From BAI: Charlie Scharf talks to Tom Brown

These are my run notes from a conversation between Charlie Scharf of JP Morgan Chase and Tom Brown of bankstocks.com at the BAI Mavericks in Banking Conference.

Charlie Scharf: Head of Retail Financial Services at JP Morgan Chase

Tom: Talk about when you came into Bank Ones’ retail and then Chase . . . what did you do.

Charlie

We were lucky we started with Bank One.  It wasn’t that complicated a job to do.  We had a great franchise . . .  First Chicago or Valley Bank . . . we had wonderful franchises but terribly managed.  Seven deposit systems.  Five loan systems.  People just couldn’t agree on what systems to go to.  It was just politics.  Lots of motivation towards the internet and being like a retailer, people forgot we were a bank.  We can’t be Nordstroms.

So we went at it methodically. There is no silver bullet.  A series of decisions.

We had to get on one platform.  Introduced new technology across the board to make it easy to do business.   You can talk all day long about customer service and if people don’t have the right tools, we won’t get there.  People need to see where we’re trying to go and how to get there.

We talked about growing the underlying customer checking base.  People come to us not because they want a card or a mortgage, it’s because everyone needs a transaction account.  Getting a growth mentality into people’s minds and then it’s all about relationships.

The single biggest thing we did was a “controllable P&L.”  If the can’t control, we don’t put it in: no overhead, pricing etc.  We want Branch Managers to act like they’re the local President.  That’s still true today

The thing that’s so fun about retail banking is that the people are wonderful.  “What mountain do you want to go up and how do we get there.”  If the plan is a good one and you don’t change it all the time, you’ll get there.

Tom: Compare Bank One, Chase, WaMu

The old Chase was a terribly run retail bank.  It was a fourth class citizen.  The company was being built like an investment bank.   At the time of the merger, ¾ of the retail people were unsuccessful corporate people.  They never went to the branches.  Not in their blood.  Never got funding.  Products were wrong. Looked terrible.

Chase had a wonderful name . . . much stronger than Bank One.  Great Brand and NE presence.

Bank One had real scale and great people.  Same with WaMu.  Great spirit.  Wonderful people who want to do the right thing.

WaMu is a different story for us.  It’s overall a very troubled place because of all the concentration in mortgage and home lending space.  Just talk about the bank.  We’ve had enormous surprises.

We went in wanting it to be a great deal.  It was the only way for us to get into the West Coast and Florida.  If we did one big deal, it was going to be our last.  We loved the franchise.   The opportunity we have to introduce our products and brand in footprint . . . it’s wonderful.

We’re blown away by the volume of customers we see in California.

Tom: Best Practices from WaMu?

In all the deals we’ve done, we really have tried to step back and say, “What do they do better?”  They were run much better than Chase or Bank of NY.  Building a sales culture.  Building a true entrepreneurial culture in the branches.

Biggest challenge is changing the banker’s mindset.  Getting bankers up and out of the chairs and talking to people coming through the doors.  That’s not in the culture of the typical banks . . . more like making phone calls.  Very typical for a WaMu manager to get up and work the line.

Tom: The Ocasio concept wouldn’t work for you . . .

Why would it work for us?

WaMu operated very differently than other banks.  WaMu was trying to carve out a niche without a lot of products and services.  It made sense for WaMu.  They were growing and opening up lots of accounts.  For us, it doesn’t make sense.  Customers don’t know where to go.  Customers didn’t really like it.  Employees liked it because they weren’t handling a lot of cash.

What we want to do is get people comfortable sitting down and having conversations.  Everyone’s life changes.  Not every week, but it does.  You have to have a format that’s conducive to sitting down and talking when it’s important.

Tom:  Another change you made at Bank One was hours.

The hours is one of those things that when your run retail isn’t on your radar screen.  When I got the job I wasn’t a retail banker.  Running large outlets isn’t something I had been involved in.  So I spent the first three or four months learning.  We’d get on a plane Monday morning and do branch visits all week.  We talked with all kinds of people asking, “What’s going on?”  We’d go to Columbus and look at the numbers.

So we were in the break room in some branch in Ohio or Indiana.  We want to see the numbers up on the walls.  They were terrible.  We started talking about FifthThird.  We shared a parking lot with them.  So I walked in and told them who I was.  We get into a conversation.  They’re growing and doing well.  I looked at their hours and looked at ours.  Completely different.

When you ask customers, convenience is always on the list.  We looked across the country and wound up adding 25% more hours.  When you do it everyone whines.  It’s just not an option.  Customers are telling us what’s important and we’re ignoring it.

Tom: One of the things you guys are known for is cost control. Extending hours must have been tough.

Jamie always talks about “waste cutting.”  You have to be tough on costs.  We have no patents.  It’s cost cutting that gives you money to extend hours and hire good people.  Smart money vs. dumb money.

We’re in the toughest environment and we’re adding bankers, hours, investment reps, and spending more on marketing.  And we’re cutting expenses in other places.  The two have nothing to do with each other.  You don’t cut at the expense of growing the franchise.

Tom: In that branch hour example, you looked at Sunday hours.  Why not do that?

We have a small amount of branches that are open Sundays.  It’s not clear it makes enough sense.  If we went out and asked customers if it made sense, we’d do it.

The bigger you get, the easier it is to try things.  They’re always testing things.  Almost everything we do, we’ve got ten things we’re testing somewhere in the country.

Tom: The last 24 months have been hell.  What are the permanent changes coming out of this?

I’m not sure we know yet.  We’re not through it.  Some companies are still reacting to that.

Some are on the lending side, and that’s for the good.  Concentration of lending in the big companies we think is good for the industry.  We can do it the right way.  The fact is that banks that see customers day in and day out, those relationships become increasingly important.  There is a lot of distrust of financial institutions.  There is a lot of blame that can be placed on Congress and others, but a lot of it came from financial institutions.

We’re in a position to do this differently.  More than a loan.  It’s advice.  The people we talk to aren’t being called on by financial advisers.

Temporarily people will cut back on new branches.  That’s a good thing.  We’re believers in building new branches, but that has to make economic sense.  Some of the real estate prices in parts of the company made it impossible to make money.

Tom: Do you see any lending area that you can go into because of pull backs from competitors?

For us the biggest places in lending are doing as much as we can in first mortgage and auto.  We’ve had sub prime in the past, student lending, and home equity.  We’re very small in student lending.  Good market but very hard to figure out what to do with it. Government is in it.

Auto is a tough business. We run the business for returns and not growth.  It’s a different story today.  Now we’re making some of our best returns.  All of these businesses go through cycles.  If you run them properly through cycles . . . it’s the best way to do it.

In mortgage, given who we are, we need to do it.  It’s good for the system and it’s good for us.  It’s just a question of how much can we get through the system.

Tom: In every recession I’ve seen, banks raise the FICO scores they lend to.  An opportunity to lend to below 700 FICO?

Absolutely?  Lots of opportunity to make money in lending across the credit spectrum.

All this talk about sub-prime is a terrible thing.  A great percentage of the people in this country are sub-prime.  They shouldn’t all have 90% LTV or buy a home, but they should all have access to credit.  The right products for the consumers.  You have to get those things right.

Figuring out the importance of FICO going forward will be a big challenge.  We aren’t yet seeing all the deterioration. There are some bad people in there who gamed us.  The trick is to separate out those people from the people that our industry as a whole helped get overextended.  You see both types.  When you go through the loans we gave them, we overextended them.

The worst thing you can do is exit businesses because you’ve gotten burned.

Tom: If you haven’t read Jamie’s shareholder letter, you should.  He says, “How can we be so stupid in brokered home equity loans?”

It’s always something when Jamie says in writing that the biggest mistake of his career is what you did.  We all make mistakes.  You try to learn from them.  You try to learn before you make them.  The trick is not to do them again.

We got to Commercial Credit, they had a broker business, it was a disaster. Bank One had one, it was a disaster, we shut it down.  We get to Chase, they had one, there was a lot going on, and we became convinced they knew what they were doing.  We’re going to lose an enormous amount of money.  Billions.

Maybe someone can run it well, but nobody we’re associated with.  I’m not saying all brokers are bad. Some are very good.  But given our scale, we need to do things in a big way to make a difference.  We can’t control it.  For us, it’s a complete exit of the business. Four times is plenty.

It’s about getting back to the basics.  We go through our practices and processes.  People ask, “How could you do that?  It doesn’t pass the common sense test.”

It wasn’t a single decision.  People would pay down some equity and put the money back in the house.  They’d keep doing this.  Nobody asked if this is the time it’s going to turn.

Our pricing models are too backwards looking.  We had never seen this kind of environment.  Everyone talks about stress testing.  We looked at what had happened in other markets in other recessions.  We talked about 10%, not 40%.

Tom: What about Loan Modifications?

Where we are is that the President announced a bunch of specifics on loan modification guidelines for government sponsored loans, for refinancing government sponsored loans, and for your loans.  They’ve announced without specifics, then they gave the specifics.  Now we have the specifics.  It’s an enormous task.  We’ve had 800,000 people download documents to inquire about loan mods.

We’ve always had underwriting, servicing, can collections.  Mods mean we’re underwriting loans in servicing.  We’ve gone from 4,000 to 8,000 collectors.  They’re not trained to do this.  They don’t have tools.

Moratorium is behind us.  Now it’s a process of executing as many as make sense.  People call you and you have to make a judgment to do this.  What product to put them in.  Then you do a trial mod.  Then them have to make three payments.  If it works, then they get  a modification.  It’s enormous.  We need to catch up.

The biggest issue . . . we’ve tried to be in the forefront.  The fact is there are a lot of people who can pay but just don’t want to.  Differentiate those people from people who can’t is a huge problem.  We don’t want to create a bad incentive.

Tom: Mods vs. Forclosure.

We service 10 million loans.  We think 500,000 to 1 million loans are candidates for modifications.

Don’t get me wrong, the lower we can drive recidivism, the better.  A lot of people are going to get thrown out of their homes.  So the more that we can help, the better.  Otherwise they’re out.

The data we’re seeing today is on modifications that weren’t done well.  When we look at our own data, our results are superior.  We can do it.

Tom:  Industry wide, 25% of the loans that were modified had higher payments.

People who get behind . . . a lot of people capitalized the deficiency and made the payment bigger.  We’re not forgiving balances, but we have lots more tools.

Tom: T Rowe Price suing to prevent mods.

You could argue that the government could do more.  Our point of view is that we could care less.  The fact is that when you go through the calculation and see if you’re going to do the mod.  In the end, you have to pass an NPV test.  If doing a foreclosure has a higher NPV, that’s what you do.  If not, you don’t.

Tom:  With securitization, we divided the loan into tranches.  The interests of one have interests different from another.

We have been avoiding principle reduction.  We do principle forbearance.  The people that own the lower tranches are going to lose money anyway.  I can see why you would be nervous, but our interest is in maximizing cash flow of the loan.

Question: What does Chase plan on doing to improve front line execution?

There is a lot we can learn from great retailers.  There’s a point where you have to pick the great things you can actually do in a bank.

For us, I would say it’s clarity of what we want people to do.  For so long people have been trained to do things a certain way.  You look at so many of our people and see how young they are.  So it’s not like we trained them that way. So they bring some kind of interaction.

Everything we do is about encouraging people around customer interactions.  When we recruit people . . . we want smart ones . . . we want the engaging ones. So we do some testing and if you answer a certain way, we won’t hire you into the retail bank.  We train like crazy.

It used to be about the products.  It’s 20% now.  The rest is about sales.  I hate to use that word . . . it’s about customer interaction.  When someone comes in, you can help them be better off then when they came in.

We don’t reward you for treating people well.  While we want you to think about running your own business, it’s really about running a franchise.  Teaching people to do a better job interacting with customers.

Nobody tells people what a great experience they had at the bank getting the exact change.  They will talk about someone saving money or getting people into another product.

Question:  Can you talk about checking account growth strategy?

It’s a balance.  You can go crazy and open a lot of dumb checking accounts.  We talk about quality checking accounts.  We expect people to be grownups.  We put controls in place.  When we find people doing stupid things, they don’t belong here.  We talk about that a lot.

There are a series of things you have to do.  We run campaigns that look for minimum balances.  We want active accounts.  We want bill pay.

We pay small salaries and big incentives.  One of them isn’t checking accounts.  That’s core.  We do pay for things that make it active.  We look at checking accounts and household growth.

Question:  Lot of movement between spread-based products vs. fee-based products.  What do you see?

We never talk about this.  I know a lot of banks do.  What we do talk about internally is deposit profitability vs. everything else.  People always ask about deposit growth.  We can easily have 3% to 5% deposit growth and 10% profit growth.  I don’t accept that, but if that’s what it is, that’s fine.

We offer so many types of products . . . if you look at our profit growth over the past ten years, 2/3 or more comes from those products, not deposits.  Businesses change over time.  The mix will change.

One of the things we can bring is that customers trust us.  Do they trust the person that they talk to?  Bring all the benefits of doing business with us with those relationships.  People always come to us for checking accounts.  Acquire and deepen.  We do those in tandem over time.

Question: In our market we’ve seen our competitors offer cash incentives on opening accounts.  Talk about those as well as loyalty programs.

Cash incentives . . . we do it.  Industry has been doing this for years one way or another.  The reality is part of me hates doing it.  Not everyone does.  Having said that, marketing is an economic decision.

Everything we do we try and do the analytics to see if it makes sense.  In some parts of the country we’ll do rewards.  In some places we don’t. We always do comparisons.

We have to believe that we’re not hurting the underlying economics of the business.  Getting the customer flow is critical.

Deep down we’re big believers on rewards programs.  Nobody has cracked the nut on how to do these on a broad based way in our industry.  If there’s a killer app, nobody has done it yet.

Tags: CharlieScharf, Tom Brown, JP Morgan Chase, Jamie Dimon, BAI, Mavericks in Banking, BankOne, FICO, Nordstroms, FifthThird, WaMu, Ocasio, Bank of New York