According to the Community Association Institute, approximately 21% of Americans live in common-interest communities. For banks, particularly those that are in FL, CA, TX, IL, NC, NY, MA and GA (in order) on a client acquisition-cost-to-cumulative-lifetime-value basis they are one of the best clients to have. The reason for this is that they are plentiful (over 342k of them in the U.S.) they have high deposit balances, and they generate large fees with their lock box activity. However, while homeowners associations are one of the most profitable customers a bank can have, they are not in the top 10. In this article, we look at ten industries that are more profitable when directly compared.
Beyond Deposit Balances
One of our most popular articles of the year (HERE), looked at the top 15 industries that we had the data on based on deposit balances. As we are big fans of segmenting a bank’s customer base for customer experience and marketing efficiency purposes, our goal was to highlight those industries that had larger than average deposit balances in order to help banks grow deposits as efficiently as possible.
As many readers pointed out, we didn’t tell the whole story, which was true. For starters, many thought our deposit balance data was too low. One flaw in our analysis was that we just looked at average account holdings and not just accounts that had their primary operating account at the bank. In other words, if you were a private school and you had a DDA account at the bank to save for a building project, we counted it. In retrospect, it would have been better to just focus on accounts where we had their primary checking.
Another flaw in our analysis was that we didn’t look at fees. For some accounts, this could make a huge difference and with many banks trying to drive more fee income in 2019, knowing what accounts generate what level of fees can be invaluable.
Focusing on Lock Box Profitability
To make our life easier, we looked at primary checking and savings accounts for accounts that had lock box with the logic that this would be one of the best indicators of a primary operating account. Lock box, or the imaging and processing of paper checks and electronic payments, is one of the most profitable products a bank can have not only because it brings in deposits AND fees, but does so with some of the highest positive convexity of any account in banking. This is to say, that when rates go up, banks tend to generate more balances and more fees from lock box accounts than any other product in the bank. The net result is more franchise value for the bank in a rising rate environment. We won’t go into the product as we have already done so (HERE), but it is one of our favorite treasury management products.
When it comes to homeowners associations, the only problem is that they are so plentiful that many of them tend to be smaller in size plus since rent and association payments tend to be larger (over $500) homeowners associations don’t get the sheer volume that a municipal utility or collection agency would.
The Data and Methodology
To take another look at both deposit profitability and lock box, we used our data, our profitability model and combined that with data from Vertical IQ and RMA to get a comprehensive look at multiple industries. Below we ranked ten industries, based on the cumulative lifetime value of deposits alone (no credit or payment products) and show average monthly balances and fees. As can be seen, both private and municipal utilities rank as the most profitable clients a bank can have on this basis followed by collection agencies, hospitals, alcohol distributors, and private schools.
Below is the ranking of cumulative lifetime value based on discounting monthly cash flows back using the swaps curve as the maximum value point. That is to say, any deposit account whose interest expense, maintenance cost, amortize acquisition cost and risk was equal to the period’s swaps rate would generate zero value and anything under that would generate positive value.
In the future, we look to add other products such as debit, merchant services, and MMDAs, but this is a good second cut and should help banks be directionally correct. We also quickly point out that, like our past analysis, this data isn’t meant to be all-encompassing as we only included the more popular community bank industries and only industries that we had the data.
Putting This Into Action
As you plan out next year, consider these industry segments where your bank may want to focus more marketing and risk dollars than average to gain a superior return. This isn’t the only way to raise deposits and fees, but we have found it to be one of the best. Hopefully, this analysis will both save you analytical time and get you thinking about other customer segments that fit a similar profile as those industries above.
Many banks consider paying a high-interest rate to attract more deposits which is one of the least effective tools a bank can leverage if the goal is to create long-term franchise value. Any bank can get a rate-sensitive customer, almost instantaneously, by paying a high rate. Building long-term franchise value takes strategy, a focused sales effort, having the right products and of course, hard work.
Submitted by Chris Nichols on December 03, 2018