Are Your Customers & Prospects Lovers, Haters, or Swingers?

I recently attended the Pacific Coast Bankers’ School at the University of Washington as an observer. Instead of observing, I went to learn from the many quality industry professionals and college professors that make up the faculty. One was Michael Swenson, a Ford Professor of Marketing at Brigham Young University. 

During his class, he discussed a case where the American Plastics Council (APC, now the Plastics Division of the American Chemistry Council) was trying to get people to feel better about using plastic. It seemed to me that the advertising campaign that ensued was specifically designed to get you to respond “plastic” when confronted by the pimply teenager at the supermarket checkout line that mumbles “paper or plastic”.

After spending millions, the APC was getting no traction. In fact, public opinion of plastics was getting slightly worse. That must have been an uncomfortable conference call.

So the APC brought in some fresh blood to figure out what to do. I can’t recall the agency they hired. But their approach was to divide their constituents into three groups: lovers, haters, and swingers. I think Professor Swenson called them the love group, hate group, and swing group, but I like my names better.

My first thought was, how could somebody “love” plastic? Not that there is anything wrong with that. But the context was that plastic had some positive influence in this group’s lives, such as the local little league switching from a chain link to a plastic-based fence just before their son Timmy (or Justin in modern day) plowed into the fence shagging a deep shot to left. So you get the picture where this group’s heads were (see video).

The hate group generally was of the tree hugging variety... plastic clogs landfills, never biodegrades, kills Flipper, etc. Swingers were indifferent. You may add a funny line now.

Based on the results of the study, you would think the APC would go about changing the hearts and minds of the haters. It’s human nature to try to get those that don’t like us to like us. But you would be wrong. Instead, the APC set to work on the swing group.

Here is where the big learning moment came for me. Instead of parading swingers into a room to do a focus group [insert joke here], the APC brought in the lovers to learn why they felt the way they did about plastic.

They took what they learned from the love group, and began a campaign to change the hearts and minds of the swing group through the eyes of the love group. And it worked.

Aha! *insert light bulb on top of head*

~ Jeff

Much Maligned Banking Business Model: Lean and Mean

Does your financial institution pursue a relationship driven strategy? If so, you would be in the majority for community FIs. If not, you are much maligned.

In my last post I identified five things I don't understand. One was "Our Money Is No Different Than the Bank Down the Street". I discussed my confusion as to how bankers could believe this and still pursue a more expensive relationship driven strategy. Instead, why don't you get lean and mean?.

I discussed this with bankers I met at the Pacific Coast Bankers School, where I am currently serving as a Faculty Fellow. As an aside, I'm still not sure what that means, except I go to class to form an opinion about the school and its subject matter. But I digress.

The bankers here did not have an appreciation for the business model of a California bank, who shall remain nameless, that sports a near 1.50% ROA, and trades at over 3x tangible book and 18x earnings. The model, is designed to be highly efficient, having an efficiency ratio in the mid 40's and an expense ratio (non-interest expense/AA) at about 2.3%. In other words, this bank is cheap.

If my experience is any gauge, most community FIs choose a more expensive business model, the relationship driven model. This strategy typically delivers a higher net interest margin, because customers won't dump you at the slightest price variation, and is more expensive as the FI invests heavily in relationship managers and high touch service.

But what does the market think of the two models?

I took a look at publicly traded FIs between $1B-$10B in assets, that had ROA's greater than 1%. I controlled for fee income businesses, as high fee income FIs skew the ratios significantly. So the FIs had to generate less than 30% of total revenue in fees. The criteria delivered 61 FIs. I then split them up into top and bottom quartiles based on the expense ratio. The results are in the table below.

Although community FIs choose the higher expense ratio, higher net interest margin strategy, the markets currently reward the more efficient FIs with higher trading multiples. 

This does not make Porter's "low-cost" model superior, as it calls into question the sustainability versus the "differentiation" strategy, especially for community FIs that lack the scale of our largest banks. But I think it's time to get off of our high horse and recognize, as Michael Porter did, that the low cost model is an option.

Any thoughts on low cost versus differentiation?

~ Jeff 

Five Things I Don't Understand

Some people see far more gray areas than I do. When common sense, reason, and facts support one direction, I am confused why we don't move in that direction.

If I listed everything I don't understand, you would be reading a long, long time. So I will limit myself to five things that recently confused me, and are relevant to banking.

1. Vision Doesn't Matter

I hear this a lot and a recent quote from General Colin Powell convinced me to put this on top. At a recent speaking engagement, he was reported to have said "If you want to make sure to keep moving forward, have a destination." I can't think of many, if any, renowned strategists that believe vision doesn't matter.

But I can't think of many financial institutions with a vision that clearly identifies a hoped for future. Most vision statements read like they came out of a Dilbert cartoon.

I think smarmy vision statements are the reason I often hear bankers and their consultants say vision doesn't matter. If you can't point to your hoped for future, communicate it and inspire your team, then maybe your bank doesn't matter. Could this be the reason for the incredibly shrinking number of financial institutions? I only wish those consultants saying vision doesn't matter would go away instead.

2. Our Money Is No Different Than the Bank Down the Street

If you believe this, then price is your only differentiator and the only way to achieve an advantage over your competitors is efficiency. Look to Oritani Financial Corp. as an example of this. But believing that you sell a commodity and pursuing a "relationship" strategy confuses me. Building a high quality staff of employees empowered with building customer relationships is more expensive than building efficient processes, using efficient systems, with a small number of high deposit branches needed to be a price leader. 

If you believe you sell greenbacks, dump the relationship platitude and get efficient.

3. We Need Experienced Bankers

Back in 2010 I wrote that our drive for experienced bankers limited banking's talent pool. Specifically, I was writing about hiring veterans. The corporate world is chock full of leaders brought in with little experience and taking those corporations to extraordinary levels. Think of Southwest Airlines Herb Kelleher, or IBM's Lou Gerstner. In banking, I identified the top 5 total return financial institutions. One was BofI Holdings Inc., whose CEO was a former consultant. Go figure.

Look through the long list of bank failures since 2008. Most were run by experienced bankers. So excuse me if I'm at a loss as to our fascination with finding more of them.

4. Finding Joy in Other's Failures

So, if you read my bio, you know I'm a Yankees fan and I'm fielding lots of questions about how I feel about Arod. Personally, I don't know Arod. Based on my limited knowledge of him, I don't think I would like him. He comes off as an extreme narcissist. But I refuse to boo the guy, or take joy in his downfall from baseball royalty. Perhaps when I reach perfection, I would be more comfortable taking pleasure in watching others fail. But I don't see that happening in my lifetime.

Failure is not testimony to your intelligence. It is testimony to your effort, and wisdom.

5. Employees Don't Match Your Strategy

Strategy shifts faster than culture. If you are moving your financial institution away from being transaction focused to relationship focused, yet leave the transaction focused people in place, you are setting yourself up for failure. How often do I hear from bank leaders that they are having difficulty getting their employees to do what they need them to do in our new banking world? 

Daily.

What is confounding you?

~ Jeff

Deposit Fees: Here Comes the Judge

This week, a US District Judge issued a snarky rebuke of the Federal Reserve's 24 cents per debit card transaction cap, sometimes known in the common sense world as price fixing. Judge Richard Leon opined that a seven to twelve cent cap would be more in line with Dodd-Frank's Durbin Amendment. 

How do I feel about the Durbin Amendment in general and how it likely came about can be discerned from a previous post. But fundamental to the Amendment, and Judge Leon's ruling, is a misunderstanding of how banks make money.

Checking accounts are not cheap to originate and maintain. Banks expend a tremendous amount of energy wrestling what they perceive as profitable customers from other financial institutions. Additionally, once they find a willing customer, they must comply with a myriad of laws and regulations to prevent fraud, money laundering, fairness (whatever that means), or any other potential financial crime our government deems worthy of bank policing.

According to my firm's profitability peer group database, it costs financial institutions, on average, $420 annually to originate and maintain a retail, non-interest bearing checking account. How do banks cover this cost?

Fees. And Spread.

Deposit fees have been on the decline for some time now (see chart). Part is because of changes to regulation, including Dodd-Frank and the dreaded Durbin Amendment. But some is also customer behavior modification. Although the overwhelming customer response to automatic overdraft coverage was positive (customers preferred their checks to be covered rather than bounced), the fees served the additional purpose of changing customer behavior.

It should be noted that the 13 basis point decline in deposit fees equates to $2.2 million in annual revenue to the average financial institution ($1.7 billion in deposits, on average). How does a bank make that up? If they did it on personnel cuts, the average bank would have to reduce staff by 44 employees. But reality lies somewhere in a combination of cost savings, revenue enhancements, and reduced profits.

Back to the checking account and its $420 annual cost. According to my firm's peer database, each retail DDA account averages $25 in fees per year. That means the checking account must generate $395 in spread to break even. Pick a spread number... say 3%? The checking account would have to carry an average balance of $13,167 to cover its costs. That's to break even!

My point to Messrs. Chris Dodd, Barney Frank, Dick Durbin,and Richard Leon is you don't know squat about how businesses make money. Why don't you analyze a McDonald's value meal, where all the margin is made on the Coke. Price fix the Coke, and the price of the burger or fries will go up. So be it in the checking account. Think about that the next time in the drive thru buddy.

Any thoughts on Judge Leon's genius comment that the fixed price on a debit interchange fee should be seven to twelve cents?

~ Jeff

Banker Quotes: As Told To Me v6

I learn a lot from bankers and industry experts as I visit their offices, speak to them on the phone or at industry events. Occasionally they will offer an insight that I think my Twitter followers would find interesting. Since I estimate my Twitter community only reads about 10% of their tweet stream, and so many of my blog readers do not follow Twitter, below are selected quotes that I tweeted since version 5.

Note that if the quotes exceeded 140 characters, I would have abbreviated or substituted some words to make them fit. So if you are a CPA and want to count, a few of the quotes may exceed the 140 here, but not on Twitter. I quote people anonymously to protect the innocent.

1. Me to bank CEO: How many customers left as a result of you consolidating a branch? CEO: 3.

If this bank's experience becomes typical, I see little reason to keep branches that have not proven to generate at least $25 million in deposits.

2. Bank CEO: Bloomberg says the duration of a 30 yr mortgage is 8-10 yrs. We think it's 29.5 years.

Not many borrowers will be running to refi their 3.5% mortgage any time soon.

3. Bank examiner: We're focusing on the interest rate risk from bankers reaching for yield.

Duly noted.

4. Bank Exec: The mortgage business only has a 30-day business plan.

Ever speak to the head of a mortgage origination shop? You wold be lucky to get them to think beyond the current pipeline.

5. Bank SVP: the mortgage lending business is like a shark. You have to keep swimming to breath.

And by the way, if Dodd-Frank tried to weed out bad actors in this market and put bankers back in the business, think again. D-F erected barriers to entry that makes it very difficult for your branch manager to talk to you about a mortgage.

6. Bank CEO: "You gotta have a dream. You may not realize it, but you gotta have one." Amen!

This is an emphatic statement about vision. Do you have a vision about where your FI is going that is clear, and resonates throughout the organization? This banker does.


7. Bank CEO: I get a lot of my financial industry updates from LinkedIn. 


Maybe social media is happening outside of the Marketing Department.

8. Bank branch construction firm CEO: The most common branch build remains 3,000-3,500 sq ft. Me: *sigh*

Old habits die hard. At least we won't have all the environmental problems that old closed down gas stations have when our branch is long empty and weeds are coming up through the parking lot cracks.

9. Bank CEO: Our current strategy is to satisfy the OCC.

What is the vision for your FI? Compliance? There's a sure thing for an enduring future. It should be noted that this bank was under a regulatory order.

10. CU Exec: We spend 30% of our time doing the right thing & 70% of our time documenting that we did the right thing.

How do you calculate that cost, Mr. Regulator?

11. Bank President: The government is intent on making banking a not for profit business. 

I thought the government was here to help?

12. Bank CEO: I'm currently a development loan workout specialist.

Two things to note here: 1) Development loans were the worst for most FI's during this recession, and 2) Lenders were generally terrible at working out their own credits.

13. Bank CEO: We do things better AND get better pricing.

I must admit I hit bankers hard on this issue in strategy sessions. I'm convinced Best Price & Best Service is not a sustainable business strategy.

14. Bank Analyst: The CEO is past the age where he should be home watching The Price Is Right.

This is a legitimate industry challenge. CEO's that hang on well past retirement age may think that there is nobody to do it as well as they did. Which is unfortunate. Because we need future leaders to do it differently.

15. NJ Banker and West Pointer Norm Beatty quotes Stonewall Jackson: "Never take counsel of your fear."

Amen Norm. Bring on the change!

What are you hearing out there?

~ Jeff

Note: To get banker/industry quotes as I hear them, follow me on Twitter @JeffMarsico

Guest Post: 2nd Qtr Economic Review by Dorothy Jaworski

Shell Shocked

If you are a fixed income investor, you have seen the worst that the markets have to offer in the second quarter of 2013. Between May 1st and June 24th, when rates peaked, longer term Treasury yields rose by 86 to 100 basis points. The 5 year Treasury more than doubled from 0.65% to 1.51% and the 7 and 10 year Treasuries each rose 1% to 2.07% and 2.61%, respectively.

Mortgage rates fared poorly too, with the 15 year FNMA posted yield moving up 1% to 3.12% and the 30 year yield moving up 1.20% to 4.12%. Mutual funds and ETFs specializing in mortgage backed securities saw their worst quarter in terms of losses and outflows since 1992. However, all bond portfolios have suffered losses in this blood bath.

You are not alone in trying to understand how quickly the markets changed. If you are looking for a villain behind this madness, you can look no further than the Federal Reserve, the once proud institution who prided themselves on communication and transparency, but whose credibility sank as fast as bond, stock, and commodity prices. If you are a fixed income investor, you are clearly shell shocked.

In the past decade, we have seen several Treasury routs that resulted in huge selling in the markets, most notably in 2003-2004, 2005-2006, and 2009. The selloffs in 2003 to 2006 came during periods of higher GDP growth (4%+), healthier home prices, moderate core inflation, rising commodity prices, strong stock prices, a weak US dollar, and Fed tightening.

The selloff in 2009 was an adjustment following the extreme crisis in late 2008. In this 2013 selloff, we have sub-par GDP growth of less than 2%, rising home prices that are still 20%+ on average below their former highs, core inflation that is very low with inflationary expectations declining, falling commodity prices (except for oil), Fed easing, and a relatively stable dollar. We have the strong stock market, but of course that is where Ben Bernanke wanted you to put your money. By the way, rates have risen so violently that the advantage stocks enjoyed for the past one to two years with a higher dividend yield than the 10 year Treasury has been erased.

As we witness the last several months of the term of the once great Ben Bernanke as Fed Chairman, we long for the nostalgic “promises,” “forward guidance,” and scatterplot Fed Funds projections that defined Bernanke’s wish to be open about Fed activity. And in a few short weeks during May and June, the message from Ben and the Fed was mishandled very badly.

The only one who has not said much is our favorite dove, Janet Yellen, seen to be in the running to replace Bernanke. The Fed Governors’ conflicting messages, miscommunication about current and future policy moves, especially as they relate to the QE3 bond buying program and rate guidance left the markets unable to believe a word they said. Even though nothing had changed in the economic realm, the Fed implied that easing is about to end and then they said it will not end—short term rates will remain low until 2015.

When the Fed first made their “promise” to keep short term rates low for two years in the third quarter of 2011, Treasuries were as follows: 5 year at 0.96%, 7 year at 1.44%, and 10 year at 1.93%. If they do not tighten until 2015, two years from now, shouldn’t the math be similar—especially with lower inflationary expectations today?

When asked about bond buying, the Fed said that it will end soon and then they said it will end later, maybe when the unemployment rate gets to 7%. Then they said that the bond buying could increase! Exactly where did that come from? It then said that the QE buying doesn’t matter, but the size of the Fed’s balance sheet does. Confused yet?

When given a chance after the Fed meeting in June to reassure the markets and clear the confusion, Bernanke did nothing to convince the markets that tightening is years away, that a healthy employment market is years away, that sustainable GDP growth is years away, or that the Fed cannot predict the future with their crystal ball any better than we can. Instead, he let the markets think that the Fed will soon abruptly “taper” and then end the QE bond buying program, which was the reason rates were staying low.

He let the markets think that rising long term rates, including skyrocketing mortgage and municipal bond rates, are acceptable. Well, Mr. Bernanke, we are here to tell you that they are not. Why did you even bother with QE3 if you were going to work so hard now to negate its impact now?

Animals

The Fed Governors were quick to talk about the markets and the volatility that they themselves created. The war of words has begun. My personal favorite was when Dallas Fed President, Richard Fisher, stated that “Big money (on Wall Street) does organize itself somewhat like feral hogs.” I am surprised he did not talk about sheep, herds of cattle, or lemmings jumping off a cliff. Instead, he tried to reassure the markets with “I don’t want to go from Wild Turkey to cold turkey overnight.”

Indeed. During the last week of June, other Fed Governors have been feeding quotes to the Wall Street Journal in an effort to let the markets know that the Fed is not tightening anytime soon, that the market reactions have been “outsized” and likely wrong. But here we sit in the new, volatile reality. I personally am waiting for Jamie Dimon to save the day.

What About the Data?

Real GDP growth for the first quarter of 2013 was just revised down to 1.8%, following the anemic 0.4% growth in the fourth quarter of 2012. The nascent housing recovery will likely see home prices face some resistance as mortgage rates moved higher so quickly. Housing affordability is still good, but mortgage borrowers are shell shocked, too.

The index of leading economic indicators for May was only up 0.1% after the stronger momentum in April of +0.8%. Payroll employment growth has averaged 189,000 per month for the first five months of 2013, which is

lackluster for a recovery this old. The unemployment rate is at 7.6%; the labor force participation

rate is at a 30 year low at 63.4%; the pool of available workers stands at 18.5 million people—

representing tremendous unused capacity. This does not seem like an environment where growth

will break out anytime soon.

If we are hoping for growth to come from international trade, we will be sorely disappointed as China’s growth is slowing, almost all of Europe is in recession, and Japan is not likely to go on a buying spree. Oil prices have held in recently much to the delight of OPEC; gasoline prices are 3-4% higher than last year and continue to strangle consumer spending.

Ever increasing regulations, health care law enactments, and now the newly approved Basel III increased capital requirements for banks make it more difficult to achieve sustainable GDP growth. The future direction of Fed policy will be determined by data that is not yet even created. I don’t care what they say.

Complacency

I have come to the conclusion that we are becoming too complacent. Why do we accept what is placed in front of us and not demand something better? One case in point is the still high price of gasoline, currently at $3.50 per gallon. Why don’t we work to increase the supply here by approving a new pipeline? Why don’t we provide incentives for researchers to find viable alternatives, ones that do not include plugging in my car for recharging like a phone! Come to think of it, why don’t we provide incentives for researchers to improve battery life for our phones?

Now is the time to incent people to improve and invest in the economy. Otherwise, we will just move along this mediocre economic growth path—QE3 or not.

Thanks for reading. DJ 07/03/13


Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy has been with First Federal of Bucks County since November, 2004.

Community Banks and Our Retirement Problem

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

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

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

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

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

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

The Harkin's report identified four principles of reform:

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

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

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

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

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

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

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

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

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

Should we band together and embrace the retirement cause?

~ Jeff