Building Banks Bites Into Efficiency Ratio

Springdale-based Legacy National Bank scraped the bottom of the barrel in bank performance indicators for virtually every category at the end of 2005.

The bank came in second to last in return on assets (-2.72 percent) and efficiency ratios (137.88 percent), beating out only startup competitor Signature Bank of Arkansas in Fayetteville. And Legacy plumb bottomed out in the return-on-equity category, sitting at the very bottom of a list of banks in the six-country market that has grown to 38 from 33 just two years ago.

But Legacy President and CEO Don Gibson isn’t worried.

Better still, he said Legacy’s board members and shareholders are actually pleased with the bank’s performance so far because it has “exceeded first-year expectations.”

Legacy officially opened as a deposit-taking institution on March 28, 2005, so like any business, it’s not really expected to turn a profit its first year — or even its second. But profits are only one barometer in the multi-faceted banking industry.

To illustrate bank performance, the Northwest Arkansas Business Journal has traditionally ranked area banks by ROA, “the great equalizer,” according to several bankers. But some banks look at ROE, and others at efficiency ratios.

The Business Journal’s official list of the area’s top private and public banks ranked by ROA is here (PDF), and a story about the top banks by ROE is here.

The chart here (PDF), which is the primary data for this article, ranks the banks by 2005 efficiency ratios and includes only public and private banks operating within the six-county market that are chartered in Arkansas. Other data included in the chart are frequently mentioned by area bankers as indicators and are provided as a service to the readers.

“Balance sheets are like an orchestra,” Gibson said, requiring many sections to work together — hopefully in unison.

It all boils down to a bank’s business strategy, he said.

Ratio Ratings

The Federal Deposit Insurance Corp. defines efficiency ratio as “noninterest expense, less the amortization expense of intangible assets, as a percent of the sum of net interest income and noninterest income.”

“It simply tells you how many cents of overhead it takes to produce each dollar of revenue,” said George Gleason, chairman and CEO of Little Rock-based Bank of the Ozarks.

BOZ has a record being one of the most efficient banks in the state and came in as the No. 2 bank in the six-county market, just behind Pinnacle Bank of Rogers.

Pinnacle opened its doors in August of 2004 and showed a 140 percent ratio at the end of that year, an expected result. During 2005, the bank reduced that bank-busting ratio all the way to an outstanding 41.75 percent.

Gleason calculates his numbers slightly differently, but the FDIC recorded BOZ as having a 42.26 percent efficiency ratio, down 1.28 percent from 2004. (Remember, in terms of efficiency ratio, negative percent change is a good thing.)

Therefore, Gleason’s bank spent about 42 cents per dollar in overhead, while Signature Bank — at the bottom of the list — spent 184 cents per dollar. The FDIC said the industry average nationwide was about 57 cents per dollar in 2005, Gleason said.

BOZ’s total net income was $33.95 million in 2005.

When asked what his optimal ratio was, Gleason said, “It’s exactly like your golf score — you keep working at it … You want to keep taking a little off.”

Efficiency is not necessarily more important than any other performance ratio, he said, but banks with a lower efficiency ratio have definite competitive advantage. Plus it’s better for customers and shareholders, he said.

And it appears BOZ has a competitive edge. The bank will add six branches in Benton and Washington counties in the next eight months.

While its performance looks good, Pinnacle Bank has virtually no infrastructure. In fact, the bank now leases one location and just started construction on its first building. Mills said that helped with 2005’s ratio, but he also likes to save dollars and do more with fewer people.

Mid Range

Arvest Bank Group of Bentonville has the most extensive banking infrastructures in Northwest Arkansas with 68 offices from Bella Vista to Van Buren.

The bank that has the lion’s share of deposits — 31.3 percent in the six-county market and 46 percent in Benton County alone — has a comparatively high efficiency ratio of 71.61 percent.

Donny Story, president of Arvest Bank-Fayetteville, said it’s just part of the Arvest strategy.

The bank seeks to serve its retail customers with convenient locations that are open early and late, meaning more overhead costs.

Arvest as a company doesn’t seek a specific ratio, Story said. If a bank in a specific market needs a larger branch structure, it builds it. If not, then it shoots for the best numbers it can get, but making sure retail customers are taken care of is priority, he said.

If the national average ratio was 57.24 percent in 2005, then only 13 of the 35 state chartered banks in the market met or beat that number. Twenty-two banks, or about 63 percent, fell below the national average.

Long-term Legacy

Gibson and Patrick Swope, Legacy’s executive vice president and chief operating officer, said the group is making long-term investments, not trying to turn a quick buck.

The two have shared a cramped office in the bank’s temporary building — which is a “mobile banking unit” — for about a year. They eagerly showed off renderings and blueprints of the 20,000-SF headquarter building that’s under construction just a few feet from the other side of the office wall. It’s scheduled to be complete by October.

Swope has every detail of the building memorized, and the two talked about how technologically savvy the structure will be and how it is user friendly.

Gibson wouldn’t say when he thought the bank would turn a profit or decrease its efficiency ratio or increase its ROA. He said that size doesn’t really matter, but that being safe and sound does.

Gibson said, “We’re not building [Legacy] to make money in 2006 — it’s because we’ll be here in 2016.”

“And in 2056,” Swope said.