What Top Performing Banks Have In Common

Bank Business Models

As the last day of the Western Independent Bankers wraps up, we thought we would highlight one of the other top presentations that made us think. Joe Cady, Managing Partner from CS Consulting, presented his data on “The Best Business Models in Community Banking.” Given that 90% of banks are re-evaluating their business models, according to KPMG, Joe looked at 59 banks from 2006 to 2011 that had an average ROA of 2.2x and an average ROAE of 19%. The study excluded credit card and other specialty banks. While we have compared bank business models before and look at bank profitability on a regular basis (you can search for it), CS Consulting put together a longer term view that is another validation to our findings.


What CS Consulting found was that 80% of the top performing banks had general, community bank business models, while 14% had a niche customer focus and 6% had a monoline, or single product focus. Those that were niche focused, 70% had a specialty product set, 50% targeted a specific industry, 20% targeted a customer set with a particular characteristic and 10% focused on private banking.


In looking at all 59 banks, Joe asked what was the main value proposition of the bank and in a strong 92% of the cases, the value proposition was the bank’s ability to provide superior customer service while focusing on the whole relationship. 38% of the banks had or also combined a focus on convenience, while 23% said pricing/terms were there main value proposition and 15% said their product innovation was their main proposition. In each of the cases, these banks had a dedicated discipline around customer service, convenience, etc. and it made a difference compared to competitors.


Interestingly, when asked to describe each of these top performing bank’s position towards credit, zero percent said they were “aggressive” and 42% said they were more conservative than average. The study also looked at how much competitive pressure these top performing banks faced and while 15% said they had no competitors 38% said they face “strong” or “intense” pressure. 46% termed their competitive environment as “moderate.”


The heart of the study was on the core competencies of these banks. 93% of the banks all said they were good at cost efficiency and expense control. The data bears this out as the average efficiency ratio of the group was 50.3%. While some of this is a result of keeping expenses low, some of the value is created by being able to charge a premium price for premium service while operating at a normal expense level. While the rest of the details can be seen in the included graph, the other items that stand out 33% attribute their compensation structure as an important factor in producing an above average return.


In terms of the most valuable business model elements, those banks that were good at executing their plan were the most common, followed by those banks that had the right organizational structured followed by those banks that had the proper alignment. In case you are wonder what having the proper “organizational structure” or “proper alignment” means, Joe looks into some case studies and asks some interesting questions.


In terms of execution, the classic example is the Merchants Bank of Indiana ($608mm, IN) which has a business focus with a secondary focus on private banking the high net worth owners of their businesses while also having specialties in ag lending and mortgage production. The bank has a very high service-oriented culture and the key to driving value is its rock bottom 35.8% efficiency ratio. Because of their ability to execute on a day-to-day basis, this bank has produced a six year ROAA of an impressive 4.5%.


There was a case study on the Bank of Hemet that has the architectural disadvantage of having a high real estate concentration. This hit hard during the downturn of 2007. Here, Hemet’s 46% efficiency rate, credit culture and national geographic presence helped produce their 2.3 ROAA.


Finally, and most interesting, Joe asked what best combination of factors showed up repeatedly in top performing banks. Here, the assumption is that portions of the business model can be replicated. Going after higher quality credits, working on increasing the share of wallet from the relationships, having staff highly trained in product and sales plus an emphasis on getting the core deposits from a customer has shown up repeatedly in the 59 banks reviewed.


In summary, these top performing banks were not always the most convenient and did not always produce high growth. What these banks did do consistently was to control expenses while focusing on customer service. In doing so, these banks were able to extract a premium price from their customers and operate at a wider operating margin than the average bank. It helped to have a niche and/or become a leader in a specific sector. As your bank evolves, this study points to having a strategic focus on developing a strong culture and combining that culture with a profitable niche. In addition, increasing resources in sales and customer service/experience training is also important. If you can do both of those elements while controlling expenses, the odds of becoming a top performing bank tilts in your favor. 

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