Saturday, March 27, 2010

Deposits: Do you want a relationship or fries with that?

Regulators have been particularly harsh to those banks whose business plans call for other-than-traditional deposit acquisition. If your bank has brokered deposits, Internet deposits, jumbo CDs, rewards checking, and in some cases CDARs, a regulator near you may be calling to order you to seek more traditional funding.

This line of reasoning centers on cost of deposits and equates high-cost deposits with less loyal customers… commonly referred to as “hot money”. What it fails to consider is the true cost of deposits, while focusing myopically on one element of cost… interest expense.

Internet depositors most likely have no affinity for the bank in which they do business. They troll the web for best rate banks, assuming one depository with FDIC insurance is no better than another. They will keep their money with your bank so long as the rate is at or near the top. I concur with regulators that if loyalty is the measure, than surely this money is “hot”.

Or is it? Internet depositors are very transparent about how to win their loyalty. If you are consistently among the best rate, you can be nearly assured of winning their business. Non-Internet depositors, on the other hand, can spin a myriad of different reasons for banking with you and/or not banking with the guy down the street. I think we all can agree that predicting loyalty is easier with Internet, and yes broker-driven depositors rather than our own core depositors.

But a business model that focuses on this customer base comes at a high cost, so the logic goes. The bank that pursues wholesale and/or Internet deposit gathering will likely incur higher interest expense than those that pursue traditional deposits from “core deposit” customers. But does this come at a higher total cost?

The chart below shows four banks, each with different deposit gathering strategies. ING Bank is a pure Internet play that builds on its brand power and competitive rates to drive deposits in its virtual doors. At first, it was a pure Internet high cost money play. As its brand evolved, ING and its well-known Orange savings account has been able to attract deposits that are not priced at the top of the market.

First Internet Bank of Indiana is primarily a pure Internet play that does not enjoy the same brand splash as ING. Its deposit rates are typically at the top of the market. It should be noted that both ING and First Internet are losing money. This is as a result of the asset side of their business, not the liability side. Dismissing their deposit gathering strategy due to their inability to generate profits on the asset base would not give these strategies their fair consideration.

Hudson City Savings Bank is a traditional thrift that gathers mostly CD deposits through a relatively Spartan branch network. It operates in densely populated areas, attracting large amounts of CDs per branch utilizing aggressive pricing. Most of their deposits come from the areas surrounding their branch network.

Fulton Bank, headquartered near my home, follows a traditional commercial bank strategy, pursuing the operating accounts of businesses from areas surrounding their branches. They pursue a retail strategy to generate additional funding for their commercial lending line of business. The traditional deposit gathering strategy of a commercial bank tends to have the lowest interest expense because of the relatively higher levels of core deposits, and therefore is highly favored by regulators.

Upon reviewing the chart, you will note that Fulton does not demonstrate the lowest cost. That is because I have added the banks’ operating expense (non-interest expense / average assets) to the equation. Traditional commercial banks tend to be more expensive to run than thrifts and Internet banks. To dislike wholesale deposit gathering in favor of core deposit gathering because of the interest expense only is wrong, in my opinion, which is supported by the accompanying chart.

A similar case was made in a comment letter to the FDIC on behalf of BancVue, a software development company that provides Rewards Checking product technology to community banks. Rewards checking, as many know, pays high interest rates on checking accounts, provided the customer utilizes the account as prescribed using electronic statements and bill pay (to reduce operating costs), and debit transactions (to increase “other revenue”). The FDIC considered these deposits to be high cost, and therefore would not allow banks that fell below well capitalized to offer it.

In the comment letter, BancVue representatives stated “These criteria either result in reduced overhead costs (e.g., electronic statement versus paper, mailed statement), lower risk (e.g., direct deposit) or provided additional income (e.g., interchange from debit card usage) for the bank and enabled the bank to pay a relatively high "reward" rate of interest. These criteria also result in REWARDChecking accounts being even more stable and reliable sources of funds than conventionally priced checking accounts.” These comments fell on deaf ears, and at this writing Rewards Checking and similar programs are disallowed at banks not considered “well capitalized”.

Here again, regulators myopically focused on interest expense, to the exclusion of all other costs and offsetting revenue.

I am not advocating using wholesale funding. I firmly believe that franchise value is driven by deep relationships with customers that would be difficult for competitors to replicate. Raising money via rate is pretty easy to duplicate. These deep relationships should result in greater net interest margins, higher customer wallet penetration, and a stickier customer base. But to write-off business models that utilize a higher percentage of “hot money” because of higher interest expense denies customers of having choices, limits competition, and further turns the banking model into one homogenized glob. We certainly don’t need 8,000 banks in such an environment.

Do we want an industry whose business model is limited to the good graces of our regulators?

- Jeff

BancVue’s comment letter to the FDIC

Thursday, March 25, 2010

Community Involvement: Good investment or waste of time?

A bank CEO at a strategic planning retreat opined: it is far more productive to implement a disciplined calling effort than to attend community events. Yet community involvement continues to be cited by community financial institutions as something that distinguishes them from large banks.

Who is right? In its most basic form such as deciding whether to attend a local Rotary Club event or to spend those two hours calling on clients and prospects, I would agree with the bank CEO. It would yield far more results doing the latter. Community involvement by financial institutions should not be considered an end in itself. It should be considered a means to an end… to build relationships that generate business.

Let’s drill down to specifics. A bank’s market manager attends four monthly Rotary dinner meetings. Let’s call her Cindy. She meets numerous people at the meetings, but it takes four times together before she thinks there is a strong enough relationship to call on her newfound acquaintances. Each dinner cost $100 for Cindy to attend.

As a result of her participation in Rotary, she calls on eight contacts. Four agree to meet with her, and one decides to do business with her bank. The new client owns a small business that requires a line of credit and a business checking account. The line of credit turns out to be essentially a home equity line of credit.

According to my employer’s 3Q09 profitability peer database, the average balance of a business checking account is $25,193. The coterminous spread is 2.44% of the balance, and fees represent 0.80%. Therefore, the checking account generates $816.25 in annual revenue for the bank (see link below to my employer’s website for profitability reporting services).

Home equity lines of credit have an average balance of $71,340 and a coterminous spread of 3.05%. This generates annual revenue of $2,175.87. Therefore, if this new customer brought the above mentioned average balances, the bank would generate $2,992.12 in annual revenue. Recall the cost of those four Rotary meetings was $400.

My marketing-type friends would jump all over this, citing an incredible ROI. This gets to a common yet energetic discussion between bank marketing and finance people. Finance wants to cover the cost of Cindy, her branch, and all those back-office folks supporting the branch. Marketing wants to focus on the marginal cost, the $400 in dinner fees. But I digress. This discussion will have to wait for another day.

The point that should not get lost is the primary purpose Cindy gets involved in the community is to get to know people that she can later call on for business. So often bankers execute on the former, but don’t follow through on the latter.

A personal example is the case of two Northwestern Mutual Insurance agents. One agent I met in business school. A few years after graduation, he called on me to discuss his company, his specialties, and to gauge if there was potential for him and me to do business together. Another agent, unrelated to the first, received my name via a referral from a mutual acquaintance. He also called on me to introduce himself and the company. As I mentioned in previous posts, my former bank never called on me in the fourteen years that I banked there. In the fifteen years living where I live, only one other bank called on me and asked for my business.

I’m not saying I should be the focus of business development efforts by local bankers. But the fact that I have been an active member of my community for an extended period of time with little in the form of proactive contact by local bankers makes me believe that others are receiving similar neglect.

Community involvement by banks was not designed to make us feel good about ourselves; although this is certainly a benefit. Community involvement supposed to initiate relationships that have the potential to become profitable business for banks. If community banks are to succeed, we must focus on end results.

Does your bank generate leads from being involved in the community?

- Jeff

The Kafafian Group website of products and services/performance measurement

Monday, March 22, 2010

Best Branch: Incentives that count

I recently read, and subsequently reviewed (see post link below), The Nordstrom Way to Customer Service Excellence. In that book, the authors cited FirstMerit Bank as an example of a financial institution that implements Nordstrom-like tenets throughout their company. One concept mentioned was a competition for Best Branch. This got me thinking of how community banks could create an objective incentive system for branch personnel to culminate in the awarding of “Best Branch”.

So many banks create branch incentive systems that are opaque, i.e. not understood by the persons that are supposed to be motivated by them. If this describes your incentive system, I suspect it doesn’t properly motivate your branch personnel. When I was a branch manager many moons ago, my incentive system was totally transparent and I knew my quarterly bonus to the penny. Problem was that it was a sales system, which brings me to another challenge, incentives that position your bank as a product pusher. This incentive manifests itself in offering the product du jour to every customer your branch personnel comes into contact with, much like when my 20 year-old daughter’s bank called her for a home equity loan.

The final common challenge of branch incentive compensation is that it is not meaningful. It equates to nothing more than a holiday bonus. If any of these three branch incentive systems describes yours, I offer you the following to consider.

The jeff-for-banks (JFB) Best Branch Incentive System

The JFB branch incentive system consists of three components: Profit performance, customer service, and branch improvement. Each component is equally weighted to determine branch ranking in a hypothetical bank’s 20-branch system. The bonus is distributed as follows: Top quartile (ranked 1 through 5) receives a $40,000 bonus (for the entire branch); 2nd quartile receives a $25,000 bonus; and 3rd quartile receives a $15,000 bonus. The lower quartile receives either no bonus or the traditional small holiday bonus. An individual branch in hypothetical bank has approximately $250,000 in annual salary and wage expense. Therefore, top quartile performers’ bonus would equate to 16% of employees’ salaries... not an insignificant amount.

Profit Performance: The accompanying table illustrates how the system works. For spread measurement, hypothetical bank uses coterminous market rates to credit deposits, and to charge loans. Your bank can have some other method to determine spreads. So long as it is used consistently and you can explain it, it will provide the same incentive. There are three components to the profit performance piece: deposit spread plus fee income, loan spread less provision, and pre-tax profit. Using profitability as the driver for incentive compensation motivates branch personnel to focus on those customers and prospective customers that are most valuable to your bank… customers that don’t squeeze you for every nickel of rate or want all fees waived. Imagine the change in branch personnel behavior. Will they plead for a rate promotion to grow deposits? Will they contact their supervisor to give a CD-only customer a special rate? Or will they develop a calling plan to build deeper relationships with those customers that deliver superior spreads to your bank?

Customer Service: Many banks already utilize external mystery shopping firms to objectively gauge the quality and consistency of customer service. The JFB Best Branch Incentive System makes those scores meaningful to the pocketbook of those being measured.

Branch Improvement: The final measurement tool is how much the branch has improved in profit performance and customer service. It is recognition that moving a poor performing branch from point A to point B will receive its just rewards.

The JFB Best Branch Incentive System can have objective add-ons, such as awarding a branch a 0.50 kicker if they ranked 1st in any of the three categories. You decide what will best motivate your branch employees to execute on your bank’s strategy, continuously improve, and increase profits.

Making incentive compensation transparent and more meaningful will identify top performers, elevate their level of compensation, and make the branch a career destination instead of a waypoint to the next best thing. After all, keeping high performing branch bankers in critical customer contact positions is key to your success, isn’t it?

- Jeff
Link to Book Report: The Nordstrom Way to Customer Service Excellence

Thursday, March 18, 2010

Book Report: The Nordstrom Way to Customer Service Excellence

B+ This book was written by: 1) an author that is on the speaking circuit regarding the Nordstrom Way; and 2) a former long-term Nordstrom employee. So in terms of expertise on how the famous department store serves customers to drive sales, these guys have it.

I have spoken and written about how banks lack the proper training, motivation/incentives, and expertise to become an advisory industry. This book, although more appropriate to retail sales, goes into great detail how the Nordstrom sales force drives sales through superior customer service. Customer service is defined, although not formally in this book but throughout the pages within it, as knowing your customers, going beyond the call of duty, and being an expert in the departments where you work so your customers walk away with the right products, with the right fit, at the right time.

Here are the top things I like about the book and how they pertain to banking:

1. Sales are the result of the superior customer service described above. We have been guilty in banking of promoting a “sales” culture that has devolved into nothing more than product pushing. By reading this book, I think bankers will have a better understanding of the genesis of a sale. As stated in the book, those responsible for sales should relax and stop worrying about making sales. When you stop worrying about money and concentrate on serving the customer, the money will follow;

2. Hire on attitude. Nordstrom doesn’t have a formal training program and the book identifies the person responsible for training a salesperson as “their parents”. In other words, parents teach their kids to be nice, to get along well with others, to listen. This is contrary to a previous post I made regarding bank training programs (see link below). But we as bankers know that no amount of training can fix a person with a bad attitude, and we have quite a few of those out there representing our banks;

3. Describes details of effective customer service habits. The book described in detail what Nordstrom Pacesetters (top sales people) do to achieve and maintain that status. Imagine if your bank personnel made 40 calls per day to customers and prospective customers. That would be a paradigm shift for our industry.

Here are the top things I didn’t like about the book:

1. The book was too one-sided. The authors, Robert Spector and Patrick McCarthy, slobbered all over the Nordstroms, the company, and its people. There was nary a constructive criticism in the book, calling into suspicion the effectiveness of some of the techniques they were touting;

2. It is a book on retailing. Even though there are great lessons and techniques in this book for bankers, it is first and foremost a book about retailing.

Considering the negatives, I would still recommend bankers read this book. The culture this company developed through superior customer service and empowering employees is one, if given the opportunity, banks would revert to in a heartbeat. The first step in changing culture is to dream what it could be. The Nordstrom Way is a vision of how it could be, and lessons in how to get there.

- Jeff

Book Report note: I will occasionally read books that I believe are relevant to the banking industry. To help you determine if the book is a worthwhile read for your purposes, I will review them here. My mother said if I did not have something nice to say about someone, then don’t say it. In that vein, I will only review books that I perceive to be a “B” grade or better. Disclosure: I will typically have the reviewed book on my bookshelf on the right margin of this blog. If you click on any book on the shelf and buy it, I receive a small commission; typically not enough to buy a Starbucks skinny decaf latte with a sugar-free caramel shot, but perhaps enough to buy a small coffee at Wawa.

Employee Training Post: Are your employees ESWS qualified:

Saturday, March 13, 2010

The social responsibility of banks is to increase profits.

When Milton Friedman penned his 1970 editorial in the New York Times regarding the social responsibility of business, there was much political upheaval against government and business by the newly enlightened hippie-set. His conclusion remains true, however, as much then as now: business has no social responsibility except to maximize profits within the laws and ethical norms of the society in which it operates. (see the link below for Friedman’s editorial)

Although Friedman remains highly admired, corporations continue to pursue the perceived virtues of social responsibility. Corporations are not people. They are fictitious entities. They are owned by their shareholders. Managers of corporations are not accountable to society. They are accountable to their owners. To engage in socially responsible activities for reasons other than serving your owners would be presumptuous.

But can there be a middle ground? Must we subscribe to Gordon Gekko’s philosophy that “greed is good” in its rawest form? (see video clip) I believe there could be a middle ground. A society where corporations, in a free enterprise society, pursue goals that are both socially responsible and consistent with maximizing profits. Let me explain.

Franklin Financial Services Corporation, parent company for F&M Trust Bank in Chambersburg, Pennsylvania, invests in the Franklin Future Fund, a non-bank investment company that makes venture capital investments in the Cumberland, Franklin, Fulton, and Southern Huntingdon counties. Banks typically lend businesses money, and shy away from early stage businesses with no operating history (and no real estate as collateral for that matter) because of the risk of not being paid back.

Franklin recognizes that new business generation is critical to the success of the communities in which they operate. New businesses evolve to better, more stable bank customers. They also employ members of the community. Although Franklin’s investment may not be consistent with maximizing profits in the short term, it certainly qualifies for executing a long-term strategy to grow surrounding communities so the bank may also grow and thrive. I applaud Franklin for their long-term vision, and encourage other financial institutions to participate in the success of budding businesses in their communities.

Atlantic Stewardship Bank (ASB) is a full-service commercial bank in Midland Park, New Jersey that was founded on the Biblical Old Testament tenet of tithing. Ten percent of its pre-tax profits are given to Christian non-profit organizations. Friedman would probably have scoffed at such high social ideals. But the Bank was established for such a purpose, and its owners knew the purpose when they invested. In fact, it is highly probable many invested because of that very purpose. (see link below)

In addition to attracting investors, ASB’s mission also attracts customers, particularly, Christian businesspeople. So its socially responsible mission has differentiated the bank from its peers in terms of attracting investors and customers. Has the tithe reduced the return to shareholders? As the chart below indicates, Stewardship Financial’s (ASB’s parent company) 10-year total return was 85%, compared to 15% for the SNL Bank Index (see chart).

ASB gave away 10% of pre-tax profits during that entire period. Has social responsibility worked for them? Could it work for you? I think Milton Friedman would agree that social responsibility could play a key role in differentiating you from competitors and enable you to maximize profits.


Note: I make no investment recommendations in my blog. Please do not claim to invest in any security based on what you read here. You should make your own decisions in that regard. I have a tough enough time making investment decisions on my own.

Milton Friedman’s 1970 New York Times editorial, “The Social Responsibility of Business”

Atlantic Stewardship Bank history

Tuesday, March 09, 2010

Is the bank sales culture gone wild?

A few weeks ago, a nice woman from Sovereign Bank called our home with news that, based on our relationship with the bank, we were pre-approved for a home equity loan. The problem… my wife and I don’t bank at Sovereign. They called for our twenty year old daughter who had a checking account with them. As far as I knew, our daughter had no home to borrow against.

I applaud Sovereign for being pro-active. I have often spoken of my fourteen years with my prior bank where I received no phone calls. Not one in fourteen years. At least my daughter’s bank reached out to their customer.

Sovereign’s approach is fairly typical today, in my experience. It is similar to retail department stores. We want customers to buy our wares. But unlike a coffee maker or a well-tailored suit, financial services are intangible and very personal. According to Bruce Clapp and Nick Vaglio, authors of Shift Happens: The New Age of Bank Marketing, “buyers of complex intangible services are buying specialized expertise.” The accompanying video SNL skit is a funny rendition of what might be the public’s perception of our industry’s expertise. With this in mind, is our approach to “sales” the right approach? Do customers pull our products from the shelf, like they are depicted in Progressive Insurance commercials?

I suggest they are not. Financial services are more complex today than ever before. Sovereign has dozens of personal and business products and services listed on their website, from the simple to the complex. The Investment Company Institute measures over 7,600 mutual funds (see link below). To the business person and consumer, this could be very confusing.

Look no further than the recent mortgage crisis, where many borrowers were sold mortgage loans they did not understand and could not pay long-term, especially in a down economy with declining real estate values. Mortgage brokers, private mortgage buyers (primarily large banks), investment banks, and Fannie/Freddie utilized the hot potato rule of investing: the last one holding the paper loses. This trading mentality versus an advisory mentality permeates our industry, although less so at community banks.

Can you recognize a trading mentality at your bank? I suspect if your branch personnel ask for a promotional rate to grow deposits or your lenders price loans aggressively to “get the deal done”, then you have the foundation of a trading mentality. Each transaction is a trade, and the customer attributes no value to your bank as opposed to a competitor.

Imagine how things would have been different if an advisory culture dominated the banking industry. Instead of borrowers going through mortgage brokers, they would seek their banker to discuss the size of mortgage they could afford. Perhaps with such an evaluation, the customer would have purchased an elegant yet affordable Cape Cod, instead of a McMansion, leaving excess cash in the bank and additional monthly cash flow to weather a recession. This customer would value the relationship with the banker, bring a greater percentage of their personal (and possibly business) financial business to the bank, and not be quick to abandon the bank for minor rate variations.

Terry Zink, EVP of Fifth Third Bancorp in a recent BAI Strategies article regarding traditional cross-sale balderdash (see link below), stated “we’re having a great deal of success in cross-selling savings products, because people realize they need to have a better savings base.” I say we should have been advising them of this all along, Terry.

What do you say?

- Jeff

Investment Company Institute January 2010 Trend Report

Making the Cross-Sale in Difficult Times (may require subscription)

Sunday, March 07, 2010

Quotes from my quote locker...

I collect quotes from a variety of sources to remind me of knowledge imparted to me by smart people. Since my memory is relatively weak, I subscribe to the theory that those that forget history are bound to repeat it. So my quote database is a compendium of reminders of historical facts or events that, if forgotten, ultimately lead to a repeat of poor results. I offer a few in today’s blog.

“The letters to the federal banking regulators are a catalog of fear.” Michael Barbaro, NY Times business writer, October 17, 2005.

Remember when Wal-Mart sought a Utah industrial loan company (ILC) charter? Our industry was in an uproar, citing the separation between commercial companies and banks, even though no such objections surfaced when Target or Toyota acquired their charters. See a past blog post regarding how Wal-Mart is working their banking strategy without an ILC at:

“The game has changed, but the people didn’t.” Head of Human Resources at a bank client (keeping anonymous to maintain confidentiality), February 26, 2009.

This was a succinct recognition of how the banking industry has changed over the past two decades and our adoption to change has been slow because the same people occupy key positions within our banks.

“Foolish governments had guaranteed the liabilities of financial institutions that used other people's money in an undisciplined way.” Martin Mayer, from his 1997 book The Bankers-The Next Generation.

In a classic example of repeating history, this Mayer statement was made in 1997 regarding the 1989-1991 S&L crisis and the early 1990’s Japanese banking crisis. I wonder how we can apply it today?

“When you run with the pack, what you generally see are other people's backsides.” Arkadi Kulhmann, Chairman & President of ING Direct USA, October 31, 2008.

Basic strategy that recognizes the need to be different than others that also sell a commodity, namely money. Say what you will of ING Bank’s performance in the United States, but being ordinary is not one of them. And for a bank established in 2000, having $75 billion in total deposits by the end of 2009 is not too shabby.

Wednesday, March 03, 2010

Have we checked out of business banking?

Alex Pollack, a resident fellow at The American Enterprise Institute, had a sobering editorial in the March 3, 2010 American Banker. The context of his commentary was on the bubble that burst in the residential real estate market, and the more methodical decline in commercial real estate. He rattled off sobering facts: fifty five percent of commercial bank loans are tied to real estate. For commercial banks under $1 billion in assets, the number jumps to seventy four percent (see chart).

These statistics ignore the amount of real estate secured bonds and government agency bonds designed to fund real estate in banks’ securities portfolio. Clearly, commercial banks’ exposure to real estate contributed to the rising number of bank failures. What brought us to this point?

Commercial banks were the connoisseurs of commercial finance dating back to the National Banking Act of 1864. That Act did not permit national banks to lend on real estate. The value of real estate was certainly more volatile then than now. Times changed, however, and banks were permitted to do real estate lending, and these loans became twenty five percent of bank loan portfolios after World War II. It remained at that level for nearly three decades when real estate lending began its meteoric rise to today’s levels.

The decline in traditional business loans, in my opinion, was the result of two forces, one market and one not. The first was the government’s intervention in small business financing, beginning in the Great Depression through the formation of the Reconstruction Finance Corporation to today’s Small Business Administration. The second was large corporations gaining direct access to the capital markets, issuing short term notes and commercial paper instead of relying on bank financing.

But we as bankers have played a role in the decline of business lending. Banks rely on collateral as a backstop for businesses that can no longer service their loans. Real estate has been a very reliable source of collateral. But the trend away from business lending will continue to lead to increased government intervention in free markets.

According to the Bureau of Labor Statistics, service providing businesses are projected to grow from 73% of the labor market in 1998 to 79% in 2018 (see link below). Many if not most of these businesses don’t own the buildings where they operate. If a bank requires real estate as collateral, we may find ourselves unable to finance a growing economy. The government will increase its participation, picking winners and losers, and free markets will suffer.

Perhaps government intervention in private enterprise financing is deemed desirable, or at least not harmful, by readers. But Peter Leeson of George Mason University’s Mercatus Center disagrees. In his recent white paper “Two Cheers for Capitalism?” (see link below), he states “although many relationships in the social sector are unclear, capitalism’s relationship to development isn’t one of them. Unless one is ashamed of unprecedented increases in income, rising life expectancy, greater education, and more political freedom, there’s no reason to be a milquetoast defender of capitalism.”

Community banks have struggled to separate themselves from large financial institutions. We say we are closer to our communities than the big fat cat bankers. But we shy away from creative ways to finance entrepreneurial growth within those communities, and diversifying the risk that comes with such lending. We opt instead to finance the buildings, but not the businesses contained within them. These are the businesses that will fuel our nation’s growth, and we as an industry have to decide if we want to be a part of it, or cede that role to our burgeoning Uncle Sam.  - Jeff

Bureau of Labor Statistics employment projections by industry:

American Banker Viewpoint by Alex J. Pollack (note: requires American Banker subscription)

Two Cheers for Capitalism? Whitepaper by Peter Leeson