Adding a Line of Business? Consider This

Establishing or deepening a specialty area can be a lot of hard work for community banks, especially if it’s an area outside their core expertise. But expanding revenue streams can be important for banks’ growth, and specialty areas such as mortgage, wealth management, insurance, small business, digital banking or others can be worth exploring. 

“As revenue and profits of banks continue to be squeezed, there’s always a need to increase revenue and profitability in an efficient model,” says Phillip Buffington, partner at law firm Balch & Bingham, LLP in Birmingham, Alabama. 

If community banks can provide a new service that’s related to an existing service, it can serve those goals. For competitive reasons, banks are also looking for ways to provide more convenient services and increase customer loyalty. Finally, adds Buffington, it’s a “way to draw in new blood” in terms of customers and employees.

Here are some ideas for community banks considering expanding into a specialty area.

Create a roadmap

Bell Bank in Fargo, North Dakota, has added several specialty lending areas over the past few decades, including capital finance, equipment finance, correspondent banking and agriculture. It always starts with identifying a market deficiency and determining how the bank can satisfy that need, says Patrick Chaffee, executive vice president of the $14 billion-asset community bank.

Banks have to carefully map out their plans to build the new specialty line. Some banks choose to grow a new specialty line organically by hiring subject matter experts and investing in the necessary technology, infrastructure and other necessities. Others acquire a nonbank or another bank with established expertise or a footprint in the desired area. 

Bell Bank decided to take the former route in several instances because it felt it had a better chance of achieving a cultural fit by hiring professionals, rather than acquiring organizations. To do this, it identified leaders in the spaces it was interested in building out and brought on teams of professionals to help it build the capabilities in‑house. 

“Our motto is ‘buy the horses, not the barn,’” Chaffee says.

Bell Bank is family- and employee-owned, so it had the luxury of waiting for new businesses to mature, which can take several years. In this way, the community bank felt it could be comfortable knowing the vision of the group would align with the rest of the organization, the ownership and the board of directors. 

“You have that ability to be patient and make things work culturally, so that for the long term, it’s a great fit for the company,” Chaffee says.

The challenge, however, is that when you are in start-up mode, it can take much more time to build a thriving business, he adds. Very often, these specialties require special infrastructure. They may have their own marketing needs, core platforms and other intricacies. 

“It takes a lot of heavy lifting to grow organically,” he says.

For example, when Bell Bank started its equipment finance lending business, it found that unique systems and accounting were required. “You can’t just start day one without appropriate infrastructure,” Chaffee says.

How long it takes to get a specialty area up and running depends on the type of specialty and experience of the bank staff, and whether you are buying or starting from the ground up, says Buffington. He notes it can take two to four years to build up a unit to profitability when starting from scratch.

Establish criteria for success

BayCoast Bank in Swansea, Massachusetts, took a different approach when building out its insurance specialty. The $2.85 billion-asset community bank was looking for alternative sources of noninterest income. It found it had strong relationships with customers for deposits and lending but was missing opportunities from an investment and insurance perspective as it grew locally, says John McMahon, senior vice president of community engagement. 

To build the business, BayCoast looked for smaller, local investment and insurance agencies that fit culturally with the bank. The community bank wasn’t interested in buying large conglomerates, and it had strict criteria. Any agency it considered had to offer high levels of customer service, quality products and be “like-minded in philosophy and culture,” McMahon says. The bank has acquired nine insurance agencies over the past 25 years.

Focus on due diligence

Community banks often seek ways to grow, especially as it relates to non-interest income, but building or buying a specialty area just for the sake of growth can be counterproductive.

Buffington tells community bankers: Don’t just search for new areas that your bank can enter. Make sure they are a good fit for your bank.

Banks can get into trouble when the attraction to profit overshadows competitive and operational realities. Buffington offers the real-life example of a community bank that established a division for leasing activities. The community bank went through certain motions, such as hiring outside people and marketing the new unit. But ultimately, the bank decided the market wasn’t there for the products it wanted to offer. Also, the competition was so strong that it couldn’t be as efficient and profitable as its unregulated counterparts. 

The community bank ultimately closed the new division, losing more than six figures in start-up costs, Buffington says. “It just did not work out the way they hoped it would.” 

He offers another example from several years back when there was significant interest from community banks in building small consumer finance companies. Many ended up exiting that business. 

If a community bank doesn’t already have the staff and the operations to handle a new specialty, it must seriously consider the costs associated with getting into that new area. How long will it take to be profitable? And can the community bank do it efficiently, given the regulatory burden? 

Many banks have had to backtrack because they weren’t making the money they thought they would make, and it didn’t make sense to allocate more resources to it, Buffington says.

Be patient

When growing a new specialty organically, community banks need to be patient, Chaffee says. It takes time to establish a strong business plan that promotes a complete understanding across the organization of the vision. It also takes time to do due diligence on the appropriate systems that will be necessary and to find appropriate personnel.

The leadership team at the bank identified the need for institutional money management services, traditional private client money management and retirement plans for business, and it found that buying a firm was the most efficient way in. It also acquired a local insurance agency whose leadership was familiar to the bank. 

“We knew them, we trusted them, we knew that they would be culturally aligned with us,” Chaffee says.

It’s been a good strategic move for the bank, he adds. For instance, when Bell Bank bought the wealth management unit more than 20 years ago, the bank had under $1 billion of assets under management. Today, that figure is $14 billion.

Integration is critical

BayCoast Bank felt strongly that the insurance agencies it bought shouldn’t be siloed; rather, they should be part of the overall referral bank network. The community bank moved agents into branches where space was available so there could be dedicated personnel for customers’ insurance needs. 

“Having a presence in the branches was a huge benefit,” McMahon says.

In addition to being good for customers, it was beneficial for the traditional bank staff to interact with the insurance agents, he says, noting that the goal was to take down barriers, not erect them.

Think long-term

When the mortgage market was hot, a lot of banks jumped into the mortgage business and benefited from the revenue boost. But when rates started going up and demand fell off, they tried to stay in and lost a lot of money, says Randy D. Dennis, president of DD&F Consulting Group in Little Rock, Arkansas. 

This underscores a problem that many community banks face when considering adding a specialist area: the frame of reference for potential earnings can be too short.

Dennis encourages community banks to consider earnings possibilities for three, five and 10 years down the road, for example. Banks should also run projections that take market cycles into account. Many business lines are cyclical, and banks need to be prepared for downturns, he says. 

Another trap to avoid: When you’re purchasing another business line, don’t look only at the existing income the organization is producing. That’s because income can change drastically after a sale, especially if the merger or acquisition isn’t handled appropriately or if there are unanticipated bumps. 

“Tomorrow is always different than today,” says BayCoast’s McMahon. The business model must be strong, well-capitalized and able to weather downturns, he adds. 

Customer service is also critical to ensuring business continuity. McMahon recommends that community banks have extra staff members on hand to make sure the customer transition goes smoothly. 

“Perception from a customer’s perspective is reality,” he says.

Understand the limitations

Branching out into new specialties isn’t an appropriate strategy for every bank. There’s no shame in staying with what you know and building that out, Dennis says. Before proceeding with a new specialty, think about whether your customers really want or need the service you’re thinking of adding. If the answer is no, then it’s OK to take a pass and focus on what you do best.

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