Do banks face a hopeless situation with failing branches? It is a pressing question as the industry gears up for 2012. Everywhere you look, networks are being dragged down by branches that were crippled during the recession and may never recover.
Based on a recent Novantas study of the entire U.S. branch system, nearly 16,000 units are facing closure over the next three years. Representing about 18% of the industry total, these “zombie branches” simply are not doing enough business to justify their existence and the chances of revival are slim-to-none under current ownership.
Many banks have put off questions about branch closures, hoping that interim cost cuts would tide them over until market conditions improve. But even under optimistic scenarios, our analysis offers little hope for today’s crop of zombie outlets if they try to continue under present circumstances (see chart, “Branches in Failing Financial Condition”). Unprofitable today, these units could not revive even if they were able to freeze costs while keeping pace with expected growth in their respective markets (de novo branches that opened over the past five years were excluded from the closure list).
The four largest U.S. mega-banks have the lowest exposure to zombie branches, roughly 3% of their combined networks, or about 600 units. Helped by their strong network planning functions, these banks have acted aggressively to optimize their local branch systems in recent years. As a result, most of their branches are situated in local networks with at least threshold density levels, critical in providing customer convenience and building market visibility.
With a 10% concentration of troubled branches, by contrast, super-regional banks have a much more difficult caseload of about 2,200 units. The proportionate burden is still greater among regional banks, which have a 21% concentration of troubled branches, or roughly 2,300 units. One reason for these problems is that regional banks are the most likely to continue running their networks as a series of regional domains with separate management teams. This often leads to a “sharing” arrangement for branch investments – if Tampa gets two, then Gainesville should have two – which can override important distinctions between local markets.
The situation is even more pressing among super community banks (from 10 to 75 branches), which rarely have a fully competitive network presence in the local markets they serve. Within this peer group, about 5,000 branches appear eligible for closure under current ownership, or 26% of the peer group total. Finally, community banks (up to 10 branches) are burdened with the highest concentration of troubled branches, about 5,250 units, or 32% of the peer group total.
One immediate implication is a rising pace of U.S. branch closures. Yet there are opportunities to contain the damage. Instead of shuttering outlets “at total loss,” we estimate that roughly 11,000 of the impaired branches, or two-thirds of the total, could be salvaged by transferring them to better-managed banks and more solid local networks.
Nationally, about three-fourths of all local markets are in need of branch consolidation. The major options include in-market mergers; spinoffs of various local networks; and targeted sales of individual branches.
All of the options depend on a clear understanding of local market opportunity and the role of network presence in winning customer patronage. Area networks perform best with adequate density of coverage and this “density factor” will be a critical guide in helping acquirers to optimize customer share of market.
It will take time to sort through the options and deal possibilities. That is why banks will need interim strategies to slash overhead at zombie branches. Quick moves include adjusting staffing levels and hours of operation, based on an understanding of emerging customer transaction patterns and preferences for service.
Considering the Options
From a strategic perspective, the most aggressive option for dealing with zombie branches is in-market consolidation, where a bank buys smaller and/or weaker competitors purely to grow customers and reduce distribution capacity within the current network footprint. There have been few such transactions in recent years. However, within the 75% of markets where we expect to see significant net branch consolidation nationally, at least 55% have regional or super-regional banks which could be candidates for merger-based consolidation.
The second option is to identify entire markets for exit, for example, large city markets where the bank’s network does not have adequate heft, or small rural markets where the bank is unable to earn a hurdle rate for branch investment. Time is of the essence in making such decisions. Given the ongoing deterioration in troubled branches, the longer the bank waits to exit a market, the less value the local network will bring.
The third option is to pursue targeted branch sales, an avenue that could be especially useful for smaller banking companies that need to retrench around a core market and customer base. Our analysis indicates that super-community and community banks have especially high percentage concentrations of impaired branches – 25% or higher in many cases – creating an especially pressing need to avoid closures at total loss.
After all other avenues are exhausted the fourth option is to close the “No Regrets” branches (units that may never meet the parent company’s hurdle rate) in all markets. These could include marginal branches in low opportunity markets and isolated branches in good markets. Closures could also extend to de novo units opened as part of the recent real estate boom in branching, which will never achieve breakeven based on current forecasts of deposit growth and customer profitability.
Nationally, the performance drag posed by failing branches has been masked by a trend of improving credit quality, which has put earnings reports on steroids as banks slashed loan-loss provisions. But the peak benefits of this trend soon will be exhausted, fully exposing the industry’s lackluster revenue dynamics and cost challenge of maintaining impaired branch network capacity.
Where some banks will go wrong, however, is in sweeping network cuts that only consider individual branch profits. Our national research continues to show material performance benefits for branches that operate within solid local networks, which offer more convenience for customers and carry more brand impact. This local market perspective not only provides a much stronger context for decisions about necessary branch cuts, but also will be essential in crafting merger and spinoff transactions that will help to avert closures “at total loss.”
Mr. Kaytes is a managing partner at Novantas LLC, a management consultancy headquartered in New York City, and can be reached at email@example.com. Mr. Travis is a partner at Novantas and can be reached at firstname.lastname@example.org.
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