No Magic Necessary

Research shows combining strong relationship banking with cost-efficient management creates a powerful business model

By Joseph H. Cady

Community bank CEOs and directors today are thinking a lot about their institutions’ business models. According to a recent study by KPMG LLP, the professional assurance services firm, 90 percent of banks are re-evaluating their business models.

But why is this executive management focus on bank business models a trend?

Simply, a bank’s business model—how it acquires and interacts with customers, what products and services it offers, how it structures itself to deliver its products and services—determines the way a bank makes its money and how much. Searching for new answers for greater competitiveness and profitability since the financial crisis and recession only makes sense.

CS Consulting Group recently conducted a study of commonalities and differences among the 50 top-performing community banks from 2006 to 2011, a period beginning just before the recession and into today’s tough economic and regulatory climate. The study looked at the six-year track record of community banks with $50 million to $1 billion in assets. Over the study’s six-year period, the top 50 community banks had an average return on assets of 2.17 percent; an efficiency ratio of 50.25 percent; an average return on equity of 18.69 percent; and net interest margins of 4.91 percent, far above the industry mean (see Exhibit 1).

Our study found that 80 percent of these 50 top-performing community banks are traditional lenders operating in urban or rural markets. These banks generally have a broad and balanced array of both business and retail/consumer lending products. Their lending products typically include a mix of residential mortgages, business lines of credit and commercial real estate loans as well as personal and auto loans. Similarly, most of the top performers also have strong customer referral networks in place, and several have been in business for more than 100 years.

The other 20 percent of the top-performing community banks are niche financial services providers operating in urban environments. Seventy percent of this subset of top performers operate specialty lending niches such as SBA lending, commercial real estate loans and residential mortgages. About half serve the special credit needs of particular industries such as medical offices or a specialty manufacturer. Another 20 percent of the top-performing niche lenders serve middle-market firms, long-established businesses or companies with sterling revenue and earnings track records. About 10 percent maintain private banking operations to serve high-net-worth customers.

Significantly, 92 percent of the 50 top-performing banks survied indicated that their primary business model involved getting and keeping clients by building strong, close relationships with their customers. Establishing strong customer relationships far exceeded any other primary value proposition, including convenience and pricing (see Exhibit 2).

Diving deeper

When it comes to how they structure and pursue credit opportunities (including their willingness to adjust pricing, loan-to-value ratios and underwriting to book loans), none of the top industry performers considered themselves aggressive players. Rather, 58 percent of the banks considered themselves moderately aggressive in how they structure and price their loans, and 42 percent rated themselves conservative in how they structure and price their loans.

With customer interactions, few of the 50 top-performing community banks professed to focus intently on achieving sales with bundled products, with only 17 percent reporting that they have an active cross-selling program. The majority of these banks (83 percent) sell one product or service at a time.

As to their internal structures, 93 percent of the top community banks claimed a core competency in finding and maintaining cost efficiencies. Other internal areas where they excel include staffing and productivity, and leadership (see Exhibit 3 for a listing). These banks also indicated that executing their particular business model was the most important element of their success, closely followed by having the right business structural components in place (such as which lines of business they engage in and how they acquire and interact with customers).

It is important to note that the success of these 50 top performers cannot be attributed to a lack of competition. Nearly 40 percent reported that they face either intense or strong competition, and another 46 percent said their competition is moderate. Only 15 percent reported facing little or no competition.

Most of these top performers have had steady business models during the downturn of the last recession. Only 18 percent of the banks made major revisions to their business models since the financial crisis and recession; 73 percent made small adjustments and 9 percent made none.

The takeaways

Overall, the study found that most of the 50 top-performers share two characteristics: having strong, close customer relationships (mainly, going the extra mile); and maintaining highly efficient and productive operations. These characteristics were shared by more than 90 percent of the top-performing community banks CS Consulting Group studied.

Other common characteristics among the best performers include being really good at serving selected product/service or industry niches, having strong leadership and a passion for a chosen business model. Other common traits include avoiding intense competition, controlling asset quality, having strong loan margins and maintaining a strong customer referral network.

Conversely, numerous characteristics were not so prominent among the top-performing community banks. Most didn’t have the lowest loan rates or the least rigorous loan terms in structuring or pursuing credits, and many didn’t customize or bundle their products and services. Many didn’t offer the most convenient retail locations, and nearly all avoided retail operations in urban markets. Most pursued few mergers and acquisitions to grow. Additionally, many did not concentrate on staff training or development. Most didn’t offer employee stock ownership, and most make infrequent, significant shifts to their business models.

So as an industry, what can we learn from these top peer performers and their business models?

Magical solutions aren’t necessary. Rather, great success can result from doing what community banks have usually done, but with some added hard work and focus. This includes creating a strong intimacy among relationship-oriented customers, developing a competency in cost efficiency and pursuing highly profitable business niches where appropriate. endmark


Joseph H. Cady is the managing partner of CS Consulting Group LLC, a San Diego-based strategy consultancy.

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