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Don’t give away your bottom line

With meaningfully higher rates way out in the future, community banks must conserve revenue

To thrive in all rate environments, make fee income a "swee spot," advises consultant and former banker Peyton Patterson. To thrive in all rate environments, make fee income a "swee spot," advises consultant and former banker Peyton Patterson.

When you last flew, you most likely paid for your baggage—both ways, and maybe even an extra fee for curbside check-in. You may have paid more for extra legroom, and you may have plunked down ten bucks more for the privilege of boarding early so you had a shot at fitting your rollaboard overhead.

Then, once aboard, you probably paid for Wi-Fi to keep in touch with the office, and something from the snack cart.

It’s a safe bet that most community bankers would never treat their own community bank customers that way. But is there a middle ground between “nickel and diming” people and free?

“Community banks give away way too much,” says Peyton Patterson. “Everything is free. And it doesn’t have to be. If customers get the things they are looking for, within reason they are willing to pay for that. But generally, community banks have been afraid to charge fees, and even if they do, they will often waive them.”

Patterson, head of New Canaan, Conn.-based Peyton R. Patterson Consulting, is no theorist. She has been in banking for over three decades, most recently at the top of two community banks—Bankwell Financial Group and NewAlliance Bancshares, both of Connecticut—as well as much larger banks. 

She says community banks need to seek ways to bolster revenue, cut costs, and improve efficiency, because the pace of interest rate increases will likely be too slow to produce the buoying effect that many smaller banks are hoping for.

Patterson believes community banks’ greatest strength remains high-quality customer service. Larger institutions have grown better, here and there, at this, but “if I had to put larger banks and community banks on a scorecard, community banks would still far exceed the big ones,” says Patterson. “They know their customers, and people still gravitate towards them because they fulfill a vital role in their community.”

To stay in the game, she says, community banks must begin pulling every lever that will help their performance. Charging appropriate fees is one lever.

“The community banks that stood their ground and survived the financial crisis play an important role in their communities, from a lending point of view,” says Patterson. “But in the regulatory environment and interest-rate environment that we are in, community banks are clearly challenged.” New capital and liquidity requirements are among the headwinds they face.

Not leaving money on the table, trimming expenses, and exploring new ways to make money are must-do’s, according to Patterson.

Community banks, generally speaking, lack a diversity of revenue sources. “They do a few things really well, and they largely depend on interest income. Fee income hasn’t been a sweet spot for community banks,” says Patterson. “But you can’t be a one-trick pony anymore. You’ve got to be able to thrive in all kinds of interest rate environments.”

Q1. Community banks traditionally employed officers who did multiple tasks. And yet increasingly, individual bankers must deeply understand key specialties. But the need to contain costs is stronger than ever. How can management make this all work?

Prompted by regulatory requirements, community banks have to invest in subject matter expertise regarding risk management, controls, credit quality, and more. And, aside from offering the benefits of working in a smaller environment, that means attracting that talent financially. It’s the only enabler you have, but you can’t just keep spending more money on investing in people without cutting somewhere else—not unless you can find new revenues to offset the expenses.

There are many opportunities in smaller banks to automate procedures and controls, and to squeeze out inefficiencies. You trade that off for good people in the front line and the back office, and the result is a more viable, growth-oriented company.

Q2. Where should bankers be looking for greater efficiency?

Account opening is one of the most inefficient processes in small community banks. Underwriting of loans, especially small business loans, from origination to closing, can often be improved; collection practices as well.

In both of the companies I ran as CEO, I found we were spending insane amounts of money on core operating systems that were way too expensive. You need to renegotiate your contract—or you need to find a new vendor. You have to cut your cost of functioning as a company.

Understand that core systems providers face their own pressures. Many larger banks brought their systems in house, so the vendors have focused on regional and smaller community banks. In this regard, something that’s very helpful is to have a former big-bank person running your IT function. There’s a bit of naiveté among smaller banks. But, given their experience, these bankers can help you because they have a better idea of what you should really be paying. Often, they’ll see the bills and scratch their heads, wondering why you are paying so much. When I saw those overcharges, I told the vendors, “We’re going to negotiate the cost down or you’re going to lose my relationship.”

Q3. What must a community bank do to move beyond a spread-based model?

There’s no magic bullet, but community banks need to focus on wealth management and trust. This is a high maintenance business and demands a lot of expertise that makes it costly to start from scratch. Buying, versus building, is an option to get into it. Annuity sales can be an excellent cross sell against low CD rates. Bank-owned life insurance can be a nice fee-income generator. And originating loans for sale can be a good income stream.

There will be some partnering by banks with fintech companies, where somebody else is building it. Private equity investors in those deals have returns they want to reap.

My only caution is to remember what happened in the subprime business. A number of those specialized lenders were bought by banks, and the end of the story wasn’t so great.

Q4. At conferences, fintech companies often don’t talk very favorably about banks. Are they right?

They’ve got a new niche to fill, and they are doing that on the backs of the banks that they feel abandoned the market. So they view things as the banks’ loss and their opportunity.

Banks, typically, are not the Apples of the world. But changes in consumer behavior and how they want to interact with banks is forcing them to value what some have dubbed the “new agility.” They need to establish a culture that rewards innovation and that rewards timeliness—that rewards being on the cutting edge with alternative delivery.

Banks have traditionally fallen down on that score. But having been a banker for 30 years, I can well appreciate why. There are lots of burdens that banks have that fintechs don’t.

Q5. In the age of the app, does “community” mean what it once did?

That’s a great question, because the traditional definition is geographic. But what is emerging is a much broader definition. The concept of “digital community” allows like-minded consumers to discuss their financial needs online and to have their product experiences online. I live in Connecticut, and my geographic community is Fairfield County. But digitally my community is much broader. I bank with a number of institutions, each relationship depending on the financial purpose of that relationship.

Q6. What will the community banker of the future look like?

Passion for the business itself is part of the current description, and that shouldn’t change. Likewise, community bankers need to be completely performance-driven. They need to be credit-savvy, client-focused, and concentrate on service. But there are also some newer, emerging attributes.

One is understanding how customers prefer to interface with us. And another is becoming savvy about marketing in the modern sense—especially social media. Similarly, familiarity with the growing role of technology is important.

And overall, the community banking leader of the future must be someone who is innovative, comfortable with change, and, most of all, be someone who can also instill that kind of culture throughout the bank.

Q7. We have talked a great deal about how bankers are changing and must change. But what about bank owners—must their perspective change as well?

Capital is king in this environment. Banks are being required to maintain certain levels of capital, but having “dry powder” is critical for a community bank that would be successful. That dry powder entails having enough capital to be able to grow the bank organically; to make investments in new profit-making business lines; and, also, to pursue acquisitions.

Having that dry powder gives you options. Insiders and board members may have to reach out for more capital—private placements among friends and family; hiring an investment bank to raise capital among a small number of outside investors; or taking the bank public through an initial public offering.

I’m an advocate of IPOs. We did them at both of my community banks. But raising capital in some fashion is critical for community banks, because it’s really what’s going to enable them to be around in the future.

This article originally appeared in the 7 Questions department of the December 2015-January 2016 Banking Exchange magazine.

Steve Cocheo

Steve Cocheo’s 39+ years in financial journalism have taken him to all 50 states and nearly every corner of financial services in companies from fintech startups to community banks to regional and national giants. He is executive editor of Banking Exchange and digital content manager of www.bankingexchange.com. Previously he spent 36 years on the staff of ABA Banking Journal and 22 years concurrently as editor of ABA Bank Directors Briefing. He is the only journalist to have sat in on three federal banking exams, was a finalist for the Jesse H. Neal national business journalism awards, and a winner of multiple awards from the American Society of Business Publication Editors. In 2017 he received three awards from ASBPE: National Gold, National Bronze, and Regional Silver. Connect with Steve Cocheo and Banking Exchange on LinkedIn. Email Cocheo at [email protected] Follow Banking Exchange on Twitter

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