Friday, July 19, 2024

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


Monday, July 01, 2024

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.