Let’s face it, GonzoBankers – we are going to have to learn how to compete with the online monsters. Sadly, in this fight, some of us are shooting blanks. The inconvenient truth is that the price leaders on the Internet are cleaning our clocks, especially when it comes to consumer banking products like checking.
Ally Bank has spent millions building a brand around the concept of eliminating classic banking annoyances. Capital One’s ads, while maybe a little annoying themselves, are also memorable. Both are growing deposits at an impressive rate (see the charts at the end of the article). Is it the branding and advertising cleverness that is doing the trick? I’m not convinced. The leap from seeing the advertising to signing up online and buying the product is a long jump. Without the aggressive pricing, nothing happens. Will advertising increase deposits 20% to 35% a year? No, but aggressive pricing will. That is why our friends at Capital One and Ally Bank are so much of a threat.
Let’s look at the three big online players that are taking consumer market share right now. ING Direct started this whole conversation with a very attractive savings rate on a very plain Jane Web site. Some years later that engine is running out of stream for the lack of revenue producing assets, resulting in pressure to raise capital.
One the other hand, Ally Bank, the skillfully rebranded version of GMAC, and credit card company Capital One are rocking. Both are promoting checking products with slightly higher interest rates, free access to any ATM, and dramatically lower account fees than the rest of us. Throw in USAA, which continues to grow nicely within its affinity niche, and it’s enough to make you wonder – is our business model going to have to change dramatically over the next five to 10 years? The research would indicate yes. Every shred of research I have seen in the last two years indicates that the two main drivers of consumer banking choice are price and convenience. The younger banking generation does not seem to need the personal contact the rest of us do and defines convenience in terms of the Internet and smart phone. So price and convenience make up the winning combo. However, price can succeed on its own merit; convenience, in my opinion, cannot. This has not changed in the 35 years I have been working with financial institutions.
Obviously, each one of these large competitors is different. Capital One is a credit card company, as we can see from its margin. Ally Bank is an auto lender with a very low charge-off rate and very little in operating costs, because its loan originators primarily work for someone else. Both have looked to the capital markets for funding until recently and both continue to be heavily leveraged. But the point is they are taking deposits through smart pricing and fee offers.
So how do we compete in this consumer space?
- Accept that fact that price is critical. Good luck to the bank telling itself that overall value, based on a combination of price, convenience and service quality is the goal. We now know that up to 22% of the youngest banking segment is using an Internet-only banking solution – based on the higher level of rates paid on deposits, ultra-low checking related fees, including very cheap NFS fees, and no-cost access to all ATMs. We also know preferential CD rates and bump-up options work to take higher cost deposits. This trend is not going to change as the economy gets better. U.S. consumers have been materially changed by the current prolonged economic malaise. With a national savings rate stabilizing above 5%, the rate of return on savings deposits will remain critical to customers.
- Accept that imbedded operating costs are too high. Look at the data from banks that maintain operating costs on the low side – they always have more pricing power. Ally Bank is a good example. This means that cost management and process efficiency are going to need more focus in the future. Most of us are supporting branch networks that have been the basis of our growth model. Branches will have to pull their weight, and consistently weak locations will have to be dealt with. Organizational structures may need to be flattened. Line of business managers will need to be held accountable for efficient operations. Lending and back-office workflows, task analysis and capacity modeling will need to be developed and refined to optimize staffing. Accurate product profitability will need to be clearly understood, as well as what product combinations offer enough profitability to support better pricing from the customer perspective. MCIF models that estimate product profitability based on theoretical transfer pricing models and averaged functional costs may not be up to the task.
Contract management, especially renewal pricing, will need to get brutal. It not only includes core banking and online banking software but also all ATM and EFT network affiliations and card transaction processors. - Accept the shift to the online channel. Begin the service model migration to the younger demographic now. By the year 2020, Generation Y will comprise 40% of the entire customer population. This means a migration away from the large branch networks of the past toward the online banking/smart phone driven delivery model of the future. We all know that we have to provide a robust online experience. But where we are continuing to hold back is in the account opening and online lending areas. We need to be able to add new customers, checking accounts, and loans with automated approval and e-signature funding online. Our older customers may be willing to continue to come to a branch for loan closure. Our younger customers will not. This does not mean that branches are obsolete – they will always be needed to support the delivery of commercial and wealth management services – but the future branch footprint will be smaller, with no teller line. In the past several years, Cornerstone has seen a 25% drop in teller transactions per checking account. We believe this trend will continue.
- Understand that marketing is critical to building awareness. Here again Ally Bank and Capital One score. Creativity and message design can gain customer attention long enough to deliver the price punch. However, many of us believe that marketing is about pictures and colors. If your marketing officer still reports at the mid-management level, you might want to rethink that position. In almost every industry outside banking, marketing holds a senior, strategic level position at the table. Accept the reality that good market research, product development and creative services are dollars well spent. This does not mean we can skimp on internal expertise providing good data analysis and targeted cross sales efforts. If we can come to the point where we understand that marketing is a key component in all decision making, we will take the process more seriously, including hiring the right people. This is a stretch for many of us that still see marketing as just promotion.
- Understand that the price is still the trump card in attracting new customers. ING Direct taught us that with the right price and business model, a bank could take significant market share with a Web site that had just words and orange balls. Competitors like Ally and Capital One have added the investment in attention-getting advertising to increase their sales opportunity.
If you have time, take a look at some of the numbers. They’re interesting.
| Ally Bank | |||
|---|---|---|---|
| June 30, 2010 | June 30, 2011 | 12-Month Change | |
| Deposits (000) | $31,887,653 | $38,461,259 | 20.61% |
| Loans (000) | $40,623,244 | $58,233,756 | 44.06% |
| Net Charge Offs | 0.51% | 0.42% | 9 bps |
| Margin | 2.52% | 2.88% | -36 bps |
| Yield of Earning Assets | 4.17% | 4.40% | -23 bps |
| Cost of Funds | 1.65% | 1.52% | 8.5 bps |
| Non-Interest Income | 0.89 | 0.77 | 12 bps. |
| Non-Interest Expense | 1.57 | 1.77 | -20 bps. |
| ROA | 1.35% | 1.22% | 13 bps. |
| Equity Capital (000) | $8,342,590 | $11,922,487 | 42.91% |
| Equity Capital/Assets | 13.52% | 15.40% | 188 bps |
| Capital One Bank | |||
|---|---|---|---|
| June 30, 2010 | June 30, 2011 | 12-Month Change | |
| Deposits (millions) | $27,649,280 | $37,049,718 | 34.00% |
| Loans (millions) | $52,434,705 | $53,386,501 | 23.15% |
| Net Charge Offs | 12.96% | 5.58% | 738 bps |
| Margin | 14.50% | 11.45% | -5 bps |
| Yield of Earning Assets | 17.33% | 13.14% | -491 bps |
| Cost of Funds | 2.83% | 1.69% | -114 bps |
| Non-Interest Income | 5.24% | 3.97% | -127 bps |
| Non-Interest Expense | 7.31% | 7.39% | 8 bps |
| ROA | 3.29% | 3.85% | 56 bps |
| Equity Capital (millions) | $5,817,784 | $7,405,079 | 27.28% |
| Equity Capital/Assets | 8.13% | 10.50% | 237 bps |
| ING Direct Bank | |||
|---|---|---|---|
| June 30, 2010 | June 30, 2011 | 12-Month Change | |
| Deposits (000) | $77,431,828 | $82,106,986 | 6.04% |
| Loans (000) | $39,520,201 | $41,069,154 | 3.93% |
| Net Charge-Offs | 0.57% | 1.06% | -51 bps |
| Margin | 1.75% | 1.86% | 15 bps |
| Yield of Earning Assets | 3.18% | 2.88% | -30 bps |
| Cost of Funds | 1.43% | 1.01% | -42 bps |
| Non-Interest Income | 0.03 | -0.77% | -80 bps |
| Non-Interest Expense | 0.74% | 0.83% | 8 bps |
| ROA | 0.32% | -0.17% | -49 bps |
| Equity Capital (000) | $8,574,304 | $8,899,804 | 3.39% |
| Equity Capital/Assets | 9.52% | 9.74% | 22 bps |
| USAA Bank | |||
|---|---|---|---|
| June 30, 2010 | June 30, 2011 | 12-Month Change | |
| Deposits (000 | $37,296,300 | $43,839,346 | 17.54% |
| Loans (000 | $32,878,571 | $34,699,113 | 5.54% |
| Net Charge Offs | 2.33% | 1.83% | 50 bps |
| Margin | 4.26% | 4.05% | -21 bps |
| Yield of Earning Assets | 5.47% | 4.95% | -52 bps |
| Cost of Funds | 1.20% | 0.90% | -30 bps |
| Non-Interest Income | 3.83% | 3.25% | -58 bps |
| Non-Interest Expense | 4.35% | 4.28% | -7 bps |
| ROA | 1.10% | 1.13% | 3 bps |
| Equity Capital (000) | $3,580,884 | $4,101,706 | 14.64% |
| Equity Capital/Assets | 8.58% | 8.41% | -17 bps |
We can’t expect that competitors like Ally Bank and Capital One will ever go away or be neutralized. As different as they are from each other – it’s my view that they will continue to take market share.
We seriously need to learn how to play at their level.
-TT
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