Time to return to banking basics

Community banks are now firmly planted in the fourth quarter of the year, with but a month to go until 2017. At the risk of being run out of town for using a football analogy, I think it is time for community banks to get back to the basics of blocking and tackling.

Traditionally, community banks engage in what I consider core, “bread-and-butter” banking—standard loan and deposit products and services that drive profitability through relationships.

Reaching beyond the basics

Over the past few years, everyone has been looking for a unique angle on profitability. This was the case in 2016 as well.

Many community banks I have worked with this year have looked to take actions that are unusual for them. This has included everything from exploring the acquisition of another bank, to buying a branch, to converting to Subchapter S, to redeeming a large block of company stock from a dissident shareholder, to issuing new equity.

All those are beneficial and exciting allocations of capital. However, they will not replace the need for core, long-term profitability.

The number one basic foundation of the obligation to enhance shareholder value is profitability.

It is for that reason I believe it is time for community banks to get back to the basics.

Community bank profitability involves a clear understanding of how the bank makes money, even in this difficult economic environment. The basics start with the fundamental profitability equation—the “secret formula” for making money in a community bank.

Revenue-Expenses=Profit

Each community bank board and senior management team should, at least annually, take a fresh look at this basic equation and figure out what adjustments need to be made.

Ask some serious questions, such as:

1. Are there any additional sources of revenue the bank can generate?

2. Can the bank increase revenue by growing the loan portfolio? Or is the loan-to-deposit or loan-to-asset ratio already too high?  

3. If there is capacity for growth, are there any untapped markets or population segments you should be reaching out to?

Can the bank capitalize on those markets without expanding its branch network? Or would it need to establish a branch or loan production office to draw in business? Does it already have a presence in the market, but lacks the personnel to service it? While there are some expenses associated with these issues, they are ultimately activities that enhance core revenue.

4. Are the bank’s policies and procedures regarding fees appropriate and competitive?

And does the bank actually adhere to those policies and procedures? Does it need to leave behind the longstanding culture that “We’re a community bank and don’t charge fees”?

5. What about additional non-interest income sources through other lines of business?

Insurance agency ownership, securities brokerage, wealth management, and trust services are all lines of business utilized by community banks across the nation. All of those potential non-interest income sources should be explored as a means to grow the revenue piece of the profitability equation.

Cutting cost and loss

From an expense standpoint, the fundamental question is “What do we need to stop doing?” Some questions to ponder:

1. Does the bank really need to keep that branch out on the highway open? It was the chairman’s pet project 20 years ago—but it has never made any money. Shouldn’t bank leadership objectively look at closing that down?

2. Does the bank continue to offer products and services that have never made money simply because it has always offered them?

I mentioned considering other lines of business as potential sources of revenue—but those same lines of business should also be considered from the expense side.

Let’s say your bank has a trust department with $20 million in assets under management that has been in place for years. But let’s also say that it loses the bank about $100,000 a year. You should probably shut down that line of business.

Again, what should the bank stop doing?

Relationships to end

I have had some clients go through this exercise and tell me later that while the bank generally watched expenses closely, no one ever really went back to see whether the bank was getting the best bang for its buck in every category.

In other words, making that effort was almost like zero-based budgeting.

Consider vendor contracts. One of my clients reviewed every single contract in the bank as part of this exercise. It took that $800 million-asset bank about two years to go through all that. But in the end it managed to save several hundred thousand dollars by the time the bank finished the process.

Another perspective with respect to expenses is considering the cost of new opportunities. Getting back to the basics of core profitability may ultimately require the bank to avoid some growth and expansion alternatives that fit the bank’s model in theory but actually provide no immediate return and possibly pose long-term drains on income.

Growth for growth’s sake needs to be a thing of the past. It is an unnecessary expense.

Revenue-Expenses=Profit

It is not a complicated approach, but you may be pleasantly surprised how many conversation points are housed in that one simple formula.

Look at what the bank should start doing from a revenue standpoint, and then consider what it should stop doing from an expense standpoint.

Basic blocking and tackling. It isn’t flashy, but it works.

These fundamentals will serve to increase profitability at our community banks and further the goal of enhancing shareholder value.