Saturday, March 18, 2017

Bankers Bank: The Next Generation

Correspondent or bankers' bank is one of those monikers that the meaning is in the eye of the beholder. Like private banking. Or superior customer service. Whenever someone says it, I look at them with an inquisitive head tilt. Like a dog when a person talks as if the dog understands them.

I think correspondent bankers are finding their way and morphing into services that banks need. Their original purpose, as I understand it, was to use up operating, liquidity, and credit capacity in larger financial institutions to benefit nearby community banks. Need access to cash? Call the correspondent bank. Cash letter for nightly settlement, same deal. An underlying, yet important plot in It's a Wonderful Life was that Mr. Potter's bank served as a correspondent bank to the Bailey Building and Loan. He caused a liquidity crunch by not advancing Bailey credit, and offered to assume the deposits at "fifty cents on the dollar"!

Today, with the Federal Reserve, Federal Home Loan Bank, and technology that has all but eliminated paper "items", the traditional role of the correspondent bank is diminished. Not that the concept of developing scale to provide banking-related services at a lower cost than a community bank can achieve on its own is not lost. In fact, I would say it is needed now more than ever.

But they are provided by other service providers. Take my firm, that builds profit reporting models for community financial institutions based on how they are individually managed, and the products that they offer. We do this for dozens of banks. It would not be cost effective for us to do it for one bank, or even a few banks. Our investment in software and management reporting expertise would be underutilized, or the service would be too costly to deliver. The same with ALCO reporting firms. We use our scale to serve the many.

But couldn't banks use a scale-driven servicer, i.e. a correspondent bank, to provide needed services at a lower cost so community financial institutions don't see a sale as their only way to cost-effectively serve customers in a changing industry?

I think so. Let's call our little hypothetical correspondent bank Schmidlap Bankers' Bank. Here are the services I would foresee under Schmidlap's umbrella.


Many of the services identified above are already provided by firms, such as mine and ALCO firms in the form of Management Reporting. I know that bankers' banks currently specialize in Loan Participations, as bankers would prefer to share a credit with a service provider than a competitor, as many do now when they do bank-to-bank participations.

Loan servicing is another vendor driven service used by banks. In fact, there is a specialty bank in New Jersey, called Cenlar, that specializes in subservicing mortgages for financial institutions. When customers call with loan inquiries, they answer the phone with the originating banks' name, and live up to service standards agreed upon between the bank and the subservicer.

So many of these services exist under several vendor umbrellas, and financial institutions have demonstrated a willingness to outsource certain non-differentiating services. So why not have these performed by Schmidlap, a new-age correspondent bank?

This idea began germinating in my head when I spoke at the Kansas Bankers' Association CEO Summit a couple of years ago. At dinner that evening, I sat with the management team from a small, family-run bank. Very common in Kansas and across the Midwest. In fact, the average asset size of a Kansas-based financial institution was $99 million. The bankers described the difficulties in running a small bank in rural markets.

I suggested banding together, not in the form of a merger, but to form a service corporation to buy services, like identified in the diagram above, to reduce the cost of doing these things on their own. They were intrigued. I haven't seen one sprout up yet. But isn't it time?

Imagine the negotiating leverage with FIS, Fiserv, or Jack Henry if the contract for six or seven banks was struck by one entity? Sure, all of the banks would be on the same platform. But isn't that the way it is now? Except you all negotiate separately. That doesn't mean you can't set up your own product set, or your bank wouldn't be segregated with its own database at the data center.

And what of things like Marketing and Human Resources? Each bank should have their own professionals. But it is difficult for banks to have the level of sophistication in terms of systems, such as CRMs or HRIS, or the resources (or geography) to hire the very best professionals. Many view Marketing and HR as collateral duties of one executive or another. Both of these functions, in order for community financial institutions to thrive, must elevate their game.

For HR, provide the best talent, employee development, and compensation systems. For Marketing, financial institutions must implement more sophisticated approaches to attracting new customers, and better serve existing ones. It's no longer good enough to run an ad, order a tchotchke, or staff a booth at the trade show. Marketers must identify the most profitable customers for gold-tier service, and implement a plan for the next tier customers to turn them into gold-tier.

Those executives and systems might be more than a community financial institution can afford. But as part of Schmidlap, that level of sophistication can be yours! There could be a geographic limitation so Marketing and HR within Schmidlap could not serve two banks with, say, greater than 20% market overlap.

I've said enough! You get the point. Incoming ICBA chairman, Scott Heitkamp of ValueBank in Texas, said at the trade association's annual convention that he is concerned about the 30% decline in banks with less than $10 billion in assets since the financial crisis. He is hearing that community banks either can't afford or don't want to deal with the regulatory burden.

Can a re-invented bankers' bank inject newfound confidence into community banks, and up their game to compete over larger geographies with more sophisticated support functions?


~ Jeff

Friday, March 10, 2017

Which Bank Will Blink on Rate?

It happened. I received an e-mail this week for a 13-month CD special. The ad insisted it would make me happy. Instead, sadness. Sad that this bank thought I wouldn't notice they were front-running a likely Fed rate hike. Sad that the bank fell back on old tricks, getting customers to bite on an odd-lot CD term that will reprice at a lower rate when it matures. Sad that they got my e-mail address.

Staring down the barrel of a rate hike, and the specter of future and faster hikes, how does your institution feel about how fast you will have to reprice deposits? Because we are coming off of unprecedented times folks. Times that had the average balance of a money market account go from $47 thousand at the end of 2005, to $129 thousand today (data taken from my firm's profitability peer database). 

Why do you think that happened? And what will customers do with that money when deposit rates become more enticing?

I know your ALCO models predict what might happen. But if we dig deep, we know we don't know. That doesn't mean we can't look around us to predict pricing pressures applied by our competitors, like the bank that solicited me for the 13-month CD.

So I took a look at metrics, publicly available in Call Reports, that were indicative of a competitor's need for funding, and therefore will drive their pricing decisions.

I focused on the St. Louis MSA. Why St. Louis? I have friends that are getting married there in the next few months, and they work for one of the banks on the below list. Together. Same bank. I will defer to them on the wisdom of this. St. Louis also has a good baseball team. And they are not likely to win as many World Series as the Yankees in my lifetime.

I looked at the top 10 deposit market share banks that were not SIFIs. True, SIFIs had a 52% market share at June 30, 2016. But the below top 10 own 29%. Not an insignificant amount. And SIFIs' need for funding is much more complicated as they have greater access to the capital markets, and don't necessarily rely on drawing funds from St. Louis.

Here is the list, their St. Louis MSA market rank, in-market deposits and deposit market share at June 30, 2016.


Once I identified the community banks, my next task was to identify the financial metrics that highlighted their need for funding as rates rise, and therefore the likelihood that they would be early movers in the pricing game. Here are the metrics I used:

-  Deposit Growth minus Loan Growth (year over year)
-  Loans / Deposits
-  Securities / Assets
-  Pledged Securities / Securities
-  Time Deposits / Deposits
-  Borrowings / Assets
-  Cost of Funds

I ranked each of the above banks based on each metric, assigning the bank a "10" if they had the top rank, and a "1" if their ratios were lower. So, if UMB Bank NA had the lowest Loan / Deposit ratio, as they did, they received a "1" for that metric. If Central Bank of St. Louis had the highest Loan / Deposit ratio, as they did, they received a "10". That means that each metric received equal weight in my analysis.

I tallied all of the scores to determine which bank needed the funding the most, and were therefore most likely to be first mover in elevating rates and putting competitive pressures on other market participants. The results are below.


I predict that Midland States Bank will be the first to offer a compelling rate to raise deposits in a rising rate environment. They have a relatively small securities portfolio, high Loan / Deposit ratio, and their loans have been growing faster than their deposits, among other indicators.

Call this method the Jeff For Banks method to predict rate warriors. I can be a narcissist.

There are some tight scores immediately below Midland States, and upon looking through the data I believe Central Bank of St. Louis would be next, in spite of it having a slightly lower score than the three above it tied for second. Their Loan / Deposit ratio was 98% and their securities portfolio was similar to Midland States, at only 10% of assets. Reliance and Midwest, conversely, have securities portfolios of around 22% of assets to fund their growing loan portfolio. So the scoring system is not absolute, especially when there is clumping such as in the second through fifth ranks.

My friends' bank looks like it can sit on the sidelines during a rate war, a good position to be in. Unless they succumb to competitive pressures, and that parked money in money market accounts starts following rate around St. Louis. 

Who will blink in your markets?


~ Jeff








Saturday, February 25, 2017

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

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

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

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

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


Marc Randolph's three keys to business success:


1.  Tolerance for Risk

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


2. An Idea

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


3. Confidence

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


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

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


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


~ Jeff


Saturday, February 18, 2017

Capacity Planning in Banks: Three Measurement Ideas

Joe Lender's loan portfolio grew $5 million last year. The Trust Department's revenues grew nine percent. The Market Street branch's core deposits grew to 64% of total deposits. All objective measurements for front liners.

But what about support centers? Loan Servicing, IT, Deposit Operations et al? Perhaps they look busy. I have actually heard that before. One CEO said he judges capacity by looking out of his office window at 6pm. Are there cars in the employee lot? Perhaps it's time to add resources. If not, the request for an additional FTE is denied!

How can executive management, most of whom did not come from support centers demanding more resources, decide if they should give it to them?

I have some ideas.

1. Number of Accounts and Operating Cost Per Account

One statistic I turn to for clues on the capacity of a support center is how they were operating at their peak. Let's discuss the accompanying table.


With the exception of one period with a slight upward blip, this bank has been losing checking accounts over the eight periods measured. Yet the bank has not been reducing aggregate costs because the operating cost per checking account is more than it was eight periods ago. According to these data points, this bank supported eight percent more checking accounts at 13% less cost eight periods ago.

This data point suggests an 8%-13% available capacity.


2. Benchmarks

Data are like humans. Rarely perfect. When data does not support our theory, we tend to point to its imperfections. So it goes with benchmarks. There are no apples to apples comparison with a basket of banks data compared to yours. But does it represent a relevant data point to consider? The chart below suggests another relevant point of information so an executive can determine the capacity of a support department.

In this bank's case, the number of deposit accounts per deposit operations FTE has been declining. When deposit accounts were greater, this bank achieved the benchmark median. As number of accounts declined, personnel did not, and this metric fell below the benchmark. At the current period, the bank is 7% below the median benchmark and significantly below the top quartile. Time to reduce resources, or at a minimum challenge the department to become more efficient?


3. Recognizing Economies of Scale

A third data point to consider when determining capacity in a support center is how much resources as a percent of the relevant balance sheet item does this center consume (see chart)?

I have written, spoken, and debated that to achieve economies of scale, you must reduce relative resource consumption as you grow. I have also pointed out that many financial institutions fail to achieve it. This is a key fact in why many mergers don't achieve the economic benefits touted on merger announcement day. To realize economies of scale at your bank as you grow, incorporate the discipline to reduce relative resource consumption per support centers.

Given the above table, should this executive increase resources available to the Deposit Operations Department?


I don't believe taking one data point of the three mentioned above would be enough. As I contend, there are imperfections to each, imperfections that you can rest assured the Deposit Operations Manager will point out to you when considering a resource request.

But the margin for error declines when you consider multiple data points to make a more informed decision. I'm not suggesting seeking data ad nauseam. There is a declining value to adding more data. At some point a leader must lead.

And in Schmidlap National Bank's case, the Deposit Operations Department can do better.


What other data should be considered in determining support center capacity?


~ Jeff


Friday, February 03, 2017

Guest Post: Quarterly Financial Markets and Economics Update by Dorothy Jaworski

Change
Happy 2017, everyone!  Who is ready for all of the change that is about to be upon us?  A new President will be inaugurated tomorrow, January 20th, and Donald Trump has promised change.  He has used his slogan of Make America Great Again to show that his focus will be on the US and the US economy.  His election has already brought change to the financial markets, sending stocks rising 6%, as measured on the S&P 500 index, and sending interest rates to their highest levels in years.  Clearly, the markets expect change.  After Trump becomes President, the markets are expecting actions that will mean positive change for the economy,

Analyzing what change will mean to economic growth is clearly a challenge.  I wrote in October that there is no momentum and no catalyst to push GDP much above 2.0%.  The thought of change may have tried to do that, but change itself may not accomplish it.  For so long, we have been stuck at 2.0% growth.  Since the recovery began in June, 2009, real GDP growth has averaged 2.3%.  Most recoveries in the US have averaged far more than that.  This recovery is already 90 months old and growth has not yet reached its potential.  In the past ten years, the economy has not managed even one year of 3.0%+ growth.  So what has been holding us back?  First, we have inordinately high debt levels, especially in the federal government sector, of nearly $20 trillion.  Actual non-financial debt in the US totals about $70 trillion, or 370% of GDP.  Debt at multiples above 100% begins to hurt the economy.  Debt at multiples above 250% to 300% has been proven to dramatically slow economic growth and push inflation downward.  The last seven years are proof.  Debt is not going away, change or not, and will keep pressure on growth.

Secondly, productivity has been very poor over the past five years or so.  Since 2011, productivity has fallen by -.4%.  Compounding the issue has been a reduction in the labor force, with retirements removing skills from the workforce, discouraged workers, and skills mismatches resulting in people not able to find appropriate jobs.  Corporate profits have been held back as costs rose on a relative basis as productivity fell.  Third, the explosion in regulations over the past eight years has served to hinder businesses, especially new small business formation, and has drained valuable resources as compliance costs soared.  Bank lending has not been the catalyst it used to be for improved growth in this recovery compared to prior ones; maybe we can point at regulation after regulation being forced onto banks and higher, more restrictive capital requirements.  Maybe change will be coming.

What Will Change Look Like?
Change has already resulted in higher stock prices and higher interest rates.  I mentioned that interest rates have risen dramatically since Election Day.  The two year Treasury yield reached 1.26%, its highest level since August, 2009 and the ten year Treasury yield reached 2.58%, its highest level since September, 2014.  The quick jump in rates in late 2016 is reminiscent of the increases in 2013, with rates rising in both cases up 100 basis points in just over 100 trading days.  The markets must think that GDP growth will soar on January 21st.  I have news for them; it takes a lot longer for fiscal policy to translate to growth than you think.

President Trump has promised several policies that should improve economic growth, and Make the Economy Great Again.  He has promised the elimination of many regulations that are strangling businesses.  If bank regulations are lifted, lending and thus growth can improve.  Some regulations have had a negative impact on the markets, such as the Volcker Rule, which has reduced liquidity in the marketplace by restricting trading activities.  I have a theory that some of the rate increases and drop in bond prices were due to reduced liquidity and lack of market making.  I cannot quantify how much at this time, but I am sure it’s there.  Other regulatory reform promised by Trump involves energy production, which could improve growth and serve to keep gas and oil prices lower, keeping inflation at bay.

Corporate and personal tax cuts were promised, with the corporate rate dropping from 35% to 15%.  I don’t know if that large a cut would occur, but these actions will add to economic growth.  I saw an estimate that 50% of the effect of tax cuts flows through to growth in the first eighteen months.  To be truly effective, tax cuts should be paired with cuts in government spending so that there is not additional borrowing to fill the deficit.  In the early 1980s, the Reagan tax cuts took two years to push GDP growth above 3.0% and that was with a Federal Reserve, run by Paul Volcker, who was aggressively lowering rates.  Trump has a Fed, run by Janet Yellen, who continues to believe that they need to raise rates.

Rebuilding our infrastructure is another proposal, but I think government borrowing would increase- either from paying for projects or from tax credits to companies to do the work.  If government borrowing continues to increase, it will add to the crowding out effect on private investment, and not adding much to growth.  But I am in favor of much of this infrastructure improvement and am so tired of having to drive to dodge potholes.

Growth Forecasts
Economists are mixed on their reviews of the Trump proposals and change on GDP growth.  The latest Fed forecasts, released in December, 2016, have ranges for 2017 for GDP of 1.9% to 2.3% and 2018 at 1.8% to 2.2%.  Wait!  That is no better than the 2.3% since 2009.  And the Fed felt compelled to raise rates and to say they will keep raising them?  I think they must be looking at a few signs of inflation and thinking they must tighten now.  If inflation sticks, they will be right, since it will exceed their 2.0% target.  More than likely, high debt levels will keep it under control.  The latest Bloomberg survey, released in January, 2017, has GDP in 2017 at 2.3% with rising rates.  Wait!  That is no better than the 2.3% since 2009.   Some of the “higher” projections are from private economists, Dr. Don Ratajczak and Brian Wesbury with 2017 at 2.6%.  Dr. Ratajczak has 2018 at 2.9%.  The lowest I have seen is for real GDP below 2.0% for 2017, because high levels of debt keep growth and inflation at reduced levels.  With many of these forecasts, I wonder:  Why did rates rise so much?


Thanks for reading!  DJ 01/18/17





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 Penn Community Bank and its predecessor since November, 2004. She is the author of Just Another Good Soldier, and Honoring Stephen Jaworski, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure of devotion.

Thursday, January 26, 2017

Bankers: Build Your Own Wealth Management Platform

Will millennials come to your financial institution once they've acquired the investable assets to make your Trust Department interested? 

Community banks must think so, because I don't hear many strategies centered on helping customers build wealth from early to late. Got $500,000 in investable assets? Boom! You'll start hearing from bankers, financial planners, and investment advisers alike. Want to start saving with $100/month. *crickets*

I wrote a blog post in 2015 about banks building their own small business loan platform. The reason: bankers tend to ignore small businesses until they are "bankable", meaning they have real estate collateral to borrow against. Well what about all that time from early stage to stable business? Credit cards still fill the breach. But into the fight came OnDeck, Kabbage, and Funding Circle. Ignoring a prospective customer until a bank is ready for them, risks that the customer may never be ready for the bank.

So, do we stand on the sidelines and let others serve Early Savers and hope bank sales forces are sophisticated and successful enough to woo them back once they meet bank thresholds?

I think this is a risky strategy. So let me suggest this to you. Build your own wealth management platform. (see below)

I will concede that banks work to get savings accounts. It is the platform that provides you with low-cost, core funding. But do you strive to grow number of accounts, or to grow savers? Does your bank have a savings account that could be opened for $100 without a monthly fee? Can branch or call-center personnel assess savers' goals and outline a path to become that high net worth or mass affluent individual or household I hear that bankers crave so much? 

Because, unless you are bequeathed with family money, we all started with a buck. Who, in your bank, will talk to customers when all that they have is that buck, and teach them to plant it, water it, give it sunshine, and turn it into real wealth?

Or do we open the savings account and hit the monthly number-of-account target?

Once enough money is built up in savings, then what? The Financial Planner doesn't want a $20,000 account. No problem. Robo-Advisers will take them. Side note: According to the President of Wealthfront, robo-adviser is a derogatory term. He prefers "automated investment services". Sorry to hurt your feelings fella.

Robo-Advisers, including Wealthfront, Betterment, SigFig and others are projected to manage $2 trillion in AUM by 2020, or 6% of all AUM. So they'll take that $20,000 account, and add $200/month to it.

No worries, right? Once that saver builds up that nest egg at WealthFront, they'll be knocking at the bankers' door to seek advice! C'mon. You Can-Not Be Serious! *insert John McEnroe voice*

So why doesn't your bank collaborate with a Robo-Adviser for this period of wealth accumulation? They are anxious to work with banks, including white labeling, so you will continue to have access to the customer although the Robo will be managing those investable assets. Create trigger points to contact customers to schedule appointments with your Financial Planners as customer needs evolve and grow. 

I modeled this relationship out in the accompanying table and infographic. I assumed the customer would go through four phases, each with differing needs of advice and sophistication: Early Savers, Wealth Striver, Future Planner, and Wealth Maximizer and Harvester. I then assigned number of years to be in each phase, and the average balance of the savers' accounts during those phases (see table).


To arrive at the Lifetime Value calculation, I used the average profit per year, for the year the platform earned the profit, and discounted it back to present day using a 10% discount rate. For the Wealth Striver years, I used a 20 basis point marketing fee against no expenses to calculate the average pre-tax profit. As one would expect, the present value of the profits in the Wealth Maximizer/Harvester years was the greatest, at $822 (see infographic). But the Future Planner and Wealth Striver years aren't so bad either. And, in my experience, banks aren't very interested in the Wealth Striver phase.

Odd because the lowest present value period is the Early Saver. That is where Wells Fargo had a big interest to meet their number-of-accounts goals. 

Would banks be better off thinking about their customers' wealth journey as depicted in the infographic? Do we think about it this way? Can your bankers advise those Early Savers on how to chart the course to become Wealth Maximizers?

Do we have the product set to help customers at each stage? Or do we pick our spots, let customers find their own way at our bank or elsewhere, and hope they come back when they are more valuable to us?

What's your strategy? Please don't say "hope".

~ Jeff







Friday, January 20, 2017

Banking Economies of Scale Revisited

In 2011, on these pages, I wrote my most read blog post ever, titled: Does your bank achieve positive operating leverage? Even today, nearly six years later, it receives a material amount of views. Particularly from larger financial institutions.

Economies of scale has eluded our industry in its purist form. For some time, banks between $1B and $10B in total assets tend to wring out the best expense ratios (operating expense/average assets) and efficiency ratios. So economies of scale hucksters walk with this chink in their armor as to why their story-line falters at a certain size.

I also noted in my most recent and in all of my past Top 5 total return posts that community banks deliver superior returns to their larger brethren. So, although there are plenty of consultants and investment bankers with pitch books telling you to get bigger, there are also contrarians such as myself that believe that bigger is not always better. And my pitch book is simply a bunch of spreadsheets. No fancy bubble charts, green light/red light tables, or tombstones. 

In this post I would like to revisit a couple of tables. First, I broke down all commercial banks by asset size to show expense and efficiency ratios as banks became larger. The results are below.



As the table suggests, financial institutions of all sizes reduced their relative operating expenses since 2011, with the only blip being a slight expense ratio increase in the $500MM-$1B commercial bank category. I should note that the efficiency ratio from that sized bank actually went down between 2011-16, suggesting a slightly better net interest margin.

The economies of scale argument clearly has merit, as you can see from the table. As asset sizes increase, expense and efficiency ratios tend to decrease. With that pesky exception of financial institutions between $5B-$10B in assets. These are averages. So there are exceptions. And I have often spoken about there being a significant number of exceptions to the economies of scale bromide. 

One example is German American Bank, highlighted in American Banker's Community Banker of the Year issue, and on this blog. It is a $3B bank with a 55% efficiency ratio. Open Bank in Los Angeles is a $722 million bank with a 58% efficiency ratio. I didn't have to research small efficient banks. They rolled off my tongue. Actually, my fingertips.

The below table was taken from my firm's profitability outsourcing database. We do the cost accounting for dozens of financial institutions that includes calculating operating cost per product account. Did costs go down at this granular level as assets grew?



Obviously, no. But why? If assets grew, and the bankwide expense and efficiency ratio has generally declined as banks grew, how did these costs go up? It is a fully absorbed cost system, so all costs within the bank are allocated to products and services.

My theory is this. Average balances per account have been growing since the low end of the yield curve has hovered near zero, and today is below 1%. The cost to originate and maintain a $100,000 money market account is nearly identical to originating and maintaining a $50,000 money market account. The growing average balance per account phenomenon has been occurring in most bank products. So, bankwide, costs would appear to go down because denominators, average assets in the expense ratio and total revenue in the efficiency ratio, are going up with the average balance per account.

Number of accounts, however, have not been increasing at nearly the same pace as the balance sheet, if at all. So all of those resources at your financial institution designed to grow new account relationships have not been efficiently utilized. 

In other words, in account originations, financial institutions are generally, and on average, over capacity. 

Financial institutions have tried to reduce this capacity in branches by consolidation and staff reduction. That is why you don't see material increases in cost per account in deposit categories. 

But either through expense reduction or new account acquisition, there is more left to do.