Why Specializing in Commercial Verticals Can Boost Bank Profitability

COMMERCIAL SEGMENTATION
COMMERCIAL SEGMENTATION

Much has been written about the merits of community banks developing banking expertise around specific verticals.  We recently worked with a bank that won the banking mandate for a family-run funeral home.  At first we were surprised that the term loan was 93% LTV.  But when we looked at the entire underwriting package and the borrower’s financials (showing 3.2X DSCR) we recognized the importance of understanding industry specifics and how the funeral industry might be a perfect fit for many community banks.

 

The Merits of Specializing

 

Banks that serve a specific industry become better able to identify profitable banking opportunities in that industry.  Borrowers tell us that they want a lending partner that understands their particular industry, market, or investment objectives.  This is important for the borrower for a number of reasons: a) lenders cannot recommend the right solution if they do not understand the borrower’s business and personal objectives, b) in the future if the economy suffers or the business is challenged, a lender that understands the risks can help the borrower survive, and c) a lender that understands the business can be a valuable consultant for M&A, referrals, accounting or financial advice.  

 

However, banks must pick the right industries or verticals to make this strategy effective. 

 

Criteria for Community Bank Verticals

 

The funeral home industry is especially attractive for community banks for a number of reasons.  The deathcare services industry consists of about 15,000 companies that employ 136,500 workers and generate about $19 billion in revenue annually.  Deathcare service providers include funeral homes, cemeteries, and crematories.  Funeral homes perform an average of 150 funerals per year, and the average cost of an adult funeral is approximately $9k. The cremation rate is estimated at 55% in 2019 and is forecast to reach 79% by 2035 (a challenge for the industry).  Annual revenue per employee is $120k, and revenue per employee is higher for smaller funeral homes (a positive for community banks).

 

Community banks should consider the following five criteria when assessing which industries to target:

 

Industry concentration – community banks are better competitors in fragmented industries.  A few dominant large firms in a concentrated industry is not a good fit for community banking.  The funeral home industry is fragmented with the top 50 firms account for about only 20% of industry sales - a perfect fit for community banks.

 

Growth and profitability trends – it is challenging to be a profitable bank serving unprofitable customers.  The funeral home industry is growing at a rate faster than the general economy.  Historically this industry has grown between 2 and 5% per year, but death rates are expected to increase by 17% after 2020 with the progressive aging of the population - an especially desirable development for the industry.  Revenue is projected to grow at just under 4% for the next 5 years.  Gross margins average 75% of sales, and EBITDA averages between 11 and 12% of sales and have been stable.

 

Capital usage – high fixed costs in the form of property, maintenance, and equipment are a good fit for community banking.  Funeral homes have substantial credit needs to finance land, building, and equipment. 

 

Relationship driven – most funeral homes are family-owned and operated and would value long term relationships.  Approximately 86% of funeral homes are owned by family or individuals and the remaining 14% are publicly traded corporations.  Community banks in most areas in the country would have access to dozens of funeral homes in their local communities.  Further, the exit rate for the industry is low, at 8% per year, resulting in more stable banking relationships.

 

Price elasticity – less volatile industries tend to be more bankable and more profitable.  The funeral home industry is recession-resistant.  While death care services are not discretionary, and economic conditions do dictate what consumers are willing to spend.  The industry has experienced stable cash flow generation and this is a fundamental appeal of the industry. 

 

Community Banking Needs

 

The bank that we worked with on the family-owned funeral home identified the following opportunities with the customer:

  • Business checking account
  • Merchant services
  • POS processing
  • ACH
  • Wire transfer
  • Payroll process
  • Commercial real estate mortgage (including a hedge fee)
  • Equipment finance
  • Lines of credit

Conclusion

 

The funeral home industry is especially well suited for community banks.  However, there are dozens of other industries in most communities that can be equally appealing to community banks.  Banks should incorporate the five criteria listed above in assessing which vertical to target