Tech upgrades: Necessity or trophy investments?
Big tech investments cut both ways for bank executives — they make for splashy headlines, but can create investor relations headaches.
Banks of all sizes in recent years have been pouring millions of dollars into upgrading both consumer-facing and behind-the-scenes technology. Some of the numbers have been eye-popping: JPMorgan Chase, for example, will invest $1.4 billion this year on new mobile banking features, blockchain-related upgrades to the back office and more.
But these big capital outlays are rarely well received by the investment community. Consider the recent case of WSFS Financial in Wilmington, Del.
When the $7.1 billion-asset company announced on Aug. 8 its agreement to buy Beneficial Bancorp in Philadelphia, WSFS said it would use cost savings from the deal to invest more than $30 million to upgrade the digital consumer banking experience, its data platform, risk management and workflow automation.
The price tag is sizable for WSFS — it is virtually equal to its second-quarter profit of $28.7 million.
The market’s reaction? WSFS' stock has fallen 11% to $49.35 per share since the deal announcement — a sharper nosedive than normal for a buyer in an M&A deal.
Investors are very skeptical about promises that big technology investments will pay off, and that is undoubtedly the reason for the extra stock drop-off in this case, said Joe Gladue, an analyst at Merion Capital Group.
“It’s unclear whether tech upgrades really do produce cost savings long term,” Gladue said. “Are you just going to have to keep spending on tech, since technology is always changing?”
Investors aren’t sold that tech investments are worth the huge expense, said Frank Schiraldi, an analyst at Sandler O’Neill.
“What investors have a tough time with is that the benefit is more intangible” than other large investments that banks can make, such as hiring sales teams away from other banks, Schiraldi said.
“It’s harder to see a clear earn-back” with technology investments, Schiraldi said. He noted that WSFS has actually been a leader among banks in making cost-effective tech investments.
WSFS made the decision to use savings from the Beneficial deal to invest in technology because “advances and changing customer preferences are rapidly disrupting the traditional banking model,” said Jimmy Hernandez, a spokesman for WSFS.
“Bank management, investors and analysts are aligned about the need for technology investments,” Hernandez said.
Constant spending to improve technology has become a fundamental cost of doing business, whether the investor community likes it or not, said Brian Johnson, CEO of the $1.3 billion-asset Choice Financial Group in Fargo, N.D.
“Especially in terms of anti-money-laundering compliance, a lot of technology goes into that,” Johnson said. “You’ve got to invest in the back office, but the consumer expects technology upgrades as well.”
Many equity analysts remain unconvinced that huge tech investments are worth the costs. But that view is simply the nature of investors who focus on a bank’s stock, rather than its long-term performance, said Scott Durant, an analyst at Kroll Bond Rating Agency.
“Equity markets tend to have a shorter-term focus than bank management teams,” Durant said. “You can’t cut your way to profitability long-term. Technology like interactive teller machines will enhance earnings power long-term.”
Since Choice Financial is privately held, Johnson said he doesn’t feel the same resistance to making tech investments as the heads of publicly traded banks. But that doesn’t mean Choice can spend unlimited amounts on technology. Since the bank’s customers are located in a large territory, its branches serve fewer customers than banks that operate in dense, urban markets.
“We explored the use of video tellers,” Johnson said. “But we have so many locations spread out in rural areas, it’s difficult to make that pencil out.”
Thus, Choice Financial opted not to upgrade to video tellers, even though the bank’s customers wanted the service.
And that’s the rub for many banks. Tech investments aren’t always made to cut costs, Gladue said. Sometimes they’re needed to just to remain competitive.
“You’ve got to keep pace with your rivals,” Gladue said. “Even if it doesn’t produce cost savings, it’s still a necessary expense for survival.”
What makes investors the most irritated is when banks invest in technology they don’t need, or spend too much, said Jared Shaw, an analyst at Wells Fargo Securities.
“You need to break down your technology spending into what you want to have and what you need to have,” Shaw said.
Some banks that have been required by regulators to upgrade Bank Secrecy Act compliance systems, such as Investors Bancorp in Short Hills, N.J., and East West Bancorp in Los Angeles, have had no choice but to spend on tech investments, Shaw said.
“It wasn’t really an option” for those banks, he said.
Often it makes more sense for smaller banks to adopt software that their core processors offer, Shaw said. There’s no need for a smaller bank to create its own proprietary system when a prepackaged system would work just as well.
“Investors don’t like it when you are talking about spending significantly beyond the table stakes of the industry and you’re trying to become more of a fintech than a bank,” he said.
If bankers get frustrated by equity analysts second-guessing their decisions on technology, a debt analyst points out that bond rating agencies tend to take a longer view of costly investments. That might help executives sell an expensive technology outlay to skeptical board members, said Lisa Kwasnowski, an analyst at DBRS.
“Bond investors tend to have more patience, knowing that the investment technology is critical to being competitively positioned in the future,” Kwasnowski said.