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Overcoming the Demographic Disadvantages of Community Banking (jan 2012)

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Community banks are at a disadvantage in terms of customer relationship expansion, mostly because the community bank customer base has less income and future earnings potential. The affluence gap ...

Community banks are at a disadvantage in terms of customer relationship expansion, mostly because the community bank customer base has less income and future earnings potential. The affluence gap between the community bank customer and the average bank customer results in community bank customers holding lower-than-average investable assets and loans overall, with correspondingly less opportunity. This article examines the degree to which customer demographics and geographic location influence both the composition and the financial behaviors of community bank customers and points out where community banks are really missing out.

By Paul McAdam
SVP, Research & Thought Leadership
Fidelity National Information Services

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    Overcoming the Demographic Disadvantages of Community Banking (jan 2012) Overcoming the Demographic Disadvantages of Community Banking (jan 2012) Document Transcript

    • Research NoteOvercoming the DemographicDisadvantages of Community BankingBy Paul McAdamSenior Vice President, Research & Thought LeadershipJanuary 2012In my September 2011 article, I talked about how community banks are at a disadvantage in terms ofcustomer relationship expansion mostly because the community bank customer base has less incomeand future earnings potential. This month’s article continues that analysis and examines the influenceof customer demographics and geographic location on both the composition and the financialbehaviors of community bank customers. All analysis cited in this article was generated from primaryresearch of 3,345 consumers conducted by FIS Enterprise Strategy in August 2011.The affluence gap between the community bank customer and the average bank customer results incommunity bank customers holding lower-than-average investable assets and loans overall, withcorrespondingly less opportunity. This means that the community bank has to capture greater sharesof available financial resources to compensate for the thinness of their customers’ wallets. Communitybanks do a good job of getting their fair share of available deposits, but they still fall short of theaverage deposit amount because their customers have fewer assets. On the loan side, communitybanks get less than their fair share of loans and fall even shorter of the average loan amount.While geography has a significant influence on the composition of community bank customers, itwould be wrong to assume that community bank customers are purely “small town folks.” Overall,community bank customers are more likely to live in a large city than a small town. Among allconsumers who identify a community bank as their primary DDA provider: ©2012 FIS and/or its subsidiaries. All Rights Reserved.
    •  29% live in rural areas or small towns (defined as fewer than 50,000 residents);  34% are in small metro areas (between 50,000 and 500,000 residents);  37% live in mid-sized to large metro areas (more than 500,000 residents).However, less than 10 percent of U.S. consumers live in rural/small towns while nearly two-thirds livein towns with more than 500,000 residents, so there are striking differences in the concentration ofcommunity bank customers between each of these markets (see Figure 1). Within rural/small towns,consumers are three times more likely to identify a community bank as their primary DDA provider(index = 319). In small metro areas, consumers are about one-third more likely to bank with acommunity bank (index = 136), while in mid-sized/large metro areas consumers are about half as likelyto identify a community bank as their primary DDA provider (index = 56). Of course, demographic andcompetitive dynamics significantly influence these concentrations as rural and smaller markets tend tohave older residents on average and a lower concentration of large national banks. The opposite istrue in big cities. Figure 1: Community bank customers are significantly more concentrated within rural and smaller towns Concentration of community bank customers by market (average = 100) 350 319* 300 250 200 150 136 National 100 Average = 100 56 50 0 Rural / Small metro Mid-size / small town large metro * Read as: Within rural and small towns consumers are 3 times more likely to bank with a community bank (index = 319). Source: FIS Enterprise Strategy, August 2011; n = 3,345 ©2012 FIS and/or its subsidiaries. All Rights Reserved.
    • Community bank customers, as a whole, have a number of demographic characteristics that putcommunity banks at a competitive disadvantage in retail banking long term. Community bankcustomers are: 1) Older; 2) Less likely to be employed (i.e., a higher portion are retired); 3) Have less education.As a result, they have less household income despite the fact they are more likely to be married,thereby providing two potential sources of income. Nearly two-thirds (65%) of community bankcustomers are married regardless of where they live — far more than the national average.So what happens when we examine community bank customers who live in rural and small townsversus those who live in big cities? Most key demographics that drive income and future earningspotential don’t shift:  Community bank customers are just as likely to be retired or unemployed regardless of where they live.  They also are just as likely to be older, which can be a positive for investment and deposit- related revenue but not for loans.  Community bank customers are just as likely to have less education regardless of where they live. Even in big cities (where the population as a whole tends to have a higher level of education), the portion of community bank customers with only high school or less education is above the norm (by 24%) while those with a college degree or higher is below the norm (by 8%).A troubling pattern emerges when we examine the average incomes of community bank customerswho live in small towns versus those who live in big cities (see Figure 2). As one would anticipate, theaverage annual household income of banking consumers’ increases with the size of the metro area.But unfortunately for community banks, the incomes of their customers fall significantly short in largermarkets.  In rural and small towns, the average incomes of community bank customers and all other bank customers are statistically equivalent. ©2012 FIS and/or its subsidiaries. All Rights Reserved.
    •  In small metro areas, community bank customers have average annual income 12% lower than that of all other banking customers.  In mid-sized and large metro areas, community bank customers have average annual income 13% lower than that of all other banking customers. Figure 2: The average income of community bank customers falls short in larger markets Average annual income of DDA households by market $65,782 $57,353 $54,110 $48,003* $47,846* $47,400 Rural / Small metro Mid-sized / Small town large metro Consumers w/ primary DDA at a community bank Consumers w/ primary DDA at another type of FI * Read as: Within rural and small towns, consumers who maintain their primary DDA relationship with a community bank reported average annual household income of $48,003. Within this same market, consumers who maintain their primary DDA relationship with all other types of banking providers reported income of $47,846. Source: FIS Enterprise Strategy, August 2011; n = 3,345The pattern of community bank customers having lower income and earnings potential results in themowning investable asset balances (deposits and non-IRA investments) 12% lower than the nationalnorm. As demonstrated in Figure 3, consumers who hold their primary DDA relationship with acommunity bank have lower incidence of deposit and investment product ownership with theirprimary bank in all products but CDs. ©2012 FIS and/or its subsidiaries. All Rights Reserved.
    • Figure 3: Community banks are missing out on investment and consumer lending opportunities Percent of consumers owning accounts with their primary DDA provider (among consumers who own each type of account) 86%* 84%* 67% 60% 60% 55% 47% 44% 40% 30% 24% 25% 24% 21% 21% 23% 11% 11% Savings Money CD Non-IRA IRA invest. Credit card First Home Auto loan Market invest. (revolving) mortgage equity loan Consumers w/ primary DDA at a community bank Consumers w/ primary DDA at another type of FI * Read as: Among consumers who maintain their primary DDA relationship with a community bank , 84% reported owning a savings account with the primary DDA provider. Among consumers who maintain their primary DDA relationship with any other type of banking providers, 86% reported owning a savings account with the provider. Source: FIS Enterprise Strategy, August 2011; n = 3,345Despite these disadvantages, community banks do an admirable job of capturing their customers’available deposit balances. For some deposit products, community bank customers — especially thosein rural areas and small towns — show a higher-than-average propensity to consolidate their assetswith their primary DDA provider. And on an overall basis, community banks capture 74% of thedeposit balances available from their primary DDA customers, compared to a norm of 70% for all otherfinancial institutions.But clearly there’s an opportunity for community banks to do a better job of cross-selling to existingcustomers. “Investment-oriented” services (money market and non-IRA investment accounts) arespecific opportunities (see Figure 3). Community banks capture money market relationships with only44% of primary DDA customers versus a cross-sell rate of 60% achieved by all other financialinstitutions. Similarly, community banks capture a non-IRA investment relationship with 11% ofprimary DDA customers compared to 21% for all other financial institutions.On the loan side of the ledger, the combination of a customer base that is older with lower earningspotential contributes to community banks capturing total loan balances from their primary DDAcustomers that are 10% below the national norm. As demonstrated in Figure 3, the percentages of ©2012 FIS and/or its subsidiaries. All Rights Reserved.
    • community bank customers holding first mortgages and auto loans with their primary DDA provider isroughly the same as that of other financial institutions. But the percentage of community bankcustomers with primary DDA-provider credit cards and home equity loans is significantly below thepenetration achieved by other financial institutions. While closing the cross-sell gap in home equitylending probably isn’t feasible or advisable in the near-term given the real estate market crash,community banks are missing opportunities with their current customer base in the form of revolvingcredit card programs.Many community banks have exited the consumer credit card-issuing business over the past coupledecades, but some are reconsidering it in the advent of Durbin debit interchange regulation.Regardless of an institution’s legacy view of credit cards, our research suggests that community banksshould look beyond the economics of credit cards as a standalone offering and consider the value thata “primary” credit card relationship can bring to overall customer relationship profitability (see Figure4). Consumers who designate their community bank as the “primary” DDA and credit card providergenerate profitability, deposit and loan balances that are 3.5 – 4 times higher than customers whomaintain their primary DDA with a community bank but hold their primary credit card relationship withanother financial institution. Figure 4: Obtaining status as the primary DDA and credit card provider yields a tremendous profitability advantage Community bank customers who… Have primary DDA Have primary DDA with the and credit card with community bank the community but primary credit bank card with another provider Number of deposit and loan products held with primary 3.2 1.8 DDA provider Annual customer profitability to primary DDA provider $1,115 $267 Deposits balances held with primary DDA provider $32,849 $8,056 Deposit wallet share captured by primary DDA provider 92% 79% Loan balances held with primary DDA provider $40,324 $11,269 Loan wallet share captured by primary DDA provider 57% 12% * Read as: Consumers who maintain their primary DDA and credit card relationship with a community bank hold 3.2 products with the provider. Consumers who maintain their primary DDA relationship with a community bank but their primary credit card relationship with another provider hold 1.8 products with the primary DDA provider. Source: FIS Enterprise Strategy, August 2011; n = 274 ©2012 FIS and/or its subsidiaries. All Rights Reserved.
    • In summary, community banks do have a disadvantage inherent in the demographics of their customerbases. Community banks in rural areas and small towns are holding their own and competing well,however. They capture strong retail consumer market share and those consumers are more likely toconsolidate with the community bank. Stagnant or declining underlying market growth is a keyproblem faced by many of these banks. Community banks that compete in small-to-large metromarkets also have disproportionately older and less educated customers and they face the addedchallenge of customer bases with household incomes 12 to 13 percent below market norms.Regardless of the size of market served, the research suggests that community banks should stronglyconsider strategies to: 1. Attract new and younger DDA customers with desirable characteristics; 2. Cross-sell to deepen relationships with existing customers — particularly in investment- oriented products and credit card programs.To be fair, there are certainly a number of community banks in both rural and urban markets thatoutperform their larger bank brethren in cross-sales and other relationship expansion metrics. It’s alsothe case that some community banks don’t place a primary strategic emphasis on retail banking andfocus instead on middle-market and small business — and also compete very effectively with largerbanks.But taken as a whole, our research reveals an urgent strategic priority for the community bankingindustry. Given the current anti-big-bank climate, the timing for such initiatives is right.I will continue to explore this topic of community bank competitiveness in future newsletter editions.In the meantime, feel free to contact me at paul.mcadam@fisglobal.com with your questions orcomments. ©2012 FIS and/or its subsidiaries. All Rights Reserved.