A wide swatch of U.S. consumers began to take notice of the Fed’s hikes last year, prompting them to switch to higher-yielding CDs, demand higher rates or vote with their feet. Many commercial and wealth depositors had already moved to Treasuries and other fixed-income investments. At the same time, inflation not only wiped out the surge deposits banks had accrued from the stay-at-home pandemic behavior and federal cash infusions, but it also put pressure on households to eat into their savings.
The result has been a deposit squeeze. Balances are falling and betas are rising in part due to more generous offers to attract and retain accounts. This dynamic has led Curinos to take the position that net interest margins (NIM) have likely peaked and will stall or begin to recede in the coming months. Adding to margin pressures has been the disappearance of fee income from overdraft and insufficient funds (which was largely masked by improvements to NIM in the early going of the pandemic), a significant falloff in mortgage fees and, more recently, and lastly, an increase in loan loss provisions.
Financial institutions have several levers to combat tighter NIM. Expense reduction, including branch optimization, region-level performance analysis and workforce overhaul, will be important to offset some of the pressure.
Strategies For Expense Reduction
Margin compression is never good news, especially for mid-tier and smaller banks, which generally can’t rely on fee income from multiple business lines to cushion it. In 2022, average NIM was up by more than 55 basis points (bp) across the U.S. industry. But while the top 20% of banks enjoyed average NIM expansion of over 130 bp, the bottom 20% experienced average compression of more than 25 bp.
Curinos believes that interest expense will continue to rise even as the Fed moderates or suspends rate hikes. That means the imperative to protect the bottom line will most likely require a harder look at other expenses, namely headcount and salaries, which are the largest single category of expense behind interest expense. And it’s not just front-line costs. The targets for operating expense reductions should also include regional and corporate staff expense that may have been discretionary at one point and have since gone either unnoticed or deliberately ignored. Here are seven areas that we believe are ripe for expense reductions that go beyond interest expense.
Figure 1: Net Revenue Per Branch
Pre-Tax, Pre-Allocation, Pre-Provision
- Optimize branches. Even after the high level of branch closures and consolidation of the past two years, as many as 30% of branches generate insufficient revenue to cover estimated direct and other allocated costs. (See Figure 1.) And the continuing decline in customer preference for in-person service and product purchases – especially new accounts opened by existing customers – will only add to the pressure to prune them selectively. As a result, Curinos believes organizations should become even more judicious about branch remodeling and replacements.
- Optimize regional expenses beyond physical branches. Not all salary dollars are in the branch headcount. For many small- and medium-sized regional banks, there are more than two regional managers and sales or relationship managers (RMs) for every branch; roles include commercial, small business, and private banking RMs, financial advisors and mortgage loan officers. The salaries for these positions are significantly higher than those of branch staff, and the ratio is becoming more top-heavy as more branches have been closed. And it is compounded when roles like regional administrative support, local underwriting and portfolio management are added to the mix. A reduction in staffing at the regional level represents a meaningful, if unfortunate, opportunity.
- Tighten management of specialist roles. This includes taking possible action on assessing the value of commercial RMs, business bankers and private bankers, especially in sub-scale markets. Too often, one-size-fits-all models for specialists are applied equally to each market regardless of the bank’s realistic potential in that market. In addition, many of these specialists are simply “tending” existing portfolios, not driving higher rates of organic growth in clients and revenue. Reducing or redeploying these salary dollars to higher-potential opportunities, such as deepening relationships with existing customers through timely touches, could simultaneously realize savings and contribute to material topline growth.
- Evolve branch sales and servicing amid further consolidations. Branch consolidations and pandemic-related deposit growth have driven the average branch size to nearly $100 million in retail deposits and to more than $150 million when local-based business and commercial deposits are included. Even so, staffing is approaching minimum levels in more than half of all branches, so additional gains in efficiency are limited. Banks will therefore need to find new ways to achieve labor savings, including streamlining branch operating processes, such as tellerless locations, varying hours and days of operation and considering approaches to multi-branch staffing.
- Assess new investments. The capitalization of new investments and how it affects incremental positive returns is often misunderstood and underestimated. The long tail of amortization can be corrosive to earnings year after year. That’s why it’s essential to scrutinize and maximize new investments for cost containment, including digital outlays, staffing, management, physical delivery and operations. For example, our cash-on-cash tracking of branch renovations reveals that many rarely generate a sufficient return and should therefore be ruthlessly reconsidered. Two-for-one consolidations can better align capabilities with greater convenience and more sophisticated servicing that customers have come to expect. And with de novo branch locations struggling to become viable across most banks and markets, digital investments need to go beyond what is often a grab-bag of rarely used me-too features and purported innovations that drive neither distinctiveness nor revenue growth.
- Weigh investments by market. Curinos analysis has shown that as many regional banks have sought growth outside of their “hometown” market(s), they underperform where they are thinly branched. This indicates that investments need to be deployed in markets where the bank can credibly win, and all assets, including the physical branch, should align with the market-based needs of the community. Any such investment should emanate from a provider’s bank-of-the-future definition, starting with agreement on what type of customers the branch is looking to target — mass affluent, small business, commercial or government. Other considerations need to include how brand recognition may be reinforced through higher-visibility locations, how the branches are appointed, the mix of professional roles and servicing capabilities and proven talent. KPIs then need to be aligned with desired behaviors and goals to ensure investment decisions pay off in an acceptable timeframe.
- Balance expense reduction and growth. As many consistently successful financial institutions have shown, reducing expenses is not a one-time special program, but rather a dyed-in-the-fabric way of life. Many have adopted the JAWS ratio, an operating method that demands that any growth rate in operating expenses, including current amortization costs from capital expenses, needs to be met or exceeded by a rate of organic risk-adjusted revenue growth. A larger positive JAWS value demonstrates that a financial institution is effectively generating more income than expenses over time, thereby increasing its profitability, and profitability growth rate, both of which the market clearly values.
Add Value In A Meaningful Way
Based on Curinos analysis, we have found that these potential cost actions collectively could have a meaningful financial impact, especially if interest rates continue to be higher for longer and the deposit squeeze gets worse. Equally important, although they are “savings,” think of them as an ongoing source of new, better-focused investment dollars rather than having them all fall to the bottom line.
This new-found pool could engender sales and servicing processes and customer experiences that are faster, simpler and easier. It could reinforce a more consultative approach where the front line and other specialists are free to generate more organic revenue by providing higher added value. Taken together, these savings-turned-investments can sustain greater productivity and lead directly to improved profitability and higher valuations.