Author: Dan Roderick, droderick@profitstars.com
The old “80/20 Rule” is dead. Today in the community banking industry that rule has become the “230/20 Rule” – a pretty startling prospect. ProfitStars has found that 230% of the typical bank’s profit is generated by the top 20% of customers. Looked at from the opposite end of the profitability spectrum, approximately 70% of community bank clients lose money.
Knowing that the top decile of the client base yields 2X the bottom line underscores the importance of protecting these crucial relationships – and identifies the need for focus when sourcing new opportunities. Finding more top 10 percentile clients will have a geometric impact on bottom line results. Possibly just as important, strategy also must reflect the fact that up to 70% of clients actually lose money. In most cases, substantial change in strategy is needed to “grow” these relationships in a way that increases profitability. The $64K question is: what strategic changes are needed and how do we quickly and efficiently implement those changes across the organization?
Pricing Impact on Portfolio Profitability
Looking at current community bank pricing practices provides insight into one main reason why customer profitability has become so concentrated. There are three very important strategic priorities to highlight that have a major impact on bank profitability.
- Strategic Priority #1: implement tactics to increase volume of large commercial loans – The average loan balance of all commercial loans at community banks range from a low of $149 thousand for banks with total assets less than $150 million to over $220 thousand for larger banks. Average commercial loan sizes reflect the fact that larger commercial loans – loans in excess of $1 million – represent a very small proportion of the overall loan portfolio. In fact, less than 7% of loans are larger than $1 million. Not only are these loans highly profitable from an ROE perspective, they are also important in terms of the gross volume of net interest income dollars they bring to the table. Customers with loans in this size range are typically “top 10 percentile” clients.
- Strategic Priority #2: implement tactics to increase volume of “bread and butter” loans – Loans referred to as “bread and butter” are loans that fall in the $150 thousand to $750 thousand size range. These are loans that offer two key advantages: 1) they are typically very profitable, and 2) there are many more opportunities in this size range vs. the larger loan category. Most every community bank commercial lender has the experience and relationship contacts to source loans like these; however, our statistics show that only 19.5% to 25.8% of commercial loans – depending on asset size – fall in this size range. “Bread and Butter” commercial loan customers are also typically in the top two deciles of a bank’s customer profitability distribution.
- Strategic Priority #3: implement tactics to price up small commercial loans – Pricing for size is a key concept that is often overlooked. Small commercial loans – loans smaller than $50 thousand – represent anywhere from 40% to 53% of community bank commercial loan portfolios. All of these loans are marginally profitable or lose money. Many customers that fall in this size category are those among the 70% that lose money for the bank.
What is your bank doing to address these strategic priorities?
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