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

Banks and Bungee Cords

Your relationships, your job, your life comes with baggage. I recently made the analogy that there are bungee cords affixed to your belt. Some hold you back. Some propel you forward.

And it applies to banks too.

In a traditional SWOT analysis, there are things within your control (strengths, weaknesses), and things outside of your control (opportunities, threats). But what are the forces that propel you towards your strengths and opportunities? Or towards your weaknesses and threats?

These forces are mostly within your control. Should you choose to embrace the challenge.

Do you?

Here are the forces I see for bankers that pull them back, toward their weaknesses and threats:

1.  Regulators. OK, I'm playing to the audience. But regulators don't want you to veer off the beaten path. Keep it plain vanilla. Build a bank that thrived in 1963. Ask those bureaucrats this question: "How many businesses have you run?" Because you would swear by their swagger they were Richard Branson or Elon Musk.  

2.  Seargents. If you have hired me, or have read what I have written, you would understand that I believe there are "old-schoolers" in your organization that cause tremendous friction to progress and change. 

3.  "No Mistakes" Culture. The amount of energy that banks commit to being 100% in compliance, find no audit findings, or, gasp, no Matters Requiring Attention on their exam, is monumental, in my opinion. Some operations managers' evaluations and, in some circumstances, variable compensation is dependent on clean audits. What does that get you? Hyper conservatism in compliance. And a whole lot of "we can't do it" from executives. It's killing our industry.

4.  He's/She's Not Ready. This is a common reason I hear why banks don't elevate forward thinkers to the executive suite. They fear those "crazy ideas" they have in management meetings, or the fact that they are willing to accept some risks old school bankers would not. Better to keep them suppressed deep in the bowels of our organization and let others pilfer our future customers than to risk innovation through calculated risk taking.

Here are the forces that I see can propel bankers forward:

1.  Allowing Experimentation. And, 'gasp', failure. I'm not talking "bet the bank" failure. But a failure that may bust your budget is not Armageddon. It is an opportunity to learn, and help you implement the next innovation. Not the reason to look back 10 years and think, 'we tried and failed 10 years ago and, dag nabbit, we are not goin' to try again!'

2.  Fire Seargents. They are not that important to your organization. In fact, they are destroying it. And when you give them their packing papers it sends a message to the masses... "We are a forward looking bank. Backward thinkers take notice."

3.  Continuous Learning. A bank that believes everyone, from the CEO to the newly hired loan operations clerk, should learn, will have a far better chance to being the one bank that survives the non-stop tide of bank consolidation.

4.  Run the bank by strategy, not by budget. Strategy forces banks to look far out into the future. Running by budget forces bankers to look to next year. Where is the puck going, versus where it is. We intuitively know that our industry would not have yielded so much market share to outsiders if we could think outside of our budget. 

So you have bungee cords hooked to your belt. Where are they pulling you?

~ 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

Ficticious Interview: Senator Chis Dodd and Rep. Barney Frank

Senator Chris Dodd (D-CT) and Representative Barney Frank (D-MA) were primary sponsors for the Dodd-Frank Wall Street Reform and Consumer Protection Act which was signed by President Obama on July 21, 2010. Rather than arrange for an actual interview with the lawmakers so they can give me non-answer answers, I envisioned how an interview with the esteemed gentleman might transpire. Here is how it played in my head:

jeff-for-banks (jfb): What is your definition of a "financial crisis"?

Dodd: When Joe the Plumber can't get a loan to buy a multi-million dollar home on Florida's Gold Coast. That's not just a crisis, it's tragic.

Frank: When Fannie and Freddie stop contributing to my PAC.

jfb: How did the Government Sponsored Entities, such as Fannie Mae, contribute to the financial crisis?

Frank: I don't think Fannie and Freddie are financially insolvent. I don't believe they require large bailouts (Note: Actual July 2008 quote by the gentleman from Massachusetts. See video below).

Dodd: Barney just told you they stopped contributing.

jfb: Should individuals be accountable for taking loans they could not afford to repay?

Frank: The necessary evil of capitalism is that there are evil forces intent on perpetrating ill-will on the working class and it is the responsibility of everyone to enlist government officials to stand guard against bad players regardless of the cost and reliance on government because we are here for you, the working class, not the rich.

jfb: Huh??? Senator Dodd, same question.

Dodd: Personal responsibility is so 1950's. It took the 60's enlightenment to end such a fascist concept.

jfb: I read that the Bureau of Consumer Financial Protection will have a $500 million annual budget. Is this accurate?

Frank: I hope not. Creating this bureau was a key provision in Dodd-Frank and a budget that doesn't end in a "B", or better yet, a "T", doesn't demonstrate our commitment to creating a black-hole bureaucracy.

Dodd: No worries. We'll charge it!

jfb: The Durbin Amendment requires the Fed to determine the "reasonable and proportionate" interchange fee that can be charged on debit and credit card transactions. Historically, when has price fixing worked?

Dodd: Nixon did it in the 70's with gas prices.

Frank: (laughs) Son, I understand you're a coal cracker from Scranton, had a hard-scrabble life, and may not understand these things. The Durbin Amendment is not price fixing. The Fed is only going to set the reasonable fee that can be charged.

jfb: How do you envision the Fed determining which systemically risky firms to unwind during a future financial crisis?

Dodd: Although the law is 5,000 pages, we left it up to the Fed to determine how to do that. I'm sure they'll do a good job.

Frank: I envision a panel like on the reality TV show America's Got Talent. Bankers like Jamie Dimon can make their case to Piers, Sharon, and Howie who can buzz him if they don't like his shtick.

Dodd: (laughing) Barney's kidding.

Frank: No I'm not. I love that show. Great concept.

jfb: Will Dodd-Frank solve the problems that created the financial crisis?

Frank: We are creating a financial system with greater government control and a new bureaucracy with a $500MM plus budget with significant powers. What could go wrong?

Dodd: What do I care? I'm outta here!

jfb: Thank you for your time gentleman.

Reminder in case you are an angry politico... the above was a figment of my imagination. Any complaints can be lodged to some government agency with a big budget that was designed so you can cry on their shoulder.

- Jeff