Carving a niche
Commerce Bank emphasizes service over price in pursuit of consumers

by Jack Milligan
for Virginia Business
February 2006

When Cherry Hill, N.J.-based Commerce Bancorp jumped into the cutthroat New York market four years ago, some industry skeptics predicted that Commerce’s cheerful service would bomb with Manhattan’s hardboiled consumers. Well, fagedabouitit! It turns out that even cynical New Yorkers appreciate friendly treatment just as much as anyone else, and the bank’s expansion into the Big Apple and nearby Long Island has been a stunning success.

“New York City and Long Island — four years ago we had no stores there,” boasts Vernon Hill, the bank’s chairman and CEO. “Now we have 71 stores with $7 billion in deposits — all taken from our competitors.” By Commerce’s own estimate, it has a 2.9 percent share of the deposit market in metropolitan New York.

Hill runs what may be the best publicly owned consumer bank in the United States, and its next target is Northern Virginia and Washington, D.C. — one of the fastest growing regions in the country. It is not a market that lacks for banks: Several large ones are already here, including Bank of America Corp. and Wachovia Corp., both based in Charlotte, N.C., and Pittsburgh-based PNC Bank Corp. But none possesses a dominant market share, and Hill has competed successfully against many of the same banks up north. “[Hill] has done very well,” says research analyst Gary Townsend at Arlington-based investment bank Friedman Billings Ramsey Group. “He has taken share from all of them. If I was a banker and Commerce was coming into my market, I’d be busy studying what they’re doing even though I might not be able to replicate it.”

Commerce, which bills itself as “America’s Most Convenient Bank,” competes on service instead of price, a strategy that few of its competitors have been able to copy. As of late December the bank had opened six locations (Commerce calls its branches “stores”) in Northern Virginia and one in the District, with approximately 15 additional openings slated for 2006. Ultimately the company intends to build a 200-office network throughout the Washington area, including the Maryland suburbs.

Hill had considered expanding to Boston instead — and will do so eventually — but chose to move into Northern Virginia first because it’s closer to Commerce’s home base in New Jersey, and also because there’s more land available for the bank to build freestanding branches, which it prefers. It also may not hurt that Hill grew up in Vienna and knows the region well. The company opened its first Northern Virginia branch last June in Manassas.

In an industry that often seems to value conformity over innovation, $36 billion-asset Commerce has been an iconoclast from the beginning. Hill considers the company to be a “growth retailer” instead of a bank and likes to tout the following performance numbers: During the past five years, Commerce’s deposits have risen 37 percent, net income is up 34 percent, and earnings per share have increased 24 percent. During investor presentations, Hill is more likely to compare Commerce to Starbucks, Wal-Mart and Home Depot than his banking rivals. Most banks saw their financial results suffer somewhat in 2005 because of interest rate tightening by the Federal Reserve, which squeezed profit margins. But Commerce still managed to turn in an impressive performance through the first nine months of the year: Revenue grew 18 percent, to $1.19 billion, while net income expanded 19 percent, to $236 million.

Because Commerce is more successful at generating low-cost consumer deposits like checking and savings accounts than most other banks, it doesn’t have to bid as aggressively for loans as many of its competitors. This helps its profitability over time because it tends to limit loan losses. As of Sept. 30 of last year, consumer and commercial loans made up only 30 percent of Commerce’s assets. Most of the balance was made up of highly rated mortgage securities and various kinds of government obligations.

Commerce draws much of its character from Hill, who founded the bank in 1973 after getting an MBA from the Wharton School at the University of Pennsylvania and putting together a property company that developed commercial sites for major retailers like McDonald’s. Hill started with just one bank branch. Today he has a network of 371 branches stretching from southern Connecticut to Virginia, with a seven-branch toehold in West Palm Beach, Fla. By 2009, Hill expects to nearly double that number to about 700 offices.

Contrary to the strategy of virtually all of its major competitors, Hill has chosen to grow by opening new branches rather than through acquisition. It is an expensive strategy. Townsend estimates that Hill — who tries to select the most desirable locations — spends $4 million to $6 million to open a new branch. But the real economics of Commerce’s branch banking strategy comes down to how quickly it can cover that sizeable investment by generating deposits and putting that money to work, either by lending it out or investing in higher yielding securities.

A recent Friedman Billings study of 19 regional banks, including Bank of America, Wachovia and PNC, showed that Commerce — at 18.4 percent — had the fastest same-store deposit growth over a 12-month period from June 30, 2004 to June 30, 2005. (Every year banks are required to report their deposit data to the Federal Deposit Insurance Corp. as of June 30. Using this data, Friedman Billings measured the year-over-year deposit growth in branches that have been open for at least two years.) Hill has told analysts like Townsend that his new branches generally cover their costs within 12 to 18 months. There is no way to verify this independently since Commerce does not provide profit and loss data for individual branches. But Townsend finds the statement credible because over a five-year period ending June 30, 2005, Commerce grew its median branch deposit size — at 13.2 percent compounded — significantly faster than any of the other 18 banks in his study.

Although Commerce recently paid $100 million for a small community bank in Florida that will serve as a platform for its expansion there, Hill is not a big fan of the merger wave that has swept through the banking industry in recent years. He believes that service quality always suffers when banks try to combine their operations, and frequent acquisitions also make it exceedingly difficult to build a consistent culture. Instead, Hill has tried to develop a highly standardized retailing concept that can be easily replicated in new markets.

Hill is confident to the point of being cocky, but he has earned respect throughout the industry for building a successful bank that isn’t afraid to be different. “It’s as far from being me-too banking as you can find in America — and perhaps in the world,” says noted consultant James McCormick, president of First Manhattan Consulting Group in New York. Adds McCormick, who has studied Commerce’s business model closely, “They’re gaining a lot of market share. Their performance has been extraordinary.”

There are several other characteristics that set Commerce apart from most other banks — including those it will be competing against in Northern Virginia. In its emphasis on service quality over price, Commerce won’t offer the highest rates on certificates of deposits or rock-bottom rates on mortgages, but customers will be treated well. During a recent visit to the bank’s location in Manassas, a concierge greeted visitors at the door and directed them on where to go for various services. The facility is bright and colorful, and everyone seemed, well, cheerful. Tellers can have bad days just like anyone else, of course. But Commerce tellers are taught to be pleasant and to maximize the service opportunity. One of Hill’s favorite mantras is to “hire for attitude and train for skills.”

Brian R. Monday, a senior vice president and manager of the bank’s metro Washington market, joined Commerce last year from Atlanta-based SunTrust Banks Inc., which also has a sizeable operation in Virginia. Monday describes the Commerce culture as “empowering.” Employees are expected to help customers solve problems at the point of service rather than pass the buck to a supervisor or turn down a request because it’s against the rules. “They’re taught to make a decision right then and there and solve it,” he says. “We say, ‘Look, don’t say no if there is any way you can help someone.’”

Commerce reinforces this service concept through its “Wow!” program, which recognizes and rewards employees for acts of unusually good service. Every year the company hosts its annual WOW! Awards at a major venue on the East Coast and brings in thousands of employees. Last year’s one-day event was held at Radio City Music Hall in New York and was attended by some 6,000 workers.

Commerce defines good service in a number of other ways as well. Like most retailers, all Commerce branches are open seven days a week: 7:30 a.m. to 8 p.m. Monday through Friday, 7:30 a.m. to 6 p.m. Saturday and 11 a.m. to 4 p.m. Sunday. Monday says that managers are encouraged to open 15 minutes earlier and close 15 later than Commerce’s official times to further accommodate customers’ busy lives. “The last thing they need is to worry about fitting their schedules to the bank’s hours,” he says. The bank also offers free personal checking and will reimburse its customers for up to 10 transactions a month when they are charged a fee to use another bank’s automated teller machine. It even has coin-counting machines in every branch lobby that are free to the public.

Commerce also has assembled a team of 35 experienced commercial loan officers who will focus on the business market in metro Washington — with particular emphasis on government contractors and professional associations, two staples of the region’s economy. Monday says that, because he is responsible for all of Commerce’s activities in the region, Commerce’s consumer and commercial banking efforts should be better integrated than most of its competitors, which often are managed by product lines.

Commerce’s success in penetrating the tough New York market is proof that in consumer banking — where most banks have traditionally operated on a take-it-or-leave-it basis — service sells. And because Commerce has already competed against Bank of America, Wachovia and PNC in New York, New Jersey and Connecticut, those companies know what to expect in metro Washington. “I don’t think there’s any element of surprise here,” says Monday. Other significant competitors that Commerce will face here include Winston-Salem, N.C.-based BB&T Corp. and Chevy Chase Bank in Chevy Chase, Md.

Some banks in the Northern Virginia market appear to have responded to the Commerce’s practices. Chevy Chase announced last year that it was adopting Sunday banking hours at 14 branches in Northern Virginia, and Townsend of Friedman Billings Ramsey says that PNC has gone to extended hours at some of its branches as well.

While banks have responded to Commerce’s competition, Hill says that none have really been able to copy his service-first business model. That’s good news for Hill, who figures that if you can make it in New York, you can make it anywhere.