Retail Revamp

By Kenneth Cline

National City's David Daberko has bet his company's future on retail banking. And to help make that bet pay off, he's got to improve cross-selling in the branches.

For David A. Daberko, the future of retail banking lies in cross-selling investments and insurance products — essentially extracting more revenue from existing delivery channels, mainly branches. "Branches are expensive and we're going to be constantly challenged to grow revenues from those branches," says the chairman and CEO of National City Corp.

This challenge has special resonance for Daberko because he's placed a big bet on retail banking. Since 2000, the Cleveland-based company has invested several hundred million dollars in upgrades that include new offices, technology and products. About one-third of the company's branch managers were also replaced.

Now Daberko has to wait and see if the bet paid off. Early indications are encouraging — National City has reported strong deposit growth in recent quarters. But the real test will come in future years as the company attempts to take its retail profitability to a new level with more effective cross-selling.

Wall Street will be scrutinizing this effort closely because National City is losing the tremendous earnings tailwind it had been receiving from mortgages. During the height of the refinancing boom last year, the mortgage subsidiary returned $937 million to the company's bottom line, or 38% of total earnings. But now the boom is over and results are trending down to more normalized levels — 21% of earnings in the first half of 2004 and heading lower. All of which puts more pressure on Daberko to show results from his retail makeover.

"We wait for further clarification on that," says Jason Goldberg, an analyst with Lehman Brothers in New York. "They essentially took a percentage of their robust mortgage earnings and used it to completely overhaul the retail system. But we haven't fully seen yet if they've been successful."

The 59-year-old Daberko himself isn't quite ready to declare victory. Although he can cite internal surveys showing improved customer satisfaction, along with the deposit gains in recent quarters, he also concedes, "This retail bank is not as good as it needs to be."

It doesn't help that National City's Midwestern markets are home to some of the toughest competitors in the business. Institutions such as Fifth Third Bancorp and Charter One Financial Corp. have had many years to refine their retail operations, while National City has only recently made this a priority.

"National City's success will be dependent on their ability to maintain the focus they've had over the last few years on becoming a better retail sales culture," says R. Scott Siefers, an analyst with Sandler O' Neill & Partners in New York. "To be really successful in retail is a day-in, day-out kind of thing — a fight in the trenches."

On the other hand, some recent mergers do provide a competitive opportunity. Hometown rival Charter One is being bought by Citizens Financial Group Inc. (a subsidiary of Royal Bank of Scotland), and Chicago's Bank One Corp. is joining up with J.P. Morgan Chase & Co. Disruption caused by these transactions may give Daberko's revamped operation — which now provides 20% of National City's net income — a chance to gain customers.

Daberko knows that winning in retail is critical if the company is to maintain its independence in a rapidly consolidating industry. "This is a game of survival of the fittest. And I believe the best retail banks will win because retail is two-thirds of the U.S. economy."

Retail Epiphany

Daberko wasn't always such a champion of retail banking. Having joined National City in 1968 as a bond trader and worked his way up through the corporate lending ranks, he wasn't naturally predisposed toward consumer operations.

Nor was the bank. National City, which holds one of the nation's oldest banking charters, has always been a corporate-oriented institution. Within the organization, branches tended to be valued mostly as a platform for small business banking. The consumer was almost an afterthought.

The change of heart, which Daberko himself describes as an "epiphany," came in 2000, when he noticed the lagging performance in the retail operation. Core deposits, for example, fell 5% between 1999 and 2000.

Like many of its peers, National City had completed multiple acquisitions in the '90s. Its modus operandi was to boost shareholder value by cutting costs and improving an acquiree's corporate and small business operations. But the company had little to offer on the retail side, which became a problem as the branch network grew through deals. Suddenly, the weakness in retail became apparent.

A tour of National City branches in 2000 opened Daberko's eyes to poor morale and insufficient resources. "These people really wanted to do the right thing, but we didn't give them any tools to do it. They weren't well paid, branches were understaffed, and products were uncompetitive." National City, for example, had no "free checking" to offer at a time when competitors were aggressively marketing that product. And the company's Internet banking system was ranked among the worst nationally.

Daberko knew that bringing the retail system up to par would require a massive diversion of resources. Fortunately, National City Mortgage was beginning to blow the roof off with earnings from the refinancing boom. "We had great profit flows in 2002 and 2003, while a lot of competitors were cutting costs," Daberko recalls. "Because of the mortgage subsidiary, we could stay the course and keep investing."

The plan that Daberko and his team devised included five elements: service quality, technology, products, people and incentives. Improving service quality was essential to stem customer erosion and lay the foundation for later gains. The company has developed a system of service quality metrics that includes 300 separate items tracked monthly. A combination of internal and external surveys allows retail chief Peter E. Raskind and his team to analyze customer satisfaction scores for the company's call centers and all 1,100 branches. These scores, in turn, are linked to incentive programs for branch and call center managers, so there's a powerful motivation within the system to keep customers happy.

Technology investments include a $125 million upgrade of all teller and platform systems in the branches, and new systems for the call centers as well. These upgrades will be fully rolled out by December. To expand its retail distribution network, National City has also been steadily opening new offices since 2002, although the total count has dipped somewhat due to the closing of old branches, particularly those acquired in recent acquisitions.

As for products, National City finally introduced its free checking offer in 2002 and followed that up with a similar product for small business customers. It also made a concerted effort to improve its Internet banking system. Gomez, the Internet research and ranking company, now puts National City's offering in the top ten for efficiency and response time.

At the beginning of 2003, Daberko and Raskind began to focus on people, specifically branch managers. "We decided that the job is important enough to us that we've got to have the right kind of people in that role," says the 47 year-old Raskind, executive vice president of consumer and small business financial services since 2002. To that end, National City undertook a systematic evaluation of all 1,100 branch managers, scrutinizing each one against a set of criteria that emphasized sales drive and relationship-building as opposed to operational skills. To provide an "exit with dignity" for those who didn't measure up to the new standards, the company also announced an early retirement program. About 300 branch managers took that option or relocated to other jobs in the company.

Most of the company's new branch managers have come from competitors; a few had no previous banking experience but brought a strong sales background. "We're very pleased with the talent we attracted," Raskind says. "Now that talent has to convert to results. But I think it just stands to reason that it will."

The final element in the retail revamp has to do with incentives, which are uncapped for branch managers — meaning that top performers can earn $100,000 and more. "We wanted our top-performing branch managers to make six digits," Raskind says. But there's also a stick to go with the carrot. Branches are stack-ranked against each other in terms of profitability, so life is hard for those managing the bottom 10%. Branch managers who fall into those depths do not receive incentive pay and face losing their jobs, absent some significant improvement.

"We think we can achieve higher levels of productivity, particularly sales productivity," Raskind says, noting that the company uses internal metrics to gauge its progress in this area. "We have data around growth in various categories and do a fair amount of our own proprietary research related to customer satisfaction and household share of wallet that tells us whether we're making progress or not.

"You can't measure with certainty against competitors, but you can know whether you're making progress or sliding backwards."

The incentive system is also designed to reduce turnover, which has long been a primary complaint of banking customers. To encourage employee longevity, National City revamped its pay and advancement structure to enable managers and tellers to earn more and get promoted even while staying in the same branch. In the past, career advancement almost always meant moving to a larger branch or out of retail altogether.

"Now, if you make your branch bigger, we'll pay you more and you'll move up through the ranks," Daberko says. "If I was 28 years old and trying to make my mark around here, I'd go to retail."

Deposit Challenge

As 2004 draws to a close, retail bankers are facing a major new challenge: rising interest rates. In the wake of the stock market crash of 2000, banks had received an influx of low-cost deposits. Now that the Fed is beginning to raise interest rates again, customers are looking for higher yields for their money, which particularly puts at risk those funds that had been parked in bank money market accounts.

Bankers can't stop funds in search of higher yields, but they can at least try to guide it to new homes within their institution, such as time deposits or investment accounts. Daberko says National City is well positioned to fight this battle on both fronts.

During the second quarter, for example, National City was able to boost its core deposits by 8% from the year-ago quarter. Most of that increase came from a recent acquisition, but raising rates on time deposits by three basis points also played a role. Competitors like KeyCorp and Fifth Third have been making similar moves, but Daberko says his institution can probably play that game more aggressively than most because of its "asset sensitivity."

National City's $6.5 billion securities portfolio represents 6.4% of its earning assets, at the low end for the top 50 banks, while its loan percentage is correspondingly high, 79%. That means the company can re-price its assets faster than liabilities to lessen pressure on its net interest margin — in other words, a rising cost of deposits doesn't hurt National City as much as many of its competitors.

Steering customers to investment accounts is a more long-term challenge, but also one that ultimately will have more impact on National City's future. Daberko sees a big opportunity in the aging of America's "baby boom" generation, which will generate more interest in retirement and healthcare savings, particularly with the many questions surrounding Social Security and corporate pensions. "People are becoming more and more aware of the fact that their financial future is in their hands, and they're going to be looking for ways to manage their own affairs."

This investor need, in Daberko's view, coincides with the need of banks to generate more revenues from their existing delivery systems. "If you don't generate more revenues with more investment and insurance products, the costs are going to eat you up," he says. "We've already got the delivery system out there, so the marginal cost of hiring or training an investment sales person is not that high. As a bank, we can afford a much lower average sale than, say, Merrill Lynch."

That should mean that banks like National City are well positioned to appeal to mass-market investors, not just the upper strata. But making this work in practice requires a smooth collaboration between branch bankers and investment sales personnel. National City has adopted a system in which full-time investment brokers, who hold Series 7 licenses, are part of the retail banking system, ultimately reporting to Raskind. These brokers are then financially incented to coach the branch platform employees in the selling of insurance and investments.

"At some banks, platform people almost compete with the brokers," Raskind says. "We've set it up so the broker basically has a team of platform bankers that they work with and their interests are financially aligned. That has worked really well for us."

Realistically, however, National City can't expect quick gains in this arena, since banks lack the reputation for investment expertise enjoyed by firms like Merrill Lynch & Co. "Success is going to be dictated over time as opposed to overnight," says analyst Siefers. "You need to gain the respect of your traditional banking customer on the banking side first. You gradually earn the right, in the customers' eyes, to manage more of their investment dollars."

Even so, Daberko feels enough progress has been made on National City's retail revamp for the company to start growing again. Back in 1999-2000, he had stopped making acquisitions, in part, because he realized National City couldn't bring value to the retail side. Since November 2003, three deals have added $20.3 billion in new assets. And according to press reports, National City was also a bidder on National Commerce Bancorp, SouthTrust Corp. and Riggs National Corp.

Without discussing those specific situations, Daberko says it's difficult for his company to win franchises in high-growth areas outside of National City's own markets: the in-market acquirer always has the advantage of being able to cut more costs and therefore offer a higher premium. His main strategic focus continues to be fill-in deals in National City's seven-state Midwestern territory. However, he adds, "I'm beginning to be of the opinion that our retail banking model and small business banking model would work in other places."

Mr. Cline is senior editor of Banking Strategies.

Copyright © 2004 by Banking Strategies, published by BAI.

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