Sunday, May 29, 2011

Is your strategy and organization built around the customer?

I was researching videos of positive customer experiences for another potential post when I discovered this gem from Forrester Research done in 2007. Four years in our information driven society may seem like a lifetime but I listened with fascination as Forrester Research Principal Analyst Kerry Bodine described key elements of a customer centric culture.

Customer centric culture is most likely an industry buzz phrase similar to Total Quality Management and may evoke negative connotations. Industry buzzwords are processes built to solve business problems that have existed since time immemorial. Total Quality Management supposed to reduce fail rates and therefore avoid unnecessary processes. Six Sigma was designed to optimize operations and reduce or eliminated wasting time and wasteful spending. These things happened prior to TQM and Six Sigma. Buzzwords are about the packaging. Similarly, the logic behind building your business around your customers is as old as business itself.

Based on Forrester’s research, Bodine identified five key elements of a customer centric culture as follows (see video):

1. View customer experience as critical to meeting business goals;

2. Develop an accurate understanding of customers and their needs;

3. Align company strategy with customer needs;

4. Support customer experience initiatives from the top down;

5. Have common goals across the organization.

These tenets seem so simple that it is difficult to fathom why we needed to research the subject. But apply them to financial institutions, and levels of complexity surrounding simplicity emerge.

Our primary hurdle to implementing the above elements is culture. As George Millward, a colleague of mine at The Kafafian Group, tells me: “strategy drives structure” (most likely a Peter Drucker quote, as told to me by Ron Shevlin of Aite Group in Boston... thanks Ron!). But strategy has only been around corporate America since the 1960’s, and much later in FIs because of repressive regulation. Ask many CEOs about their strategy, and you may get a blank stare or a clear indication that strategy looms solely between their ears, never to descend to those responsible for executing it. According to my experience though, strategy is clearly taking hold in our industry.

So how about a strategy that puts the customer first? Customers are surely one of an FI’s constituencies, along with employees, communities, regulators, and in some cases shareholders. This form of strategy requires some thoughtful deliberations on our organizational structure.

For example, plenty of banks deem small to mid-sized businesses as their primary customer constituency. But their business bankers are typically lenders, leaving the majority of business deposit gathering to branches. To fully align with customer needs, one would think a business relationship manager would be able to advise the business person on all facets of their income statement, cash flow statement and balance sheet... not just their borrowing needs. But lenders like to lend, and talk deposits only if their boss makes them do it.

Again, it’s culture. FIs tend to organize more around product than customer. I often hear from bankers that a significant percentage of businesses do not borrow or only require a small line of credit. If true, why are lenders responsible for calling on them?

If the business person would like to add a 401(k), the lender can make a referral to some other department with separate responsibilities and reporting lines. In fact, I often hear that the lender or other FI “relationship manager” is hesitant to bring in other FI employees for fear they might screw up the relationship. Does this happen at your FI?

I do not deem the above five elements to be impossible for an FI to achieve. But I have not experienced many, if any FIs that implemented them. We talk about customer centricity, for sure. But if we want to design a strategy focused on customers, it’s time to start walking the walk.

What other elements do you believe are critical to a customer-centric strategy?

~ Jeff

Saturday, May 21, 2011

The coming bank consolidation... but not why you might think.

If I had a nickel for every time an investment banker predicted the mass consolidation of our industry I could buy a free round to all attendees at next month's Financial Managers' Society Forum. Financial Institutions need greater scale to offset the rising regulatory burden imposed by Dodd-Frank and soon to be imposed by the Consumer Finance Protection Bureau (CFPB) is the most often cited reason.

But I have noticed a couple of trends that may be a better leading indicator of coming FI consolidations, one old and one new.


The old reason is that our CEOs are old... pun intended. Prior to the 2007 financial crisis, we prognosticators used to look at CEOs age as an indication of whether a financial institution would sell. See the table for the average age of FI leadership for publicly traded banks and thrifts.  It tells a challenging story... one quarter of FI CEO's are two years from retirement. Half are seven years away. Are there successors in the wings?

I have not read one press release announcing a merger that stated: "Our CEO is old, we have nobody to replace him, so we sold." But the cynic in me says this reason stands tall in prominence in the Board meeting when the sale decision is made.

This could be because the CEO does a good job, and neither the CEO or the Board thinks there is another potential CEO candidate that can do as well. If this is the case, then I put to you that neither the CEO nor the Board has done a very good job of developing leadership in the organization making successful next- generation passing of the baton doubtful. The cynic in me suspects there may be no opportunity for the retiring CEO to unlock the value of his investment in the FI without a sale.

But there are exceptions, such as how Wayne Bank in Honesdale, Pennsylvania implemented a leadership change flawlessly. Bill Davis, a great banker who never thought the success of the bank was all about him, moved out of the executive suite on retirement day and passed leadership to his second in command, who had been groomed from within. See the link below for the jfb post on Bill Davis.


The newfangled reason for the coming consolidation wave, in my opinion, is the change in our shareholder base (see chart). Community FIs used to have very predictable shareholders. They were typically within our communities, liked the dividend, and were proud to own a piece of their local bank.

Having gone through a few consolidation waves, our shareholders have become more diverse. They're also becoming older, and many have already passed shares to the next generation that lacks that same connection to the bank.

Lastly and possibly more importantly, FIs have needed capital during the past few years as loan problems and operating losses have reduced industry capital ratios. We turned to the most prominent underwriters of community FI stock, Sandler O'Neill, KBW, and Stifel to replenish our capital coffers. Where do these underwriters place the community bank issues? With institutional shareholders such as asset managers, hedge funds, and the like.

These institutional shareholders have little interest in what you think you mean to your communities or employees. They plug in the number they bought into your shares, and expect a certain return. If you can't deliver the return via profitability, then you better sell to give it to them. These shareholders at times own a relatively large percentage of a stock that doesn't trade heavily. In these instances, it would be difficult for the institutional shareholder to exit the stock through any other means than a sale.

Yes, those that successfully raised capital in the past two years are proud that they have done so. But I wonder if, while basking in the glow of that success, they understand that they may have sealed their fate far in advance?

Do you think there will be an increase in FI consolidations? Why or why not?

~ Jeff

Ode to Bill Davis:

Saturday, May 14, 2011

Four Not-So-Serious Don'ts for Financial Institutions

Movies tell great stories. Most times they exaggerate real life. So I am pouncing on the opportunity to over-dramatize four things I don't think FI's should do.

1. Don't ignore your CEOs age. Prognosticators are predicting incredible shrinkage in community FIs because of regulatory burden. I think it is equally likely that boards throw in the towel because their CEO is far closer to the grave than the cradle, like Aunt Edna from National Lampoon's Vacation. Don't prop your CEO on top of your family truckster.

Note: I wanted to use the "You're my boy, Blue" clip from Old School. But in the movie Blue passed while wrestling sorority girls in a tub of KY Jelly, and I thought it may be a wee-bit inappropriate. But I really, really wanted to use that clip.

2. Don't implement a sales culture that results in no more than product pushing. There are many variants of sales culture. Many FIs went for the worst, the used car salesman variety. If your customers visit your website or branch, and the best you have to say is "yeah, she's a beauty, I can see you behind the wheel, wind blowing in your hair", you better revisit your strategy. We don't want product pushers like Kathy Bates selling squirrels in Rat Race, do we?

3. Don't let Bloomberg radio or the New York Times build your brand. We're taking it on the chin by mass media and it's time to stop the madness. Letting others define who you are may lead to tremendous misunderstandings, such as how Jon Lovitz's family was portrayed in Rat Race to a gathering of World War II vets.

4.  Don't "pants" your regulators. I, myself, have peaked into clients' conference rooms at the young-gun examiners and wanted to give them a Three Stooges slap or two. There are some distasteful things we must do in business, and treating our exam team like industry professionals during a time when they seem to be out to get us is one of them. Don't "pants" them as in this Meatballs clip.

Sunday, May 08, 2011

Three Banking Lessons Learned from Girls Lacrosse

Several months ago I was enlisted to coach middle school girls lacrosse. It is a relatively new sport to our area, so my learning curve was steep. We are nearing the end of our season, and yesterday we completed our first double header sweep. As I reflected on how far the girls have come, I thought of the lessons we learned along the way. These lessons apply to many areas of life, including the banking profession. I would like to share them with you.

1.  Stack the D

Easter weekend we played a game with a thin roster as many of our players had family commitments. Lacrosse is often referred to as the fastest sport on two feet, correctly implying a great amount of running. With limited substitutes, this puts pressure on the players on the field to perform while being gassed. Midfielders run coast to coast, so I had to be creative in substituting and switching player positions on the field.  In so doing, I weakened our defensive unit by moving key defensive players to midfield and middies back to D so they can rest. What I learned was that not adequately protecting our goal can lead to terrible results.

Most financial institutions are not lacking for customers. If we tallied up all customers that do business with us, a likely conclusion may be what one bank CEO stated as "there is enough 'there' there". I have been in countless meetings that the head of retail wonders why their total number of checking accounts remained stagnant while their monthly production reports show great progress in new account acquisition. The reason... customers walking out the back door while the FI tracks new customers coming in the front.  A classic tale of not stacking the D and defending your goal. Pay attention to the customers you have, and you will get more business from them.

2.  Win in Practice

How you practice drives your game performance. Lacrosse is a sport won in the trenches. If you win the draws, be first to pick up the ground balls (see photo), and disrupt opponent passes you will be successful. But having better skills than your opponent is not bestowed upon you by a higher power, as some may think. To consistently put passes on your teammates stick requires that you do so hundreds of times in practice.

The same goes for serving FI customers. If you are to tailor a solution to a business customer, it is critical you understand his or her needs, their industry, and general economic conditions. Having done your homework allows you to bring a greater amount of value to customers, an imperative in a competitive industry where one FI's money is as green as the bank down the street. If you want to solidify existing customers and win new ones, you better get serious about practice.

3.  Find the Hidden Gems

I found it difficult not to make quick judgments about my players. This girl is slow, that one is athletic, etc. To deny that we judge people with minimal information is to ignore human nature. During the course of the season, some of my early judgments proved wrong... dead wrong.  Some girls worked hard in practice, improved their skills quickly, and began making significant game contributions. This reminded me that Chase Utley and Michael Jordan were each cut from their high school teams.

Within your employee base there are unpolished gems waiting to shine. It is incumbent on us to identify them, encourage (yes, coach) them, train them, and let them show their brilliance. Most companies have varied levels of employees from stars to, well, not-so-much stars. Often, potential stars are kept under wraps by supervisors that want to keep them for themselves, co-workers that are paranoid about a star's brilliance, and general mediocrity that tends to keep people down. Do you reward mediocrity or protect so-so employees? Do stars receive a 4% raise while not-so-much stars get a 3% raise? Does longevity count more than performance?  These are some common ways that FIs keep potential hidden gems from shining.


In a rapidly changing industry, we frequently look outside of our organization to transform our FI for a sustainable future. But the lessons I learned by coaching youth lacrosse can be applied to your FI... there are opportunities to transform ourselves by looking within. First, by defending our market share and customer base we can reduce attrition and increase the amount of business we do with current customers... Stacking the D. Secondly, in a highly commoditized industry we can differentiate ourselves by being better prepared than competitors... Winning in Practice. Lastly, when product differentiation and cost leadership is difficult, as it is in our industry, then we must find and develop our best employees to elevate our game... Finding the Hidden Gems.

~ Jeff

Sunday, May 01, 2011

Does your bank achieve positive operating leverage?

When a significant portion of your cost structure is fixed, then growing revenues should generate positive operating leverage... the cost of generating the next $100 of revenue should be less expensive than generating the previous $100.  This fundamental logic stands behind the banking industry buzzphrase, economies of scale. The fixed cost of your IT infrastructure is less on a relative basis for a $1 billion in assets financial institution (FI) than a $500 million in assets FI.

Because it is intuitive, doesn't make it so. Over the course of the past 10 years, the number of FDIC-insured FIs decreased by 23% (see chart). The average asset size per institution increased from $753 million to $1.7 billion. Clearly, part of this consolidation wave was attributable to FIs striving for economies of scale and positive operating leverage.

Has this consolidation, partly designed to give surviving institutions scale so they can spread relatively fixed costs over a larger franchise, resulted in positive operating leverage? My research into the subject says no.

One measure of achieving positive operating leverage is the efficiency ratio, defined as operating expense divided by the result of net interest income plus fee income. The lower the efficiency ratio, the greater the profitability. As an institution grows and is able to spread costs over a larger base, the efficiency ratio should go down.

But over the past ten years, efficiency ratios have risen in every asset category in both banks and thrifts with the exception of the very largest (>$10B in assets) banks (see charts).

The efficiency ratio measures how much in operating expense it takes to generate a dollar of revenue. So what if revenues (net interest margin, or fee income) are on the decline? Naturally, the efficiency ratio will go up. To further isolate expenses, I reviewed how expense ratios, defined as operating expenses divided by average assets, fared for our industry (see chart).

For banks, expense ratios have not budged during the period that resulted in a 23% reduction in FIs. Thrift expense ratios rose materially. I reviewed my company's bank and thrift product profitability reports to see if operating expenses per account declined during the 2000-2010 period. The answer: not one spread product group showed a decline in annualized cost per account. Not one.

Let's look at a couple of highly acquisitive FIs to see if they are achieving positive operating leverage by growing their balance sheets through mergers.

Fifth Third Bancorp

Fifth Third Bancorp is a $110 billion in assets financial institution with 1,363 branches and is headquartered in Cincinnati, Ohio. It has made six acquisitions totaling $32.6 billion in acquired assets between 2000 and 2007. The largest acquisition by far was the second quarter 2001 acquisition of Old Kent Financial, a $22.5 billion in assets bank. I chose this period to offset any impact from the 2008-2009 financial crisis. Clearly Fifth Third undertook acquisitions to achieve economies of scale. Relevant statistics during this period include:

While Fifth Third’s assets grew at a compound annual growth rate (CAGR) of 13.5%, earnings per share grew at a 1.1% CAGR and both the efficiency and expense ratios were higher in 2007 than when the bank was $45 billion in assets in 2000. Positive operating leverage should result in EPS growing faster than asset size because adding the next $100 in assets should cost less than the previous $100. Has Fifth Third achieved positive operating leverage by more than doubling the size of the bank during the measurement period?
BB&T is a $157 billion in assets financial institution with 1,791 branches headquartered in Winston-Salem, North Carolina. It made 21 acquisitions totaling $44.6 billion in acquired assets from 2000 through 2007.  BB&T acquired more, and often smaller, financial institutions during the measurement period than Fifth Third.  Relevant statistics include:
While BB&T’s assets grew at a CAGR of 12.2%, earnings per share grew at 10.8%. But the efficiency ratio remained relatively steady in spite of BB&T’s net interest margin falling from 4.20% in 2000 to 3.46% in 2007. The expense ratio declined, realizing economies of scale from its asset growth. Although EPS did not exceed asset growth, the culprit lies more in revenue generation than on realizing efficiencies from growth.

This analysis is a simple undertaking to determine if your financial institution is getting the results you want when executing a growth strategy to achieve economies of scale and positive operating leverage. If your results more closely resemble Fifth Third’s than BB&T’s, you should ask yourself why.

Economies of scale should result in lower efficiency and expense ratios, and greater profitability… i.e. positive operating leverage. If you are growing to spread relatively fixed costs over a greater revenue base, then you should measure to determine if you are succeeding. Success should result in better results to peer, industry benchmarks, and downward trends in operating costs per account. Growing absent success in these metrics means you are simply managing a more complex organization for no additional benefit. 
Do you measure and hold yourself accountable for reducing relative costs as you grow?
~ Jeff
Note: The above post was excerpted from a soon to be published Financial Managers Society (FMS) white paper drafted by the author.