Profile of an interstate bank that looks for a solid reputation in the community.
Can Blackstone Bank succeed by focusing on markets other lenders ignore?
In 1986, Roxbury, a predominantly black district of Boston, attempted an unusual ploy. The community proposed to secede from the city proper and reincorporate itself under the name Mandela (after South African dissidents Nelson and Winnie Mandela). As a piece of political strategy, the referendum fizzled; it was soundly defeated at the polls. As a symbol of community frustration, however, the movement was significant. In many of Greater Boston's poorer, more ethnically insulated neighborhoods, people heard the news about their region's booming economy and wondered why the gravy train was passing them by.
Their concerns had merit. To a large extent, Boston's heavily Brahmin banking establishment shunned them, major developers ignored (or exploited) them, and politicians dutifully counted their votes -- only to vanish with their tax dollars after election time. Need operating capital to feed a growing business, or a pipeline into federal funding? Good luck. Around Roxbury, leaders knew, the celebrated Massachusetts Miracle often meant nothing more than getting someone at the State House to return your phone calls.
While Roxbury considered its political fate, Daniel Dart and Ann Hartman had a different dilemma on their hands. Approval of their application to charter a new bank to be called Blackstone Bank & Trust Co., filed in September 1986, was being mysteriously delayed, to the point at which they began to fear the worst. Their plan -- to create a community bank making loans in Roxbury and in Boston's South End, to make it a low-cost provider of basic financial services, and to attract depositors from all over the country by offering top-end rates on deposit accounts -- seemed reasonable on paper. Both officers, though young, had a wealth of big-bank experience. Both had strong ties to the area and were intimately acquainted with Boston Redevelopment Authority projections of job growth, population growth (Roxbury up 10%, the South End up 20% by 1990), and investment in the two communities (a new subway station, the Copley Place retail development, a $275-million expansion of Boston's Prudential Center).
Well on their way to raising the minimum $4 million in start-up capital required by state banking regulators, Hartman and Dart were convinced that while most of Boston appeared "overbanked," their target neighborhoods did not; only three branch offices existed in the South End, six in Roxbury -- with no bank headquartered in either community. On the lending side especially, this competitive vacuum suggested the kind of value added to the community that regulators look for when considering new charter applications. So what was the problem?
The problem, as it often is in Massachusetts, turned out to be political. Word leaked to Blackstone's founders that one of the charter's signatories, facing a tough reelection fight, wanted to see which way the Mandela referendum went before approving the proposal. Only after the referendum was defeated -- actually, on the same day -- did Dart and Hartman learn that their application had been approved. Eight months later, in July '87, Blackstone Bank & Trust opened for business.
"These neighborhoods had a horrible reputation," concedes Hartman, 37. "Not only did bankers not think them 'tame' enough [to invest in], but people literally feared for their safety down here. We don't look at it that way. From our perspective, this area is pretty mainstream.'
Community banking, she adds, is as much a state of mind as it is a function of resources or geography. "You need to know the territory and who the local players are," she avers, "but you also need to know how your customers want to be treated. We don't offer the lowest loan rates -- in fact, we charge a premium for our [lending] services. But we don't take six weeks to make a decision, either. Or turn down a loan for no apparent reason. Borrowers come to us because they know they can always get Ann or Dan on the phone. Not everybody needs that kind of service. But a lot of people seem to want it.'* * *
Speaking as someone who never balances his checkbook or shops around for the best CD rates (journalists tend to be notoriously bad money managers, perhaps because we have so little to practice with), I address the question of how a bank makes money with some trepidation. The logical answer seems simple: by dealing with customers like me. Actually, according to Dan Dart, the real explanation is not much more complicated than that.
"We rent money for a fee," says Dart, 32. "Or, to put it another way, think of our deposits as finished-goods inventory. We mark that inventory up and sell it at retail, principally in the form of commercial loans. The difference is, we don't actually own our deposits, nor do we give away our loans on a permanent basis. What we're really in is the money-renting business.'
All banks make their profits off the spread between what they pay to depositors in interest rates and what they earn from borrowers (or other investments) on "rented" money. At most banks, these constituencies are primarily one and the same. Not at Blackstone, where the deposits are mostly national and the investments largely local. Most banks have traditionally pursued growth through bricks-and-mortar expansion: more branches, more customers, more products, more volume. Again, not Blackstone. To Dart and Hartman, these concepts are at best unwieldy, at worst obsolete.
"A lot of banks are driven by a market-share mentality," points out Hartman, "and that's fine if it works for them. Here we're more driven by an earnings-per-share philosophy. Our belief is that a bank can stay small and still turn a respectable profit -- if it knows how to keep costs down and make use of technology. I tell customers that the picture of banks they carried in their heads doesn't exist anymore.'
You can pretty much tell that just by strolling through Blackstone's two-floor, 3,700-square-foot headquarters. Downstairs is a main office housing four account executives and the vice-president of retail banking, who smile frequently and greet customers by name (there are no tellers and no automatic teller machines, or ATMs). The account execs will cash a check if you insist, but they wouldn't know a velvet rope if one crawled through the lobby and bit them on the ankle. Upstairs, where the executive offices, computer room, and mortgage banking department are squeezed together, sits an old Mosler safe tucked inside a nondescript closet. Take a gander, folks, at Blackstone's main vault. It looks like something Butch Cassidy would drag outside and ask Sundance to stick on his horse.
A decade ago, Blackstone could not have operated this way. Or at least not for very long. Today, thanks to such innovations as shared ATM networks and financial data-processing services, coupled with fundamental changes in banking's regulatory climate, it's a different ball game. Perhaps the biggest change was the passage by Congress, in 1981, of the Garn-St. Germaine Act. This legislation effectively deregulated the industry by phasing out interest ceilings on deposits over a six-year period. Like other industries before it -- trucking, airlines, the phone company -- banking deregulation in turn created niche opportunities that cost-cutters have rushed to fill.
The late 1980s have seen the industry shaken up by deregulation. At one end has come a wave of mergers and acquisitions rolling above a sea of red ink, as hundreds of thrift institutions have tottered and failed -- some due to outright fraud, many more from the pressure caused by conversion to stock ownership. Banks thus infused with large amounts of new capital have been forced to lend that money out, and quickly; in cases in which commercial-lending expertise has proved less than stellar, fast-growth banks have seen their loan portfolios become riddled with bad debt.
At the other end, meanwhile, new players have been arriving on the scene. Some bill themselves as "boutique banks': specialty banks offering limited product lines, often to a preferred clientele (oil-and-gas companies, agribusiness concerns, wealthy individuals with leather-bound portfolios, and so forth). A subset of this group are the so-called de novos -- mostly full-service banks targeting narrow geographical areas ill-served by larger lending institutions.
As a low-cost provider, Blackstone is not precisely any of the above. With low minimum deposits and a distinct antielitist bias, it is definitely no boutique. And although it does target a narrow community of borrowers, Blackstone's low-overhead strategy dictates severe restrictions on the product line it offers to depositors. No IRAs or Keogh plans or credit cards. No discount-brokerage or financial-planning services. Not even an on-site ATM, although the bank does belong to a New England-based network with some 20,000 outlets. "Our products are plain vanilla," says Dart. "Money-market accounts, NOW accounts, CDs -- that's it. We call full-service banks 'brokerage houses,' because what attracts their customer base is really investments. We're not looking for investors, just savers. And if a customer needs to transact business with a teller, he wouldn't be happy here.'
On the lending side, Blackstone has a similarly stripped-down look. Specializing in commercial loans to small businesses -- they include developers, an equipment-leasing company, restaurants, and professional offices -- the bank decided to eliminate both consumer lending ("lots of competition on rates there') and asset-based lending ("too complicated, too labor intensive'). Adjustable-rate mortgages are held in-house as attractive investments. Long-term, fixed-rate residential loans, which often pose a higher risk due to interest-rate fluctuations, are routinely packaged and sold into the secondary-mortgage market (Fannie Mae and Freddie Mac). Nothing extraordinary there. So why would borrowers come to Blackstone when they could save a point-plus elsewhere? For one thing, many are unhappy with the service they've been getting at other banks. For another, at Blackstone they don't have to deal with committees or trainees.
"Dan and I are on the loan committee," says Hartman, who after 12 years with the Bank of Boston, managing a $300-million portfolio, relishes the idea of bringing big-bank services to small-business customers. "When we opened, practically everyone I saw had some horror story to tell about dealing with one of the big banks in town. And to borrowers, cost [of a loan] is only one consideration. What's the turnaround time? Can I get a straight answer next week, or am I going to get strung along? In terms of my market, how knowledgeable is this banker? Dan and I don't delegate these decisions. When one of us approves an application, it's approved, period.'
Clearly somebody is happy banking with Blackstone. In a year of operation, the institution grew from $4 million in deposits to $46 million, with an average climb now of $5 million a month. Last April, when its loan portfolio reached the $25-million mark, Blackstone started breaking even; by June, it was turning a tidy profit. Growth is an issue for any business, and banks are no exception. But banks cannot grow simply by generating deposits. They must lend that money out, and profitable lending is a function of knowledge, experience, research -- and philosophy. In many ways, Blackstone's approach is a conservative one. The bank solicits deposits only after the corresponding loan commitments have been written. In other words, it doesn't shovel in the money and then figure out what to do with it later. When deposits threaten to outpace loans, the bank adjusts the balance by lowering CD rates.
"One California bank I know of grew from $10 million to $800 million in the space of 18 months," notes Dart. "When the regulators finally stepped in, 98% of its loans turned out to be nonpaying, and the bank president turned out to be a former dentist. It cost the FDIC more than $1 billion to clean up the whole mess. Bigger is not better.'
And periodontists do not sound loan officers make.* * *
Ever wonder who the most discriminating depositors are? Yuppies with oodles of disposable income? Computer hacks with access to this minute's market rates? Guess again.
"Florida retirees," says Dart. "They sit on the beach reading all the literature on which banks are offering the highest yields. Then they move their money about accordingly. If you can reach them with your numbers, the post office and telephone do the rest.'
Ordinarily, reaching them would be a problem. By law, Blackstone is limited to advertising only in New England. Nevertheless, it currently has depositors in 48 states. How does it pull this off? Free publicity. Week after week, Blackstone's rates on money-market accounts place the bank high up the list of average yields posted by The Wall Street Journal and the newsletter 100 Highest Yields. Both have national circulations. Voilà: coast-to-coast depositors.
By advertising with direct-response coupons in The Boston Globe (which has distribution in Florida), Blackstone also reaches those nimble-fingered retirees. It was a Globe ad, in fact, developed by the Boston firm of Witham, Childs & Siskind, that truly put Blackstone over the top. "No branches, tellers, velvet ropes, marble lobby or toaster ovens," boasted the headline, "just the best rate in the State." Not only did the campaign win praise from the trade industry (AdWeek mentioned it in a piece on the bank last February, and Bank Marketing named it January's Bank Ad of the Month), but it also drew an astonishing response from customers. In one week, $4 million in new deposits came in, quadrupling the expected $1 million windfall.
Marketing to its other customer base, borrowers, is more a one-on-one proposition. "The community knows we're here," says Hartman, who has pulled in a number of former Bank of Boston loan customers herself. "When Dan and I were out selling stock, we spoke to a lot of groups and met other people socially. Our best marketing tool is basically word of mouth -- customers referring other customers. We probably get two or three refugees from big banks in here every week.'
Keeping overhead down has its risks. By locating outside Boston's financial district loop, Blackstone pays a certain price in terms of lost prestige and visibility. In Dart and Hartman's view, they more than make up for that by paying a modest $21 a square foot for office space, versus up to $40 per square foot downtown (they hold a five-year lease on their current site). Blackstone's monthly operating costs, including rent, insurance, computer time, salaries, benefits, and the like, comes to about $100,000. It incurs no costs from branch banks. By way of contrast, New England's two leading lending institutions -- the Bank of New England and BayBanks -- have 486 and 222 branches, respectively. Big nut, big difference in profitability.
Given Massachusetts's tight labor market, another concern of Blackstone's founders was attracting qualified help. They started with 10 employees and have added 3 more -- with room for an additional 13 as the need arises. The hiring problem was solved through a combination of job flexibility and competitive compensation. Blackstone pays half again as much as a starting teller's salary for its account executives, puts its small staff of loan originators on commission, and provides equity kickers for key management people (5 bank officers in all). The bank has no chief financial officer and no secretaries -- if Dart wants to send out a letter, he types it himself. Three employees are working mothers, one of whom does bank work on a part-time basis.* * *
Blackstone started looking for capital in the summer of 1986, a go-go season for bank stocks. Hartman and Dart initially offered 400,000 shares of common stock at $10 per share, with the stated policy that dividends would be forsaken for retained earnings. According to Dart, lending institutions were going public at "outrageous multiples" that summer, creating the impression among potential investors that they could make a quick killing trading in new-bank issues. Because they understood that equity turnover often resulted in management turnover, the founders set forth a strategy that would minimize their own risk of being tossed into the street.
"Our personal goal was to be able to manage the bank over the long haul," Dart explains. "It was really nonspeculative in nature. We wanted to sell the stock ourselves, but we also wanted a diversified group of [investors] who shared similar investment goals, who were willing to let the bank grow with us. We probably could have found three or four investors who wanted to kick in $1 million each, but instead we deliberately went after a much broader base.'
Over a six-month period, Dart and Hartman succeeded in lining up 90 buyers, at an average investment of about $50,000 apiece. Some were friends, some movers and shakers in local communities. No investor was allowed to purchase more than 15% of Blackstone's equity. At the same time, written into the bank's bylaws were several antitakeover provisions. One specified that any move to unseat a director (board terms are staggered over three years) would require a two-thirds vote of the board. Another, termed a "poison pill" provision, allows the bank to issue preferred stock to current shareholders. A third states that in the event 10% or more of the bank's outstanding stock is sold, that block of shares cannot be voted.
Advised by their attorneys that such restrictions could make it difficult to market their offering, Dart and Hartman stuck to their guns. Yes, they'd invested personal savings jointly to the tune of about 15% of Blackstone's equity. No, they were not looking to cash out soon. Or, for that matter, to feel pressured by one or two investors to take the money and run.
"The problem with taking it and running," explains Hartman, "is what do we do next? Start another bank? Retire? Even on my worst days, that has no appeal.'
The capital needs of lending institutions do not, of course, remain static for very long. By federal law, banks must maintain a 6% capital-to-assets ratio (the ratio of thrifts is only 3%). Otherwise, the regulators fear, a bank can weaken its capital base to the point that a rash of nonperforming loans could wipe it out. That's especially true in today's shaky banking climate, where the vagaries of local economies (the Texas oil industry, to cite one dramatic example) can shred a portfolio.
As Blackstone approaches $60 million in assets, therefore, another round of capital will soon be called for. Three options are currently being contemplated: issuing more common stock; creating a class of preferred stock; and floating subordinated debt, convertible to common stock. Whichever route they take, the founders know that they will draw the regulators' close scrutiny. Already they've been audited twice in the past year.
"If one bank fails because its capital-to-assets ratio falls too low," notes Hartman, citing the example of one Texas bank used as a personal piggybank by an unscrupulous developer ("You supply the dirt," went its slogan, "and we'll supply the green'), "the regulators come into yours next and set the ratio at, say, 10%. They can't hold you to that legally, but they can make life tough if you don't comply. Taking out the systemic abuses on the next guy may seem unfair, but that's the way the game is played.'
Which is not to say that community banking is a no-risk proposition for Blackstone. At $5 million in growth per month, the danger of burnout is real. Macroeconomic issues aside, bad loans could result from management's inability to scrutinize each application thoroughly enough. And then there is the question of whether Dart and Hartman can maintain their personalized approach to customer service without working 14-hour days -- never mind bankers' hours.
"The two main asset-management issues are interest-rate risk and credit risk," explains Dart. "Credit risk -- borrowers being unable to meet loan obligations -- is a fact of life with small-business customers, because growth companies don't always manage their finances well. Interest-rate risk arises when what you pay depositors exceeds what you make off investments. Because we're not burdened with a lot of long-term, fixed-rate investments, we believe that risk is minimal.'
Dart concedes that New England's move toward interstate banking could open up the playing field soon. As more banks are bought up and consolidated, he figures, more small-business customers will fall through the cracks. And that will open up further opportunities for low-cost/high service providers like Blackstone.
"We're operating in a $3- trillion industry," he points out. "To get hung up on market share would be dumb. All we're looking for is a solid reputation in our community and a profitable niche in our marketplace.'
Plus a nice chunk of those Florida retirees.
The company: Blackstone Bank & Trust Co., Boston
Concept: Create a small, low-cost community bank, offering high rates to depositors and personal service to borrowers
Projections: Assets of $115 million by June 1990, with return on equity of 21%; income per share of $0.21
Hurdles: Maintaining a stable deposit base while soliciting price-sensitive, mobile deposits; keeping loan quality high and contact with borrowers frequent as the funds that need to be loaned grow rapidly
Blackstone Bank & Trust Co. Operating Statement
June 1988 June 1990
Interest and fees from loans $344,000 $1,121,681
Interest on investment securities 82,000 108,100
and federal funds
Noninterest income 16,000 25,000
Total revenues 442,000 1,254,781
Cost of revenues
Interest paid on deposits 224,000 698,625
Provision for loan losses 58,000 30,000
Total cost of revenues 282,000 728,625
Gross profit 160,000 526,156
Salaries and employee benefits 52,000 90,000
Rent and utilities 8,100 16,200
Office services 13,800 27,600
Furniture and computers 12,100 24,200
Marketing and PR 10,000 20,000
Miscellaneous 20,000 40,000
Total operating expenses 116,000 218,000
Net pretax income 44,000 308,156
Provision for taxes 0 104,773
Net income 44,000 203,383
Income per share 0.10 0.21
Blackstone 6/90 Industry
6/88 (projected) Average*
Total assets $44.5 mil. $115.0 mil. $83.3 mil.
Total deposits 34.1 mil. $103.5 mil. $74 mil.
equivalent) 13 18 52
Return on average assets NA? 2.57% 0.86%
Return on average equity NA? 21% 10.54%
Interest-rate spread 3.62% 3.76% 3.86%
*Averages for all U.S. commercial banks in the $50-million to $150-million asset range. ?Not available.
Source: Veribanc Inc., Wakefield, Mass.
Ann O'D. Hartman, 37, senior vice-president and chief lending officer
Daniel J. Dart, 32, president and chief executive officer
Ann Hartman graduated from Smith College in 1973 and immediately joined Bank of Boston as a management trainee. Ten years later, having served as a loan officer for, among others, Bill Rodgers's running-clothes company ("Heartbreak Hill," April), she was elected a vice-president in commercial lending. Her interest in small-business customers convinced her that a new era in banking signaled a new career opportunity for herself. "There's an aura about starting a bank," Hartman admits. "People would hear what Dan and I were doing and faint away. Most had no idea how banks work -- nor any desire to learn.'
Dan Dart did. At State Street Bank, Dart had risen to the position of vice-president of marketing of the mutual-funds services division when he hit the proverbial wall. Eager to develop an insurance strategy at the bank, he instead was spending most of his time troubleshooting for unhappy mutual-fund customers. The more displeased clients he saw, the more turnover he had to deal with among bank personnel. At the same time, Dart recognized that the distribution system for mutual funds (primarily phones and mail) made sense for the low-overhead, high-yield banking profile suggested by industry deregulation. A call to the Massachusetts State Banking Commission in November 1985 gleaned the necessary information on how to start a bank of his own. Dart was encouraged to get in touch with another young banker who understood the local market: Ann Hartman.
"We found we shared similar backgrounds, philosophies, and ideals," explains Dart. "The more we talked, the more we realized what a good fit this could be.'
WHAT THE EXPERTS SAY
CARL J. SCHMITT
Founder, chairman, CEO, University National Bank & Trust Co., a small, eight-year-old bank in Palo Alto, Calif. Former head of California State Banking Department
What Hartman and Dart are doing is the Schwab approach -- raising deposits not on the quality of service, not on building loyalty, but on brokered deposits: nonloyal, price-sensitive, broad-based accounts. And they even say they're going to regulate how much business they get merely by adjusting their interest rates to turn the spigot off and on.
That's OK, as long as they know that when rates start moving away from them, they'll have to chase the deposits with price -- and when that happens, they'd better have a variable loan portfolio. Because if they're having to chase deposits on price, then costs are going to be moving up based upon the credit market. For example, when prime is at 21%, the six-month T-bill might be at 18% -- and you might be paying 18% to your CD customers. If you had taken your deposit base in former months and put it into fixed-rate mortgages at 10%, you'd be 8% underwater -- a gross negative spread.
That's the classic problem of many banks: they get into a position of lending long and covering short. Much of our industry has passed off the rate risk and ignored it, based on doing variable-rate mortgages. That's fine, but those mortgage rates are not as variable as the deposit side is; typically the variable-rate mortgage has an annual cap of 2%, and we have seen periods in which the deposit interest rates have run up more than 2% -- which means you can still get your spread squeezed.
If the deposit side of banking is science, then the lending side is art. There's no reason Blackstone's strategy can't work. You can get a little higher price by providing service on the loan side, there's no question about that.
Is Blackstone a riskier bank because it's going into traditionally redlined areas? Absolutely not. The risk is in the quality of the lenders. If they're good lenders and good loan officers, and they know how to structure and read the community, it will probably be less risky than many major Boston banks that have got large portfolios in South America, in tankers, and in the oil patch. It's that simple.
I like their concept, but it will be three to seven years before we'll know how well they'll do, because we'll need to see how well they'll manage their loan portfolio. That's the Achilles' heel, and the main question mark.
KENDRICK BELLOWS JR.
Founder and chairman, The Burlington Bank & Trust Co., a community bank in Burlington, Vt., due to open shortly; formerly CEO of Bank of Vermont
It's a tough thing to perpetually chase money with high rates, but they're doing it.
On paper they've got what appears to be pretty hot money -- money that, because it's been wooed in at a high rate, could leave. If someone else's rates go higher, some portion of those deposits will shift. They may be hedging against that by running at a somewhat lower than average loan-to-deposit ratio (average in my terms would be something around 90%). They're more like 70% to 75% -- though it's hard to say for sure, given that they're in a growing business. On the surface that appears to manifest some concern with what we call liquidity -- the possibility that some segment of those hot funds could be withdrawn. They would be wise to keep that loan-to-deposit ratio lower than average.
One of my concerns for them is that, as they grow, they'll lose that close contact with customers, which is one of the harbingers of loan difficulties. They've really got to project their personalities and their experience. If you're paying attention, you don't get surprised very often. The bigger banks tend to build layers, and those layers are like walls between customer and decision-maker. I think that's more often the cause of loan payment difficulties than is the underlying character of borrowers. The same borrower will be a better borrower at a small bank than at a big bank; the difference is contact with the decision-maker, and the advice and counsel of the banker/manager.
I don't see much risk in competition from larger banks. I think larger banks will regard Blackstone as sort of a gnat for a long time to come, and gnats don't do much to elephants.
Their numbers suggest that they're growing faster in asset terms than in profitability terms. That's not unusual, but they're 18 months ahead of their asset forecasts and just about on target for profitability, which suggests that their margins aren't quite what they hoped they'd be.
I think they've got a good chance of making it. Time will tell. They may need some capital. They're running around 8% on capital-to-assets, which in the big picture is OK. But they may get some regulatory pressure to raise additional capital, in part because of their dependence on high-rate purchased money, and in part because of the nature of the loans they're making -- questions about loan quality.
Professor, Boston College School of Management; teaches strategic management of financial institutions
The big issues will be how quickly Blackstone wants to grow, and how it will ensure that it's managing that growth. It's amazing to see repeatedly how banks can't resist the temptation to get big -- which adds to costs. With Blackstone I don't think it's a question of how big is too big as much as ensuring that as it grows, a gap does not develop between the size of its loan portfolio and its deposit base. As the bank grows,