Building Loyalty Through Second-Chance Checking Accounts

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N early 80% of American financial institutions use ChexSystems, a national database of consumer checking history, to determine whether an applicant should be allowed to open an account. If an applicant 9s name appears in the database, it means he or she has had an account closed sometime within the past five years 4and that alone is reason enough for banks to deny an application. But, as some critics have pointed out, the database provides scant detail regarding the reason an individual 9s account may have been closed, and is there- fore a poor tool for assessing risk.

Was it overt check fraud? Identity theft? A modest overdraft that piled up?

For the estimated seven million people whose names appear in ChexSystems, the reasons matter little. It simply means they are shut out of the financial mainstream. Giving the Unbanked a Second Chance 1 ChexSystems emerged as the industry standard for the simple reason that it does a good job in helping financial institutions to minimize risk.

But there 9s also a significant downside. Because it offers few details on an individual customer 9s past, the system thus does a poor job of assess- ing the quality of risk an individual customer might ... more. less.

pose. The way banks use data is even more capricious. A 2000 bank survey by the Greenlining Institute found wide disparities in the criteria that banks used when reporting customers to ChexSystems. Some banks reported customers to ChexSystems for overdrafts of $100 or more, though others set the limit at $35. One bank gave customers 30 days to rectify an overdraft while another waited 60 days. In recent years, financial institutions have begun rethinking how they use ChexSystems. In 1998, a coalition of financial institutions, credit unions, and social service agencies came together to form cGet Checking, d a national financial education program designed specifically to help consumers establish a primary banking relationship and gain access to mainstream financial services. Today, 164 financial institu- tions with 4,700 branches now participate. Five years ago, Bank of America announced it was relaxing its guidelines. Second-Chance Accounts | 6.1 SHAPING BETTER CUSTOMERS: Building Loyalty Through Second-Chance Checking Accounts CHAPTER SUMMARY PRODUCT/STRATEGY DEFINITION 4 Second-chance checking accounts are bank accounts for customers who are listed in ChexSystems, a national database of consumer checking history. By using financial education and monitoring, financial institutions are able to lower their exposure to risk. (Some second-chance accounts restrict account activity, as well as transactions.) The expectation is that new customers will transition into mainstream banking. CRITICAL SUCCESS FACTORS 4 Institutional commitment. Board and staff must be committed to understanding why a potential customer is unbanked. And, they must build an infrastructure that offers the guidance and trust necessary to help customers develop banking skills and habits. Customers need to value and maintain an ongoing relationship with a depositary institution. Right products. Institutions need low-fee, low-risk starter products that bring customers into the institution 4but in a controlled way. Monitoring. Second-chance account customers often overdraft, almost always accidentally. Institutions need systems to catch overdrafts early, and protocols for contacting customers to work out payment options and to help them avoid future overdrafts. Outreach strategy. Customer development strategies need to educate and build trust among customers, as well as ensure a steady flow of new customers. Partnerships with community organi- zations are an ideal vehicle to build this market. INSTITUTIONAL FIT 4 Second-chance accounts are a good fit for institutions in communities 4or those entering new communities 4where there are substantial numbers of formerly banked individuals. Second-chance accounts are one way to serve the market. Washington Mutual and Wells Fargo followed suit, announ- cing plans for a pilot project in Oakland that would give an account to anyone within ChexSystems as long as he or she had not committed outright fraud. But, what goes into a successful second-chance checking account product? How can banks minimize risk while accept- ing more applicants? What kind of support, monitoring, and financial education do second-chance customers need? This chapter explores the second-chance account program developed by Legacy Bank, a $108 million African American- owned state-chartered commercial bank in Milwaukee, Wisconsin. Originally developed as a product for customers who had never had a bank account, Legacy Bank 9s Financial Liberty First Accounts morphed into a second- chance account after realizing that many of the ostensibly unbanked customers were, in fact, cunder-banked d 4they once had accounts but closed them for any number of reasons: overdrafts, high fees, dissatisfaction with customer service, etc. Working through a network of partnerships with community-based welfare-to-work agencies and the childcare industry, the Financial Liberty First Accounts combine financial education, outreach, and scrupulous monitoring to make sure customers stay solvent. This ctech- meets-touch d approach has proved remarkably effective in attracting and retaining low-income customers. Since launching the Financial Liberty First Accounts in 2002, Legacy Bank has opened 1,800 accounts through the third quarter of 2005, over 1,000 of which are still on the books. Product and Strategy: Minimizing Risk and Maximizing Opportunity in Second-chance Checking Accounts Given ChexSystems 9 inability to differentiate among customer histories, might there be better ways of assessing and mitigating customer risk? These are the questions Margaret Henningsen, one of Legacy 9s three co-founders, set out to answer in designing the Financial Liberty First Accounts. In 2002, Legacy Bank was selected as one of 15 institutions nationwide, and the only bank, to receive a grant from the Treasury Department 9s First Accounts program, which sought to develop commercially viable products for the unbanked. At the time, Legacy 9s loan port- folio included small-business loans to childcare providers, home-based businesses that had proliferated in the wake of Wisconsin 9s ground-breaking experiment in welfare- to-work. In the late 1990 9s, Wisconsin 9s work-first require- ments created a surge in demand for childcare services as thousands of single mothers entered the workforce. Childcare centers were also one of the few viable businesses that former welfare recipients could own. An estimated 75% of former welfare recipients were also unbanked. Henningsen saw an opportunity to bring former welfare recipients into the financial mainstream while also developing a new customer base for her bank. cA lot of the women who were starting these childcare programs were unbanked, d Henningsen says. Some had never had bank accounts, but many more had blemished credit histories. cAs we looked at their history, we found that few of them had committed fraud, d Henningsen says. cIn many cases, they had bounced a check or two and landed themselves in ChexSystems. d In 2002, Legacy Bank rolled out three Financial Liberty First Accounts products. There is a checking account with a debit card, which carries some restrictions (a good history with the bank, no overdrafts, and direct deposit); a savings account with an ATM card; and, a money market checking account with no debit card and a minimum balance of $100 to open and maintain the account. The first two types require a $10 minimum to open an account, but there is no minimum balance thereafter. The accounts have no monthly service charges, unlimited checking, and unlimited ATM transactions. But what distinguishes the 6.2 | RFSI Strategy Guide Financial Liberty First Checking Account Features " Non-interest-bearing " Direct Deposit Available " Minimum to open is $10 " No monthly service charges " Unlimited check writing " No minimum balance requirement " Unlimited ATM transactions " ATM card available " Debit card available " Statement sent monthly Financial Liberty First Accounts from similar products is the supporting structure Legacy has established to make the accounts sustainable. On one hand, there is the high-touch component. As an institution, Legacy is committed to serving low-income customers, and its corporate culture emphasizes the importance of personal banking relationships. The bank has established long-term partnerships with local social service agencies and childcare centers, allowing the bank to attract and educate low-income consumers, including a high percentage of formerly unbanked customers. On the other hand is the technology component. Legacy set up the Financial Liberty First Accounts as a separate bank branch, a simple step that allows the bank to monitor account activity and intervene quickly when problems crop up. Operations: Using Technology to Minimize Risk Henningsen recognized from the outset that Financial Liberty First Accounts holders would need a little more hand-holding than regular customers. Setting up the Financial Liberty First Accounts as a separate branch allows the bank to monitor overdrafts, analyze patterns, and intervene early. Using the bank 9s data processing system, Henningsen can get daily reports on all of the accounts. In most cases, overdrafts occur when customers misjudge the timing of deposits and withdrawals. A customer will make a deposit and immediately write a check before the deposit has cleared. Henningsen established an account monitoring team, which includes personal bankers, customer service representatives, members of the finance department, and Henningsen herself. If the team notices a pattern 4for instance, a customer bouncing a check on the same day in successive months 4Henningsen will pull the customer 9s account application and contact him or her. This combination of tech-meets-touch has gone a long way toward reducing overdrafts. cIf they 9re bouncing a check on the same day every month, it usually means they are writing a check on the day a direct deposit happens but before the deposit clears. d Though there has been some fraud, the bank 9s internal system has managed to minimize it. Under the bank 9s deposit rules, customers have access to only $100 until the check clears, so if a customer deposits a blank envelope in another bank 9s ATM (Legacy 9s machines do not accept deposits as a fraud-protection measure), the bank 9s expo- sure is minimized. In other cases, a customer will deposit a check from a third party, which will then bounce. In these cases, customers get a second-chance. Either way, Legacy is quick to close fraudulent accounts. cIf someone tries something like that, they are gone, d Henningsen says. By and large, however, the combination of close monitor- ing and individual outreach with troubled account holders has proved remarkably effective in minimizing fraud and overdrafts. In fact, a recent analysis of Financial Liberty First Accounts versus the bank 9s regular checking accounts revealed that the Liberty First Accounts were actually out- performing the others. In the three years that the program has been up and running, balances have increased 4a sign that the lessons of Legacy 9s financial education courses are finally sinking in. The bank also has a stringent early intervention policy. If a customer overdrafts more than three times, he or she is required to take a remedial financial education class. This combination of intervention and education has sharply reduced overdrafts. In class, customers learn about the penalties of criminal fraud, a lesson that usually scares them straight. (By contrast, Henningsen notes that 75% of customers who overdrafted had not been to class.) Slowly but surely, the bank has seen the number of over- drafts decrease. Partnerships: Local Networks Support cHigh Touch d Education and Counseling As important as Legacy 9s high-tech tools are, the bank 9s second-chance account strategy depends on the bank 9s ability to provide high-quality, on-going financial education and counseling to higher-risk customers. The unbanked typically face a number of intertwined obstacles to entering the financial mainstream. Foremost, most low-income families live paycheck-to-paycheck, leaving little room for financial error. Many have had negative experiences with banks and credit unions, accruing overdraft fees and minimum balance charges. Many are suspicious of banks, having been burned before. Conversely, most potential customers lack fundamental financial literacy: how checking and savings accounts work, how to budget, how to avoid Second-Chance Accounts | 6.3 overdrafts, how to save. Finally, because their financial lives are so rocky, the unbanked tend to move around more than customers with stable finances, making them difficult to reach through conventional marketing and outreach. Legacy has addressed the need for high-touch customer relationships by cultivating partnerships with community- based organizations whose clients constitute Legacy 9s target market: low-income people, former welfare recipients, and the unbanked. Most of the bank 9s partners are agencies that have contracts with the state 9s welfare-to-work program. The other partners are childcare providers, an industry that overlaps with welfare-to-work. Legacy 9s network includes 20-25 different community organizations. As of this writing, however, the bank was working closely with 11, teaching weekly, monthly, or quarterly financial education courses. Community partnerships have helped Legacy overcome three important barriers: financial illiteracy, market penetra- tion, and a lack of trust among customers. Welfare-to-work agencies and childcare centers are one-stop shops for customer acquisition, allowing banks to save on marketing and outreach while providing the core services 4education and counseling 4that make better customers. Obliged to attend work-readiness classes by the state 9s welfare-to-work laws, customers are essentially a captive audience. Welfare- to-work agencies, in particular, also have the infrastructure in place to do counseling, education, and outreach. By inserting itself into the welfare-to-work curriculum, Legacy is able to educate its customers and build trust. For sheer numbers, childcare agencies were a particularly fruitful entry point because both caretakers and parents were former welfare recipients. With over 100 children in some of the centers, childcare agencies represented a huge, untapped niche market. Partner agencies 9 staff members are eager to reinforce the lessons that Legacy Bank teaches. As Henningsen notes, cPartnering is like having extra employees. They serve as my eyes and ears. d Henningsen teaches the financial literacy classes herself, but agency staff members play a central role as well 4reinforcing the lessons, talking up the importance of banking, and lending a stamp of approval to Legacy 9s name. From the agencies 9 side, the partner- ships with Legacy have helped to improve client outcomes. cDeveloping relationships with social service agencies was the easy part, d Henningsen said. cThey view this as addi- tional service to their clients. d As clients 9 finances improve their lives become more stable, and they are more likely to stay employed. 6.4 | RFSI Strategy Guide LEGACY BANK 9S HIGH-TOUCH/HIGH-TECH SECOND-CHANCE ACCOUNT MODEL " Trusted Institution d " Knows Customer Needs " Corporate Culture Emphasizes " Personal Banking " Captive Audience " Reinforce Financial Education " Liberty Accounts Branch Coded " Regular Monitoring " Individual Account Analysis Legacy Bank Tech Meets Touch " Partners provide access " Bank builds high-touch relationships through education, counseling, personal banking " Technology offers monitoring and analysis " Lower Risk " Customer Loyalty " Asset Development " Migration and Profit Local Agency Partners Technology = early intervention monitoring trust education customers In some cases, having a bank account actually helped clients land jobs. One of Legacy 9s partners is a welfare-to- work agency called Maximus, which focuses on getting former welfare recipients ready for the workplace. But the agency found that otherwise qualified and work-ready clients still struggled to find jobs. The reason was tragically simple: The prospective employers paid through direct deposit, and without a bank account the agency 9s clients would never be hired. Through the agency 9s partnership with Legacy, clients could now tell prospective employers that the bank will open an account for them if they are hired. Since making this change, the number of clients who get turned down for jobs began to decrease. Direct deposit also helped keep clients in class 4a crucial benefit for welfare-to-work agencies whose pay-for-perfor- mance contracts with the state have stringent attendance goals. At the beginning and end of every month, Henning- sen noticed something strange about her class. cInstead of talking to 30 people, I 9d be talking to two, d she says. It was payday, and students were down at the agency offices picking up their checks, or at home waiting for them to arrive in the mail. Since welfare-to-work programs sanction clients who don 9t attend classes, direct deposit put more money in clients 9 pockets by helping them stay in class. cThere was a direct correlation between direct deposit and attendance, d Henningsen says. Helping clients stay in class was an important feature for welfare-to-work partners and an added incentive to partner with Legacy. Though Legacy 9s community partnerships have paid off handsomely in the long-run, they required only a modest investment of time and effort to get up and running. Because of Henningsen 9s existing relationships with agency staff members, the concept of partnership was never a difficult sell. Developing curriculum, setting up classes, scheduling 4all the nitty-gritty operational details 4was more labor intensive. Henningsen estimates it took her a month working full-time to get the program off the ground and another month working half-time. She held group and individual meetings with representatives from 35 childcare providers. Legacy 9s tellers and personal bankers were also involved in start-up marketing. In all, one month of up-front investment has yielded a steady stream of customers, and provided the infrastructure needed to service them. Marketing, Outreach, and Customer Relations: Building Personal Banking Relationships Thanks to its strong community partnerships, Legacy has had to do little formal marketing. Most of the marketing has come through community partners, and Henningsen estimates that nearly a third of the new accounts now come through word-of-mouth referrals as second-generation customers and graduates of the welfare-to-work agencies tell their friends and families. As word got out among social service agencies, other institutions began inquiring about forming partnerships as well. Much of Legacy 9s success is rooted in its long-standing institutional mission to serve the unbanked, a commitment that resonates with potential customers. Beyond the Financial Liberty First Accounts, over a third of Legacy 9s overall staff time goes into reaching the unbanked through classes, new accounts, monitoring, and account admini- stration. cWe educate all of our customers, d Henningsen says. cWe believe that if we provide old-fashioned banking services one customer at a time, at some point, they will become profitable. d This high-touch banking relationship has also led to a better product. First Accounts initially required an opening minimum balance of $100, but the bank soon realized that few customers could afford the short-term restriction in their cash flow, even though they could get the money out in a couple of days. When Legacy dropped the mini- mum balance requirement to $10 the accounts took off. In response to surging customer demand, the bank hired a third personal banker. cThese customers are high- maintenance, d Henningsen says. cBecause they trust us, they come in to ask about other financial issues 4credit cards, home loans, or major purchases like cars. d Performance & Outcomes: Investing for the Long-Term Henningsen readily concedes that Financial Liberty First Accounts are not profitable as a stand-alone product 4 but adds that checking accounts rarely are, regardless of the market segment. On the other hand, First Accounts have proved less expensive in the short-term. According to an internal analysis, monthly losses for the First Accounts program were 15% lower than losses for other accounts. Second-Chance Accounts | 6.5 Legacy 9s second-chance banking accounts have helped cement the bank 9s reputation as an industry leader in serving the unbanked. Henningsen 9s calendar is crowded with speaking engagements, and she was recently approached by the British consulate in Chicago for her advice on a similar national program currently under devel- opment in the United Kingdom. The bank has won awards and grants from private foundations and government agencies, including a pair of Treasury Department Bank Enterprise awards totaling over $1.1 million. This acclaim has translated to the bottom line. Over the years, the bank 9s mission has attracted over $5 million in deposits from foundations, corporations, religious orders, and other financial institutions. The national recognition that Legacy received for being one of the most successful First Accounts programs in the country also brought a long-sought deposit of $8 million from the City of Milwaukee. Legacy was also the recipient, in partnership with the Wisconsin Housing Economic Development Authority (WHEDA), of $100 million in New Market Tax Credits, which will allow the bank to leverage $300 million on behalf of its broader mission. In any case, Legacy regards its second-chance customers as long-term investments. Over the past two years, customers have started moving to higher-margin products like loans, savings accounts, and certificates of deposit. But, the main benefit has been in increased customer loyalty, which will pay off in the future as more customers migrate. cPeople who are given a second-chance are some of our best customers, d Henningsen says. cThey are incredibly loyal. d 1 Parts of this chapter are adapted from Carlson, Neil, cCapital Ideas, d Ford Foundation Report, Fall 2004. http://www.fordfound.org/ publications/ff_report/view_ff_report_detail.cfm?report_index=526 2 Barr, Michael, cAccess to Financial Services in the 21st Century: Five Opportunities for the Bush Administration and the 107th Congress, d (Washington, DC: Brookings Institution, 2001). 6.6 | RFSI Strategy Guide

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