Small Banks Taking Another Swing at Cutting Costs

Community banks are trying to find more ways to run leaner operations as they struggle to bolster their bottom lines.

A number of banks have already implemented plans to reduce headcount, trim branch networks and upgrade technology to reduce long-term expenses.

Unfortunately, compliance costs keep rising and the interest rate environment remains unforgiving, forcing management teams to take a second look at ways to trim expenses, industry observers say. Improving efficiency should be a widely discussed topic as banks start to report quarterly results in earnest next week.

"As companies look at 2013 budgets, they're realizing that the rate environment will stay the same — so they'll have to cut costs," says Mark Fitzgibbon, an analyst at Sandler O'Neill. "Virtually everyone we speak to is trying to attack their cost structure."

Executives of banks with efficiency ratios above 60% can "expect some hard questions from analysts on driving that a bit lower" during quarterly calls, says C. K. Lee, managing director at Commerce Street Capital in Dallas. He says efficiency ratios have been declining steadily since 2009.

Three of the five biggest priorities in 2013 for the chief executives of small and midsize banks involve efficiency, based on a recent survey from Abound Resources. Those priorities included the use of technology, streamlining workflow and a broad need to "become more efficient."

Earlier in the credit cycle, banks focused on reducing nonperforming loans and dealing with expenses from foreclosed properties, Fitzgibbon says. As those issues dissipated, banks are challenged to make more money, forcing many to revisit cost cutting, he says.

Banks are generally looking to get their expense ratios below 60% by closing branches, laying off worker, improving technology and renegotiating vendor contracts, Fitzgibbon says.

Efficiency ratios, which divide revenue by expenses, are likely to rise in the fourth quarter from a quarter earlier because banks often record additional expenses at the end of the year, says Brad Smith, president of Abound Resources, a management consulting firm in Austin, Texas. Still, banks should appear more efficient compared to a year earlier, he says.

The number of efficiency projects should rise this year as banks go beyond more obvious expense cuts, such as layoffs, and examine overall workflow, Smith says. Such changes are harder to complete and require looking at the loan-origination process, which spans several departments and software applications, to identify efficiencies, he says.

When Berkshire Bank began redesigning its branches, it examined the workflow of the entire branch and decided to make drastic changes, says Sean Gray, executive vice president of retail banking.

Though it began the redesign before the financial crisis, Berkshire, a unit of the $5.5 billion-asset Berkshire Hills Bancorp in Pittsfield, Mass., is now reaping the benefits of lower overhead and more chances to sell additional products to customers, both factors that can improve the efficiency ratio.

New branches use technology that eliminated some traditional teller responsibilities. The branches have open floor plan without distinct teller platforms, allowing for more interaction between customers and employees, Gray says. Three full-time employees can operate the model, compared to four for a traditional branch. The new branches are a third smaller in size and cost about 30% less to build.

Berkshire expects its new branches to generate 10% to 20% more in revenue than a traditional branch. At Sept. 30, the company's efficiency ratio was 57%.

"Being efficient is not a new concept, but it is a necessity for the current environment," Gray says.

More banks are also looking at opening up a single loan office, rather than several branches, in certain markets, Fitzgibbon says. These lenders can cover a larger region, compared with full service branches, he says.

Smaller banks also face more headwinds when it comes to lowering their efficiency ratios, industry experts say. Because of this, smaller banks, particularly those with less than $500 million of assets, must find ways to add revenue to improve their efficiency ratios, Lee says. For sellers with high ratios, a merger can produce cost savings.

For buyers, a deal usually adds less in infrastructure and compliance costs than potential benefits, Lee says. This strategy can be seen in several community banks buying unwanted branches from Bank of America.

"A lot of smaller banks are looking at deals, either for branches or merging with their peers, to gain the size and scale needed to be more efficient," Lee says. "It's really all about what it costs to make a dollar."