Fintech'ers Will Be Right on Branching. Unless Bankers Act.

Are branches dead? The conventional wisdom from the shouters would be yes. Look at transaction counts. Look at the decline in branches since 2009. Look at the surveys.

I read a recent interview of Members 1st Credit Union CEO Bob Marquette by S&P Global Market Intelligence (link requires subscription). When asked, Marquette said of the death of the branch: "I think it's bullcrap. I think banks are closing branches for one reason: to cut costs and prop up their earnings and boost their stock price." 

Clearly he is not attending FinTech conferences. 

Remember those predictions about the checkless society, and cash being dead? Yet both live on. Although the trend is decidedly in that direction. I sometimes quip that FinTech prognosticators are like futurists. They make educated predictions. And they typically miss the timing. Sometimes by decades or generations.

In Brett King's 2012 book, Branch Today, Gone Tomorrow, he called for a 50% reduction in branches while asking what would banking look like in 2015. Between 2012 and 2015, there was a 4% branch reduction. As Bob Uecker would say, "Just a bit outside." The decline between 2015 and 2016 was 1.5%. I'm not sure if Brett's intention was to make a prediction or a wish.

But I believe Brett's prediction will become truer by the year. I am not smart enough to make a prediction combined with the timing of the prediction.

I also believe that branches can be developed as competitive advantages for community financial institutions. Much like the credit union CEO thinks his branching strategy differentiates his CU. But, as our current strategy execution stands, there is much work to be done.

On March 6th, I tweeted one inconvenient truth for FinTech'ers (see pic). 

The green bar was all respondents. The red: millennials. The gold, Gen Z, which I didn't know was a Gen yet. They are under 21 years old!

And when my friend and fellow bank consultant Mary Beth Sullivan from Capital Performance Group in DC shared the post in the below pic on LinkedIn, it stirred a spirited rebuttal. I only hope my friend Ron Shevlin from Cornerstone Advisers still owes me a drink. Don't click on those links! They're competitors. :) 

I don't want to engage in a tit for tat on studies. Figures don't lie but liars figure, right? Note to Mary Beth and Ron. I'm NOT calling you liars (I would be calling myself one too). No alerting the press required. And would they cover consultants bickering anyway?

I digress. Back to the post. Perform this common sense test when there are a group of you in a room... a group of regular people. Not bankers. Not bank consultants. Not FinTech'ers. Ask for a show of hands how many people bank with a bank that has a branch in the town where they live. My guess, if you asked 10, eight would raise their hand. Common sense.

But perhaps it would've been nine in 2012. I will give the branch doomsayers that. And I think the trend would go down over time. So here is how I think bankers can slow branch decline. I don't think it will stop. Because the large banks look to branches for continuous cost savings, and I don't foresee that changing. Which is good if a competitive advantage is what you are after.

1. Identify what makes the branch important to your customers. I think if bankers asked this from the start, we could've avoided the WaMu Occasio experiment. Although I read a story today about a FinTech firm in Vietnam opening bank branches because the government requires an employee to verify the account holders' identity in-person. But the rest of the branch is essentially a customer hang-out. Like Occasios were supposed to be. If this is important to your customers, then perhaps a hang out is what you should build. But my "ears to the tracks" tells me customers want to open accounts, get loans, and solve problems at branches. Small businesses still want to drop off deposits. So take the pulse of your markets, and make the branches into what your customers want and will want them to be.

2.  Elevate branch employees. If your market wants business acumen from your branch employees, can they do it? Did you know the University of Toledo offers a Certified Business Advisor designation? And banking associations offer a host of certificates for increasing the knowledge base and skill sets of branch employees to meet the emerging needs of customers in a new-branch environment. The all-too-familiar approach of putting branch employees in a position to fail because we elevated them from teller-head teller-assistant branch manager-branch manager without giving them the skills to do what your market demands will doom the community banks' attempt to position branches as a competitive advantage.

3.  Make your branches look the part. Once you identify what customers want and set out to elevate employees, take a look around. I wrote about branch decor in these pages. In it, I wondered if customers would drink your brand Kool Aid if your branch manager had stacks of paper on her desk, or if your carpet had coffee stains from 1984. Cher got a facelift and looks pretty good. So should your branches.

4.  Pull the plug on poor performers. Where will you get the money to pay for those higher skilled branch managers (and perhaps all branch personnel), the training it will take to get them there, and a date with HGTV's Fixer Upper? By pulling the plug on those branches that were $18 million in deposits last year and grew to $18.3 million today. They are dogs. You're investing $500k (more or less) per year per branch to keep them open. And you will lose very few deposits by closing them, particularly if you have a branch nearby and good online banking technology. Stop it! Close them! Invest the savings.

Interesting that I call for branch consolidation when I'm arguing for the relevance of branches, no? I'm a modern-day consultant.

You can do the above or some variation of it. Or....

You can continue with business as usual, or some minor modification of it. And run the risk of proving the branch haters right. Your choice.

~ Jeff

What's With Regulator Agita Over Bank Commercial Real Estate Lending?

Anxiety, anxiety, anxiety. The recovery from the Great Recession is eight years running. Ample time to look down the road towards our next recession. And regulators are getting anxious. Anxious about commercial real estate (CRE) concentrations. 

Last December, Astoria Financial Corp. and New York Community Bancorp called off their planned merger. Why? They couldn't get regulatory approval. Both institutions were over the CRE concentration guidelines, so putting them together would exacerbate this risk, so the regulatory thinking must have been.

Today, I read an American Banker article on how a multi-billion dollar bank is going to ramp up its business lending. Why? Reading between the lines, this bank is likely over the CRE guidance levels, and were probably getting grief from their regulators about it.

To remind readers, in 2006 the OCC, Federal Reserve, and FDIC issued joint interagency Guidance on Concentrations in Commercial Real Estate Lending. They need a marketing person to title their reports. Maybe sub out an economist or two.

To summarize, banking institutions exceeding the concentration levels should have in place enhanced credit risk controls, including stress testing of CRE, and may be subject to further supervisory analysis. Whatever that means.

The CRE concentration tests are as follows:

1.  Construction concentration criteria: Loans for construction, land, and land development (CLD) represent 100% or more of a banking institution's total risk-based capital.

2.  Total CRE concentration criteria: Total nonowner-occupied CRE loans (including CLD loans), as defined in the 2006 guidance (“total CRE”), represent 300% or more of the institution’s total risk-based capital, and growth in total CRE lending has increased by 50 percent or more during the previous 36 months.

The OCC did an excellent analysis of the impact of this guidance in 2013. If you have some free time to read it, I encourage you to do so.

The upshot of the analysis, in my opinion, is that the risk can be further limited to CLD lending, more so than straight, plain vanilla CRE lending that is so common in community financial institutions. See the chart below from the OCC report for net charge-offs during the Great Recession.

To be balanced, and not a news media outlet, it is true that banks that grew CRE fast, i.e. over the guidance levels mentioned above, regardless if in the CLD or straight plain vanilla categories, were more likely to fail during the period measured. But isn't fast growth by itself an indicator of increased risk of failure, regardless of the loans that fueled the growth? Risk mitigants tend to lag growth, especially fast growth. And success is the great mollifier to risk managers that wish to take away the punch bowl when the party's rockin'.

So, yes, fast growth leads to greater failures. But that's why fast growth is riskier, and tends to reap greater rewards for stake holders. Look at technology companies. Their shareholders are highly rewarded for fast growth. And they take on greater risk, because earnings have yet to materialize.

I would like to take issue with the implicit pressure on financial institutions for going over the 300% guidance levels for plain vanilla CRE. Note that the guidance says AND 50% growth over the past three years. But is that how it is being examined and enforced? Or are examiners, and perhaps bankers, pulling back on bread and butter lending, seeking loans where they have less experience or there is riskier collateral?

The below two charts tell a story. The Great Recession lasted from the fourth quarter 2007 through the second quarter 2009, according to the National Bureau of Economic Research.

For the below chart, I took every bank and savings bank, not federal thrifts because during this time they still filed TFRs versus Call Reports, and therefore their loan categories were different. But look at the asset classes that were on non-accrual during this period. How significant was CRE lending to the souring of bank loan portfolios?

The following chart is from my firm's profitability outsourcing service. It shows the pre-tax profit as a percent of the loan portfolios measured. We perform this service for dozens of community banks. CRE lending remained more profitable and stable then C&I portfolios, which seems to be the asset class banks try to increase to offset the risk of CRE concentrations and raising the ire of their examiners.

CRE not only remained profitable during the Great Recession, but more profitable and more stable than C&I. Indeed, even today, CRE is the most profitable community banking product. If you wondered why community banks feast on it, there ya go!

I don't want to suggest that banks continue packing on CRE and relegate C&I to the back burner. C&I loans are typically smaller than CRE, are more difficult to underwrite, and require more resources to monitor. Yet the pricing we see in our product profitability service does not show bankers getting paid for these challenges. C&I spreads were very close, and in some institutions inferior, to CRE spreads. Also, there are an increasing number of technology solutions that can reduce resources needed to more profitably deliver C&I loans to the market.

So, don't let this blog post motivate you to double down on CRE, and turn your back on C&I. What do your customers demand? What is the trend in your market? How can you reinvigorate economic vitality into your communities?

Don't let regulatory guidance or the inefficiency in your lending processes answer those questions. Let your markets and customers do the talking.


~ Jeff

Who Am I?

Who I am is in the eye of the beholder, right?

Quick note: I mostly blog about banking. Today I blog about myself so you can have a better idea of the person behind the writing.

I am a recent member of my local Rotary Club. New members typically give what is termed a "Classification Speech" to the membership. I was no different, and was tapped to deliver mine last month. So I called the club president to ask what I should talk about.

"Anything you want" he said. He later regretted it. Giving me an open mic is ill-advised, as my wife would tell you.

I formatted my Classification talk in "Who Am I" format, much like how Admiral James Stockdale quipped in a 1992 Vice Presidential debate. I delivered it extemporaneously, so I don't have the exact words I used on that day, just an outline scrawled on a piece of paper.

But here is the essence of what I said.

Who Am I? I am John and Joyce Marsico, my parents. My dad died of Hodgkin's Lymphoma when I was six years old. Eleven months from diagnosis until death. He was the local McDonald's manager. My mom was a stay at home mom, which was more typical in those days. Work life was different then. If my dad took weeks off to get and recover from chemo, he wouldn't be paid for that time. So after chemo, no matter his condition, he went to work to keep the family money flowing.

When he passed, my mom was left with three boys, ages 8, 6, and 3. No income. And little life insurance. She went to work, and we lived off her wages and the social security survivors benefit. In spite of those tremendous challenges, she kept us in Catholic school for fear that without a father, we were at greater risk to getting into trouble or hanging out with some bad kids.

In today's society, we call people hero's for not so heroic things, like scoring a goal, or being in a film. Today someone called Kurt Russell and Goldie Hawn "inspirational". Try going to work the day after chemo. 

I am the husband of Jackie. We were high school sweethearts. I was working the charm on her since Mrs. McTighe's high school English class. Took three years. Got married when I was 21, she was 20. Everything we have we built together. Nothing was given to us. Today, if you saw us walking down the street together, you would think I was rich. Well I am. Not in the money way.

I am a sailor. I served in the Navy because my father, grandfather, and uncles served. And I could've used the funding to pay for college. It was a tremendous adventure. I remember being taken out to my first ship that was sailing into the Mediterranean Sea, the USS Coral Sea, an aircraft carrier. I was flown out on a C-2 Cod, the only cargo plane (at the time) to be able to land on carriers. It had one window on each side, and I got the window seat. Coincidentally (or not), the chaplain was in the seat next to me. Aircraft carriers are mighty big ships, but very small airfields. I survived. Many of my old Navy friends remain my shipmates.

I am the father of two girls. As I mentioned above, I grew up in an all boy household. Girls, as I entered adolescence, were awesome. I didn't know why I played ball with Jane all the way up to middle school, and suddenly I was ok with being her cheerleading base! As a dad, I knew. So God sent me two to test me! Ok, maybe that's exceedingly narcissistic. Raising girls was difficult for me because I had no frame of reference. And the emotional ups and downs of growing up is more pronounced on girls than boys, in my experience. It weighed heavy on me when my girls went through it. But they made it through with flying colors! So far. Fingers crossed.

When our first was born, my wife and I were stationed in Rota, Spain. Twenty one hours of labor, the last three pushing. My wife, not me. I just experienced a couple uncomfortable hand squeezes and a difficult glare when I ordered pizza. After those 21 hours, the doc decided on a c-section. After trying to push my daughter out for so long, she had a conehead when she was born. So my first words when she was born was not "beautiful", or "wow". It was "is that normal?". It was normal, by the way. 

I am a bank consultant. When I first started, I worked primarily on mergers and acquisitions, where my boss told me that my job was 20% math, 80% psychology. It hit home when we were negotiating a transaction that the handshake-creating concession was to allow the chairman to keep his Bentley. Psychology. 

My kids still don't know what I do. In simple terms, some of what I do can be described by example. I watched a banker in deposit operations reviewing checks. She was flipping them one at a time. I asked what she was doing. She said checking for fraud. I asked what fraud looked like. She didn't know. I asked how long she did that per day. She said one to two hours. I suggested she stopped doing it. 

Perhaps that's an oversimplified example of some of the things that I do. But it's true. 

I am a Rotarian. Truth be told, I probably wouldn't have joined Rotary if not for my friends Dan and Kevin. But I was getting to the point where I was growing tired of the excuse that I travel so much that I can't commit to much. Travel is the primary reason I had to hang up the whistle as a lacrosse coach. 

I was getting a haircut one day at Manny's barber shop. I call him the hip-hop barber because he was playing hip-hop the first time I visited. While getting my haircut, Manny took a call. After getting off the call, he explained that he had to schedule a haircut for a bed-ridden young man, who had a catastrophic accident years ago. He had been cutting his hair for years. What made Manny's generosity even greater, was the young man lived 30 minutes away. 

That's charity for your fellow man. And that's why I had to be more than the contributor to the family checking account.

~ Jeff

Did you know? That since Rotary's first effort to eradicate polio from the face of the earth in the Phillippines in 1979, polio cases are down 99.9%! How about that! *Mel Allen voice*

Cultural Conversation in Banking

Are your incentives consistent with your strategy and culture?

I was recently interviewed by the Financial Managers Society on this topic, and as a lead-up to my presentation on the subject at the upcoming FMS Forum in Las Vegas in June.

Here are excerpts from the discussion.

FMS: Why is measuring account openings such a misguided endeavor?

JM: If a bank measures product profitability, costs follow activity. Those that don't measure product profitability intuitively tend to believe that the number of accounts drives the work more than balances, even though balances, for the most part, drive revenue in banking.

So if customer A comes in with $10,000, an accounts-driven institution would try to split up that $10,000 between two or three accounts so they can hit their targets. The profit-focused bank, on the other hand, would do what the customer originally intended, and open up that checking account knowing full well that they would get similar or equal spread on the $10,000 in the single checking account, but have less back-office expenses to absorb than if they opened three accounts.

FMS: Which numbers should matter in the quest for better profitability - and why?

JM: Co-terminous spread and direct pre-tax profit - and the trends for both - would create an environment to drive profitability rather than activity. Bankers typically hold lenders accountable for the size of their portfolio and their production. What if they were instead held accountable for the spread (after provision), both in dollar aggregate and the ratio, and the trend for each?

So if Lender A had a $50 million portfolio at a 1.25% co-terminous spread, or $625,000, would that be better than the lender with a $35 million portfolio, with a 2% co-terminous spread? The math says no. But who reaps more reward in today's environment?

FMS: Bigger picture, how can the right incentives lead to a better culture?

JM: We look for the path of least resistance in terms of meeting goals and incentives - it's human nature. If I'm a branch manager whose incentive kicks in if I grow branch deposits by 10%, then I'm looking to do that with the least resistance. So I might call my regional manager daily for CD rate exceptions to get that $200,000 CD, even though with the rate exception, that CD might have a five-basis-point spread.

On the other hand, if I was held accountable for growing my branch's co-terminous deposit spread, would I still chase the CD customer? Or would I maybe seek the operating account at the tire and battery shop down the street, even though that might bring 25% of that CD balance to my branch? Multiply that logic to every profit center within the bank. Now you have a culture!