Strategies for smart growth going into 2024

Hey, everybody, you're listening to Top Quartile, where we bring you stories from the front lines of growth in community-focused financial services. So great to have Chris Nichols on the show today. Welcome back to Top Quartile. Chris, great to have you.

Great to be on your podcast. Thanks, Dan, for you guys having me. Sure. Well, as we get started, tell everybody a little bit more about your background and what you're doing right now at the bank.

Sure. So I handle capital markets for the bank, a variety of products they're in, largely our hedging product, ARK, where we turn fixed rate loans into floating. Banks can use it and we use it for our own bank. So our banks don't have a swap on their books.

In addition to that, I have a variety of business lines that I manage, fintech investing, fintech partnerships. I support our payments effort, small business, SBA, product line, employee retention credits, a couple others. Work on pricing and sit on outcome. Yeah.

What a great perspective. And you really feed into what we're talking about today. So maybe not professionally, but what's one fascinating fact that most people don't know about, Chris? That I dabble in law enforcement.

I'm a deputy sheriff for our county sheriff department, specializing in search and rescue and large-scale disaster management. Wow. That's my night job, weekend job. That's, I mean, people talk about getting back.

That's actively getting back. So it is active. It takes my mind off banking, which consumes my life. But other than that, it's a lot of fun to work with our community and work with our department.

I bet. Yeah. Well, maybe we'll work in some of those stories along the way. You talked about all the perspective you have in correspondent banking.

What are some of the key growth trends that you see with your clients? Well, growth is a funny one because normally I'm pro-growth. Now I'm a big fan of shrinking. So we spend a lot of time on looking at our cost of capital here at South State, but also when we work with our community banks across the country, we often start the conversation with what's your cost of capital?

How can you become more efficient? Right now, the cost of capital is around 12 and a half percent. So banks need to produce over that in a risk adjusted return to be capital formative. If not, it's best to shrink.

And so, you know, the calorie to that is a lot of banks are growing themselves out of existence. And the faster they grow, the faster they're going to go out of existence because they're not producing over the cost of capital to attract new capital to support their growth. And so now is a particularly curious time, as you know, in that, you know, looming potential credit crisis, you know, the cost of funds ramping up, all that presents some challenges, both, you know, in the past year, but also, you know, for the foreseeable future of what will happen.

And sometimes we think that, you know, hunkering down and just surviving the time and positioning your bank to thrive in a period of, you know, chaos or dislocation is probably the best strategic move. Yeah. So that's, that talk about, talk about growth in a long-term basis, right? The best move to position yourself to, to, to survive and thrive is, is just what you're talking about.

So, you know, as you were talking, I was remembering the old Saturday Night Live sketch. Remember the, remember the sketch about first bank of change, you know? That's right. So you're saying that growing uneconomically is not growing at all, like the first bank of change.

That's right. That's right. Cool. So in that context, what are some of the, I mean, that's sort of a non-intuitive growth driver, but it's a real growth driver.

How are you focusing on enabling that with the clients you're working with? Yeah, so a couple of different dimensions to that. But one is, you know, really, you know, our job or I believe every banker's job is to collect profitable customers and be engaging to them and be relevant to them. And so that's the question that comes in, obviously, many flavors.

But we tend to look at and preach, you know, lifetime value. You know, it's not just your cost of funds today, as you know, but your cost of funds over time in an up rate and down rate environment. And so, you know, that's very near and dear to our hearts, the work that you guys do. And we're fans of your work and the firm's work in being quantitatively focused on producing the best long term customer value.

And that means, you know, sometimes grabbing lower margin loan customers while working with them on non maturity deposits and trying to figure out how we can do a better job at marketing, sales, product development. And so when we talk about growth, we always talk about quality growth and scale. And we're always cognizant that of the quality of that growth and the more higher quality of that growth can be, the faster we'll put it on. And in many cases, it means, as I said previously, shrinking, but also means maybe, you know, deemphasizing some of your capital investment and focus and direct your marketing dollars.

So while I don't expect, you know, every bank to go after a niche industry, you know, particularly niche industry and build the whole bank around it, at least we talk about skewing the capital allocation and the focus to certain industries that are more profitable than others or where the bank could be more relevant to others and at least have a larger share of the wallet Yeah so the effect is where do you actually have an advantage in attracting economically attracting, retaining, growing, economically profitable customers, right?

And every bank's going to have a little bit of a different set of strengths and weaknesses. If nothing else, just the geography they're in. That's right. And we play this game.

We used to play this game. We play it less now, but we would all guess the profitability of a bank in five years time. And we would do that by just looking at the geography and really a bank takes on the profitability of that geography. And so we talk about, well, maybe you're not, you know, maybe we'd redefine community and you don't have to be beholden to that geography.

Or if you are, you can emphasize certain aspects of that geography. So you're banking the more profitable customers, depending on what the bank's needs are. And that, you know, that can be found in many different shapes, as you know, and sizes. but it doesn't mean you have to bank everyone in the community equally.

And so, you know, just that small shift in mindset and that small proactive allocation of capital and resources gets to, you know, between a 7% or 9% ROE to brings that bank to a 12% to 15% ROE. Yeah, just because they're a little bit more focused than spread then. So said very well. So you talked a little bit about customer acquisition and sort of long-term thought.

How does that sort of practically come in and sort of prioritizing things that may be harder or more expensive in the short term? Or at least harder than just sort of calling up a trade desk and placing a big order for wholesale funding. Yeah, that's right. So we're fans of wholesale funding to protect your customer base, particularly now.

Right. Um, you know, but when you wholesale fund, we say you're adding zero value and oftentimes you're detracting value, um, from your balance sheet. And so, you know, use that sparingly, but we'd rather see you use wholesale funding than go out and offer, you know, a five and a quarter percent or five, five 30, uh, rate on deposits and attract a bunch of rate sensitive customers. Um, worse, uh, in our book of not only training your deposit base and cannibalize your deposit base to be more rates rate sensitive.

we think the biggest disservice is training your employees. You can always drive off those customers, but it's really hard to change out employees over a 10 year period. That culture gets built up. And while one or two employees may go, the culture of, oh, we can make those customers happy by paying the top rate in the market, I think is a disservice to banking.

And it's what we call lazy banking. And so we work a lot on, really it's our job to do the hard stuff, to do the blocking and tackling it takes to put on a couple hundred thousand or a million here and there, as opposed to going out and offering a big 5% rate in the marketplace and raising a bunch of CDs. That's not really banking. It's not going to add franchise value.

So protect your franchise with wholesale funding, but then really focus on the blocking and tackling. And every bank should be running multiple marketing campaigns to promote their non-mature deposits, or at least their low interest rate sensitive of deposits across the board. Yeah, we talk about sort of sustainable base hits, building relationships. I mean, because it's not a quick switch.

You know, you don't flip it on and off as you can with CDs or other things. But, you know, if you focus on getting a base hit every day, building those relationships, meeting needs, all those kind of things, it adds up over time. Yeah, and we love that. And I mean, just think of the culture that that instills to know that you have to show up to work each day and run a deposit campaign on, you know, business savings or health savings accounts or 401ks.

And if that everyone's in that mindset, that's great. As opposed to rushing out and saying, oh, we need deposits. What do we do? Which, you know, it's basically happened in the last year.

It's a much better culture and much better education for some of the younger bankers and reminds the older bankers, you know, that are in the twilight of their career that, hey, you know, this is how you do it. And many of us have forgotten that since we haven't had to raise deposits in a long time. Yeah, for two years, it was really easy. Yeah.

What are, you know, you mentioned some of the product focuses, HSAs, what are some other best practices you see in really driving that relationship deposit growth? One, we're big fans of advocating towards product design. We don't think that we do that enough in banking. Innovation, you know, is few and far between.

And so, you know, we kind of start and stop there. We have a unique situation in payments as you know, with real-time instant payments coming along between the clearinghouse and FedNow. And so we're huge fans of treasury management. And that customer is multiple times more valuable than your average customer.

And building out that suite, we believe that part of the future of banking rests on instant payments. And so that's a bet that, you know, we believe in that we're pushing. kind of because as you know, I think checks are probably the first area that gets cannibalized by instant payments. Right now, it's really easy for a business in particular to make a payment via check and more importantly, send the check and the invoice at the same time.

And now with instant payments, you won 24-7, 365. So you can make that payment anytime you want at your convenience and you can schedule at any time. Two, you have a bunch of data with that. So now you can put the invoice, just like you can a check, together with the payment.

And then you get a bunch of other data included in that message. And that's a game changer. And then three, the fact that you're always reconciled, that you never have to go back and say, hey, they had an outstanding invoice. There a 30 payment period Do we ever receive that check Where that invoice And and try to match that up And that happens on the sender side the bank side and the receiver side So that a lot of wasted energy that banks could be in the forefront now and take back the payment channels.

You know, long ago, you know, we used to have, you know, charge cards that are bank brand. And then we seeded that to the use of MasterCard and Discover and Amex, et cetera. And this is kind of a time to take back some of those payment channels and to, you know, better compete with the Venmos, the Zells, you know, with checks in particular and cash. Yeah, for sure.

And how about kind of just everyday retail banking? What is it? What do you see there? Well, we see more focus on the customer experience, so it has to be easier for the customer.

So, you know, many banks have made some huge strides with online account opening, but that was one where we scratched our heads why it took our industry so long to have online account opening. And then, you know, those banks that had it during the pandemic were extremely grateful. And we always talk about technology giving us options. And that's a perfect example of that, that when pandemic hit, those that were technology forward had that ability, were able to adapt much more quickly than having to figure out how to do that via drive-through or walk-up window, what have you.

And so what we see on the consumer side is we see more choices, more data, a whole new interface coming out with generative AI. And so we see some of those changes really affecting the consumer all for the better, making them smarter and making banking easier. Yeah, for sure. And yeah, just the blocking tackling, like you said, is getting better every day than being on the front foot.

So you talked about data. What are some of the other ways you think about data can inform strategies? Well, as you know, data's all around us. And I think in this day and age, if you're still mass marketing in particular, you're not doing it right.

And so we have enough data on our customers as an industry to get very personalized. And whether that means, you know, personalized deposit pricing over time, you'll see more and more of that. But it also means, you know, leveraging data in terms of profitability data that we have, how sensitive they are to rates when we talk about different deposit products and cross-sell what affinities they have. We know from the data that if you like certain brands or certain activities, you are more apt to care about banking.

And we have a mantra that you should find customers that care about banking and then show them that you care more than they do. And if you can exercise that formula, you will gain more customers than you know what to do with. And so that formula, along with selling more profitable customers, more profitable products has never failed banking. And so those are two formulas that kind of drive our strategy and tactics.

And so when we look at data, we often look for the intersection of what customers does the bank want, what customers want us as a bank, and then what customers are profitable to go after that we can serve appropriately. And that intersection is where, you know, I think banks need to target. And if we do that effectively, we'll have plenty of growth and we'll be producing above our cost of capital. Yeah, very well said.

We talk a whole lot about understanding a customer's capacity and propensity for a particular product and service. And obviously, the beginning of that assumes that you want to sell that product. But assuming you want to sell the product, different people have both an ability and a desire to buy that. And so using data, you can do that in ways that's very privacy-friendly, too.

I mean, being relevant does not have to be creepy. And I'm curious what you're... We talked about that the other day. Absolutely.

You know, right, a thin line between being creepy and adding value. And I think when you add value, no one thinks you're creepy. When you're just trying to sell something and you're in it for yourself, I think that's a whole different story. But, you know, like you said, data can inform your product choices and your tactics as a bank and as a customer, small business or retail.

But I think now in this day and age, we can arrive, you know, what we call anticipatory banking. we can be anticipatory in what that customer needs and realize what they need before they know it. And so, you know, often if you're looking at, I mean, something simple in terms of, you know, when we see a draw on a letter of credit that's non-seasonal, we know either two things are happening. One, they're running into problems because, you know, revenue isn't where it should be or margins isn't where it should be.

Or two, they're growing at, you know, more than anticipated. either way, they're going to need a conversation with the banker. And so that's our, our trigger that when we see that a banker gives them a call and kicks off a conversation and it helps protect the credit. It also helps, you know, sell more products because in the past several years, the growth has been tremendous.

So even during the pandemic, those conversations took place faster than the average bank. And so we, you know, kind of pride ourselves on having that focus overall as, as bankers. And that also means, you know, if you're spending money to fix up your house, you go in the house for a couple of years and you start fixing that up and we see, you know, transactions from Lowe's or Home Depot, we know that, hey, you may be getting ready to sell your loan, your house, and you may want another loan.

And so we can do some cross marketing in our industry for that. And again, before they go to a realtor, before they even look for a new house, before they even look for a new loan, we can be right there providing them intelligence, providing them rates, providing them structuring ideas on, you know, what a potential mortgage would look like to help factor them in and make the customer smarter. Yeah, I think you're touching on something really important, Chris, of, you know, triggers are somewhat either table stakes or but there something already happened And so the really smart guys on data are using data to sort of inform what are those things that people are going to likely have needs before the event right So based on, you know, somebody's profile, I just think about, you know, you sell a house or something, right?

By the time the money shows up, or frankly, by the time you've listed the house these days, you've already got a pretty good idea of what you're doing. And so harnessing data to think about what are the characteristics that mean this group of customers is likely to have a need before they have it? And you sort of get out ahead of it. I think that's where the really smart banks are placing their bets.

I don't know what you see there. Absolutely. And we see this huge shift in the industry with generational transfer that a lot of people talk about. But when you look at the practical application of that, we know, you know, we like to purchase data to know about our small business customers and trying to figure out what is their exit plan.

And when we see the age and we see the value in that business, we often have our, you know, bankers ask, find out what they're planning to do. Because if they, the minute they say they're going to pass it on to the next generation, they say, oh, I got my son or daughter working for me and they're going to get it. That has a whole different meaning than if they're going to sell with a whole different set of, you know, engagement strategies that banks should employ. And that's, you know, one thing that's taking place over the next five years, that this huge generational wealth transfer that we can really do a service to our customers and lock in that next generation into our bank by being proactive and helping them think through some of the issues before they, you know, actually sell the business and let the, you know, kids run away to another bank, which is probably going to be, you know, a JP Morgan or Bank of America.

America, we should probably keep that in the community banking sphere. Yeah, very well said. All right. So it's kind of, I mean, the time's flown, but, you know, kind of as we think about wrapping it up, you know, you sit in a very unique spot in the industry.

Knowing what you know now, what type of things do you think when we get to the end of 2024, when we get to 2025 and we're looking back on 2024, what are the kind of things that we all wish we knew now? That's a great question. I haven't had that question before. Listen, I think banks need to be focused on, you know, obviously controlling deposits and marketing non-maturity, lower cost deposits.

Same, they need to pay attention to credit. And I think in 2025, we're going to look back and say, well, everyone knew that we didn't place enough emphasis on it. because I think that we have an unprecedented time given the rise in rates, given the number of balloon mortgages that we made on the commercial side or rate resets that this borrower is gonna go from three and a half percent to eight and a half percent and is gonna be shocked by that. The drop in value of commercial real estate office in particular, I think some of these things are gonna have reverberations more than we really know when we're gonna lose 100 plus banks easily at the next downturn.

And it's a question of where that is. And I think by 2025, we'll see those cracks, if not, you know, be in a state of crisis by that time. And I think that, you know, everyone kind of intellectually knows that you don't really see the action. So I think 2025, we're going to say, I wish we took more actions in 2023 and 2024 to prepare for that time.

And you'll see deposit costs continue to rise up from them. I'm not sure we've seen the brunt of how far deposit costs can go. I don't think it's like last cycle. And I think with the feds, as the stimulus dies down from, you know, the infrastructure bill and a bunch of you cares act, et cetera.

I think you'll see more pressure on banks. I think as money runs off from quantitative easing or tightening, you'll see more pressure on banks and the rise of the direct banks with their, you know, higher rates and the rise of money market funds. you know, all these banks weren't really banks, you know, the American Express and the CITs of the world that weren't really that active at the last upcycling rates. We're now going to have more pressure on this going forward.

Makes sense. You know, somebody, some famous banker said something about fortress balance sheets. What I think what you're summarizing is the smart banks are going to put fortresses around their key customers. Around the customers, around the balance sheets, for sure.

I think it's a time to watch your growth, make sure you're adding sacrifice earnings for quality credit and quality depositors that are not going to be that rate sensitive, that are going to stick with you while increasing liquidity and controlling cost, of course. But I always say, we need to be effective before we're efficient. And so this is a great time where we see many banks just cutting costs, trying to worry about their margins next year and try to be more efficient, but really they should be more effective by going after some of these strategies, marketing some non-interest rate deposit applications, focusing on better credit and going up in credit quality.

All those tactics I think will pay off handsomely by the time we get to 2025 and build that Fortress balance sheet customer base. There you go. Well, Chris, thanks again for coming on the show. Really great insights.

And it was a pleasure to have you. Dan, appreciate it. Thank you for all the work that you guys do for the industry. All right.

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