The chatter about community banking these days is that it is an industry in peril. Hamstrung by problem loans and scant access to capital markets, countless community banks that once had growth ambitions are shrinking their balance sheets in order to preserve capital.
While it's true that some small banks struggle to remain solvent, others are thriving, like First Virginia Community Bank. The $275 million bank in McLean, Va., earned a record $2 million last year and grew its loan portfolio by nearly 30% in a weak loan demand environment. Founder and CEO David Pijor says much of the growth has come at the expense of larger rivals that have become increasingly inflexible.
His four-year-old bank has not yet tapped the capital markets, but it raised $36 million from local investors and customers, and has a waiting list of people ready to pony up next time it needs capital. Pijor says he plans to pursue a public offering within a few years, with the hope of reaching $1 billion in assets soon thereafter.
Even in hard-hit regions like South Florida, bankers are optimistic. Charles Brown, CEO at the $145 million Insignia Bank in Sarasota, says community banks are winning back mortgage-lending business that they ceded to larger banks years ago. Insignia, primarily a business bank, recently lured a team of mortgage bankers away from a much larger rival, and Brown is eyeing more hires as a way to grow market share.
The challenges facing community banks are nothing to sneeze at. All have been contending with a significant squeeze from new regulations that simultaneously undermine revenue and inflate compliance costs. Despite that, deposits are flooding community banks as larger competitors impose new fees and shutter branches. And while loan growth remains sluggish industrywide, smaller banks are adding loans at a faster clip. But the threat from the big banks remain. Bank of America, JPMorgan Chase, Huntington Bancshares and others are ramping up small-business lending-community banks' bread and butter-with scores of new hires in recent months.
Community banks have no chance of competing with large banks on marketing. "Our biggest competitor is [the $25 billion] First Tennessee, and they'll spend more on marketing in a year than we'll make in 10 years," says McCall Wilson, president and CEO at the $308 million Bank of Fayette County in Moscow, Tenn. Bank of Fayette is coming off its most profitable year ever in 2011, and Wilson is confident that it will see record earnings again this year.
He's not the only one who is bullish on community banks. Gregory Mitchell, president and CEO of First PacTrust Bancorp in Irvine, Calif., says, "For those community banks that have a strong, scalable balance sheet, a solid capital base and a capable management team, these are probably the best times to gain market share."
Why is it such a good time to be a community banker? Here are several reasons.
COMPETITION IS DWINDLING
Banks have little to fear from start-ups since regulators have essentially stopped approving new charters. Only two new banks opened in 2011. In contrast, 155 banks opened in 2007.
Given the lack of newcomers, the impact of failures and mergers has been more pronounced. More than 430 banks collapsed in the last four years, and with roughly 800 on the FDIC's watch list, experts predict the demise of dozens more before the economy recovers.
While merger-and-acquisition activity is at a trickle now, analysts believe a mass consolidation will begin soon and ultimately could slash the number of banks-now at 7,300-by a third in coming years.
"What other industry is consolidating as rapidly as the banking business?" asks Frank Sorrentino, chairman and CEO at the $730 million North Jersey Community Bank in Englewood Cliffs. "Competition is going away, and that's good news" for the surviving banks.
National and regional banks have the advantage of extensive branch networks, but are downsizing to cut costs as they contend with new caps on interchange fees, limits on proprietary trading and other direct hits to revenue. Bank of America is closing roughly 10 percent of its branches. Many are in small towns where community banks already have the dominant market share.
THE TALENT IS OUT THERE
First PacTrust grew its loan portfolio by about 15 percent in 2011 without the benefit of acquisitions because it landed experienced, well-connected lenders from competitors.
Most of this talent has come from smaller banks that have essentially stopped lending because they are either troubled or too concentrated in one area, like commercial real estate.
Sorrentino attributes the torrid loan growth at his bank-total loans rose 27 percent in 2011-in large part to superstar lenders wooed from larger competitors over the past two years.
The $4 billion Berkshire Hills Bancorp in Pittsfield, Mass., added several teams of commercial lenders (typically three to five people) in recent months, mostly from large banks. The new hires helped the bank grow its commercial and industrial loan portfolio by more than 6 percent between Sept. 30 and Dec. 31, according to CEO Michael Daly.
There's perhaps even more talent on the mortgage side, prompting small thrifts and even business-focused banks to ramp up their residential lending, which can be a significant driver of fee income.
MetLife Bank's exit from the mortgage origination business earlier this year flooded the market with experienced lenders, and thrifts like Provident Bank in Riverside, Calif., and HomeStreet Bank in Seattle scooped them up by the dozens.
Cardinal Bancshares in McLean, Va., has hired dozens of mortgage lenders in the past year-mainly from big banks where lenders grew frustrated with the plodding pace of the mortgage process.
Few community banks have been as aggressive in raiding rivals for talent as the $3 billion Eagle Bancorp in Bethesda, Md. It hired roughly 100 commercial and residential bankers in the last year. CEO Ronald Paul estimates that 80 percent of them came from large banks.
CAPITAL OPTIONS ON THE RISE
It used to be that privately held or thinly traded banks could raise capital fairly easily by teaming up with other small banks to sell pools of trust-preferred securities. But the trust-preferred market dried up during the financial crisis. That's left many small banks with limited options.
But capital raising could get a whole lot easier for small banks, thanks to a jobs bill that President Obama signed into law in April. A key provision in the bill would allow banks to have as many as 2,000 shareholders without having to file financial reports with the SEC. Since the mid-1960s, that threshold held at 500, so any bank with that many shareholders had to submit to the same reporting requirements as the very largest banks. Wayne Abernathy, executive vice president for financial institutions policy and regulatory affairs at the American Bankers Association, says this had stifled growth at many community banks for years. Reporting to the SEC is costly and many small institutions simply can't afford it.
Under the new law, reporting requirements won't kick in until a privately held bank has 2,000 investors, providing significantly more freedom for banks to solicit locals "who see investing in a bank as a way of investing in the community," Abernathy says. Another plus: More small banks will now be able to offer stock to employees-a potentially powerful incentive in attracting and retaining talent.
Private equity groups are also eager to help capitalize banks, though their criteria are pretty strict, says William Spiegel, a managing director at Pine Brook Partners in New York. Pine Brook is a major investor in the $1.3 billion Green Bank, a C&I lender in Houston, and it is eyeing more investments in similarly sized banks in metropolitan markets.
Spiegel says the "big winners" when the economy hits its stride will be banks with $1 billion to $10 billion in assets that are nimble enough to quickly respond to customers' demands, but substantial enough to make the $5 million to $20 million loans that job-creating businesses will need.
LOAN DEMAND WILL PICK UP
Banks like First Virginia, North Jersey Community and the $402 million Meridian have reported substantial loan growth over the last couple of years, but Christopher Annas, chairman and CEO of Meridian Bank in Devon, Pa., acknowledges that in the Delaware Valley most of that growth has come at the expense of other banks as opposed to new business.
Meanwhile, there's growing concern that banks that don't necessarily have the expertise in C&I lending are lowering their lending standards to win business. William Demchak, the vice chairman at PNC Financial Services Group, said at an investor conference in March that "smaller banks have become fierce and often irrational competitors for small-business and commercial clients as they struggle to grow top-line revenue."
First PacTrust's Mitchell adds: "You've got [bankers] doing really stupid things to secure asset growth; like dropping their standards from a credit and pricing perspective and causing future problems for themselves."
Still, many community bankers are confident that loan demand will increase as the economy strengthens.
Annas says he is planning to raise $5 million to $10 million from local investors during the second quarter in anticipation of further loan growth.
Mitchell is already seeing demand surge in Southern California. During one six-month stretch last year, First PacTrust reviewed $800 million in commercial loan applications, a clear sign that businesses in his market are ready to borrow. The bank approved about $70 million of those loans.
In the Sarasota area, which was devastated by the real estate crash, "we're seeing a big uptick in residential lending," says Insignia's Brown. "Residential home sales will lead you into a recession and they will lead you out of a recession," he adds.
SERVICE MATTERS MOST
The one big advantage small banks have over large banks is that they are more familiar with their customers and generally are more willing to tailor products and services to meet their needs.
Now that most large banks are eliminating free checking, and small banks can offer similar conveniences through remote-deposit capture and surcharge-free ATM networks, "the differences aren't as great as they once were," Mitchell says.
Customers seem to have noticed. New data from J.D. Power and Associates shows that more than 10 percent of customers at large and midsize banks moved their accounts to smaller banks and credit unions in 2011.
Data from the Birmingham, Ala., consulting firm Bancography suggests that consumers began fleeing large banks even before they began jacking up fees last year. Excluding large corporate and municipal deposits, which skew results in large banks' favor, community banks with less than $1 billion of deposits saw deposit growth of nearly 19 percent over the last four years, compared with 3.5 percent at large national banks and 5.2 percent at super-regional banks, defined as those with branches in 10 or more states.
Small banks also have the advantage of being more nimble. Insignia's Brown says he recently approved a loan to a borrower who was turned down by a large bank even though he had $5 million in the bank and was making about $150,000 as a consultant. The reason he was rejected by the large bank? He's semi-retired and couldn't show steady income.
Pine Brook's Spiegel says that business owners, too, want this kind of flexibility from their bankers. "Big, out-of-state banks tend to be very clinical. They say, 'Here's my underwriting box, and any request for deviation has to go all the way to headquarters,' and headquarters doesn't know the client and therefore may not respond in a client-friendly way."
Still, when it comes to service, it's human contact that matters most, says Bank of Fayette County's Wilson. He says his bank has the No. 1 market share in the county because it does the right thing by its customers. He's proud of that, even if it means being less profitable than some competitors.
"Who needs a 20 percent ROE?" he asks. "Community banks were never meant to be huge moneymakers for shareholders. We're here to make a difference in people's lives."
Alan Kline is an editor at American Banker.
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