CFPB: Are They Coming to Get You?

A bank trade association CEO asked me a couple of questions while he was researching an op-ed piece. The edited Q&A is below.

Q. Shouldn't the CFPB work to address the impediments to starting a bank in LMI markets rather than punish community banks who scrambled to serve their customers when the economy shut down?

Author's note: This was probably relating to the late January released statement about the acting director of the CFPB's promise to take aggressive action in response to perceived Covid-19 relief violations, including the policy of some banks to only take PPP applications from pre-existing customers, which may have a disproportionate negative impact on minority-owned businesses.

 

A. The problem stems from the spreadsheet, in my opinion. With deposit spreads so low, branch deposit sizes need to be very large for a branch to be profitable. According to my firm's profitability peer group, a branch with $74 million in average deposits made a mere pre-tax profit of three basis points. That is a fully absorbed number, with support center expenses allocated to it. On a direct cost basis, the branch must be at least $38 million in deposits. Knowing this, very large financial institutions operate branches where they can have greater scale to drive greater profitability, which frequently excludes LMI neighborhoods, creating what is termed "bank deserts."

Another challenge is imposed by the very government that tries to assist LMI households: regulation. The average operating cost to originate and maintain an unsecured personal loan is $287 (again, according to my firm's profitability outsourcing service peer group). And the average balance per account is $3,800. The spread needed to cover the cost alone would be 7.5%. That's not the yield... it's the spread. So if the bank's cost of funds was 1% the yield would have to be 8.5%.

But there's more! The provision for loan loss is 1.25% of that balance. A bank would have to charge a 9.75% yield on an unsecured personal loan just to break even. The operating cost is largely attributable to the distribution through the branch network and regulation. Since a bank can't cut regulation, they trim their branch network to lower those costs. And the obvious bullseyes are on branches that lose money.

Similarly, the annual operating cost per account for a retail checking account is $398. With a 1.89% spread and with 0.91% average fees as a percent of balances, the average balance of a retail checking account would have to be over $14,000 to be profitable. A very high hurdle in an LMI neighborhood. Again, much of the cost per account is driven by branch distribution and regulation. Retail banking is heavily regulated. And it's difficult for financial institutions to operate in neighborhoods that have low average balance loans and deposits. Plus, if an institution charges the high yields on loans to be profitable, or assess the high fees it would need to make the retail checking account profitable, think of the reputation risk they would assume. That is why very few of our clients consider retail banking as the driver of future profitability in strategy sessions. 

Q. Should communities today be concerned by the M&A activity taking place? What advantages or disadvantages do they face when institutions consolidate?

A. If we lose 4% of FDIC-insured institutions per year, which was pre-pandemic pace, we will have ~ 3,300 institutions in 10 years. There are people that believe we are over banked, and look to Canada and Europe as case studies for having fewer, larger banks. There are benefits to scale. The most efficient banks in the U.S. tend to be between $5 billion - $10 billion in total assets.

But there are myriads of examples of very efficient $500 million banks, and technology should make it easier for smaller community banks to deliver relevance-sustaining profitability that enables the bank to invest in its future by remaining relevant to its stakeholders. The really small institutions, however, should consider merging, even if one or two engage in a merger of equals to have the resources to remain relevant. Smaller institutions run the risk of nobody wanting to buy them.

As institutions get larger, and their HQ's get farther away, decisions are made that can be sub optimal to the local area, town, and/or borrower. For example, think of the Credit Analyst in Charlotte evaluating a rural Indiana ag loan to an Amish borrower. What does that write-up look like? We will lose that local flavor to allocating capital by centralizing banking. That is what I fear we will lose by continuing the trend that took us from 15,000 banks in 1990 to less than 5,000 today.

~ Jeff

Bank Branches: A New Model

This design or that design. Digital, pods, low square footage. All the talk around the branch of the future is about design, staff levels, square footage, and technology. 

Yet the people that carry balances, the boomers and older, can't figure out where to go when they come in for a teller transaction. And the younger generation want help managing their budget, using the improved technology tools, and applying for loans.

Sorry youngster. But look at our cool design! 

The slimming of our branch networks, both in number, square footage, and number of staff was used to increase our technology spend, compliance costs, or dropped to the bottom line.

Well I propose something different.

A Different Branch Model

I have a habit of asking almost every head of branches I encounter if they experienced, at any time in their career, a support center person transferring to a branch. In all of the years I've been asking, only one said yes. Because of a toxic boss in the support center. Otherwise, crickets. 

Why? Why doesn't anyone transfer to branches? Why is the branch so important to the execution of strategy, yet nobody wants to be there?

The reasons I hear most are: hours, pay, accountability. They want to transfer to the back office for greater pay, regular hours, and little accountability.

And I have personal insights because I was once a branch manager. Granted in the mid 90's. But still. Then as now, it was a stepping stone for me. No intention of remaining in the branch. The pay wasn't enough. And it was organizationally a thankless position. No thank you. 

Has it changed?

But I propose it should. Because what I hear in community bank strategy sessions, the branch is an important if not critical portion to an enduring future. Why? That one-on-one relationship can't easily be replicated by technology, a bot, or a phone call (when not accompanied by an in-person relationship). 

Survey after survey continues to show that a local branch is important for customers or would-be customers, no matter the age. 

Yet we're blowing it. 

We continue to make the branch a waypoint for our most promising employees. So here is what I propose:

1. Increase the pay- At least two branch employees should earn household breadwinning pay. Right now, the way we pay branch managers, either they are supplementing family income or are young without the outsized financial responsibilities of supporting a home and family. We think increasing teller pay, in the face of rising wages led by larger banks, is enough. It's not. It's branch leadership that needs to earn breadwinning pay. This may increase compensation expense in branches. According to my firm's profitability database where we measure hundreds of community bank branches, each branch generated 2.19% in total revenue as a percent of deposits (spread plus fees). And the median branch deposit size was $61 million. To cover the extra costs, that $61 million branch would have to be $65 million. Would greater talent with the ability to deliver on what people want a branch for in today's environment get you there? I think so. And then some.

2. Rethink the hours- Nothing that customers say they want branches for requires 44 lobby hours and an additional eight drive-thru hours. How about 7-3 M-T, and 11-7 Wed-Thurs and 9-5 on Friday? That allows time for early morning people to bank and after-work people to bank and see your bankers for their more sophisticated problems. Put an inter-active teller machine (ITM) in your man trap or drive up for doing transactions during other hours. This would allow branches to have four FTEs, assuming one is absent at all times for training, customer visits, PTO. You can make up some of the costs of paying people more by having fewer people. Floaters can cover crunches.

3. Design should match emerging needs for branches- Taj mahals are not necessary unless you are using a hub and spoke where the hub is in larger towns, and spokes in lower footprint branches such as the 1,000 square footer. But pay attention to design to make sure you convey the look and feel consistent with customer needs and what you want them to think about you. Check out Associated Bank's design (a couple pictures from their annual report). They took part of the savings from reducing their number of branches by investing in the look and feel of the remaining branches. Check out my post from nearly four years ago on branch décor for more on this. And oh yeah, don't spend money on making your branch a destination. Because people don't want to hang out in bank branches. 

4. Automate support functions- Want to save money? Look at HQ. The promise of AI looms large.

If we believe in strategic alignment, that our day-to-day actions should be consistent with our strategy, then we need to re-think how we feel about branch staff. Because I don't know many banks that want their branches to be staffed with our lowest compensated, highest turnover employees. 

Yet here we are.

Thoughts?

~ Jeff

The bank branch is dead. Long live the branch.
https://www.forbes.com/sites/forbesfinancecouncil/2019/04/10/the-bank-branch-is-dead-long-live-the-bank-branch/#6d595a2f32d0

Regions New Branches
https://www.youtube.com/watch?v=wycNfFk6Dic

Chase Branch Design
https://www.youtube.com/watch?time_continue=45&v=yCe9yPKyd9Y

Evolution of Banking: Three Slam Dunk Predictions

The sheer number of strategic initiatives and technologies in the banking industry makes it very difficult to predict outcomes with any certainty. Not that me or other industry pundits don’t try.

I have been noticing some trends that are providing insights on our direction, evolution, and ultimate picture of our future.

Future Picture was coined by the US Military for defining flight mission success, and was brought to business prominence in Air Force pilot James D. Murphy's 2005 book, Flawless Execution.  Using his example of envisioning what success would look like, a bank’s Future Picture should be a detailed description of successful execution of strategy. I challenge bankers’ to describe their Future Picture.

It can be highly subjective and difficult, particularly in an era of unprecedented change. But I would like to share three strategic directions where the train has either left the station, or is boarding.

1. Branches must be larger to survive. According to my firm’s profitability database, branches generated revenue (defined as consumer loan spreads, deposit spreads, and fees) as a percent of branch deposits of 3.50% in 2006. Today, that number is 2.08% due to the interest rate environment, the regulatory environment (reducing deposit fees), and customer behavioral changes. Therefore, the average deposit size of branches grew, to over $60 million at the end of 2015 (see chart). This trend is not likely to change, as bankers are more apt to prune their network and increase overall branch profitability. And the customer. Don’t forget them. They use branches less, although many still identify branch location as important to bank selection.

2.  Technology expenditures will grow faster than overall expenditures. I recently performed this analysis for a client, identifying the “Data Processing” expense as a percent of total operating expenses for all FDIC insured banks as identified in their call report. Surprisingly, it represented only 4% of total operating expense.  Note this excludes IT personnel expense. But the number is growing faster than overall operating expense (see chart), meaning that IT expense is becoming a larger proportion of operating expense. It is disappointing that this trend is slowing so banks can meet their budgets and profit objectives, regressing back to old habits of cutting IT projects to make budget. But overall, banks are seriously evaluating technology to improve efficiencies and their clients’ banking experience.

3.   Robotics are coming. It was only recently I began to believe this. But there are opportunities being evaluated and implemented to automate repetitive processes to reduce overall costs, minimize risk, and speed the process. A couple examples where automation and/or robotics are ripe to improve processes include reviewing remote deposit checks, currently eye-balled by humans. Not scalable. The x-point evaluation could more quickly and effectively be accomplished by a robot. Another area where automation is coming is BSA case evaluation, where the bank’s BSA application identifies potentially high-risk client activity and a program goes through several standardized checks to clear the case or elevate it for human intervention, reducing the overall number of cases needing human review.

These aren’t the only changes. Just the ones that I believe are coming, no matter who tries to stop them.

So why try to stop them?

~ Jeff

How About Profits in the Branch of the Future?

“[Sample] Bank has reinvented banking with the opening of the [Branch of the Future]. To experience the future of banking today, simply step across the threshold.” So went the 2012 press release announcing the opening of the next generation of the bank branch.

At June 30, 2014, that branch had $23 million in total deposits, down $1 million from one year ago. The branch of the future concept was not enough to inspire customers to open accounts in droves while sipping coffee and surfing the net.

Branch demand and utilization by customers is changing rapidly, and there is no shortage of opinions on the look and feel of the branch of the future. I recently read an article about Poland’s mBank that is designing kiosk and light branches to complement their traditional branch network (see photo). 

The smaller branch concept gets significant play in professional publications. But let’s not forget that we have past experiences with a “light branch”; namely the declining in-store branches. These branches were notorious for being low-balance transaction-oriented branches that did not enjoy great success.

From first-hand experience training in an in-store branch, I found it difficult to attract higher balance and small business customers, significant contributors to branch balances and therefore profits. This highlights an important banking concept: revenues are mostly driven off of balances, not activity. 

mBank’s light branch depicted above is located in a mall. Malls are experiencing difficulty in the United States, as millennials opt for smaller, urban environments to shop. And the rest of us are increasingly buying online. So putting a light branch in a mall that is being vacated by Macy’s may not be a winning strategy if your bank’s objective is to increase visibility through strategically located, yet smaller branches. 

All talk of visibility and foot traffic aside, the measure of branch success should be profits. In the chart below, derived from The Kafafian Group’s (TKG) peer database of hundreds of community bank branches, we see that the revenue generated from deposit spreads, asset spreads (typically consumer loans), and fees (typically deposit fees) as a percent of branch deposits averaged 2.08% for commercial banks and 1.88% for thrifts during 2014. This is down from 4.17% for banks and 2.51% for thrifts in 2006. So if your “light branch” has $23 million in average deposits, as our “branch of the future” example above does, then it generates $478,400 in annual revenue, on average. Not very inspiring. 

Since 2006, community banks have recognized the need for greater balances in branches to improve profitability. See the next chart for average branch deposit size trend from the TKG database. Interestingly, the average branch deposit size for thrifts declined. This phenomenon is largely attributable to the 2008 recession and the ensuing drop in loan demand which allowed thrifts to run off their high rate CDs. But since that drop-off, the increase in average branch deposits can be attributed to: 1) deposit growth without the commensurate growth in branches, and 2) pruning branch networks without significant deposit attrition.
Branch deposit growth combined with reviews of transaction activity to reduce branch personnel has buttressed the decline in deposit spreads and fees, and branch profitability. But not to the point of the profits enjoyed by branches in 2006, which was approximately 2.73%, compared to 0.86% in 2014. These pre-tax profit ratios are a percent of average branch deposits, and excludes indirect branch operating expense such as Deposit Operations and IT, and overhead such as Executive and Finance. Not only are branches not supporting the army of support aligned behind them, they are barely supporting themselves. 

I have written and spoken about accountability for branch profitability. Accountability gets a bad wrap. It can convey pressure, discipline, and failure. Applied correctly, accountability could promote focused effort, rewards (financial and non-financial), and triumph. 

Imagine holding branch managers accountable for increasing deposit and loan spreads, and generating direct pre-tax profits. Those that rank as top tier performers receive meaningful incentive compensation and recognition. Branch administrators charged with the profitability of the branch network won’t fear pulling the plug on profit laggards, because they are dragging down the profits of the whole. Who cares if a director drives by the unprofitable branch every day? 

Branch of the future discussions would focus less on design and “gut” feel, and more on profit potential and profit drivers such as demographics, visibility, personnel, deposit growth, the experiences of other profitable branches in your network, and how this aligns with bank strategy. Not how many Keurig cups were consumed last month. 

It is possible to view branch profitability in market clusters, if the cohesiveness of a community spans multiple towns. One branch may be a laggard, but its presence is critical to the success of the whole. 

It is also possible to build large branches that are successful. If a large, marquis-like branch costs $700,000 per year to run, yet has $80 million in deposits with our aforementioned revenues as a percent of deposits of 2.08%, isn’t it better than our branch of the future mentioned above that has $23 million? 

Using profitability as your measuring stick likely will eliminate rationalization to keep underperforming branches open. I hear arguments about poor performing branches being critical to a market area. To which I would ask the logical question, “what market area”? Let’s compare to other market area profits. Does the rationalization hold water? 

Constant evaluation of branching, a little growth here, a little pruning there, will be essential to effective deployment of your bank’s limited resources available to remain relevant. To keep your best performing branches and to motivate your best performing people, branch profitability can be an effective tool to make the right decisions in our rapidly changing industry.


~ Jeff


Note: The above article first appeared in the March-April 2015 edition of paBanker Magazine, a publication of the Pennsylvania Bankers Association.

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

The Case for the Big Branch

I had a very interesting conversation with a bank client today. He called me to discuss, among other things, his bank's expansion strategy. During the discussion, I mentioned that I had recently driven by one of his branches and that it was the biggest in town. What he said about it inspired this post.

Being the biggest branch in town, in terms of square footage, is not something cheered among industry pundits these days. Indeed, if I were to summarize the sentiment, it would be that future branches would be much smaller, but with big a** signs. Those were another bank consultant's words, not mine.

This CEO isn't buying it. He said that since that branch underwent a $1.5 million renovation, its deposits grew by 40%. In prior years its deposit totals had remained in a relatively tight band. He opined that it is "amazing what visibility, access, and egress" does for a branch. He also said that his business owner customers demanded a nearby branch.

But he did not think the branch had to be in the same town as the business. The next town over would due.

Now that makes sense to me. If it costs, on average, $600,000 per year in operating expenses to run a standard branch, wouldn't it make sense to build a large, marquis-type branch in every other town that cost $800,000 per year? By abandoning the every town strategy, you effectively save $400,000 per year.

I looked at a few banks that I know that do very well with their branch networks but were not clients so I can opine based on public data and not inside knowledge. One such bank, First National Bank & Trust of Newtown (PA), had a similar branch as my client's (see photo).

This is FNB&T's New Hope office. It is two towns, or nine miles, from the nearest office. The New Hope office is an end cap to a very nice strip mall that has excellent traffic patterns and easy access. According to FDIC data, the branch grew from $41 million in deposits at June 30, 2007, to $70 million at June 30, 2012, a 70% increase.

Lest you think that price promotions drove their growth, this bank's time deposits as a percent of total deposits declined during that time. Oh, and time deposits/total deposits is currently 18%. So, even though I can't tell the exact deposit composition of the New Hope branch from public data, I would doubt that CD's drove this branch's growth. It is not in FNB&T's DNA.

Before we jump hard onto the mobile is king bandwagon, perhaps we should pause to think about what my client told me today. It only took 10 minutes of non-scientific perusing to find another bank's branch to validate his strategy. Perhaps, then, the branch is not dead.

~ Jeff

The Elephant in the Room: Branches

In keeping up with industry reading it is clear to me that we, as an industry, are perplexed at what to do about branching. The recently released FDIC Summary of Deposits showed the second year of branch decline. The most recent ABA study on delivery channel preference showed online banking eclipsing branch transactions for the 55+ set. That's right... old people letting their fingers do the walking.

But the #1 or #2 reason cited by small businesses and individuals as to why they select their bank remains branch location. When I ask executives what makes a branch successful or not, the top two reasons continue to be branch location or personnel, not necessarily in that order. Confusing? Yes.

But the progressive talk about the future of the branch at times lacks common sense, in my opinion. This dates back to an interview I did with American Banker about a community FI that was opening coffee shop branches. I gave a twofold comment: 1) I saluted the FI for being creative; and 2) I doubted it would work, particularly in the locations and relatively conservative markets where they tried it. AB published the first and the second didn't make the editorial byline. The coffee shop experiment turned out to be a disaster, and the FI was later sold.

I recently had a Twitter conversation with a banker about branches that lack tellers. According to feedback from bankers that tried this concept, customers were confused when they walked into the branch. That made sense to me. We like the familiar... i.e. the teller line. But branch transactions have fallen off of the proverbial cliff. Do we need a long line full of bored tellers reading Nora Roberts novels? No. But perhaps we need a couple teller windows to process transactions and bring comfort to those of us that like familiarity.

As we evolve, I envision the comfort of knowing there is a branch nearby to continue. But the people who occupy those branches should evolve to those that can open accounts, troubleshoot problems, advise customers, develop business, and occasionally process transactions. This branch will probably be smaller, and less expensive to build out. Smaller is certainly a theme I am hearing from bankers and industry professionals. If you are of a mind to continue trying to make the branch into a destination to drive traffic, let me introduce you to Sisyphus. Going to the bank is a chore. Boom.

So what about these big branches that we all have? An industry stock analyst told me that big banks have advantages over small banks because they can pay for increased compliance expenses by closing branches. The community FI may not have this luxury. But big banks have challenges here, in my opinion. Many have built palatial branches that have no discernible value except as a bank branch.

The poster child of this concept is Commerce Bank of Cherry Hill, New Jersey which was acquired by TD Bank (see photo). Their brand is wrapped around their number of branches, the primo locations of their branches, and the look of their branches. But if branches become less important, and big banks can consolidate one branch with the one in the next town over, what are they going to do with the palace? These branches are very expensive, are fixed assets on the bank's books, and are 100% risk-weighted for capital calculation purposes. In other words, you have to carry more capital against the branch than a bond in the investment portfolio that might be 20% risk-weighted.

The pictured TD branch is about 100 yards from the Wells Fargo branch pictured below. Sorry for the poor focus but I took the picture with my phone while walking so cut me some slack! If Wells decided to consolidate this branch, it could easily be converted to an office, a hair salon, or a coffee shop. In other words, Wells could sell it and, current real estate market woes aside, can probably sell at a gain. The buyer can convert it to whatever they want. TD, on the other hand, may have to devalue their branch because they can't sell it. Or if they can, it would be for the land and the buyer may have to raze the building to something more functional. Think of all the empty gas stations dotting the landscape.

To be fair, the Wells branch had $52 million in deposits and the TD branch $130 million at June 30th. But the old Commerce was known for large branch deposit sizes because they aggressively pursued municipalities for their banking business. So aggressive, indictments were involved. But I digress. The TD branch does have more deposits, and perhaps this is partially due to the palace.

But as we determine our next step in branching, we can't ignore the trends that are telling us that transaction processing in branches is becoming secondary to something else. As branches decline in prominence, we should plan our next branch with the gas station in mind. We don't want to manage multiple properties of former branches that sit stale on our books eating our capital.

What is your opinion of what the "next" branch should look like?

~ Jeff