out this year. Correct? What are you guys doing? What should banks be doing? What are your thoughts around that issue? It seems to be a fairly big one.
Kevin: It clearly is. It’s kind of been hovering out there for a while now. This sort of looming storm coming our way. As we look and see the discussion of the proposal, I think the proposal become more finite this year, so we get a lot better feel for how it comes out. It’s a slight shifting from the current allowance calculation where our allowances sort of reflect previous history on loan credit performance. It gets more into a projection.
From our standpoint it really works very well with the mathematics that we’ve been doing in the forecasting for interest rate risk. It may be an eyebrow-curler but I think there some really definite, clear parallel there. We’re expected to put a present value on the projected losses for a particular loan, loan portfolio, or loan type. However we want to look at that. That really kind of goes along with the same type of mathematics we run now for expected cash flow.
From our standpoint, this is more of a pivoting of how we’re going to create that projection of loan losses from a look-back historically to a forward-looking calculation. The technology that we have isn’t going to require us to make any major changes in the mathematics of it. We’re just applying it a slightly different focus. To be projecting a current value of a future cash flow, that’s kind of what our whole business is about.
While it is somewhat scary, because we still don’t know exactly what it is, and it’s going to change to focus of what we’re doing. We feel very strongly that we have the tools, and the expertise in place to help management get their arms around this forecasting process. Then, sort of tweak the way put the input into a loan-stressing calculation or a forward-looking calculation.
It’s so similar to what we’re doing now that we’re trying to take a sort-of … Let’s relax, focus on it, and apply that same thought process into the loan loss process. We think we’re going to be able to come up with a solution that’s going to be fairly well understood, fairly well put into place, and maybe less stress than we we’re thinking at the beginning, simply, because of the unknown.
Kelly: You guys aren’t currently doing that now for loan portfolios. You’re doing it for assets. You’re doing it for investments. Correct?
Kevin: Yeah. Absolutely. We’re applying that same concept to losses. What is the value of that loss? Is it the currently value of those future losses? The same discounting process that we’re going to go through. We’re just using that into a different piece of the balance sheet than we’ve had in the past. We’ll do a study so we can build an assumption built on some sort of a historic look-back as to how the depositors behave. We’ll help them understand the pre-payment speed. All the different assumptions that have to go into that technology in order to understand the behavior of the cash flows under different rate environment. We help them with that point.
I mentioned earlier that I think one of the biggest assists we’ve had right now is just bringing people up to speed into what it is we’re doing. The board can handle those responsibilities that have been squarely put into their lap, but they just don’t have the day-to-day expertise to deal with making sure that they can deal with what’s going on. When they see what comes out of that technology, they get a better feel for what went into it and what it’s telling them once they see the results.
Kelly: Okay. You guys are well-positioned, I’m thinking or at least from what I’m hearing, for this CECL ruling. Correct?
Kevin: Yeah. We’re very confident that we have the tools in place now to tackle CECL. There’s still a lot of detail that needs to be brought out and put into place, but we understand the mathematics of it very well. That’s the business we’ve been in for decades.
Just merely applying that concept here isn’t overly frightening. Again, there are detail that need to be brought out. There are certain things that we need to make sure we’re comfortable with so that we’re applying it properly to comply with the CECL guidelines. Without a doubt, we’re very confident that we have the knowledge, expertise, and the tools in place to tackle this once we get around what all the specifics are.
Consciously optimistic is the right way, I think, to put that.
Kelly: Okay. That’s great. Do you have any take-aways that you’d like to go away with?
Kevin: Sure. Let’s start with CECL because that’s what we we’re most recently discussing, and again, it’s going to bare a repeating.
We have the knowledge and the expertise in place already as banks, and institutions. We’ve been working with these concepts. We’re now applying it to a different area of the balance sheet and the balance sheet reporting. I think it’s important to know what the guidelines are, but by the same respect we want to make sure that we don’t get overly concerned with the concept of moving from a backward-looking to a forward-looking projection of losses. It’s merely applying the concepts we know into a different area.
The biggest concern that we have on CECL is more making sure we understand the guidelines behind the assumption building process and get that done. We want to make sure that we don’t step into a panic state because it’s something new.
From an interest rate standpoint, one of the things that we’re trying very, very hard is to get people to conceptualize as they get into the balance sheet management process. Not merely the interest rate reporting process.
What do we mean by that? As I’ve mentioned before, we have the technology side of our business. We do a great job of getting the information, and reporting that information. What we do with that information becomes the big next step. From the consulting side, what we’re trying to get organizations to understand is more the movement up the scale towards this modern portfolio theory.
We want to look at the balance sheet as an entire entity rather than component, as most things are done now. For instance, organizations that run an investment portfolio with a certain set of guidelines, because we don’t want risk here. We take risk elsewhere. That isn’t necessarily beneficial to the overall organization, or to the balance sheet.
We want to look at how a decision is made in a loan portfolio. It has an impact on the balance sheet. We want to understand that. A decision made in the investment portfolio has an impact on the balance sheet, and we want to understand what that is.
Understanding how things interact with each other when we’re going through the risk management process is one of our biggest challenges. Trying to evolve organizations out of the component style management into a more holistic balance sheet style management.
In order to do that, you really need how the balance sheets react to each other. In order to do that, you need to be able to break down interest rate risk reports that we’ve provided. In order to get to position, we have to take three steps backwards. We need to make sure the policies are written correctly, that the management understands what we’re doing, that the process of doing testing, stress testing, movement rates, and seeing how different decision’s reactions appear on the balance sheet.
All of those things become critical in order to look at the balance sheet management as opposed to component management. When we start using this information to make management decisions as to merely reporting what our risk profile is, that is a huge step forward in getting everybody aligned.
We’ve got Board alignment through line management alignment. Everybody understands what we’re trying to accomplish. Everybody understands how things impact, and we know that before those decisions are made. We just feel that’s a much better approach. One that if we embrace the holistic approach, the decision making process becomes more a matter at looking at the menu and picking which we want to have as opposed to hoping that things work out our way.
Kelly: Great. Very helpful. Do you have a favorite quote?
Kevin: There’s one from a business standpoint that I was told a long, long time ago. I try to remind people of the same thing. When you find yourself in a hole, the best exit strategy is to stop digging. You see how people try to manage their way out of that hole. It sounds kind of basic. Maybe a little too folksy, but it makes a whole lot of sense. Whatever put you in that spot, you need to stop doing it first. That’s our first strategy. Stop doing what put you in that world of hurt, and start trying to come up with ways to get out of it.

Kelly: That’s great.

We want to thank you for listening to the syndicated audio program, BankBosun.com The audio content is produced by Kelly Coughlin, Chief Executive Officer of BankBosun, LLC; and syndicated by Seth Greene, Market Domination LLC, with the help of Kevin Boyle.

Video content is produced by The Guildmaster Studio, Keenan Bobson Boyle. The voice introduction is me, Karim Kronfli. The program is hosted by Kelly Coughlin.

If you like this program, please tell us. If you don’t, please tell us how we can improve it. Now, some disclaimers.

  Kelly is licensed with the Minnesota State Board of Accountancy as a Certified Public Accountant.   Kelly provides bank owned life insurance portfolio and nonqualified benefit services to banks across the United States.  The views expressed here are solely those of Kelly Coughlin and his guests in their private capacity and do not in any other way represent the views of any other agent, principal, employer, employee, vendor or supplier of Kelly Coughlin.  
May 6, 2016

Kelly Coughlin interviews Donald Moore about generating more revenues from trust and wealth management clients and managing risk in that business line. Moore is a former OCC examiner.

 

Donald Moore Jr., CEO of Bearmoor, LLC has over 20 years of experience in the asset management and fiduciary industry. He has served in senior fiduciary positions with various US Treasury agencies, as well as a leading financial services consulting firm. He began his career as a Trust Examiner with Office of the Comptroller of the Currency. He has examined over 50 trust divisions, including the lead position at two of the nation’s largest trust institutions. He has assisted in the development of national policy and guidelines at both the Comptroller’s Office and the Office of Thrift Supervision.

Kelly Coughlin is CEO of BankBosun, a management consulting firm helping bank C-Level Officers navigate risk and discover reward. He is the host of the syndicated audio podcast, BankBosun.com. Kelly brings over 25 years of experience with companies like PWC, Lloyds Bank, and Merrill Lynch. On the podcast Kelly interviews key executives in the banking ecosystem to provide bank C-Suite officers, risk management, technology, and investment ideas and solutions to help them navigate risks and discover rewards. And now your host, Kelly Coughlin.

Kelly: I’ve got Don Moore CEO of Bearmoor LLC. Don, how are you doing?

Don: I’m doing well, thank you Kelly, I appreciate the opportunity to chat with you today.

Kelly: Don, you’re in Boulder?

Don: I’m not quite in the Republic of Boulder, I’m a little bit closer to the Breckenridge area up in the hills of Colorado.

Kelly: You’re happy because the Broncos just won the Super Bowl, I take it.

Don: I’m slightly indifferent to the Broncos winning, although they had their ginormous parade yesterday down in Denver. Everyone’s excited that Peyton got his Super Bowl, but again, I think it was the defense that won it for him. Yeah, we’re happy here in the state. No one’s going off the edge yet.

Kelly: Let’s get right into it. Tell me what Bearmoor does. What’s your value proposition?

Don: Basically, it’s the optimization of risk-adjusted revenue from an organization’s existing fiduciary activities portfolio. It’s basically their personal trusts, their investment management accounts, their retirement accounts, foundation endowments and custody. All those off-balance-sheet activities within the fiduciary world. Again, the optimization of their risk-adjusted revenue from their existing portfolio.

Kelly: First of all, it’s banks that are in the wealth management business. They have trusts, they have wealth management capabilities, correct?

Don: Correct, a lot of organizations that are clients, their definition of wealth management differs, but it does include trusts, insurance, and private banking.

Kelly: You help those kind of banks do what?

Don: Optimize top-line revenue. What we mean by that is, I like to use a quote from Bono, the lead singer for U2, he was up at his concert and doing one of his social announcements where he was clapping his hands and he said, “Do you know, every time I clap my hands, a child in Africa dies?” And someone screamed out, “Stop clapping your hands.” We don’t focus in on expense because for the past 10 years in the industry, the industry’s been focused on nothing but expenses. The expenses have outpaced revenue growth 6 out of the last 10 years. Their focus on expenses I don’t think, has been all that fantastic. We like to say, “Well you’re already focused on expense reduction, we want to help you grow top-line revenues.” Our value proposition leads to an increase to revenue top-line.

Kelly: Before we get into how you do that, let’s talk about some personal background.

Don:

All right, I’ll start out with education. I went to school, got a degree in finance and accounting, after I graduated from that I went to work for the United States Treasury Department as an examiner with the Office of the Comptroller. The currency, the OCC, I found an opportunity to begin examining in the fiduciary world and I became a fiduciary examiner. Through that, I went to Washington, DC. For those of you in the fiduciary world that have an understanding of Regulation 9, when I was in Washington, DC I helped draft and write that regulation that now national banks follow. For most states, it’s been adopted verbatim on that.

I left there, and went over to another Treasury Department, the Office of Trust Supervision, which has now been rolled into the OCC and wrote their fiduciary training program and some of their examination procedures over there in a fellowship capacity of 18 months before leaving and going to the consulting world, and focused on consulting in the fiduciary world, and that brings us to where we are right now.

I am married to my wife Toni, we live out here in Colorado, we have four children. Hobbies; I would say right now we’re doing lots of skiing, got some good snow out here in Colorado, so that’s one of my hobbies. Do a lot of running, outdoor activities is me. That’s who I am, I’m 52 years old and I feel it every day.

Kelly: Don and I have known each other for probably 15 years, and we made a good connection when we found out you grew up in Minnesota, correct? St. Louis Park?

Don: Yeah, sure, you betcha.

Kelly: Let’s talk about the business. How do you help these banks make money? How do you help a wealth management bank make some money? I want to come up with let’s say five take-aways on how our listeners can make money through what company like yours offer.

Don: Let’s start out with, the opportunities for increasing top-line revenue within your fiduciary activities exist. They are out there. I like to use the phrase, “You’re standing on a whale, fishing for minnows,” because there’s already opportunities to increase your top-line revenue within our organization. What we mean by that is we go through and do an analysis account by account basis and identify opportunities in three phases: one, gap analysis which is, “Hey, where are you missing it?” From the standpoint of what you think you’re getting. You may have some system errors, system inaccuracies that can help you identify opportunities, that’s one phase.

Second one is competitive analysis. Where is it that you would like to beat your competition, and where is it that you actually are? We ask you what your business’s strategic plans are, we go out and do mystery shopping and competitive shopping for the organization to make sure that they understand where they are and where their competition is, and where they can go with their current level of pricing.

The third analysis is a regulatory analysis. What’s changed in regulation that allows you to either understand the regulation and generate additional revenue, or do we have some risk there? Again, gap analysis, competitive analysis, regulatory analysis to help you identify those opportunities, because they do exist. I would say that’s the first area.

Kelly: You exposed that just recently, gap analysis. You’re looking at pricing, and how competitive they might be in pricing in addition to more of a qualitative, these are the type of services they would offer?

Don: Along the lines of both, Kelly, with regards to the types of services we want to break it down so we understand the types of services they offer. Then the pricing that they have on each of those services. When we talk about pricing, we all know that there are committees, and then there are boards, and we’re talking about the board-approved pricing for these services.

Kelly: This is for wealth management services. These are the basis points. This is how much we charge for a $5,000,000 fiduciary trust account, correct?

Don: Correct. Absolutely. Those are established by, I would say, the business line which then goes to the committee and the boards approve. These are the pricing and it would include not just basis points, but it would include minimum account fees, it would include fees for ancillary services such as real estate administration, closely held business administration. Maybe there’s a tax prep fee or a tax information letter fee. Maybe there’s a stand-alone fee for extraordinary type services. All the fees charged for the services provided within wealth management on the fee schedule. We then go through and see what accounts are actually on that schedule, and what accounts are not, what accounts have customization, what accounts have discounts. It doesn’t make sense for the level of service being provided.

What’s critical with that, from a Bearmoor perspective, is what I would say would be the second take-away, which would be a risk understanding of your accounts. If you haven’t done a risk assessment on an account by account basis, it would be highly recommended that you do so. This would allow you to identify the level of risk for each account and type of account using system information. This isn’t something that’s subjective, it’s based upon system criteria that you’ve established and put risk weightings on it. Let’s say you have an account that is an irrevocable trust account with two co-trustees, five beneficiaries, some unique assets in there, and maybe it’s over $2,500,000. You would assign various risk criteria to each one of those factors. Maybe that has a higher risk than a revocable trust.

Kelly: You’re not talking about portfolio risk, you’re talking about risk of an unhappy client (other than portfolio volatility).

Don: Correct. What we’re seeing is a fair amount of, I hate to go back to the regulatory side, but a fair amount of regulators are saying, “Hey, we can risk rate loan accounts on the banking side, why can’t we individually risk rate these off-balance-sheet trust accounts from an administration standpoint, from a level of risk?” and then get some understanding about what may be some levels of capital might be for this entire portfolio. It’s not investment portfolio risk management, for lack of a better term it’s complexity rating the account.

Kelly: Give us three things that you like to look at, that might go into the calculus of that.

Don: I would say type of account.

Kelly: The fiduciary, non-fiduciary.

Don: Correct, you would have the fiduciary accounts would be those revvocable and irrevocable trusts, investment management accounts, foundation endowments, IRAs. Then the non-fiduciary lower risk would be a custody account, where you don’t have any investment management responsibilities. Another item would be the type of assets in there, so maybe less risk would be a mutual fund portfolio, that’s made up of a bunch of mutual funds to meet the account’s objective. A higher risk would be, “Hey, it’s a stand-alone investment in a large piece of commercial real estate.” High risk on that. The third thing would be type and/or number of beneficiaries. The larger the beneficiary pool, the more risk you may have because you have different competing objectives. Some of those might be income beneficiaries, others might be remainder beneficiaries, or growth beneficiaries.

Kelly: The high-risk account would be one in which there’s a fiduciary relationship to your holding assets that are perhaps individual securities and not mutual funds and the third?

Don: Number of beneficiaries.

Kelly: Number of beneficiaries. Is that because the more people you have in the equation, the more likely it is you’re going to have somebody complaining about it?

Don: More likely there’s going to be a complaint there, but more likely that there’s going to be conflicts of interest. What I mean by that conflicts of interest is those beneficiaries may all have different needs and you as the fiduciary that’s managing that account, have to take all those into consideration and make sure you treat them equitably and fairly based upon the information you have.

Kelly: Tell us how you help the bank make more money.

Don: From that account by account analysis on the gap analysis and identifying opportunities within their portfolio. Not just from a best practices from what we’ve seen over the past 15 years of doing this, but also what’s taking place within their lines of business and their strategy. Overlaying that on that analysis and saying, “Hey, here is the opportunity, and here’s how that opportunity impacts each account.”

Kelly: This is for your part one you look at the market, you look at competitors, and you say, “Oh, your competition’s charging 200 basis points, you’re only charging 150. You could charge 180,” for example.

Don: Correct. If you still want to be the low-cost provider and the lowest-cost provider is charging that 200, and you’re at 150, you could go all the way up to that 200 and charge 190, 180. Right.

Kelly: Right.

Don: Do that complete analysis. Or your minimum fee is stated to be this, we’ve done in a cost analysis of your portfolio and you’re not even covering your costs with your minimum fee. You’ve got to adjust your minimum fee.

Kelly: Don’t you think most banks know their competitor? Let’s say pricing, and their level of service, because they either get clients poached frequently, or infrequently, and if they find out why, then it’s well, his is cheaper, or better service, whatever it was. Don’t you think they know that?

Don: That’s what we thought. That’s what we were counting on, but when we started doing the mystery shopping, because we asked our clients who are their competitors, who do they want us to mystery shop. Then we also provide them all the other information that we have. That, other than the actual opportunities, was one of the most highly prized pieces of information that we provided to our clients was, “Oh, look at all this competitor information.” My business partner and I looked at each other and said, “Wow, we didn’t realize how valuable this was. We thought you guys knew it, we’re showing it to you to let you know that we know it.” You would think they would know it, but a lot of times that isn’t the case based upon the information that we were able to gather and the reaction that we get from those. I think they have an understanding of it, but once they actually see the documentation and support for that that we’re able to gather, that brings it full circle.

Kelly: I’m intrigued by, and I always have been intrigued by you being a former regulator with all due respect to your former profession, the dark side I suppose, or actually I think when you go into industry, they say you’ve gone to the dark side, I believe. However you look at it, how a former regulator can help on the revenue side is always been amusing to me. I know you do have a pretty good reputation out there, so kudos. You’ve been doing it quite a while, I believe.

Don: Yeah, I appreciate those comments. Perhaps my capitalistic views weren’t always the right forum to be a regulator, so maybe I’ve always had to get back to this side. Maybe I was on the dark side and came back to the light.

Kelly: Any more takeaways?

Don: I would say re-acceptance, and what I mean by re-acceptance is, based upon the information that you have today on your existing accounts, the level of administration, the level of responsibility, the potential problems associated with the risk audit compliance items, the regulatory issues, and the revenue that you’re making on it, would you re-accept the accounts in your portfolio today? If the answer to that is no or maybe, you need to actually go through and do this risk assessment and the revenue opportunity assessment to make sure be able to answer that question yes or these are accounts we no longer need to be a part of.

Kelly: It isn’t just no longer be part of, it may be no I wouldn’t accept it under these terms. These terms being pricing, but would you accept it at 50 basis points? No. Would you accept at 150? Yes. Isn’t that as much of a relevant question as acceptance or non-acceptance, it’s how should we price this thing?

Don: Proper pricing is critical. We have top 10 risk piece that we do and one of the top 10 risks is appropriate pricing, so you’re absolutely right. “Hey, I wouldn’t re-accept it because of the assets.” That’s one thing. I wouldn’t re-accept this because of the price and the assets. Could we price it accordingly where you would accept it? Absolutely. That’s part of the analysis we do.

Kelly: Why don’t you post on our website the top 10 risk pieces in a blog post?

Don: Absolutely, I can do that.

Kelly: That’d be nice to accompany this. That’s it for now, give us your favorite quote.

Don: It’s Milton Friedman the great economist. “The question is, do corporate executives, provided that they stay within the law, have responsibilities in their business activities, other than to make as much money for their shareholders as possible?” My answer to that is, no they do not. Basically, everyone should stay focused on generating revenue for the shareholders for where they have their fiduciary duty.

Kelly: What’s the stupidest thing you’ve said or done in your business career?

Don: This is classic me, and this took a long time to live down. This was years ago. I basically said, I used another quote when I was giving a presentation because someone asked a question with regards to revenue enhancement and I said in front of this entire group, “Life’s tough, but it’s tougher if you’re stupid.” Yep.

Kelly: Good one.

Don: I was much younger.

Kelly: Don, I enjoyed talking to you, thanks so much for your time.

We want to thank you for listening to the syndicated audio program, BankBosun.com The audio content is produced by Kelly Coughlin, Chief Executive Officer of BankBosun, LLC; and syndicated by Seth Greene, Market Domination LLC, with the help of Kevin Boyle.

Video content is produced by The Guildmaster Studio, Keenan Bobson Boyle. The voice introduction is me, Karim Kronfli. The program is hosted by Kelly Coughlin.

If you like this program, please tell us. If you don’t, please tell us how we can improve it. Now, some disclaimers.

  Kelly is licensed with the Minnesota State Board of Accountancy as a Certified Public Accountant.   Kelly provides bank owned life insurance portfolio and nonqualified benefit services to banks across the United States.  The views expressed here are solely those of Kelly Coughlin and his guests in their private capacity and do not in any other way represent the views of any other agent, principal, employer, employee, vendor or supplier of Kelly Coughlin.  
May 6, 2016

Kelly talks to Dan Hill, CEO, Sensory Logic, about how the latest face recognition techniques and technology can tell you many things about people before you agree to do business with them or hire them.

 

Kelly Coughlin is CEO of BankBosun, a management consulting firm helping bank C-Level Officers navigate risk and discover reward. He is the host of the syndicated audio podcast, BankBosun.com. Kelly brings over 25 years of experience with companies like PWC, Lloyds Bank, and Merrill Lynch. On the podcast Kelly interviews key executives in the banking ecosystem to provide bank C-Suite officers, risk management, technology, and investment ideas and solutions to help them navigate risks and discover rewards. And now your host, Kelly Coughlin.
Kelly: Dan, I want to do introduce you and talk to you briefly about what you’re doing with your role as CEO of Sensory Logic, and generally get some of your background and talk about the science of what you guys are doing with this technology. My summary of it is something like you’re using technology to objectively measure 12 human emotions. They range from joy to sadness, and anxiety with the purpose of evaluating personality traits, measuring personality traits, to determine how neurotic or how normal people are for the purpose of identifying matches with whatever the goal might be to using that. Is that a reasonable estimate or summary of what you guys are doing?
Dan: We are trying to capture and quantify emotional response and that can apply to consumer’s reactions to the advertising, website, and other touch points of thanks for instance, but if you move over to the more personal side in terms of financial advisors or trying to reduce risks when looking at hedge fund managers, yes, then you start getting into the personality dimensions. Obviously for hedge funds you want to make sure that they are prudent investors and not someone given to overly large risks. There’s both a general consumer application we are talking about here, and one that’s more personnel driven.
Kelly: That sounds interesting, using technology to evaluate those things that are clearly has been in the realm of subjective interviews and personal objective evaluation is fascinating. Let’s go over a little bit of your background, Dan. Currently you’re CEO of Sensory Logic, and a little bit about what you are, who you are, and then who Sensory Logic is.
Dan: I started the company in 1998, and I got lucky. Someone I knew at IBM sent over to me an article about the breakthroughs in brain science and how much people are emotional decision makers. You may know the conservative estimation is that at least 95% of peoples’ mental activity is subconscious. A lot of what happens to us and for us is below the water line so to speak, and it’s important to access that and the emotional part of the brain sends ten times as much information to the rational part of the brain and vice versa. As to the ratio of emotional to rational in terms of the interactions it is a ten to one ratio.
Kelly: Presumably we have a rational mind that’s informing our subconscious mind, correct?
Dan: Sure, the mind is very interactive so there is an interplay back and forth, but I think the real thrust of the breakthroughs in brain science in the last 25 years aided by technology and from MRI brain scans for one thing, is that we really have to change our viewpoint. We probably have run for 300 years with Dick Hart’s assumption that we are rational beings. The famous comment, I think therefore I am. Ambrose Bierce, a contemporary of Mark Twain said, “I think therefore I am.” That’s probably a lot closer to the truth.
In the financial industry you want to go to the numbers and facial coding gives us a chance to bring numbers to something that otherwise might have seemed rather soft and squishy which is emotions. In reality there’s really two currencies in the business world. Dollars and emotions, and we’re after the second one on behalf of the first one.
Kelly: Not to be outdone with your quoting of philosophers, I will reference Aristotle who also used the concept of having, of creating habits that are natural to the human that just make it part of the unconscious, subconscious mind so that your naturally inclined to do, he felt like, the virtuous, the right thing. That took kind of integrating the conscious mind, the rational mind, with the subconscious mind. Is that consistent?
Dan: I think the metaphor that Aristotle used actually was that human beings is as if they are in a chariot, and it’s driven by two horses and one’s the rational horse and one’s the emotional horse. He was already acknowledging, obviously, the importance of emotions. I think what the neuro biology advances have suggested is that maybe the darker horse, the emotional horse, may be the stronger of the two, most likely is.
Kelly: Dan thank you, you crushed me on your quoting of Aristotle. Thanks, I appreciate that.
Dan: That wasn’t my goal, but whatever helps illuminate things for people.
Kelly: And I went to a Jesuit school! So let’s talk about your education. You have a PhD. Tell us about your education.
Dan: I do have a PhD in English literature, not psychology as some people might assume, but I’m an inquisitive learning sort of guy and really what happened is once I got this article brought forward from the IBM person, I really started on a second education. I don’t have a formal degree, but I have spent a great deal of time reading and talking to experts in neuro biology and psychology over the last 20 years to understand really one of the drivers of human nature and just to give you some feeling for the groundings here.
If you go back to Latin motivation and emotion have the same root word, move, to make something happen. That’s how essential emotions are to human behavior, and the person who first realized the importance of emotions was Charles Darwin. In his work on evolution he essentially said to himself, “Okay, emotions must give us an adaptive advantage, otherwise they would have gone away. How can I best capture emotions?” That turns out to be the face, so what we do is use facial coding to be able to bring science to bear on emotions.
Kelly: Dan, where do you live? Tell me a little bit about your personal, family life. Do you have any hobbies?
Dan: When I have the time, sure. I like to play tennis. I’m an avid movie goer. I enjoy traveling so I’ve been to about 80 countries including a year ago or so was in Botswana on a non-hunting safari. It’s whatever can broaden the horizons. There’s readings, there’s films, there’s tennis, there’s travel, obviously time with my wife, so there isn’t anything remarkable there, it’s just try to be a busy and engaged guy.
Kelly: Let’s get down to some business stuff. Tell me in fifteen words or less, roughly, what the value proposition of Sensory Logic is.
Dan: Actions speak louder than words, and there are things people can’t or won’t say, and if you can get to emotions you can get below the surface and get to the real thing.
Kelly: In terms of the banking ecosystem which is the ecosystem we are navigating through, what is the applicability or this, not necessarily your company, but this technology if you will, that value proposition, how would it benefit, how is it connected? Is it connected now, or is it an area that you guys want to be connected to. Where’s the applicability? Generally speaking.
Dan: There’s really two realms. Let’s start with the one we’ve historically been in, because I’ve run my company for 17 years, and we’ve done work for nearly half the world’s top 100 consumer facing companies, so things outside of the industrial realm and so forth. That’s plenty of things in the financial services industry. It’s a long list of banks and institutions, also in the insurance industry, as well that we’ve done work. From that point of view, obviously if you have these touch points with consumers you want to connect effectively.
I think the place you have to start is that of course, trust is the emotion of business. Trust is not an emotion you can capture through facial coding, but you can capture its opposite which is contempt. Contempt means I don’t trust you, I don’t respect you. If you’ve ever read Malcolm Gladwell’s best seller “Blink”, facial coding was the only tool described in the book for some 30 pages.
At the University of Washington in Seattle they have a love lab where couples come in who are in distressed marriages, they use facial coding to figure out whether they can save the marriage. Contempt is the most reliable indicator that the marriage will fail, so if it’s not good for a married couple you can imagine it’s not good for a company and its clients.
We use this in advertising testing and websites to understand how people are responding. There’s several varieties of information that is important. The first one is actually do you engage them. Do they emotionally respond? You don’t want to waste your advertising dollar, you don’t want to just be talking to yourself, you need to make that emotional connection. That’s one of the first things we go after.
Kelly: Put yourself in the place of a community bank CEO and they’re in the business of making business loans, by example. How does that CEO or that credit officer, how could that credit officer utilize this technology? Not your company, but the technology. How do you envision that this technology could be employed by a credit officer at a community bank in any city in the USA.
Dan: There’s actually a template here. I mentioned Charles Darwin earlier, but there’s a man named Paul Ekman, E-K-M-A-N, who’s been honored by the Smithsonian who has been cited by Time Magazine as one of the 100 most influential people on the planet. Paul worked as a colleague at the School of Medicine in San Francisco. Over the course of about 15 years he created what is called the Facial Action Coding System. He figured out from 43 muscles in the face what are the muscle movements, the action units, the activity that reveals seven core emotions which you alluded to earlier. They run from joy, the high end of happiness, through things like fear and contempt.
These muscle movements correspond to the emotions, this is relative public knowledge, also in a book of mine, and that information for a loan officer if they were to do their due diligence, and take some homework assignments, and actually study this a little bit, would give them a feel for the person across the table. There is no lie muscle in the face, it’s not that simple, but there are patterns you can look for. Obviously if the person is unusually anxious, if they show contempt, if there’s an unusual rhythm to how they’re emoting, if the emotions seem inappropriate to the conversation. There’s probably a half dozen little ways in which you can get a feel for whether the person is solid and honest, and therefore a loan risk worth taking, or ones that are passed on.
Kelly: These quantifiable and emotional metrics, I’m just going to quickly list them. Joy, and they’re more or less in a continuum here, starting with joy going down to anxiety. Joy, pleasure, satisfaction, acceptance, curiosity, alert, skepticism, dislike, contempt, frustration, sadness, anxiety. So you guys can measure these twelve emotional reactions that appear on a person’s face, convert those into a profile. The profile has to equal 100%, so it comes up with a profile. Again, back to the CEO that’s going to potentially do a loan to this business customer. It comes up with that profile and then what?
Dan: In our case we were trained directly by Dr. Ekman, so you are right. You get to a pool of 100%, so you distribute which emotions are occurring based on those muscle activities, and as to the output. Once you know the emotional profile of somebody, I would suggest, for instance, they index very high on anger, or what we call frustration, that should be of concern, because frustration obviously is an emotion about I want to hit you. I want to break through barriers to progress, I want to control my destiny. That all sounds good except the hit part, so someone who is violent or combustible, if they index high in frustration, is there a greater chance that someone is at risk? Definitely for you as a banker.
If they are really high on anxiety, why are they so anxious? What is going on here? How solid is the scheme in which the bank is taking a chance. I think particularly when you look at the negative emotions you’ve got to be careful, because we have more negative core emotions as human beings than positive ones, not because we’re negative or Dr. Ekman is negative, but rather it’s a survival technique. People hear bad news more loudly because it helps defend themselves.
You want to look at negative emotions like the two I just mentioned, also contempt. Frankly it often corresponds to a lack of honesty or a lack of connection back to you as a banker. If I had to highlight three, those are the one I would probably go to. Although I will say that someone who is overly happy, it’s a nice emotion in terms of it’s embracive, it’s accepting, but a really happy person can be sloppy with the details, so strangely enough, there, too, a banker might face a bit of a risk factor.
Kelly: You also have the external environment, for instance, that can influence a person’s behavior on that given day. Could be they just got in a fight with their wife that morning, or their favorite football team lost so they’re having a proverbial bad day. Especially if you have this human subjectively scoring this stuff. I’m intrigued by that, so you have some kind of de facto shrinks up there kind of ticking off, watching the video saying, “Oh look at that he frowned, we’re going to check off he dislikes this,” or “Look at her eyes. She looks a little sad, we’re going to mark her down a little bit for sadness.” It scares me a little bit that police interrogation might be using this.
Dan: Quite often that cat’s already out of the bag. Dr. Ekman has done training of the CIA and the FBI. We worked a bit with a company trying to automate facial coding for the TSA, so yes, this is a huge interest, obviously, to anyone involved with national security or policing matters. Whether it’s used properly, whether inaccurately, whether it’s done within the boundaries of the law. That’s really outside of our purview, that’s not how we’re trying to use facial coding, but there’s no doubt that obviously every angle of life people are looking for advantages and security, and because if you’ve never been lied to in your life, congratulations. Facial coding gets you past the lip service to behavior, to actions, as to how people respond based on what they reveal in their face. It’s going to be of interest to a lot of parties.
Kelly: From this data that these scores are measuring they are taking that data, and then scoring it. I’ve seen some stuff that talks about the big five model, ranging from extroversion, agreeableness, conscientiousness, openness, to neuroticism. Tell me about that.
Dan: I have ten US patents, most of them related to facial coding, and one of them does involve personnel. I have been at work for a few years now looking to see if we can come up with an emotional formula and algorithm so to speak, that can match these big five personality traits. I wouldn’t say we have anything definitive at this point, but I am making the effort because the one thing that bothers me about all manner of these self-reported psychology personality profiles is that it is self-reported. Self-report is a big problem.
People tell lies. Dr. Ekman has estimated the average person tells three lies per ten minutes of conversation, but the biggest lies in life are the ones we tell ourselves. I’m reasonable, but everyone else in this meeting is crazy, etc., etc. Self-reporting is rather dubious, and so yes, we are looking for a way around that to say that by picking up these muscle activities, which by the way, all have numbers to them, and I realize you might feel it’s subjective, but we’ve done coder reliability. We have been trained by Dr. Ekman, so we know which muscle movements correspond to which emotions. Studies would indicate that human coders well-trained and versed in doing this will be over 90% accurate.
Kelly: What would the goal be for this credit officer, he probably does this subconsciously anyway, but he certainly is making some judgements alright, how normal, how neurotic is this guy. Am I able to pry this data out of him and he’s in charge of sales? What’s the likelihood that this company is going to be successful if I have to pry this stuff out of him.” Same with openness, right. Agreeableness. I don’t know how you would determine conscientiousness. Does he show up to the meeting on time, and doesn’t care, I mean that’s kind of a real fuzzy one, that conscientiousness.
Dan: Actually that’s one of the traits where we have some of the inklings of an algorithm or a correspondence. You’re not going to want someone who is overly happy and blissful. I already mentioned that if you really index high in joy you tend to be a bit more of free thinker, which is great, but you can also be sloppy with the details, so that doesn’t square very well with conscientious.
Being hot-headed and having really intense anger doesn’t work, but actually the face shows eight different versions of anger, from slight annoyance to outrage. The lower grade versions of frustration can actually be helpful from a conscientiousness point of view, because one of the definitions or understandings of frustration is I want to be in control of my life and I want to make progress. If that is done in a way that is not overly combustible then you have the makings of someone who might indeed, if it’s leavened by some other emotions, be conscientious.
Kelly: Give me the three to five takeaways that a bank CEO should take from this.
Dan: One is they’re going to be making some outreach to people so let’s start on the marketing side. Presumably they’re going to have a website. It’s easy for someone inside the organization to think that their website is really clear, and I can tell you from doing usability tests for all sorts of companies on websites, that it’s often about as clear as mud. So I would say the first takeaway is they should think if their website a lot more like it’s the drive through lane of a fast food joint. That may seem demeaning to them, but these people know how at quick service restaurants to get it across to people and quickly and let them keep moving. If they look at their website from that perspective, and it doesn’t resonate, and it’s not quickly understandable, they’ve got a problem. The joke that has to be explained to you in life is never as funny as the joke you just get, so think in terms of hut, hut, hike. If the connection isn’t about that readily done, you’ve got a problem.
The second thing I would suggest is probably a lot of banks will at least, if nothing else, have some print ads or some mailers at times. We’ve discovered that if you put your company logo in the lower right hand corner which is where ad agencies love to put it, that is typically about the second to last place anybody will look at on a piece of paper. That’s bad news because we’ve found that people read quickly, they barely read at all. The banker, the CEOs, the bank may think that people are going to study my marketing material closely, read it word-by-word, not the case. Likelihood is they’re going to spend three to fifteen seconds on it. If you advertise for yourself and it’s unbranded in effect because they don’t get to the logo, then you’ve got a problem. I’d say that’s the second one.
Third one is you’re in the people business. If they come into the bank or the bank branches, we respond to nothing more strongly than other people. We can tell the difference, human beings. There is a difference between a true smile and a social smile. Social smile is clearly less authentic than the true smile. It is hard for employees to be able to manage a true smile repeatedly during the day, especially on demand, but knowing that that emotional connection with the customer is important. I sit on airplanes often for my business, and I facially code the people who are serving us in the isles, and look for those little moments where they give away weariness, or something else that’s a little off putting sometimes.
Dan: That’s three for you. I think we’ve already touched on the loan officer, so I’ve got you up to four. I guess the fifth one would be, frankly, who you hire, and taking a little more care. Not just look at their credentials, but look at their personality which is what Southwest Airlines does.
Kelly: What does Southwest airlines do, briefly?
Dan: They actually have their people look for a sense of humor. They ask them to tell little stories about themselves, or incidents, or I think even, if I’m not mistaken, at times literally play comedian for a bit, and try to tell a joke. They don’t want to hire somebody who’s just ultra serious and has no levity to them because if you have no levity you can’t be flexible, and if you can’t be flexible you can’t adjust to your customer’s needs.
Kelly: To that end, I’m going to ask you what’s the stupidest think you’ve ever said or done in your business career?
Dan: That would be numerous no doubt. I would say one is, someone asked me once if I was quote/unquote a “rebel” and that’s the way they phrased it. I simply said, “I suppose so.” That’s not the answer I should have given. The truth is I’m a reformer. I’m not interested in rebelling against something, I am interested in improving something. Whether it’s market research or in the financial sector, making sure your advertising dollar is not wasted, and that your customer service is better, I go back to my earlier quote. “There’s two currencies: dollars and emotions, and you need both of them and they interact with another.” I’m not a rebel, I’m a reformer and someone who is eager to make sure that people aren’t inefficient, don’t waste their money, make the best progress, the best connection they possibly can. If you step closer to the customer you can step ahead of the competition.
Kelly: And since you’re an English lit PhD, I’m going to see if you can identify it. If you can’t, I will think very lowly of you.
Dan: Wonderful, wonderful.
Kelly: “Arise and go now. I will arise and go now, and go to Innisfree.”
Dan: That would be Yates.
Kelly: Very good. He’s my favorite writer.
Dan: Yates is a tremendous poet. I was in Dublin a couple of years ago, there was special exhibit on Yates’ poetry, and I fell in love with all over again.
Kelly: Good for you. Now I’m uber impressed. Do you have a favorite quote?
Dan: I have so many favorite quotes. It’s probably one of them is from Groucho Marx, “Who are you going to believe, me or your own eyes?”
Kelly: Very good. Dan, I appreciate your time. CEO of Sensory Logic. How can people get hold of you?
Dan: We’ve got a website, of course. Sensory Logic.com should be able to do the trick

We want to thank you for listening to the syndicated audio program, BankBosun.com The audio content is produced by Kelly Coughlin, Chief Executive Officer of BankBosun, LLC; and syndicated by Seth Greene, Market Domination LLC, with the help of Kevin Boyle.

Video content is produced by The Guildmaster Studio, Keenan Bobson Boyle. The voice introduction is me, Karim Kronfli. The program is hosted by Kelly Coughlin.

If you like this program, please tell us. If you don’t, please tell us how we can improve it. Now, some disclaimers.

  Kelly is licensed with the Minnesota State Board of Accountancy as a Certified Public Accountant.   Kelly provides bank owned life insurance portfolio and nonqualified benefit services to banks across the United States.  The views expressed here are solely those of Kelly Coughlin and his guests in their private capacity and do not in any other way represent the views of any other agent, principal, employer, employee, vendor or supplier of Kelly Coughlin.  
May 6, 2016

Kelly Coughlin is interviwed by Chris Carlson. Chris is a lawyer and actor in Minneapolis and applies his Socratic method to extract from Kelly what the heck he is doing with BankBosun.

Kelly Coughlin is CEO of BankBosun, a management consulting firm helping bank C-Level Officers navigate risk and discover reward. He is the host of the syndicated audio podcast, BankBosun.com. Kelly brings over 25 years of experience with companies like PWC, Lloyds Bank, and Merrill Lynch. On the podcast Kelly interviews key executives in the banking ecosystem to provide bank C-Suite officers, risk management, technology, and investment ideas and solutions to help them navigate risks and discover rewards. And now your host, Kelly Coughlin.

Kelly: Hi, this is Kelly Coughlin. I’ve got my long-time friend Chris Carlson on the line. He’s CEO of Narrative Pros. Chris, are you there?

Chris: I am.

Kelly: Great. How are you doing?

Chris: I’m pretty good. How about you?

Kelly: I’m terrific. Chris and I were catching up. We haven’t talked with each other in a while, and we were catching up on what’s going on. Chris had a bunch of questions about what we’re doing at the Bank Bosun, and we thought, “Well, let’s turn this into a podcast.” Rather than me talking to Chris about what I’m doing, he’s going to ask me some questions so it will help him and the audience better understand what we’ve got going on. Chris I’m going to turn it over to you.

Chris: All right. Well, I think first up on the order of business is letting everyone else know a little bit more about who you are. I’ve known you for a while, but why don’t you let people know a little bit more about yourself.

Kelly: I’m 58, 4 daughters, 4 granddaughters, and I don’t know if you knew this, I have one grandson. Finally a male in the family.

Chris: Oh, congratulations! Finally!

Kelly: CPA. Went to Gonzaga University. My uncle is Father Bernard J. Coughlin who is President. Go Barney! He’s 92 now, and I always give him a shout-out when given the opportunity. I also got my MBA from Babson. Let’s see, I worked for PWC when it was Coopers and Lybrand, and then Lloyd’s Bank, CEO of an investment and financial technology company that I founded, managed, and sold. I don’t if I’ve touched base with you since I’ve started working with Equias Alliance as a risk consultant. They do bank-owned life insurance (BOLI) and non-qualified plan programs for banks. I don’t think we’ve really touched base since I started with them.

Chris: No. It’s interesting.

Kelly: Yes, it is.

Chris: Speaking of which, explain to me this BankBosun. Am I saying that right? I take it it’s a nautical term.

Kelly: Yeah. Technically, it’s spelled B-O-S-U-N on the website, BankBosun, but Bosun is actually spelled B-O-A-T-S-W-A-I-N, like boat swain, but it’s pronounced Bosun.

Chris: Okay.

Kelly: BankBosun, it’s a syndicated audio program, really, that’s designed to bring together executives all throughout the U.S. who are participating in what I call the bank ecosystem.

Chris: Wait. I’m not going to let off the hook here. What does a boatswain do?

Kelly: The captain of a ship needs help and guidance and support, so the boatswain helps the skipper, the captain of the ship, achieve its mission and purpose.

Chris: All right. Yeah, that’s a segue because I’m connecting the dots as we speak as I listen to you. BankBosun helps C-level execs in the way. Is that right?

Kelly: Yeah. That’s correct. We’re not dealing with ship captains. We’re dealing with bank officers, chief officers. It’s a clever play on the words C-officers, sea-level officers.

Chris: It is clever. It’s very punny. A lot of puns. That’s good though. It keeps the interest. I’m not going to let off the hook with the other fancy term which is banking ecosystem. An ecosystem, if I remember it, that’s like the jungle. Right? What do you mean by banking ecosystem?

Kelly: The jungle is one ecosystem, so technically it’s a biological community interacting within a set relationship among resources, habitats, and residents of the area. By this, I mean the residents of the banking community, so it’s all the residents of the banking community interacting among each other. The area is not defined as a physical definition like a pond or an ocean or a jungle. It’s defined as a business industry, and in this case, it’s the banking industry.

Chris: Sure. All right. What do they need? I mean, why them? I mean, given your background it makes sense.

Kelly: Why the banking ecosystem?

Chris: Yeah, why do they need particular help and why are you the one to help direct that assistance?

Kelly: Well, bankers are just fascinating, interesting people, aren’t they?

Chris: Yes, yes they are. They evidently need a lot of help.

Kelly: Well, I’ve been in the banking ecosystem, if we can keep using and then abusing and overusing that term, since I was 22. I started my career at Merrill in Seattle in the early 80’s selling mortgage-backed securities to the banks and credit unions. That was a good introduction to navigating this ecosystem. I would say that I learned a lot from that. Then I was consultant at PWC, and CEO of Lloyd’s at two asset management subsidiaries of Lloyd’s Bank, and then as a CEO of our financial technology company Global Bridge. Our primary market was banks, so I’ve been in this ecosystem, if you will, for many, many years, and I do find it interesting and fascinating. The 2008 crash, or melt down I should say, and several others that we’ve had in history, emphasize that banks are a foundation or bedrock of the economy. Frankly, they need all the help they can get. It’s good for the economy.

Chris: These bankers you’re trying to reach, I’m assuming you’re doing it through these podcasts and other high-tech, and you’re pretty comfortable that they’ll be able to get the help they need through that and not be put off by it? It’s a good way to reach them?

Kelly: Well, it’s certainly is not something that historically they’re used to and comfortable with. Historically it’s been print media, download reports, print them, stick them in your briefcase, read them when you can. Half the time you don’t read them, or if you do, you read them on the airplane and then chuck them. It’s not something that they’re used to right now, but I know as a CEO of a couple of companies in my past, that we pulled in so many different directions from different constituents whether it be board members or key customers or regulators, employees, suppliers, consultants, accountants, everybody is pulling at us and yanking at our time.

CEO’s, generally, and CFO’s, but C-level execs, they need to extract value from all these different sources of information efficiently and effectively. I really am a proponent of the multitasking concept, so the idea was, “Let’s give them some good information, bring together this ecosystem, give them some good information but in a way that they can do other things.”

Kelly: Frankly, we’re right in the middle of sporting season, football season and the World Series. I was actually down in Kansas City for the World Series. That was fun. The commercials are ridiculous in these sporting events especially football, so I figured out a way to multitask during these games. Certainly during football games you can read if you want, but also you can listen and learn too. CEO’s, you run your own company. You got a million things going on. Right? You’ve got to figure out a way to maximize the return off of that.

Chris: Absolutely. Yeah. You said earlier that you think that it’s a time when banks have a greater challenge than they’ve had in the past, and with your nautical-themed assistance, give me a sense of why now is a particularly challenging time for banks and how you’re going to be able to help us.

Kelly: Well, I like the nautical theme for the Bank Bosun. I’ve sailed for many years. I’ve lived in Seattle in the 80’s. To me skippering a boat was, where you have a lot of moving parts and people and weather and tides and currents and rocks and other boats to deal with and coast guard, the regulator, and it really served as a great metaphor for running a business, but especially a bank. I think any executive that’s been in charge of a boat knows exactly what I mean about that. When you’re out sailing in the Puget Sound or the ocean, you use whatever tools and information you can muster up to get you and your crew and your boat to the next point. There are no guide posts. There are no signs. You have to watch weather, currents, tides, all that kind of stuff. All of those principles apply to skippering a company, but especially a bank.

Chris: That makes sense. You sold me on the metaphor.

Kelly: Good.

Chris: Tell me more about where you’re at right now and what the connection is with your Bank Bosun. Are they okay with this new gig? How do they relate?

Kelly: Well, Equias is in the bank-owned life insurance space. BOLI is the acronym for that. I came across Equias and the BOLI industry when I was working on a management consulting project. I didn’t know anything about the industry or the product at that time, but after I finished the engagement I thought, “Man, I need to get into this space,” because I love the asset class, if you will. Frankly, it’s an alternative investment for banks’ portfolios. Now, it has to be surrounded by insurance and you have to make sure that insurance is a key part of it, but at the end of the day, it’s a phenomenal asset class. It transfers balance sheet risk. You get a higher return than treasuries, than municipal bonds, and that sort of thing, but I really do like the asset class. Then it has some benefits for funding non-qualified plans.

The thing that I liked about it is it reminded me of my early Merrill Lynch days selling mortgage backed securities. At the time, mortgage backed securities were a new, innovative product. They had a few more moving parts involved, and it required me to simplify the value proposition. You really need to focus on the benefits, which everybody needs to do in any business. With any product, you’ve got to focus on the benefits. I always think of the line, “People don’t want a quarter-inch drill. They want a quarter-inch hole.” Now this is, at the end of the day, a life insurance product. I also love the line by Woody Allen, “I tried to commit suicide one day by inhaling next to an insurance salesman.” There’s always some inherent bias against that. My father sold insurance, and I told that to him when I was about 22 or something. He didn’t find it that funny actually. I find it funny.

Chris: It is funny. It’s a funny line.

Kelly: Yeah, it is.

Chris: It’s funny because the word inhaling is funny.

Kelly: You’re going to probably offend somebody.

Chris: Probably, but that’s not your target market.

Kelly: They’re my colleagues.

Chris: Your friends, as it were. Speaking of friends, I haven’t wished you, my friend, a Happy New Year. We’re about a year into it here, and you see all these lists coming out, top movies, top TV shows. Why don’t you give me the top three initiatives for, BOLI, or for the banking ecosystem?

Kelly: Okay.

Chris: Pick your field.

Kelly: Well, I certainly have three, but I’m not going to tell you two of them because I wouldn’t want to tip off our competitors onto what I’ve got up my proverbial sleeve.

Chris: Okay.

Kelly: Stay tuned. News at 5.

Chris: That’s right.

Kelly: Let me hear your sales voice say that.

Chris: News at 5. Now it’s, News in 5 seconds. I asked you for the top three initiatives for 2016 and you said that you’ll give me one.

Kelly: I’ll give you one.

Chris: It’s called negotiating?

Kelly: Yeah.

Chris: Okay.

Kelly: The one that I’m intrigued by is a confluence of two things. One is cyber security risk.

Chris: All right.

Kelly: The other is risk transference of that risk. I want to explore whether it makes sense to pursue a captive insurance program for banks to underwrite cyber security risk. Setup a collective or a community to do that. I think it’s being mispriced now by insurance companies because they haven’t really identified the risk. They haven’t really identified how big the risk is, how to mitigate the risk, and then how to price it. Anytime you have unknowns like that, especially in insurance, you get over, mispricing, I should say. That’s something that intrigues me.

Chris: Yeah, it makes sense.

Kelly: Yeah. The other two I’m not going to tell you about.

Chris: Perfect! In the acting business, we call this dramatic tension, which you’ve done a good job of creating.

Kelly: Thanks!

Chris: Well it sounds interesting. It’s good stuff.

We want to thank you for listening to the syndicated audio program, BankBosun.com The audio content is produced by Kelly Coughlin, Chief Executive Officer of BankBosun, LLC; and syndicated by Seth Greene, Market Domination LLC, with the help of Kevin Boyle.

Video content is produced by The Guildmaster Studio, Keenan Bobson Boyle. The voice introduction is me, Karim Kronfli. The program is hosted by Kelly Coughlin.

If you like this program, please tell us. If you don’t, please tell us how we can improve it. Now, some disclaimers

  Kelly is licensed with the Minnesota State Board of Accountancy as a Certified Public Accountant.   Kelly provides bank owned life insurance portfolio and nonqualified benefit services to banks across the United States.  The views expressed here are solely those of Kelly Coughlin and his guests in their private capacity and do not in any other way represent the views of any other agent, principal, employer, employee, vendor or supplier of Kelly Coughlin.  

 

May 6, 2016

Kelly talks to Chris Carlson, CEO, Narrative Pros, about what business leaders can learn from a stage and theater actor about presentations to small and large audiences.

 

Kelly Coughlin is CEO of BankBosun, a management consulting firm helping bank C-Level Officers navigate risk and discover reward. He is the host of the syndicated audio podcast, BankBosun.com. Kelly brings over 25 years of experience with companies like PWC, Lloyds Bank, and Merrill Lynch. On the podcast Kelly interviews key executives in the banking ecosystem to provide bank C-Suite officers, risk management, technology, and investment ideas and solutions to help them navigate risks and discover rewards. And now your host, Kelly Coughlin.
Kelly: I’ve got my friend Chris Carlson CEO of NarrativePros on the line, Chris are you there?
Chris: I’m here.
Kelly: Great, Chris and I have known each other for many, many years. Chris is an actor at the Guthrie Theater in Minneapolis He’s also a lawyer and an entrepreneur, and I’m a big fun of his. Listeners are saying, why does he have a starving actor, lawyer on here? Before we get to your connection in to the banking ecosystem. A little bit of personal background.
Chris: Minnesota residence, most of my life, three kids, I’m 46. I’ve been, as I said earlier acting professionally for 22 years. I’ve been an attorney for about as long.
Kelly: Well let’s get into why I have you on BankBosun and your connection to the banking echo system. If you recall, I asked you to give a talk at a conference my company was hosting for banks and investment managers. I think we had like six or seven speakers there over a two day period, probably eight or nine I suppose. You got the highest rankings of anybody in terms of popularity. Tell me why you think that happened and what your value proposition, if you will, to the banking industry is. What was it that resonated with these bankers in that message?
Chris: Absolutely, and I to think to answer as many of those question as efficiently as I can, it has to do with the value of genuine connections between individuals, whether that’s one on one or one to many, or many to one. The expertise that I have amassed over the years, is to how to efficiently create that. How to make that efficient, how to maximize the feedback that you get from any communication.
Kelly: What does that really mean?
Chris: Let me give you an example, bankers are smart guys. They tend to live in their heads when it comes to ideas. They believe if they have a great piece of advice, that that’s the end of their value. That I tell you to invest in stock A, because that will help you. But the real world has as much to do about that conversation and whether or not you say invest in stock A, in a way that is meaningful, whether it makes sense to them. Whether you’re rude, whether you’re cold or indifferent. The value of advice when it’s person to person, which is at the center of any banking relationship, depends on the connection between two people. It’s not whether or not I like you necessarily, but it’s I have to trust you. I have to respect you. I have to understand you absolutely. It has as much to do about that as anything.
Kelly: How I perceive you or how a customer perceives a banker. Not necessarily how he really is.
Chris: Well actually I would say that the goal is to have them perceive you as you really are, and we are many different people to many different audiences. You yourself are a father, a friend, a boxer. You will behave differently in the ring than with a client. What you need to do is harness what will be of the most value, and make the strongest connection with the audience that you’re in front of. That has to come from somewhere that’s true. One of the things that people often mistake is that acting is fake, and it actually has all to do with truth. If you see a good actor, you get them, you buy them, you connect with them. If you see a bad actor, you absolutely reject them. You don’t get it. It’s not real.
Kelly: I think what you’re saying is that you learned this in your acting career. And as a lawyer, you practice this. But you learned this through your acting training to be real. Two scenarios, one is making a one on one presentation, and another is giving a talk to 20 people. What does your advice do in those two scenarios?
Chris: My advice hopefully will encourage people to understand that their impact on their audience, whether it’s one person or 20 people, has more to do with how they say their message, and how they’re able to let people connect with them as real individuals. How they’re able to be themselves in a very genuine and authentic way, and then share the advice that they have. Far too often people, I call them left brain professionals. People who think a lot will sit in front of their computer and work on their outline in their PowerPoint and then get up and give it, without really spending much time on whether or not they’re giving it in a way that incorporates who they are. I think you, Kelly, are a good example of an effective delivery. That’s you, when I hear you talking, that’s the same Kelly that I hear when I’m having a conversation with in the coffee shop. People are drawn to that.
For a banker to have an interaction with somebody, the more genuine they can be, the more that they can focus on that individual as a human being, and also share with them, themselves as a human being. That will make the advice that they give, that much more meaningful and valuable. In many ways it’s the same thing when they stand up in front of 20 people. It‘s genuine and real and to a degree vulnerable. That has a lot to do with fear that is natural, standing in front of a group of people or a high pressure sale. Anyway that you can wrestle that fear, and you kind of say look, “This is me, and this is what I have to say and I think it would be great if you used it, or bought, but if you don’t I understand.”
That’s incredibly attractive for people to be around that kind of energy versus, “Look you really got to buy this and it’s really important to me. I don’t know what I’m going to do if you don’t, if you don’t buy this, if you don’t listen to me.” Even though it is important what the person thinks about you, or whether or not they take your advice or buy it. Showing that, gets in the way of who you are and their comfort quite honestly.
Kelly: Give me a couple of takeaways that relate to preparing for a presentation and then three or four related to the actual presentation itself, beginning, middle and end that kind of thing. We’ve got some real solid takeaways, I can put some guiding principles here.
Chris: Let’s start with the content, that’s where everyone’s comfort is, and most people will spend 100% of their preparation time working on their PowerPoint slides, and you definitely have to work on some kind of presentation, outline and some visuals do help. Number one, when it comes to the visuals, speaker support, PowerPoint, I would work as hard as you can to get rid of all the words quite honestly and just focus on graphs and charts, and pictures or visual creatures. There is a huge disconnect when somebody puts up a bunch of words on a slide, and reads them, or makes the audience read them. It’s just counterproductive and disingenuous to a live environment. You as the speaker need to be considered to be value bringer and you have to explain these things.
I would say as few words as possible on any kind of visual support. The content in what someone says, you should outline in bullet points, words or phrases, but not in complete sentences. Don’t lock yourself into phrasing them, in any particular way. Let yourself react to those ideas and explain them, and that’s come off and it’s very authentic and genuine.
Kelly: No words on slides.
Chris: No words on slides. I would join the audience in cheering if I were to see less words on slides. It’s easy to do, and I think it’s actually fear. People are insecure and they’re like, ”Ah, I got to put all these words on here.” Well take the words off and say the words to people.
Kelly: No words on the slide, that’s number one. What was number two?
Chris: Number two outline your points in a way that you can speak to them in a genuine way instead, for example, I have been involved in the banking ecosystem since I was 22. Instead of writing that out and then reading it, you might just have something that says 22. You look at it and you say, “Ever since I was 22, I’ve been working in banking.” Let those words, let you work through the thoughts, so that the words come to you at that time. You have to have good notes but it will force you to pick the words authentically and people will hear that. That’s number two. Number three is when you pick these ideas and when you explain them, pretend you’re explaining them to your 92 year old father, or your grandma next door.
In other words avoid jargon, you’ve got to be simple, direct and accessible, and I think that people who work in the idea profession tend to be complicated, inaccessible and you always want to be as clear as possible. Simplicity is not easy, it’s very difficult and working on that simplicity is an incredible investment in giving your audiences, who’s paying attention, a return of interest. They will appreciate you, summarizing things very simply and to button this third point off. Work very hard to summarize the single point that you have to make in one sentence.
Imagine that your audience is walking out the door, and they don’t have time to hear your whole speech, what would be the one thing you would want to tell them. If you complain, oh no it’s too complicated, it can’t be distilled into one sentence, I would say to you that your audience is doing that anyways. After they walk out, someone’s going to say, “What did Kelly Coughlin talk about?” “Oh, Kelly is working on this cool BankBosun thing, that it’s needed, it helps out C-suite Executives in the banking industry.” They’re summarizing what you’re saying anyways. If you jump into their shoes and try to say all right, “What is the one takeaway from this? You’re going to help them do that.
Kelly: That’s good, I recall again from that conference you spoke at. There was some prep work that you recommended.
Chris: Sure, let me focus on one of them. A lot of acting technique or approach is focused on combating the nerves and stress of performing. That we appear, genuine, authentic relaxed. One of the truths of performing in front of a bunch of people is that you are nervous. It’s human, so what we want to do is make sure that we find another truth to counteract that. The best counter measure to stress is breathing. When we’re with our friends, or when we’re relaxed, or when we’re uncomfortable and not threatened, the human being breathes from the belly, they use … we use our diaphragm to pull in breath, and when you’re very relaxed, and actually if you watch your kids when they’re sleeping, you’ll see their stomachs go up and down.
Now their stomachs are going up and down because the diaphragm is pulling in breath. When we’re nervous we tend not to breath from our diaphragm, our belly, we tend to take shallow breathes and it makes us more nervous and it changes our voice. Someone who’s really relaxed would sound like this, but if they were breathing … their voice goes up a little bit, and it gets a little breathy, and it’s just not as grounded. We can hear that, we feel that someone has a breathiness to their voice and it’s a little higher in pitch, but if you take a breath, and breathe from your diaphragm, not only does the pitch go down, but you can also project your voice further. You can talk louder.
So breathing, putting your hand on your stomach and trying to train yourself to breathe so that your stomach flops out when you breathe in, is one of the most effective counter measures to stress and to get you back into yourself, to being a relaxed confident genuine person.
Kelly: Let’s talk about, what are kind of some of the deal killers out there. The absolute be cognizant that you don’t do this.
Chris: We’ve already touched on some them. These things would be anything that disconnect you from your audience; that separate you from them. For example, number one, the minute you start reading off of the slide, you’re not being in front of an audience genuinely. You’ve turned towards the screen, you’re reading something that everyone else is perfectly capable of reading. I mean that’s just a fundamental disconnect with one audience. “Hey buddy, I can see the slide and you’re reading it for me and it doesn’t make any sense.” Another one would be reading your speech which is very similar, and that’s telling the audience, “I’m not going to talk with you. I’m not going to share with you my ideas, I’m going to read what I wrote, and you’re going to listen to it.” At which point the audience feel like, well why don’t you just give me them for the reading, so that I can read it.
Something that’s kind of fun, that I’ve uncovered, is that the average person speaks at about 150 words a minute. We can understand and we think at about 800 words a minute. That means that there is an attention gap. Every time someone starts talking over a couple of 100 words, where my mind is running circles around what you’re telling me. You always have to participate in that because if you don’t, if you don’t give them something to think about that is helping you, they’re going to think about something else.
Kelly: Well don’t the non-verbal clues fill that void to a certain extent?
Chris: They can, or they cut against it. Something that I was just doing some research on, hand gestures and body gestures. It’s fascinating, the neuro-scientists have studied it, and we use specifically our hands to make gestures, to help us think of a word, and so if we’re genuinely using our hands it’s because we’re trying to think of how to say something, but if you want someone who has prepared a hand gesture like a politician or a bad speaker. The hand gesture comes at or after what they’re trying to say, not before. In the real world, the hand gesture comes a little bit before what it is that they have to say. That’s what the hand gesture is for. When someone plans it, when someone says, “I think it would be good if I moved my hand like this.” They tend to do it in a way that’s very disconnected and fake, because we can tell that. Instinctively, they do it as you’re saying the word or phrase, or after it.
That’s an example of another disconnection with an audience where they get the sense, and it’s an unconscious sense, it’s not, “My, he moved his hands in a way that was not matching with the phrase. Therefore I think he’s fake.” We’re not aware of that consciously but unconsciously we think to ourselves, “Wow this guy is a … he’s a fake, he’s not being real with us.” It’s very common.
Kelly: Tell me about what should people do with their hands as a default, and then how should we stand? One foot, two feet, hands in the pocket, hands by the side? Give us a couple of ideas on that.
Chris: It’s hard to do, but you forget about your hands. Don’t plan any gestures, let your hands go. Just like I was suggesting with your words to jot a note, and then let the specific words you use to express that idea come out in that moment. The same thing should be with your hands. Let your hands make whatever gesture. If you’re an Italian, outspoken hand gesturing person, that’s what you have to do.
Kelly: Even if it’s a distraction I’ve been to talks where somebody will be using their hands, you end up following their hands the whole time.
Chris: I would say to you that hands gestures become distracting when they’re not connected with what they’re saying. If they’re connected with what they’re saying, you’re not even going to notice them. You become attracted when they’re not connected. If someone has a non-verbal tick, if they’re just moving their hands and it has no connection with what they’re saying, yes it becomes repetitive and it’s a distraction. It’s just like someone who says, has a verbal tick and says um, um all the time and it’s distracting because it’s getting in the way of um, um what you’re trying to say.
Kelly: What about movement on the stage?
Chris: Less is more, when you start moving around, there’s a huge temptation because of nerves, the sympathetic nervous system, the fight or flight reaction kicks in, and people want to move and I see this so frequently with inexperienced presenters. They’ll start wondering around the stage, or they’ll shift away back and forth on their feet, and that is not connected with anything they’re saying 90% of the time…99. They’re just moving because they’re full of adrenaline and they feel like they should move. But, if it’s not connected with what they’re saying, it is inherently destructive. Why is someone pacing back and forth on the stage?
It’s funny because I’ll get push back on that, people will say, “Well I’m trying to be more interesting and dynamic on the stage.” I have no problem with being interesting and dynamic, I have a problem, if it’s not connected with what you’re saying. When in doubt, you need to practice standing still because you’re going to want to move. Move if there’s a reason, move if it makes sense. For example, if you’re separating a point. In the first situation, the FED needs to do XYZ and I’m going to talk about this for a while. In the second situation, and then you can move on that, that might make sense. That’s an example, but that requires practice and planning. So I always recommend that people just stand still.
Kelly: Do you prefer microphone that is attached to you versus attached to a podium, because you’re kind of stuck and glued to the podium, but is that your preference?
Chris: Yes, a lapel or lavalier microphone allows you to forget about the microphone and that’s what you need to do with a majority of the technology that’s helping support you. Some microphone on a podium tends to trap you behind the podium, which is bad for a number of reasons. You have a temptation to lean on the podium, you’re blocked and a lot of your body language from the audience. You might have more of a tendency to look down. A lavalier microphones will allow you to just take one step to the right or left of the podium, and to find a comfortable position in front of the audience and be accessible.
Kelly: That’s terrific, I appreciate that. Chris do you have a favorite quote to finish off here? I always like to get one
Chris: Any good quote.
Kelly: Good quotes.
Chris: Good quotes. “In law, what place are tainted in corrupt but being seasoned with a gracious voice obscures the show of evil.”
Kelly: Good one, Chris I appreciate your time on this, and good luck to you with NarrativePros, and we’ll be in touch. Anybody wants to contact Chris, feel free, Narrativepros.com, is that the website?
Chris: That’s it.
Kelly: Thanks Chris

We want to thank you for listening to the syndicated audio program, BankBosun.com The audio content is produced by Kelly Coughlin, Chief Executive Officer of BankBosun, LLC; and syndicated by Seth Greene, Market Domination LLC, with the help of Kevin Boyle.

Video content is produced by The Guildmaster Studio, Keenan Bobson Boyle. The voice introduction is me, Karim Kronfli. The program is hosted by Kelly Coughlin.

If you like this program, please tell us. If you don’t, please tell us how we can improve it. Now, some disclaimers.

  Kelly is licensed with the Minnesota State Board of Accountancy as a Certified Public Accountant.   Kelly provides bank owned life insurance portfolio and nonqualified benefit services to banks across the United States.  The views expressed here are solely those of Kelly Coughlin and his guests in their private capacity and do not in any other way represent the views of any other agent, principal, employer, employee, vendor or supplier of Kelly Coughlin.  

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