In April of 1912, eight musicians boarded the RMS Titanic in Southhampton. Their job was to provide entertainment for the passengers on the ship’s maiden voyage.
As most of us may recall from history, the Titanic hit an iceberg on the night of April 15th. The musicians quickly assembled in the first-class lounge and began playing music to help keep the passengers calm as they were being assisted into lifeboats.
They stayed in their places and kept playing, even as the ship took on more and more water. They continued to play after it became clear that the ship was sinking. All eight of those men perished that night, along with 1,500 other passengers and crew members. They made the ultimate sacrifice in the performance of their duties.
Oddly enough, this scrap of history popped into my head as I was reading the 1st quarter 2021 earnings releases from some publicly-traded community banks. Most of the releases happily announced strong earnings for the quarter based on standard financial performance metrics. They positioned the results as evidence that the business model is still working. Investors should be calm and reassured.
For now . . .
I happen to know that many of these companies are very traditional organizations. They have business models and executive mindsets that are fairly old-school. They remain saddled with legacy core systems and technology. They lack technical expertise in the management ranks. Their customer-facing systems are mediocre at best. Their back offices are still driven by old paper-based processes and procedures.
They may talk amongst themselves about digital transformation and the importance of change for their long-term survival. But many don’t have a viable digital strategy. Those that do struggle to achieve their goals. There are always more immediate priorities that push ‘discretionary’ transformation projects into the future. They are something to address after more urgent tasks are completed.
One common reason that I hear for not prioritizing these projects falls along the lines of: “We’re a small company with limited resources. We can’t afford to make the investments in technology and process improvement that larger institutions can”.
But. . .
At the same time, some of these companies are announcing higher dividend payouts. Some are resuming share buy-back programs. For me, that creates a little cognitive dissonance.
Let’s consider dividends first. When a company pays out earnings in the form of dividends, one thing they are saying is that their future is rosy. They can afford to return some of their capital to shareholders. They don’t need it today because they can easily earn more tomorrow. But is the future really that ‘rosy’ for community banks in general? More on that in a sec.
Another argument for dividend payments comes from economics, which says that it is better to return capital to shareholders if they can use it more productively than the company can. This implies that the bank has no investment projects that can generate returns higher than their cost of capital. That’s hard to believe given the tremendous efficiency improvements that can come from digital transformation investments. Not to mention the relatively low cost of capital today.
Share buy-backs, on the other hand, use capital to artificially increase earnings per share and to help stabilize falling stock prices. Depending on how incentive plans are structured, a higher EPS may also trigger nice bonuses for executives. But it doesn’t do anything to increase long-term franchise value.
The cold, hard reality today is that customer expectations are continually rising. Advances in technology have exposed the weaknesses and inadequacy of legacy core platforms. Increasing competition from traditional and non-traditional sources makes customer growth and retention more challenging. And the pace of change continues to accelerate, leaving many financial institutions further and further behind.
The future does not bode well for those companies who aren’t proactively responding to this reality. Their future looks more ‘dire’ than ‘rosy’. Jamie Dimon recently talked about these industry challenges in his 2020 letter to Chase shareholders. If the CEO of the largest bank in the US is worried, what does that say for the typical community bank?
So why are banks returning essential investment capital to shareholders? Why use it to play games with share prices? Instead, why not reinvest it in the company to build for the future and support the needs of all stakeholders: customers, employees, communities, partners, and shareholders?
There are, of course, other reasons why many institutions have been reluctant to embrace new investments aside from just the cost issue. For some, it’s a lack of motivation to change as long as the old business model appears to be working. Others feel that change involves risk and an uncertain ROI, and don’t wish to try anything that might fail. Occasionally you find executives nearing retirement, and who are content to let it be the next person’s problem.
Honestly, I think it’s often more a matter of some well-intentioned people who are simply not approaching the challenge with a sense of urgency. Maybe that’s because they do not fully understand the magnitude of the threat, or think they still have plenty of time to address it. Or perhaps they are just too consumed by the day-to-day management of the company to take a clear-eyed look at the future.
But the issues surrounding digital transformation are not going to fade away. On the contrary, they will become more pronounced with each passing day. Not directly addressing the challenge just leaves companies further and further behind.
Making a commitment to digital transformation may seem like a daunting task. But prioritizing needs and taking the initial steps is important. It will help companies exert some control of their destinies.
Aim for easy wins early on, and then continue to raise the bar. Foster a willingness to innovate. Risk trying new things. Success will begin to feed upon itself as you invest in your future.
The musicians on the Titanic were later recognized for the heroism they displayed on that fateful night almost 100 years ago. But history may not look as kindly on today’s financial messengers. Rather than offering bland reassurances that extrapolate the past, it would be better to discuss the concrete strategies that are being put in place for the future survival of their companies.
