Why are your clients looking at branch divestiture?
The business of banking is essentially the same as it always has been: Banks take deposits and make loans in order to earn the spread. However, as the spread narrows, more business is required relative to operating costs in order to maintain or increase profits. Some branches that previously made sense may not make much sense now. Also, branches that were opened five or more years ago and have not achieved a critical mass of business may not be worth keeping. Shareholders still want a good return on their investment and it is management’s duty to allocate capital to produce a good return in a sound manner. That said, the challenging operating environment is causing bankers to make shrewd decisions in order to be as efficient as possible. For many, divesting underperforming or non-core branches is becoming more attractive than before.
Historically, if a branch had $15 million to $20 million in deposits, even if there were not many loans, the bank could invest those deposits in securities and earn a return. These days, that’s not the case. With a lower margin, you need to have a larger base of earning assets in order to cover the fixed costs, such as real estate and personnel. In short, each branch needs to have more business to earn a respectable return. When a management team does not see a clear path to garner the additional growth needed to justify a branch, then closing, consolidating or selling the location may be the best option.
What are banks doing now to respond?
Banks of all sizes are evaluating their options to become more efficient and more profitable. For example, Bank of America didn’t sell a branch location for 10 years prior to 2012. During the last 18 months, it announced 12 deals to sell approximately 180 branches in total and a little more than $5 billion in deposits. The average amount of deposits for those branches was about $30 million per branch. It seems reasonable to assume that Bank of America believes its branches should have more than $30 million in deposits in order to justify the costs of that location. This is clearly a bank pursuing a strategy to improve efficiency.
Some are being closed or consolidated, but who is buying the branches that others divest?
The pace of de novo branching has slowed so significantly that the industry has shifted from adding more than 2,000 branches on a net basis, which is openings minus closings, in 2007 to shedding more than 1,000 locations on a net basis last year. That said, many banks are still looking for the best way to grow and expand. There is always the question: Is it cheaper to build a location or acquire one? It’s a question just about every community bank CEO asks when looking to grow. These days, since more business is needed to achieve economies of scale, it is taking longer for most de novo locations to become profitable. Thus, many growth-minded banks are looking to buy branches rather than start from scratch. Additionally, acquiring a branch also takes a competitor out of the market that the buyer is entering.
What should management teams be doing now?
Evaluate the bank by branch as well as on the whole. Ask, ‘Do we really need that branch? Can we use remote deposit capture or courier service to serve that market? Are we earning a healthy return from the branch or could the capital used to support that branch earn a better return if it was put to work elsewhere?’