How to Create Strategic Value in the Current Environment | AOBA 2017

How to Create Strategic Valuein the Current Environment

Acquire or Be Acquired ConferenceJanuary 30, 2017 | Phoenix, Arizona

Andy Gibbs Chris NicholsJay Wilson CenterState Bank

MERCER CAPITAL

About the Presenters

How to Create Strategic Value in the Current Environment // © 2017 Mercer Capital 2

Andrew K. Gibbs, CFA, CPA/ABVMercer Capital

Senior Vice [email protected]

901.322.9726

Jay D. Wilson, Jr., CFA, ASA, CBAMercer CapitalVice President

[email protected]

Chris NicholsCenterState Bank

Chief Strategy [email protected]

925.202.8944

Chris Nichols is the Chief Strategy Officer for CenterState Bank, a $5 billion, publicly traded Florida bank. As Chief Strategy Officer, Chris specializes in predictive analytics, marketing, pricing, technology/innovation, risk management and creating superior bank performance.

Chris has 25+ years of banking experience, is an active bank investor, small business owner, banking school instructor, a frequent speaker and author on a multitude of banking topics including his new book the Successful Lender’s Field Guide. In addition, Chris is producer and host to a weekly podcast show on iTunes called Bank To Bank.

Jay Wilson, Vice President, is a senior member of Mercer Capital’s Depository Institutions practice. Jay also leads Mercer Capital’s Financial Technology industry team and publishes research related to the FinTech industry. He is also the author of the upcoming book, Creating Strategic Value through Financial Technology (Wiley Finance Series, Summer 2017).

Jay’s practice involves in the valuation of depository institutions and FinTech companies for purposes including ESOPs, mergers and acquisitions, profit sharing plans, estate and gift tax planning, compliance matters, and corporate planning.

Andrew Gibbs leads Mercer Capital’s Depository Institutions Group. Andy provides valuation and corporate advisory services to financial institutions for purposes including mergers and acquisitions, employee stock ownership plans, profit sharing plans, estate and gift tax planning and compliance matters, corporate planning and reorganizations. He also works with financial institutions in merger and acquisition advisory engagements.

In addition, Andy is a frequent speaker on topics related to community bank valuation and co-authored several books.

Outline of Today’s Presentation

Community Banks Are Facing Challenging Market Conditions

Why Do Large Banks Outperform? Is There Any Hope?

How FinTech Can Help Create Strategic Value

How Banks Can Develop a FinTech Framework

Bank and FinTech Case Studies

Conclusion / Questions


Community Banks Are Facing Challenging Conditions

Community Banks Are: Not Earning Their Cost Of Capital…


Source: Mercer Capital Research and S&P Global Market Intelligence

Declining in Number…


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94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 9/16

# of Banks Overview of U.S. Banks

Assets >$10B Assets $1B-$10B Assets $100-$1BN Assets <$100M Source: QBPR, www.fdic.gov

Facing Elevated Regulatory Burdens…


Call Reports Are Significantly Longer • < 10 Pages up until the mid-1980s • Today > 80 pages

Sharp increase in both the number of new banking acts and the length of those acts in each decade since the 1960s

• From 2001–2010, there were 10 new banking acts that became law and totaled approximately 2,000 pages of new legislation

Hiring additional staff to handle this growing regulatory and compliance burden can have a significant impact on bank profitability

• Feldman, Schmidt, and Heinecke (2013) at the Federal Reserve Bank of Minneapolis found a reduction in profitability of 45 basis points for increasing staff by two people for smallest banks (less then $50 million in assets)

Source: First Two Bullet Points http://mail1.dallasfed.org/assets/documents/banking/firm/fi/2015/fi1504.pdLast Bullet Point “Quantifying the Costs of Additional Regulation on Community Banks,” by Ron J. Feldman, Jason Schmidt, and Ken Heinecke, Economic Policy Paper 13-3, Federal Reserve Bank of Minneapolis, May 30, 2013.

Developing Greater Concentration Risk…


Source: Mercer Capital Research and S&P Global Market Intelligence

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Real Estate Loans Commercial / Industrial Loans Agricultural Production Loans Consumer Loans Leases / Other Loans


Source: CB Insights https://www.cbinsights.com/blog/disrupting-banking-fintech-startups/

Facing More Competition from Non-Banks…

Losing Market Share to Larger Banks, and…


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94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

% of Total Assets Overview of U.S. Banks

Assets >$10B Assets $1B-$10B Assets $100-$1BN Assets <$100M Source: QBPR, www.fdic.gov

Less Profitable Than Larger Banks


Source: Mercer Capital Research and S&P Global Market Intelligence | Big Banks are Assets Greater than $5BN and Community Banks are $100M-$5BN

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Bank Profitability Trends Return on Assets

Big Banks vs. Community Banks

Big Bank Median Small Bank Median

Why Do Large Banks Outperform?Is There Any Hope?

Community Banks Tend to Have Higher Net Interest Margins and…

Why Do Large Banks Outperform?



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Lower Provisions (i.e., Higher Credit Quality) Than Larger Banks



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Large Banks Outperform Small Banks Primarily Due to Greater Non-interest Income and…

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Lower Efficiency Ratios Than Community Banks



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Efficiency Ratio - Big Bks Efficiency Ratio Comm. Bks



Is There Any Hope?


Many FinTech companies are focused on areas where community banks have historically underperformed: efficiency and non-interest revenues…

What About FinTech?

Source: “The Future of Financial Services and Technology Explained,” BI Intelligence, April 7, 2016 http://www.businessinsider.com/fintech-ecosystem-financial-technology-explained-2016-3




What is FinTech?A number of definitions exist but consider the following:• First applied to back-end software of established financial institutions• More recently expanded to include any technological innovation in finance• My definition is: Companies that use technology to provide financial services to customers either

directly or through partnerships with traditional financial institutions

How many FinTech companies are there?Reports vary in a number of publications and it is growing daily • Per McKinsey: 12,000 FinTech companies worldwide as of August 2015• Per AngelList:

• 1,887 FinTech Startups with an average valuation of $4.8 million• 2,469 Payments Startups with an average valuation of $4.1 million• 1,525 Mobile Payments Startups with an average valuation of $4.5 million

Enhance Customer Satisfaction…



FinTech equals the Great Equalizer

We cannot hope to compete with a mega-bank’s branch footprint, but we can compete against their innovation

Some Reasons for Bank Innovation:• Cut costs• Increase Revenue• Increase Engagement• Lengthen lifetime value / retention• Capture imagination / leadership

Source: Crossroads Banking & FinTech Conference, April 2016Chris Nichols, CenterState Bank



FinTech Investment vs. Branch Build – Traditional Strategy

Comparing FinTech Investment vs. Branch Build Decision

Branch Cost Online / Mobile CostTo Build (2) $750,000 To Build (2) $650,000

To Maintain $949,000 To Maintain $324,000

To Serve 2,500 To Serve 23,000

Cost Per Customer $390/Yr Cost Per Customer $20/Yr

Engagement 24/Yr Engagement 122/Yr

(1) Online Mobile: Online banking, bill pay, geolocation, payments, alerts,

specialty apps

(2) Depreciation: 30 years for building / 5 years for online/mobile Source: Crossroads Banking & FinTech Conference, April 2016Chris Nichols, CenterState Bank



Lowering Expenses…

Source: Crossroads Banking & FinTech Conference, April 2016, Chris Nichols, CenterState Bank



Improve Profitability… Trad'l Comm. Bank

FinTech Comm. Bank

Net Interest Income 36,000 36,000 Non-Int't Income 10,000 12,500 Non-Int't Operating Expenses (31,050) (30,313) Pre-Tax, Pre-Provision Inc. 14,950 18,188 Provision Expenses (2,160) (2,160) Pre-Tax Inc. 12,790 16,028 Taxes (4,477) (5,610) Net Income $8,314 $10,418

ROAA 0.83% 1.04%ROTE 9.24% 11.58%

Avg. Equity 90,000 90,000 Avg. Loans 720,000 720,000 Avg. Earning Assets 900,000 900,000 Avg. Assets 1,000,000 1,000,000

Net Int't Margin 4.00% 4.00%Non-Int't Inc./Avg. Assets 1.00% 1.25%Efficiency Ratio 67.50% 62.50%Provision Exp. / Avg. Loans 0.30% 0.30%



Valuation Multiple Expansion…

Banks with higher levels of non-interest income and efficiency are more profitable and receive higher valuation multiples (Holding asset size constant)

Price /Price / Tangible

LTM Core Book CorePublic Banks (Assets between $500M-$1BN) EPS Value ROATCENational Banks: Assets $500M - $1B 13.4x 1.02x 8.36%High Non-Int't Income Banks: Assets $500M - $1BN* 14.2x 1.18x 9.47%Low Efficiency Ratio Banks: Assets $500M - $1BN** 13.7x 1.19x 9.23%

Source: S&P Global Market Intelligence

Market Pricing Information as of 6.30.2016

* Non-Interest Income / Assets > 1% in LTM Period

** Efficiency Ratio < 60% in LTM Period



Creating Strategic Value for Shareholders…

Implied Fin'l Performance Price to Earnings MultipleNet Income ROAA ROTE 10.0 12.5 15.0 17.57,000 0.70% 7.78% 70,000 87,500 105,000 122,500

Trad'l Bk 8,000 0.80% 8.89% 80,000 100,000 120,000 140,000

9,000 0.90% 10.00% 90,000 112,500 135,000 157,500

FinTech Bk 10,000 1.00% 11.11% 100,000 125,000 150,000 175,000

11,000 1.10% 12.22% 110,000 137,500 165,000 192,500

How Banks Can Develop a FinTech Framework

FinTech Framework


1. Determine the FinTech niche to pursue further

2. Identify potential FinTech companies/partners

3. Develop a business case with estimated Internal Rates of Return (IRRs)

• Examine Build, Partner (And Possibly Invest) Strategic Decision

4. Execute strategy and compare IRRs from FinTech strategies to traditional strategies

Step 1. Identify Attractive FinTech Niches


Key objectives from Bank’s strategic plan:

• Grow and diversify revenue base in less capital intensive businesses, particularly non-interest income

• Customer surveys indicate an interest in providing more financial and wealth management solutions

• Would like to create an additional touch point with customers

• However, historically haven’t been able to attract traditional asset managers/RIAs to the bank due to cultural differences

• Bank would like to explore robo-advisory offerings further



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Key Takeaway’s From Robo-Advisory Industry Trends• Lot of interest in sector with VC funding up from non-existent levels to hundreds of

millions annually in last few years• Noted as the FinTech innovation most likely to have the greatest impact on the

financial services industry in the short-term (one year) and medium-term (five years) by CFA Institute

Key Advantages Over Traditional Wealth Management Services Include:• Low Cost• Accessible• Personalized Strategies• Transparent• Convenient



Robo-advisors are separated into three tiers

1. Tier I consists of early robo-advisory firms who have positioned themselves at the top of the industry.

2. Tier II consists of more recent robo-advisory startups that are experiencing rapid growth and are ripe for partnership.

3. Tier III consists of robo-advisory services of traditional players who have decided to build and run their own technology in-house

Step 2. Identify Attractive FinTech Companies

Step 3. Develop a Business Case


Once the FinTech niche and target companies are identified, there are a number of strategic options to consider

Each has varying degrees of commitment

Key question is often: Should we build, buy, or partner (and possibly make an investment)?

One way to answer that question is to look at potential returns from each strategy and compare

IRR Comparisons of Different Approaches



FinTech Partnership (Licensing) Initial Year 1 Year 2 Year 3 Year 4 Year 5

Cost Outlay (100,000) (275,000) (275,000) (275,000) (275,000) (275,000)

Revenue Enhancement 300,000 306,000 312,120 318,362 324,730 Total Cash Flows (100,000) 25,000 31,000 37,120 43,362 49,730

Internal Rate of Return 22%

FinTech Partnership + Minority Invt't. Initial Year 1 Year 2 Year 3 Year 4 Year 5

Cost Outlay (100,000) (250,000) (250,000) (250,000) (250,000) (250,000) Equity Investment (1,000,000) IPO / Sale Proceeds 4,000,000Revenue Enhancement 300,000 300,000 300,000 300,000 300,000 Total Cash Flows (1,100,000) 50,000 50,000 50,000 50,000 4,050,000


FinTech (Full Acquisition)

Internal Rate of Return (Full Acquisition) Closing Year 1 Year 2 Year 3 Year 4 Year 5Deal Consideration (25,000,000) Closing Costs (2,000,000)Opportunity Cost of Cash (1,000,000) (1,000,000) (1,000,000) (1,000,000) (1,000,000) Cash Flows Generated from Target 0 1,000,000 2,000,000 3,000,000 4,000,000 Terminal Value 60,000,000 Total Cash Flows (27,000,000) (1,000,000) 0 1,000,000 2,000,000 63,000,000




IRR Comparisons of Different Approaches

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FinTech Analysis Partner vs. Investor vs. Acquirer

Step 4. Execute Strategy and Compare FinTech vs. Traditional Strategies


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FinTech Build? Partner?

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Bank Growth

Some Common Challenges with FinTech for Banks Include:

FinTech Can Be Challenging Though


Vast array of start-ups to consider

FinTech acquisitions/investments can be difficult to consider and structure

• Valuations of FinTech companies can be challenging and significantly different from traditional bank valuations

• FinTech acquisitions can result in goodwill creation

Is the bank comfortable with the risk profile of the FinTech company?

What will the regulatory reaction be?

Is the partnership consistent with the bank’s long-term plan?

FinTech Case Studies

How Are Banks Approaching FinTech?


Source: “The Future of Financial Services and Technology Explained,” by BI Intelligence, April 7, 2016, http://www.businessinsider.com/fintech-ecosystem-financial-technology-explained-2016-3

How Are Banks Approaching FinTech?


Source: Crossroads Banking & FinTech Conference, April 2016Chris Nichols, CenterState Bank

FinTech Case Studies –Build Strategy


Some traditional financial services companies have elected to build their own robo-advisory offering

Examples of those who elected to build or are in the process of building their own robo-advisory platform include: Schwab, Vanguard, Morgan Stanley, TD Ameritrade and Fidelity

FinTech Case Studies –Partnership Strategy


Community Bank Robo-Advisory Partnerships• Partnership between Cambridge Savings Bank, a $3.5 billion bank located near

Boston, and SigFig, a robo-advisor founded in 2007

• Built a service called “ConnectInvest“, which is available to Cambridge’s customers digitally (mobile and website), and “allows customers to easily open, fund, and manage an automated investment account tailored to their goals.”

• Personal Capital, a robo-advisor started in 2009, announced a partnership with AlliancePartners to offer its digital wealth management platform to approximately 200 community banks

• Other Robo-Advisory partnership examples involving larger financial services companies include:

• UBS/SigFig, Wells Fargo, Future Advisor / RBC, BBVA Compass, LPL, Motif / JP Morgan

Ally Financial, Inc. (ALLY) & TradeKing

FinTech Case Studies –Acquisition Strategy


ALLY acquired TradeKing, a discount online brokerage firm (~$5 equity trades) for $275 million in cash• Deal announced in April 2017 and completed in June 2017

TradeKing also had a robo-advisory platform that appeared to be a key piece of the puzzle

Strategic rationale reflect creative thinking on the part of Ally executives and/or its investment bankers

• FinTech acquisition that is focused on revenue synergies as TradeKing enhances wealth management offering to their existing bank customers

• Versus traditional bank acquisition strategy that often focuses on expense savings

“Banking and brokerage should be together so you can save and invest—and easily move money between the two.” – Don Montanaro TradeKing, CEO

“We have a good composition of customers across all demographic segments, from affluent boomers to millennials… Our customers have been happy with our deposit products, but are asking for more from the online bank.” – Diane Morais Ally Bank, CEO

Other Robo-Advisory Acquisitions by Traditional Financial Services Companies Include:• Invesco/Jemstep, Goldman/Honest Dollar, Blackrock/Future Advisor

FinTech Case Studies –CSFL Projects


• International services• Invoicing / AR Management• Fixed asset management• Alert functionality• Budget management• Prepaid cards• Lock Box• Risk management• Loan structuring

Striving for a goal of 40% plus from fee (i.e., non-interest) revenueSource: Crossroads Banking & FinTech Conference, April 2016

Chris Nichols, CenterState Bank

FinTech Case Studies –CSFL Branch Innovation


Universal banker model

More automated tellers - IVTs

Cash recycling – branch + at the customer

Smaller, open footprint

Video conferencing

Positioned for less transaction more sales/consultative focused

Source: Crossroads Banking & FinTech Conference, April 2016 Chris Nichols, CenterState Bank

About Mercer CapitalMercer Capital is a national business valuation and financial advisory firm. Financialinstitutions are the cornerstone of Mercer Capital’s practice.

Founded in 1982, in the midst of and in response to a previous crisis affecting the financial servicesindustry, Mercer Capital has served clients through a variety of market environments. Today, as in 1982,Mercer Capital’s largest industry concentration is financial institutions.

Despite industry cycles, Mercer Capital’s approach has remained the same – understanding key factorsdriving the industry, identifying the impact of industry trends on our clients, and delivering a reasoned andsupported analysis in light of industry and client specific trends. The Financial Institutions Group of MercerCapital provides a broad range of specialized advisory services to the financial services industry.

The Financial Institutions Group broadly assists:

• Depository institutions • Private equity, hedge funds, trust companies, and TrustCos / RIAs

• FinTech companies • Specialty finance and real estate investment companies• Insurance companies• Investment funds

For more information please visit www.MercerCapital.com


Mercer Capital’s Core Services for Financial InstitutionsAdvisory Services

• Strategic consulting• Buy-side and sell-side financial advisory services• Fairness opinions• Advisory and consultation regarding capital transactions (raising, deploying, and restructuring capital)

Corporate Valuation Services

• Equity transactions (share repurchases, issuances, and conversions)• Corporate transactions (recapitalizations, divestitures, reorganizations, and the like)• Employee benefit plans (ESOPs, KSOPs, stock option plans, and restricted stock)• Tax compliance (income, estate, and gift)• Buy/sell agreement consulting and the valuation of securities with contractual restrictions on transfer• Valuation of complex securities (convertibles, options, warrants, and the like)• Valuation of securities with impaired marketability• Litigation support

Financial Reporting Services

• Purchase price allocations (ASC 805)• Stock-based compensation (ASC 718)• Goodwill impairment (ASC 350)• Illiquid financial instruments (ASC 820)• Portfolio investments held by business development companies, private equity firms, and other financial intermediaries

47How to Create Strategic Value in the Current Environment // © 2017 Mercer Capital

About CenterState BankCenterState Banks, Inc., headquartered in Winter Haven, Florida, is a financial holding company with one nationally chartered bank: CenterState Bank of Florida. The Company, formed in June 2000, operates through 74 branches in 22 counties throughout Florida, providing traditional deposit and lending products and services to its commercial and retail customers.

Since 2009, the Company has utilized its strong capital levels and financial stability, positioning the Bank to be opportunistic within the fluid banking environment. Acquisitions and new business lines have helped the Company grow to approximately $6.5 billion in assets. Activity during this time includes:

FDIC Acquisitions Non-FDIC AcquisitionsOcala National Bank TD Bank Branches in Putnam County, FloridaOlde Cypress Community Bank Federal Trust Acquisition from The Hartford Insurance CompanyIndependent National Bank Gulfstream Business BankCommunity National Bank of Bartow 1st Southern BankCentral Florida State Bank Community Bank of FloridaFirst Guaranty Bank and Trust Company of Jacksonville 1st National Bank of South Florida

Platinum Bank (Pending) Business Lines Gateway Bank (Pending)Correspondent Banking DivisionPrepaid Card DivisionWealth Management Division

For more information please visit www.CenterStateBanks.com


New Book Coming in Spring 2017

Creating Strategic Value Through Financial Technology


While many bankers view FinTech as a potential threat, FinTech offers the potential to improve the health of community banks for those banks that can selectively leverage FinTech to enhance performance, customer satisfaction, and improve profitability and returns. FinTech can also help level the playing field for community banks to compete more effectively with larger banks and non-bank lenders.

Creating Strategic Value Through Financial Technology illustrates the potential benefits of FinTech to banks, both large and small, so that they can gain a better understanding of FinTech and how it can create value for their shareholders and enhance the health and profitability of their institutions.

The book contains 13 chapters broken into three sections. Section I introduces FinTech. Section II explores FinTech niches such as bank technology, alternative lending, payments, wealth management, and insurance niches. Section III illustrates how both community banks and FinTech companies can create strategic value.

Visit http://mer.cr/FinTechBook for more information.

Contact


Andrew K. Gibbs, CFA, CPA/ABVMercer Capital

Senior Vice [email protected]

901.322.9726

Jay D. Wilson, Jr., CFA, ASA, CBAMercer CapitalVice President

[email protected]

Chris NicholsCenterState Bank

Chief Strategy [email protected]

925.202.8944

Economy & Finance

How to Create Strategic Value in the Current Environment | AOBA 2017