As I mentioned in a previous article, community banking is under threat.
The profitability of larger banks has increased as they transformed their balance sheets and recovered from the credit woes of the late '80s and early '90s.
This, coupled with margin shrinkage that many banks are experiencing as a result of the changes in the yield curve, poses some critical questions for community banks, such as: how can they effectively respond to the challenge?
The idea of transforming one's balance sheet is scary because it often means giving up traditional identity and the comfort associated with doing what you've always done. Sometimes, however, radical surgery is essential to survival.
In other situations, midcourse corrections and specific revenue enhancement initiatives are sufficient. What can a community bank do to change its fundamental profitability dynamics? In this article, I will talk about the revenue side. In a subsequent article, I will address the cost aspects.
The greatest source of strength for most community banks is the customer and customer loyalty. Many community banks have extremely loyal customers who enjoy doing business with the bank and value the relationship.
What community banks often do not have is the breadth of product offerings that many of their customers require and that can allow them to make more with the same customer base and distribution network.
The question that community banks need to ask themselves is, how can I leverage effectively this distribution network in which I have a significant amount of invested fixed cost and a customer base. There are several ways to do that.
Generating assets for sale. Most community banks are extremely conservative in their credit underwriting, and rightly so. One large bad loan can wipe out equity, and the risk is too great.
However, there are many other players in the financial services industry with different risk appetites, companies that are interested in a different risk-return tradeoff.
The community bank has the ability to originate such assets but no appetite to hold them. That's O.K., as long as the community bank can find a buyer for those assets and, in effect, originate to somebody else's specifications.
For example, many community banks originate and retain only A-grade mortgages. They have no interest in grade B and C paper, which has greater credit problems and inferior credit quality. There are many other banks and mortgage companies that specialize in B and C paper.
A community bank can increase its profitability by originating and selling that type of paper to pre-identified buyers, as well as finding buyers for its own turndowns.
In other words, a community bank often has 30% to 40% of its loan applicants turned down because they do not meet the bank's credit underwriting standards.
Since the bank has already spent the time and money to underwrite the loan, why not leverage it by selling it to somebody else? Not only are you maximizing your own resources, but you are meeting the customer's need and expanding services into the community. This is a win-win strategy for all.
Specializing in niche products. First Federal of Middletown, a $150 million-asset savings bank in New York State, was among the first to introduce home equity loans in the mid-'80s. That became its product niche and has been the main reason for the bank's intense profitability since that time.
First Source, a $2 billion-asset bank in South Bend, Ind., is a nationwide lender for small aircraft. It is well known in the industry for this specialty.
Imperial, a $5 billion-asset community bank in downtown Los Angeles, specializes in lending to title companies. While its other businesses have declined, the title company business keeps the company afloat and generates future revenues.
Identifying a niche business and developing the expertise and the reputation in it is an excellent way to increase profitability and build business in a safe way. The key word is acquiring the requisite expertise.
By so doing, you will avoid the pitfalls of the business that novices are bound to experience. Once you have established yourself in the niche business, and do a good job in it, the marketplace will realize it and will seek out your business more vigorously.
Doing more with what you've got. Cross-selling it a tired and overused word, but it is still valid. The problem is that most community banks do not have a sales orientation, and therefore do not actively seek the business opportunities that their customers represent.
By consciously pursuing a greater share of the wallet of your customers, and by compensating your people for successful execution, you can significantly increase your volume of business as well as customer retention prospects without increasing overhead.
In a sense, by doing more with the current customer base and employees and staff, you're leveraging existing capability while increasing franchising value.
Renting services. Many community banks are reluctant to offer brokerage services, annuities, and mutual funds and other services that they do not "make themselves."
Their reluctance arises from elements such as their perception of lack of control, possible cannibalization of the bank's deposit base, and the fear of the unknown.
However, as National Bank of Sussex County, with $180 million in assets, and many others have demonstrated, the sale of annuities and mutual funds brokerage and other services generated by other sources can make a meaningful contribution to a bank's bottom line without a significant addition to cost.
The bank mentioned above generated $315,000 in discount brokerage fees last year and a similar amount in annuity sales. For that sized bank, this is a lot of money.
The key, of course, is doing it right. Identifying the right vendors, not choosing Executive Life to sell your annuities and then disappointing your customers, and not giving up your customers to someone else's sales force.
All can be accomplished with careful contemplation and striking the appropriate balance between commission incentives and a relationship orientation.
Vertical integration. Most community banks have good technical knowledge of at least one product line, such as commercial loans or mortgages or other types of consumer loans. Leveraging that knowledge represents a great opportunity for revenue enhancement.
If you are, for example, in the mortgage business, you may wish to get into the appraisal business, the title-search business, deed custody business, hazard and mortgage insurance business, and other related businesses that you encounter in day-to-day management anyway.
Guaranty Savings, for example, a $350 million-asset institution in Milwaukee, has parlayed its title-search activities into a fraud-prevention business that has been extremely successful and is an example of a unique and creative leverage of knowledge generated in the normal course of business.
These are five ideas for community banks that wish to enhance their income and improve spreads.
Quality revenue enhancement is not. Thinking creatively about your current market strengths and customer base is one key to success. Think "outside of the box" about your assets.
By so doing, you will be able to identify new opportunities to leverage existing capabilities while generating the profitability that your shareholders and the investment community demand.
Ms. Bird is chairman and CEO of Finexc Group LLC, New York, and editor in chief of The Community Banker, a quarterly journal.