2020 was the year of the great pivot.  Nearly every service industry pivoted from in-person service to something less personal, less interactive, and less direct.  Now that we are anticipating an expiration date on the pandemic, the pivoting continues for bank management.  This time, however, the pivot is how bankers are viewing their branch network.  What worked just a little over a year ago is now being questioned.

Several articles have been written recently that discuss how many branches will be closed due to the pandemic.  To be sure, branch closures were occurring pre-pandemic, so that trend is not just beginning, it is being accelerated.  Especially now since the pandemic has altered bank customers’ habits.  According to a recent article at spglobal.com “U.S. banks and thrifts opened 68 branches and permanently closed 405 in April, leaving 82,655 active branches as of April 30. Over the last 12 months, the industry has closed 4,263 branches and opened only 1,065, according to S&P Global Market Intelligence data.”  According to Insider Intelligence “Branches are forecasted to continue their decline over the coming years, per Insider Intelligence, with the rate of adults who visit at least once annually dropping from a 2019 rate of 70.1% to just 62.3% in 2024.”

Branch closure activity remains almost exclusively within the realm of larger bank strategies and continues to be avoided by “community” banks (banks with less than $3billion in total assets).  Of the 405 branches permanently closed during the month of April, the smallest bank closing branches was Carter Bancshares Inc., with $4 billion in total assets, which closed 19 of their 71 branches.  Only four banks with less than $20 billion in total assets, (including Carter) closed branches in April, accounting for only 38 of the 405, less than 10% of the branches closed.  Despite this long standing historical trend, community banks under pressure from decreased Net Interest Margin and rising efficiency ratios are seriously considering branch closures as an option facilitated by technology.

Within this environment, quantifying the effectiveness of branches has never been more essential.  Some institutions may decide not to close branches, but to transform them into specialized service centers, community centers or even financial coffee houses. , Continuing to use the physical structure but repurposed for something other than traditional transaction processing, customer interaction in forms other than transaction handling.  And to be sure, not every bank is considering branch closure.  We just completed a digital banking evaluation for Embassy Bank for the Lehigh Valley in Bethlehem, Pennsylvania.  A $1.4 billion bank that began in 2001, now very successfully servicing its customer with 9 full service branches (one opened in 2020!) and one more to be added in 2021.  ITMs (interactive teller machines) have been gaining attention as an alternative to placing staff directly in contact with customers but still providing face to face (albeit via video) service to customers, and, in many cases, well beyond normal branch hours.

There are many avenues to consider.  However, a prerequisite to taking any action is to first analyze branch effectiveness, and as many institutions have found out in the past year, increase the effectiveness of their digital delivery channels.  In the case of Embassy Bank for the Lehigh Valley, the Bank felt compelled to elevate the services offered in their digital deliveries.  The Bank’s success has been in part providing high levels of services to its customers through its branch network.  Even with a growing and very effective branch network, the Bank’s management realized its digital channel also needed to provide the same level of service as provide in the branches and required significant upgrades.

There is a vast difference in the level of service provided by digital banking alternatives.  Some are very basic, unchanged for the past several years.  If that defines the service your institution is offering, it definitely needs to be reviewed.  Other digital banking services provide exceptional servicing features with more being added each year.  Many bankers we have spoken to have recently expressed their concern that their digital banking service was not robust enough in its capabilities, especially when their lobbies were closed during the pandemic.  Most often the concern was focused on a digital banking services offered by the bank’s core vendor.  Considering that all digital banking services were created at a time before any of us ever considered branch closure due to the pandemic, it is no surprise that some solutions were not nearly as robust as was needed when the lobbies were closed.  Especially online account opening services.  Today’s fully featured solutions provide far more than account balances and transaction history.  Mobile check deposit has become a standard over the past several years, this is no longer considered an advanced feature.  Now advanced self-servicing, card management, personalization, personal finance management, call center connections (including video), marketing and analytics, chatbots, mobile account openings and much more are all available to virtually any size institution.

If your core vendor has an advanced digital banking solution available, it is no doubt an easier transition to upgrade to that solution.  While those solutions may be sufficient, how do they stack up against the competition?  Not only your brick and mortar competitors, but also third-party digital banking vendors, and more importantly, the ever-growing number of digital only banks that seemingly are announced every week.  Digital-only banks must depend on a world class mobile offering to do everything.  Just offering a solution that is better than the previous is a low bar in many cases and may miss the target in years to come.  There is too much at risk not to fully study digital banking alternatives.  ProBank Austin can assist your institution in reviewing the effectiveness of the alternatives available.

The financial metrics used to analyze the impact of potential branch closures are relatively clear cut and straightforward and apply to community banks in the same manner as have been used by larger banks.  The process simply involves weighing the benefits of branch closure against any real or perceived downside risks.

The beginning of the process includes determining which branches are underperforming to the extent that a branch closure analysis should be considered.  If your bank has a branch profitability analysis system in place, chances are you already know which branches are “on the bubble”.  This will include branches that are not growing core deposits, or growing at a below average rate, have high percentages of total deposits in CDs, and which are not generating loan referrals sufficient to support the branch’s cost structure.

Your bank’s branch profitability system will likely include a fairly determined Credit for Funding, (CFF) rate attributed to core deposits based on the “stickiness” of those deposits as determined by a recently performed, but long-term look at the decay speeds and average life of those deposits.  Longer termed deposits will have higher CFF rates applied, and shorter-term deposits will have lower CFF rates.  With market rates at historically low levels currently, you should expect that the profitability of even your best core deposits will be relatively low as compared to longer term averages.

The next step is to determine the hard dollar cost savings that the bank will experience if the branch is closed.  If your branch profitability system allocates bank-wide overhead out to branches within your analysis, these costs should be disregarded, as these fixed overhead expenses will likely not change at the bank level if only one or two branches are being closed.

You’ll want to only count those costs that you can be assured will actually go away when the branch is closed.  These costs will primarily include all occupancy related costs, (rent, depreciation, real estate taxes, utilities, maintenance costs, and the direct salary and benefit costs of branch staff that will be permanently eliminated).  Employees reassigned to other currently open positions within the bank, (positions that would normally be filled in the normal course of business), are still counted as cost savings related to the branch closure decision.

If the real estate housing the branch is owned, you’ll want to include the net realizable value from the sale of the real estate as a part of your hard dollar cost savings from branch closure.  The value shown on a recent appraisal, less costs of sale, would represent a reasonable amount of cost savings to include in your analysis.

Once you’ve assembled your estimate of the hard dollar cost savings related to branch closure, you’ll want to compare this savings to any losses that may occur as the result of lost business due to closing the branch.  For the most part, this will be limited to an estimate of the percentage of profitable core deposits moving to other banks or credit unions due to closure of the branch.

You’ll want to use your estimate of profit earned on those core deposits as the value of lost business due to branch closure.  This will include collected fee income together with the net interest income from core deposits, the difference between the actual interest rate paid to depositors and the CFF rate on those deposits.  You will also deduct an estimate of the direct variable costs of servicing those deposits from your profit lost calculation (if those deposits stay, you’ll still have to service them, decreasing your profit, but if they leave, the direct variable costs will decrease, increasing your cost savings upon closure).

Since it is very difficult to estimate in advance what percentage of core deposits will be lost upon closing a branch, we recommend that banks avoid that effort all together by calculating a break-even point for this estimate of lost core deposits.  Because you already have knowledge of what the hard dollar costs savings are from closing the branch, use this information to determine a break-even point; the point at which your hard dollar cost savings exactly equals the lost profit on core deposits.

We’ll use a simplified example to illustrate the point.  Let’s assume that the bank has determined that hard dollar cost savings from branch closure will equal $300,000 per year, and that the annual profitability on core deposits is $500,000 per year.  Given this scenario, the bank would have to lose less than 60% of core deposits ($300,000/$500,000 = 60%) for the branch closure decision to be financially feasible, otherwise the branch should remain open.

Armed with this break-even point, management’s decision is greatly simplified to the point of determining “do we think that closing the branch will cause more or less than 60% of core deposits to be lost, or not?”

Other factors that bankers will want to take into account will include what current or future technological changes will potentially lessen the loss of core deposits upon branch closure.  Actions such as provision of ITMs in convenient locations near where the branch was previously located, or campaigns to grow the use rate of internet and mobile banking within the customer base prior to announcement of the branch closure decision (months or years before, perhaps).  Advance planning related to technology deployments prior to implementation of branch closures will greatly improve the financial effects of these difficult decisions.  Financial analysis along the lines of branch and product profitability will also make these difficult decisions easier to get right.

As your financial institution looks toward a post-pandemic future, it will very likely ponder branch profitability or digital banking alternatives.  Or both!  The environment has changed due to the pandemic.  ProBank Austin can provide the guidance necessary to determine the best steps for your institution.  For a discussion on branch studies, contact Jeff Morris jmorris@probank.com 419-517-1775.  For a digital banking discussion contact Steve Heckard sheckard@probank.com 219-246-2300.


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