Given the ongoing challenge of near-term revenue growth, many financial institutions struggle with deciding what steps need to be taken to ensure long-term survival and prosperity. BAI’s director of research, Mark Riddle, has indicated that his organization’s research points to expense control as the key. And two of the main areas that financial institutions are focusing on to reduce costs are back-office operations and the branch network.
Yet, branch network reduction and/or redesign inevitably receives some pushback from senior executives in the following areas: branch maturity and its impact on new office size; marginal branch profitability and contribution to return on equity (ROE); fear of losing valuable customers; criticism from the media or concern in the community; and issues related to the Community Reinvestment Act (CRA). Let’s look at these areas in detail and parse through the problems and possible solutions:
Branch maturity. To evaluate the validity of this reasoning, we looked at five-year growth trends of new offices. The data can be used in determining if branch maturity should be a factor against branch restructuring. The bottom line of our analysis is that if a new office is growing more slowly than the overall averages or if it has become stagnant, then the argument about branch maturity is likely a faulty justification for not taking action.
In an FIS analysis of more than 15,000 offices with deposits of less than $15 million, it was found that approximately 9,200 are more than six years old, and of that total, over 6,138 are more than 12 years old. So, the majority of these small branches are not small as a result of being new.
Another determinant in considering the potential for any branch to achieve a minimally acceptable profit contribution is the overall population trend within a given market. In our study, we found that nearly 30% of these small offices are located in markets that are either declining or have no forecasted growth. This makes it difficult to argue that their small size can be corrected by adding business.
Marginal branch profitability. Two criteria should be considered in relation to this factor: how is profitability calculated and what constitutes a viable use of capital as the industry moves forward?
Assuming a bank holds capital well in excess of the amount required to support its risk assets, an argument can be made for any strategy that contributes positive ROE. However, if the only way an institution can deploy equity is through businesses that produce minimal returns, then it should find new ways to invest the equity or return it to shareholders, allowing them to do something constructive with it. Generating a risk-adjusted return that is less than the cost of the capital destroys shareholder value. If the environment is such that more capital is going to be required to support risk assets, it cannot be easily justified to use marginal cost justification, because less under-utilized capital is available to deploy in this manner.
Calculating profitability and performance of a branch can be done using an analysis of revenue and expenses, including in the revenue calculations transfer credits for excess balances and an adjustment in the balances of the branch for inter-branch activity. In the hypothetical example of of a $10.2 million-asset branch evaluated for continued viability, we look at data for one quarter (see chart, Time to Cut). While variances from office to office could be expected, it is reasonable to assume that this is representative of the average $10 million branch (traditional, stand-alone, “brick and mortar”) of any bank. Some changes could be made to reduce the operating costs of this branch, such as reducing hours or days of operation. However, $200,000 worth of annual savings to get the branch to breakeven are clearly not available. This demonstrates the type of branch profitability analysis that is needed in today’s environment.
Fear of Losing Valuable Customers. Detailed studies have concluded that the customers of small branches are overwhelmingly merchants and low-balance transaction accountholders. While merchants can be highly profitable, small-balance accounts have not been profitable as a whole. That segment has proven to be largely composed of money-losing customers, with the overall profitability of the segment supported by less than 5% of the customers generating income with high overdraft fees. With the recent Reg. E and the OCC/FDIC overdraft rule changes, this approach to justifying small accounts represents an endangered business model.
Financial institutions never want to lose customers, and closing any branch can endanger a profitable relationship. However, concerns of losing these relationships can cloud the bigger picture. There are strategies that can be used to retain profitable businesses and those strategies can be executed when a branch is closed or consolidated. An array of service options exist that can remotely service a bank’s critical merchant customers, including remote deposit capture, online treasury management services and armored carrier services.
As business owners gravitate more toward online management of their accounts, mobile and online banking solutions for small businesses will serve to connect them to the bank. In addition, using social media sites, such as LinkedIn, to deliver content that is specific to small businesses will help in cementing the online bonds with the institution. As online products and services continue to grow, the rationale for continuing to operate many small offices will continue to erode.
In the event that no options exist to salvage a profitable relationship, the deciding factor should be the net impact of the closing. The one-dimensional impact of a lost profitable relationship should not sway the decision. In the case of the hypothetical $10 billion branch mentioned above, the entire operation creates a clear drag on bank earnings despite the existence of profitable individual relationships. While some revenue will undoubtedly be lost, the cost savings from exiting this location far exceed the lost income.
Media criticism: Financial institutions are under considerable scrutiny as a result of the country’s current financial climate. When a financial institution finds it necessary to consolidate or close existing branches, utilizing internal public relations to effectively communicate is the best solution. For the most effective results, explanations for business changes should take the following approach:
- Provide consistent messages across all media channels. All external messages should flow from a single source that reviews content for uniformity.
- Leverage several direct channels for communications to customers. Use electronic methods such as e-mail to communicate directly with customers as well as traditional mailings and newsletters.
- Use social media with caution. Negative news has the potential to go viral. Limit social media postings to positive events and save sensitive matters for more direct channels.
- Draw from prepared speaking points. Provide speaking points regarding the branch consolidation activities to client-facing staff as well as bank executives.
- Promote continued or new commitments to community giving and charitable events. This will help reinforce the bank’s commitment to a specific market area.
- Ensure consistency between external and internal messages. Provide the same consistent messages internally that are communicated externally, making use of intranet sites, newsletters and e-mail.
Clear, positive messages about the bank’s ongoing investment in new products and services should also be a part of these communications. Be sure to promote services that provide 24/7 banking access via mobile devices, the Internet, contact centers, ATMs and an array of card-based payment products. These offer far more convenience than any given branch location.
CRA Issues. The CRA can be a constraining factor when making decisions to consolidate or close branches. Ultimately, the CRA can limit the possibilities for a given branch location as the rules controlling decommissioning offices where the CRA is a concern are clear.
As an example, a financial institution may choose to significantly reduce the cost of an operation as opposed to completely exiting a market. Cost reductions can occur by moving from a stand-alone branch to an in-store branch, substituting secure, high-functionality ATMs and night depositories in place of a branch and providing increased armored carrier support for merchants. Another solution to reduce the impact of closing a branch is for the bank to donate the branch building to a nonprofit or community development financial institution, creating a positive and lasting legacy in the community. A bank should, in any case, be proactive in identifying community concerns and offering constructive alternatives to maintaining an unprofitable operation, which avoids having to respond to objections during the application process to close the site.
Shifting preferences on how consumers do their banking and deteriorating underlying branch economics make the case for consolidating branch networks more compelling than ever. The overall industry results over the past 30 months suggest that financial institutions are seeing this more clearly.
Mr. Shannon is a senior vice president with FIS Consulting Services, a subsidiary of Jacksonville, Fla.-based FIS. He can be reached at Dan.Shannon@fisglobal.com.
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