Thursday, January 26, 2017

Bankers: Build Your Own Wealth Management Platform

Will millennials come to your financial institution once they've acquired the investable assets to make your Trust Department interested? 

Community banks must think so, because I don't hear many strategies centered on helping customers build wealth from early to late. Got $500,000 in investable assets? Boom! You'll start hearing from bankers, financial planners, and investment advisers alike. Want to start saving with $100/month. *crickets*

I wrote a blog post in 2015 about banks building their own small business loan platform. The reason: bankers tend to ignore small businesses until they are "bankable", meaning they have real estate collateral to borrow against. Well what about all that time from early stage to stable business? Credit cards still fill the breach. But into the fight came OnDeck, Kabbage, and Funding Circle. Ignoring a prospective customer until a bank is ready for them, risks that the customer may never be ready for the bank.

So, do we stand on the sidelines and let others serve Early Savers and hope bank sales forces are sophisticated and successful enough to woo them back once they meet bank thresholds?

I think this is a risky strategy. So let me suggest this to you. Build your own wealth management platform. (see below)

I will concede that banks work to get savings accounts. It is the platform that provides you with low-cost, core funding. But do you strive to grow number of accounts, or to grow savers? Does your bank have a savings account that could be opened for $100 without a monthly fee? Can branch or call-center personnel assess savers' goals and outline a path to become that high net worth or mass affluent individual or household I hear that bankers crave so much? 

Because, unless you are bequeathed with family money, we all started with a buck. Who, in your bank, will talk to customers when all that they have is that buck, and teach them to plant it, water it, give it sunshine, and turn it into real wealth?

Or do we open the savings account and hit the monthly number-of-account target?

Once enough money is built up in savings, then what? The Financial Planner doesn't want a $20,000 account. No problem. Robo-Advisers will take them. Side note: According to the President of Wealthfront, robo-adviser is a derogatory term. He prefers "automated investment services". Sorry to hurt your feelings fella.

Robo-Advisers, including Wealthfront, Betterment, SigFig and others are projected to manage $2 trillion in AUM by 2020, or 6% of all AUM. So they'll take that $20,000 account, and add $200/month to it.

No worries, right? Once that saver builds up that nest egg at WealthFront, they'll be knocking at the bankers' door to seek advice! C'mon. You Can-Not Be Serious! *insert John McEnroe voice*

So why doesn't your bank collaborate with a Robo-Adviser for this period of wealth accumulation? They are anxious to work with banks, including white labeling, so you will continue to have access to the customer although the Robo will be managing those investable assets. Create trigger points to contact customers to schedule appointments with your Financial Planners as customer needs evolve and grow. 

I modeled this relationship out in the accompanying table and infographic. I assumed the customer would go through four phases, each with differing needs of advice and sophistication: Early Savers, Wealth Striver, Future Planner, and Wealth Maximizer and Harvester. I then assigned number of years to be in each phase, and the average balance of the savers' accounts during those phases (see table).

To arrive at the Lifetime Value calculation, I used the average profit per year, for the year the platform earned the profit, and discounted it back to present day using a 10% discount rate. For the Wealth Striver years, I used a 20 basis point marketing fee against no expenses to calculate the average pre-tax profit. As one would expect, the present value of the profits in the Wealth Maximizer/Harvester years was the greatest, at $822 (see infographic). But the Future Planner and Wealth Striver years aren't so bad either. And, in my experience, banks aren't very interested in the Wealth Striver phase.

Odd because the lowest present value period is the Early Saver. That is where Wells Fargo had a big interest to meet their number-of-accounts goals. 

Would banks be better off thinking about their customers' wealth journey as depicted in the infographic? Do we think about it this way? Can your bankers advise those Early Savers on how to chart the course to become Wealth Maximizers?

Do we have the product set to help customers at each stage? Or do we pick our spots, let customers find their own way at our bank or elsewhere, and hope they come back when they are more valuable to us?

What's your strategy? Please don't say "hope".

~ Jeff

Friday, January 20, 2017

Banking Economies of Scale Revisited

In 2011, on these pages, I wrote my most read blog post ever, titled: Does your bank achieve positive operating leverage? Even today, nearly six years later, it receives a material amount of views. Particularly from larger financial institutions.

Economies of scale has eluded our industry in its purist form. For some time, banks between $1B and $10B in total assets tend to wring out the best expense ratios (operating expense/average assets) and efficiency ratios. So economies of scale hucksters walk with this chink in their armor as to why their story-line falters at a certain size.

I also noted in my most recent and in all of my past Top 5 total return posts that community banks deliver superior returns to their larger brethren. So, although there are plenty of consultants and investment bankers with pitch books telling you to get bigger, there are also contrarians such as myself that believe that bigger is not always better. And my pitch book is simply a bunch of spreadsheets. No fancy bubble charts, green light/red light tables, or tombstones. 

In this post I would like to revisit a couple of tables. First, I broke down all commercial banks by asset size to show expense and efficiency ratios as banks became larger. The results are below.

As the table suggests, financial institutions of all sizes reduced their relative operating expenses since 2011, with the only blip being a slight expense ratio increase in the $500MM-$1B commercial bank category. I should note that the efficiency ratio from that sized bank actually went down between 2011-16, suggesting a slightly better net interest margin.

The economies of scale argument clearly has merit, as you can see from the table. As asset sizes increase, expense and efficiency ratios tend to decrease. With that pesky exception of financial institutions between $5B-$10B in assets. These are averages. So there are exceptions. And I have often spoken about there being a significant number of exceptions to the economies of scale bromide. 

One example is German American Bank, highlighted in American Banker's Community Banker of the Year issue, and on this blog. It is a $3B bank with a 55% efficiency ratio. Open Bank in Los Angeles is a $722 million bank with a 58% efficiency ratio. I didn't have to research small efficient banks. They rolled off my tongue. Actually, my fingertips.

The below table was taken from my firm's profitability outsourcing database. We do the cost accounting for dozens of financial institutions that includes calculating operating cost per product account. Did costs go down at this granular level as assets grew?

Obviously, no. But why? If assets grew, and the bankwide expense and efficiency ratio has generally declined as banks grew, how did these costs go up? It is a fully absorbed cost system, so all costs within the bank are allocated to products and services.

My theory is this. Average balances per account have been growing since the low end of the yield curve has hovered near zero, and today is below 1%. The cost to originate and maintain a $100,000 money market account is nearly identical to originating and maintaining a $50,000 money market account. The growing average balance per account phenomenon has been occurring in most bank products. So, bankwide, costs would appear to go down because denominators, average assets in the expense ratio and total revenue in the efficiency ratio, are going up with the average balance per account.

Number of accounts, however, have not been increasing at nearly the same pace as the balance sheet, if at all. So all of those resources at your financial institution designed to grow new account relationships have not been efficiently utilized. 

In other words, in account originations, financial institutions are generally, and on average, over capacity. 

Financial institutions have tried to reduce this capacity in branches by consolidation and staff reduction. That is why you don't see material increases in cost per account in deposit categories. 

But either through expense reduction or new account acquisition, there is more left to do.

Sunday, January 08, 2017

Are Bankers At the Intersection of These Three Traits?

Jeff Weiner, CEO of LinkedIn, penned a post titled The Three Qualities of People I Most Enjoy Working With that was based on a Venn diagram (see below) he had previously posted. The diagram had 20k+ likes and comments on LinkedIn, and 2.2k retweets and favorites on Twitter. 

Does any bank culture produce these qualities? Does yours? There are headwinds. Banking, a slow moving tortoise of an industry until only recently, was not a big thinking industry. With all of the scrutiny, negative press, and regulatory change, I don't experience many bankers having fun, either.

What I do see at good performing financial institutions is the get sh*t done attitude. But even that is inconsistent. Impeding this culture is a "no mistakes" culture, or as we used to say in the Navy, "one aww sh*t wipes out 10 atta-boys". So whatever needs to get done goes through unnecessarily long approval chains to dilute accountability in case something goes wrong. And by wrong, I'm not talking something big, such as a regulatory order, or big losses. I'm talking about the possibility of an audit finding being enough to kill a get sh*t done culture.

A culture with all three would indeed be unique. And I'm confident there are financial institutions that have all three. I would like to hear from you about your bank, or one that you know, that has these three in their DNA.

Here are a couple of financial institutions that possess these traits.

Dream Big

In the fourth quarter of 2010, an investor group recapitalized a $66 million in assets financial institution, that was breaking even, and had less than $6 million in capital. The investors changed the management team, moved the headquarters, and dreamed big. Today, First Commerce Bank, in Lakewood, New Jersey, has $826 million in assets, $101 million in equity after a recent capital raise, and delivers a 1.56% ROA and a 17%+ ROE. By every financial metric this bank has been a success. The secret: Work Hard, Dream Big. My words, but not dissimilar to the words I've heard their CEO, Herb Schneider, say.

Get Sh*t Done

In my firm's most recent podcast, Tony Labozzetta, CEO of Sussex Bank, described how his team engineered a simultaneous turnaround, growth, and profitability story. When Tony's team was forming in the first quarter 2010, the bank had $452 million of assets, was barely making money, and over 5% of its loan portfolio was non-performing. Rather than hunker down and work through their troubles, they assigned bankers to work through them, and built a wall around them so the rest of their team could focus on that other thing... running and growing a profitable bank. Asset growth has been 12%, 15%, and 27% (year-to-date September 30th) the last three years respectively, the ROA was 0.72%, and non-performing loans to total loans was less than 1%. I'd say they got sh*t done. And they're still doing it.

Know How to Have Fun

A bank that knows how to have fun is difficult to pinpoint, although I'm confident there are some. With so many financial institutions tense about their next exam due to regulators' often times capricious interpretation of the implementation of regulations and law, how can bankers channel this tension into experimentation, technology adoption, and yes, fun. I think fun can be had. Here are a few things I think would work in creating an atmosphere ripe for employees having fun. 

1. Embrace mistakes as opportunities to learn. So long as the mistakes aren't of the "bet the bank" variety. 

2. Highlight and reward successes. Do so publicly, in the company newsletter, or an awards ceremony, etc. So often the positive to negative feedback ratio is way out of whack. Catch people doing something right. And train your supervisors to do the same.

3. Fire people. That's right, I'm suggesting firing people in creating a fun culture. Because nothing kills a fun culture than those sergeants in your bank that criticize far more than compliment, have zero tolerance for mistakes, and thwart efforts to move your bank forward. Get rid of them. The employees that remain will silently cheer. 

4. Start at the top. CEOs and executives could smile more, lighten up a meeting, pat people on the back, say thank you, etc. Your team is more likely to have fun if most signs they see from you is that you are having fun.

Tell me, what bank culture has all three?

~ Jeff