Financial Wellness as a Profit Center for Financial Institutions

So many financial institutions list "financial literacy" or customer "financial wellness" as one of their higher purposes. Which makes immeasurable sense given how defined benefit pension plans are now the exception and households are left to fend for themselves when it comes to their own financial wellness. 

And by objective measures they are not doing too well. According to a 2023 Payroll.org study, 78 percent of Americans live paycheck to paycheck, meaning if they miss a paycheck they would have trouble paying their bills.  That is up 6 percent from the prior year. 

Further, in 2022, only about 46% of households reported any savings in retirement accounts. Twenty-six percent had saved more than $100,000, and 9% had more than $500,000. This was why my firm did a recent This Month in Banking podcast with our friends from CentSai as our guests on how promoting financial literacy can help financial institutions perform better. You read that right. 

The need for someone, anyone to help Americans become first financially sound and then financially free was driven home by Anne Shutt of Midwestern Securities, presenting Creating a Financial Oasis at a recent banking conference I attended. Anne said that only 14 percent of respondents of a recent survey said their financial institution helped them with their financial wellness. 

I contend that financial institutions should serve a higher purpose other than maximizing profit to benefit shareholders. But in serving your communities, employees, customers and shareholders, profit should be your yardstick in a stakeholder driven, higher purpose financial institution. And right now, financial literacy is executed for the benefit of one, maybe two constituencies, at the expense of the others. To create alignment, I propose a different path.

Make financial wellness a profit center. Like a branch. Assign personnel to it. Like a branch. Instead of branch manager, assistant branch manager, and three universal bankers, staff with two financial coaches, and a financial wellness assistant. 

When we onboard new customers, as part of our Know Your Customer, determine their financial well-being. Ask if they would like, as part of being a customer of the bank and for a small quarterly fee (perhaps... might waive this as the Financial Wellness Center (FWC) builds its customer base) they can opt-in to improve their financial well-being. If they opt yes, then their account, balances, spread, fees are part of the balances and revenue streams of the FWC. 

In addition, we can market to existing customers that struggle financially based on observable criteria, human judgment, or generative AI. At first, this center will bleed red ink. So do new branches. Even some mature branches that banks refuse to close. But red ink should not be the goal, as many altruistic, CRA-driven community initiatives are.

The challenge is that those most in need of the FWC will likely carry low balances and are in the Cash Flow & Basic Needs or the Financial Safety rungs in the chart below, presented by Anne. Low balances per account have a strong correlation to low profits, as spread represents so much of profit in community financial institutions. Revenues are generally driven by balances, where expenses are driven by number of accounts. Not a great mix for the FWC.

But we don't have a physical facility, like a branch. Although the FWC might have to absorb or incur some sort of internal transfer payment to branches servicing their accounts. That said, there would be less expenses than a branch that would have more employees and physical plant than the FWC. The FWC would likely have more fees, as lower average balances and the need for a financial coach probably equates to more insufficient funds charges, etc. This has consistently been the case when we measure the profitability of higher versus lower average balance accounts in our profitability outsourcing service. And there would be those coaching fees. 

In addition, I find it plausible, even likely that a bank with an FWC designed to improve their customers' financial well-being will include some account ornamentation, such as credit score monitoring, lower my bills services, etc. that the bank can charge a fee for service. 

I don't think the FWC could achieve the same level of profit as some of the bank's larger branches, commercial lending center(s), or mortgage department (during good times). The FWC could strive to achieve some pre-tax profit number as a percent of average deposits of, say, 50 basis points for a bank that strives to achieve over a one percent ROA. In addition to that accountability metric, the FWC could ensure all of their clients are on the bank's personal financial management tool, and gauge improvements in customers' net worth as a sign of success. Lastly, the FWC could use improvement in customers' credit score as objective evidence of success. 

And when customers elevate to Accumulating Wealth or higher in the chart above, they can graduate from the FWC with a natural referral to our wealth group. Because right now, wealth groups are not seeking many customers at or below the Accumulating Wealth level. They just can't make any money doing it. So we let customers seek other alternatives and hope we win them back when they have $500,000 or more in investible or bankable balances.

Financial Wellness Centers can work. But we have to elevate beyond altruism and CRA and migrate to profit to make it a viable line of business to our financial institution.

~ Jeff

Guest Post: Financial Markets and Economics Update - Second Quarter 2024

Financial Markets Update – Second Quarter 2024

A dream vacation!  I went with family and friends to Holland and Belgium during peak tulip season during April.  It was so beautiful and lots of fun.  We saw so many fabulous places, including Amsterdam, Kinderdijk and its windmills, Keukenhof Gardens, Brussels, Bruges, and Antwerp.  We learned how Holland keeps the floodwaters away.  It was my first vacation in decades where I did not have work waiting on my desk when I got home.   Also, my family and I got to spend three days in Hershey last week watching the excitement on the children’s faces as they moved from ride to ride and played in the water parks.  For me, this is what my retirement is all about.  That and getting consumed by Euro 2024 and Copa America soccer and of course, the Phillies.

Where is the Recession?

I think I’ve spent too much time reading and studying economics.  The time-honored indicators that so many of us review for signals of recession continue on, month after month, and yet their ability to project recession has not turned into reality.  Take, for instance, the inverted yield curve.  In July 2024, we will mark two years of inversion between the 10-year Treasury and the 2-year Treasury yields.  It is already the longest inversion on record, surpassing the 624-day inversion ending in 1978.  The spread currently stands at -37 basis points.  At times, the spread exceeded -100 basis points.  The 10-year Treasury versus the 3-month Treasury spread, which turned negative in October 2022, is now -101 basis points.  So, after 18 months to 2 years later, where is the recession?  Some say it will appear when the curve re-steepens and some say it is coming soon.

And what about the index of leading economic indicators?  For this cycle, the LEI first had a negative monthly reading in April 2022.  Other than a slight positive of +.2% in February 2024, when the Conference Board gleefully announced that there would be no recession, the index has been negative for 27 months and is down a cumulative -15.1%.  So where is the recession?  I think we have to wait.  We know the Conference Board measures three factors with the LEI, including duration, depth of the decline, and diffusion indices; but, seriously, two of three are screaming watch out below.  The same Conference Board reversed course and now says there is a “fragile outlook,” making themselves look ridiculous as the LEI continued its descent.

And what about tight Fed policy leading to weaker growth, especially if they hold rates too high for too long?  We have many examples, notably 2000-2001, 2006-2008, and 2019, when restrictive rates impaired growth and recession followed.  Between March 2022, and July 2023, the Fed increased rates by 525 basis points, with Fed Funds at 5.50% ever since.  Are they restrictive?  Yes, when Fed Funds is above inflation and above nominal GDP growth.  Note all of the following:

FF less CPI of 3.3%= 2.2%; 

FF less core CPI of 3.4%= 2.1%; 

FF less PCE of 2.8%= 2.7%; 

FF less core PCE of 3.7%= 1.80%; 

FF less nominal GDP 1Q24 of 4.5%= 1.0%; 

FF less nominal GDP 4Q23 of 5.1%= .4%.  

We’ve seen slowing from this restrictive policy but not recession.

And what of QT?  The Fed was allowing $95 billion of Treasuries and MBS to roll off of its balance sheet but reduced the total to $70 billion starting in May.  It seems to be an acknowledgement that they must reduce this restrictive policy and that easing is coming soon as money supply was being impacted too much.  But I will get to money supply later.

Parts of the economy are suffering, including housing from high rates affecting affordability, weak housing starts and a 30-year low for existing home sales with low inventories keeping home prices higher than normal.  Manufacturing is weak.  Consumer spending and retail sales are declining this quarter as people cope with high inflation, especially on food prices.  Retail store closings have escalated as sales weaken and retail theft skyrockets.  Both consumers and businesses are paying high interest rates on their increasing debt balances.  One of the components of the LEI which is up strongly is the S&P 500 stock market index, by +14.5%.  Rallies in the Magnificent 7 stocks and Artificial Intelligence’s transformational potential mean that we may not get a recession signal yet from stocks.

So there is still no recession, although I stubbornly refuse to remove it from my forecast.  Rates that are kept too high for too long will not lead to anything good.  Signals from the yield curve and leading indicators dampen the outlook.  In my mind, recession should have already happened.  So I am obviously not accounting for existential or even psychological factors that are delaying the inevitable.

Real GDP.

Chairman Jerome Powell recently called economic growth “strong” in his press conference.  I hope he was not looking at the first quarter at 1.4%.  OMG!  Or maybe he was looking at the notoriously volatile Atlanta Fed’s GDP Now projection for the second quarter of 2.2%.  It’s a sad day when GDP growth of 2% or less is “strong.”   Of course, that’s what we lived through from 2010 to 2020.  Regardless, the FOMC projection for GDP is 2.1% for 2024 and 2.0% for 2025 and 2026.

My favorite banker, Jamie Dimon, recently called his economic outlook “cautiously pessimistic.”  He has been worried for such a long time; remember when he said in 2022 that there would be a storm, or even a hurricane that would hit the economy.  I have shared this same view with him.  And interestingly, he must now be thinking about retirement, because when asked how much longer he will stay at Chase, he did not respond with his traditional “five years,” but said “less than five years.”

With recession in many people’s projections, but not appearing on the horizon yet, we have to navigate our boats as best we can.  GDP is projected at 2% for an extended time.  I think it could be lower.  If we look at out-of-control federal government spending, budget deficits, and ever-increasing debt, it is having an impact on our growth potential.  Debt-to-GDP at the end of the 1Q24 was 122.3%; studies show that debt levels greater than 90% of GDP (which we’ve had since 2010) lead to a severe reduction in GDP.  Debt service payments for the government are accelerating at an unsustainable pace.  Lower GDP means lower inflation but it may also mean lower tax receipts.  Maybe the roller coaster in Treasury yields will come to a stop and we will see lower long-term rates.  The 10-year Treasury has been quite volatile in 2Q24, starting at 4.20%, peaking at 4.65% in April, and ending at 4.35%.  The 2-year Treasury started at 4.62%, peaked at 5.01% in April, and ended at 4.72%.

Money Supply M2

The 16-month streak of declining M2 money supply has been broken, when April and May showed slight year-over-year increases of +.2% each month, following declines of -1.0% in March, -1.9% in February, and -2.2% in January.  M2 had been declining on a y-o-y basis since December 2022 and this was the first time since the 1930s where we saw M2 fall.  We are still far below the long-term average M2 growth of 6% to 6.9%, which approximates nominal GDP growth.

In the past 150 years, excluding the current 2022-2024, M2 has declined only four times on a y-o-y basis, in 1878, 1893, 1921, and 1931-1933.  These four instances led to recession/depression and high unemployment.  I’m not sure about this time, but I think it was necessary to offset the massive federal deficit spending so that inflation could fall.

Let me repeat Milton Friedman’s quote and add more to it: “Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output (GDP).”  He made this quote in 1963, referring to persistent inflation, not short-term supply shocks.  Maybe everyone will forgive the Fed and people like myself in 2021 for initially thinking inflation would be “transitory” because of supply shocks.   We were wrong and quickly realized it because M2 was growing so much faster than GDP.  Not until mid-2022 did CPI peak at +9.1% y-o-y and start its deceleration in pace.  But now think of Friedman’s quote in reverse; if the quantity of money drops more than output, should we not see disinflation?

Misconceptions about Fed Inflation Targets

The Fed’s targets for inflation of 2% apply to PCE and core PCE.  The Fed does not target CPI.  I repeat, they do not target CPI, but they inherently consider it.  Prior analyses have shown that CPI tends to exceed PCE by .5%, due to the different construction of the underlying indices.  If the inflation target is 2% for PCE, CPI can be 2.5%.  

The Fed does not target wage growth per se.  Did anyone catch Powell’s comment during the press conference in June that linked inflation and productivity to arrive at acceptable wage growth.  I’ve written about this several times; if PCE is 2% and productivity averages 1.5% (as it has for long periods of time), then wage growth can be 3.5% and can co-exist with a 2% PCE inflation target.

Employment

In my last newsletter, I wrote that I had real reservations about the employment report.  Now I feel vindicated.  In his press conference, Chairman Powell expressed the same doubts about the employment report and the birth/death ratio applied to small businesses, which accounted for over half of all jobs added in the establishment report in the past twelve months.  Since April 2023, the B/D ratio accounted for 1.9 million, or 56%, of all new jobs.  In the May 2024 report, payrolls rose by 272,000 jobs, which included 231,000 jobs added for the B/D ratio in the face of declining business formation.  It’s ridiculous.

Look at the contrast between establishment (payrolls) and household surveys since February 2024 and the number of unemployed and pool of available workers:

Payrolls May +272,000, April +165,000, March +310,000, February +236,000; total +983,000

HH survey May -408,000, April +25,000, March +498,000, February -184,000; total -69,000

Unemployed May 6,649,000, April 6,492,000, March 6,429,000, February 6,458,000; chg +191,000

Pool AW May 12,366,000, April 12,129,000, March 11,872,000, February 12,130,000; chg +236,000

The unemployment rate now stands at 4.0% in May, up from a low of 3.4% in 2023.  The payroll numbers get the headlines, with almost 1 million jobs added in 4 months, but look deeper.  Household jobs are down and the unemployed and pool of available workers (unemployed plus those not in the labor force who want a job) are growing and the unemployment rate is on the rise.   Thankfully, the unemployment rate is calculated from the household survey, not the fictitious payroll numbers.  They are almost as fictitious as the JOLTS reported job openings.  Additionally, full-time jobs are down 1 million to 133.3 million in the past year, while part-time jobs are up 1.5 million to 28.0 million.  So, you tell me, is this a strong labor market?  Should I keep recession in the forecast?

End of an Era

In June, there was another end of an era for one of our rate indices.  Just like LIBOR was kicked to the curb, now FNMA discontinued posting its historical daily required net yields for 30- and 15-year mortgages on June 3rd, claiming that many market participants didn’t use them.  But what about the ones who did?  To me, they were worth tracking as an indicator of the mortgage whole loan versus MBS market spread.  Gone is the history back to 1985, too.  Very sad.

Summer is here.  May you all enjoy wonderful dream vacations!

I appreciate all of your support!  Thanks for reading!  DLJ 06/30/24

Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy recently retired from Penn Community Bank where she worked since 2004. She is the author of Just Another Good Soldier, and Honoring Stephen Jaworski, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure of devotion.

Disclaimer:  This publication is provided to you solely for educational and entertainment purposes.  The information contained herein is based on sources believed to be reliable but is not represented to be complete and its accuracy is not guaranteed.  The expressed opinions, views, and estimates are those of the author as of this date and are subject to change without notice.  The author cannot provide investment advice but welcomes all comments.

Regulators War on Banking

Last year I wrote a Forbes Finance Council article What's Missing in the CFPB's War on Junk Fees? That war was being waged against overdraft fees. I stated that comparing the fee assessed on an overdraft to the cost of processing one is like comparing the cost to manufacture a pill to the cost of the medication. It is short-sighted to isolate overdraft fees from the total cost to originate and maintain a checking account. If the CFPB was so concerned about fees charged by banks, perhaps they should perform an analysis of over regulation that is a key contributor to fees charged by banks.

Regulators must not have read that article. Because they have since expanded their war to include, among other things, debit interchange. Oliver Wyman said this in their Impact of Simultaneous Regulatory Proposals in Retail Banking: 

"The Fed proposes under Reg II to decrease the maximum allowed debit interchange fee from $0.22 + 5 basis points to $0.157 + 4 basis points for issuers above $10 billion in assets. With a 2021 average ticket of $46.26, Reg II would decrease the average interchange transaction by ~28%. Debit interchange is a significant component of checking accounts non-interest income (around 50% according to data from payment card publication Nilson Report). Therefore, the proposed rule has a more significant impact on the profitability of low-balance checking accounts due to banks' relatively higher reliance on non-interest income for these consumers (versus high-balance checking accounts that rely more on interest income). Additionally, this may lead banks to start charging for fraud losses to recoup lost revenue - under Regulation E, banks are able to charge $50 for fraud losses to the customer, however, most banks cover those losses for their customers."

I should point out that when the Durbin Amendment of the Dodd-Frank Act (2010) capped interchange fees, it did not result in any measurable benefit to the consumer. Why take a second bite at the apple?

In my Forbes article, I demonstrated that banks' reaction to downward pressure on fee income, be it overdrafts or other fees, was to increase their average deposits per account. Meaning that they started focusing on more affluent customers that tend to carry higher balances so they can offset the fee decline by driving more spread through the account. 

Yet here they go again. And Oliver Wyman is what I believe to be correctly assuming that banks will make moves to cover the revenue shortfall from debit interchange mandated by Reg II. What do regulators think will happen?

When I look at the average cost per retail checking account, be it interest bearing or non-interest bearing (see chart, courtesy of The Kafafian Group performance measurement), I see consistency in operating cost per account.

This is in spite of the average balance per account in interest checking growing 44% between the first quarter of 2007 to the fourth quarter of 2023. The average balance per account of non-interest checking accounts grew 152% during that same period. Banks themselves grew asset size to achieve that holy grail of growth, economies of scale. So why have we not lowered our average operating cost per account in retail checking accounts?

I cannot lay the sole blame at the feet of regulators. In every institution we have served with Process Improvement services we have found onerous processes, inefficient technology utilization, and silos prohibiting greater efficiency and therefore lower average costs per account. But many of those processes were belts and suspenders responses to regulatory scrutiny or the fear of that scrutiny in the bank's next exam. 

If regulators work overtime to keep bank's operating expenses higher than need be through regulatory activism (see recent consent orders to BaaS banks around BSA/AML/OFAC compliance-classic checking account critiques) and keep pretending to be the Champion of the Consumer through price fixing regs like Reg II, expect financial institutions to rightly try to fill that profit hole. Be it through charging other fees or increasing minimum average balances that is suggested in the Oliver Wyman report, or through focusing on more affluent customers that carry higher average balances, as stated in my Forbes article.

Either way, will it end up better for the consumer? Look at how so many banks have significantly curtailed consumer lending. It's not because they don't want to serve their retail customer base with a more robust product offering. It's because regulation increased the cost so much and elevated the risk, that they drove many banks out of it.

Is that what we want?

~ Jeff

We Need a New Funding Strategy

In December 2021, when the Fed Funds Rate stood at 0-25 basis points and prior to the Fed's tightening beginning in the first quarter of 2022, there were $18.2 trillion in domestic deposits, according to the FDIC's Statistics at a Glance. In December 2023, a full three quarters after the Fed paused its tightening of the Fed Funds Rate (QT continued), domestic deposits stood at $17.3 trillion. Nine hundred billion dollars, or 5% of deposits... gone. 

What happened?

Money market total financial assets, according to the St. Louis Fed, went from $5.2 trillion in total assets at December 2021 to $6.1 trillion in December 2023. Not so coincidentally, a $900 billion change.

Read this comment from M&T Bank Corporation's (MTB) fourth quarter earnings release:

"Net interest margin of 3.61% in the recent quarter narrowed from 3.79% in the third quarter of 2023 reflecting the higher costs paid on deposits amidst a continued shift of customer funds to interest-bearing products."

And indeed, MTB did grow deposits during this period. But the industry as a whole, not so much. Nationwide, depositors did switch to interest bearing accounts. But money market mutual funds seemed to be the benefactors of the switch. 

As far as community banks, I look to data gleaned from all of the banks where my firm does profitability outsourcing because we have a level of granularity that the FDIC and most readers do not have. Look at the two average balances per account charts below courtesy of The Kafafian Group.

It is true that the average balance per retail (non jumbo) CD account was higher in the fourth quarter 2023 than the fourth quarter 2021. But it was not materially so. In fact, if I multiplied the change in CD balances per account times the average number of CD accounts for all of our outsourcing clients, it would equate to a positive aggregate change in CD balances per bank of $65.7 million. For retail money market deposit accounts alone, the same math equates to an aggregate decline in those balances of $105 million. Of note there were 11% more CD accounts and 8% more retail money market deposit accounts. 

The outflow of deposits was not driven by a decline in the number of accounts. It was driven by the decline in the average balances of those accounts. The story is similar regarding business deposits (see chart above).

Although financial institutions cost of funds are now stabilizing yet still slightly increasing, it has been one year since the Fed paused its Fed Funds Rate tightening. This was similar to the tightening cycle between 2004 and 2006 when Fed Funds rose again to 5.25%-5.50%. But since the financial crisis came quickly on that cycle's heals, banks cost of funds rose two or three quarters after the Fed paused. Because the Fed then precipitously dropped the Fed Funds Rate to offset the negative economic impacts of the financial crisis. For this tightening cycle, the tail of increasing cost of funds amidst a Fed pause is lasting much longer. Higher for longer.

Most of our deposits are immediately callable. We believe we established relationships with our customers so they won't flee with every rate increase. A relationship is built on trust. And if our deposit strategy was to keep rates as low as possible so long as our depositors didn't notice, we have broken that trust. And they fled. Or we had to apologetically raise their rates to be closer to the market to keep their money. Something we continue to do.

What we can learn from this is there is value in a relationship, if we truly have a relationship where our depositors know our bankers and have someone to call to discuss banking matters. Some self-reflection might be needed here.

And secondarily, we have to assess the value of that relationship or other differentiated value we deliver. And by value I mean how much less than market deposit rates they will accept for that perceived value, which appears to be what they can earn in a money market mutual fund. Maybe it's 50 basis points. Maybe 100. But as we found out, it's not 300 or more.

Our cost of deposits will have to be managed by the strength of our differentiation and the mix of our deposits. Because this cycle proves that customers will flee. They may not close their account. But they will drain it. And we may not even notice it.

~ Jeff

Memorial Day Post: Honor Those Fallen During Our Afghanistan Withdrawal

On August 26, 2021, ISIS-K detonated a deadly bomb outside of the Abbey Gate of Kabul's international airport. The blast killed 13 U.S. service members and 170 Afghans. It occurred amidst the chaos of the U.S. withdrawal from Afghanistan.

The pullout was indeed chaotic and marked by a series of rapid events that unfolded unpredictably. 

Here's a sequence of events:

Initial Plans

The withdrawal was part of a broader plan initiated by the Trump Administration and continued by the Biden Administration. If we listened to representatives from either Administration, you would think it was the sole fault of the "other" Administration. Both have their fingerprints on it. As my former Navy division officer once told me, "Careful pointing fingers because the others are pointing at you."

Rapid Taliban Advance

As the withdrawal commenced, the Taliban rapidly gained ground across Afghanistan, seizing control of provincial capitals and major cities with surprising speed that was not predicted by U.S. forces nor intelligence. Afghan security forces that we trained struggled to resist the offensive. As provinces fell, the Taliban acquired U.S. weapons and equipment.

Fall of Kabul

The situation escalated dramatically when the Taliban entered Kabul on August 15th, leading to the collapse of the Afghan government. President Ashraf Ghani fled. Chaos ensued as panicked residents rushed to leave the city.  

Evacuation Efforts

The U.S. military, along with our allies, launched a massive airlift operation to evacuate American citizens, Afghan allies, and vulnerable Afghans from Kabul's airport. The scenes of desperate Afghans crowding the airport, clinging to departing planes, became emblematic of the chaos and desperation of the situation. U.S. troops stationed there and new troops shipped over to assist with the evacuation were concentrated at the airport. A ripe target for terrorists to indiscriminately kill to grab headlines.

Concurrent with the fall of Kabul and chaotic evacuations, there were heroes. Retired Green Beret Lt. Colonel Scott Mann assembled a group dubbed the Pineapple Express, so named because Afghan allies were instructed to display pineapples on their phones to gain access to the Kabul airport and eventual freedom. The group of active and retired military orchestrated the evacuation of those that helped U.S. forces during our time there. Mann's account of what happened can be found in his book, Operation Pineapple Express. 

Amidst the chaos, an explosion. ISIS-K is no friend to the Taliban. Although the Taliban would form an Islamic State, ISIS are generally more radical, believing only God can rule. From time immemorial despots have been using God's name to assume power over people. ISIS-K took advantage of the chaos surrounding the airport and at the Abbey Gate in particular to do their "Godly" deed. 

Those Who Perished

Below are those U.S. forces that perished in the blast outside of Abbey Gate while they were trying to establish security during the evacuation. Their photos are courtesy of NBC News. I ask that you remember them this Memorial Day.

David Espinosa, 20, Laredo, Texas

Nicole Gee, 23, Sacramento, California

Darin Hoover, 31, Salt Lake City, Utah

Ryan Knauss, 23, Corryton, Tennessee

Rylee McCollum, 20, Jackson Hole, Wyoming

Dylan Merola, 20, Rancho Cucamonga, California

Kareem Nikoui, 20, Norco, California

Hunter Lopez, 22, Riverside, California

Johanny Rosario, 25, Lawrence, Massachusetts

Humberto Sanchez, 22, Logansport, Indiana

Jared Schmitz, 20, Wentzville, Missouri

Maxton Soviak, 22, Milan, Ohio

Daegan Page, 23, Omaha, Nebraska

Sources:

Kabul airport explosions: US Marines among troops, Afghans killed | CNN

Service members killed outside Kabul's airport remembered as heroes (nbcnews.com)

Timeline of U.S. Withdrawal from Afghanistan - FactCheck.org

Ex-army generals testify on chaotic US Afghanistan withdrawal - BBC News

Two weeks of chaos: A timeline of the U.S. pullout of Afghanistan - The Washington Post

What Was Operation Pineapple Express In Afghanistan? (va.org)

Special op veterans carry out secret ‘Pineapple Express’ mission to rescue 500 Afghans | The Independent

What is the ROI of a Banking Conference?

Are conferences more than a vacation? 

Last week I attended two back-to-back banking conferences and it was apparent that attendance was down. This is the likely reaction to banks' profit challenges resulting from net interest margin pressures that are due to slowly repricing loans accompanied by ever faster repricing deposits. Let's tighten our belts to offset revenue decline. By the way, I'm off to a warm and swanky place next week.

I wrote most of this article early on a Saturday morning during the business session at one of the conferences. During the prior break, I struck up a conversation with a person from Lendio, a small business lending platform, that was there to promote their white-label platform to bankers. Back in 2015, almost nine years ago, I wrote an article about banks building their own small business loan platforms. Getting much needed capital into the hands of small businesses that can lead their economies forward. 

I still find this to be a challenge at community banks. They want to grow small business deposits. But they will only lend what fits in their credit box. And the hypothetical loan to the expanding engineering firm that leases their office doesn't fit the bill. So the engineering firm ends up at "Big Bank", and the community bank wonders why.

I described the problem to the Lendio guy, and we had a back-and-forth on how community banks can solve it. Using the Lendio platform of course, but that doesn't decrease the value of the problem-solving discussion that happened only because I met him at the conference and we got to talking. 

Who should call on the small engineering firm: a lender, branch manager, or possibly a small business banking specialist? His platform would have the borrower enter the information and the loan could be routed based on the credit appetite of the bank, and its partners outside of the bank if it doesn't fit the bank's appetite. This makes it more possible that a branch banker could be the relationship manager, as I often hear that fear of credit discussions keep branch managers from being effective small business bankers. How do I calculate that ROI?

I talked about the concept of pulling into the pits in my 2021 book Squared Away-How Can Bankers Succeed as Economic First Responders. It goes like this: when a race car enters the pits, it is losing time. If not to recalibrate, refuel, and re-tire, drivers wouldn't do it. If you compare bank strategy to a 500-mile race, banks would also enter the pits. But if you compare bank strategy to a few times around the track, you would be foolish to do so. Is saving the money by skipping conferences short-term track thinking? That is, if the conference was purposefully leveraged to benefit the bank, help solve its challenges, strike relationships with other problem solvers (either bankers or suppliers), or further develop employees. 

Here are ways that I think banks can leverage conferences to deliver long-term benefits to a strategically focused bank.

1. Solving a particular challenge at your bank. When we identify weaknesses in a strategic plan, we encourage bankers to only identify ones they wish to solve. Pick one or two of these weaknesses that are most conducive to getting a variety of ideas of how to solve by engaging with other bankers, particularly ones that don't directly compete with you, or suppliers that are anxious to talk to you at the convention. Many bankers avoid the suppliers because they fear the barrage of post-convention sales pitches that sometimes follow. But there is a reason why they are often called "solutions providers." My ideas on how bankers can solve the small business banking challenges are more informed because I had the discussion with a solutions provider. Once you are focused on finding ideas to your greatest challenges, you can bring ideas back to your bank for discussion and debate with your leadership team and implement a plan to solve them.

2. Purposeful Education. The conference agenda is set and you know the topics and speakers. Perhaps you influenced the agenda because you are on the association board or you provided input via survey. You know the blind spots of your management team and knowledge gaps with your board. Put together a game plan where an executive can amass information that can be presented to the rest of management to help reduce your blind spots or have a board member attend the relevant sessions to help improve board education. A trade association could make it easy for executives with perhaps a "blind spots" presentation tool that could be easily built in the convention app or another tool so an executive could drop slides from multiple presentations to create something unique to their bank's strategy that could be taken back, shared, and presented. 

3. Reward for a job well done. I recall being in a Pittsburgh bank CEO's office where he said he sends the director with the most customer referrals to the state association's annual convention. This is aligned with banks that want to establish a positive accountability culture, where they visibly reward employees (or directors) for moving the bank forward. Expanding on the concept, perhaps consider taking a high-performing, high potential next-level employee to the conference charged with amassing information (see Purposeful Education above) to present to either executives or the Board (or perhaps both) when they return. It will give that next-level employee exposure to the association, suppliers and other bank executives so they plant the seeds for relationships, and builds their presentation skills, knowledge base and confidence. What a great succession planning tool!

How else can bankers leverage conferences so they pull into the pits to refuel and move their bank forward?

~ Jeff

Notes from This Month in Banking Podcast

I was rustling through papers on my desk to clean it up and not look like a candidate for the Hoarders TV show. In the clutter I found my sloppy copy notes from two podcast interviews. I put them in the shred pile.

Then I read them. And rethought about shredding them. There were some valuable nuggets in there. They were uttered in some form by our guests and I thought them so insightful that I wrote them down. So I wondered if my Jeff4Banks.com readers would appreciate them. 

Not knowing for sure, here they are. Why not, right?

Episode: Managing Through Change (or in other words, getting stuff done).

Release: November 2023

Guest: Mike Butler, CEO of Grasshopper Bank

Link: Managing Through Change (or in other words, Getting Stuff Done!!) - The Kafafian Group, Inc.

JPM Notes

- Mistakes are often silo issues.

- Despise bureaucracy.

- Our bank does not want to be a software company.

- We have a partnership strategy with technology companies.

- Successful companies that get stuff done push decision making down.

- Fail fast and fix it.

- Commercial banking is ripe for disruption.

- Build an environment where people can thrive personally and professionally. 

- Culture: When hiring people, the candidate has three decisions to make: 1) is it exciting for the candidate, 2) is it not for them, and 3) do they believe or call BS on what the CEO is trying to create. 

Episode: Ingredients to a Successful Management Team

Release: March 2024

Guest: Bartow Morgan, Jr., CEO of Geogia Banking Company

Link: Ingredients to a Successful Management Team - The Kafafian Group, Inc.

JPM Notes

- We changed how we attracted talent. Didn't necessarily need the banking experience.

- We run each line of business in a more entrepreneurial way.

- Only one person drives culture (CEO).

- Put people at the top. Successful people are usually successful. Passionate people usually win.

- Break down silos by creating cross-functional teams.

- What to look for in leaders: driven, accountable, self-aware, collaborative and ethical.

~ Jeff

What #Banking Trend Will Have the Greatest Impact on Your Bank?

This was the question posed to Bank Profitability students as part of the Oregon Bankers' Association's Executive Development Program (EDP). These were up-and-coming bankers, the future leaders of our industry, identifying industry trends that will have the greatest impact on their bank, in no particular order. 

1. Interest Rates

So many financial institutions had a positive GAP (assets that are maturing or repricing within one year minus liabilities that are maturing or repricing within one year) during the Fed's ambitions five quarter rate hike from zero to 5.25%, meaning that they were asset sensitive and their net interest margins should have expanded. And then what happened in 2004-06 happened again. Depositors woke up and thought "what is my bank paying me?" And our cost of funds chart looked like the trail lift at Breckenridge. The Fed has paused for nearly a year now, and it was our experience in 2006-07 that bank cost of funds continued to increase as the market closed the delta between what someone could earn in a money market mutual fund and a bank account. Cost of funds is leveling off now. But not until $1 trillion went from banking to money markets. Will NIM compression continue, as it did last year (see chart from American Banker)? Will bankers reposition their balance sheet to be liability sensitive so NIMs will improve with falling rates? And will their ALCO reports accurately predict what will happen? Time will tell and it is weighing heavily on bankers' minds as the most impactful to their banks' success. And with our industry still heavily dependent on net interest income for revenue, I think they are right.

2. Consumer Demographics and Changing Customer Demands

Remember all the pre-pandemic talk about millennials? You couldn't go to a conference without every presenter having millennial this or millennial that on their slide decks. They are digital native, meaning they never knew life without the Internet. We've been able to ignore them because, well, they didn't have big borrowing needs nor did they have any money in their deposit accounts. Besides what was needed to buy some Keystone Light and Vlad for this weekend's party. Now the oldest millennial is 43 (see table by Statista). They have cars, houses, and are nearing their peak earning years. They are starting businesses and inheriting money from The Greatest Generation and Baby Boomers. In other words, great bank clients with high lifetime values. In fact, there are segments of millennials that have always had high lifetime values. That's why Sofi went after them at the end of college, focusing on the engineering majors and leaving the English majors to others. High lifetime value. Now we have to tailor what we do, how we do it, and how we differentiate to these young whippersnappers that never had to scroll through library microfilm when researching a college paper. Our tortoise approach worked when Baby Boomers controlled the wealth. EDP students fear it will work no longer. 

3. Shadow Banking

This trend seemed very specific to current commercial lender anxiety today. Because of our current liquidity situation, where depositors now carry lower average balances per account, the aforementioned trillion that went to money market accounts, and our bond portfolios being underwater, nearly every banker is hunting for deposits. As part of that full-court press, commercial lenders are being asked for higher and stricter compensating balances from borrowers. Experienced borrowers are feeling the pinch from the multiple banks they deal with. And, according to some EDP students that are lenders, are turning to the shadow banking market that do not have deposit demands. Such as direct lending funds, and insurance companies. Shadow Banking refers to banking-like operations that take place outside of the mainstream banking industry. Shadow bank lending is similar to bank lending but is not subject to the same regulations, and compensating deposit balace requirements. Typical shadow banking entities are bond funds, money market funds, finance companies, and special purpose entities. Business Research Insights estimates the worldwide shadow banking system to be over $53 trillion in 2021 and believes it will grow to $85 trillion by 2031, a 5% compound annual growth rate (see table). Although shadow banking mostly serves larger corporations, think money market funds buying commercial paper, bankers fear the trend will continue going downstream to more traditional community bank customers.

4. Commercial Real Estate Uncertainty/Vacancy Rates

Nineteen point six percent of office space is vacant at year end 2023, according to Axios.com (see chart). Vacancy reached a record high in the fourth quarter and surpassed previous peaks last reached in 1992. Office buildings are emptying around the U.S., as companies continue to adapt to the new norms of remote and hybrid work by shrinking their real estate footprint. Although large office towers in big cities are not usually part of a community financial institution loan portfolio, smaller commercial real estate in urban areas and throughout suburbia and rural markets are. Commercial rents are projected to decrease by a small amount this year, while borrowing costs will escalate as those that borrowed in the low interest rate environment of 2017-19 have their loans coming due, some at twice the rates of their maturing loan, putting pressure on debt service coverage ratios. Rents are lower, borrowing costs are higher. Do bankers make exceptions to policy, ask borrowers to kick in more equity, or push borrowers out of their bank? There's better news for multi-family and warehouse lenders, as these sectors of CRE are doing just fine. But bankers should be preparing for a devaluation of the collateral used by their borrowers to determine how best to manage this emerging situation.

5. Regulation and the Political Environment

"Last month, the CFPB reported how banks have become more dependent on these fees to feed their profit model on checking accounts. In 2019, bank revenue from overdraft and non-sufficient funds fees surpassed $15 billion with the average cost of each charge between $30 to $35. But that's not the only product where large financial institutions feast on their customers through fees. In 2019, the major credit card companies charged over $14 billion each year in late fees with an average charge of around $35. And when buying a home, there's a whole host of fees tacked on at closing where borrowers feel gouged."

~ Rohit Chopra, CFPB Director, January 26, 2022

"I am pleased to support this adoption (of required climate disclosures) because it benefits investors and issuers alike. It would provide investors with consistent, comparable, decision-useful information, and issuers with clear reporting requirements."

~ Gary Genslar, SEC Chairman, March 6, 2024

"The CFPB and other regulatory bodies will use the disclosures required by Rule 1071 of the Dodd-Frank Act as a cudgel to pressure bankers to lend to politically favored small businesses or to not lend to politically disfavored small businesses."

~ Jeff Marsico

6. Technology Advancement and Generative Artificial Intelligence

In the third quarter of 2023, the total operating expense to operate a branch was 47% direct cost: branch salaries and benefits, lease expense, etc. and 53% indirect costs: operations, IT, human resources, etc. This is a hefty burden to put on a branch that is competing with branchless banks that don't incur the direct costs and can pass that on to depositors in the form of higher interest rates. Bankers must get serious about driving down the cost of the pistons, carburetors, and batteries of running a bank. Technology offers opportunities to do just that. Additionally, customer acquisition is another significant cost to financial institutions. Technology and Generative AI could dramatically lower those costs. As well as compliance, fraud, credit, reconciliations, reporting, and other risk mitigation that is currently performed in a resource intensive way. The opportunity to lower costs without escalating risks, in fact likely lowering risks, is near. EDP students think this could have a significant impact on their banks. 

7. Branch Consolidation

Community financial institutions are caught in this place where they want to demonstrate commitment to the communities where they operate yet can't figure out how to do it profitably in certain locations. Large financial institutions simply consolidate their branches. Community bankers still consider this as a sign of weakness to the market, lack of commitment to its leaders and residents, and admission to a mistake to enter the market in the first place. This, of course, was a Bank Profitability course, and when staring in the face of hard data, namely a branch's income statement showing perpetual red ink, it becomes more difficult to justify keeping the branch open with those soft reasons such as not supporting the community. I got news for you, if you can't operate a branch profitably and you are satisfied that the reason is not because of poor execution by your bank, perhaps the community doesn't support you.

~ Jeff

Guest Post: Financial Markets and Economic Update - First Quarter 2024

Four Years Ago

It was on March 11^th, four years ago in 2020, that the WHO declared a global pandemic due to the Covid virus threat that originated in China.  Our lives changed forever from this whole experience of the government’s declaration of a national emergency, leading to forced shutdowns of businesses and schools, mandated mask wearing, forcing 6-foot distances between people, travel restrictions, fear mongering with case and death counts, and forced vaccines/boosters.  No one who lived through this will ever forget what this time was like. 

In the markets, we watched helplessly as real GDP plummeted -5% in 1Q20 and -31% in 2Q20 before rebounding by +33% in 3Q20.  No one will forget how quickly stocks plunged and recovered.  Interest rates fell to incredible lows, forced there by the Federal Reserve’s rate and bond buying policies.  No one will forget the inflation that followed in 2021 to 2023, started first by supply chain issues, but then fueled by the Fed’s purchases and the obscene amount of cash handed out by the federal government.  M2 growth was out of control at over 20%.  Initially individuals and businesses saved their cash, but then as the pandemic eased, they spent with abandon, pushing up demand on everything from food, autos, clothing, travel, and entertainment to home goods and service-related businesses, such as restaurants.  It was not until May 11, 2023, that the US national emergency was lifted, but sadly, the free cash handouts continue.

The Fed and Inflation

The Fed raised rates by 5.25% between March of 2022 and July of 2023 to try to crush inflation.  I’m sure they are surprised that we did not get a recession yet, but more on that later.  The Fed Funds rate stands at 5.50%, compared to its starting point of .25% in 1Q22.  Although they are willing to admit that they will lower rates, they are not willing to admit that they are too high.  When Fed Funds exceeds inflation, the positive spread between the two creates a “real” rate and indicates tight policy.  Fed Funds minus CPI (3.2%) is 2.30%, Fed Funds minus PCE (1.8% 4Q) is 3.70%, and Fed Funds minus core PCE (2.1% 4Q) is 3.40%.  Are they tight enough?  Yes, absolutely!

Inflation relief may come from an unlikely source- China.  I’ve previously theorized that China would try to reclaim its global market share lost during the pandemic by flooding the markets with cheaper goods.  According to a Wall Street Journal article on March 3^rd, this time has come.  This development could give us good news on inflation.  China, however, is struggling with their economy, too much debt, $4 trillion in real estate losses, and a shaky stock market, so these goods may be slow to arrive.  By the way, China is about to get an inverted yield curve.

Since tight policy has a detrimental effect on GDP growth, the Fed usually lowers rates when nominal GDP falls below Fed Funds.  Since Volcker’s reign, 14 of 18 easing campaigns started with Fed Funds above nominal GDP.  Nominal GDP for 4Q23 was +4.8% (real was +3.2%) and nominal GDP for 3Q23 was +8.2% (real was +4.9%); the latter was clearly too high to start easing, but the 4Q23 nominal rate fell substantially, creating a spread below Fed Funds of .70%. 

Nominal GDP is not the only consideration, but it’s a pretty important one.  Other factors include PCE inflation, M2 growth (or lack of it), consumer spending levels, the dollar, employment, and the real Fed Funds rate.  If the Atlanta Fed’s current GDPNow projection for 1Q24 GDP of +2.1% comes true and the implicit price deflator is 2%, the Fed Funds minus nominal GDP spread will be 1.0% or more.   It’s my thought that the Fed is waiting for 1Q24 GDP to check the spread.  Then they can have more confidence to lower rates in May or June, given that the unemployment rate has been rising slightly recently.  Should they lower rates at that point?  Yes!

I say “yes” for two reasons.  M2 year-over-year growth continues its unprecedented decline that began in December, 2022.  We have not seen a contraction in M2 since the 1930s.  January’s M2 y-o-y was -2.0%, December was -2.4%, and November was -3.0%.  Declining M2 is pulling inflation down.  Paired with a velocity of money that is low, at 1.35 in 4Q23, and projected to fall, there will be downward pressure on GDP.  Look at this equation and think.  GDP= M * V.

The second reason is something I always harp on- the lags in monetary policy- generally 6 to 9 months but they can obviously be longer.  Fed Chairman Powell even acknowledged, as did several of his Governors, that the Fed should begin to ease when inflation is headed to their target, NOT when inflation hits the target due to the risk of overshooting and inflation that turns into deflation.  And don’t forget QT; the Fed continues to let $100 billion per month mature off its balance sheet, further contributing to tighter conditions.  So, why not lower rates now?  Mark Zandi of Moody’s just discussed that a major risk to the markets and the economy is the Fed holding rates too high for too long.

Government Debt

Our government’s debt is now over $34.5 trillion, or 124% of GDP.  Weakness in GDP is a general rule after extended periods of the debt/GDP ratio exceeding 90%.  High debt levels continue to harm GDP as the US Treasury issues new debt with abandon and the politicians hand out money like candy.  It is mismanagement of the worst kind as budget deficits explode; the fiscal year 2023 deficit was -$1.7 trillion, following 2022’s deficit of -$1.4 trillion.  2024 could exceed -$2.0 trillion.

The cash continues to fuel the economy temporarily and then it’s gone.  Some of the infrastructure projects are admittedly investments but many are not.  Real GDP was +3.2% in 4Q23, of which .73% was government spending; the 3Q23 real GDP was +4.9%, of which government was 1.0% of that.  Trillions of dollars of subsidies on “green” BS projects, electric vehicles no one wants, tax credits, debt forgiveness, and free money all fuel demand and contribute to inflation.  I’m surprised no one ever talks about maybe the Fed is keeping rates too high to fight the inflation caused by our own federal government crowding out the private sector. 

Where is the Recession?

I have spoken continuously about a recession coming, so where is it?  Why can’t we see it?  I was taught to watch specific indicators that are extremely efficient in forewarning about recession.  The inverted yield curve persists and is at record times- 10s to 2s since July, 2022 and 10s to 3 months since October, 2022.  Most recessions occur within 14 to 18 months following inversion, especially of both yield curve measures.   

ISMs and regional Fed surveys have been mostly negative for months on end.  Inventory has been building in the second half of 2023, with +$63 billion in 3Q23 and +$5 billion in 4Q23.  GDP shows up as weak every other quarter.  Stocks had their big selloff in 2022 and no recession followed.  In fact, stocks are now at new highs this quarter, led mostly by the Magnificent 7- MSFT, AMZN, NVDA, TSLA, AAPL, GOOG, and META- so there is no recession signal from stocks.  I think stocks are up on the potential of AI to massively increase productivity.

Leading economic indicators, or “LEI,” continues its long stretch of negative readings with January at -.4% and December at -.2% and is now down -3.0% for the past six months annualized.  The LEI index has now fallen 23 months in a row and is the lowest since April, 2020.  Even with the continued dire condition of this index and its trend, the Conference Board gleefully announced that they do not see a recession.  Oh, brother!  It sounds like 2007 all over again, when people got tired of looking at LEI and then in 2008, all hell broke loose.  Remember, hope does not stop recession.

CBS News just released a report saying that the average family is spending $11,434 more per year today than at the end of 2020 to maintain their standard of living.  Tell me that that’s not a bad sign.  JP Morgan Chase estimates that 80% of consumers have depleted their Covid savings, so they have no real extra cash.  Credit card and auto delinquencies have risen above pre-pandemic levels.  Insurance costs have been soaring.  CRE and its depleted value are a problem for many banks, not just NYCB, as vacancy rates for offices top 19% and 190 million square feet of office space is available for sale, lease, or sublease.  These are all signs of recession.

The Fed is holding interest rates too high, creating real spreads to inflation and to nominal GDP.  At this point, I can only say that I believe that recession will come, but I hope there will not be a major shock to cause it.  Of course, if the Fed eases enough soon, we can avoid bad outcomes.

The Employment Report

In my mind, I find that the monthly BLS report has lost some of its credibility.  February’s report showed payroll growth of +275,000 but restated growth in December and January by -167,000.  Challenger layoffs ran above 80,000 for both January and February, but they never seemed to show up in the numbers.  Unemployed persons rose by 300,000 to 6,488,000.  Household employment fell by -184,000, exactly the opposite of payroll growth once again.  The unemployment rate, which has been below 4% for 2 years now, rose by .2% to 3.9%.  The household report and resultant rise in the unemployment rate contrast with the sweet story of ever growing, then constantly restated downward, payrolls making headlines every month.

Here's a rant.  Every time the JOLTs report is issued, headlines say how “tight” the labor market is.  The JOLTS report for January showed 8,863,000 job openings and unemployed persons were 6,488,000 in February.  That’s 1.4 jobs for everyone looking for a job, right?  NO!  Maestro Greenspan taught me many things, including that the supply of labor is measured as the pool of available workers, which is the sum of unemployed persons AND those not in the labor force but want a job.  That number has been rising and is now at 12,130,000.  There are not enough job openings, or .7, for the supply of labor.  Why does everyone ignore the pool of available workers?  One ratio they do follow is the quits rate, which is a leading indicator of the jobs market; the rate was 2.1% in January, which is getting low, as people hold onto their jobs, at which they have to work longer and harder to beat inflation.

Wage growth was 4.3% year-over-year in February, which is not that far above Fed “targets.”  Their inflation target of 2.0% can be added to average historical productivity of 1.5%, which creates a “target” of 3.5%.  Productivity in 4Q23 was twice the historical average at +3.2% and very helpful to offset wage costs.  Greenspan also taught me this.  And a word about Fed targets.  Chairman Powell testified last week to Congress for two days and stated that their 2% target is based on PCE.  So let’s clear up any misconception that they target CPI, which traditionally runs higher based on its different construction.  CPI can be acceptable at 2.5% when PCE is at 2.0%.

 

In the past 18 years, I’ve written over 70 quarterly newsletters and plan to keep them going, as long as I have the energy and desire to rant and to try to make sense of things that just don’t make sense.  I retired in November of 2023, after 49 years in banking and I can tell you it is hard to walk away from something you loved.  When Jason Kelce announced his retirement from the Eagles on March 4^th after 13 years, I truly understood why it was so emotional for him.  And yes, I cried every time he did.  So soon I’ll be off to watch the solar eclipse in totality in NY and I’ll be tending to tulips soon thereafter.  Retirement does have its benefits.

Thanks for reading!  DLJ 03/15/24

Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy recently retired from Penn Community Bank where she worked since 2004. She is the author of Just Another Good Soldier, and Honoring Stephen Jaworski, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure of devotion.