By Kevin Tweddle
High-performing community banks know that the key to growing profitably and building franchise value is to control what they can and strategically manage against market factors they cannot. Banks have recently had a laser focus on the efficiency ratio as they strive to offset the additional expense of loan loss provisions to cover asset quality issues.
The efficiency ratio is comprised of noninterest expense, noninterest income and net interest margin. However, we’re going to focus on expense management and fee income, because community banks have the greatest control over these variables. The management of these two elements is critical to maintaining or optimizing overall earnings performance.
To start our assessment of noninterest expense, we will focus on three of the following categories – personnel, occupancy and other non-interest expenses.
Personnel expenses – The average personnel expense runs about 54 percent of non-interest expense for banks and thrifts in the United States. Personnel decisions are amongst the most difficult to make and many banks put off these decisions even though they can have the greatest impact on the bottom line. Take a close look at hiring and salary increases (freezes may be necessary for cutting costs and even saving jobs) and items such as 401(k) discretionary/matching, health benefits and training/recruiting and flex hours. Adjustments in these areas can enable your bank to better weather the economic storm and immediately improve its efficiency.
High-performing banks also pay close attention to how they staff their branches in both thriving and turbulent markets. This is something that often goes unnoticed. When is the last time you took a hard look at your bank’s staffing per branch? High performers typically hire fewer employees who take on multiple responsibilities and compensate them well. This is particularly the case with branch staffing. High performers also do an excellent job of setting forth achievable incentives that are aligned with shareholder objectives, especially those actions that generate revenue to drive better individual and overall bank performance.
Occupancy expenses – If you ask a high-performing community bank whether its branches are profitable, the answer will likely be “yes.” However, many average performing banks can’t answer this question. Branch profitability plays a huge role in overall franchise performance, yet banks don’t often focus on this factor. Occupancy expenses represent about 14 percent of noninterest expense, so evaluate them as with personnel expenses on an annual basis – small adjustments here can make a big impact. One simple metric to analyze is revenues generated per branch office. U.S. average is about $2.1 million, but success will be determined based upon your specific operating strategy. We often notice banks that have not generated enough revenue to support even the fixed costs of a branch. With continued pressure on deposit services charge fee income, it will become increasingly difficult to justify underperforming branches.
For new locations, consider the average square feet per branch (ask yourself, how much do you really need?); for existing leased locations, can and should you renegotiate leases (after all, it is a buyer’s market right now); and if sale/leaseback is an option that could provide your bank with short-term benefits. Also examine where technology could reduce occupancy costs. For example, Voice over Internet Protocol technology or remote branch capture could potentially save thousands of dollars in communications costs.
Other non-interest expenses – There are a number of other expenses impacting your community bank’s efficiency ratio, such as vendor costs, that you can also control. It’s vital to review every vendor contract carefully and categorize each by need. Can you rationalize each on an annual basis? Consider economies of scale and vendor consolidation.
FDIC premiums, an expense you can’t control, are likely to go up. Develop a strategy to make up those costs through fee adjustments or by lowering your bank’s cost of funds. Another way to keep expenses in check is to employ technologies to lower payment costs. Lastly, take full advantage of your association memberships and their benefits; you may be able to leverage association programs that reduce the costs of things like supplies, subscriptions and insurance.
Increase Noninterest Income
When community banks think of efficiency, expenses are top of mind, but most banks have already cut expenses significantly; they have no more to gain right now and expense reduction is not sustainable for the long term. The other important side of the equation is fee income. Often overlooked, fee income offers banks of all sizes the greatest opportunity to improve efficiency, but the current climate necessitates that you think of new and creative ways to generate it. Following are things that the high performing banks are doing:
Deposit service charge fees. Now that many banks have completed the Reg E opt-in process, they will find that that even in the most optimistic cases they will have lost about 20 percent of their overdraft/NSF fee income. It is critical that the bank comes up with alternatives to make up this deficiency. We recommend a full review of all customer charges and focusing in on those that incent the proper behavior from your customer and don’t penalize your better customers. Examples include charging higher foreign ATM fees, charging for incoming wires, raising limits on reward programs (i.e. debit card usage) and annual card fees.
Remote capture/cash management. For commercial-oriented institutions in metro areas, remote deposit capture is a “must-have” product offering. It creates cost savings in reduced courier expenses and is a great way to bring in non-interest bearing demand deposit accounts. High performers grow small business/commercial deposits by packaging commercial and retail accounts, and by tying loans and other products to deposits (and vice versa), to offer preferential rates. It’s critical to know the competition and their small business offerings so that your bank can clearly differentiate itself.
Wealth management. This is an area that takes more time to build into an efficient operation. It’s important to consider whether there is sufficient demand for wealth management products (primarily comprised of trust, brokerage and insurance) in your bank’s particular market to make this effort worthwhile. Transaction activity volume must be solid and customers’ current price sensitivities must be considered. Establishing clear benchmarks, understanding the demographics of your market and price analysis through peer analysis are factors critical to the success of a wealth management program.
Every community bank’s efficiency ratio can be optimized by gaining greater control of expenses and by taking steps to increase or add revenue streams. However, no all-encompassing target ratio applies to all banks. Each bank’s efficiency ratio reflects the specific kind of business it’s in, so the strength of your bank’s ratio will be dependent upon its specific operating strategy.
So who is the best of the best in Virginia? For banks and thrifts less than $20 billion in asset size, The National Bank of Blacksburg has consistently been among the lowest efficiency ratios in the state for years. Year-to-date in 2010, their efficiency ratio was 42 percent, just edging out Burke and Herbert Bank and Trust Company at 44 percent.
Kevin Tweddle is executive vice president of sales and operations for Bank Intelligence Solutions from Fiserv. Reach him at email@example.com.