There are many examples of successful branches operating in less-than-ideal market environments. New branching opportunities, however, may not be obvious on the surface.
“The communities in our area are overbanked” is one of the most common concerns that we hear from our clients when we discuss their market expansion opportunities and branching strategies. Intense competition is becoming a fact of life.
How do you identify whether a market will be able to support a new branch office or whether it is over-banked? You may want to begin with the population-per-branch ratio, and compare it with the regional or other relevant averages. In addition to the resident population, daytime population and the size of the business base should be considered in relation to the number of branches. Generally speaking, the higher the ratio, the less competitive the market. A more important measure, however, is the strength of the competitors (versus your strength) and how they are perceived by the community. You will need to examine the type and quality of your competitors, and which niches they are pursuing. Depending on the expertise of your competitors and how they are positioning themselves in the market, you may be able to identify potentially underserved market segments. An analysis of the competitor branch locations, centralized draws in the area, and the existing traffic patterns may help you identify underserved geographic locations. The number of competitors operating in the area is less relevant if you are the only bank targeting a specific market segment or you are able to stand out from the competition in other ways. If you are confident in your expertise and your service quality, some of the nearby competitors may present an opportunity, not an obstacle.
Flat Growth and Small Markets
Many community banks operate in smaller, rural markets with limited population growth and less-than-average demographics. They realize that future growth will have to come from markets outside of their local community but keep postponing expansion due to the lack of growth in the area. Although stagnant markets may not offer the instant growth potential of expanding suburban corridors, the branch expansion benefits are often still available. Attractive demographics usually come at the expense of a higher cost-of-market entry and a higher competitive intensity. If the slower growth or the smaller size of the market is aligned with a lower-cost branch service model, the new branch is very likely to become a profitable component of a bank’s network.
Avoid gauging market opportunities based on a few demographic characteristics. The size and dynamics of your market are affected by not only the population living in the area, but also the population commuting to the area for work, retail draws, travel patterns, or the businesses operating in the area. Many people bank close to where they work, and the places of high workforce concentration do not often pop up on the list of high-growth areas, although they may be attractive branching markets. New growth adds to the market potential, but household turnover is also a good source of new household arrivals offering similar opportunities. These are just a few examples of factors that should be taken into consideration.
Justifying Branch Investments
New brick-and-mortar branches do not come cheap and, in most cases, you will need to wait several years to see them contribute to the bank’s bottom line. A typical community bank branch begins generating profit in the third year of operation and breaks even within the first five years. However, if you have identified a market where you can grow, the branch investment may be a very effective way of utilizing your capital and adding value to your bank over the long term.
The key is to watch the relationship between growth, profit, and the amount of capital that needs to be deployed. Let’s look at an example of an average branch in an average market. Within five years, the branch would grow to about $15 million in assets, and its profit contribution would be around $150,000. Assuming a 10 percent equity-to-asset ratio, $1.5 million in equity is needed to support the asset growth. If the bank’s value is about 14 times its earnings, the $150,000 profit generated by the branch in Year 5 would theoretically represent a value of $2.1 million, or $0.6 million more than the capital invested. In this case, growth is adding sufficient profit to justify the capital allocation. With an average profit contribution of $400,000 per year for a mature branch, the value in earnings generated by the branch is significant.
Although branching opportunities are harder to find, branch banking continues to be critical to retail banking success.
If you are interested in discussing this article or evaluating your bank’s potential expansion opportunities, please call Martina Dowidchuk at 1.800.525.9775 or click here
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