Top 50 Low Cost Banks

Thomasville National Bank is a small bank with a mission: pay employees well and get higher productivity, keep other expenses low and generate fee income through a large trust and investment division that also generates core deposits. It seems simple enough, but the equation ends up making the bank one of the most efficient in the nation-and that efficiency translates into high profitability over a long time period.

In fact, Thomasville National Bank, a $592-million asset bank based in Thomasville, in southern Georgia, was about three times more profitable than the median financial institution and had five times the median growth rate during the past five years ending in 2013. The bank was able to do this despite the apocalypse of the last financial crisis when Georgia had the most bank failures in the nation. “We did not take the risk other banks took to try to create a return,” says Chief Executive Officer Stephen Cheney. “Every single day, we will look for a streamlined, common sense way of doing things.”

Thomasville National Bank has just two branches and a $1.5-billion trust and investment division that contributes $150 million in core deposits to the bank. Employees are paid above average, a deliberate move to attract and retain the best workers. Personnel expenses are $85,870 per person versus $71,500 for banks of similar size, from $300 million to $1 billion in assets, according to the Federal Deposit Insurance Corp. Plus, because the bank was so conservative when it came to credit, it was able to grow during the last few years while other banks were cutting back in Georgia because its balance sheet was stronger, which enabled it to steal market share.

During the slow economic recovery of the past few years, when growth has been hard to come by, efficiency and a low cost of funds have been instrumental for many banks in achieving a higher level of profitability. This may be even more important going forward, as interest rates are expected to rise at some point in the future, making banks that have a lower cost of funds and lower overhead more resilient because they have more wiggle room in the event of a crisis. Such levers are important for bank boards to understand if they are to guide and oversee success of their management teams.

Almost everyone can agree that efficiency is important, but how important, and what levers banks should pull, is often up for debate. When Kevin Tweddle, the president of Bank Intelligence Solutions, a consulting division of Brookfield, Wisconsin-based technology company Fiserv, did an analysis of the most profitable banks in the country during the last five years, he found that efficiency and non-interest expense ratios were the biggest differentiators between the most profitable banks and the median banks and thrifts in the nation-a bigger differentiator than, say, loan yield, loan growth, asset quality or net interest margins, for example. Tweddle identified the most profitable banks as those that were in the top 15 percent in terms of return on average assets and return on average equity during 2013, and in the top 30 percent for each of the preceding four years. Those banks, which had to be well capitalized and have positive growth in the last five years in order to be deemed top performing, tended to be highly efficient banks. As a way to explore the costs of banking further, Tweddle identified a metric he called the “cost foundation,” calculated by adding overhead to interest expense and dividing by average earning assets. In the digital edition, Bank Director magazine has identified those top performing banks with at least $500 million in assets ranked by cost foundation, in an effort to learn more about how they operate and became so profitable.

Click here to review the Top 50 Performers
on the digital edition of Bank Director.

Tweddle found that many of the banks on the list were privately owned, and in rural areas-a possible advantage since they might have less competition, be able to keep expenses low and charge a little bit more in interest. However, there are still banks on the list in metro areas that did well in terms of efficiency. Some banks, such as Thomasville National Bank, simply have hit on a common sense, yet disciplined approach to keeping expenses low and profits high. A common story is that these banks resist the urge to build a wide network of branches, which can be expensive, and use technology to reduce overhead as well as paying staff better-than-average wages to reduce turnover and attract highly productive employees. They also have a tendency to emphasize simplicity in products and services. Forget offering 20 different checking accounts, for example, when your own staff can’t remember the difference between that many, let alone your customers.

“Banks have a tendency to become overly complicated,” says Jim McCormick, a bank consultant and founder of First Manhattan Consulting Group. “Most customers don’t value complexity. They won’t pay extra for it and in many cases, they dislike it.” One example he uses is a bank’s tendency to want to offer all the products that a big bank has. That adds unnecessarily to costs, he says. Diligent expense management, which comes from a culture of cost control and a simplified approach, is a low risk way of increasing return on average equity and return on average assets, and will be reflected in stock price, he says.

Another metric frequently talked about is the efficiency ratio. Analysts tend to focus on it, and therefore, public companies often talk about trying to reduce it. The measurement is normally a simple ratio of non-interest expenses to revenues. If you spend 50 cents to get $1 of revenue, you are doing pretty well. That gives you an efficiency ratio of 50 percent. “The best performers tend to have lower ratios,” says Chris Marinac, the research director at investment bank FIG Partners LLC.

Few big banks made it to the Fiserv list of highly efficient top-performing banks, but those that did, such as San Francisco-based Wells Fargo & Co. and Minneapolis-based U.S. Bancorp, tend to have low efficiency ratios. For a community bank, a good efficiency ratio is below 60 percent. Larger banks tend to have high expenses, more complicated business structures and higher efficiency ratios. They might have a high level of noninterest expense from non-commercial banking services such as asset management or trading activities. That is not necessarily a bad thing. But for traditional banks that rely on making loans for the vast majority of their income, efficiency ratios and something like the cost foundation metric can create a competitive advantage. If you have a lower cost structure, you could be more strategic in how you price loans and deposits, so you could be more aggressive on price with certain customers that you really want and feel will grow with you, says Marinac.

Banks have been trying to cut costs for years. Overhead has been on the decline during the past several years, as banks have seen reductions in loan losses and foreclosure-related expenses. Many have been closing branches that were not profitable, cutting employees or simply not replacing them when they left. Still, Marinac feels as if many banks have only scratched the surface in terms of expense reduction. Community banks fall into the trap of confusing scale with focus, he says. You don’t need to get bigger as the sole way to drive efficiencies. In fact, you could do more with less. Marinac uses the example of banks that once used 10 to 13 people to process a loan, but have realized they can do it with seven, making the process more efficient and less cumbersome for both the bank and the customer.

Cost of funds is another key metric that goes into reducing costs. If you are able to pay less for the funding you need for loans, that goes directly to the bottom line. “Low cost funding is precious and enables you to enjoy wider net interest margins without pushing on assets with risk,” McCormick says. Interest rates have been so low the last few years, it is extremely hard to differentiate your bank on this point, but it is a metric that could prove to be increasingly important if rates begin to rise rapidly. Banks with a low cost of funds tend to generate lots of noninterest bearing deposits from customers who may be more loyal to their bank than those customers looking for a high rate of interest. Those loyal deposits usually are referred to as core deposits.

As rates rise, some banks will find that core deposits stay with their banks while others will be surprised by the rate at which they lose deposits, and their cost of funds will increase. Understanding your deposits and the strength of those relationships will be key to maintaining profitability even with a sudden rise in interest rates. If someone has both a loan and a primary checking account relationship, that person is more likely to keep deposits at your bank when rates rise than someone who only has a certificate of deposit since CD-only customers tend to be very rate sensitive. When rates rise, “we are going to see banks that have core deposits and banks that thought they had core deposits, but didn’t,” says Dory Wiley, president and CEO of Commerce Street Holdings, where he is a portfolio manager for various funds that invest in community banks.

However, not all banks that are extremely efficient have a low cost of funds. For example, New York-based Signature Bank tops the list of high-performing banks ranked by cost foundation. It does not pay a lower rate for deposits than many of its competitors. What it achieves in efficiency is through a focus on overhead reduction and a business plan that generates income by catering to the needs of small- and mid-sized business owners rather than retail clients, thereby spending less money to get more assets. CEO Joe DePaolo says his bank does no radio, television or print advertising but relies on referrals from existing clients. Signature Bank keeps a low profile but pays well. Signature Bank spends $196,000 per employee in personnel costs, whereas the peer group average is $91,000 for banks above $3 billion in assets, according to the FDIC.

“The costs we do have are the people we hire,” says DePaolo. “If you hire the right people, and they target people who own privately owned businesses, then that is very efficient.”

The results pay off. Signature Bank has $25 million in assets per employee, compared to $9 million for its peer group. That has helped the bank achieve an extremely low cost foundation, essentially just 2.55 percent, more than 200 basis points more efficient than the median bank or thrift. The bank also is highly profitable, with a 1.82 percent return on average assets during the past five years, more than three times the profitability of the median bank or thrift. “[The officers of Signature Bank] are magicians at operating at low costs,” McCormick says. “They are unbelievably productive. They are very distinctive.”

Not every bank is able or wants to cater to the unique business clientele of Signature Bank. Some extremely efficient banks have a traditional strategy and want to serve a variety of interests in their communities, including mortgage loans for retail customers and checking accounts for modest households that don’t own a business. Their community-wide clientele does not mean they can’t be efficient. Lakeland Financial Corp., the $3.2-billion asset holding company for Lake City Bank in Warsaw, Indiana, is one such example. The 143-year-old bank’s cost of funds is not particularly low, and its net interest margin is lower than its peer median. Yet it generates a 47 percent efficiency ratio, compared to 62 percent for peers above $3 billion in assets. It tries to offer a superior level of service and invest in technology that benefits its customers and its efficiency while keeping overhead low. The bank’s headquarters is in a modest red brick building where the second floor was added in 1971, lending a crooked aspect to the windows and uneven floors. Some of the bank’s operations are housed in the old Kline’s department store offices in downtown Warsaw. “We are proud of the modest nature of our administrative infrastructure,” says David Findlay, president and CEO of Lake City Bank.

He says his feelings about efficiency date back to when he worked as a correspondent banker for Northern Trust Corp., and on his visits to banks, he was struck by the grandiose look of many community bank buildings. Many banks are the signature building in a town’s square, but what does that say about the bank’s focus on keeping costs low? “We simply don’t spend money that we don’t need to spend,” Findlay says.

Keeping costs low and having that drive profitability is an extremely difficult thing to do. It is much easier to take on additional risk by growing the loan portfolio through stretching the underwriting rules or getting into new businesses the bank knows nothing about. “It takes time to be a low cost producer,” Tweddle says. “It is a huge separator, the cost piece.” With a low cost foundation, Tweddle says banks don’t have to chase risk, yet can still generate growth with a solid return. And that might just be where the magic in banking comes in. It sounds simple, but is far from simple to do.


Naomi Snyder


Editor-in-Chief Naomi Snyder is in charge of the editorial coverage at Bank Director. She oversees the magazine and the editorial team’s efforts on the Bank Director website, newsletter and special projects. She has more than two decades of experience in business journalism and spent 15 years as a newspaper reporter. She has a master’s degree in journalism from the University of Illinois and a bachelor’s degree from the University of Michigan.

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