A Road Map for Branch Realignment

By Steve Reider

At a time of declining in-branch transaction volumes, many financial institutions have concluded that branches can operate with less space and fewer employees. Accordingly, the average size of new branches continues to decrease, and numerous institutions are testing pilot floor plans in the 800 – 1,600 square foot range.

Evaluating Branch Reconfiguration Projects

Architects designing new branches enjoy the luxury of a blank canvas, even though they may face site constraints and the challenge of housing all core banking functions in a reduced space. Most of the time, however, the opportunity to reduce occupancy burdens and staff costs lies in reducing the footprint of current branches. This tends to be an expensive effort that may involve substantial interior reconfiguration. And it may prove difficult to justify.

In one context, bankers can easily rationalize branch renovations and reconfigurations. Even if the institution cannot achieve the desired floor plan in the current space and must relocate the branch, the project still will rarely carry incremental staffing costs. In many cases it will reduce those costs. But any renovation or relocation still requires capital—about $125 per square foot in construction for a typical renovation, or more than $300,000 for a 2,500 square foot branch before any new equipment costs. It can be difficult to rationalize that capital request for an investment that does not bring the potential for additional customers.

Example – Consider a bank with ten branches and two prospective renovations, each costing $500,000. The bank can renovate two branches for a total cost of $1 million, but afterwards it would still have ten branches. Or, it could build one new small branch for $1 million, and then have 11 branches—serving 11 different potential groups of customers.

Which option would you favor? When weighed against devoting the same capital to network expansion, renovations and relocations become difficult to justify. That said, such ongoing network maintenance remains critical to maintaining an efficient and updated network. Substantiating those projects requires one of two analytic paths.

The Cost Equation

The simplest justification for a project occurs if it can immediately improve earnings, i.e., if the cost savings from any staff reductions realized from the renovation exceed the annual depreciation incurred from the capital outlays for the project.

Example – A $500,000 renovation with a weighted average depreciation term of ten years would add $50,000 in annual expenses. If the redesigned branch could then operate with two fewer tellers, each at a fully loaded annual cost of $30,000, then the $60,000 annual staff savings would more than offset the $50,000 gain in occupancy expenses. The project would then prove irrefutably justifiable.

The Revenue Equation

If projected cost savings alone remains insufficient to offset the increased depreciation expense, the institution must then determine the revenue gain to justify the project.

Example – Consider the previous scenario, but this time the renovation allows reduction of only one teller, i.e., $50,000 in expenses but only $30,000 in savings. In this case, the pertinent question becomes: “How much in incremental income does the branch need to generate to offset the incremental costs of the project?”

To compute this, divide the net project cost (the overage after subtracting any staff savings) by the bank’s gross margin (the net interest margin plus the ratio of noninterest revenue to deposits). The result of this equation yields the deposit gain required to turn the project breakeven.

So in this scenario, if the bank shows a 3.00% gross margin and earns 0.50% per deposit dollar in noninterest revenue, the branch would need to generate $571,000 in incremental deposits to achieve exactly the $20,000 in revenues needed to offset the project’s net costs ($20,000 / (.0300 + 0.0500) = $571,428).

Keep in mind, though, that for the project to prove truly beneficial, those balances must represent gains above and beyond what the branch could otherwise generate without the renovation. That remains abstract, and especially difficult to consistently ascribe across a network in order to prioritize reconfiguration projects. Thus, if an institution maintains more than eight to ten branches and wishes to recast all branches so that their size aligns with market demand—but it lacks the capital to retrofit all branches at once—it will need a method of prioritization.

Prioritizing Bank Reconfiguration Projects

One approach for prioritizing renovations is to group branches into tiers, based not only on the cost-benefit proposition but also on the long-term role of each branch in the overall network. Then reserve the majority of renovation investments for two types of branches:

  • Anchor branches that carry sizable deposit bases in top potential submarkets, with a history of top sales performance
  • Rising sales engines, with low-to-moderate current balances, but in submarkets with the highest upside opportunity

Even if you’re striving to recast the entire network with new design and technology concepts, consider an approach that allocates a full renovation framework for the top-tier branches as described above, but a lesser program for branches that remain secondary drivers of revenue or hold limited upside potential. To maintain brand consistency and enthusiasm corporate-wide, be sure to allocate some level of investment to every branch. That could mean complete transformation of the top-tier branches, modest technology investments in the second tier, and cursory merchandising in all others. In this way, an institution can effect the comprehensive retrofit its network requires while remaining within its capital budget.

Steve Reider is President of Bancography, based in Birmingham, Ala., and provides consulting services, software tools and marketing research to financial institutions.