In our years of working with commercial banks, we’ve come across dozens of successful strategies. One common element they all seem to share is the focus on “relationships.” Read the commercial section of just about any financial institution’s website, and you’ll find strikingly similar language.
The marketing copy is universal because it works. Commercial customers like the idea of having a trusted advisor and being treated more like a business partner than just a series of independent transactions. While the messaging is spot on, unfortunately it often ends up being an empty platitude.
But what, exactly, is relationship banking? Ask 10 bankers and you’ll likely get 10 different answers. And that, for something clearly so fundamental to the business, is a problem.
For a bank to have a clear path to profitability and high performance, you need a clear definition of what it means to be a relationship bank. You need organizational alignment on what constitutes a good relationship, a bad relationship, and how to attract the right relationships and improve them over time. Relationships are a collection of transactions and accounts that take years to accumulate, so a bank must be purposeful and intentional about its strategy.
What does relationship banking look like in reality? To find out, we’ve turned to the data. Over the next few weeks, we’ll take a deep dive into the relationship data of some real (but anonymous) banks. We’ll see which relationships deliver significant returns, where money is being lost, and what these banks can do to improve their long-term performance. Along the way we expect to find some very different strategies, but also a few universal truths.
The Story of Deadweight Bank
We’ll start first with a look at a traditional regional bank with just over $20 billion in total assets. We’ll call it Deadweight Bank, for reasons which will soon become apparent. It has a CRE focus and has had steady, unspectacular results over the last decade. They currently sit squarely in the middle of their peer group, trying to counter declining NIM by adding non-interest income and improving efficiency. They have reduced both branches and headcount by more than 10% since 2016.
Top? Heavy. Bottom? Also Heavy
We’ll start by plotting the profitability of the bank’s nearly 25,000 commercial customer relationships, from most profitable to least profitable.
A few things stand out about this view. First, the relationships in the tails are driving nearly all the results, both good and bad. The “typical” Deadweight Bank customer is, from a financial standpoint, largely irrelevant.
This phenomenon is not unique to Deadweight Bank, but it’s particularly pronounced here. The top 25 customers, just 0.1% of the total, make up more than 15% of total portfolio profits. In fact, the top quartile of customers by profitability makes up 117% of profits. Meanwhile, the bottom 75% collectively lose money, and a full 46% of ALL the bank’s relationships are unprofitable!
What gives? A closer look reveals a far different profile for Deadweight Bank’s top customers. The average customer has 3 accounts with the bank, but the top 25 average 164 accounts each. The key: many of those accounts are for fee-generating products. The top 25 have 23% of their profits come from non-interest income compared to just 6% for the entire portfolio.
When viewed by profitability quartiles (we sorted all the relationships by annual profits, and divided them into 4 buckets), the top quartile generates 91% of the commercial bank’s total fees.
Balances
Deadweight Bank’s branch network is necessary to bring in retail deposits that fund the commercial loan portfolio. The commercial book is far from self-funding. Deadweight Bank’s commercial loan/deposit ratio – 195% – is the highest of the banks we reviewed. That issue is even more exacerbated at the top end. The average loan balance for the top 25 customers is $42.8 million; the average deposit balance is just $7.5 million.
Deadweight Bank generates 65% of their commercial portfolio profits from lending. But that high level of focus on commercial loans hasn’t led to a corresponding high level of performance. Deadweight Bank generates a 0.68% return on their average loan balances, the lowest among the banks we studied.
That metric is even worse for their top 25 customers. Even though those customers make up 11% of total loan balances, they only generate 4% of total profits, and that is with the massive outperformance in fees. They only generate a 0.22% return on those loan balances, again the lowest in our sample. The rest of their top quartile performs relatively well on loan profitability.
For all the other banks in our sample, their top 25 customers actually have a higher ROA than the average portfolio, showing you don’t have to give away credit to generate healthy deposit and fee business.
RMs
Usually when we see a customer profitability makeup that’s so top heavy, it’s reflected in the production by Relationship Managers (RMs). Curiously, that is not the case for Deadweight Bank. The bank certainly has a couple of big producers, but the load is spread more evenly than we see in most banks.
But while there top RMs aren’t carrying an outsized load, the RMs on the low end are acting like an outsized anchor. About 50 RMs are likely not covering their own salaries, much less any overhead allocation to their portfolios. And the bottom four RMs are digging an especially deep hole – the 3,000 relationships they service collectively lose just over $630,000.
Prescription
In a nutshell: Deadweight Bank doesn’t cross sell enough deposits and fee products to their loan customers, and they are carrying far too many unprofitable relationships. Here are our proposed solutions. They won’t be easy, but we think their impact on profitability makes them worth the effort.
Add Steps for Collecting on Promised Cross Sell
First and foremost, Deadweight Bank needs to stop the bleeding on the bottom half of the portfolio. While most banks have some anchors at the bottom (generally with credit problems), Deadweight Bank also has an unwieldy middle group of clients that generate a ton of effort but lose small amounts of money (11,000 relationships lose $10k or less). Many of these deals were likely approved with the assumption the loan-only relationships would become more profitable over time through cross selling. That’s clearly not happening, so the bank needs to add meaningful accountability for RMs who are booking unprofitable loans.
All deals with profits under a threshold would require special executive approval, with a clear path evident to an acceptable profit level. A series of follow-ups would be put in place to test against that plan. For example, promised deposit balances should arrive within 90 days, and promised fee business should arrive within 180 days. Compensation tied to those deals could be held until cross sell materializes.
Add Rigor to Renewals
With so many unprofitable deals already on the books, Deadweight Bank needs to do more than just clean up their origination process. They also need to pay more attention to renewals.
Any unprofitable relationship with a renewal should face the same rigor as a new credit; it must either reach a profitability threshold under improved terms or have a clearly defined path to profitability via cross sell. And that cross sell should then tracked over the following months to ensure it arrives as promised.
Essentially, Deadweight Bank needs to institute an “up or out” profitability strategy for a big chunk of its portfolio. This will result in some lost relationships and declining loan balances. While this will create some temporary pain in the form of excess liquidity for the bank, the improved discipline will help Deadweight Bank ensure they are lending profitably. And that will enable them to make better strategic decisions about the retail branch network.
Create a Training and Performance Improvement Plan for Bottom 50 RMs
Finally, while most banks’ performance is dictated by their top RMs, Deadweight Bank has a balanced team of RMs producing steady results. Their issue is the ~50 RMs who are not producing a positive return.
They are managing more than 8,700 relationships, so they can’t simply be trimmed. However, the count could certainly be consolidated. Deadweight Bank will need to be tough with these RMs, and like their bottom relationships, create an “up or out” plan for each of them. This will likely involve some training programs as well as some accountability to the new approval standards. Any RMs who cannot meet expectations on those issues within the next year are likely not cut out to be successful commercial RMs. Deadweight Bank should either part ways with them or find them new roles where they can succeed.
See Anything Familiar?
Chances are you may have seen a little of your bank in the story we just told. If not, you’ll likely come across an issue that hits close to home at some point in our series.
If you’re looking to make some improvements on the relationship profitability front (and really what bank isn’t?) we can help. Just click on the banner below to get a walkthrough of the PrecisionLender platform and how it can help you solve your most pressing profitability problems.
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