Friday, October 22, 2010

This Week in Bank Failures

Most of the banking industry is completely unprepared for what is about to hit it.

I came to this conclusion yesterday after poring over surveys of bank executives and banking customers.

Banking customers, as you would guess, say that banks don’t understand or care about their banking needs and aren’t particularly good at charging fair fees or providing accurate information. They say that the banking system is getting worse. Bankers, in turn, say that banking customers don’t understand or appreciate what it takes to run a bank. But they say they think customers notice and appreciate the improvements they’ve made since last year.

None of this should come as a surprise to anyone. The alarming thing in the survey is the part about what banks are planning to do.

Most banks say they plan to raise account maintenance fees, or introduce them where they didn’t exist before. These new fees will hit mostly in 2011. Banks say they will avoid losing customers by focusing on improving the customer experience and building “deeper” customer relationships. But they can do this, of course, only if the customers agree, and the changes the customers say they want are almost the opposite.

If you are old enough to remember the office supply stores of the 1980s, you have some idea of how big the change in banking could be. In the 1980s, the number of office supply stores was huge. There were almost as many office supply stores then as there are bank branches now. Shopping in these stores was uniformly treacherous. Products were hard to find and often weren’t marked with prices, or if they were, those weren’t the real prices. That’s because the business model of the stores depended on charging different customers different prices. It could take an hour in one of these stores to buy a box of pens and a pack of 100 sheets of copy paper — and for that, you would spend over $20 if you weren’t a high-volume customer. The office-supply stores justified their high prices with the thought that office supplies was a labor-intensive, hands-on business. And it was. Back then, it was almost like doing business with a bank.

Then Staples and the other modern office supply stores came along. Staples charged less than half as much for everyday supplies, and the prices were publicly displayed, right there on the shelf tags. It was easy to find products because everything was organized into departments and displayed in plain sight, with nothing hidden in the back room. You could load up your shopping cart with whatever supplies you needed. Within 3 years, 100,000 old-style office supply stores had closed their doors.

Banks say they need new fees to cover the cost of operating the bank. Customers say banks take too much money already for the transaction processing they do. Guess what? In this case, the customers are right. The bankers are wrong.

In surveys, the largest group of bank executives said their top priority was either to improve the customer experience or expand the customer relationship. Virtually none said that cutting operating costs and streamlining operations was their top priority. But it should be. Customers want banking to be simple and inexpensive, and that is possible only if banks stop spending so much.

The banking industry has locked itself into a model of operations that, between the branch offices and the back offices, costs probably 8 times what it could cost. Banks cost so much to operate that one bank earlier this year failed apparently just from paying full price for its key operating equipment. Banking technology has remained expensive, even as the costs of technology everywhere else have declined, because:

  1. Banking is a very conservative business, reluctant to try new things even if it can save a fortune.
  2. The current setup maximizes the banks’ opportunities to upsell their customers — to sell more expensive services than what the customers thought they wanted.

The new wave of account maintenance fees are essentially the banks’ way of telling customers, “You need to cover what it costs us to sell you something more expensive.” The customers, naturally, see things differently.

When banking executives say their top priority is to improve and expand the customer experience, they’re really talking about new ways to charge some customers more than others. To trick more customers into getting more expensive services than they need. And in general, to become more like the office-supply store of the 1980s than they are already.

But what most banking customers really want is for banking transactions to be simpler, less expensive, and most of all, quicker than ever.

The banking market, then, is wide open for a new entrant to walk away with most of the banking customers, much as Staples came to dominate the office-supply business with no resistance at all from its old-style competitors.

This could be a Silicon Valley startup that naively believes banking transactions are no more complicated than status updates. It could be a Wall Street venture that imagines that banking transactions can be as quick and simple as stock transactions. Or, it could be an existing bank whose executives stubbornly refuse to impose new fees, and are willing to try anything to cut operating costs instead.

People do not move their bank accounts lightly, but the kind of monthly fees the larger banks are talking about, typically around $15, are large enough to force the average customer to wake up and look around. People will naturally gravitate toward the low-cost, low-fee banks. And since modern network-computing technology is highly scalable, the new banks will be prepared to handle an influx of tens of millions of additional customers.

And the old banks, the ones that think they can collect all the revenue they need to cover their losses just by raising fees and upselling their customers more often?

They’re screwed.

One of the former office supply stores in my local area is now a Starbucks. Another turned into a pizza restaurant. There is no reason for anyone to stop to wonder what was there before.

Tonight’s bank failures were concentrated in areas we had already heard from recently. The one billion-dollar bank among them was Hillcrest Bank. It had $1.5 billion in deposits in 41 locations in Kansas, Missouri, and three other states.

A Boston-based private equity group is setting up a new bank to take over the deposits of Hillcrest Bank. The new bank will keep the Hillcrest Bank name for now, and will also be buying the assets of the failed bank. The bank holding company, NBH, will eventually sell stock to the public. In an announcement, it said it plans to combine Hillcrest Bank with Bank Midwest, also based in the Kansas City area. Its acquisition of that bank was recently announced, but won’t go forward until regulators approve it. The combination would be the fourth largest bank in the Kansas City area.

The failure of Hillcrest Bank was the result of real estate losses nationwide. The strategy of geographical diversification was supposed to protect it, like the investors in mortgage-backed securities, from losses. But when the real estate market declined nationally, Hillcrest Bank faced stiff losses in both its Kansas City and national portfolios. Its Florida affiliate had failed a year ago, as Florida real estate declined sooner than the rest of the country.

In Arizona, First Arizona Savings, which had seven branches in five Arizona towns, failed tonight. It had been operating since 1988. It had $200 million in deposits, of which the FDIC estimates 99 percent was within the deposit insurance limits. The FDIC was unable to find a buyer for the failed bank, so it will mail checks to depositors beginning Monday.

Five small banks, with deposits totaling $472 million, also failed:

  • First Suburban National Bank, with four locations in Illinois. Seaway Bank and Trust Company is acquiring the deposits and assets.
  • The First National Bank of Barnesville, with two locations in Georgia. United Bank is acquiring the deposits and assets.
  • Progress Bank of Florida, with two locations. Local competitor Bay Cities Bank is acquiring the deposits and assets.
  • First Bank of Jacksonville, with two locations in Florida. Ameris Bank is acquiring the deposits and assets.
  • The Gordon Bank, based in Gordon, Georgia. Morris Bank is acquiring the deposits and about half of the assets.

A credit union failed this week. Phil-Pet Federal Credit Union of Pampa, Texas, had 765 members but less than $4 million in assets when the NCUA put it into liquidation on Monday. Share accounts were transferred across town to Pantex Federal Credit Union.