Is cutting branches the best answer when times are tough?

Bank of America is slashing 30,000 jobs, which one bank analyst estimated would lead to the shuttering of 600 of the bank’s branches, as the bank tries to reduce expenses in a sputtering economy and in the midst of an avalanche of bad mortgages. London-based HSBC already announced it was selling nearly 200 branches in the U.S. to First Niagra Financial Group.

On the other hand, JPMorgan Chase & Co. is doing quite the opposite: it announced plans earlier this year to add 1,500 to 2,000 bank branches in the next five years. Many of them will be in California and Florida, hotspots for the last mortgage meltdown.

Is this lunacy, or is JPMorgan up to something smart?

Of course, a lot will depend on how the next five years turns out.

But the simple idea of cutting branches to save money isn’t necessarily the brightest, according to research by New York City-based First Manhattan Consulting Group. The bank consulting firm did an analysis of branch consolidations and found wide discrepancies in how successful branch consolidations were.

The hitch is that cutting branches can also cut into revenues, and banks often underestimate this impact.

The typical branch’s direct expenses equal only about 25 percent of the revenues it produces.

According to First Manhattan:

• Deposit loss within the first two years following a consolidation ranges from as much as 55 percent or more to as little as less than 5 percent of the closed branch’s portfolio. Based on our analysis of over 500 consolidations, we estimate that 60 percent of branch consolidations resulted in a negative NPV (net present value) because of higher than acceptable (revenue) attrition.
• Beyond short-term runoff, consolidations also have longer-term effects on revenue momentum. Following a 3-year stabilization period, a typical branch that absorbs the customers of a nearbyclosed branch experiences a decline in revenue growth of 4 percentage points per year relative to local market performance. However, here again, averages can be misleading and some banks outperform while others really suffer.

JP Morgan says the 1,000 branches it has opened since 2002 have contributed as of this spring $148 million to the bottom line and brought in 2 million new checking accounts.

Because of the time it takes for new branches to be profitable, JPMorgan is seeing its plans as a “significant long term investment for growth.”  A chart in the bank’s investor presentation shows the new branch build becoming profitable in 2018 or 2019.

“Yes, we are concerned about technology reducing the need for physical branches, but all our research shows that we still will need branches to serve our customers,’’ CEO  Jamie Dimon writes in his 2010 annual report. “While use of the Internet and ATMs has skyrocketed, branch traffic essentially has remained steady. Over time, branches may become smaller, but we still think they will remain essential.”

JPMorgan had 5,340 bank branches at the end of the second quarter. Bank of America has about 5,700 branches. Don’t be surprised if JPMorgan soon becomes the biggest bank in America.