Finding Balance Between Efficiency and Humanity

Finding Balance Between Efficiency and Humanity

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In case you missed it, on Friday, January 20th, several news outlets reported that Capital One Financial would be eliminating more than 1,100 tech positions. Interestingly, the systems designed by these workers, and intended to increase efficiency, are now being cut increase efficiency.

In a nutshell, a bank’s Efficiency Ratio measures how much of its operating revenue is spent on overhead. Its another useful way to assess profitability, other than  looking solely at net income and return on assets or equity.

As a general rule, credit card banks are one of the more efficient sectors of the banking world. In fact, according to the FDIC Quarterly Banking Profile (QBP), the average bank efficiency ratio at September 30, 2022 was 56.17%; the average for credit card banks was 54.8%.

That means it costs an “average” credit card bank $1.37 less than any other “average” bank (54.8 cents as opposed to 56.17 cents) to generate $1 in revenue. At September 30, 2022 it cost  4-Star Capital One, N.A., McLean, VA a whopping 73 cents to generate that dollar.

That may be why the parent, Capital One Financial, decided to merge its two banks (Capital One N.A. and Capital One Bank (USA) N.A) together on October 1, 2022. Capital One Bank USA’s efficiency ratio prior to the merger was 22 basis points lower (51%).

An optimal efficiency ratio is considered to be 50% or lower, (i.e. spend $1 to make $2). However, as a group, only mortgage lenders and consumer lenders are currently operating under 50%. Community banks, which make up over 91% of the industry, lowered their average efficiency ratio by 203 basis point during the third quarter, bringing it down from 61.57% to 59.54%.

This change is the result of operating revenue growing faster than noninterest expense, so you can imagine it is prone to quarterly  fluctuation. A better comparison may be the year-to-date numbers. For the first nine months of 2022 the efficiency ratio for community banks was 61.63%; it was 60.66% a year earlier.

The 50 community banks listed on page 5, though, all reported much lower efficiency ratios than average. They share other commonalities as well. At 9/30/22, each reported:

  • assets per employee (another measure of efficiency) exceeds $12 million;
  • an efficiency ratio of less than 50%; and
  • each is profitable, both for the third quarter and year-to-date.

On top of all that, each has  minimal (mostly zero) delinquent loans, as evidenced by the difference between the leverage capital ratio (CR) and Bauer’s Adjusted CR.

All 50 community banks on page 5 are also recommended (rated either 5-Stars or 4-Stars) by Bauer. Let’s take a closer look at a couple.

Established in 1963, 5-Star River City Bank, Sacramento, CA had assets of $3.960 billion, at September 30, 2022. That’s up over 11% from a year earlier. Just over $3 billion of that is in the form of loans, which were also up considerably (18.17%) from a year ago.

At $29.123 million, River City Bank is in the top 10% of all U.S. banks when it comes to assets per employee (based on year-to-date average assets). As for provisioning for loan losses, River City Bank continues to increase its reserves. That’s good. While its delinquent loans are minimal now (its delinquency to asset ratio is just 0.002%), 85% of its loan portfolio is commercial real estate (CRE).

The bank is aware of the current pressures on CRE loans. In fact, according to the bank’s own year-end assessment, 2022 was River City Bank’s 7th consecutive year of record net income, but the bank remains “cautious about the impact to the office segment of commercial real estate”.

It went on to state that operational efficiency is one of its primary objectives. With an efficiency ratio of just 26%, we can say they are achieving that goal with flying colors.

A little further down on page 5, you’ll find another, 5-Star West Bank, West Des Moines, IA, operating under similar circumstances. West Bank is much older, established in 1893, but of similar asset size to River City Bank.

West Bank operates through 12 branch offices and has 174 employees, whereas River City Bank employees 128 people in ten branches. This difference is likely a result of the banks’ physical locations. River City Bank, in Sacramento, CA (pop. 525,000) and West Bank, headquartered in the much smaller city of West Des Moines, IA (pop. 70,000).

West Bank, which touts itself as the oldest business of any kind founded in West Des Moines, broke ground for new corporate headquarters in the city last June. Not only is the new location in a highly visible area, it is also in an area in need of reinvestment and redevelopment. Chairman and CEO, Dave Nelson explained, Redevelopment is both more difficult and more expensive, but as community leaders, we think it’s important to support the community that has supported us for so long.” That commitment has earned West Bank Outstanding ratings on its last three CRA exams (2014, 2018 & 2020). Kudos.

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