Friday, June 18, 2010

Branch Math: To branch or not to branch?

Opinions are wide and varied on the subject of branching. Trends indicate that more customers are using electronic means to interface with their bank and are visiting branches much less. However, customer surveys continue to favor branch locations as a critical factor in determining where to bank. In the mid 1990's, many industry professionals feared branch extinction. The former Commerce Bank of Cherry Hill, New Jersey proved these fears wrong by racking up impressive growth and profitability numbers through de novo branching.

But as branch lobbies become emptier, senior managers are wondering again if branching is becoming a dinosaur. I predict branches as we know them will slowly become obsolete. I do not know the date of their obsolescence.

I do think banks must be more exact in the communities they select and the types of branches they build. Reasons for branching into a community are wide and varied. But typical themes I have heard include: a builder saved a pad site for the bank; a senior manager lives in that community; and the CEO has a second home there. Before branches popped up on every street corner, margins were greater, and the cost to erect a branch was not so dear, this approach may have still yielded positive results. Today, a branch built without rigorous analysis is more likely to be unprofitable and a candidate for closure.

Here are a few questions senior managers should ask themselves prior to branching:

1. What customers are the focus of our strategy?
2. Where are concentrations of these customers located?
3. What are the market demographics of the communities where these customers are located (growing, shrinking, etc.)?
4. How many competitors are there?
5. Is average branch deposit sizes growing or shrinking in these communities?
6. Do we have the ability to attract quality bankers to serve these communities?
7. Are there attractive sites to open a branch that is convenient and consistent with our brand?

After answering the above, senior managers may want to get busy with Branch Math. I built a branch profitability model designed to estimate the income statement impact of a prospective branch (see below).

Assumptions, such as deposit growth, can be tested looking at other branches in the community or nearby communities, and past experiences the bank has had opening branches. Senior managers can model base, worst, and best case scenarios in order to make an informed decision and give the Branch Administrator and prospective Branch Manager a template to guage success.

Note that the branch is charged the opportunity cost of building the branch (i.e. the interest income foregone by buying land and paying a builder to erect the branch). This gives senior managers an idea of the higher hurdles they are creating for hitting profit targets if they build a palace. I often see this expense overlooked.

The future of banking is being determined at a pace not seen since the Great Depression. Much of it is being decided in the halls of Congress. But most is being decided in the minds of our customers and prospective customers. Part of that future will be the importance of branches. To give new branches the greatest chance to succeed in this evolving world, we must inject greater analytical rigor in determining where to branch, and the type of branch to construct. In a highly competitive marketplace, having a higher percentage of branches delivering desired profitability will help your bank stand out in the crowd.

- Jeff

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