We don’t talk enough about community banks on the podcast. Coming in to the COVID crisis, community banks lagged large banks and fintechs in technology. But when you look at what’s happened over the past 6 months, community banks committed acts of heroism to serve their customers during the height of the crisis.
Raymond Chandonnet, chief revenue officer at Neocova, joins us on the podcast to talk about the window of opportunity community banks have to compete. He describes the role technology plays in driving innovation for community banks and how smaller FIs are migrating to new core banking tech slowly and as part of a larger journey.
The evolving community banking space
I have been in the space — the community banking world — for a long time. For north of 30 years, I would describe my career as sort of a circle. I started my career as a computer scientist, working for a community bank in the late 80s, teaching people how to use PCs, and designing enterprise-level software to help automate and digitize certain processes that went on at the bank. We’re talking about things like digitizing the bank, safe deposit box rental operations, creating the first BSA and AML automation processes when anti money laundering regulations were first coming out.
I migrated from there to bank financial management and spent the latter part of 20 years or so as a bank balance sheet strategist for a number of different investment banking firms. About six years ago, I left that world and circled back to the technology space, because I came to the conclusion that as a bank strategist, the balance sheet issues that I was used to solving weren’t the most pressing challenges that my banking clients were facing. Their pressing challenges were predominantly technology focused. And so I circled back into the technology world and ran my own business for a while connecting smaller financial institutions with fintechs. And that led me ultimately to my role here at Neocova.
Technology and community banking
It’s an amazing time to be thinking about technology and community banks because of the COVID phenomenon. If you back up six months, anybody in the technology space would have argued that community banks have fallen hopelessly behind on technology relative to the fintechs and the large banks, who have much more agile, much more proactive technology stacks that both reduce their cost of delivery, improve customer experience — and that the small banks and credit unions have fallen so far behind that they were obsolete.
And you could make an argument for that when you look at the amount of consolidation there’s been in the bank space, which has hit the community banks the hardest.
But interestingly, when you look at what has happened in the last six months, the technology impact for community banks has been a bit of a double edged sword. On the one hand, the fact that community banks’ technology is outdated and has left them lacking in agility to keep up with the larger competitors is still there and was exacerbated by COVID when these banks had to close down all their physical branches and focus entirely on digital delivery to their customer base.
On the other hand, I would be remiss if I didn’t provide a major shout out to the community bank space, because the efforts that the community banks made to roll out the Payroll Protection Program loans were heroic and far outpaced what their larger bank competitors did, despite those technology challenges. It really enforced what the value proposition is for community banking in the United States.
So we’re really at a nexus in terms of solving this outdated technology problem. The value proposition has been revalidated and creates a tremendous opportunity for these community banks. It’s sort of a pivot point, but we’ve got to solve the technology piece.
PPP and community banks
I’ll give you a couple of statistics and anecdotes here. In round one of the PPP, roughly two thirds of the PPP loans made in the United States were made by community banks, even though they represent somewhere around 40% of the total assets of the banking system. Okay, that’s heroic. Right?
If you look at the study that the ICBA put out, they were able to demonstrate that pretty much anywhere in the country, the more community banks that were operating in that marketplace, the greater the percentage of payroll in that community that was covered by PPP loans. That’s community banking.
The community banks did it by literally pulling people from every department of the bank and allocating them running 24 hour cycles, or shifts, handling the applications because it was a very manual process. From the front end gathering applications, to the middle of underwriting them and getting them approved by the SBA, to the back end of booking them into the loan system — it is all incredibly manual.
Compare that to the large banks, who within 24 hours, the ones who wanted to play in the PPP space, had spun out client facing application portals, figuring out a way to aggregate applications and submit them in batch mode to the SBA thousands at a time. And as they were approved, they were automatically booked into their back end system. That’s the technology disadvantage. Yet if you look at the top 20 PPP lenders in the country, I believe at least six of them were community banks.
Technology challenges for smaller institutions
Scale certainly matters, right? The larger the bank, the more assets — both financial and human — you have to allocate to the technology challenge. But when you look at the community bank and credit union space, it’s not just a scale issue. It’s the fact that the underlying technology that they all rely on is antiquated.
This is technology that was state of the art in the 1990s. And working. And it’s incredibly risky to uproot these core banking systems, because if a core conversion fails, it could literally be an existential risk to the bank. And so, they continue to rely on these really antiquated pieces of technology that work well enough in the status quo but fail spectacularly when it comes to being agile, being able to roll out new products, enter new businesses, respond to crisis, and respond to changes in regulations.
These technology stacks all have to be customized, which is a big distinction between being configured to the way modern technology is. The bank simply cannot turn around new technology on a timely enough basis. I’ll give you one interesting example away from the PPP program: Zelle. When the Zelle network was rolled out by the larger banks, it very quickly overtook Venmo as the primary P2P payment network that banks used. If you are a small financial institution today, working with these legacy, core technology platforms, the timeframe to deliver Zelle is still measured in months, if not a year to a year and a half.
It’s not because the banks don’t want to deliver results to their customers. It’s not because they don’t have a qualified CTO on staff to make it happen. It’s that the limitations of their legacy technology mean that implementations have to be customized. These are the kinds of challenges that Neocova is striving to improve on.
Neocova’s solution and process
We are the first cloud based, fully open architecture API-driven banking technology platform that was built specifically to support community banks and credit unions. We’re focused on breaking that cycle of delayed access to new products by putting actionable data, tools, AI and machine learning in place that help these community banks automate their internal processes, particularly some of their regulatory processes. We enable them to, in a far less risky way, take on a technology transformation journey that slowly reduces their reliance on this legacy technology and leads them to a place where at the end of that journey, they have a modern, agile technology stack.
I’ll give you a little bit of data to back that up. Core conversion is viewed as so risky that even though the weaknesses of these legacy systems are well known, a recent survey said that only 20-ish percent of banks in the United States said they were even modestly satisfied with their current technology provider. And yet, every year, I believe only 3% of expiring core banking contracts end up with the bank choosing a different vendor. That’s an incredible dissonance that speaks to how risky that conversion is to these banks.
Our approach at Neocova is our technology stack helps these small and mid sized banks mimic what the large banks have done with their technology transformation. The large banks didn’t start with their core. And in fact, in most cases, they still haven’t done a core conversion. They take a step by step process that involves getting control of their data, unifying that data onto a platform, using that data to drive better insights into their customers to speed the time that it takes to make decisions on loans, to speed their ability to launch the next best product to their customers.
Then, they put in middleware that allows them to systematically test and migrate customer facing functions from the legacy technology to new modern technology. It is very much a migration process, not a conversion process. So Neocova’s technology stack and the way we roll it out to our customers in this sort of multi-year digital transformation process follows that journey. We’re able to deliver immediate value around customer insights, analytics, and process automation, and slowly but surely reduce the bank’s reliance on their legacy technology.
Community bank customers
For the community banks, their primary delivery mechanism has historically been in-person engagement with their customers, which meant within the context of branches and call centers (for the large community banks).
That’s probably the biggest difference between the way the community banks approach their customer relationships, particularly on the technology front, with the larger banks. When COVID hit, and the banks needed to physically shut down their branch network, it accelerated. I’ve seen people argue that it accelerated the migration of transactional activity by as much as five years. We’re talking about the deposits, cashing checks, and sending out wires. It really accelerated the migration of that activity to digital channels.
There’s been a long held view with community banks that, because their customer base skews older and older Americans don’t want or need to engage with their bank digitally, they prefer the in-person engagement. That may or may not be true. I would argue that that’s not necessarily the case. But COVID made that whole argument moot. At this point, it doesn’t matter how much your customer has an aversion to using your technology. They’re required to use it. And so for these small banks, if their technology stack is incomplete, or there isn’t integration among their different customer-facing pieces of technology, online, mobile bill pay, mobile deposit, capture, it leads to frustration on the part of customers who are now being forced into engaging with their banks digitally.
Biggest priorities for community banks
Community banks have a credit problem. COVID has certainly created lots of credit issues, lots of loan loss provisions that have been taken, lots of loan deferrals. We’ll only figure out at the end of 2020 how many of those deferrals will turn into problem credits.
And they are very, very focused on technology. The COVID environment has has forced a reckoning around technology. And when you look at the Neocova story, you get to see just how important that technology transformation is. We are entirely funded by community banks and community bankers. You don’t normally think about community banks as venture capital investors. And yet, all of our all of our outside capital was provided by community banks and bankers. It tells you how focused they are on being able to modernize their technology, that some of them were literally willing to invest in technology players who are trying to support them in that journey.