"WHY THE CHURCH BUILDS CATHEDRALS"

Last year we conducted some analysis for a client bank to answer the question - should you lease or own your branches. The answer it turned out, in our opinion, was that a bank was better leasing. On one side of the equation, we noticed banks that owned their own branches traded at higher multiples to tangible book value by an average factor of 0.24. In addition, the average branch property (with land, and assumed a 3,700 sq ft property) had a 5Y annual appreciated rate of approximately 6%. We took that premium (done using 2006 multiples) and appreciation and then compared that return to the amount of leverage that could have been gained by had those banks used that capital to book loans and securities. We assumed banks could fully redeploy capital in a 75% mix of commercial loans (non-construction) (average loan size $3mm with a 5Y term) and a 25% of agency securities. We used an average risk and cost-adjusted margin of 2.05% and maintained a 10% Tier-1 capital ratio. We also assumed a triple net lease rate of $20/sq. ft. Because the present value of income from those marginal loans and deposits was greater than the 0.24x tangible book plus appreciation (net of lease and assuming the same operating costs), we came to the conclusion that the average bank should lease their branches and redeploy the capital into loans and deposits. This was our belief until the other day when we ran into a veteran banker that believed the opposite. His take was that since significant improvements are largely wasted on a leasehold interest, only by owning the property does it makes sense to build a grand branch. The impact that the branch has on a brand, morale and marketing, the CEO argued, was not taken into account in our analysis. This CEO built a Taj Mahal-type branch that, by conventional analysis, would not break even for 5+ years. However, after approximately 6 months of operation, the branch was a lynchpin in the community's revitalization efforts. As such, it raised the bank's profile in the community, garnered a tremendous amount of goodwill and grabbed profitable customers better than any marketing promotion. The net result is that deposits are growing like crazy and this branch looks like it will be profitable in a much shorter amount of time. While we are still not sure our analysis needs refinement, we are willing to take another look. Regardless, this banker made us re-think the role of the branch as a substantial contributor to brand and made us better appreciate the practical logic of the Catholic Church building cathedrals.