Tepid loan demand and near-zero interest rates made 2021 a challenging operating environment for banks. Yet, a number of institutions attained above-average loan growth and profitability. The annual analysis of the factors that contributed to top performance, conducted by Capital Performance Group and the American Banker Magazine, show that the strategies which contributed to top performance last year will remain essential for attaining and sustaining that level of performance in today's economic environment.
A key takeaway from the analysis of last year’s top- performing banks is that they generated much higher levels of revenue growth compared to their peers. The higher rate of revenue growth was largely driven by higher organic loan growth, significant fee-based revenue streams or a combination of these factors. While top-performing institutions generally had a higher growth in expenses than peers, this was more than offset by higher revenue growth.
Top-performing institutions, ranked based on three-year average return on average equity from 2019-21, significantly outpaced peers in loan growth, with some recording double-digit loan growth. Many achieved this level of growth by operating lending businesses beyond their branch footprint or focusing on providing credit to specific customer segments or targeted geographies.
The industry overall benefited from the red-hot housing market that prevailed in 2021, but many top-performing institutions were especially effective in capitalizing on the opportunity. Many originated mortgages on a regional and sometimes national scale and some conducted significant servicing operations.
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Fee revenue was especially important last year as net interest margins contracted. In addition to mortgage banking revenue, several top-performing institutions generated high levels of fee revenue from businesses such as wealth management, insurance, brokerage and payment services.
Interestingly, many of the most profitable banks operated fewer branches compared to peers; instead, they leveraged digital channels or third-party channels for growth. This contributed to a lower level of operating costs and, coupled with higher revenue growth, enabled the top-performing institutions to report efficiency ratios that were significantly lower than peers.
While there is reason for optimism that overall industry profitability will improve this year given the rise in interest rates and a rebound in loan demand, these factors alone will not lead to peer-leading financial performance. To achieve above-average growth and profitability and to drive returns for investors, banks must:
- Develop strategies that can generate double-digit annual loan growth by targeting high-growth geographies and industry verticals. Specialization improves a bank's industry-specific knowledge which, among other advantages, enables the bank to tailor products and more accurately price for risk.
- Build lending businesses that can be expanded out of footprint, such as SBA lending, commercial finance or equipment financing. Executive teams should not be content to limit growth opportunities to those contained within their bank’s traditional service area.
- Augment traditional loan and deposit product offers for particular customer segments with technology-based solutions, such as processing or payments solutions, to generate fee income and enhance the bank’s value proposition.
- Develop digital lead/demand generation capabilities to support the acquisition of new relationships and to deepen existing relationships. The latest digital tools, often including marketing automation and CRM, can significantly increase opportunities delivered to the sales teams in consumer banking, business banking and wealth management.
- Develop fee-based sources of revenue that make a material contribution to earnings. While margins are expected to expand this year, they have been inexorably contracting over the long term. The shift will not be easy, but it is not impossible. Some institutions have already accomplished it.
- Reduce efficiency ratios in the traditional intermediation business through digitization and partnerships. Banking-as-a-service represents an opportunity to reach a greater number of customers at a lower cost.
Many of the institutions that consistently place among the most profitable institutions employ some combination of these strategies. Banks that embrace these tactics will be best positioned to generate above-average growth and profitability regardless of the operating environment.
