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February 8, 2010 by Eric Weikart Eric Weikart

High Yield Checking … Gonzo Style

**VISIT YOUR LOCAL GONZO COMMUNITY BANK AND
EARN 6% INTEREST**

020810-1GIT-R-DONE High Yield Checking

Pays a 6% rate on balances up to $50,000,
goes down to 1% after that

To qualify, you need:

  • 20 debit card transactions per month
  • Sign up and receive e-statements instead of paper statements
  • Direct deposit of more than $500 per month

*There is a $5.00 per call/branch visit charge if customer has the ability to use an electronic channel.

– – – – – – – – – – — – – – – – – – – – –

Does this fictional product example look familiar? The world of retail checking products is going through boatloads of change these days. The traditional free checking account is dying, and banks are looking to new relationship-based structures as a profitable replacement. In the midst of this change, “high yield” checking products have taken the industry by storm, and importantly, many banks have tended to either over-glorify or mismanage this new product strategy.

A bit of history…

It appears that the first “high yield” checking account can be traced back to April 2000 when City National Bank, based in Taylor, offered the NetAdvantage account to leverage its investment in electronic banking and to compete with the larger banks beginning to invade from Austin. The premise, albeit simple, was unique: Offer a product that would help retain customers via a high rate and “sticky” products while pushing them into less costly electronic channels and generate revenue through more interchange. Kudos to City National for thinking outside the box in a time where many bankers were complacent.

020810-2The Vendor Market

It is definitely worth noting that it was a couple of Austinite techies (hook’em horns) that helped City National with the rollout. These guys were the pioneers in getting the technology built behind the scenes. They later joined with BancVue, which still services City National today. In 2005, BancVue launched REWARDChecking, a nationwide product that now has around 600 banks and credit unions signed up. BancVue does more than just provide the technology to qualify and update interest rates. Where it shines is in the area banks and credit unions need it most, on the data side, which is key when analyzing high yield product profitability because there are so many moving parts. BancVue takes disparate, non-integrated systems and combines the data in its proprietary warehouse to provide a full picture of the customer’s activity. BancVue guarantees profitability … although, as always, be careful with the fine print and understand the variables and assumptions before signing on the dotted line.

Today, while BancVue is still the predominant player, others are showing up to get a piece of the action. Most notable are the core vendors that have come to the plate touting integration and an overall cheaper solution (some are including it as part of their base fee). While it has taken them a few years to get up to speed, look for the core providers to become the preferred system long term to analyze qualifications and automatically update interest rates.

020810-3My “Git-R-Done” checking product above is a good example of criteria that may be too complicated to track. For instance, the $5.00 charge for calling the call center or visiting the branch will be pretty tough to enforce. Also, even something as simple as putting a dollar limit on direct deposit and not allowing a non-payroll ACH as a qualifying transaction can cause all kinds of challenges in the back office. So, obviously banks need to think through their tracking capabilities as they develop product criteria.

The Profitability Debate is Real, GonzoBankers!

A major debate has been spurred in our industry around the question, “Are high-yield checking products profitable?” While this debate with the VPs of finance and marketing will continue to play out in the board room, here’s the bottom line for Gonzo readers. Banks that declare “success” from high yield checking products simply because they have opened a high number of these accounts just don’t get it. Analyzing this “blue-light special” type of product requires that banks carefully monitor this strategy in four key areas:

  1. The value (or cost) of deposits generated based upon the bank’s balance sheet position
  2. The marginal lift in account growth
  3. The marginal lift in fee income
  4. The marginal lift in relationship cross-sell

Let’s review each of these components that ultimately drive or destroy value with high yield products.

1: The Value (or Cost) of Funds Raised

With eye-popping rates on these checking accounts, the first and obvious factor to consider is interest rate expense. To minimize cost of funds, most financial institutions are capping their teaser rate, which can actually make quite a difference. Also, in practice, there are many accounts that don’t meet the qualification criteria; therefore, the actual cost of funds will be lower than the offered rate – sometimes in the magnitude of 50%+ less. So, for someone offering a 4% high yield checking account, it is possible that actual cost of funds will be less than 2% depending on those customers who “think” they will live by the rules when the account is opened, but fail to meet the criteria. This blended cost of funds based upon teaser rate caps and disqualifying factors is an important data point that should be reported to management regularly. Recently, the value of deposit balances in these high yield checking products has declined. One need only look at the Fed Funds chart below and the highly liquid balance sheet positions of many community banks and credit unions to know that balance growth in these products is not a high priority today.

 020808-5

 Source: Federal Reserve Bank

Back in 2007, 4%-5% (and maybe even 6%) high yield checking accounts were plausible given the Fed Funds rate. However, as rates have dropped, the relative cost to financial institutions offering these high rates has skyrocketed.

Most profitable high yield products in today’s environment offer a maximum of 2.5%-3.5% that is tiered down to <.50% at $15-$20K. The question that banks need to answer is this: “Can we put these funds to use for a lending or investment strategy today?

020810-42: The Marginal Lift in Checking Account Growth

Banks need to show more discipline in terms of how they view account growth with the high yield product. Banks invest lots of money in a branch network, advertising, sales training and incentives. When introducing a high yield product, some banks essentially give credit for all growth in this product to its marginal investment. Instead of declaring instant success, banks need to analyze how overall checking accounts have grown and understand to what degree they have cannibalized more profitable products. Would you rather open 100 traditional checking accounts a month adding $50 per year in profitability or 200 high yield products generating $20 per year?

3: The Lift in Fee Income

In reality, debit card interchange revenue is the revenue driver of these products. While clearly NSF/courtesy pay is a factor, a correlation between the high yield product and other checking accounts needs to be performed, and remember that overdraft revenue is pinching fast now because of regulation. So, for debit interchange, an analysis of transactions is critical to determine the qualification criteria to use. For most, this data is very hard to obtain, let alone understand. A quick read of Michael Croal’s article, Time to Optimize POS Earnings, would be a good first step.

Banks shouldn’t always rely on “industry statistics” when it comes to interchange analysis. Consumer behavior can vary from institution to institution, and some of these “statistics” are stale. Banks need to closely track figures such as:

  • EFT transactions per checking account (break out sig-based POS and PIN-based POS)
  • Average transaction size (break out sig-based POS and PIN-based POS)
  • Average interchange revenue per PIN POS transaction.

Next, banks need to determine whether to include PIN-based POS transactions or just sig-based POS transactions in their product qualification. Keep in mind that interchange assumptions will be different depending on the choice. If a bank chooses to include PIN, each transaction is worth $.30-$.35, whereas sig-based transactions are based upon a percentage of the transaction price … around 1.3%. The industry average purchase is between $35 and $40, which equates to about $.48 per transaction, but each bank’s numbers are different.

As if compressing interchange isn’t enough, banks also need to analyze customer behavior when rolling out a high yield product and closely monitor as the average purchase price begins to drop. At the end of the month, consumers that have not made their transaction quotas and who are paying attention will want to make it up by multiple micro-payment transactions (10 transactions for $1.00 each).

4: The Lift in Relationship Cross-Sell

Finally, we have heard many bankers state that products like “Git-R-Done” are relationship builders and that they attract a profitable segment of the market. While this may be true, the team at Cornerstone  is amazed how little tracking is being done to test this hypothesis. How does the bank know it’s not being gamed by a smart and crafty mass affluent customer? Going forward, banks need to formally track the relationship value of the high yield customers (services per household, profit per household) when compared to the overall retail customer base.

Conclusion

There is no doubt that more and more banks are jumping onto the high yield bandwagon to create some new wins in the retail banking area. However, banks have as yet to demonstrate the product management and profitability discipline necessary to ensure that these product introductions are truly strategic.
-ew

JUMPING ON THAT WAGON?

Banks interested in determining if they have adequate product management and profitability discipline in place to launch a high yield product offering should contact Cornerstone Advisors as Step One.

Cornerstone can provide an objective review of the institution’s strategy and processes to evaluate how competitive the bank could be in this  – or any other – new market.

Visit Cornerstone’s Web site to learn more about us.



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3 Responses to “High Yield Checking … Gonzo Style”

  1. Tom Baldwin says:

    I have seen an example where an institution reported 40 to 50% breakage in a high yield checking account, but it was based on number of accounts. In truth, 80% of the balances were being paid the high rate of interest. There was a low barrier of entry based on balance, but the account holders with the money tend to meet the criteria.

  2. Jean says:

    I rarely see or hear anyone talk about the costs of these accounts from a customer service perspective? If you are counting on a (probably low) breakage rate of 20%, that means 1 in 5 of your customers are not going to get what they are expecting to from you? How many of these customers contact the institution to research and/or request the higher rate?

  3. Dave says:

    These products are destructive. They’re nothing more than a high yield money market account with full transaction features. Over time, the proportion of rate chasers, who are willing to do what it takes to earn the high rate (using their debit card to buy coffee once a day) will increase, and those who don’t qualify will figure it out and switch. This will drive up the blended cost of funds to an untenable level. Like CD teaser rates and “new money only” promotions, they create temporary relevance, and promote mercenary behavior. How many of those customers will stick around when the rate drops? Plus the product is inherently anti-consumer as it relies on a large number of lazy/inattentive users to not qualify for the benefit offered. One can rationalize this as “they know what the rules are”, but I would suggest that any product that depends on large numbers receiving no benefit is fundamentally flawed.

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