The Scale Imperative: Banks Can Acquire Credit Unions

The traditional financial industry is facing a quiet, steady drain of its lifeblood. While the "unbanked" population is shrinking, the "loyalty" of the modern consumer is fragmenting. Millennials and Gen Z—the oldest of whom are now 45—are systematically moving their balances away from traditional institutions toward "cool" digital tools and high-yield platforms like Rocket or SoFi. Even loyal Gen X customers are increasingly treating their primary bank accounts as "paycheck motels", a term coined by Ron Shevlin, quickly routing funds to wherever they earn the most.

To survive this shift, banks don't just need better apps; they need scale.

The Untapped Reservoir of Retail Funding

Many banks have pivoted toward business banking to find higher balances and margins, but the foundation of a community bank’s funding remains retail deposits. Interestingly, the most robust retail deposit bases are currently locked inside credit unions—institutions that are struggling with their own scale issues and merging at a similar clip to banks.

While credit unions buying banks have dominated the headlines and trade group lobbying, it is time for the industry to flip the script. Banks can—and should—buy credit unions.

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Industry Interest

I recently sat on an ABA panel at the recent ABA Washington Summit about this very issue. Joining me were industry experts on such transactions from law firm Luse Gorman and the ABA, moderated by Dave Daraio of Maspeth Federal Savings and Loan Association in Queens. The message: let’s pivot from lobbying against CU-bank deals to executing our own. It can be done.

Debunking the Myths of the "Impossible" Deal

The industry has long viewed bank-on-CU acquisitions as a regulatory and accounting nightmare. And recent history is no help. But the landscape has shifted:

• The Legal Path Exists: Federal law (12 U.S.C. §1785) and NCUA regulations (12 CFR Part 708a, Subpart C) explicitly provide the roadmap for a bank to acquire the net assets of a credit union.
• Regulatory Winds are Changing: The NCUA is currently rewriting its rules to make charter conversions to mutual banks easier, and is potentially "defanging" the poison pills of the past that they have wielded to thwart bank-CU deals.
• The Efficiency Edge: Despite their tax-exempt status, credit unions are often less efficient than banks. For similarly sized institutions, banks have historically delivered better financial performance, even after paying taxes.

Overcoming the Capital Hurdle

The primary challenge is accounting. These deals are structured as asset purchases where the credit union’s value must be distributed to its members. While this can strain a buyer’s capital, it creates a unique opportunity for:

• Stock Banks: Their ability to raise fresh capital gives them an advantage in absorbing these assets.
• Larger Banks Buying Smaller CUs: When a larger bank acquires a smaller credit union, the capital contingencies become negligible, making the deal "cleaner" and faster to execute.
• Member-to-Mutual Deals: The NCUA would likely be friendlier toward deals where credit union members gain depositor rights in a mutual bank.

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Call to Action: Who Will Step Up?

We are currently in a favorable regulatory environment for deal-making. And I will confess that my firm would welcome the opportunity to be at the forefront of this deal-making. More important to readers, we cannot continue to ignore the fact that our retail funding base needs a massive infusion of scale to compete with non-traditional providers while doing so profitably.

Credit unions have the deposits banks need, and many are looking for an exit due to scale or succession issues or a way to provide more flexibility to their members.

The tools are in the manual. The law is on the books. The market demand is clear.

It is time for bank leadership to stop complaining about credit union expansion and start executing their own. Who is going to step up and lead the first major "reverse" merger of this new era?

~ Jeff

Bottom-Up Capital Calculations

Ten years ago I wrote What's Your Well-Capitalized on these pages. It was in response to regulators persistently asking bankers the same question. Today, we have not done much about it because we have relied on that lazy space using the regulatory definition of well capitalized. Or at least regulatory expectation of it.

I recently spoke at the American Bankers' Association Conference for Community Bankers regarding risk appetite statements in a presentation called Leave Nothing Unspoken. Drop me your e-mail if you would like me to send the presentation. One slide, however, dealt with this very issue of "what's your well-capitalized." Because developing your risk guardrails for executing strategy, which is what a risk appetite statement should be, is far less effective if you don't build the culture and accountabilities throughout the organization to be consistent with your risk appetite.

Exhibit number 1 is a bank whose main incentive for lenders is volume. This creates the incentive to do deals based on size, regardless of structure, duration or rate. What does it matter if the lender does a thinly priced $4 million, 7-year commercial real estate deal with a 25-year amortization and lite covenants or a fairly priced, 5-year deal with standard covenants? If their goal is $20 million of annual production, they are 20% there regardless. Right? 

In comes risk adjusted return on capital, or RAROC. Most loan pricing tools use an ROE hurdle rate to determine what the rate should be. Aside from proper use of these tools and any manipulating that might go on to get deals done, the goal is a good one. Assign capital to a pending loan deal based on risk to the institution. Like the slide I showed to attendees at the ABA conference.

These capital allocation tables should be done in advance, be simple and understandable, and be transparent to all that use them. I imagine a small risk committee that develops these lookup tables and assigns capital to every balance sheet item. And for many categories, such as loans and investment securities, which carry the most risk to a financial institution, have necessary granularity so a 5-rated, 5-year and 20-year amortizing commercial real estate loan gets a lower capital allocation than a 6-rated, 7-year deal. Now the lender has to seek a better yield to get the same RAROC. And perhaps the ROE for the riskier deal is also higher. Further aligning risk versus reward.

Other major asset categories such as "Cash & Due", "buildings", and "BOLI" can be assigned capital at the balance sheet level, such as "buildings" receive a capital buffer of 1%. Naysayers might argue that a building is a 100% risk-weighted, and therefore needs to carry 10% capital (5% well capitalized under the Leverage Ratio, plus a 5% buffer). But that assumes, as prompt corrective action capital requirements must assume, that liabilities do not have risk.

Ask former Silicon Valley Bank executives if that is true.

For sure there is no 5% Leverage Ratio requirement for liabilities, but buffers should also be assigned to them based on the bank's perceived risk of those liabilities. Deposits and borrowings (i.e. the bank's funding) should create greater granularity based on product and product characteristics and the attendant risk of the instrument, much like loans and investments. 

Some may say that the above model is overly simplistic. I'm a simple man. And there is beauty in simplicity. No matter how complex a model you make, it will be some form of wrong as it stands the test of time. Being simply off is far better than building a highly complex black box to be as off, or even a little less off, than a simple one. Because users of the information will be less motivated to adhere to it if they don't understand how it was made.

This, in my opinion, should be done to identify what is your well capitalized. Because you have evaluated risk by balance sheet category and assigned capital based on risk. You can then determine if you have enough capital to support your current balance sheet and your strategically projected balance sheet. You know what buffer you have to withstand stress events.

If your strategic plan calls for a 15% ROE, now you can create a threshold by loan type for lenders to pursue and fairly price to be consistent with your strategy goal and risk appetite. Plus you would create the cultural discipline to manage risk from your first line of defense, the front line.

As I told attendees to my presentation, all banks should do this.

Do you?

~ Jeff

Conference Watch: How To Be Successful in a Changing Industry

How many consultants go to banking conferences and attend the sessions? At least one!

I may have been accused of being arrogant once or twice, which inspires me to continuously elevate my abilities so the perception of arrogance is seen for what it is; confidence. And the only ones accusing me of arrogance are those that elevate themselves by sniping at others.

As a bank consultant, I attend many conferences. Many, many conferences. So many that I wake up in hotels wondering... where am I? Or pulling up to conference venues thinking... when was I here last?

So was the case at the ABA Conference for Community Bankers. A well-run operation where I get to know the folks at ABA better, meetup with clients and "conference buddies" (other service providers that we see at many other conferences), and learn. Because most conference presenters, although obviously trying to expand their client base, deliver deep knowledge and great insights.

If they're offering, I'm accepting.

The flip side to service providers delivering knowledge, are paid speakers for hire. At the #ABACCB, one paid speaker was Ben Sherwood, former head of ABC News.

Cue In Ben Sherwood

A little of Ben's bio for background: a Rhodes Scholar, he came up the ranks at ABC News and NBC News in the late 80's and 90's. He was named executive producer of ABC's "Good Morning America" in 2004. He left the show in 2006 but returned as president of ABC News in 2010. On his watch, "GMA" rose in the ratings to top its a.m. arch rival "Today" in 2012 for the first time in 16 years. Sherwood attributed the flip to "Today" foibles and "GMA" trying new things, such as five hosts, to change the dynamic. He headed Disney/ABC TV Group from 2015-18, when he left the network.

In his talk, he spoke of four keys to being successful in a changing industry. I think it's obvious that TV has been changing at a rapid pace. Faster than banking, I dare say. So I was interested in what he had to say. Below are the four keys and my opinions on how they apply to banking.

How To Be Successful in a Changing Industry

1.  Fighting a stronger opponent by unconventional means yields victory two-thirds of the time.

Ben gave some facts on this, although I can't recall them. I'm not a huge fan of comparing military endeavors to business. But there are lessons here. Think how Afghanistan frustrated the Soviets. And how the North Vietnamese overcame us. Both were victories for a hugely inferior force. This is why Sun Tzu's "Art of War" is such a digestible business book. According to him, 

"If your enemy is secure at all points, be prepared for him. If he is in superior strength, evade him. If your opponent is temperamental, seek to irritate him. Pretend to be weak, that he may grow arrogant. If he is taking his ease, give him no rest. If his forces are united, separate them. If sovereign and subject are in accord, put division between them. Attack him where he is unprepared, appear where you are not expected."

~ Sun Tzu

Don't fight PNC at PNC Park, playing their brand of ball. 

2. In ideas, quantity matters. 

I remember at this same conference a few years ago, Marc Randolph, co-founder of Netflix, said the idea to waive late fees which set the wheels in motion to unseat Blockbuster was one of several they tried to grow subscribers. And he didn't even think it was a good idea. But they were trying something, anything! And boom! Look at Netflix now. All because of a weird idea that would reduce Netflix revenues in the short term. Yet they were willing to try it to rule the world. And rule the world they did. Ask Blockbuster. 

Banks have cultural challenges to implementing this success strategy. Failure is a dirty word. There will be recriminations, heads rolling, bonuses slashed. Sure, you can implement ideas that fail, but don't miss your budget. Better to make slight modifications to business as usual, right? Think about your culture. Is it conducive to implementing several ideas, with most of them failing?

"Failure is success in progress." 

~ Albert Einstein

3. Believe in your magic.

Nothing like a nod to Disney in a former Disney executive's speech. But as my "conference buddy" Tim Pannell from Financial Marketing Solutions points out, what company do you think of when somebody says "magic" or "magical"? What a word to associate with your brand! At any rate, I digress. Back to banking.

I believe in strategic alignment. If your vision is to "elevate our customers' self worth by increasing their net worth", then everything you do should be designed to deliver that "magic". Think in practical terms. Does your branch manager know how to use your personal financial management tool and sit down with a retail customer to set it up and make recommendations? Will your commercial lender help the local bike shop obtain inventory financing even though it might be "small potatoes"? Yet I hear some of the "help customers" platitudes like the vision above with little "hands dirty" work behind it.

Believe in your magic, and deliver on it. It requires work, both in talent management and cultural change.

4. Quit talking and begin doing.

Don't suffer from analysis paralysis. That drives back to your culture, and fear of failure. I'm not saying don't make informed decisions, but more data has declining value and is more difficult to gather. Would your bank ever make the decision to forego late fees, a significant revenue source for Netflix, in that situation? 

Do you have friends that you view as do'ers? May not be the sharpest, or the most well-read. They just do. We need more of them in our banks. Because in a changing industry, we need to be bent toward action.

Those are Ben Sherwood's four approaches to be successful in a changing industry. 

Take an inventory of your bank and culture. How do you stack up?

~ Jeff

Consumer Lending: Should Banks Do It?

We’re running out of assets.

When I first read Standards Needed for Safe, Small Installment Loans from Banks, Credit Unions by the Pew Charitable Trusts that encouraged financial institutions to get back into small ticket consumer lending, I thought “what are they nuts!”

Consumer loans for those banks that utilize my firm’s outsourced profitability reporting service lost (0.26%) as a percent of the average consumer loan portfolio in the fourth quarter. And it wasn’t an anomaly. Ever since we formed our company in 2001, this has been the case.

Sure, home equity lines of credit made 0.71% for the fourth quarter. But it was the only sub-product that showed a profit. Fixed home equity loans… nope. Indirect loans, unsecured personal loans? No and no. So why would banks expand small-ticket, unsecured personal lending?

Because we’re running out of assets. Pretty soon we’ll be left with small to mid-sized business loans and commercial real estate that isn't big enough for large banks or conduits. And there are FinTechs, loan brokers, insurance companies, and investment funds chipping away at them.

Mortgage lending is getting away from us. Mortgage bankers and brokers own a significant share of market (although less than prior to the 2007-08 financial crisis). And Quicken Loans is in the top 5 HMDA market share in nearly every market we analyze. Oh, and Quicken is hammering away at home equity lending too.

We lost auto loans to the indirect market. Who comes to our branch for a car loan today? If we don’t consider how we intend to defend our small business and CRE lending, and re-enter some of these other loan markets, we may end up as a balance sheet for hire. Which we already do via buying mortgage back securities and using loan brokers in metro areas.

Are you ready to be Web Bank, part deux?

So I reconsidered my knee-jerk reaction to the Pew Charitable Trusts report. Most community financial institution strategies has some sort of “community” focus. It’s implied whenever someone says “we’re a community bank”. Which nearly everyone does. Even the big banks. So maybe we should put some moxy behind those words. Profitable moxy, though. Not charitable moxy.

Why do consumer loans consistently lose money? Looking at our peer group numbers, the consumer loan costs a little above $1,100 per year in operating expense to originate and maintain. Expensive. This is a fully absorbed number. Meaning that all bank resources that are dedicated to the consumer loan function is fully allocated to the product, whether they are being used or not. And recently, they have not been used.

For example, there is a fair amount of branch expense in that number, because branches are typically responsible for originating those loans, and participate in their maintenance. If we got rid of consumer loans, that expense would migrate elsewhere. And if we are not originating new loans, then resources dedicated to origination, such as branch staff and credit, for example, are dormant but must be paid for by the existing loans in the portfolio.

Four Ways to Bring Back Consumer Loans, Drive Volume, and Increase Profits

1.  Make consumer loans more than an accommodation. Not many financial institutions consider consumer loans as a strategically important product group that will drive growth and profitability into the future. Perhaps it is because of the hurdles to achieving meaningful growth and market share. Or the competitors that wedged themselves into the dominant market position. But if executive management and the Board aren't committed to pursuing consumer lending to be more prominent on your balance sheet, then you will not succeed.

2. Align your credit culture and risk appetite to be successful consumer lenders. It is not lost on me that the last bastion of consumer lending at banks is home equity loans. Real estate secured. Hard collateral. Relatively low charge-offs. It is difficult to change that mindset when doing loans with little to no collateral, such as small ticket consumer or credit cards. Charge-off rates of 4%-5% with no collateral? Yes. Get used to it (other than home equity). Or don't do it.

3. Drive down costs. Regulation has driven up costs and made us gun shy. But we can't continue to put $1,100 of resources per year into a consumer loan. Especially if the loan balance is $2,500. How can we possibly make money on that? We can't. The ABA recently conducted a survey on the State of Digital Lending (see chart) that said that, although consumers were happy with how smooth and quick online lending decisions were made, online lenders only received a 26% approval rating, versus 75% for banks. Driving more volume will drive down costs by putting under-utilized resources to work, and digitizing end-to-end will reduce the amount of resources needed for consumer lending. 

4. Price right. Even if banks cut the cost of originating and maintaining consumer loans in half, to $550, what rate will they have to charge to make a reasonable profit? Let's say a reasonable profit is a 1.5% pre-tax profit as a percent of the portfolio. And the non-home equity portion experienced a 4.5% charge-off rate. And the cost of funds for such lending is 1%. If the average loan size was, say, $3,000, the bank would have to charge an effective yield of 25.3% (($550/3,000)+1%+4.5%+1.5%). Those rates get the scrutiny of do-gooders and "champions of the people" that could cause negative press. And keeps community financial institutions out of this business. Take note Pew Charitable Trusts. However, knowing this math, the bank can work at pressing the levers needed to do this lending profitably, at the right price, that benefits borrowers and the banks. And keeps those borrowers out of the hands of the sharks that prey on their misfortune.

Should we give up on consumer lending?

~ Jeff

Netflixed: Co-Founder of Netflix Tells Bankers How It's Done

This past week I attended the American Bankers' Association National Conference for Community Bankers (NCCB). At such affairs, I like attending the general and education sessions for my own knowledge, and for the benefit of my clients and readers.

The NCCB was no different. If there was one session that struck me like a lightning bolt, it was the general session, with keynote speaker Marc Randolph. It was riveting, and challenging. And I'm not too sure bankers are up for the challenge. 

Riveting because he spoke about the founding of Netflix. The idea was not a lightning bolt, as Netflix co-founder Reed Hastings tells of his late fee epiphany when returning the movie Apollo 13. Rather, it evolved during long commutes between Hastings and Randolph. In other words, car pooling planted the seeds of Blockbuster's demise. This factoid is sure to get me social media shares from environmentalists.

The tale of the early years of Netflix is very instructive to an industry experiencing change. Think banking. The talk was challenging because Randolph's keys to being successful in such an environment may, and should scare bankers.

Marc Randolph's three keys to business success:

1.  Tolerance for Risk

Number one is already turning off readers. Low risk tolerance is suffocating. Why? It promotes a "no mistakes" culture. When you have low tolerance for risks and mistakes, you lose innovation. Who will stick their neck out in such a culture? Who will endure five failures to discover that one idea that turns your business model on its head and plants the seed for an enduring future? Bankers may hate the analogy, but Blockbuster was not willing to gut their main revenue source to build out and promote streaming. Does the term "disintermediation" in banking sound familiar?

2. An Idea

And it doesn't have to be a good idea. When Netflix decided to forego late fees their business took off. If Randolph was writing a letter to himself how he thought Netflix would evolve in five years it would not have read like it played out. But they tried anything and everything to get subscribers, and more revenue into their company. They had many failures. The idea wasn't an "in the shower" epiphany. But after trying several things, the one that stuck ended up being the hurdle that would eventually lead to what we have today. An idea. Not a good one. As Randolph mentioned, many of us have great ideas in the shower. Few of us get out of the shower and do something about them. In a culture with a low tolerance for risk, would one of your bankers step out of the shower and do something about their idea? Would such a person even work for your bank?

3. Confidence

It takes confidence to fail several times, and to get up and keep going. As Rocky once said, it's not how many times you get knocked down, but how many times you get knocked down, get up and keep moving forward. That's right, I made a Rocky reference. Say what you will about the Italian Stallion, when he was in the ring, he had confidence to go toe to toe with the best in the business. Think about little $5 million in revenue Netflix, going toe to toe against multi-billion dollar Blockbuster. 

I will close by paraphrasing Randolph. Business success is not about coming up with the best or even good ideas. It's about building a culture to try lots of bad ideas.

And with our own culture in banking, to try few ideas and even fewer that have not proven tried and true, do we have the culture to succeed in a changing industry.

Should we build such a culture? And if so, how?

~ Jeff

Are You a Bank With Benefits?

The American Bankers Association (ABA) recently announced a new benefit to assist its employees with repaying student debt. Beginning next month, ABA will provide each eligible employee up to $1,200 per year toward the payment of student debt, in addition to their current compensation. According to the Society for Human Resource Management, only four percent of employers nationwide offer this benefit. 

Is this an altruistic statement regarding the $1.4 trillion of student debt in America, or a prudent employee benefit targeting recent college graduates that each average $30,000 in student debt?

I recently proposed this topic for my firm's podcast, This Month In Banking, which is released on the last Wednesday of every month. Shot down. Too boring. But hey, I have a blog too! And I think it is an extremely important topic in talent acquisition and retention.

According to the Bureau of Labor Statistics June 2016 report, salaries, commissions and bonus accounted for 68.6% of total compensation, and benefits accounted for the remaining 31.4%. This is an increase from 29.9% in 2013. So benefits is a large, and increasing proportion of total compensation.

What makes the ABA announcement interesting is: 1) it is a benefit specific for those that carry student debt, meaning mostly millennials, and 2) that they felt they should announce it.

I don't think it is a mystery that bank employees seem to be getting older. And that succession planning in our industry is an issue. Since the financial crisis our industry's brand as a go-to employer has been hurt. And hurt badly. 

How do we attract quality, younger people and then retain them to be the future leaders of our industry? 

What employees value is in the eye of the beholder. Younger workers, for example, value cash on the barrel-head. Less important would be insurance (health or life), and retirement benefits. Not that it is unimportant. According to the Willis Towers Watson Global Benefit Attitudes Survey (What a mouthful! Some marketing person should revisit that title.), only 42% of US respondents said they would opt for more pay/bonus as opposed to other benefits if they had the choice (see chart). So other employees have different priorities.

For younger employees, there are some startups that focus on benefits important to them, such as Gradifi, that focuses on student loan paydown. Imagine the recruitment and retention with this benefit!

But as this benefit becomes less important to employees, perhaps a migration to something more meaningful, such as a greater 401k match, a more robust health plan, or life insurance benefits. Is it practical to earmark certain benefits dollars per full-time employee, and let them select, in menu fashion, what is important to them? For example, the recent college graduate may opt for a student loan paydown benefit, and take a high-deductible HSA health insurance option, rather than the traditional plan.

I think what is clear is that benefits that are important to your employees differ over different times in their life cycle.

Can bankers devise a cost-effective benefits program that recognizes this, would help them attract the best talent, and keep them?

~ Jeff

The Sun Sets on the ABA's National Conference for Community Bankers

On February 14-17 the American Bankers Association held their National Conference for Community Bankers. I made my first trip to the conference because I was asked to moderate a CEO Exchange, where bank CEOs sat, round-table style, discussing their most pressing issues.

The format was to first ask a couple of group questions. My first regarded attendees growth strategies. Did their markets support their growth aspirations? If not, do they intend to grow by expanding, taking market share from competitors, or merging. 

I would say the answers were yes, yes, and maybe, with only a small number stating they were exploring strategic combinations with like-sized institutions. I salute banks that forge forward independently. But perhaps considering a strategic alliance with a like-sized financial institution can give the combined institution greater resources to compete, and greater liquidity and possibly trading multiples for shareholders.

In terms of taking business from others, the primary, head nodding answer as to how to do it was apple pie. The community bank takes deposits from your community, and then lends into your community, with decision makers based here, where the financial institution's employees live, work, and volunteer.

The second group question regarded capital. Where would the smaller financial institution get its next injection of capital, should it need it? Most relied on retained earnings/profits, as expected. Some rely on a relatively small group of local investors, including employees and board members. Read my post on using an ESOP here. A minority were exploring subordinated notes, that can be issued at the holding company and down-streamed as common equity into the bank, should it need it.

After group questions, the Exchange turned to round-table discussions among the CEOs. Below are some of the questions addressed, and a summary of ideas on how to attack these challenges.

If you could make one change in law or regulation that would provide you with the greatest regulatory relief, what would it be?

• The CFPB should tailor their rules for appropriately sized financial institutions.
• Eliminate the right of rescission. Nobody uses it.
• Change the CTR threshold.
• Reduce the BSA workload.
• Disband the CFPB.
• Revise HMDA so it doesn't require so much bank resources.
• QM and TRID delays closing times and disproportionately impacts rural banks (makes mistakes punitive). 

Where is the greatest competition for loans?

• Credit Unions, Insurance Companies, and 3rd parties are competing for commercial real estate loans.
• Farm Credit, particularly in rural markets, are a significant threat to community banks.

Have you experienced a trend of easing underwriting standards over the past year?

• Commercial real estate loan spreads are shrinking.
• Competitors are lengthening loan terms (10yr fixed rate)
• Attendees are being more selective on these loans that are aggressively priced or structured.
• One reaction: make better use of 504s (SBA loans) to reduce risk.

How will you attract the next generation of leaders, employees, and customers?

• Employees: Pay aggressively. Give them increasing responsibility. Identify keepers early.
• Employees: Use stronger screening processes.
• Employees: Internship programs for college students.
• Employees: Have good wellness programs.
• Employees: Use them for process improvement/special project teams.
• Employees and customers: Target bounce-back millennials/ ones that leave the area but miss home and come back. 
• Customers: Put millennials in meaningful roles to attract millennial customers.
• Customers: Use technology such as text messaging to wish happy birthday, low balances, etc.

How are you assessing and managing cyber risk?

• Professional certifications.
• More aggressive testing.
• Customer education (i.e. wire transfer vulnerability, etc.)
• Have to make the resource commitment to manage it.
• Regulators frequently drive risk mitigation.
• FFIEC testing.

The above are simply bullet points for difficult challenges. This is why the round-table discussions surrounding these issues was so important to attendees. To get the full benefit, you will have to attend. 

It's not so bad. It was in Palm Desert this year and in Orlando next year! A welcome respite from winter, and beneficial exchange between community bank senior executives!

~ Jeff

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Bankers: Build Your Own Small Business Loan Platform

Banks that grow revenues do it in spread or fees. To grow spread, increase your net interest margin, or grow earning assets while maintaining net interest margin. To grow fees, either increase your fee schedule or the activities that generate fees, or grow fee-based lines of business. 

Since 2007, banks have been challenged to grow revenues. And if the bank strategic planning sessions I attend are an indicator, bankers think small business account acquisition and growth will be a significant driver of revenues.

This presents a challenge. Many if not most small businesses are not “bankable”, in the lending sense of the word. I once offered this hypothetical situation to a senior lender: An owner of a three year old engineering firm wanted to expand. The expansion would take him into the red for the next two years and his seed capital, taken from his personal savings and a home equity loan was not enough to fund the expansion. He leased his office space. Would the senior lender make the loan? His response: “I’m glad you’re not one of my lenders.”

Would his reaction be different at your bank? Check out your current and recent past loan pipeline. How many non real-estate backed business loans did you make? Yet this hypothetical business is more typical of the businesses that will lead our economy forward. So to grow revenue, perhaps your bank should be a little more creative in getting capital to businesses of the future.

No risk appetite to do early stage business lending? There are alternatives to help that business get much needed capital to grow without plunking a risky loan on your balance sheet. Perhaps develop a small business lending marketplace with several options. One option could be balance sheet lending in the form of home equity loans or other similar avenues that fit your bank’s risk appetite. Think: Your Bank’s Small Business Capitalizer package.

If outside of your risk appetite, how about SBA lending? Ridgestone Bank, a $395 million in assets Wisconsin bank was ranked seventh in SBA 7(a) lending last year, generating between $20 – 25 million in gain on sale of loans per year. 

SBA loans not an option for our hypothetical engineering firm? How about a partnership with a peer to peer lending platform such as Prosper that can be co-branded with your financial institution? Prosper will pay an affiliate fee for each loan offered. OnDeck Capital, which specializes in business cash flow lending, will also affiliate with financial institutions, providing another avenue to fund our hypothetical engineering firm.

It’s not necessarily the affiliate fees that will move our revenue needle, but providing budding businesses within our communities the needed capital to succeed will build loyalty, deposit balances, and eventually “bankable” loans should these businesses succeed. Instead, we send them elsewhere, giving a potential competitor the opportunity to win these businesses’ relationships.

Imagine the “Your Bank” small business loan platform, with multiple opportunities for the local business person to help fund their growth. You start with the least expensive, such as “bankable” real-estate secured loans from your bank, and work through the other options such as SBA, OnDeck, Prosper, and even equity platforms such as Kickstarter. That would be a bank dedicated to small business capital formation, and growth, within their communities.

And a growing community usually leads to revenue growth at your bank.

Or you could stick to business as usual, and hope small businesses come your way. Your choice.

~ Jeff


Note: This article was previously published in the April 2015 issue of ABA Bank Marketing and Sales magazine in the Growing Revenue series.

De Novo Banks: Only Apply If You Intend to Matter

ABA President Frank Keating wrote an Op-Ed piece recently in The Hill entitled New jobs and new growth call for new banks. I don't believe it. A more accurate title should have been New jobs and new growth call for new businesses. His leap-of-faith assumption was that new banks are critical to new business formation. I'm skeptical.

Why? I don't think de novo banks are key players to business startup capital formation. Sure, if you cite studies that say these banks' loan books are predominantly small, as the FDIC measures them. But that is because de novo's are limited to making a loan to one borrower of 15% of their capital position. If a de novo starts with $15 million of capital, its largest possible lending relationship is $2.2 million. So the bank necessarily hunts for smaller relationships.

I'm also skeptical that small community banks in general are financing startup businesses. See the accompanying chart for the loan composition for all FDIC-insured banks and thrifts with less than $1 billion in total assets.

So, if a de novo bank has $100 million in total assets after its first year of operation, and it's loan portfolio was $70 million, then its business loan portfolio would be $9 million, if they achieved the community bank average. And that's all non real-estate loans to businesses, not necessarily startup or early stage businesses. Since I often hear credit people talk of getting three years of tax returns to get a loan decision, it makes me wonder how a 1 year old business can satisfy the requirement.

OnDeck Capital, not a bank, will lend to businesses with one year of operating history and only $100,000 of annual revenues. How do I know this? They tweeted it to me. That's right, they tweeted it.

I am doubtful many financial institutions would make such a loan.

To be fair, the loan portfolio composition in the above pie chart is from Call Reports, which categorize loans by collateral, not purpose. There may be small business loans in the residential category, because the business owner pledged his or her house as collateral for the loan. But I doubt OnDeck or similar neo-banks are requiring such collateral. And OnDeck and similar lenders are growing rapidly in the startup or early stage business financing landscape.

So, no, Mr. Keating, I don't think de novo banks, being run and regulated as they are currently, are critical to small business formation. Who wants a regulator to come in for their periodic exam cycle and ask "why did you make this loan"? What banker is running to capitalize an early stage business without real estate as collateral?

I don't know of many.

Do you think de novo banks are actively participating in startup or early stage business financing?

~ Jeff

Five Bank Marketing Leadership Takeaways from the ABA School of Bank Marketing Management

Lance Kessler introduced a new subject to the ABA School of Bank Marketing Management (SBMM) this week... Marketing Leadership.

A few months ago, he asked me and two other marketing experts to be on a panel for the class. I rejected the moniker "marketing expert". I may be an expert on a couple of topics, but marketing is not one of them. But I applaud Lance and the school for putting a finance and strategy wonk on the panel to get some outside perspectives on how the marketing function can be a significant contributor to the evolution of our respective banks from what we were to what we can be.

The class was a combination of lecture, questionnaire, and panel. So there was not a list of key takeaways displayed in a slick PowerPoint presentation. But I was taking notes on key items identified as critical takeaways for marketing leadership. Unfortunately, I left my notes back in Atlanta. So you, my readers, are stuck with my memory.

Key takeaways for marketing leadership:

1. Speak the language of the C-Suite. As much as marketers read and discuss the increased number of "impressions" they get from a witty Facebook post, your CFO could care less. If you talk social media impressions, you better know how that translates to greater unaided brand awareness, and ultimately more at-bats for your sales force that leads to greater balances than you would have otherwise achieved without the increased impressions. Tell the CEO/CFO how you will drive volume, increase margin, or drive down costs, and their ears will spike like a German Shepard that heard a rabbit shuffling in a thicket. Otherwise, check the marketing-speak at the door.

2. Take your CFO to lunch. But first take heed of (1) above. Building internal relationships will be critical to improving the marketer's influence on the future direction of your bank. Having stronger relationships with bank executives will give you the opportunity to demonstrate you do more than run the ad budget and branch merchandising. 

3.  Be analytical. Many if not most marketers got into the profession to leverage their creative nature. But the marketing function is evolving to be more analytical. Correlating organizational actions to outcomes based on statistical analysis gives the marketer far greater internal credibility than a discussion on how different primary colors impact the senses. You're going to have to trust me on this one.

4. Don't wait to be asked for help. It grates me when marketers focus on retail account acquisition when the bank's strategy is to grow commercial customers. I have not yet concluded that this is because it is within the marketer's comfort zone or that commercial bankers simply don't think they need marketing's help. Maybe a combination of both. If marketers' want to be an integral part of executing bank strategy, then go to the senior commercial banker and show them how marketing will be helping them achieve their objectives.

 5. Grow revenue. Position marketing expenditures as the fuel that grows organizational revenue. Having a well thought out campaign that shows multiple financial outcomes should result in funding. Delivering on the results improves your internal credibility and will make it easier to fund your next project, reducing the need to "whine for dollars" (i.e. can I puhleeezzzz have $50,000 for a direct mail campaign?).

Five is all that my memory will allow. There was a lot of great discussion, and marketers had excellent questions for panelists. 

What else is critical to marketing leadership?

~ Jeff

Community Banks and Our Retirement Problem

How can your financial institution stand out in a crowded marketplace? Why don't we play a critical role in solving the nation's retirement problem?

I recently read a report by the US Senate Committee on Health, Education, Labor and Pensions titled The Retirement Crisis and a Plan to Solve It, led by Senator Tom Harkin (D: Iowa). It called for the establishment of USA Retirement Funds to re-establish pension funds as part of the three-legged stool of social security, pension, and personal savings.

Although it calls for USA Retirement Funds to be private, it used the typical keywords of "transparency, accountability, etc." that reads... government controlled or heavily regulated. The current methods proposed to fix social security such as increase retirement ages, change cost of living calculations, make wealthy people subsidize it, should give us pause that putting more resources and control in the hands of government flies in the face of our unique American independent streak. But how do we overcome the retirement problem?

First, I agree we have a problem. If a 35 year old earns the average household income in the country, then they will need over $1 million in savings to maintain their standard of living for a 25 year retirement (see table). This equates to saving $17,000 per year, every year, until this family reaches 67. I think this family needs a trusted advisor to tell them this, and map their path to get to their hoped-for retirement.

So how can this family save $17,000 of a $50,000 annual income? Well, part of it can be accomplished through the now-typical employer 401(k) plan, where the employer matches some form of employee savings. 

Also, Uncle Sam picks up part of the tab. The employee can save all of the needed savings tax deferred. If the family is in the 15% marginal rate, then Uncle Sam picks up the equivalent of 15% of those contributions.

The Harkin's report identified four principles of reform:

1. The Retirement System Should Be Universal and Automatic. I agree it should be automatic. Universal sounds like Big Brother is telling you what to do. This is a continuing theme with the US Government... Americans are too stupid to care for themselves and need us (i.e. the Government). 

2. The Retirement System Should Give People Certainty. I think peace of mind would be better than certainty. Many great US companies went down the tubes as a result of defined benefit pension plans.

3. Retirement is Shared Responsibility. The US Government already shares with Social Security. The only other sharing (i.e. controlling) they should do is enforce laws against the charlatans that plague the investment community.

4. Retirement Assets Should Be Pooled and Professionally Managed. Well, we call that mutual funds, don't we? But I think Harkins' group is suggesting more centralized control in defining "professionally managed".

I don't disagree with the retirement challenge. I also think saving should be automatic. But I disagree with greater control of a national pension system in Washington. Here is where I think community banks, banded together through associations such as the ABA or ICBA, can play a critical role in solving our problem.

There are countless examples of organizations coming together for a cause. The Rotary Foundation strives to eradicate polio. Feed the Children, well, is self explanatory. Why can't community financial institutions band together to help customers prepare for retirement?

I'm not talking about our frequently half-hearted attempt at retail investment sales. I'm talking about a national program, established through our associations, that vets money managers like associations now vet "approved" vendors, and establishes low cost investment option packages that customers can select based on their risk appetite.

They can range in risk from mostly all stock funds, to mostly all bank CDs. The key will be to automatically move the money monthly from customers checking account into a tax advantaged IRA-type account. I'm not suggesting receiving no compensation for it. But keep fees low, such as 25-50 bps. Negotiations with money managers can partially offset these fees, since nationally community banks will be placing large sums of money into these funds. The money will be portable, and owned by customers, and not the federal government. I think we can establish a national program that meets the Senate committee's four principles, without it morphing into another federal bureaucracy to be tinkered with by future elected officials, as is the case with the Social Security system.

Imagine, a middle class family, through their local financial institution, putting away $250/month into such a program, in addition to their 401(k) plans at work. We can play a positive role in helping our customers enjoy their retirement years, and achieve piece of mind.

Should we band together and embrace the retirement cause?

~ Jeff

Banks Versus Credit Unions: Much Ado About Nothing

Credit Unions don't pay taxes! They're trying to steal our business customers!

I often quote Sun Tzu from his over 2,000 year old book, The Art of War. One of my favorites: "If you know the enemy and know yourself, you need not fear the result of a hundred battles." The frequent and resource sapping waling about credit unions tells me that banks don't know their enemies, umm, competition.

Last year I attended the CUNA Government Affairs Conference (GAC). By the way, it was the trade show beyond all trade shows. Clearly credit unions put heavy resources into lobbying. So I will give banks that point. We had a booth, and my company's tagline is "helping banks perform better". We like the alliteration, and use the word "banks" in a generic way, like Kleenex.

But one would think we would hear about it from CU executives and trustees. And we did hear some quips. But one CEO opined that the rift between banks and CUs was greatly exaggerated by trade associations to keep the masses engaged. I believe her.

Why? Take my home state, Pennsylvania, for example. We do business with both banks and CUs in the state. Admittedly, mostly banks. And we hear plenty about credit unions in strategy sessions. But I pulled deposit market share data for the state, and the results are telling (see table).

Credit Unions boast a 9.5% deposit market share in the state, or $33 billion out of $345 billion total. There are 497 credit unions headquartered in PA, but 447 of them are less than $100 million in deposits (ok, shares for you CU technocrats). All PA CUs combined have the same in-state deposits as Wells Fargo, and half that of PNC. There are only two CUs in the state's top 20 in deposit market share.

Does the banking industry dedicate disproportionate strategic decision-making, marketing and lobbying resources fending off CU competition? Because when I look at the above table, it's clear where a community bank's strategic focus should be. And it shouldn't be on the Locomotive & Control Employees FCU in Erie.

What is this table telling you?

~ Jeff

Your Branch in Your Pocket

I am attending the annual ABA Marketing Conference, where I spoke on how marketing can focus efforts on improving profitability and moving their bank forward.

The program had plenty of learning opportunities. One was the best attended general session in conference history, Brett King on the future of banking. Brett is the author of Bank 2.0, Branch Today, Gone Tomorrow, and the forthcoming Bank 3.0 and is what I would term an industry futurist, predicting and staying ahead of where he perceives the industry is going.

In the below clip, Brett speaks of the friction in our system that is slowing our adoption of change. He used the example of Compliance friction, that often thwarts efforts for online account opening and other technology adaptations. He makes the point, quite correctly in my opinion, that there is an irreversible trend in our industry away from customers coming to our branch, and calling us on the phone.

That puts a premium on building our bank's team on customer and prospect outreach, visiting them on their turf, with convenient technologies. Because if we wait for them to come to us, they're likely to go somewhere else.

Are you trying to reverse the trend and encourage customers to come to your branch? If not, how do you reach them?

~ Jeff

Customer Profitabilty in Banking: Do you do it?

According to an ABA survey (see table), I doubt it.

I am speaking at the upcoming ABA Marketing Conference next week. Well, maybe not as much speaking as appearing. Mary Beth Sullivan and I are appearing as guests of Susquehanna Bank's Susan Bergen, in an Oprah like talk show format. I suggested Saturday Night Live's Point-Counterpoint format, but it was rejected. To appease my objection to appearing on Oprah, they orchestrated my entrance to a Pitbull song. I did not know who Pitbull was.

Our discussion will revolve around an ABA survey done this summer regarding actions banks have taken, or intend to take, to improve profitability. One question that didn't make the cut in the interest of time, was the one represented in this post's table: Does everyone in management know profitable versus unprofitable customers the bank serves today?

If you were in the corporate headquarters of McDonald's, you would be alarmed at the results. If you are in banking... not so much alarmed as happy that so many others remain as in the dark as you. I think lack of knowledge of profitable customers comes from three things:

1. Getting such a number requires investment in resources your FI currently does not have:

2. The regulators don't require the information; and

3. Even if you had the information, what would you do about it anyway?

All are related. FIs earn money on the spread. In order to create spread, FIs focus on creating a basket of the highest yielding assets within risk parameters, while funding them with a basket of the lowest costing funding. Why do you need some fancy profitability information to tell you that?

Problem: Various assets and liabilities take differing amount of operating expenses to accumulate. Also, based on risk, different assets and liabilities require different equity allocations. If your attitude is that the "incremental" cost of chasing this business or that is minimal, you may very well be mis-allocating your precious resources to low profit customers.

For example, we have a client that served the bar/restaurant business in a college town. These establishments brought decent balances to the bank. The problem: we found employees that spent half their day sorting through the bag-fulls of cash delivered every day. Could the bank allocate that operating expense to a campaign to acquire and serve higher profit customers? Without determining the profitability of those customers, we would never know about the opportunity lost.

I think it's time to change the paradigm from acquiring the highest yielding assets and the lowest costing liabilities based solely on interest earned or cost of funds. We should instead focus on acquiring and serving baskets of the highest profit customers. Doing so will efficiently allocate resources, improve our profitability, and enhance our FIs value.

~ Jeff

Banking: Data hungry and decision challenged?

I had lunch today with a client's regional manager. We discussed many things, but one thing he told me stuck... they used average balances to determine their highest priority customers. Many of my comrades in the community FI blogosphere feed on data, some good, some bad. But using average customer balances to determine your best customers is unfortunately very common... bad use of data.

Similar to the above, a client of ours requested that my firm identify their top 100 customers by coterminous spread. We distributed the list. They reviewed it quizzically. The senior management team did not know half of the customers on the list. Their perception of their best customers also revolved around balances.

Financial institutions have in their possession more information about their customers than any other industry, with the possible exception of medical. How do we collect it, parse it, and use it? My guess is we don't do a very good job of harnessing this information to identify top customers, profitable products, or strategic opportunities.

I teach at the ABA School of Bank Marketing Management. One of my courses is Profitability & Strategic Issues. I distribute a questionnaire to determine what information students' FIs use to make strategic decisions. The below chart identifies their response to one of the questions.

Forty three percent of respondents reported that their institution did not use marketing data for strategic planning. Another 11% reported using it sometimes. This is astounding but consistent with past years' responses. Marketing data about customers, products, and markets should be critical to strategic decisions. Yet frequently, this data remains within the confines of the Marketing Department. Trapped as bits and bytes in the FIs MCIF or similar system, only to be busted loose to help with the next product promotion.

Aside from information trapped within our core processing and ancillary systems, there is ample data available for strategic decision making in the public domain and primary research conducted by industry professionals. Are we identifying the necessary data points to make important decisions?

For example, if considering branching, one would think the key data points are as follows: Are their enough of the types of customers within a certain community that we typically target and have success with? How many competitors are in the community and what is their branch size? Are branch deposits growing or declining in the community? Are businesses growing and in what industries? Are new housing developments on the horizon and are average home prices increasing? Are branch sites available in locations with adequate traffic?

Most if not all of the data mentioned above is either publicly available or can be obtained from private sources such as local realtors and from the FIs own marketing databases. But if your experience is similar to mine, you understand many branch decisions are made based on anecdotal data or because somebody we know owns the prospective branch property.

As succeeding in financial services becomes more challenging, making informed strategic decisions will be critical to our success. The days of throwing grass into the air to determine wind direction is no longer adequate. Important information need not be out of our reach. Much can be obtained freely via public sources, or can be mined from our own systems. When making decisions with long-term impact, FIs must identify the information needed to make informed decisions and collect and analyze it. Successful execution of the strategies to lead us into a successful future depend on it.

How does your FI use data to make strategic decisions?

~ Jeff

An open letter to bank marketers...

Change is difficult. Consider the difficulty in changing our own behaviors. A friend of mine that runs fitness clubs on Florida’s Gold Coast told me that it can be more effective to increase weight training in my workout regiment if I want to shed some pounds because muscle burns calories. This required me to rethink and change my workout routine. The end result: I decreased my cardio workout and increased weight training five measly minutes.

I did not doubt my friend’s advice. I had difficulty changing my routine, a routine that is totally under my control. Imagine changing the culture of a whole organization. To my bank (thrift and credit union) marketing friends, I throw this challenge to you.

The talent of the individuals facing me these past two days at the ABA School of Bank Marketing Management in Dallas was impressive. Collectively, they have intelligence, education, intuition, and the ability to think strategically. Marketers, in my experience, have demonstrated a greater acceptance of the need for cultural change in banking.

But there is a challenge to them. In many instances, they have been marginalized in their institution; relegated to running the ad budget or organizing the next customer mixer. Many, if not most bank employees, think about the next loan deal, or the next CD promotion. Marketers are the proverbial right brain thinkers in a left brain world.

But banking is changing rapidly. The need to develop a vision and a strategy to support achieving that vision is greater today than at any time since post WWII. If our bank is simply an efficient processor of debits and credits, are we needed? There are plenty of other financial institutions to fill that role. Each bank must assess where it stands in its communities and among its customers. Once completed, they need to identify the type of bank they want to be and set about getting there.

Marketing is in a unique position to play a critical role in evolving our industry and be the lynchpin for cultural change (see link to Susan Heathfield’s blog on organizational cultural change below). The personality of Marketing leaders are typically well-suited for strategic thinking. They have their fingers on the data about the bank’s customer base, markets, and prospects that is critical to creating strategy. They have the skills to design service standards that are truly superior, to implement training that goes beyond compliance, and to demonstrate to employees how to execute on those standards.

But how should a bank marketer implement cultural change in an industry that has not yet embraced it? How should one convince a CEO that the long-term relevance of the bank is dependent on cultural change and not simply minor tweaks to business as usual?

I don’t think this will be easy. But I find the marketing function to be in a unique position to start the process of cultural change. Marketers intuitively recognize the need for change, have the ability to pull back the camera and think strategically, and have the ideas to show a path to successful change and lead their banks back to relevance. Take the initiative.

-Jeff

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