One might assume that many attendees at Bank Director’s Acquire or Be Acquired Conference in Arizona left town with an M&A game plan focused solely on their next acquisition, but a legendary banker suggested a different strategy.

John B. McCoy, the former chairman and chief executive officer of Banc One Corp., recommended during a presentation on the final day of the conference that bankers consider a strategy his father used that ended up revolutionizing banking.

This year’s conference, which celebrated its 25th anniversary, was held at the JW Marriott Phoenix Desert Ridge resort in Phoenix.

McCoy’s advice is a page taken directly from the playbook of his father, John G. McCoy, who founded Bank One and turned it into a regional powerhouse before it was eventually acquired by JPMorgan Chase & Co. in 2004.

“One of the things he did, which I suggest for all of you, is he set aside that first year 4 percent of the profits, (which) went to (research and development) to do new things, not fix old problems,” McCoy said.

The advice is especially prescient today because the banking industry is being pressured to keep pace with an evolving digital economy and changing customer preferences for how they bank, especially in the retail sector.

Bank One spent that money building an exceptional retail franchise. It was the first bank to place ATMs in every branch, add drive-thru lanes at its branches, offer a Bank of America credit card and essentially invent the country’s first debit card.

“That set us off,” McCoy said. “One took us to the next.”

That investment strategy played an important role in its growth: Bank One’s assets grew from $140 million in 1958—when it was the smallest of three banks in Columbus, Ohio—to more than $8 billion 25 years later, eventually becoming the sixth-largest bank in the country.

Early in its history, Bank One pursued an ambitious M&A strategy where it bought dozens of small banks—first in Ohio and later in surrounding states—using a concept that it called the “Uncommon Partnership,” where it would leave the management team of the acquired bank in place while centralizing many of its back office functions to save money. In fact, McCoy said they would only acquire a bank if the CEO agreed to stay in place.

Bank One also limited the risks of its acquisition program by never buying a bank that was more than 20 percent of its own asset size.

An announcement on Monday that Detroit-based Chemical Financial Corp. was acquiring Minneapolis-based TCF Financial in a $3.6 billion deal, creating the country’s 27th largest bank with $45 billion in assets, also generated a lot of talk during the conference. Chemical and TCF billed the transaction as a merger of equals even though Chemical’s shareholders will own 54 percent of the merged company.

While some some conference presenters suggested that mergers of equals could occur with more frequency given the recent declines in bank valuations, which has made it more difficult for acquirers to pay a big takeover premium, others were more skeptical.

Tom Brown, founder and CEO of the hedge fund Second Curve Capital, which invests exclusively in banks and other financial companies, doubted that those deals will become regular. For one thing, there are significant social issues to resolve, like which CEO will end up running the company, how many directors from the two banks will constitute the new board and what will the new company’s name be. (In the TCF/Chemical deal, the new company’s headquarters will be in Chemical’s hometown of Detroit, but it will take the TCF name.)

“They’re just really tough to do,” Brown said during the conference’s closing session. “Someone who has been a CEO is not going to take a different role. And, while they all make great sense to me as an investor, the amount of work before the deal could even be agreed upon is just too challenging.”

Several speakers at the conference also said that smaller banks will need to gain scale to compete in a consolidating industry. Conventional wisdom says that scale helps improve efficiency, reduces costs and boosts profitability–but the urge to grow bigger purely for the scale must be tempered, Brown said.

“I talk to all sorts of CEO’s who are $250 billion assets and they still think they don’t have scale,” Brown said. “Let’s just stop using the get bigger to get scale idea because I haven’t seen that work yet.”

Most people assume that fintech companies are out to take business away from banks, but what if the opposite is true?

What if, instead of being a threat, fintech companies actually open up new opportunities for banks?

That’s what a handful of banks are exploring right now. They’re doing so by essentially white-labeling deposit insurance, regulatory expertise and access to credit platforms.

You can think of it as a partnership that leverages a fintech company’s strengths on the front end of the customer experience, with attractive and refined digital interfaces, as well as a bank’s strength on the backend, by providing access to safe and secure financial products.

It’s a classic win-win situation.

One bank pursuing this course is TAB Bank, an online bank based in Ogden, Utah, with $711 million in assets.

“We came to the conclusion that we would build our strategy around how we think the market will look in two to five years, not how it behaves today,” says Curt Queyrouze, president of TAB. “What we determined was that once consumers try a digital interaction, they stay in that lane.”

Queyrouze has been cultivating this model for years.

The 20-year-old online bank has “sponsored” non-banks before who wanted access to the Visa and MasterCard credit platforms, says Queyrouze. Then TAB began working with marketplace lenders and offering traditional transaction accounts—in other words, white-labeling banking services to its partners.

“To the extent we can be the infrastructure for that cash account that attaches to whatever payment systems are out there, yeah, there’s a lot of benefit to that,” says Queyrouze. “As traditional banks we can hold that money, we can insure it and then we can take that money and turn around as the traditional banking model has always been and lend out that money, (or) use it in other ways to create profitable margin.”

The Bancorp Bank is pursuing a similar course. The $4.4 billion online bank headquartered in Delaware makes it clear what their model is all about: enabling non-bank companies to offer bank-like products.

“Take a close look behind some of the world’s most successful companies: that’s where you’ll find The Bancorp,” the company boasts.

The Bancorp backs Varo Money, for example, a mobile app offering users insured deposits, fee-free ATM withdrawals, interest-bearing savings accounts and personal loans in 21 states. (Varo Money was among the first fintechs to apply for the new national charter offered by the Office of the Comptroller of the Currency last year.)

Yet another bank pursuing a similar strategy is Cross River Bank, a New Jersey-based bank with $1.2 billion in assets.

Getting back to TAB, another epiphany came to Queyrouze in late 2018 at one of the biggest financial services conferences of the year.

Queyrouze thought about all the money being spent to lure new customers by both banks and non-banks.

As Queyrouze saw it, this gave TAB two potential paths to follow.

One would require a massive marketing budget to compete against bigger banks and fintech companies in the competition to acquire customers. The other was to stick to what it knew on the backend—namely, banking—while leveraging the strength of fintech companies on the frontend.

“While we do have the option to market against this tide, we also have the opportunity to build a banking infrastructure to align with the fintech world and provide banking services to support their client base,” says Queyrouze.

In short, small banks like TAB don’t have the resources to compete in the digital realm against larger peers. Nor can they pump money into a national marketing blitz to grow their customer base.

But they can stick to what they do just as well as any bank regardless of size—banking—and let fintech partners handle the rest.

When Bank Director hosted its first Acquire or Be Acquired Conference 25 years ago, Whitney Houston’s “I Will Always Love You” held the top spot on Billboard’s Top 40 chart.

Boston Celtics legend, Larry Bird, was about to retire.

Readers flocked to bookstores for the latest New York Times best seller: “The Bridges of Madison County.”

Bill Clinton had just been sworn in as president of the United States.

And the internet wasn’t yet on the public radar, nor was Sarbanes Oxley, the financial crisis, the Dodd-Frank Act, Occupy Wall Street or the #MeToo movement.

It was 1993, and buzzwords like “digital transformation” were more intriguing to science-fiction fans than to officers and directors at financial institutions.

My, how times have changed.

When we introduced Acquire or Be Acquired to bank CEOs and leadership teams a quarter century ago, there were nearly 11,000 banks in the country. Federal laws prohibited interstate banking at the time, leaving it up to the states to decide if a bank holding company in one state would be allowed to acquire a bank in another state. And commercial and investment banks were still largely kept separate.

Today, there are fewer than half as many commercial banks—of the 10 banks with the largest markets caps in 1993, only five still exist as independent entities.

It’s not only the number of banks that has changed, either; the competitive dynamics of our industry have changed, too.

Three banks are so big that they’re prohibited from buying other banks. These behemoths—JPMorgan Chase & Co., Wells Fargo & Co. and Bank of America Corp.—each control more than 10 percent of total domestic deposits.

Some people see this as an evolutionary process, where the biggest and strongest players consume the weakest, painting a pessimistic, Darwinian picture of the industry.

Yet, this past year was the most profitable for banks in history.

Net income in the industry reached a record level in 2018, thanks to rising interest rates and the corporate tax cut.

Profitability benchmarks in place since the 1950s had to be raised. Return on assets jumped from 1 percent to 1.2 percent, return on equity climbed from 10 percent to 12 percent.

Nonetheless, ominous threats remain on the horizon, some drawing ever nearer.

• Interest rates are rising, which could spark a recession and influence the allocation of deposits between big and little banks.
• Digital banking is here. Three quarters of Bank of America’s deposits are completed digitally, with roughly the same percentage of mortgage applications at U.S. Bancorp completed on mobile devices.
• Innovation will only accelerate, as banks continue investing in technology initiatives.
• Credit quality is pristine now, but the cycle will turn. We are, after all, 40 quarters into what is now the second-longest economic expansion in U.S. history.
• Consolidation will continue, though no one knows at what rate.

But it shouldn’t be lost that certain things haven’t changed. Chief among these is the fact that bankers and the institutions they run remain at the center of our communities, fueling this great country’s growth.

That’s why it’s been such an honor for us to host this prestigious event each year for the past quarter century.

Is it now a big bank world that the rest of the industry is just living in?

One could justifiably come to that conclusion based on comments by Tom Michaud, president and chief executive officer at the investment bank Keefe Bruyette & Woods during a presentation on the opening day of Bank Director’s Acquire or Be Acquiredconference Sunday in Phoenix.

Approximately 1,300 people are attending the 25th anniversary of Bank Director’s Acquire or Be Acquired event at the JW Marriott Phoenix Desert Ridge resort, which will run through Tuesday.

It’s no secret the four largest U.S. banks—JPMorgan Chase & Co., Bank of America Corp., Wells Fargo & Co. and Citigroup—hold dominant positions in the country’s banking market. These four megabanks control approximately 45 percent of the U.S. deposits. But historically, large institutions have been less profitable than much smaller ones in part because their size and complexity have made them more difficult to manage.

That is now changing, according to Michaud.

Bank of America, for example, posted a return on tangible common equity (ROTCE) in 2017 of 10.8 percent. The bank’s ROTCE rose to 15.4 percent in 2018 and is projected to hit 15.9 and 16.5 percent in 2019 and 2020, respectively.

Similar ROTCE increases are forecasted for JPMorgan, Wells and Citi through 2020.

The reason these banks are now operating at a much higher level of profitability is in part because their management teams have figured out how to turn their enormous size into an advantage. Although analysts, consultants and the banks themselves have often touted the advantage of size, it has had an averaging effect on their financial performance as they have grown increasingly larger in recent years.

“It seems now that the scale argument has a lot more traction,” said Michaud.

Just three years ago, the most profitable U.S. banks based on their performance metrics were in the $5 billion to $10 billion asset category—just large enough to gain some benefits from scale but still small enough to escape the averaging effect. This so-called “sweet spot” shifted in 2017 to banks with assets greater than $40 billion, and Michaud expects these large institutions to again claim the sweet spot in 2018 by an even wider margin once the industry’s profitability data are finalized.

One important place large banks have been able to use scale to their advantage is in technology. The U.S. economy is in the midst of a digital revolution, and the banking industry is being forced to embrace digital distribution of consumer products like checking accounts and mortgages. “Consumers really like the digital delivery of retail banking services,” Michaud said.

And it’s the national and super-regional banks that are capturing the greatest share of “switchers”—consumers who are leaving their current bank for another institution that offers a better digital experience. Michaud cited data from the consulting firm AT Kearney showing that national banks are capturing about 41 percent of the digital switchers, with super-regionals taking 28 percent. Even direct banks at 11 percent have been gaining a larger share of switchers than regional banks, local banks and credit unions.

The advantage of scale becomes most apparent when you look at the amount of money large banks are able to invest to upgrade their digital capabilities. Each of the big four banks are expected to invest a minimum of $3 billion a year over the next few years in technology—and some of them will invest significantly more. For instance, JPMorgan’s annual technology spend is expected to average around $10.8 billion.

While not all of that will be invested in digital distribution, the country’s largest bank is investing heavily to build a digital banking capability capable of penetrating any consumer market anywhere in the country.

Data has never been more important for the banking industry. In this video, Eric Weikart, a partner at Cornerstone Advisors, interviews South State Bank Senior Vice President Jamie Kerr about the bank’s disciplined approach to data and benchmarking. She also explains the importance of incorporating benchmarking into South State’s culture.

• Developing key metrics
• Using data daily

Ten years ago a technology session at a banking conference wouldn’t have drawn a standing-room only crowd of experienced community bankers, but in 2019 you’ll see a much different scene.

Many of the 800-plus bankers attending Bank Director’s Acquire or Be Acquired Conference at the JW Marriott Phoenix Desert Ridge resort in Phoenix, Arizona were eager to soak up knowledge about technology—which many experts see as the answer to both the competitive pressure being applied by fintech companies from outside the industry, and from customers who want digital alternatives to the industry’s traditional distribution channels.

The shift in attention to tech-focused content is a clear indication that bankers are taking technology more seriously than they ever have—and for good reason.

“We’re entering a time where outside forces feed on the unprepared—maybe not directly but I think they create conditions that will make it very hard for unprepared institutions to survive,” said Mike Carter, executive vice president at the consulting firm SRM Corp., who made a presentation Monday on the threats posed by nonbank payments companies.

The good news, Carter said, is community banks can now more easily compete up-market despite the wide gap in deposit share compared to the country’s biggest money center banks that invest as much as $11 billion per year on technology. It no longer requires millions in up-front investment, Carter said, as many fintech firms now sell their technology through licensing fees.

The catch is that some banks will have to recalibrate their strategies and think of it as “banking in reverse,” said Frank Sorrentino, chief executive officer of $5.6 billion asset ConnectOne Bancorp, based in Englewood Cliffs, New Jersey.

Sorrentino, who participated in a panel discussion Sunday outlining strategies for growth, said ConnectOne has operated from its formation as a de novo in 2005 with the customer’s needs foremost in mind. Instead of thinking about what products would sell best, they thought about what the customer wanted and how they could provide that—and that has contributed to the rapid growth that ConnectOne has experienced.

“Technology gets you on the road to (grow),” Sorrentino said.

Before he became a banker, Sorrentino was a home builder who had become frustrated with the service he received from his bank—so he decided to start his own bank with a customer-first strategy.

Sorrentino’s philosophy is one that is becoming increasingly common among executives, said Pierre Naudé, CEO of nCino, which markets a cloud-based bank operating system to banks.

“I think it’s a new breed of C-suite people that’s coming up that’s actually adept and used to technology and very comfortable talking about it,” Naudé said.

That philosophical shift among bank executives has been a transition, Naudé said, which began with the initial wave of fintech firms that caused disruption in the industry through their technical innovation.

This disruptive dynamic has been exacerbated by the growth in market share by the country’s largest institutions.

Since 1992, deposits held in the country’s 100 largest banks have increased more than 700 percent compared to a mere 18 percent in the smallest institutions, according to data presented Monday by Don MacDonald, chief marketing officer for MX, a Utah-based fintech firm.

MacDonald made the case that the industry is entering a fifth age—the so-called “data age”—that emphasizes the use and leverage of various levels of information to reduce cost, increase revenue and deliver an exceptional customer experience, regardless of asset size.

“What’s amazing about it is the role of the consumer,” MacDonald said.

That role was a common thread in technology-focused presentations and conversations at the conference, where most agree that the focus should become what the consumer wants, not what banks can deliver that will appease them.

It’s a reversal in the traditional relationship between banks and customers.

“We as consumers have more choice than we’ve ever had in our lives, and perhaps more important is the friction to change is virtually nil,” MacDonald said.

“So if I don’t like you I can move from you at the click of a button, or from my current provider I can move to you at the click of a button.”

That precipitates a shift in perspective about how banks will think about growth, and in what terms that’s defined.

“Size isn’t a number,” Sorrentino said. “Size is your capability.”