June/July 2016 Banking Exchange

Competitive intelligence for bankers

June/July 2016 bankingexchange.com

Mutual with moxie How Eastern Bank’s Holbrook pushes the envelope

engagement score: Analytics at work “robo advisors” come calling 1

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/Contents June/July 2016

16 Mutual moxie Crossing the $10 billion line, Eastern Bank melds community with digital strategy.

Tithing and advocacy, a potent mix– p. 18

By Steve Cocheo, executive editor Cover photo by Arthur Pollock

22 “Robo” impact Call it new tech meets old touch. “Robo advisors” push wealth management into 21st century.

By John Ginovsky, contributing editor

June/July 2016

BANKING EXCHANGE

1

/ contents / 4 On the Web

June/July 2016 Vol. 2, No. 3 Editorial and Executive Offices: 55 Broad St., New York, N.Y. 10004 Phone: (212) 620-7210 Fax: (212) 633-1165 Email: bankingexchange@sbpub.com Web: www.bankingexchange.com Twitter: @BankingExchange

Warning: personal compliance liability; How about a little BSA cooperation?

6 Like it or Not

Success is fleeting, but these six qualities transcend time.

Subscriptions: (800) 895-4389, (402) 346-4740 Fax: (402) 346-3670 Email: bankingexchange@halldata.com

8 Threads How do bankers’ children bank?; Why outrageous deal prices may not be; What happened in Vegas didn’t stay there.

8 13 Seven Questions

32

Executive Editor & Digital Content Manager Steve Cocheo scocheo@sbpub.com

27 Compliance Watch

Creative Director Wendy Williams

How can you cram 40 pages of disclosure into a smart phone? Creativity and dash of “Yelp” might be the solution.

Designers Nicole Cassano Emily Cocheo

Needham Bank created and succeeds in spec-home lending niche.

32 Risk Adjusted Never say never: The time to discuss the potential risks and impact of negative interest rates is now.

Contributing Editors Ashley Bray, John Byrne, Nancy Castiglione, Dan Fisher, Jeff Gerrish, John Ginovsky, Steve Greene, Lucy Griffin, Ed O’Leary, Dan Rothstein, Melanie Scarborough, Lisa Valentine

Production Director Mary Conyers mconyers@sbpub.com

Digital innovation doesn’t make bankers passé. But it changes their jobs.

36 Subscription Information: Banking Exchange Magazine (Print ISSN 2377-2913, Digital ISSN 2377-2921) is published February/March, April/May, June/ July, August/September, October/November, December/January by Simmons-Boardman Publishing Corp., 55 Broad Street, 26th Floor, New York, NY 10004 Pricing: Qualified individuals in the banking industry may request a free subscription. Non-qualified subscription printed or digital version: 1 year, financial institutions $67; other business $93; foreign $508. 2 year, financial institutions $114; other business $155; foreign $950. Single Copies are $35 each. Subscriptions must be paid for in U.S. funds.

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Contents may not be reproduced without permission.

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Editorial & Sales Associate Andrea Rovira arovira@sbpub.com

Director, National Sales Robert Vitriol bvitriol@sbpub.com

36 Counterintuitive

BANKING EXCHANGE

Editor & Publisher William Streeter bstreeter@sbpub.com

As branch traffic slows, Orrstown Bank builds relationships based on data.

30 Idea Exchange

2

Chairman & President Arthur J. McGinnis, Jr.

Circulation Director Maureen Cooney mcooney@sbpub.com Marketing Manager Erica Hayes ehayes@sbpub.com Editorial Advisory Board Jo Ann Barefoot, Jo Ann Barefoot Group, LLC Ken Burgess, FirstCapital Bank of Texas, N.A. Steve Ellis, Wells Fargo & Co Mark Erhardt, Fifth Third Bank Joshua Guttau, TS Bank Jane Haskin, First Bethany Bank Trey Maust, Lewis & Clark Bank Earl McVicker, Central Bank and Trust Co. Chris Nichols, CenterState Bank of Florida, N.A. Dan O’Malley, Eastern Bank Dan Soto, Ally Bank McCall Wilson, Bank of Fayette County

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/ ON THE WEB / Popular stories on

bankingexchange.com

Could compliance trouble make you a federal target?

You say de-risking, I say de-marketing ...

Payments trends tracked on our web channel

Two noted cases, and a Department of Justice directive, make it clear that compliance officers may be held personally accountable for major regulatory transgressions. Here’s what to do about that exposure. Read more at http://tinyurl.com/personaliability

Bankers deciding whether to bank certain businesses seek an assurance regulators decline to define. So many play it absolutely safe and bar such firms. Blogger John Byrne says it’s time for a better solution. Read more at http://tinyurl.com/byrnesblog616

From stories about leading edge matters like the blockchain to fast payments to company-specific stories such as Visa’s new digital commerce app, you’ll find it on our Payments Channel. Read more at http://www. bankingexchange.com/payments

You can’t summon regulatory change by app Uber often serves as a model for disruptive innovation. But at a recent compliance conference, banking innovators from Citi and BBVA and their compliance partners noted that Uber was an outsider breaking in, while banks are regulated, and on the inside, breaking out. Here’s how these banks handle their transitions. Read more at http://tinyurl.com/banksnotuber

Subscribe to our free weekly newsletters, Tech Exchange and Editors Exchange at bankingexchange.com/newsletters

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June/July 2016

To suggest topics, new blog subjects, and other web ideas, contact Steve Cocheo, digital content manager, scocheo@sbpub.com, 212-620-7219

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/ like it or not /

Six qualities that defy time

M

y eye was caught by this headline in a Wall Street Journal magazine supplement in June: “The Unimprovable: Awards for Six Things that Time Can’t Touch.”

The article was about six products that have remained popular over many generations—the Rolex Oyster Case watch, denim fabric, and a Knoll chair among them.

The point was that certain designs have stood the test of time remarkably well, especially in the age of electronics where things are considered outdated in t wo to three years. Kudos to the designers and craftsmen behind these innovative products. But I couldn’t help but think that the article wasn’t addressing what is truly timeless.

We all tend to focus on the physical object itself (or its design) or on the monetary success of a venture and not on the qualities of the people that created that success, nor on the qualities learned by those people in the process. Only rarely, after all, does success come easily. So herewith a different list of “Six Things That Time Can’t Touch”: 1. Patience. In our current world, the media, the public, boards, analysts, pundits, et al expect quick results and get restless when they aren’t forthcoming.

Patience involves self control, especially in trying circumstances, and at present the lack of it is far more evident than its presence. Yet having patience allows one to deal with the pressure of demands and to not be thwarted by setbacks, delays, and distractions. Patience is not a common quality, but a very powerful one.

Most of the great developments in history have come about only after long and tedious effort, and after overcoming stumbles and roadblocks—all of which requires patience.

2. Courage. This quality is often associated with life-threatening or similarly dramatic events, yet it takes a stout heart to stick with an idea—or to hold the line on a matter of ethics—when one is confronted by naysayers, and by those who feel you are out of touch with reality or similar forms of dismissal.

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3 . C a l m n e s s . C lo s ely r el at e d t o patience is the ability of some people to not be rattled by unexpected developments, including not overreacting when things go right (see humility, below). We live in a world of overstimulation, which makes it more difficult than it already is to maintain calmness. Nevertheless it is possible to create a mental oasis within oneself no matter what is going on around one. Far from easy. Yet rarely do good things come from a rattled, muddled, or confused mind.

4. The will to go on. We hear or read of many inspiring stories of people persevering against frightful odds. Often such people say that only sheer will kept them going. Everyone has a will but few of us come close to using it to full potential.

Instead we let shortcomings such as fear, worry, and laziness get the upper hand.

In the depths of disappointments and failures, draw on that will to keep on trying. There is a time to move on, but not because we gave up.

5. Adaptability. The ability to adjust to changing circumstances is a very useful attribute in business. Things rarely go completely according to plan, so having the quality of adaptability is a true asset.

Its opposite—obstinacy, unwillingness to change, and even failure to recognize the need to change—dooms many enterprises and projects.

6. Humility. Some of the biggest whoppers of judgment occur when one is flush with success and full of oneself. Humility—that rare quality of being modest in success—will not only enable us to avoid such missteps, but will make us more effective leaders or team members. People will work tirelessly for someone who has humility, less so for the boaster.

• • •

The value of these qualities, and others like them, is truly timeless. One gains them, or a degree of them, mostly from life’s difficulties. Yet they contribute greatly to life’s successes. Ironically, even when a person is seen as a failure by others (and sometimes by himself), that cannot be true if he or she has gained any of the six qualities above.

BILL STREETER, Editor & Publisher bstreeter@sbpub.com

In measuring success, rarely do we focus on the qualities within people that led to that success, mostly just on the trappings of success

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/ THREADS ALL IN THE FAMILY? Bankers discuss their children’s banking habits By Ashley Bray, contributing editor

M

uch has been written about millennials and the way they bank, but what of those with a banker in the family? Does having an insider’s view change the way this select set of millennials bank? What we found after talking to several bankers with adult millennial children (and some with slightly older Gen X kids) is that the answer, in short, is “No.” One well-known habit of millennials is that they handle most, if not all, of their banking online and rarely go into a branch. Bankers with millennial children unanimously confirmed this.

Dan Blanton, CEO of $1.8 billionassets Georgia Bank & Trust, Augusta, says his five children (ages 26 to 42) all predominantly bank at his institution, but do so through mobile and online platforms. He also cites the example of his daughter-in-law, who handles everything financial through her PayPal account— from business payments to receiving payments from family members.

All this online activity naturally carries over to cash, which is decidedly not

king amongst the millennial set. Most rely on debit or credit cards for everything. “They would use a debit card for a $2 item,” says Thomas Boyle, vice-chairman of $560 million-assets Countryside Bank, Countryside, Ill., of his four children, ages 31 to 38. “It doesn’t matter what the [dollar] size of it is.”

This move away from cash is emblematic of a move away from all paper. Boyle says his son takes pictures of important documents like receipts and files them digitally. “Paper is insignificant to [millennials],” he says. “They’re a technology age.”

Still, only so much can be accomplished digitally, and the bankers we spoke with all agreed that for complex financial matters like mortgages, loans, or investments, their kids go into a bank to seek advice. “When it comes to a major decision, that’s when they want to come in and sit down and talk to somebody they know,” says Blanton.

Sources differ on the exact age range of the millennial group, but generally speaking they include people between the ages of 18 and 35. Because this is such a large

MOBILE PAY SKEWS YOUNG That headline may not be a surprise, but the survey

by Pew Charitable Trusts that prompted it did produce some insightful statistics, a few of which are shown at right. Read survey coverage on BankingExchange.com at tinyurl.com/PewstoryBE

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mobile payments users 72% of are millennials or Gen Xers seven in ten U.S. 7/10 Nearly adults own a smartphone

age range, habits can vary. John Eilering, president of the Mount Prospect (Ill.) State Bank, part of $1.2 billion-assets Glenview State Bank, has kids who are a bit older (38 and 41). They have applied for mortgages and dealt with more complex financial issues, and Eilering finds that as a result, they’ve forged a connection to one bank—happily, it’s the Mount Prospect bank. “Loyalty is pretty important to my son and even more so to my daughter,” he says.

Paul Mollica, Boston regional president for $24.6 billion-assets Webster Bank, based in Waterbury, Conn., also has observed this as his twin 25 yearold daughters encounter more complex financial needs or require service from a bank. In fact, after experiencing inferior service from a previous institution and having a credit card hacked, both girls decided to switch to Webster. “Service quality is a big deal,” maintains Mollica. “I think as you get older and as your needs start to become greater . . . it’s an added dimension.”

(All this loyalty also suggests that one way for bankers to build their customer bases is to raise them!)

Most of the time, features are what draw in millennials. A senior vice-president at Glenview State Bank said that her two kids (ages 28 and 30) get most excited by rewards, a lack of fees, and the convenience of nearby locations—in

Making a purchase is the most common mobile pay activity

44%

Total population

52%

Millennials

the rare event that they need to visit a branch. She says they also look for additional features like people-to-people payment capabilities.

Dan Blanton’s kids constantly make suggestions and requests for new technology. “It’s a cost balance,” notes the CEO, who is current chairman of the American Bankers Association. “You want to be careful where you jump in and be sure that it’s been tested, it’s been

The millennial set’s move away from cash is emblematic of a move away from all paper. They’re a “technology age” proven, and that it’s been adopted as the technology for the youth right now.”

With millennials already on Blanton’s staff, including two of his own children, it may make it easier to see what’s on the horizon. “The exciting thing with banking is we’re bringing these millennials into the workplace,” he says. “How will they transform banking? And how will that naturally evolve into how bankers do business in the future?” he asks. Time will tell.

Concern about safety is the biggest obstacle to mobile use At

70% or above for all but one segment

June/July 2016

BANKING EXCHANGE

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/ THREADS / Readable guide to tech projects

H

ow of ten have you been told that there is no replacement for experi ence? Well, there is. You can find it in The Complete Software Project Manager by Anna Murray.

If you are a new CIO, CTO, or have just been given a software application project, Murray prov i d e s a ro a d m a p to s u cce s s .

She’s organized the process into a textbook that almost reads like a novel. She even brings a sense of humor to the subject with section headings like: “Some Tech-Types to Avoid: Dot Communist s and Shamans” and “ How to Stop a Technology Religious War.” M o re o f te n t h a n n o t , b a n k s decide to purchase of f-theshelf software out of fear of the unknown. As convenient and safe as that strategy may seem, in the long run, it may cost you.

Murray does a great job outlining and explaining the approaches to software project management.

This is not a “do-it-yourself” book as much as a “things you should know, use, and avoid” book. It is loaded with insight derived from the author’s experience in management of software development projects.

One other point: Ever y major software vendor has its own project management approach. Once you execute a contract or purchase order, the vendor imputes its project management methodology. In my experience, that has the potential to doom your project.

The Complete Software Project Manager provides a toolbox of items that you can use to tailor the project management process to your organization. The vendor must comply with your expectations and deliver what is defined by you.

— Dan Fisher, contributing editor Read Fisher’s full review, containing insights from his own experience as a bank CIO, at tinyurl.com/FisherBEreview

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SO LONG, TELLERS Branch design fits “universal” model

By Ashley Bray, contributing editor

W

hile banks and credit unions continue to duke it out over tax and other competitive issues, they face similar challenges in other areas. One being the need to change the look and role of physical branches. First Tech Federal Credit Union opened a dramatically redesigned branch in spring 2014 in Bellevue, Wash., with the goal of becoming a collaborative financial partner for its customers.

Since then, the institution has opened three additional branches and updated five existing ones. The layout eliminates teller stations in favor of a relationship center (pictured), which gives customers a more relaxed atmosphere akin to a living room. Private “suites” are available for closed-door meetings and sport a restaurant-style booth versus traditional desk.

As its name ref lects, First Tech operates in one of the tech capitals of the world (Microsoft’s and Amazon’s headquarters are nearby), yet not all its customers are on the leading edge. So the $8.7 billion-assets credit union installed mobile bars in the redesigned branches. These have mobile phones, tablets, and laptops on hand for staff to educate customers on mobile and online banking. First Tech also is in the process of introducing a mobile scheduling capability and

exploring customer videoconferencing.

The new model stems f rom a sea change in customer behavior. “We see transactions continuing to decline, but we’re not seeing the decline of people coming in for complex issues and problems,” says Brad Calhoun, head of retail and senior vice-president at First Tech.

Calhoun says the industry is seeing a drop of 5%-10% in traditional transactions due in part to the rise of mobile and online banking. First Tech has embraced this, and its newly designed branches now see an average 40% drop in traditional transactions. This frees up First Tech employees to engage in deeper conversations with customers. Plus, since the credit union eliminated the traditional teller and banker roles, customers now meet with a universal role player who can handle any transaction or financial need.

“In the traditional model, we do 100 transactions to generate one partner referral,” says Calhoun, referring to product partners offering mortgage loans, investments, and insurance. “In the new model, we are able to generate a referral with only four transactions.”

First Tech is in the process of rolling out its new design in all 40 of its branches, transitioning three to four branches a year.

Why are prices Outrageous?

In the community bank M&A market, sale prices must be put in context, with some fresh thinking

T

here’s no doubt that the community bank market is in the midst of an M&A sea change, resulting in ma ny que st ions f rom bank management and owners. Kamal Mustafa, chairman of Invictus Consulting Group and a former head of global M&A at Citibank, has heard them all. On BankingExchange.com, he gives answers to eight common questions. Here is one of them related to bank sale pricing: Question: The asking price for some banks seems outrageous. When do you think the valuation expectations of selling banks will come back to earth?

Mustafa: “Outrageous price” implies its measurement against a certain standard.

The choice of standard—historical book values, multiples, tangible book value dilution, etc.—is fraught with danger.

In e ver y i ndu s t r y, when or g a n ic grow th prospects are poor, multiples tend to rise, and the reverse also is true.

You cannot look to historic multiples without looking at the economic context.

The post-recession env ironment , with its drastically changed capital adequacy requirements, low interest-rate

An “outrageous” price may be reasonable after proper analytics monetary policy, and highly competitive loan demand, remains in f lux. You can’t compare it to pre-recession banking. These radical changes demand an equally radical change in the approach to M&A valuation in banking. The new and evolving environment presents several wrinkles that affect how a buyer can

assess a target’s true value. Consider: • The buyer’s own profile. The same target has different values based on the potential acquirer’s loan mix, risk profile, profitability, and capital structure.

• No vacuum: Economic and monetary conditions matter. The same target will have different values to the buyer based on current and anticipated economic conditions and monetary policy.

• Filtering with outdated screens. Analyzing publicly available financial data using traditional metrics is misleading.

Due diligence based on pre-recession practice cannot accurately evaluate the pro forma implications of the transaction.

• Historical statistics mean nothing.

This applies even when banks are evaluating similar institutions in overlapping geographic territories.

Bottom line: There is no such thing as an outrageous price. You could be paying an outrageous price, but the same outrageous price could be reasonable for an acquiring bank that has done its homework with the proper analytics.

Read the full article at tinyurl.com/ CBmergerquestions

What do you want in a lender?

Assessing the qualities your bank needs in a candidate means looking beyond the resume

B

a n k i ng E x c h a ng e . c o m blo gger Ed O’Leary has hired and trained many lenders in his years in banks large and small. In a recent blog, he addressed what to look for in a lending officer candidate: • Personal integrity. All we’ve got at the end of the day are our personal reputations. If they don’t stack up well, we are not going to be respected by our customers, prospects, peers, and examiners.

• Intellectual curiosity. How do things work? How does a specific credit work in terms of purpose and source of repayment?

• Outgoing personality. I’m not talking

about glad-handers. Does the person listen carefully? Speak thoughtfully?

• No “show dogs” please. Can he demonstrate that he is a team player?

• Social graces are important. Does he speak and write clearly?

• Fit. Do a careful mental audit of your bank’s internal culture and try to determine whether the candidate “fits.”

• Pay attention to personal references.

• Upbeat attitude. Hire people who are quick to smile. It’s easier to teach them banking than to teach a sourpuss to smile.

Read the full blog at tinyurl.com/ yournextlender June/July 2016

BANKING EXCHANGE

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/ THREADS /

MIXING RURAL WITH URBAN

Core values help New Mexico bank succeed at its new city location

By Ashley Bray, contributing editor

S

outhwest Capital Bank is proof that staying true to your culture can lead to grow th. The New Mexico bank dates back to the 1890s. Owned since 1969 by the Levenson family, the $338 million-assets bank has been steadily growing since then.

Now under the direction of third-generation CEO Greg Levenson, who took over in 2000, the bank was ranked No. 32 on SNL’s 2014 list of top-performing banks with assets below $500 million. In 2015, its ranking rose to No. 22 for banks below $1 billion in assets.

Much of this success is attributed to Southwest’s 2014 expansion into Albuquerque, New Mexico’s largest city, a market almost 125 miles from the bank’s Las Vegas, N.Mex., branches. Unlike the other Las Vegas, this one is a rural market. It and the surrounding region were the bank’s home market for most of its life, and are still important.

Expanding into Albuquerque isn’t as radical a move as it first appears. It was actually a return, as the bank previously did business in Albuquerque in the early 1980s before leaving to focus on northern New Mexico. Also, after the financial crisis, two large community banks in Albuquerque failed, leaving behind a need for a community bank in the area.

Management realized that for growth 12

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to continue, the bank needed to focus on all of New Mexico, and Albuquerque was the logical next step. Greg Levenson personally moved to Albuquerque to scout out land for a new branch, work on integrating back into the community, and explore what the business needs were. A few years later, in 2014, the bank opened a branch, which now serves as the bank’s

Chemistry is critical in an organization, especially as it develops a new extension far from its base headquarters. “When we opened our doors, we already had a number of customers and a number of opportunities due to Greg’s early entrance,” says Lonnie Talbert, the bank’s chief operating officer.

Transplanting culture One challenge to getting the branch up and running was finding the right people.

“Chemistry is critical in an organization, especially as you’re developing a new extension,” says Talbert, and especially

when there is such a large physical gap between locations. The A lbuquerque branch started out with four employees: Levenson plus three others from the northern branches. That nucleus brought the bank’s culture with them. Talbert came in as the bank’s first COO from a position at Bank of America. In the last two years, Southwest Capital has added 45 new employees to the location.

“We tried to hire people who had the same characteristics that had been built into the organization,” says Talbert, who describes them as: “extreme customer service, great attitudes, willing to help, personable, smart.”

The bank’s markets differ significantly.

In northern New Mexico, the focus is on consumer loans and accounts. In Albuquerque, the focus is on businesses. But in both areas, Southwest Capital believes the driver of its success is its being the “Long-Term Relationship Bank.” It builds those relationships through community involvement. Branch managers volunteer, join boards, and participate in local events. The new Albuquerque location was built specifically to hold community events, and it hosts seven to nine a year.

One thing Southwest Capital doesn’t claim to be is a transaction bank. It offers its customers all the channels and products that its competitors do, but it knows transactional banking is an area where the big banks usually come out on top.

But as these large institutions continue to pull investment out of states like New Mexico, which has a very large rural base, Southwest Capital sees an opportunity for further growth. “[The big banks’] profit and loss model is based on fee income. So when you don’t have growth in a market in terms of population growth, and you’re a transaction kind of institution, then you’ve got to have new people walking in the door every day,” points out Talbert. “Our model is not built on that. Our model is built on the entire relationship, on the net interest margin. Our true competitive edge is our people, our culture, and our focus on relationships.”

/ Seven Questions /

WHEN YOU’RE NOT FACE-TO-FACE

With branch visits down, relationships are built on data and analytics, says Orrstown Bank’s Ben Wallace By Bill Streeter, editor & publisher traditional strength—customer relationships—by becoming data-driven.

Q1. Community banks pride themselves on knowing their customers. At a recent convention, you indicated that when you came to Orrstown Bank, you realized its customer knowledge wasn’t as good as it could be. Why?

I

t ’s ha rd not to wonder why more bankers wouldn’t leave their bigbank jobs after hearing Ben Wallace’s story. Wallace first worked at First USA, which was acquired by Bank One, and then ultimately became par t of JPMorgan Chase. He ended up running the giant bank’s Consumer Technology Group out of Wilmington, Del.—a good job, but requiring a lot of travel—much of it around the world; tough w ith a young family. He and his wife had been mulling over a different lifestyle when a recruiter reached out to him about an opportunity at $1.2 billion-assets Orrstown Bank, based in Shippensburg, Pa., near where his wife’s and his parents lived.

Wallace joined the bank in 2013 as part of a management rebuilding following some tough years. Not only did Wallace eliminate most travel, as executive vice-president of operations and technology, his responsibilities became much broader, more quickly than would have been likely at Chase. He now oversees traditional operations, IT, and the

“If all we are is a commodity banking provider, we’ll lose as switching banks becomes easier” bank’s digital and virtual channels. At the time he joined, the board took the opportunity to not only remediate the balance sheet and invest in a risk management upgrade, he says, but also to ask, “What’s the right technology for a $3 billion to $5 billion bank?” Wallace has been a key part of helping in that transformation.

The timing has been fortuitous. With six consolidations occurring around it, including BB&T’s acquisition of Susquehanna Bancshares, Orrstown Bank has been able to capitalize on the disruption.

In the following dialog, edited from an interview transcript, Wallace talks about how a community bank can enhance its

There’s this perception that as community banks, we win and lose all day on our relationships—we know people by their names, go to church with them, see them in the branch a couple times a week. That may have been the model, but when you begin to look at the stats, you realize you have fewer and fewer visits into these branches. In our case, maybe 40% of the people in a given year will not visit a branch.

So then you begin to ask yourself, “If our differentiator historically has been that high-touch personal relationship, but we don’t have the physical manifestations of that anymore, how does our ability to win change? And how do we respond to that?

“When they call our call center or visit us online, how do we capitalize on it to make people still feel and believe that they’re talking to a little bit different organization than a money center bank?”

That’s the journey we’ve been on the past three years: creating a system using customer data and analytics to make money and grow relationships.

We want our agent on that telephone that greets the customer not only to potentially know them from the community, we want them to know what they’ve been doing with the bank, how many relationships they have. Many front-facing folks don’t have 20 years of banking under their belt, so it’s hard for them just to say to somebody, “Hey, I’d like to earn more of your business.”

So we built a customer engagement score. We’ve given it to our customer service center people and said, “When someone calls, you can at least begin to use these four or five data points along with how much the engagement score June/July 2016

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/ Seven Questions /

Given the right data tools, customer service is empowered to earn more business.

has changed over time.” And also, “Here are some of the things you may want to talk to them about because of what we understand about them.” We’re finding that giving staff data and the tools to use it is extremely helpful because they feel a little bit more empowered.

Q2. What does the engagement score consist of? How do you use it?

We score deposit relationships, lending relationships, and wealth relationships.

Let’s say a customer has four accounts with us. On those four accounts, we measure “recency” and frequency, and take monetary measurements. Recency is how many days since the last customer-initiated transaction occurred. Frequency is average transactions per month based on a window of six months. And then monetary is what’s the average transaction amount of those debits and credidts over the same period.

So all this tells you that maybe you have a fairly modest borrower, not a whole lot of means, but uses the card every day at McDonald’s. Or you may have someone who uses the card to buy gas for their boat—so that customer gets a different score than the other.

At the end of the day, we arrive at a 14

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score of zero to nine for the three buckets—deposit , lending, wea lth—nine being the most wealthy. We aggregate that across three buckets so the score could be between zero and 27. And that score is used to engage the customer.

It’s fairly basic, but it’s so much more powerful than trying to have someone look at a screen and think, “Well, I see they have three deposit accounts and a loan, but that’s all I really know about the customer.”

For a call-center employee, we present the scores and the trend on their screen. So if the customer was a “four” six months ago, the rep sees how they’ve changed over time. They also see a bar chart of where they are in deposits, loans, and wealth. So at one quick glance, they may see, “This person’s a 20—he’s a really engaged customer across more than one line of business.” Not only do they see he is a VIP customer, but they may decide to not try to cross sell him a debit card. All that goes into the scripting we prepare for them and the training. We try to keep it very basic—score and trend for each business unit.

We want it to be a discussion and to make sure that we preserve that community bank feel. Frankly, I suspect

customers think, “You have all this data about me, at least act like you know who I am.” I certainly do when I call a business.

We don’t have any 27’s by the way. If a customer is a 24, that’s a decent proxy for a profitable customer in most cases. At present, we don’t do things like transfer pricing, and we don’t shoot out a dollar number.

We’re currently working on applying the score data to mobile and online. It will be much more of an inline offer concept, along these lines: “We know you’re very engaged; here are a couple of offers that may be of interest.”

Q3. Even community banks have silos.

How do you get around that in building this relationship database?

A ny bank that has some retail business will really struggle without some type of relationship system. Once you embrace the concept of understanding customer engagements and monetizing them, there has to be a framework. In the age of Salesforce.com, this technology has been somewhat commoditized.

We’re using a fintech solution provided

by Race Data.

We aggregate every relationship we have with a customer in one system, so if they call, I can tell what relationships

they hold with the bank at any given time.

That’s where this all has to start, and you can use it to drive marketing or specific offers. Also, you’re going to need some framework to capture engagements and to trend it as the regulatory environment matures. The Consumer Financial Protection Bureau, for example, is expecting us to track complaints and correspondence with customers.

Often, I hear from other banks that the wealth team uses one system, the lending team uses another system, and never the two shall meet. But we’ve been pretty prescriptive that any referrals go in this system. It’s not perfect, but the power of getting one uniform system is really impactful.

To make sure it happens, we drive compensation and branch scorecards out of it. We tell people, “If you want to get paid for a sales referral goal, the only referral system we have is this one.” So the more you can tie the system to normal business processes, it takes care of itself.

Q4. You’re using a fintech solution.

Generally speaking, do you view fintech companies more as potential partners or as competitors?

It depends on which one, but we’re pretty bullish on the fact that fintech firms can be good partners and not really a competitive threat.

A lot of our friends are now working at these companies, and in speaking with them, we find that lending and payment start-ups need banks more than maybe they recognized at the outset, right? They may have technology, but they don’t have customers, trust, or brand loyalty.

For the right opportunity, they can be really good partners. However, it’s still early and many of them have solutions that are only 70% there—they’re just not quite operationally ready for a bank yet. But without a doubt, some of them have better technology than most banks because they’ve had so much money to pour into it.

Q5. Speaking of technology, what did you have to do in terms of IT infrastructure to get your relationship program up and running?

Much of the heav y lifting was in the ex tra c t ion a nd ma nagement of t he data from our various core systems of record—working to redact and cleanse the data and send it over to our fintech

partner. Race Data aggregates the data on its platforms and runs some of the algorithms to develop the scores.

We think many bank s can do the same—they’re probably already taking extracts to their financial systems. Then it’s just a matter of what do you do with that data.

The work isn’t insig n if ic a nt , but because of the challenges we had in 2013, we invested in talent that helped us do it. Back then we asked ourselves, “What business are we in? Are we going to run data centers and servers?” We concluded that we would never be able to run a data center as eff iciently as Chase can—certainly not as efficiently as Amazon or Microsoft. So today, our bank has an insignif icant number of physical servers—we’re very, very light.

Jack Henry [& Co.] hosts our core platform. We have systems with Amazon and at other vendors.

I’d much rather use our technology horsepower on the stuff we talked about before—how you do algorithms around data and customer information versus keeping a system up and refreshing it every three years.

Q6 Where are you now in terms of becoming a “data-driven bank” and where do you want to be in five years?

The first step was to gain a more complete view of the customer. We got that done, and over the last 18 months, we’ve been rolling out the customer engagement score. Phase two will be, “How do I use the basic data around engagement to actually anticipate customer behavior?”

I think it’s clear we’re going to have to

continue to invest in this space as people engage more and more with our online channels, and fewer and fewer people walk into the branch. If we don’t, we’ll find we have a sea of people using our online systems and won’t know much about them. If all we are is a commodity banking provider, we’re going to lose as switching banks becomes easier.

Q7. Apropos of that, you have 22 branches. How do you see the role of the branch evolving?

It’s funny because when we speak with millennials, they always say, “While we may never go into a branch, we still like to know we can.” They’ve seen their parents go through the Great Recession, and they want advice on saving and planning.

So I think the local branch still has a tremendous impact on customer acquisition in certain markets.

L i ke ot her ba n k s, we’re retrof itting our branches to be less reliant on teller-driven transactions and more on engagement, which gets back to the whole idea of the engagement score— making sure that when people do walk in, it’s a much different dialog.

To d a y, m o s t p e o p l e c o m e i n t o branches—at least ours—to transact, engage for a specific purpose. Very rarely are they coming in just to explore. Yet people think nothing of going to an Apple Store and playing around with a n Apple dev ice for 15 m inut e s.

Wou ld n’t it be wonder f u l if people approached their f inancial lives like that—come into a bank and say, “Are we doing everything right?” Maybe in time we’ll get closer to that.

“We’re pretty bullish that fintech firms can be good partners and not really a competitive threat” — Ben Wallace, Orrstown Bank

June/July 2016

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“Fin” meets “Tech” with great success at Eastern Bank. CEO Richard Holbrook, left, with Chief Digital Officer Dan O’Malley.

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Mutual with

moxie Poised to cross $10 billion, with its tithes and Labs, Eastern Bank is a community bank with a difference

By Steve Cocheo, executive editor & digital content manager

All Photos: Arthur Pollock

R

ichard Holbrook’s corner office and anteroom are chockablock with clocks. A pair of handsome, antique grandfather clocks, one with a moon-phase dial, catch your eye on the way in. A gamut of timekeeping sits on two tables and elsewhere in his office, right down to a pair of Dr Pepper clocks, one made from a soda can.

At home, Holbrook has three windup ma ntle clock s w ith inna rds that he finds fascinating.

But there’s more to the collection than mechanical interest. It’s symbolic.

“I like time,” says Holbrook, chairman and CEO of $9.9 billion-assets Eastern Bank. “It goes one way—forward. You can look back, but you can’t do anything about the past, right? You can learn from the past, but you can’t change it. So you ask, ‘How can I change the future?’”

Eastern’s future has occupied Holbrook pretty much from the get-go. He joined the mutual bank 20 years ago as CFO. With year-end retirement in the offing, he can look back on growth from $1.8 billion when he arrived to Eastern’s impending advance over the $10 billion frontier.

To Holbrook, mov ing for ward has always meant having ambitious goals.

When he arrived, the bank, now headquartered in Boston, was concentrated in Essex County, to the city’s north.

“Our mission statement at the time sa id t hat we wa nted to be the pre mier, independent commercial bank in northeastern Massachusetts,” explains Holbrook, “which meant Essex County.

I asked, ‘Who has the number one market share in Essex?’ They told me, ‘We

do.’ So I said, ‘You mean our goal is to be who we already are? Don’t we want to reach a little higher than that?’”

no one-time boosts To Holbrook, who advanced to president in 2001 and to his present posts in 2007, simply growing larger didn’t mean as much as growing to a purpose. Creating a better Eastern, beyond just a bigger Eastern, was important.

“If you just buy another bank with costcutting in mind, that advantage goes away pretty fast,” says Holbrook. “There’s economy of scale because they don’t need a CEO, a CFO, a marketing manager anymore. But that’s just a one-time boost. It doesn’t build anything new.”

Elaborating, Holbrook explains that Eastern regards an acquisition as an opportunity to bring more to that bank than it offered to its customers before.

“That’s products, service, delivery, and capability,” he says.

A s one e x a mple , Hol br o ok c it e s Eastern’s 2008 deal for Massbank for Savings. The traditional home lender had $600 million in deposits, but much of this money sat in secur ities. “We liked the marketplace they had, and we knew we could do a lot more commercial lending than they had been doing,” says Holbrook. Eastern sold the investments, picking up liquidity that went into commercial and other lending, and meanwhile, it brought many new services to Massbank’s market.

Grow th came both organically and through acquisitions, both of other mutual and commercial banks and of June/July 2016

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/ eastern bank / Tithing and advocacy, a potent mix

A

ll banks suppor t their communities. At Eastern Bank that help takes some traditional and some atypical forms.

“As we’ve grown, we’ve added more expertise in certain areas, which has made us able to provide more solutions to our communities’ financial challenges,” says Richard Holbrook, chairman and CEO. “That will continue over time. We aren’t ever going to be JPMorgan Chase or Citicorp, working with the largest companies in the world. We’re going to be a local player who helps local businesses and local individuals succeed.”

Since 1999, Eastern has tithed for its communities, putting 10% of net income into its charitable foundation.

Holbrook says that foundation, now $100 million in size, contributes $7 million to community causes annually.

“As a mutual, we have no shareholders, so this is our sort of dividend,” Holbrook explains. He says this helps sell Eastern to new markets and to potential acquisition candidates.

Acquiring Wainwright Bank & Trust in 2011 helped Eastern with its communities as Wainwright had community development lending expertise and strong ties to nonprofit organizations.

Beyond this, “Wainwright was very active in social justice issues,” says Holbrook. The bank took public positions, with rhetoric and sometimes with funding or credit, on many issues that some bankers would not feel comfort-

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able commenting on. Eastern adopted t h i s p h i l o s o p hy. “ Th ey h a d b e e n longtime supporters of the LGBT community particularly, and they were one of the first organizations in this area to lend for housing for people with AIDS,” he says. “We’d always been supportive of many of these issues, but they were advocates, and Wainwright showed us how we could use our voice to be more than simply a supporter.”

“We were the first company in the country to sign onto a brief being filed challenging the constitutionality of the Defense of Marriage Act. We have since learned to use our advocacy voice in issues of gender equality, wage equality, and other areas,” says Holbrook.

Holbrook acknowledges that not all employees nor 100% of the board support the bank’s official stances. “We don’t take a stance on everything,” he says. “But we’re learning how to say what we believe is important for the rights of our customers and employees and communities. We’ll take a chance that we’ll lose a customer here or there who doesn’t agree with us. We’ll get a lot more. We’re not trying to get anybody angry at us—that’s not the point. We believe it is important to have an image that is consistent, that people understand, and that attracts a lot of people.”

Is Eastern sending a message of tolerance? “No, I would say the word is ‘respect,’” says Holbrook. Immigration rights is an area that he sees as important, as Boston is a city of immigrants.

“Boston is a majority-minority community, meaning that more than 50% of the people who live here are nonwhite.

Many are non- English speaking. A bank like ours can’t operate like it had all English-speaking, white people as their customer base because we don’t.

How will we meet their needs? One way is to support their causes.”

Many bankers wouldn’t feel comfortable endorsing causes beyond those of the industry or general community.

“We’re either courageous or foolhardy,” says Holbrook. “Depends on your view.”

nearly two dozen insurance companies.

But beyond that, there has been a willingness to allow the acquisition of other organizations to evolve the parent company. Often, beyond geographical reach, Eastern’s acquisitions have led to changes in business approach and loan mix, in its approach to its communities, in its specialties, in its corporate abilities, and, in 2003, in its relocation of its headquarters from Lynn, Mass., where its operations center remains, to Boston.

Acquiring people also comes into Eastern’s philosophy, most notably through bringing aboard f intech experts who became the core of Eastern Labs, a very large commitment to next-generation financial services. The Labs’ first new product release, Express Business Loan— an automated platform that can make working capital loans of up to $100,000 in under five minutes—won Eastern the distinction earlier this year as Celent’s “Model Bank of the Year.” And, as Eastern grew nearer to the $10 billion threshold that, among other things, entails direct examination by the Consumer Financial Protection Bureau, the bank brought aboard a regulatory veteran as head of compliance—CFPB’s former No. 2, Steve Antonakes.

In conversation, Holbrook makes it clear that Eastern still considers itself to be a community bank, and that mutuality, though a moderating inf luence on growth due to capital restrictions, remains part of its identity. Holbrook has enjoyed the freedom to pursue strategies without the need to appease stock markets and analysts.

“We found that we could be more than a single locality bank,” Holbrook points out. “We found we could be a bank for a larger region.”

How large is that region going to be?

“We actually figure that it’s the eastern part of the galaxy now—no limits,” Holbrook maintains.

just Get over it The words “no limits” may not resonate with many bankers who complain about the baggage that accompanies being an insured depository. Holbrook has participated actively in industry government relations efforts, including efforts to improve conditions for mutuals. But he declines to let regulatory mental malaise hinder Eastern.

“I’ve been hampered over the years by

being short,” says Holbrook, who stands at five feet five. “So there are things I can’t get off certain shelves, you know?

But when I get on an airplane, I fit the seat pretty well. Every model, whether you are a bank or a nonbank, has pluses and minuses. One group has more regulation; another has less. One has more access to capital; another less.”

As a mutual, Holbrook continues, he can’t sell stock, so acquisitions and other expansion are limited by Eastern’s earnings. “Is that a challenge? Sure, in the sense that I can’t grow as fast as somebody else might be able to grow,” he explains. “But I think we’ve grown at about the same pace that we’ve learned, so we have avoided mistakes that other banks who could grow really fast may not have avoided. And more banks have failed because they grew too fast than because they grew too slowly.”

Nonbank fintech players may not—at least for now—have bank-like regulation.

But Holbrook says that many of those companies envy banks’ ability to raise low-cost deposits and access large, established customer bases—not to mention repositories of data that Eastern Labs digs into like a kid with a jar of jelly beans.

Holbrook says that the key is making the most of the pluses, and counteracting the minuses. “So I never sit there saying, ‘Oh, woe is me,’” says Holbrook. “Choose how to compete: Don’t complain about what you don’t have; take advantage of what you do.”

One exception, he adds with a grin: “Credit unions should pay taxes.”

Eastern Bank and Holbrook knew Steve Antonakes, senior vice-president and chief compliance officer, for years as Massachusetts Commissioner of Banks, before he went to CFPB. So he came aboard knowing Eastern pretty well. He sees his role in part as helping Eastern evolve into its new league.

“We’re moving into a period in which strategically Eastern has determined to take a little bit more risk than previously, through investments in innovation and steps along those lines,” maintains the former regulator. “These are sound strategic decisions, but still taking a little more risk than we have historically. And this is a bank that I think has generally not taken much risk. That’s coupled with operating in an environment of heightened regulator y oversight as a larger institution.”

We’re more than a single locality bank.

We’re for a larger region, the eastern part of the galaxy—no limits” – Richard Holbrook, CEO Antonakes says his role thus far has been modernizing and maturing the Eastern compliance approach, including adoption of the “three lines of defense” concept, in which the front line takes on a much more significant role in compliance. In the f uture, he hopes the organization will begin to do more direct lobbying on financial issues that it finds important, to add its specific points to the industry’s shared perspectives. (See w w w.Ba n k ingE xcha nge.com for a n interview with Antonakes.)

Getting past limits Today, Eastern is America’s largest and, nearing 200, oldest mutual bank, and it is the largest independent bank in Massachusetts, but that is at this end of a long road.

In 1997, Eastern, venturing out of Essex County, opened a loan production office in Boston, during the tenure of Stanley Lukowski, Holbrook’s predecessor in his current post, who retired in 2006. The bank was in the midst of acquiring its first target outside of its “home zone” of Essex County—Hibernia Savings—but that wasn’t finalized until 1998. Management wanted to make it clear that it aspired to be a Boston-based company by planting that f lag right away. Hibernia served markets south of Boston, but had several Boston locations. When the deal had been finalized, Lukowski moved his own office to the city’s downtown.

Holbrook said these moves—“Stan Lukowski was very wise in this”—had June/July 2016

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/ eastern bank /

The concept of failing and having ideas not work is culturally challenging, but it’s essential to innovation and doing your job right” – Dan O’Malley, EVP & chief digital officer

a two-fold purpose. First, to attract the kind of commercial bankers it wanted, and to demonstrate its intent to customers. The Boston presence declared that Eastern intended to be a serious business banking player.

“It was also a great first step to changing our own attitudes about ourselves,” says Holbrook.

“It definitely worked,” he adds. “We were able to attract people we wouldn’t have been able to get before. And once we had the right kind of business lenders, we were able to attract the kind of customers we needed to be able to expand.”

Today, through moves like these and other acquisitions, Eastern’s loan portfolio is heavily weighted toward C&I, CRE loans, and other commercial credit, at 63% of the portfolio at year-end 2015.

Over the years, most Eastern expansion has been via acquisitions—“with de novo branches, you wait forever” for the payoff, Holbrook explains. Where warranted, the bank continues to branch, though with a smaller branch size now.

Meld the cultures When banks buy nontraditional businesses, they tend to put them into silos, or otherwise segregate them so they don’t mix with the “banking culture.” That is something that Holbrook has learned to avoid, beginning with Eastern’s move into insurance.

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the insurance business decided to keep their banking and their insurance operations apart,” points out Holbrook. “‘Oh, they’re two different cultures; you can’t mix them.’”

Holbrook scoffs, “They miss all the opportunity. If you are going to do something together, then do it together.”

Eastern began with an outside partnership. This hit a bump when the partner needed more capital and decided to sell out. Eastern won a “vigorous bidding war with a couple of other banks” in 2002. Since then, it has been buying other agencies under that umbrella, now called Eastern Insurance Group. “We’ve done more of these than we have bank purchases,” Holbrook says, though most insurance acquisitions have been small.

Eastern offers property, casualty, and life and health insurance plans to both firms and individuals.

Collaborating, learning to share space, share customers lists, and find ways to market to each other’s customers were only the basics to Holbrook. He says that not putting insurance in a silo has benefited both the bank and its employees.

Under insurance law, he says, a commercial lender can get $25 for referring a customer to the insurance arm. However, “if they get a license, they can get a big hunk of the commission.”

A s a result, says Holbrook, bankers who took the next step were getting checks in the thousands for the first-year

commissions, “just like a producer would in the insurance agency. All it took was for a couple of bankers to get those big checks, and suddenly everybody wanted to be licensed.”

Insurance is a significant part of the bank’s revenue. Approx imately 350 employees work in the insurance group, which generated about $70 million in commissions for Eastern in 2015.

at home with fintech Speaking of culture, right on a wall at Eastern Bank headquarters, someone has hung a tie on a nail—the only tie in sight in the room. Nearby, in scrawled felt-tip marker, someone has tabulated the names of famous sci-fi robots right on the whiteboard wall. The same space includes work spaces that aren’t workstations. They are seats at long white tables—one long sprawl punctuated by very large Macintosh computer screens borne on articulated supports, and, on a corner, an inflatable ball chair instead of the usual swivel.

How would you feel about your staff writing on the walls? Could they, in turn, work without personal walls, except for a few small, glassed-in rooms shared for consultations? Could you cope with a completely open dress code?

Welcome to a portion of Eastern Labs, sitting just to the left of the bank’s headquarters lobby. It’s a work space doubling as a declaration.

Labs employees don’t look like “bankers”—they watch a visitor who does, dark suit and all, coming through, and you can hear them thinking, “Who’s the guy with the tie?” But it’s Labs that produced the award-winning Express Business Loan that management expects in time will change how it serves the small business market—and beyond.

“We put this smack dab in the middle of our operations,” says Holbrook.

“You can’t miss them. They look different. Their work space looks different.

They dress differently. We wanted them to come here and build cool stuff, buy cool stuff, and most importantly, change our culture. We can’t stay the same if we want to succeed in the future. And we have to figure out new ways to interact with our customers, new ways to service those customers, new ways for our employees to work, and to find new kinds of employees with new skill sets.”

Holbrook credits his announced successor, Robert Rivers, president and COO, for making this begin to happen.

Several years ago, Rivers and some other Eastern bankers went to the nearby Cambridge Innovation Center—its website boasts, “More start-ups than anywhere else on the planet”—to meet innovators and see how the world was changing.

This resulted in two things: the addition of Joseph Chung, a serial entrepreneur, to Eastern’s board, and engaging in a consulting deal with Dan O’Malley, who had previously run PerkStreet Financial, and a team working on financial innovation projects at the center.

The bankers found the experience eye opening. Weeks later, “Bob [Rivers] said, ‘I wonder if they’d join us? Because we could use them on the inside,’” says Holbrook.

O’Malley, with key players, accepted and built a team that is now Eastern Labs. It works closely with, yet is distinct from, the bank’s IT department. O’Malley—a member of the Banking Exchange Editorial Advisory Board—is executive vice-president and chief digital officer.

The cultural impact of no ties and an open f loor plan is of the surface. The more important philosophical, cultural shift that clearly emerges is a creative tension that O’Malley and the Labs bring to a banking environment.

O’Malley explains that a two-way exchange has taken place. The culture of the innovator hinges on a word bankers don’t like: Failure. Innovation begins

with ideas, but what produces the ideas that light the lightbulb and grow is testing, failing, testing, failing, and revamping and retesting along the way.

“You’re going to fail if you’re doing your job right. In fact, you should fail more than half the time,” O’Malley explains.

“The concept of failing and having ideas not work is a culturally challenging one within a bank.” O’Malley feels the bank has evolved so that it understands this Labs essential.

At the same time, he says that Labs staff has undergone its own evolution, even though some, like himself, have worked in financial organizations before. “ There’s a learning cur ve regarding how different technology needs to be when it’s built for banks versus built for a fintech company,” says O’Malley.

“The rigor you have to hold yourself to for audit, for compliance, for regulatory work—it’s a higher standard.”

Meanwhile, says Holbrook, the IT operation in Lynn has been renovated for collaboration, and he believes the two tech teams have learned to work well together. “Our technology group was all for this,” he says. “They were waiting for senior management agreement. We needed to do something radical to make that happen.”

A major thrust for O’Malley’s group right now is a massive revamp of the bank’s entire digital face to the public. This involves look, feel, and ease of

use. O’Malley says this goes far beyond millennials: “Who wants to wait? Who wants to f ill out paperwork? No one.

Nobody says ‘I really liked your old process because it took three or four weeks.’”

crossing the rubicon Holbrook, it turns out, is not the kind of banker who never met a regulation he couldn’t dislike. “I’m actually not against regulation,” he says. “I wish regulation were much more by principle rather than by rules. But many rules exist because some players in the industries, banking as much as any, tried to find loopholes to get around things, and so they set up rules to stop that. It’s unfortunate.”

Holbrook sees the increasing regulatory regime that will come with moving beyond $10 billion in assets as mostly appropriate and even, in some aspects, positive. (The Durbin rule will cost Eastern $7 million or more, pre-tax, annually, and he’s not happy about that.)

One positive that he cites is the DoddFrank Act Stress Tests. Eastern has added staff to help beef up its existing stress test process to DFAST expectations. “Whether or not the DFAST test is perfect doesn’t really matter,” says Holbrook. “It’s a good idea that more complex organizations should have a better, more formalized process of understanding the risks that they’re taking, and how the risks interact with each other and with changes in the economy.”

As a larger institution, Eastern is strategically taking more risk in an environment of heightened regulatory oversight” – Steve Antonakes, SVP & chief compliance officer

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Wealth management jumps into the 21st century, pushed along by “robo advisors”

ealth management, the hot ticket in recent years for banks looking to boost noninterest income, has joined the ranks of other traditional financial service offerings challenged by tech-driven products and companies. And just as with other disrupted areas, banks face the crucial question: Is this more threat or opportunity?

Accelerated technological development, however, is just one piece of the wealth management puzzle. There also is a huge pending transfer of wealth among the U.S. population from older generations to younger generations, and the much-hyped emergence of the tech-savvy millennial generation. Both developments have potential for new revenue generation—and both, along with tech change, argue for seizing new opportunities to refocus wealth management offerings.

At ground zero, technology is both the enabler and the threat in the new world of wealth management. New tools have emerged, including “robo advisors” (essentially online, automated portfolio management advice), data aggregation, and mobile applications.

In combination, these allow banks to provide, cost-effectively, relatively high quality, personalized wealth management to a huge, so-far-underserved population segment, the so-called “mass aff luent.” On the other hand, start-up companies, unburdened by ponderous legacy systems, have already stepped nimbly into this space to disintermediate traditional financial service providers. Examples include Wealthfront, Betterment, and TradeKing.

There are many others, and based on their success, investment giants Charles Schwab and Vanguard have rolled out versions as well, with several big banks reported to be following.

By John Ginovsky, contributing editor

Shutterstock/John Williams RUS

Revenue play in flux Banks have what the fintech start-ups don’t: customers, assets already under management, and a bedrock reputation as trusted sources. However, bedrock can crumble, assets can be easily transferred, and customer preferences for service, access (mobile and digital), timeliness, and value continue to shift. These converging technological and social forces, say industry analysts, service providers, and bankers, call for a fundamental change in how banks provide wealth management services.

“You don’t need to be a bank to be in wealth management,” says Chris Nichols, chief strategy officer, CenterState Bank of Florida, a $5 billion-assets bank headquartered in Davenport, Fla. “Wealth management is just marginally profitable, if that, for many banks. It’s ripe to try to figure out how to lower the cost of service and lower the cost of acquisition, while providing better service. It’s a good growth opportunity.”

“The question should be on [every banker’s] mind, if they are going to adopt some of these technologies. When? That’s a complicated issue,” Nichols adds.

Central Bank and Trust, a $300 million-assets bank based in Hutchinson, Kan., provides wealth management services mainly in the traditional way, one-on-one and in person. Still, Earl McVicker, chairman, CEO, and president, recognizes the changing environment.

“We are competing with a whole variety of companies and even individuals that see themselves as wealth managers, when in reality, they are selling a product or a narrow range of products,” McVicker says. “Certainly there are people who would like to be able to purchase stock online or through their mobile phone. Or they would like to set up an account or something like that. That’s what we’re competing with. But . . . our version of June/July 2016

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“Algorithm-based robo advisors appeal not only to younger generations of investors, but to mature users as well”

wealth management goes much deeper than that. It is relationship driven.” And it’s profitable. Nevertheless, McVicker knows his bank will have to make it easier for customers to open accounts, make transactions, and review accounts online.

Lurking behind it all, say analysts, are the potential short- and long-term returns that wealth management can bring to banks—if they can figure out how to tap into them.

“One of the things that has lit a fire under the financial services industry is that they need to find a way to boost the bottom line,” says Mark Schwanhausser, director, Omnichannel Financial Services, Javelin Strategy and Research.

Community banks like McVicker’s, a long w ith most larger bank s, have been in trust and wealth management for a long time. But since 2008 and the onset of rock-bottom interest rates and

“The beauty of robo advisors is they can look at hundreds of alternatives and find the best one for a customer” ­ Chris Nichols, — CenterState Bank 24

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narrow interest spreads, more banks have jumped in. That dynamic hasn’t changed much in eight years, but technology and demographic shifts have.

Looking down market Shifts in age and income demographics play a central role in this new wealth management world.

“If you look at Gen X and Gen Y [millennials] together today, they control a little less than 25% of assets under management in the United States. Fifteen years from now, they will control half of the assets in the United States,” says Gauthier Vincent, U.S. wealth management leader for Deloitte Consulting.

Vincent adds: “This new generation of investors who have new preferences for digital and things like that, they are younger. You can’t ignore that.”

William Boland, senior analyst, Aite Group, offers further data: “Millennial assets are going to more than triple. They are about $2 trillion today. They are going to be about $7 trillion by 2018. If you think about the wealth management landscape, there is about $20 trillion in investable assets. [Deloitte puts a higher estimate on the total wealth management market: $32 trillion.] Even over the next three years, if millennials’ share of the pie gets that

much larger, this is a huge opportunity.”

Speaking about millennials, Boland says, “A lot of these people today only have $20,000 or $50,000 to invest.

Wealth management firms will have to cast a broad net, leveraging digital technology to do that. It’s an opportunity and also a challenge.”

Schwanhausser breaks this cohor t down further: “We actually see two generations. There is Gen Y-one, ages 18 to 24. They really are unaware of finances and the like. They need help, but it’s about day-to-day transactions. Then there is Gen Y-two, 25-34. That’s when you see a rapid and critical change. You start to see people laying down financial roots, starting to add f inancial institutions. The number of accounts and financial products they have rises considerably. People in that range, 25 to 34, are much more interesting [in relation to wealth management services].”

From a banker’s perspective, Nichols points out: “What is different is how you approach [millennials]. They are actually a little more open. They have a lower trust hurdle to get over [than baby boomers]. However, they are more discriminating in terms of issues like transparency, business conduct, and ethics. We will design anything for the millennials because if you design good technology, it will go across generations.”

Tapping mass affluent “Who are the most profitable client relationships? It’s the mass-aff luent clients, def ined as clients who have between $100,000 and $500,000 of investable assets. These are the profitable retail banking clients,” DeLoitte’s Vincent says.

Traditionally, wealth management was seen as profitable for providers if clients individually had $1 million or more in investable assets. For mass-aff luent people of more relatively modest means, however, the challenge becomes how to provide effective advice, cost effectively.

“When you’re going for younger customers, you’re going to have to deal with the need to start going through life stages: saving for an emergency fund; saving for big goals like cars, houses, or marriages, college; saving for retirement.

They are going to have to help a customer understand how to prioritize. Technology is going to be the enabler of that new kind of relationship if it’s going to succeed,” Schwanhausser says.

“Technology is making the experience for the aff luent investor more effective, and it’s making the operational infrastructure for the provider more efficient.

You will see greater penetration by banks in a more profitable way with the mass aff luent,” points out Al Chiaradonna, senior vice-president, SEI.

Rise of the robo The first of such technologies that everybody mentions is “robo advice.” Steadily improved over several years, these algorithm-based applications have appeal not only to younger generations of investors, but mature users, as well.

“There are robo advisors now that are cutting edge,” says CenterState’s Nichols.

“They ask our customers a set of questions, understand what their goals are and their current position, and then create an allocation for them and actually execute that allocation once they approve it.”

One of the things that that prevents is the inherent biases that wealth managers sometimes have for or against a certain set of products, according to Nichols. “If done right, it becomes a little more transparent. The beauty of some of these robo advisors, they can look at hundreds of different alternatives and create the best solution for a given customer.”

Now, according to Deloitte’s research, out of a total wealth management market of $32 trillion, about $150 billion is under robo-advisor management.

That’s a “drop in the ocean,” says Vincent, but further projections estimate that by 2025, out of a total market of $51

trillion, robo advisors will manage $5 trillion-$7 trillion.

Aggregation’s appeal

Another technology banks are reexamining is data aggregation—much improved from clumsy earlier efforts. Data aggregation is loosely defined as the gathering of information across all of a given customer’s accounts, both inside and outside the bank. This allows a wealth manager to put together a holistic view of where the customer stands financially, and how she may adjust going forward.

“Banks are including [aggregation] tools,” say Aite Group’s Boland, “giving clients the ability to see what their assets are. In doing so,” he adds, “it gives the banks greater opportunity to attract those assets.” It used to be that lines were drawn between various channels and between products—deposits, auto lending, home insurance, says Boland. “Now, there’s a lot of interest in consolidating platforms to ensure that you’re able to capture all the client’s data. It does two different things. It allows banks to have more access to information. It also gives clients one-stop shopping,” says Boland.

Even traditionalists like Central Bank and Trust’s McVicker recognize this: “There is no doubt that a benefit to the customer is to deal with one institution across all of their financial needs.”

But there’s a problem. “There’s a difference between hav ing information available and actually [being able to use] it,” notes Mark Schwanhausser. He says many banks are wary of aggregation for

“Long-term: Take Gen Ys and build them to a day when they have assets to invest.

Robo players start now, economically” ­— Mark Schwanhausser, Javelin June/July 2016 BANKING EXCHANGE

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“Fifteen years from now, Gen X and Gen Y will control half of the assets in the United States” ­ Gauthier Vincent, — Deloitte Consulting

a variety of reasons: cost, effectiveness, not sure what to do with it. “But what you’re seeing is a real awakening to the need of aggregation, and nobody needs aggregation more than banks themselves,” he says.

Mobile—the end all?

As with everything in banking today, mobile can reconfigure the provision of wealth management. “There’s a greater client interest to interact remotely. It’s digital first,” Boland says. But it’s not digital- or mobile-only.

“It’s true the millennials are very mobile.

But I like to put it as they are very multichannel,” observes Stephen Bruggers, vice-president financial services and OEM solutions, MicroStrategy, which provides a platform for mobile wealth management.

He explains: “Everybody has a mobile device. You want to check the market. You want to do a trade or something like that on the road. You can do that. But if you are back at home and sitting at your desk, you look at your laptop,” he says.

Mobile goes both ways, Bruggers adds.

“It’s good for the advisor, too. We see that in any kind of sales-enablement occasion where the mobile device makes a lot of sense. It has a small footprint. You’re on the road, and you can access everything you need, certainly from a wealth management point of view. [It can] help them do financial planning while sitting with a customer with a mobile device.”

That resonates w ith CenterState’s Nichols. “One of the things that we’re looking at is something as simple as 26

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equipping our relationship managers and business developers with iPads.”

Don’t ditch the touch

One size does not fit all, which then leads to combining technology with touch.

“The way we look at it in the wealth management area is to give the customers access to their own information as seamlessly and electronically as possible. But then we provide the hands-on personal service that I think will always set apart a community bank from an online service,” says McVicker.

“The point of building a hybrid model is right on. That’s the next evolution,” says Deloitte’s Vincent. “The key question is how do you create a hybrid solution that is still going to allow you to serve the mass aff luent and mass market in a way that is economical for you as a bank?

You need to find the right balance.” Vincent believes banks will create a menu by which clients can engage more or less with a person depending on the size of their relationship and the price they pay. “ The robo adv isors aren’t going to handle sophisticated timing issues or multi-country investment issues or complicated tax issues. So there’s still a role for the more advanced wealth management advisors. As we provide a [wealth management] solution going forward, it’s going to be both,” says Nichols.

“There is a kind of continuum between completely self-directed investment versus completely a dv isor- d irec ted investment,” says Bruggers. “The younger generation is more comfortable with the self- or tech-directed approach. The older

generation may be still more advisordirected. You have to be able to create a user experience for all the customers.”

“I don’t believe technology in wealth management is a replacement for human interaction. It’s an augmentation,” says SEI’s Chiaradonna.

What’s the payback?

So how does a bank sort out all of this?

There’s a short-term and a long-term way to look at it. Focusing on the massaff luent segment, Chiaradonna says the mass-aff luent person “is going to grow and will have deposit needs, checking needs, mortgage needs, credit needs.

They’re also going to have an investment portfolio. Banks want to see that massaff luent customer grow up to a high net worth or ultra-high net worth customer.”

Others agree: “The long-term play is taking those Gen Ys and building them toward a day when they have assets to invest,” says Schwanhausser. “ That’s where I think the robo players . . . have the potential to start now, serving them in a very economical fashion, to build toward something that’s going to come to fruition years down the line.”

A nd Boland: “Banks need to, ultimately, f ind a means of serving their existing clients and deploy some of these tools, and at the same time, keep the lights on. On the other hand, it’s a huge opportunity to deepen share of wallet.”

Sense of urgency The time for holding back and watching how things shape up is gone. Tech-enabled wealth management is moving rapidly.

Schwanhausser notes that at this year’s Finovate spring meeting, of 72 start-up presentations, at least ten were related to investment or wealth management.

Deloitte’s Vincent adds this warning: “Mass-affluent clients tend to get wealth management service somewhere else, and over time, they may gravitate [all their accounts away]. It’s a major risk for a bank. . . . The name of the game for a bank is to keep the assets at the bank and retain all these mass-affluent relationships.”

MicroStrateg y’s Bruggers believes banks are focused now to make sure they don’t lose business to fintechs. “They are adapting to the new technologies and delivering solutions.”

On t he ot her ha nd, C hia ra donna admonishes, “if the banks lose this game, it means they didn’t change fast enough.”

/ Compliance Watch /

DISCLOSURE IN A MOBILE AGE

Creativity and a smidgen of “Yelp” may help meet the challenge of handheld compliance By Kathie Beans

Shutterstock/Duncan Andison

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lectronic bill pay and remote deposit services have joined the list of services that mobile users expect from their institutions.

Mobility continues to grow in banking services, with nonbank, “disruptor” providers v y ing for consumers’ relationships. Unlike nonbank competitors however, banks must innovate while keeping an eye firmly on compliance.

Lengthy disclosures, particularly for loan products, are not mobile-friendly and can result in slower rollouts of mobile products. So how can banks meet their customers’ expectations while also satisfying disclosure requirements?

It is a conundrum shared by banks and regulators alike. “The financial industry has a responsibility to meet the public demand for mobile products, and regulators have to recognize that demand and start building in appropriate regulations for those products,” says Umpqua Bank

Chief Compliance Of f icer Elizabeth Clarkson. This responsibility also could be shared by nonbank firms, now that regulators have them on their radar.

About 90% of the U.S. adult population ha s a mobile phone, a nd approximately 62% to 64% of consumers own smartphones, so it’s not surprising that consumers are increasingly using these devices to manage their financial lives. The March 2016 Federal Reserve Board report, Consumers and Mobile Financial Services 2016, indicates that 43% of all mobile phone owners with a bank account had used mobile banking in the 12 months prior to the survey, up from 39% in 2014 and 33% in 2013.

Keep disclosures relevant Based on his remarks at a recent industry conference, Comptroller of the Currency Thomas Curry agrees with Clarkson.

“If banks are to remain relevant in a

changing world, they have to be able to adapt quickly to changes in technology and business practices,” he said. “So it’s important that regulators are open to the changes that are underway in both technology and business practices, and that we are able to evaluate both the risks and the opportunities that innovation presents.”

Curry was discussing the OCC white paper, Supporting Responsible Innovation in the Federal Banking System: An OCC Perspective. Published in March, it discusses principles that OCC will use to guide the development of its framework for evaluating new and innovative financial products and services. The principles outline OCC’s support for responsible innovation and the agency’s intention to foster an internal culture receptive to it.

(Read more on OCC’s white paper by visiting http://tinyurl.com/OCCinnovate.)

The white paper acknowledges that mobile payment ser vices and mobile June/July 2016

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/ Compliance Watch / wallets are changing the way consumers make retail payments and that new distributed ledger technology has the potential to transform how transactions are processed and settled. New technology services offer the prospect of a banking relationship that exists only on a smartphone, tablet, or personal computer.

The Consumer Financial Protection Bureau is similarly open to innovation around disclosures in the mobile envir on ment . D av id Mayor g a , a C F PB spokesman, says the bureau favors innovations that “increase the likelihood that consumers will read them; enhance consumers’ understanding about fees and terms and conditions; and allow consumers to compare costs and make the right choices that fit their needs.”

Mayorga says CFPB has finalized a trial disclosure program and a no-action

eight-ball in keeping up with technology.”

She notes, however, that the Military Lending Act has an “interesting” provision requiring lenders to provide an 800 number for verbal disclosures.

“We’re going to have to get very creative when we go down this road,” Clarkson says. “Key information will need to be provided up front, whether in text, voice, or video. There is no way around it.”

Customers will have to be able to demonstrate they received the disclosure.

“The disclosure is going to have to be delivered in a manner where it can be retained and consumed in a manner that the customer can find it,” notes Clarkson.

With a more complex product, key information would need to be provided as customers go through the application on their devices. Clarkson expects a detailed packet of information would

conveniently accessible for all clients. For example, when it comes time to close a mortgage, Quicken Loans arranges for a closing agent or notary to meet the client wherever they desire to review and sign the necessary closing documents.” It’s a “mobile human” strategy for now.

Fylonenko a lso point s out that Quicken Loans is one of the first lenders to allow customers to e-sign their loan application package. “With Rocket Mortgage, the application process, as well as the majority of the underwriting, can be completed online,” he explains.

“Quicken Loans requires f inal closing documents to be ‘wet signed’ with a notary or closing agent. As consumer behavior continues to evolve and technology progresses, we foresee the entire process, from application to close, being conducted online.”

In a move toward transparency, Yelp-style evaluation of financial products will emerge, says industry consultant Jo Ann Barefoot

letter policy “designed to help foster a consumer financial marketplace where companies develop safe, innovative products and approaches that can help make people’s lives better. The trial disclosure waiver policy is designed to allow financial services providers to take advantage of new technologies in designing and testing improved alternative federal consumer disclosures. The no-action letter policy establishes a process for companies to apply for a statement from bureau staff that would reduce regulatory uncertainty for a new product or service that offers the potential for significant consumer-friendly innovation.”

Get creative Umpqua Bank has not yet taken steps to change the presentation of disclosure requirements on mobile devices, but “we’re definitely looking at that and considering different ways we can do it,” says Clarkson, noting that one of the challenges is regulations that are “behind the 28

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have to be provided via a more traditional channel as follow up. Legal documents and information about fair lending, equal opportunity, and multilingual disclosures are not currently available for mobile devices.

At Bank of the West, compliance and business teams work together on challenges unique to mobile and digital disclosure, says Michelle Scott, a bank spokesperson. “As an example, last year during our rollout of online and mobile banking enrollment on a smartphone, we leveraged disclosures that feature a ‘Send by email’ function,” she says. “The ‘Cancel’ and ‘I Accept’ buttons are always visible at the bottom of the screen so customers can easily accept the ‘Terms & Conditions’ and move on to their banking functions.”

Jordan Fylonenko, a spokesperson for Quicken Loans, which offers the mobilebased Rocket Mortgage, says that “any disclosures, whether they be digital or presented in a paper package, need to be easily understandable, practical, and

Innovation in compliance

Industry consultant Jo Ann Barefoot says that she believes regulators are embracing the upside of innovation that benefits consumers, but also are addressing downside risks. “Regulators have a cultural ref lex of seeing things negatively,” says Barefoot, noting that the OCC white paper is “a sign of a shift in regulatory thinking, and it will cause the regulators to evolve and be more electronic and digital and mobile. I’m optimistic about it. People are using technology to comply with regulations.”

Barefoot, also a member of the Banking Exchange Editorial Advisory Board, expects that mandator y disclosures will be layered, with mobile disclosures containing a link to more information.

While there are some concerns about the effectiveness of mobile disclosures, Barefoot notes that “we already have the issue of effectiveness with paper disclosures.”

On the upside, mobile and online dev ices present the oppor tunit y for

interactive disclosures. As an example, Barefoot says that a potential borrower could use an electronic slider to determine how a loan pay ment would be impacted by interest rate changes or the amount of a down payment.

Third-party evaluations On the horizon are a number of issues driving change. Barefoot says innovators starting with a blank screen want to design products for an optimal user experience (UX), and that UX goal may lead the way toward better disclosures.

She also expects an upsurge in thirdparty evaluation of financial products and choices. “That will bypass the disclosure efforts,” she suggests, noting that CFPB’s shopping tool for consumer loans and NerdWallet are already helping consumers to evaluate products.

“I think Yelp-style evaluation of products will emerge. It’s harder to evaluate a loan than a restaurant meal, but I still think there is a big move toward transparency,” according to Barefoot, a former senior national bank regulator who also has served with a CFPB adv isor y g roup. Ba refoot adds that consumers will use Google to research financial products and institutions and also look at customer reviews.

“Per sona l f i na ncia l ma nagement technology will educate people in the moment,” says Barefoot. “We’ll move away from classroom-style to more justin-time education. They’ll have a tool to help them evaluate everything from consumer scores to the complaint database.”

In May, the Treasur y Depar tment issued its long-awaited report on marketplace lending, Opportunities and Challenges in Online Marketplace Lending. In the list of recommendations, the report noted that “smart disclosure” is a concept that the Obama Administration has favored since 2013, and noted that online lending would be a good product to apply this concept to. The intent would be to have providers issue information in formats that third parties could capture and reissue in digested form to enable better comparison shopping.

The report states: “In such complex markets [including lending], it can be prohibitively time consuming and complicated for consumers to read and process all the relevant disclosures on their own. In the context of online marketplace lending, smart disclosure will

When weighing mobile technology adoption, banks must balance costs, creativity, compliance, and consumer preference allow third-party companies and nonprofits to create comparison shopping sites for loans, similar to popular travel and f light comparison shopping sites today. Consumers can then use these sites to more easily compare terms to determine which specific offer might best fit their needs. To expand the use of smart disclosure in marketplace lending, Treasury recommends the CFPB and FTC include the use of smart disclosure in its guidance and standards on consumer disclosures.” [Emphasis added]

Not so fast . . . .

Although Barefoot believes mobile technology will become dominant for bank customers, she believes mortgages are the least likely product to be mobile because homebuyers need time to pause and think.

Brandon Dingeman, senior digital product manager at Wolters K luwer, agrees that “the long, arduous process of mortgage lending isn’t likely to be completed end-to-end on a mobile device, but it could be started on a mobile device.”

“Quicken is doing that,” says Dingeman. “There has been some reluctance among banks to adopt mobile technology because of budgetary constraints and because it’s outside their wheelhouse.”

Dingeman says that customers are pushing banks to provide more technology, so smaller banks are turning to third parties to develop this capability. “Larger institutions have those applications,” he

says. “In order to compete, small banks know they have to get there.”

Brent Gohl, also a senior product manager at Wolters Kluwer, says some mobile bank customers don’t have a computer at home, so they will want all products to be as mobile as possible, including the disclosures for those products. He says banks need the infrastructure in place to support mobile disclosures so that when mobile disclosures become the norm, banks would be able to provide them.

“The competitive nature of banking will drive adoption,” he says.

Ultimately, though, banks will have to balance costs, creativity, compliance, and consumer preference.

“You need to do it smart,” cautions Umpqua’s Clarkson. “You need to understand your customer and your market. I don’t think customers want to get a loan over their phone. We need to understand what the customer is demanding and how wide the demographic making that demand is. We should not try to present everything on mobile ‘just to be cool.’”

Adds Clarkson: “Mobile is a good entry point. You don’t need to deliver every serv ice you have t hrough your mobi le channel. You want customers to reach you easily and be able to reach through to other services. That’s important.”

Freelance writer Kathie Beans contributes to Banking Exchange and www.BankingExchange.com.

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/ Idea Exchange /

SPEC-HOME SPECIALIST

By targeting both builders and buyers, Needham Bank generates non-speculative business By Melanie Scarborough, contributing editor our builders get their product out faster; they’re paying their sub[contractors] s faster; the houses are selling faster— and we hope to make those [mortgage] loans.”

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f ever there was a garden spot for mortgage lending, it’s Needham, Mass.

Only ten miles outside Boston, the town’s location combines convenience to urban amenities with the comforts of suburban living—a prime location that draws residents who can pay a premium for real estate. The median home sales price in Needham is $798,000, a price well within reach of the town’s families, who have a median annual income of $186,000 and an average net worth of more than $1 million.

Given the area’s appeal to high-end homebuyers, it is no surprise that many builders do a lot of spec construction in Needham; and Needham Bank, with assets of just under $2 billion, offers unique loans tailored to that market.

“That’s always been a niche for the bank,” Stephanie Maiona, senior vice-president

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and senior commercial lender, explained during a session at ABA’s National Conference for Community Bankers earlier this year. “We do construction loans for builders as well as [lend to] people who want to buy one of the new homes.”

Indeed, Needham Bank dedicates a staff exclusively to builders and buyers.

All its CRE lenders work on construction loans so no one ever has to wait on a call back from a construction lender.

Another group of employees does the bank’s C&I lending. If builders who want to draw from their construction loan call the bank by 9:00 a.m. on a business day, the bank will send one of its inspectors to the site. If work has been done to the bank’s satisfaction, it disburses the funds that day. “With this model, we’ve been able to fund construction loans very quickly,” Maiona said. “That helps

Needham Bank not only finances construction projects, but helps builders sell the houses by offering spec-home buyers lower mortgage rates and fast-track financing. Those who want to purchase one of the spec homes that a builder financed through Needham Bank can apply for a builder-to-buyer loan—a 30-year mortgage with a discounted interest rate for the first three years and a fixed rate for the remainder of the loan term. The bank also offers an adjustablerate version of the product with a rate reduced 0.125% from market rates.

As Maiona explained, builder-to-buyer loans require only a 15% down payment and no points or application and processing fees. To qualify for the discounted rates, the borrower must open a Needham Bank premium interest checking account with direct deposit and automatic mortgage payment, as well as have an average credit score of 720.

For those who want a custom-built home, the bank offers a construction-topermanent mortgage that requires only one closing before building begins. During the construction period, the bank manages the advancement of funds to the builder or contractor, with the borrower paying interest only on the amount drawn. Once building is complete, the loan converts to a conventional home mortgage w ith monthly payments of principal, interest, and real estate taxes.

Internally, the bank’s staff works in concert to keep the construction and c u s t omer loa n s f low i ng. Ne e d ha m Bank operates three distinct groups— c om me r c i a l r e a l e s t a t e , C & I , a nd residential lending—with the goal of constantly referring business to one another.

The model evidently works; the bank enjoyed 20% loan growth in the past couple of years. Laura Dorfman, senior

Shutterstock/Meilun

Linking builders with buyers

v ice -president for residentia l lending, who spoke along with Maiona, told attendees that the bank probably hit maximum loan-volume capacity last summer when it had in the pipeline 190 loans totaling about $90 million.

By year-end, the bank had made construction loans totaling $105 million.

Needham Bank’s staff does construction lending so well that other banks in the Boston area refer business to them.

Other signs of success Dorfman said she was brought to the bank to capitalize on its relationships with builders, relationships the bank cultivates in part by assigning each builder in its portfolio a residential loan officer and construction loan officer. The bank also helps them sell their spec houses by advertising its financing deals. “We create f lyers, and every builder has a stack of them for their par ticular project, which they and their realtors pass out to prospective buyers,” Dorfman explained.

“That program has been very successful.”

Homebuyers get the same fast-track service as builders: If they call the bank by 9:00 a.m. that morning requesting a draw on their construction loan, the request generally can be filled that day.

“We capitalize on the spec-home buyer,” Dorfman said. “It’s the same back office, the same quick process.”

While the bank typically gets referrals from builders, another big source of new business is signs. “On every project— commercial and residential—there is a sign that says ‘Fast Track Financing by Needham Bank,’” Dorfman said. “That’s all it says, but you can’t believe how many calls we get from people saying, ‘I saw your sign, and I need a construction loan, and I heard that you are the bank to go to.’ I would say we get three of those calls a day. It’s a cheap way of advertising that gets us a lot of business.”

Capital offsets concentration Unique lending products and effective advertising strategies bring in customers, and the bank’s financial soundness

keeps business going even in an economic dow nturn. “One of the things that’s helped us is that, despite some declines in market conditions over the past 20 years, the bank has always continued to lend and do construction loans,” Maiona said. “We’ve never had to shut it off and say, ‘We’re not comfortable with the risk right now.’ If it’s a good project with a good builder and good market conditions, we’ve had the benefit of a capital base to support it.”

After their formal conference presentation, Maiona and Dorfman took questions from the audience. One banker asked if requiring only a 15% down payment for the builder-to-buyer loans represented much of a risk. Dorfman said it does not. “Given the credit scores involved—upwards of 720—we’re not too worried.” Maiona added that most of the people buying homes also become customers on the retail side, which is an additional boon for the bank. “If they can buy a $1 million home, Needham Bank wants them as a customer,” she said.

Another banker in the audience asked how such a heavy concentration in construction lending passes muster with regulators. Maiona said the bank has the advantage of “a huge capital base” and also is diligent about its account officers and security committee members keeping close tabs on the construction projects. (At year-end 2015, the bank had a leverage ratio of 12.75% and Tier 1 capital of 16.49%.) “Based on our continual monitoring, we’ve done quite well with the regulators,” she said. “We identify the risk; we know it’s there. We put extra in our reserve to support it.”

Dorfman added: “The other piece to it is the market we’re in. Our average loan amount is $500,000, so we’re dealing with a different risk-profile customer.

The quality of the loan portfolio has a lot to do with our exam results.”

One participant pointed out that a lesson for bankers is that Needham Bank did the opposite of what many do: Rather than find a niche and capitalize on it, it created a niche and made a success of it.

Needham Bank enjoyed 20% loan growth over the past couple of years, hitting maximum loan-volume capacity last summer with 190 loans totaling $90 million, said SVP Laura Dorfman.

With a dedicated bank staff for builders and buyers, “builders get product out faster; they pay sub[contractor]s faster; houses are selling faster— and we hope to make those mortgage loans,” said SVP Stephanie Maiona.

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/ Risk Adjusted /

REAL RISKS OF NEGATIVE RATES

Running the scenario now can lead to some practical steps that could avert big headaches later By Jeff Reynolds, Darling Consulting Group more thought into how your bank will live in a sustained lower-rate environment—lower than what we have already had. Is your balance sheet exposed to falling rates? If the ten-year Treasury dropped to 75 basis points, would you lend or invest long?

This would probably give you a reasonable proxy for answering many questions about how you would operate in a negative rate scenario.

With that as a backdrop, what if we actually did drift into negative rates?

What would the world look like for the typical community bank?

The follow ing is a summa r y of thoughts and some of the discussion we had at our staff meeting that day.

Negative rate scenario

O

nc e a mont h , we h ave a n internal meeting at Darling Consulting Group where all our consultants get together to discuss the current banking environment.

Recently, the meeting topic was negative interest rates. The Federal Reserve mandates that the “Severely Adverse” capital stress test economic scenario— performed by all Comprehensive Capital Analysis and Review (CCAR) and DoddFra n k Ac t St re ss Te st i ng (DFA ST) banks—employ a recession so severe that the Fed takes rates negative. Ever since that scenario was added, community

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bank directors have been asking questions prompted by it at ALCO meetings.

Among those questions: • What would cause negative rates?

• How would cash balances be impacted?

• How would negative rates affect loan spreads and demand?

• What would be the impact on deposit costs and fees?

Let me start with this thought: Yes, negative rates have become a reality in other parts of the world. But before thinking about negative rates in your bank, start with something closer to home. By that I mean: First, put a lot

What do negative rates look like? First, you have to get that picture nailed down.

The scenario we discussed was the Fed’s “Severely Adverse” for 2016 stress tests. This makes a good basis for discussion because it is a regulator-defined scenario, and it is the item that is causing all the chatter to begin with. (If you want to read the playbook, go to http://tinyurl. com/FRBstresstestscenario) Here are the basics of the scenario: The global economy plummets into a recession. GDP growth goes negative for a year, with a low-water mark of –7% or so.

Unemployment hits double digits. Credit spreads widen as a result of increased default probabilities. Equities get hit hard (the Dow gets cut in half). And real estate values decline sharply (the home price index declines by 25% and the commercial real estate pricing index declines by 30%). The three-month Treasury hits –50 basis points, the five-year Treasury goes to 0%, and the ten-year Treasury goes to 50 basis points.

There’s more detail in the actual documents, but you get the idea.

This Fed “Severely Adverse” sce nario posits a number of variables that are designed to place a severe stress on operations, similar in nature to the environment in 2008. A main difference

between 2008 and now is the level of current market rates. If we actually saw this environment, the FOMC does not have as many levers to pull to try to steer the economy out of a tailspin.

Here is an important point to unders t a nd: If re a l it y fol lowe d t h i s Fe d negative rate scenario, I submit that the focus will be credit, capital, and liquidity as it was following the 2008 crisis.

Interest rate risk—at least initially— will be a distant fourth place on the list of concerns.

Accordingly, if your ALCO is not prepared to include a credit stress test and full capital planning exercise in the overall analysis of negative rates, there really isn’t a lot of sense in spending much more energy on it.

But what if . . . ?

During that recent consultant meeting, we tried to table that part of the discussion as best we could. We ran down a chart of accounts and put a number of asset and liability classes on the table for discussion. The following summary may be useful if your ALCO tackles the question of negative rates: Life as we know it is over. It was agreed that if we actually were to dip into negative rate territory and stay there for a long time, the business would probably change for many community banks once the dust settled.

Because of that, you need to avoid the trap of saying, “We would never do that.”

The reality is if the rate environment did something it had never done before, everything should be on the table for a potential response to it.

Cash and investments. In the early stages of most banking crisis scenarios, having a stockpile of cash (or access to it) is almost always an enviable position to be in. A key problem with cash is the cost of carry (historically low or zero yield to other market alternatives). Another is how channels to access cash can evaporate in the face of a crisis.

In this scenario, the cost of carry on that stockpile of cash will not be based

on a zero interest rate f loor. The cost of cash reserves would move to (for argument’s sake) –0.50%. Would the desire to hold cash reserves still hold true to historical biases if we actually had to pay the Fed to hold cash?

Let’s start with this: If the world economy is blowing up and your stakeholders and reg ulators are super concerned about liquidity, would you f linch at paying $4,200 a month to have safe access to $10 million via the Fed? We discussed ordering a bunch of $100 bills for the vault, but between limited vault space and security concerns over holding high levels of cash, that interest charge seemed like the lesser of a few evils.

Bond cash flow. What you have for cash entering the crisis is one thing, but what would you do with portfolio cash flow over time?

In this scenario, you have to consider ex tending the duration on reinvestment (remember: the five-year Constant Maturity Treasur y is 0%) or f ind an alternative to defray the cost.

Given how reluctant bankers were to invest cash in the beginning and middle of the last crisis, I suspect that community banks would be more inclined to stay short on investments and cash, and try to

slow the margin drag via other actions.

Loan pricing. The best example of what will happen is the early stage of the last crisis in 2008 through 2011.

• Mortgages: If you remember, mortgage spreads widened out to the Treasury, and refinancing was not that big of a deal until the start of TARP, so it is difficult to predict what would happen here because one would assume the government would once again want to prop up housing.

• Commercial real estate spreads will widen by a lot, refinancing will decelerate, and banks will be in the driver’s seat on pricing of existing deals in their portfolio that do not sour. In the last crisis, spreads did not seem to “normalize” until three years or so after the start of the crisis.

• On commercial loans, shor t-term credit facilities would likely be frozen, rollover spreads will widen, and outstanding lines will decrease. With the economy in the tank, the typical reason for someone drawing a line is survival, and most banks will not extend credit under those circumstances.

• Consumer finance will freeze up, with auto manufacturers bearing the responsibility of f inding a way of extending enough credit for new purchases.

• O th e r th o u ght s o n l oa n s: W h i le

If the rate environment were to do something it had never done before, everything must be put on the table in potential response June/July 2016

BANKING EXCHANGE

33

/ Risk Adjusted /

Do you put reasonable floors on your adjustable and variable rate products today?

‘Not useful,’ you say? Never say never

creditworthy customers may want to lock in lower rates, banks will not likely play ball—at least not early on in the credit deterioration cycle as banks willing to lend will likely be fewer, and thus able to command higher pricing. The terms offered on rollovers would likely shorten as well.

A nother point raised in our meeting was that banks that have f loors on adjustable-term resets and prepayment penalties will f ind themselves in real positions of strength.

Do you put reasonable f loors on your a dju stable and var iable rate products today? “Not useful,” you say? Well, remember to never say never.

Wholesale funding costs. This was an interesting one. Would Federal Home Loan Banks lend money at a negative rate? Only if their cost was significantly less than that rate, and they could make a spread off it. So, again, never say never, but in our war game, we were not counting on it.

We did consider the ability to lock in ridiculously low-rate funding for a longer term as being a viable strategy in this scenario, potentially utilizing derivatives to craft the strategy.

This served as a good reminder to stay up to date on the ins and outs of plain vanilla interest rate derivatives, and not allow education and policy development to be the roadblock standing in the way of executing on a good strategy.

Recent histor y has shown that the demand for term money will likely be low bec ause most ba n k s have been awash with cash, and they are struggling to find quality assets. The same could well be true in this new, hypothetical economic world.

Deposit costs/fees. One comment we have heard a couple times from some banks is that they would never apply or increase fees to deposits because, culturally, their customers will not accept it.

To that, we say: “Hooey.”

Remember, under this scenario, it now costs you money to park cash at the Fed. So there is going to be a ceiling on how much cash you will take before you are forced to pass costs back to the customer.

That ceiling might not be that high when you consider investing into a five-year Treasury only gets you to a 0% yield.

The logistics/security issues we outlined above for the bank would hold true for your deposit customers. The number of institutions increasing fees would likely afford your deposit customers few alternatives for their safety and soundness of liquidity.

Think about it: Twenty basis points over the next year to keep $100,000 secure and accessible is about the cost of a decent safe at Walmart.

We surmise that most banks would increase fees and, because of that, customer pushback would be limited.

Systems. Can your core processing

Editor’s Note: As this issue was being prepared, the consensus on Federal Reserve’s rate moves shifted from “likely increase” to “no increase.” Even the likelihood for increases later in the year was in question. And as we have already seen, one change in direction doesn’t guarantee similar moves will follow.

Further, as the article notes, negative interest rates exist in Europe and Japan.

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system actually function in a negative rate scenario? How about other support systems? We have received a wide range of answers to those questions. It may be worth researching them, given all the hysteria Y2K created.

Back to the present At the end of an hour on the subject, we wound down the discussion and concluded our meeting. The value of the exercise was two-fold.

First, we identified some actions that community banks could take today to improve their balance sheet posture for low rates (e.g. loan f loors) that likely would not cause a big stir among their customers. This is likely the best value in the exercise of looking into the impact of negative rates.

Second, we feel that in doing this exercise, we laid out a decent, rational path for defusing the question, “Can we run this scenario?”

Do the larger banks do it? Absolutely they do.

But remember, they are forced by regulation, and the cost of doing this correctly should not be underestimated.

Can a community bank run a similar process? Absolutely. But doing so without addressing the biggest risk variable of credit would make it an exercise in futility and not likely worth the resources to answer.

Hopefully this article will help shorten your path of discovery on the matter.

Jeff Reynolds is a managing director at Darling Consulting Group. This article was adapted from Darling Consulting’s DCG Bulletin. For a free subscription, visit www.darlingconsulting.com.

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June/July 2016

BANKING EXCHANGE

35

/ CounterIntuitive /

BANKERS STILL MATTER

Not even head of a major fintech lab thinks banks should ditch human element By Steve Cocheo, executive editor

E

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BANKING EXCHANGE

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Eastern Labs’ Express Business Loan tool offers ease and speed, but with a banker behind it come in. “We’re working hard at that right now, and we’ll have some exciting launches coming this year,” he says.

“I think small business lending should be done by banks,” says O’Malley. “It should be done by local banks. Not that there’s not someplace for national scale lenders for small business. But I think the smallest of businesses benefits from that personal connection with their banker.”

That has been a key difference between online lenders and Express Business Loan. The Eastern product provides ease and speed, but with a banker behind it.

Beyond the persona l connec tion, O’Malley says the bank model’s efficiency surpasses fintech players’. Banks’ funding approaches and their established customer bases and connections simply work less expensively than do marketplace lenders’, O’Malley continues. “We charge less than 10% for even the riskiest business borrowers that we approve today,” he says.

“I think marketplace lenders w ill serve the riskiest businesses,” O’Malley

continues. “Some businesses you need to charge 30%, 40% if you want to be able to make a return on that segment. That’s not what banks do.”

O’Malley says that the perception that efforts coming out of Eastern Labs and similar groups will replace humans in banking is based on a misconception.

“For sure,” he says, “specific functions done by people now can be automated, absolutely. But does that mean we need fewer people? I don’t think so.”

“You would never be a surgeon today— not a good surgeon—if you chose to not use robot-assisted techniques, right?” says O’Malley. “We’re building technology to assist bankers in doing their jobs faster and better than they ever have been able to do them before. But bankers aren’t going away. The back office isn’t even going away. But the nature of the banker’s job is transforming.”

This article is based on a Q&A you’ll find on www.bankingexchange.com.

Shutterstock/musicman

arlier this year, Eastern Labs, part of $9.9 billion-assets Eastern Bank, introduced an online lending platform called Express Business Loan (for more about Eastern Bank, see cover story, p. 16). The new product—initially rolled out to existing customers to enable them to apply for up to $100,000 in working capital loans in less than five minutes—earned Eastern top honors as “Model Bank of the Year” from Celent. Currently, a major project of the Labs is building out the rest of the Express Business Loan product. Already, it has begun making the platform available to new customers, and a version for credit lines is in development. In addition, the Labs is working on putting the technology behind Express Business Loan into the hands, literally, of its bankers.

“If our bankers can walk around every day with a way to take a loan application out of their pocket in five minutes, that’s really exciting,” says Dan O’Malley, Eastern’s executive vice-president and chief digital officer. “That’s transformative for the industry.”

Bankers need to get out of the branch and into the community more and more, O’Malley explains. “That’s what customers want them to be able to do. They don’t have the technology to do that yet. It’s going to take us a few months of focus to get that rolled out right.” Other organizations have put loan applications on laptops for bankers in the field. What Eastern will be doing is bringing the application to the customer plus the analysis that will produce an answer on the spot—a leap of technology.

At a time when some nonbank marketplace lenders have been stumbling, you might expect Eastern to take Express Business Loan national—introduce a bank-backed online lender. This would seem a natural competitive move.

But that ’s not Ea ster n’s strateg y.

O’Malley says that the bank does plan to license its technology to other banks.

He points out that Eastern does business in two states, leaving 48 where licensing can happen. Many inquiries have already

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