Branch Talk

"The legacy [of build it and they will come] is an inefficient allocation of resources dedicated to supporting a less relevant delivery channel..."

So went an informative branch research report put out by my old friend and excellent bank stock analyst, Matt Schultheis of Boenning & Scattergood. At lunch recently, he said that the battle for retail deposits has already been won. Won by the national banks. It is a very similar point I made in an article to soon appear in a trade publication. 

With all of our hubris about how great community banking is compared to national banks, we are not winning market share from them. 

Here are some additional points I made to Matt via e-mail after I read his branch research piece. Edited for your clarity and context. All comments are my own, as his firm is a broker-dealer which would require a monumental amount of compliance review and disclosures. To wit, the research report actually used the term "Flavor Aid" instead of "Kool Aid" because it is likely a compliance person wouldn't let them use the obvious. #AddingValue

↭ __________________ ↭

Point 1: Pricing is becoming more transparent and I believe it will be increasingly difficult for banks to maintain deposit betas of 12 to 25, as [the research report] demonstrated in Exhibit 2. It is much easier now to switch from a local bank money market account to a Goldman Sachs Marcus account than last year, and it will be even easier next year.

That is why I suggest banks build a cost of funds advantage by 1) having a relatively higher proportion of non-interest bearing checking, and 2) a relatively higher proportion of "store of value" accounts like interest bearing checking and special purpose savings. I define store of value accounts as those where depositors are looking for safety and ease of use/access more than rate. Such as having a real estate taxes savings account.

Point 2: I am not sure deposit market share is the metric for branch success [as mentioned in the research report]. I believe it is branch deposit size, growth and spread delivered by those deposits. The challenge with the 3,000 square foot to a 1,500 square foot branch transformation is that larger branches tend to have more deposits.

A former bank CEO, responding to my questioning one of his branch's multi-million dollar expansion, said he got $40 million MORE in deposits when he did it. The math looks good in that context. Great actually.

Over and over we see these tiny, cutesy, 1,000 square foot branches maxing out at $20 million in deposits. I say put in a big branch and get $60 million, which is the average branch size in our profitability outsourcing service. The deposits per square foot calculation works out marvelously. Perhaps lease part of the branch to a CPA or a small insurance agency or something that tends to serve the same customers you are targeting to recoup some of the build-out and real estate taxes that come with a larger branch.

Point 3: You can "spoke" from the larger hub, as the research report suggests. And if your spoke maxes out at $15 million over a reasonable time, then close it and transfer those deposits to your hub. At an 80% retention rate, Charlie Sheen would call that #winning. Another strategy would be to measure the profitability of the hub/spoke region, rather than holding every individual branch accountable for spreads and profits. Although either is better than total deposit or number of accounts goals.

Point 4: The median direct expense of a branch as a percent of deposits in our profitability database is 98 basis points. That's 98 basis points that a branch bank can't pay in interest to their depositors that Ally Bank can pay. Perhaps that's overly simplistic as Ally has elevated digital expenses, low pull-through rates, and higher back office expenses because they have no branches.

But let's say that accounts for 20 basis points on the margin. Still a 78 basis point beta. Banks have to figure out how to sell the advantage of their branch network, which by the way survey after survey says customers want, and figure out a way to lower the 98 basis points direct expense of branches or support center expenses. Preferably both in order to lower that 78 basis points. Because customers won't accept that size of a haircut for the convenience of having a branch. But I believe they will accept some haircut.

By the way, the 98 basis points direct expense is off of a $60 million average branch deposit size. That means it costs ~ $588k in direct operating expense to run a branch. If you go with a wee-little branch, perhaps you shave off $150k of that. If that branch maxes at $20 million, then your branch direct expense of the "branch of the future" is 2.17% of deposits, versus 98 basis points for the "branch of today". Which is better?

                                                        ↭ __________________ ↭

Thought you might enjoy our exchange.


~ Jeff

To Branch or Not To Branch: Here Is The Answer

During periods of uncertainty lies opportunity. Vernon Hill, legendary leader of the former Commerce Bank in Cherry Hill, New Jersey, took advantage of the last time bankers were contemplating the future of branching by beating them over the head with his high profile and rapidly expanding branches. Can another Commerce Bank eat our lunch this time around?

Only if you develop a decade long strategic plan that maps the decline in branch prominence. If you are a shorter term strategist, and you want to grow, then branching remains on the table because it remains high in importance when customers are asked why they bank where they do. Even if they do not frequent their local branch, they tend to bank where a branch is nearby.

But what kind of branch? The Financial Brand did a showcase piece on innovative branch designs. I don't know which one is best, if any, but do know that the answer to proper design lies in your target customers as identified by your strategy. So, the branch question, be it design, location, and staffing, should be driven by the type of customers you are targeting, as identified in your strategy. If you haven't identified your target customers in your strategy, read no further and go do it.

But for those that know who they are targeting, the branching decision should be built on analytics. Branches represent such a significant expense, and average deposit size to achieve desired profitability has gotten so large, that we can no longer decide to branch at a location that is convenient to one of your directors.

Here are what I believe to be the critical pieces of information in determining where to branch:

1. Where are your customers now? Banks often have concentrations of customers that are in towns where they have no branches. This could be a significant starting base to grow your branch. I attended a banking conference recently where the presenter said your best source of new customers are the neighbors of your existing ones. If you have a solid foundation of households within a geography, that is a great start for a successful branch. Note I'm not suggesting branching just to bank existing customers, as that would erode overall profitability. But existing customers are the seedlings for new customers. So identify where your customers are.

2. Are there enough opportunities to bank your target customers in the new market? If you specialize in banking doctors and dentists and there are paltry few in the new market, I'm lost why you would consider going there. The exception may be that your niche rests on the loan side of the business, and funding those loans evolves from a more general strategy to generate funding. But if you can't dominate your niche in a certain geography, consider going somewhere where you can.

3. Is the market growing? Household and business growth demographics are pretty easy to obtain, either through government sources or systems such as your MCIF. Deposit growth and market share, and number of branches in a market (see tables) are available via the FDIC website. Are deposits increasing? Are competitors struggling? Are average deposits per branch increasing and of sufficient size to achieve your desired level of profitability?  

4. Are bankers available to staff the branch? In nearly every strategic planning session I attend Senior Managements place great emphasis on successful strategy execution on their people. There is no substitute to having the type of staff with the greatest likelihood of successfully executing your bank's strategy in your new market. You want to fail? Put no emphasis on branch staffing. You'll fail. I guarantee it.

5. Is a reasonable site available. I'm a realist. You can set your branch up for failure if you don't find a reasonable site. The term reasonable is in the eye of the beholder, but if you are tucked in the middle of a dying strip mall, that may not bode well for your visibility and your brand. Find a location where your people can succeed.

6. Can you de-branch painlessly? This is a new question for your branch analysis. There will come a time when your contemplated branch, and other branches in your network, will be unnecessary. Customers will be accustomed to banking online and/or via mobile, advice and problem solving can happen via the phone or in-person visits to the customer, and the psychological attachment to the branch will be gone. Can you close shop without incurring significant expense? 

I don't think branching is dead. But I do think that the need for marquis, high cost branches is waning, and smaller and more tech savvy branches will emerge as the norm. I also think staff per branch will decline, but capabilities per staffer will increase. The importance of getting your next branch decision right is critical to successful execution of your strategy. Don't let your director bully you into putting one near his/her house.

How do you think branching decisions should be made?

~ Jeff