July 17, 2021 / VOLUME NO. 166
The Power of Niches

Warren Buffett once observed that there are only two ways to achieve a sustainable competitive advantage in an industry with numerous competitors, low entry barriers and a product that cannot be meaningfully differentiated.

“In such a commodity-like business,” Buffett wrote in his 1987 shareholder letter, “only a very low-cost operator or someone operating in a protected, and usually small, niche can sustain high profitability levels.” (He was referring to the insurance industry, but it applies with equal force to banking.)

This is by no means revolutionary business theory, yet it’s still interesting to observe in the proverbial wild.

If you look at the performance of every bank in the United States over the past 15 years, those with the highest and most consistent annual returns on assets are those that fall squarely into a niche. First Credit Bank is a textbook example. It’s a $438 million bank with its sole location on Sunset Blvd. in tony West Hollywood, California. It specializes in providing bridge financing to speculative real estate developers, a type of lending that most banks tend to avoid because of the perceived risk. For First Credit, however, it’s turned out to be a consistently lucrative niche. The bank has averaged a 5.29% return on assets over the past 15 years, more than six times the typical bank, according to data from the Federal Deposit Insurance Corp.
And it’s done so consistently. Even at the depths of the financial crisis it produced a 3.79% return on assets. Granted, First Credit hasn’t grown much through the years, but that’s the point: If it were to outgrow its niche, it wouldn’t earn such resplendent returns.

• John Maxfield is a Portland, Oregon-based financial writer

This article is part of Market Intelligence, which is sponsored by D.A. Davidson & Co., and first appeared in print in the third quarter 2021 issue of Bank Director magazine on July 14, 2021. For more articles like this and in-depth features, send subscription requests to circulation@bankdirector.com.
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