Is the FDIC Summary of Deposits Pure Fiction?

For decades, FDIC deposit market share data has been one of the banking industry's most important tools for assessing competitive position. It is relied upon by regulators, banks, consultants, and investors to measure market presence and evaluate branch expansion opportunities. However, analysis of two Pennsylvania counties, Lackawanna and Luzerne counties, suggests that the traditional branch-based methodology may be becoming increasingly disconnected from how households actually manage their savings.

These counties offer an interesting case study. Between 2021 and 2026, the number of households increased from approximately 220,300 to 225,000, representing modest but steady growth. At the same time, FDIC-reported deposits attributed to physical bank offices in the two counties increased from roughly $15.8 billion to $16.1 billion. Deposits per household, however, remained essentially flat, moving from approximately $71,870 to $71,490. The compound annual growth rate of deposits per household was actually slightly negative, while household growth exceeded total deposit growth.

The most striking trend may not be growth rates but rather the declining importance of physical offices themselves. The number of bank branches included in the market fell from 177 offices in 2021 to 157 in 2026, an 11% decline. Yet deposits remained relatively stable. This suggests deposits are becoming less dependent on branch proximity and more dependent on digital relationships, brand strength, rates, and product offerings.

The below table indexes 2021 to 100 to demonstrate what I just described.

This raises a fundamental question: what exactly does FDIC deposit market share measure today?

The FDIC Summary of Deposits system attributes deposits to physical banking offices. That methodology was highly logical when households overwhelmingly banked at institutions with local branch networks. 

Today, however, consumers routinely place funds with institutions that may have no branches in their county, state, or even region. Online banks such as Ally Bank and SoFi Bank compete directly with community and regional banks for deposits while maintaining little or no branch infrastructure. 

Similarly, consumers increasingly hold cash-equivalent assets in brokerage sweep accounts, money market mutual funds, Treasury bills, and other vehicles that sit entirely outside traditional deposit market share calculations.

As a result, a bank's reported deposit market share within a county may tell us where deposits are booked rather than where residents actually store their wealth. A community bank could maintain a stable branch-based market share while losing household wallet share to online banks and investment platforms. Conversely, an online institution could have substantial relationships with local households while appearing to have no market presence at all.

The competitive implications are significant. Regulators use deposit market share extensively in merger and acquisition analysis. Yet if a growing percentage of household savings resides outside locally reported branch deposits, concentrations based solely on branch data may overstate actual market power and understate competition. The market experienced by consumers is increasingly national, not local.

A potential solution would be for banks and credit unions to report deposits based on the ZIP code of the depositor's residence or business location rather than solely the location of the branch where balances are assigned. While implementation would require some data cleanup and privacy safeguards, the resulting information would provide a much more accurate picture of where households and businesses actually place their money. It would also allow banks to make better strategic decisions and regulators to better evaluate competition from digital banks, credit unions, and other federally insured institutions that operate without extensive branch networks.

The Lackawanna-Luzerne data support this theory. Household growth has continued, branch counts have fallen, and deposits per household have not grown. All this while inflation rose a total of 23% since 2021, and money supply (M2) has grown 2.3%, and banks cost of deposits averaged 1.5%-2% annually. Aggregate deposit growth in Lackawanna-Luzerne was less than the interest paid on those deposits.

Those trends are consistent with a banking system in which physical location is no longer the primary determinant of deposit gathering. As banking becomes increasingly digital, a branch-based deposit market share framework may be measuring yesterday's competitive landscape rather than today's reality. The next evolution of market share reporting may require shifting focus from where deposits are booked to where depositors actually live.

Let's make the change.

~ Jeff

 

Calculating a Bank's Uninsured Deposits

The critical fact contributing to the Silicon Valley Bank and Signature Bank's demise was the level of uninsured deposits at each institution, estimated to be at 94% and 90% respectively. Many community bankers received concerned calls after the bloody weekend of March 10th through 12th from depositors that had deposits that exceeded the FDIC insured limits.

Most financial institutions, particularly community financial institutions, have jumbo deposits, as deposits over $250,000 are known, nowhere near SVB and Signature. 

But how much do they have? I recorded this tutorial so you can calculate on your own using publicly available data.

Apologies for using "unsecured" so often in the video when I meant uninsured.

Youtube link if you have difficulty viewing here: https://youtu.be/CSNetCgAAnY

The Difference Between a Community Bank and a Big Bank

I recently spoke to a community group, and subsequently a community bank all-staff meeting regarding the definition of a community bank. The FDIC has defined community banks in their December 2020 Community Banking Report that either exclude or include the following criteria:

Seems complicated. Especially when a community bank could have no office with more than $8.24B in total deposits but could have no more than $1.65B in total assets. A pretty small asset size, in my opinion. But the FDIC did confess that a community bank was not easily defined. 

If you ask me, the definition of a community bank is more subjective. Here is how I defined the difference between a community bank and a big bank.

A community bank lends depositor money here.

A big bank lends a little here, there, and everywhere.

A community bank is vested in the success of the communities it serves. When the community(s) suffer, so does the bank.

A big bank is hardly vested in the success of any one or a few communities.

A community bank's risk management practices, such as lending to certain industries, making character loans, deposit availability, etc. are made near the customers most impacted by those practices.

A big bank makes risk management decisions at headquarters in a location far, far away.

Community bank customers get the bank's A-team.

If you're not a very large borrower with eight figure loan needs, you're likely getting a bench player, if you get a player at all. You might end up with a bot named Michele or Michael.

Community bank leaders are at your churches, in your restaurants, at the ballfields, and in your community organizations.

Big bank leaders are not.

Communities are better for having community banks in them. Is that true for big banks?

~ Jeff

The Federal Home Loan Bank System: Lender of Next-to-Last Resort

"The FDIC recently has observed instances of liquidity stress at a small number of insured banks." So opened the Summer 2017 FDIC Supervisory Insights issue. And so went your exams.

At a recent banking conference an industry consultant said, matter of factly, that in times of stress your Federal Home Loan Bank (FHLB) borrowing capacity would dry up. Nobody challenged him, including me, by the way. But when I mentioned the comment to the attending FHLB rep, she was not particularly happy.

This has happened before. Regulators and consultants promulgate this untruth. And having heard it so much, bankers are beginning to believe it. 

This week I sat in a bank CEO's office where he complained, ranted really, about his latest exam and the regulators' perception of liquidity risk, driven by the aforementioned Supervisory Insights. He was confident in his bank's liquidity position, but felt regulators could artificially create a liquidity problem.

Their conversation goes something like this: pretend that your non-core and wholesale funding dries up, and you are unable to attract local funds via rate promotion because of our restrictions on rates paid above the national rate cap. What would you do? Prepare for that.

I recently wrote that I thought bankers would have to prepare to offer rates more in line with the market. I noted that there was a greater than 100 basis points difference between what a customer could earn on an FDIC-insured Goldman Sachs Marcus account than what they could earn in your bank's money market account. And that bankers are going to have to build the infrastructure that allows them to be closer to market.

The national average rate for a money market account at the end of last year was 0.09%. The Fed Funds Rate was 1.25%-1.50%. So, according to the FDIC rate cap "guidance", you could not exceed 84 basis points on your money market accounts at December 31, 2017 if you were under regulatory scrutiny. Sixty six basis points less than the Fed Funds rate at that time.

I monitor trends. I know loan/deposit ratios are going up, and liquidity ratios are going down (see charts). But what are the chances that your liquidity position plummets, you lose access to your

correspondent line(s), you can't attract local deposits, your municipalities withdraw, and your FHLB line "dries up", all at once? As the FHLB rep mused to me, it could happen if say, an extreme black swan event much worse than the 2007-08 financial crisis happened.

More to the point, she directed me to her FHLB's president's message on their website where he wrote: "As long as markets remain open, and a member has pledged sufficient qualifying collateral and is willing to purchase the requisite amount of capital stock, the Home Loan Bank will always continue to lend to our members to help you meet your community's needs." 

We need a smarter discussion on liquidity. Before we create an artificial liquidity crunch.

The consultant at the above mentioned conference did have some solid recommendations that I would like to share, even though he is a competitor. Pretty magnanimous of me, right?

1. Create detailed funding concentration risk analytics, that includes:

     -  Stratify funding using a liquidity matrix

     -  A deposit loyalty study (to classify what regulators consider non-core as core)

     -  Determine a local rate cap (to use vs. the federal rate cap)

2. Conduct forward looking stress tests that include realistic contingency funding strategies

3. Train board members

4. Update liquidity policy and contingency funding plan to be consistent with the above process

Are you feeling pressure internally or from regulators on liquidity?

~ Jeff

Why are banks slow to adapt alternative credit data? I'll tell you why!

Deposit insurance. 

In order to get federally sponsored deposit insurance, that is industry self-funded mind you, the Federal government and state governments set up a regulatory scheme to ensure the safety of customer deposits.

All have benefited. The banking system is stable, which is critical to national and state economies. Depositor money is safe. Also critical. And let's not forget about the thousands of employees that work for regulatory bodies, compliance personnel in banks, and consultants that help them comply.

So what am I talking about, that deposit insurance is why banks don't do like FinTech lending firms and use alternatives to the FICO score in underwriting consumer credits? 

Our legislatures did not limit themselves to safety and soundness when they created banking law. No, they dabbled in money laundering, terrorism, drugs, Internet gambling, and, oh yes, fairness.

Fairness.

What does that mean?

Whatever you want it to mean.

So when yesterday's American Banker asked why alternative credit data was a hard sell for small banks, running afoul of the Fair Lending Act was a key concern (see table).

I would argue that using alternative data to make consumer loan decisions scares bankers because it has not played out with the "fairness" laws and regulations out there, and the disparate impact doctrine used by regulators to determine if a practice is discriminatory. 

According to the FDIC, disparate impact occurs when a policy or practice applied equally to all applicants has a disproportionate adverse impact on applicants in a protected group. Even if it serves as a good predictor of a borrowers propensity to pay back the loan. If a financial institution uses payment of utilities in its credit decisions, and declines credit because prospective borrowers pay utilities late, this could have a disparate impact on a protected class. But bankers won't know that when they establish the criteria. They have to find out later, after a bureaucrat in Washington does a white paper.

This application of law will continue to be a challenge for financial institutions looking to compete with FinTech firms and mine other data sources to predict a customer's credit worthiness.

I got news for our lawmakers and regulators. I only know bankers that want customers to pay back their loans. And because deposit insurance is a national program, so should they.

~ Jeff

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

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

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

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

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

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

The CRE concentration tests are as follows:

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

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

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

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

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

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

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

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

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

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

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

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

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

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


~ Jeff

Why No De Novo Banks? Math.

There is increasing chatter about relatively small banks, under $100 million in assets, looking for an exit. Because they are so small, there may not be a line of buyers waiting for a book to come out from the investment banker. So perhaps an investor group would be interested in taking out current shareholders and recapitalizing the bank?

During previous periods of bank consolidation, the net decline in financial institutions was buffered by the number of de novo banks. For example, in 1997, the merger peak in the past 20 years, there were 725 mergers, and 199 de novo banks.

Not so today. Conventional wisdom puts the blame on regulators. They’re not approving charters, or making it extremely difficult to do so. The regulators deny this. But there is truth to it, in my opinion.

If a bank has a business model that is unique, or serves a narrow constituency, regulators push back in the name of concentration risk, or untried business models. I recall an Internet bank that was trying to get off of the ground in Michigan in the late 1990’s. The concept was new, and growth was projected to be robust, albeit not off the charts.

The FDIC required the bank to raise $20 million in capital, a tidy sum back in the 1990’s when banks got started with less than half as much. So because the business model was relatively unique, the regulators required a very high level of capital. The bankers couldn’t raise it, and the de novo never got off of the ground.

Today, regulators still favor plain old business models. Yet they are also requiring high levels of capital. Primary Bank in New Hampshire, started last year, raised around $27 million. Sure more is better from a safety and soundness perspective. But that capital comes from somewhere. And that somewhere, investors, have choices on where to invest their money.

In comes the math problem.

Let’s say an investor group, tired of big banks making decisions about their communities hundreds of miles away, decide to explore starting a bank. They put together an outline of a business plan, project out their financials several years, and go visit the FDIC.

The FDIC looks at the business plan, critiquing any part of it that is outside the norm, serving a particular industry or industries, relying on non-traditional distribution methods, and so on. They suggest that being more plain vanilla will increase their chances of approval. And by the way, it will require $25 million in startup capital.

The investor group puts together a prospectus, and begins soliciting shareholders for commitments. 

Now, Joe Investor has $10,000 to invest. Does he put it with this new bank? Or does he invest in an S&P 500 Index Fund?

The S&P 500 has a compound annual growth rate of 5.0% over the past 10 years, and 13.0% for the past five years. And The 10-year includes the Great Recession, so Joe Investor projects the S&P 500 compound annual growth rate of 9.0% for the next 10 years. For reference, the S&P 500 grew 9.2% annually during all of my adult years since 1984. 

For Startup Bank, the organizers have projected the following over the next 10 years.

A $10,000 investment in a de novo bank pales in comparison to the return Joe Investor could receive by investing in an S&P 500 mutual fund. And if Joe needs his money out of the fund, he places his trade and the money is in his bank account within three days.

Startup Bank, on the other hand, would likely trade very little. For all publicly traded banks between $400-$500 million in assets, the average trading volume is 1,432 shares per day. Joe putting in a sell order on his holdings could move the market and decrease his value. I learned this the hard way, by the way. So take it from my experience.

Lest you think that the dearth of de novo banks is a regulatory problem. I got news for you. It’s a math problem.

~ Jeff

Bank Board Compensation: An Amateur's View

Lately I have been asked to opine on bank Board compensation. Although not a compensation expert by any means, I suspect I am being asked for an outside-the-box opinion. This reminds me of one of my colleagues favorite quotes; "those that live outside the box have never been in it." But with most areas that are outside of my technical expertise but within my industry expertise, I tend to revert to common sense.

What are we trying to accomplish with Board compensation?

The FDIC Pocket Guide for Directors identifies the Board's responsibilities as:

- Select and retain competent management.

- Establish, with management, the institution's long and short-term business objectives in a legal and sound manner.

- Monitor operations to ensure that they are controlled adequately and are in compliance with law and policies.

- Oversee the institution's business performance.

- Ensure the institution helps to meet its community's credit needs.

How do we establish a compensation plan that is consistent with the above?

I have opined in the past that financial institutions' fixed to variable expense equation tilts too much towards fixed. So why exasperate the situation by creating more fixed expense with Board compensation? 

But there are certain moral hazards to incentive compensation at the Board level. Basing it on short term financial performance encourages greater risk taking. And the Board is responsible for the safety and soundness of the institution. To overcome this moral hazard, I suggest two things: 1) make the incentive compensation based on three-year average performance, and 2) include safety and soundness metrics to the equation.

This is similar to an unnamed bank that was suggested to me by an industry compensation consultant. I looked it up in their proxy, and their plan, which was for both executive management and the Board, looked similar to the below table.

The unnamed bank did not name the performance metrics, calling them "Category 1", "Category 2", etc. because the actual metrics need not be disclosed. Shareholders that deem themselves compensation experts are a dime a dozen so why give them ammunition! 

So I decided to insert what I thought would be performance metrics consistent with Board responsibilities. 

The metrics are relative to a pre-selected peer group, which is very common in executive compensation. But rather than limiting performance metrics to short-term, the unnamed bank used three-year averages. Meaning that there would be no payout for the first three years. All calculations thereafter would be based on three-year averages.

This did two things: 1) encouraged longer-term thinking so strategic investments can be made so long as it improved longer term performance, and 2) discouraged short-term risk taking that might result in future losses. It is not perfect, but what plan is?

The above table goes beyond the traditional performance metrics, and includes risk ratios such as leverage ratio growth, non-performing assets to total assets, net charge-offs to loans, and the one-year repricing GAP to assets. These are all risk metrics. But they should also be consistent with the Bank's strategic plan. If the plan calls for better than market growth, perhaps the leverage ratio will decline in relation to peers, etc. In such a case, perhaps exceeding long-term projected leverage ratios would be the metric.

The final addition, which was not in the unnamed bank's comp plan, was achievement of strategic objectives. I have expressed my concern over banks short-term, budget-centric focus on business results that discourage long-term strategic thinking that builds sustainable institutions. Why would I encourage it in a Director Comp Plan? 

So achieving strategic objectives is a litmus test to making the incentive comp available for payment. Note that not all strategic objectives need to be achieved because incenting for 100% success encourages sand-bagging, which is another industry obstacle to long-term excellence.

If adopted, Director's that received $30,000 in annual compensation could be eligible for incentives that increase total compensation by one third. Not an immaterial sum. Such comp could be paid in cash or stock, and expensed as incurred.

I recently mentioned to an industry colleague and bank Board member that you don't want to create unfunded liabilities for Board compensation that will ultimately get deducted from a buyer's offer to your shareholders, should one come your way. The savvy shareholders will catch on, and could make your life a little uncomfortable. 

What are your thoughts on incentive comp for Board members?

~ Jeff

Dear Mr./Ms. Bank Regulator

My firm will occasionally provide feedback on correspondence to our clients' regulators. Today we did just that. Our advice: don't come off as combative. Since hitting send on that e-mail, I reflected on how a half Italian, half Irish firebrand like myself became so melancholy. 

Truth is, I haven't. I thought about what we should have said to the regulator, versus the sweet words I was encouraging our client to use. I mentioned to him that we should keep two versions of the letter: one that we will send crafted to get our intended result, and one that says what we mean. Below is a sample letter to your regulator, saying it like you mean it.

August 2, 2014


Mr. John Whatshisname
Examiner In Charge
Bank Regulatory Body
1 Bureaucrat Way, NW
Washington, DC 20429

Mr. Whatshisname,

Below is our response to the Matters Requiring Attention ("MRA") that were included in your most recent examination report on Schmidlap National Bank ("Schmidlap"). 

Although our Tier 1 leverage ratio is greater than 10%, you criticized us for our stress scenarios contained in our capital plan. You opined they lacked analytic rigor. Aside from the clear lack of analytic rigor you exercised to come to this conclusion, it is important to remind you that estimating future negative events that impact our capital is guesswork. We like our guesses better than yours, and our spreadsheets are bigger than yours. So, no, we are not re-doing our capital plan.

Our level of investor commercial real estate is trending closer to your guidance levels. We get that. What you suggest we do is create greater diversity in our loan portfolio. We have a lot of small restaurants in our markets that can pledge pizza ovens as collateral. We are now training our lenders on pizza oven market valuations and setting a pizza oven loan to value limit in our loan policy. We will be dispatching lenders to pizza shops up and down our valley in the coming months. Mangia!

In the management section, you had two items for us: our succession plan and strategic risk. If I win the lottery, Frank will take my slot. If Frank gets hit by a beer truck, Jane is up to the task. If Mary goes buh-bye, Alex will step in. There's our succession plan. The Board is a little more difficult, because getting local luminaries to get paid twenty five grand a year to put up with your bullsh*t is difficult. We're working on it.

In terms of strategic risk by the recent new products and delivery channels we have added, we will need further definition from you on "strategic risk". When sending your clarifying statement, also send your resume containing the qualifications you possess to dictate product and delivery channel strategies. Also, please clarify the definitions contained within CAMELS, because we didn't think the S meant strategic. If our memory serves correctly, and the S does not stand for strategic, then we don't give a rats a** what you think about our products and delivery channels.

We recognize that there are so many laws and regulations that apply to banks that you can couch any criticism you have for us under some law, such as the Truth in Lending Act. It reminds me of high school geometry, when the teacher asked me to solve for a triangle, I would say "CPCT", knowing it could be so. So you can say, "I don't like this checking account... BSA/AML", and I would have to enlist regulatory attorneys to investigate the matter only to come to the conclusion that "you can't fight Uncle Sam".

That, Mr. Whatshisname, is the definition of tyranny. And Schmidlap is not gonna take it.

Warm Regards,
Schmidlap National Bank

To Branch or Not To Branch: Here Is The Answer

During periods of uncertainty lies opportunity. Vernon Hill, legendary leader of the former Commerce Bank in Cherry Hill, New Jersey, took advantage of the last time bankers were contemplating the future of branching by beating them over the head with his high profile and rapidly expanding branches. Can another Commerce Bank eat our lunch this time around?

Only if you develop a decade long strategic plan that maps the decline in branch prominence. If you are a shorter term strategist, and you want to grow, then branching remains on the table because it remains high in importance when customers are asked why they bank where they do. Even if they do not frequent their local branch, they tend to bank where a branch is nearby.

But what kind of branch? The Financial Brand did a showcase piece on innovative branch designs. I don't know which one is best, if any, but do know that the answer to proper design lies in your target customers as identified by your strategy. So, the branch question, be it design, location, and staffing, should be driven by the type of customers you are targeting, as identified in your strategy. If you haven't identified your target customers in your strategy, read no further and go do it.

But for those that know who they are targeting, the branching decision should be built on analytics. Branches represent such a significant expense, and average deposit size to achieve desired profitability has gotten so large, that we can no longer decide to branch at a location that is convenient to one of your directors.

Here are what I believe to be the critical pieces of information in determining where to branch:

1. Where are your customers now? Banks often have concentrations of customers that are in towns where they have no branches. This could be a significant starting base to grow your branch. I attended a banking conference recently where the presenter said your best source of new customers are the neighbors of your existing ones. If you have a solid foundation of households within a geography, that is a great start for a successful branch. Note I'm not suggesting branching just to bank existing customers, as that would erode overall profitability. But existing customers are the seedlings for new customers. So identify where your customers are.

2. Are there enough opportunities to bank your target customers in the new market? If you specialize in banking doctors and dentists and there are paltry few in the new market, I'm lost why you would consider going there. The exception may be that your niche rests on the loan side of the business, and funding those loans evolves from a more general strategy to generate funding. But if you can't dominate your niche in a certain geography, consider going somewhere where you can.

3. Is the market growing? Household and business growth demographics are pretty easy to obtain, either through government sources or systems such as your MCIF. Deposit growth and market share, and number of branches in a market (see tables) are available via the FDIC website. Are deposits increasing? Are competitors struggling? Are average deposits per branch increasing and of sufficient size to achieve your desired level of profitability?  

4. Are bankers available to staff the branch? In nearly every strategic planning session I attend Senior Managements place great emphasis on successful strategy execution on their people. There is no substitute to having the type of staff with the greatest likelihood of successfully executing your bank's strategy in your new market. You want to fail? Put no emphasis on branch staffing. You'll fail. I guarantee it.

5. Is a reasonable site available. I'm a realist. You can set your branch up for failure if you don't find a reasonable site. The term reasonable is in the eye of the beholder, but if you are tucked in the middle of a dying strip mall, that may not bode well for your visibility and your brand. Find a location where your people can succeed.

6. Can you de-branch painlessly? This is a new question for your branch analysis. There will come a time when your contemplated branch, and other branches in your network, will be unnecessary. Customers will be accustomed to banking online and/or via mobile, advice and problem solving can happen via the phone or in-person visits to the customer, and the psychological attachment to the branch will be gone. Can you close shop without incurring significant expense? 

I don't think branching is dead. But I do think that the need for marquis, high cost branches is waning, and smaller and more tech savvy branches will emerge as the norm. I also think staff per branch will decline, but capabilities per staffer will increase. The importance of getting your next branch decision right is critical to successful execution of your strategy. Don't let your director bully you into putting one near his/her house.

How do you think branching decisions should be made?

~ Jeff

Are the regulators getting you down?

These past two years have often been extremely difficult. As consultants, we should try not to personalize engagements. But I can’t change the internal wiring. Last year, a client failed, and many more received regulatory orders.

Memorandums of Understanding (“MOU”), Formal Agreements (“FA”), and Cease and Desist Orders (“C&D”) have been on top of our reading list for the past two years. The stark increase in such orders has been alarming. The FDIC has nearly quadrupled its enforcement actions (“EA”) over the past three years.

Many of these EAs have very similar, if not identical, provisions. Take for example the language from an FA Article relating to a strategic plan issued by the OCC to The Suffolk County National Bank of Riverhead (“SCNB”) in New York on October 25, 2010:

“The Board shall adopt, implement, and thereafter ensure Bank adherence to a written strategic plan for the Bank covering at least a three-year period. The strategic plan shall establish objectives for the Bank's overall risk profile, earnings performance, growth, balance sheet mix, loan mix, off-balance sheet activities, liability structure, capital adequacy, reduction in the volume of nonperforming assets, product line development and market segments that the Bank intends to promote or develop, together with strategies to achieve those objectives…”

Get in your time machine and go back to February 6, 2009 when the OCC issued a Consent Order to Bay National Bank in Lutherville, Maryland. It too had an Article regarding a strategic plan that read:

“The Board must within sixty (60) days of the date of this Order, adopt, implement, and thereafter ensure Bank adherence to a written strategic plan for the Bank covering at least a three-year period. The strategic plan shall establish objectives for the Bank's overall risk profile, earnings performance, growth, balance sheet mix, off-balance sheet activities, liability structure, capital adequacy, reduction in the volume of nonperforming assets, product line development and market segments that the Bank intends to promote or develop, together with strategies to achieve those objectives…”

So what, right? The OCC cut and paste because they wanted a similar strategic plan from both institutions. People and organizations do this all of the time.

The difference here is that SCNB has been profitable throughout the crisis, and achieved a 1.12% ROA for the third quarter 2010. Bay National failed on July 9th. In this context, is similar treatment in an EA fair?

I would vote no. There are many Articles in EAs, and the strategic planning article in the above institutions is one of many. But life, and business, is not necessarily fair. I’m not sure the lesson we should glean from the similarity of these two orders should be about fairness.

The productive view about the similarity of EAs is why haven’t we been doing some of the things required by regulators in the first place? Why do many, if not most of these orders contain Articles relating to strategic and capital plans?

Banking is a highly regulated industry, and has been since the Great Depression. Regulators must approve our initial business plans, capital plans, and various other operating procedures prior to granting a charter. Once granted, regulators examine us at least annually, and frequently more often, to ensure we are complying with the myriads of laws and regulations designed to promote safety and soundness. They used to approve interest rates and limit products.

Given the highly regulated environment, bankers are kept in a tight box of things they can and can’t do. So why develop a strategy? Budgets have successfully served as strategy the past three generations, haven’t they?

In the context of EAs, I don’t believe regulators are compelling bankers to develop strategic plans to identify a competitive advantage, to differentiate from other banks, or to build a roadmap to the future. When we read between the lines of EAs, we see regulators looking to tighten the box, remove gray areas, and exert greater control by requiring banks to seek permission to deviate from the plan.

But that should not stop those operating under EAs from taking maximum advantage of the consulting and advisory dollars they are required to spend. If required to develop a strategic plan, why don’t banks assess the competitive environment and build a vision and plan for their sustainable future? Similarly and almost complementary, the capital plan should be a component of bank strategy. How much capital will the bank need to execute the plan? What are the preferred and secondary sources of capital?

Imagine a bank that seeks to grow organically by positioning itself as a small business expert within its communities. This will drive products, risk appetite, credit decisions, strategic alliances, training, and capital requirements, to name a few. Perhaps the bank would like to pay higher than market dividend yields because their investor base enjoys dividends. So growth can only be partly funded by retained earnings.

Planning for this, perhaps the bank can establish dividend re-investment plans and employee stock ownership plans to enhance capital. In this context, the bank decides what it wants to be, and sets strategy to accomplish it. We don’t need the OCC to tell us that!

A third Article that is oft repeated in EAs is a management study, requiring the bank to hire a consultant to evaluate the board, senior management, and/or staffing levels. Strategic plans, capital plans, and management studies are my firm's top three regulatory-mandated engagements over the past two years. So if these appear in your EA, fear not. They are appearing in many.

Similar to strategic and capital plans, why not take advantage of the required management study expenditure to determine if you have the right team in place to execute your strategy and succeed into the future? I understand that management studies are not particularly comfortable. But, since you are required to undertake one, why not make it as beneficial to the future of your bank as it can be? You have a good idea what team members might be holding you down. Chances are the outside advisors will discover it too, and perhaps find some diamonds in the rough!

The level of regulatory activism is greater today than at any other time in the past 20 years. The political climate is exasperating the situation and creating uncertainty. Amidst our efforts to avoid or get out of enforcement actions, perhaps we should take advantage of the required introspection to determine a strategy that improves our competitive position and sustains our future.

I would like to read your thoughts on the regulatory environment.

~ Jeff

Note: The above post was taken from my firm's First Quarter, 2011 newsletter. To obtain a copy of the newsletter see the link below:

http://www.kafafiangroup.com/PDF/TKG%20Newsletter_1Q_11.pdf

Is the pie getting smaller?

I have what I consider a very astute friend. He’s a relatively young guy (in his 40’s), and seems to be very smart with his money. I perceive him as being a very good bank customer. When he told me he does a family balance sheet every year, he piqued my interest. I asked if he would be willing to share it with me in common-sized format, changing the numbers to percents of his total assets.

He only counts his financial assets and liabilities, and only counts fixed assets such as his home if he borrowed against it. Having a mortgage and an auto loan, he therefore counted his estimated market value of the car and home in his assets and included the loans in the liabilities. The results of his efforts are in the accompanying table.

My suspicions were confirmed. Less than 14% of his family’s assets were in a bank. Brokerage companies and mutual funds were the benefactors of the majority of his financial assets. His mortgage, the only significant liability, was with a credit union. The credit card balance was de minimus, and as you would suspect is with a large bank.

Is my friend’s balance sheet typical? I would not base strategic decisions on such a small sample. But perhaps we should reflect on our own family’s balance sheet and use a little common sense. In my opinion, my friend’s situation is probably typical for a family in their 40’s. It is perhaps not typical for those in their 70’s, as they may have more in the bank. It is these customers that give the banking industry the false sense of security and results in only minor tweaks to business as usual.

Banks can also look at the nationwide growth in deposits for comfort. In the past ten years, deposits in FDIC-insured institutions grew approximately 7.4% annually*. But wait, in the past two years, deposit growth slowed to 4.7% annually.

I suppose the good news is there are fewer banks almost every day. Through mergers or failures, the flock is being reduced. That may also give us the false sense of security that all will work out for those that survive. But I suspect it’s not. Preferences are changing, particularly from one generation to the next. Younger families are putting their serious money outside of the banking system.

If you believe this trend to be true, what is your strategy to deal with it? Should you accept it at face value and set your sites squarely on competitors to fuel your growth, going toe to toe for their customers’ 14%? Do you buck the trend, trying to win back a greater percentage of the next generations’ balance sheet, increasing wallet share to, say, 25% or greater? Or do you expand into lines of business that are already taking business from you, i.e. brokerage or mutual funds? Perhaps you should send up the white flag on retail and focus on businesses that tend to have a higher percentage of financial assets with banks?

I think the answer lies somewhere within the preceding paragraph, and perhaps a combination of the above. What seems clear is that sitting back and doing nothing assures your future. You will have none. Put up the for sale sign. Investment bankers could use the business.

- Jeff

*Source: FDIC