Small Banks Finding It Difficult to Cut Operating Costs

You must spend money to make money, the saying goes. Analysts just wish community banks would spend a lot less.

Expenses remained stubbornly high at small banks during the second quarter, despite efforts to make cuts. Noninterest expense at banks with $40 billion or less in assets was, on average, flat with a year earlier, at $29.7 million, according to American Banker analysis of 345 banks and thrifts. Those costs edged up 1% from the first quarter.

High costs have made it tough for banks to significantly improve profits. Bankers would love to aggressively cut costs, but a need for revenue has forced many to hire lenders and add branches.

A need for upgraded technology also complicates matters, says Rick Weiss, an analyst at Boenning & Scattergood. "Customers get a lot more banking options and better service than they used to, but all that does cost money," he says.

First Connecticut Bancorp (FBNK) in Farmington demonstrates the difficulty of cutting costs while making investments. The $1.8 billion-asset company has opened 13 branches since April 2010 and upgraded technology.

First Connecticut's noninterest expenses jumped 11% in the second quarter, compared to a year earlier, to $15 million. The company said in a July 29 press release that salary and employee benefits rose "primarily due to an increase in incentive compensation and other salary related costs to support our strategic growth."

Still, the company has done a nice job of reining in "heavy investment in infrastructure and human capital," to contain operating expenses, says Damon DelMonte, an analyst at Keefe, Bruyette & Woods. First Connecticut has been breaking even on new branches within two or three months after opening, he says.

"A lot of times, it doesn't work out too well for banks that open a lot of de novo branches," DelMonte says. "They're basically just paying for deposits, and it takes a long time for the branch to break even. That's not happening" at First Connecticut.

Other banks have reported big increases in costs while chasing growth opportunities. Texas Capital Bancshares (TCBI) in Dallas reported bigger-than-expected quarterly costs after it hired lenders and added products.

Noninterest expenses at the $11 billion-asset company rose 27% from a year earlier, to $69 million. George Jones, Texas Capital's president and chief executive, said during a conference call last month that the added costs would "pay off in spades on a go-forward basis" in the form of revenue.

Other banks have increased spending to open branches and hire lenders. Noninterest expenses at Southern First Bancshares (SFST) in Greenville, S.C., rose 14% in the second quarter from a year earlier, to $5.3 million. The $839 million-asset company has opened branches in Charleston and Columbia, S.C.

Southern First also "has a special proclivity in attracting talent," says Jefferson Harralson, an analyst at Keefe, Bruyette & Woods.

Cost-cutting has become a balancing act at most banks, including Valley National Bancorp (VLY) in Wayne, N.J. The $16 billion-asset company plans to cut third-quarter expenses by about 2% compared to the most recent quarter.

Valley National has already cut mortgage-related jobs and closed some branches, but management wants to avoid cutting too much, Gerald Lipkin, the company's chairman, president and chief executive, said during a July 25 conference call.

"We remain focused in our pursuit to reduce operating expenses," Lipkin said. "However, we adamantly believe that the value of deposits will increase as interest rates rise, and we must be conscious of closing locations that may prove to be more valuable in a higher interest rate environment."

A reluctance to aggressively cut costs also applies to mortgage banking. Most small banks "made the investment to hire more mortgage officers" during the refinance boom, DelMonte says. "If anything, they've turned up their dials to go after the purchase market."

Many small banks have few options left for cost-cutting, Weiss says. "They've been talking about expense controls for at least 15 years so … the low-hanging fruit has been taken off," he says. "You can cut fat, but you don't want to be cutting a lot of muscle."