How do the top-performing banks continue to post double-digit returns,despite having the same serious profit-dampening challenges as their peers? The answer isn't exactly straightforward.
Last year the top-performing banks in each asset tier had a median return on average equity that was between 420 and 570 basis points higher than the peer median. The standouts have different business models, operate in diverse markets and face their own unique challenges. But in studying this wide range of strategies, we found that the best banks typically follow one of three pathways to financial superiority.
Traditional intermediation powerhouses: Even with tighter margins, excellence in financial intermediation - using deposits to fund loans - remains the most common path to high performance. In every asset size group we examined, at least 70% of the top performers had a ratio of net interest income to average assets that exceeded the peer median.
High performers in this category, including Bank of the Ozarks in Little Rock, Ark., and Western Alliance Bancorp in Phoenix, are characterized by high growth rates in loans and core deposits. But they grow without sacrificing credit quality or margins. They have higher yields on earning assets and lower costs of funds than peers.
Over the past few years, the most successful banks in this category have maintained high profitability by building scale and streamlining processes. This has allowed them to continually reduce their expense levels as a percentage of average assets.
Fee income superstars: Other high performers are reliant on fee income as the key contributor to the bottom line. Across each asset size group, fee income superstars more than doubled the industry median of noninterest income to average assets. But they are very different from each other in how they generate fees. Some, like Federal Savings Bank in Chicago, rely on mortgage banking. Woodforest Financial Group in The Woodlands, Texas, generates high levels of interchange fees and deposit service charges. Others have wealth management, insurance or cash management businesses.
Many of these fee-based businesses require banks to take on higher expense levels as they build scale, which can adversely impact overall efficiency. To be successful in this space, banks need total commitment by executives. Without it, pressure to create efficiency can reduce commitment to invest and the impact to the bottom line will be minimal or even adverse. Banks offering these services must also foster collaboration and integration with other business lines. This allows for deepening customer relationships more cost-effectively.
Niche champions: Intense focus pays off for others. The niche champions pursue well-defined, high-opportunity customer segments, many of which have unique needs. The most successful ones meet these needs by providing their customers with specialty products and pair those with delivery of remarkable experiences. They have well-defined value propositions that ensure they emerge as the clear choice to these target segments.
The financial advantages that come with this strategy tend to be high-yielding loan portfolios and lower cost of funds. These banks are often selective with their physical presence and some even focus on building revenue streams outside of the traditional branch footprint. This allows many of them to carry low levels of overhead.
Examples include SVB Financial in Santa Clara, Calif., which focuses on startups and innovators, and Signature Bank in New York, which targets privately owned businesses, their owners and managers.
To select the right strategy, and execute on it, banks also need a strong executive team. As Stephen Covey said, "Management is efficiency in climbing the ladder of success; leadership determines whether the ladder is leaning against the right wall."
Our study of top-performing banks demonstrates that the most successful institutions have a vision for success and they know how to pursue it. They have well-defined plans that lead them to pay dirt.