“An Internet-only bank will never challenge the traditional bank institution that we have come to know.”
–Paul Jamieson, Gomez Advisors
“It has been proven pretty definitively that, as a free-standing distribution network, there is not a lot of attraction [to Internet-only banks].”
–Nancy Bush, Prudential Securities
“It ain’t over ’til it’s over.”
–Fast Eddie Clarke
I can’t tell you how many bankers I’ve spoken with recently who are as giddy as school girls now that the branchless bank threat is finally over. They read the prognosticators’ quotes, the headlines of Wingspan, G&L Bank and other Internet-only failures, and they swell with pride, knowing that their traditional, brick and mortar model is the only one that can survive. They truly want to believe that Internet-only banks are managed by 24-year-old hacks who underestimate banking’s complexity and spend their time playing Nerf basketball and video games in the company game room.
But not so fast, Chachi. A recent American Banker article caught my eye. It was about State Farm Bank, an Internet-only bank owned by the insurance giant. This is a bank that has grown to more than $1.8 billion in assets since it opened in 1999. This is a branchless bank that, while not yet profitable, registered a 3.03% net interest margin at year-end 2001 – compared to the 3.29% of its thrift peers. Not bad for a start-up CD shop. For several reasons, State Farm and other niched, Internet-only players with skilled, established sales organizations and monstrous customer bases have a real shot at making some noise in the long run.
First, they have some home-grown advantages that allow them to avoid the common pitfalls encountered by many Internet-only banks. (I’ll use State Farm as an example because it is representative of the branchless competitors that stand a chance of winning some battles with the branched establishment.)
Internet-only banks have traditionally struggled to create brand awareness and a customer base large enough to generate the volumes necessary to make money in a low margin business. On the other hand, EVERYONE has heard of State Farm; it has millions of established customers with more than 69 million policies in effect; and State Farm has a sales force of more than 16,000 sales reps to whisper the company name in your ear in case you have forgotten it.
Internet-onlies have had mixed success developing respectable loan portfolios. Many of the branchless banks are forced to buy loan packages and load up on securities, consequently squeezing an already tight net interest margin. Typically, there is no compelling reason for someone to go to a branchless bank for a loan, and it frankly is a hassle to take care of the closing logistics, particularly for a mortgage loan, with an Internet bank. But State Farm lends on what it insures – cars and homes. Auto loans and residential mortgages comprise roughly $875 million of the bank’s $905 million loan portfolio. And it is 102% loaned out – compared to 96% for its traditional thrift peers. And as for loan closing logistics, let’s remember those 16,000 agents in 48 states who understand auto and home loans because they have helped their insurance customers with them for years.
A common knock on branchless banks is that customers typically have very limited ways to make deposits and withdraw cash. Agreed. This is also true for State Farm Bank and those like it, but it is a fairly low speed bump due to their deposit mix. State Farm is primarily a CD shop, so it has relatively little need for ATM access. And snail mail, wires and ACH work just fine to fund a CD account. State Farm pays for it in its margin, but its margin only trails that of its traditional thrift peers by 26 basis points.
Bankers love to point out that branchless banks only attract rate shoppers and otherwise transient (read: unprofitable) customers. Not so with the State Farm Banks of the world. Roughly 95% of State Farm’s banking customers come from its insurance client base. This is a sticky client base with deep ties to the State Farm organization.
Too many Internet-only banks (and traditional banks, for that matter) are trying to execute the All Things to All People Strategy. But State Farm is not even pretending to be a mime in that ludicrous charade. It knows about cars and houses, and that is the focus of its lending efforts. Divine simplicity. Want a crop loan or a working capital line? Well, you are probably better off going elsewhere. State Farm will give you a good rate on a CD, but you are welcome to take your 50-transaction-per-month checking account to Bank One.
These are the ways State Farm is bucking the system and avoiding the common landmines of branchless banking. These factors alone should summon a double take from the traditional bank managers who are patting themselves on the back over slaying the Internet-only dragon. But ho-ho, GonzoMongers, there’s more.
The most undeniable reason that State Farm Bank (and other insurance and brokerage companies’ banks) could become a, uh, fly in the punchbowl at traditional banks’ annual meetings is its sales force – 16,000 agents. Sixteen-freakin’-thousand people getting paid to sell State Farm insurance and banking products!! They are cufflink-wearing, toothy smile-flashing, firm handshake-offering salespeople – and proud of it, thank you very much. They do not even try to hide under fancy titles or in any way feel belittled because their job is to SELL. They are positively myopic on sales, feed their families solely on their ability to sell, and are utterly indifferent to any stigma attached to being a sales rep. They are, compared to most bank branch personnel and loan officers, highly paid and the heroes of their companies.
Now compare that to their bank competition. Many CEOs and retail heads would love to brag of having a world class sales organization, especially those who have sipped the Cohen Brown Kool-Aid. But precious few would look you in the eye and say that they have arrived. Bank executives are running into too many organizational and political brick walls built by hundreds of years of the banking system. What happens the first time a commercial lender’s salary is higher than the chief lending officer’s, much less the CEO’s? If a branch grows DDAs by $15 million in a year, would they pay the branch manager 10% of the marginal profit? Doubtful.
You have to squint to be able to see the sales-based salary at risk for most bank lenders and new accounts reps, and they bend over backwards to avoid admitting that they, God forbid, sell things for a living. The truth is that most bankers cannot get past the Salesman Stigma and just get on with selling. Employees who sell loans are Loan Officers or Rocket Scientists and shudder at the thought of being considered a lowly salesman. And in the branches, we have Customer Service Representatives, Product Consultants, Financial Counselors, etc. Deep breaths, guys, it is OK to be a salesperson.
That said, I agree with many that 99% of start-up Internet-only banks do not have much of a chance. It is simply too difficult to develop brand awareness and generate the volumes of customers needed to become profitable in branchless banking’s low margin arena.
But think about the insurers and brokerage houses starting banks. They have a simple, executable strategy, brand awareness to spare, and built-in lending avenues. The sheer volume of trained, well-paid, professional sales agents at these companies should make traditional bankers at least break into a cool sweat. They are not going to put traditional banks out of business or take over the marketplace, but they are definitely poised to teach us a thing or two about doing things differently.
That’s all the smack I can spare for now, Fair Readers. I got myself all riled up there for a minute, and now I have to go make a Prospective Client Acquisition call.