Why Community Banks Matter, and Will Survive


2-2-15-KPMG.pngDrive into most any town in America and you’re bound to spot one fairly quickly. Whether on Main Street or tucked in a shopping center on the edge of town, a branch of one the country’s 6,600 community banks probably is nearby.

As institutions that offer much-needed credit to small businesses, make mortgages that turn the American dream into reality, and support public projects that enhance our daily lives, community banking’s impact on our country’s economic growth and stability cannot be overstated. While strengthening these institutions is in everyone’s interest, those at the senior level—management and boards—are facing tough choices and challenges as they attempt to modernize, streamline and digitize their banks.

Although there are 57 percent fewer community banks today compared to the number in business when I began my banking career 26 years ago, and the percentage of overall U.S. banking industry assets they hold has declined from about 40 percent to about 14 percent in that period, today’s community banking system is no less vital to consumers and businesses.

A Federal Deposit Insurance Corporation (FDIC) report shows that community banks make up about 45 percent of the industry’s small loans to farms and businesses. Small business is the backbone of America and community banks are the engine that drives small business. Further, the FDIC report indicates that in 20 percent of America’s counties, there would be no banking offices if not for community banks. Those communities would tell you how fortunate they are to have community banks to provide credit and other needed financial products. They would point out local public projects that wouldn’t have happened without community bank support. They would tell you they are also grateful for the leadership community bank executives provide in the business, philanthropic and public realm, and for funds they donate to local nonprofits.

Community banks epitomize all that is important in our industry—the personal touch. Yes, banking is quickly becoming a digital business. And, yes, banks will need to ramp up their mobile and social-media capabilities for reasons of competition and connectivity. Still, banking comes down to making connections with people.

Think what these statistics say about the importance of face-to-face interaction with banking customers: From 2002 to 2014, the number of commercial banks and savings institutions has declined by 2,700 to about 6,650. But in that same timeframe the number of bank branches increased by 9,400; from 86,500 to 95,900, according to the FDIC.

When community banks succeed, they are staffed by individuals who share a sense of the bank’s strategy of offering customers the products and services they want, when they want them. Today, that mandate might mean banks will need to offer such services as new apps on smartphones or they may need to lean more heavily on cloud computing as a means to reduce cost. Regardless of the need, community banks cannot lose sight of the customer, who is becoming much more demanding with the introduction of each new technology. They have become accustomed to a one-click, right-now retail environment, and they expect banks to act in the same manner.

A community bank’s shared sense of strategy hinges not only on how well its leaders read and quickly adapt to their customers’ demands, but also their ability to clearly articulate the bank’s mission and purpose to employees and customers. Those same leaders also must be able to accept change when transformation is necessary.

Nothing stifles potential growth quicker than an inability to accept that some traditions and ways of working must be set aside for the sake of progress and connectivity. When resistance to change is permitted to exist inside the walls of a bank, little good can come of it. 

Some may believe that the United States is headed for a time when community banks will vanish and be replaced by just a handful of megabanks. There is no question in my mind that community banks will remain a vibrant segment of the industry, if for no other reason than they continue to make the personal connections that any business requires. We may, however, see the number cut in half again by the time I retire from my career. Those that survive will be the ones that give total attention to the customer, focus on agility and differentiate themselves with the best talent.

Using Social Media to Engage Your Shareholders: What Community Banks Should Know


11-3-14-OTC.jpgLast year, the Securities and Exchange Commission (SEC) issued a report stating companies could use social media such as Facebook and Twitter to announce key news and information in compliance with Regulation Fair Disclosure (Reg FD)—so long as investors are informed in advance which services will be used to disseminate information. The Federal Financial Institutions Examination Council (FFEIC) later released its own guidance to financial institutions on crafting their social media programs and managing risk in the social media landscape.

Social media presents an enormous—and unique—opportunity for community banks when it comes to shareholder communications as many community bank shareholders are also depositors or have a lending relationship with the bank. This opportunity will only grow as older, baby boomer depositors are replaced by technology savvy, young customers who seek to connect with their financial institutions in new ways.

Yet, sharing material news and financial information on social media is not without its pitfalls. In this article, we outline some of the Dos and Don’ts if your company is considering incorporating social media into your shareholder communications program.

Dos

  • Do disclose to shareholders which social media channels you will use to share news and other material information. A good place to do this is in your annual report or on the investor relations section of your website. Check out the investor relations page on OTC Markets Group’s website for an example.
  • Do use social media to share more than just your corporate and financial news. Include photos and links to video broadcasts from investor conferences, links to industry news and media coverage as well as analyst reports and trade information.
  • Do proactively engage your followers with direct questions to stimulate discussions. Consider soliciting questions from investors during shareholder conference calls or annual meetings to let them know you’re listening.
  • Do use active shortened hyperlinks (using an online service such as Bitly) to link to press releases and other documents that can’t be included in full social media posts (e.g. Twitter is limited to 140 characters). The SEC stated earlier this year that if a communication is limited by the number of characters or amount of text that can be included, an “active hyperlink” will satisfy Reg FD compliance rules.
  • Do include your “cashtag”; the dollar sign and your stock symbol (ex. $OTCM) in tweets, so investors can easily track conversations about your stock in Twitter.
  • Do consider a social media management tool like Hootsuite to manage your social accounts, schedule messages and measure the return on investment of your social programs.

Don’ts

  • Don’t restrict access to your company’s social media site. Disclosing material information on a password-protected or otherwise restricted website will likely not be considered Reg FD compliant.
  • Don’t share only positive news. Best practice in investor relations is to share your good news as well as your bad. If you share your earnings results on Twitter, don’t only share your results when they’re positive. The same with analyst reports. Don’t only share your upgrades.
  • Don’t ignore social media altogether. With so many new technologies to consider, it may be tempting for community bank boards and management teams to stick their heads in the sand. But they do that at their peril. The motto for social media is the same for traditional media: if you don’t own the conversation, it will own you. So, even if your bank isn’t using social media to engage with shareholders, create social media accounts so you can monitor what is being said about your company, your peers and the industry.

If you’re still stumped on how to start, check out some of your larger public banking peers who are proficient on social media such as JP Morgan Chase ($JPM) and Bank of America ($BAC). Happy tweeting!

Breaking the Mobile Banking Mold


As more and more consumers are relying solely on their mobile devices, banks have to provide mobile products that their customers want and need. In this video, Dave DeFazio of StrategyCorps shares how some community banks are moving their mobile banking applications beyond the standard transactions.


Getting Business for Your Bank: How to Get Involved at the Board Level


6-30-14-Naomi-DC.pngAt KeyWorth Bank in Johns Creek, Georgia, serving on the board means bringing business to the bank. Directors are expected to make referrals to the bank’s officers and lending team. That’s just part of the job.

It’s not unusual for small community banks to ask their directors to take on a business development role. But KeyWorth steps it up a notch. Board members are divided into teams where they compete for points based on the amount of business each team member brings to the bank. Only new deposit accounts or closed loans count, not referrals. At the end of the year, the losing team buys the winning team dinner at a nice restaurant; last year it was a private dining room at the casually elegant Grace 1720. There is no other financial remuneration, aside from dinner. The competition provides a way to nudge board members along in helping the bank grow, with some friendly ribbing as part of the process.

“Our board does a very good job in identifying and referring opportunities,” says Jim Pope, president and chief executive officer of the state-chartered, $380-million asset bank, which has five offices north of Atlanta. “They don’t have to be the loan officers or the experts. They just need to constantly be promoting our bank.”

As banks get larger, the focus on business referrals from the board diminishes and other governance-related needs become more important, such as the need for a risk expert on the board, or someone with deep banking experience. Still, boards take a variety of approaches to the question of what role board members play in bringing business to the bank.

Pretty much all the community banks John Geiringer works with as an attorney at Barack Ferrazzano in Chicago have a role for the board in recruiting business to the bank. He thinks the role has shifted slightly in recent years. For instance, there is much more of an emphasis on quality of governance and quality of the loan portfolio. Many of the banks that survived the financial crisis did so by focusing on the quality of their underwriting. It wasn’t just about bringing any business to the bank, but the particular kind of business the bank wanted. Board members should have a strong handle on the bank’s strategy and what kind of business the bank needs to generate, even if they aren’t underwriting loans. “Pre-crisis there was more of an emphasis on volume and now there is more of an emphasis on quality,” says Geiringer.

Nancy Eberhardt, a director at Congressional Bank in Potomac, Maryland, which has $452 million in assets, says she believes the role of the board is shifting. “It’s more important for directors to be independent and informed first and foremost, and looking to what’s next for the bank,’’ she says. She thinks it is great for board members to bring their connections with them to the bank, but the regulatory environment and the difficulties of oversight are making governance more of a focus for boards.

Robert Monroe, a law firm partner with Stinson Leonard Street in Kansas City, Missouri, says most of the time, board members are majority shareholders in the bank and their job is to bring their friends to the bank. He argues with his clients in favor of term limits and a diversified board but he thinks a diversified board can still bring business to the bank. “My community bank view is that they still want people who produce loans and deposits [on the board],’’ he says.

At Avenue Bank in Nashville, the board was selected for its expertise in the different areas the bank specializes in. For example, the $890-million asset bank has about $200 million in combined deposits and loans in the music business. Three of the bank’s directors are in the music business as well, and are expected to contribute their expertise and referrals: Joe Galante, the former chairman of Sony Music Nashville; Ken Robold, the former executive vice president and general manager of Universal Music Group Nashville; and Steve Moore, the former head of the County Music Association. Music star Kix Brooks was on the board as well, but had to step down to go on tour. Chairman and CEO Ron Samuels says board members will go on visits with potential clients if asked, but they don’t have specific referral metrics they have to meet.

One way to set expectations is for the CEO or chairman to be very direct and lay out expectations for each board member, Monroe says. Some banks will even go so far as to give directors a specific dollar amount of deposits or loans to achieve, he says. The expectations written down on paper also lay out other duties, such as attendance at board meetings and what committees the board member will sit on.

The board members can’t just bring any business to the bank. They need a clear handle on exactly what type of business the bank needs, and they should have a handle on this through their participation in strategic planning and understanding of the bank’s business.

At KeyWorth, annual off-site strategic planning meetings clarify what kind of business the bank needs to pursue and this is well known by the board. Monthly updates during board meetings show the board how the bank is accomplishing its goals. “Education of the board on the kind of business you want is important,’’ Pope says. For instance, KeyWorth likes owner-occupied commercial real estate properties. Also, one-third of the business-focused bank’s customers are in the medical profession. If a board member is going in for an annual physical, he might ask his doctor, ‘where do you bank? I’m on the board of KeyWorth, and our specialty is medical banking. Maybe I can have someone call you?’”

Pope makes it clear that the board members aren’t supposed to answer questions about lending or deposit products. “Don’t let the person lead you into a specific question about a product or a loan,’’ he says. “That’s not expected, nor [is it] your responsibility. Just say, ‘let me introduce you to one of our bankers. That’s not something I have the expertise to answer.’”

There is another incentive for KeyWorth board members to bring business to the bank, aside from the competition: they are also shareholders. The bank is majority owned by members of its communities, and one fourth owned by executives and board members. Directors are expected to make a financial commitment that ends up being more than $100,000 worth of shares.

Advisory boards are another way banks can bring influential members of the community into recruiting business. Geiringer says he knows of several banks that use advisory boards members, who generally attend only a portion of the regular board meeting and provide information on particular communities or industries where they have expertise.

Still, there are a few cautionary notes for directors who refer potential new customers to the bank. Geiringer says banks should be careful about paying a “finder’s fee” or commission to directors who bring business to the bank. “We’ve seen regulators criticize that in the past, ’’ he says. Boards should also be careful to avoid possible conflicts of interest and directors should abstain from any bank board or committee votes on the business of friends or family. The bank should not provide a special deal for any friends, business associates or family members of directors. Bringing business to the bank should be balanced against the director’s fiduciary role on the board. With that in mind, and with the right education and clear communication, board members can play an effective role bringing business to the bank.

Mortgage Outsourcing: Benefits Beyond Cost Savings


Rising compliance costs and net interest margin pressure continue to impact community banks as they search for ways to streamline processes and cut expenses. In this video, Mike Baker of Sutherland Global Services outlines how banks can outsource their mortgage lending processing without negatively impacting the customer’s experience.


Community Banks: You Don’t Have to Get Left Behind


5-12-14-naomi.pngHeartland Bank has just 11 offices in central Ohio. The holding company, Heartland BancCorp near Columbus, Ohio, has $600 million in assets. The company is not traded on any public exchange and traces its roots back more than 100 years in agricultural lending.

But that doesn’t mean Heartland is behind the curve when it comes to technology. In fact, Heartland developed its own mobile banking applications, has person-to-person bill pay, mobile bill pay, surcharge-free ATMs across the nation searchable on your smartphone, and a host of other digital products designed to serve customers’ needs.

“The technology is here and it’s affordable,’’ said Heartland Chairman, President and CEO G. Scott McComb at Bank Director’s Growth Conference in New Orleans recently. More than 120 bank directors and officers attended the two day conference May 1-2, which focused on growing the bank organically, mostly through technology, data-based marketing and sales, and niche or specialized lending.

Bank of America and JPMorgan Chase & Co. may have more resources to develop technological solutions and service them, but community banks increasingly have options as well. Technology providers such as Deluxe Corp., CSI, CDW, StrategyCorps and MoneyDesktop described how banks well below the $50-billion asset range can still gain access to sophisticated technology. For instance, community banks can now analyze credit agency data to find out which of their customers are shopping for an auto loan, and then send customized marketing materials to those customers.

Banks can help customers budget and manage their entire financial lives with online banking tools, which also give banks a trove of potential marketing data on them. Banks can generate fee income by sending coupons to their customers based on the geo-location given by their smartphones. Analytical tools also allow banks to track what customers are saying about them on social media.

First Financial Bankshares, a $5.8-billion asset bank holding company in Abilene, Texas, allows customers to take pictures of their bills with their smartphones, send the pictures to First Financial Bank, and the bank will pay their bills. Similar products are being marketed to banks much smaller than First Financial.

Jeff Casey, a senior vice president at the bank, said mobile customers use three times the number of products and services of other bank customers and are 2.5 times more likely to stay with the bank than other customers. He advised banks to think five or 10 years into the future and plan for the fact that technology will be radically different by then. A full 25 percent of First Financial’s mobile banking customers currently don’t use a laptop or desktop to do their banking. “You have to get rid of this idea that you’re always going to have online [desktop or laptop] banking,’’ he said.

This fact is creating challenges for banks trying to decide where to invest. Deluxe Corp.’ Vice President Scott Wallace cautioned banks not to try to be all things to all people. The type of customers you want and the delivery mechanisms they need will determine the technology and tools to buy.

McComb, Heartland Bank’s CEO, said that community banks actually have an advantage when it comes to data and technology. Community banks are nimble because of their size and can make decisions quickly based on their customers’ needs. They know their customers better than bigger banks do. They are the American colonists fighting the English in a war against the big banks. They can be first to market, not laggards when it comes to meeting their customers’ needs. And that could mean the difference between being relevant or not at all.

Solutions for Community Banks in the Public Markets: Q&A with Broker-Dealers


5-9-14-OTC-Markets.pngSmall banks that have a tough time generating interest from shareholders have numerous tools at their disposal. OTC Markets Group talked recently to two broker-dealers who specialize in community bank stocks about their advice to small, publicly-traded banks and their outlook for the community bank market this year. Joey Warmenhoven of McAdams Wright Ragen has more than 16 years of experience in community bank stocks. Nick DeMaria and Tim Padala of StockCross Financial Services have more than 24 years and 23 years of experience, respectively, in the public markets.

OTC Markets Group has approved both of the FINRA-member* broker-dealers as “corporate brokers” for OTC Markets Group’s new public market for community and regional banks, called OTCQX Banks. The new market will provide banks the opportunity to have their stocks trade on a trusted and shareholder-friendly marketplace with dedicated capital market support and increased visibility with investors. For more information on the new marketplace, click here.

What is the most common question you receive from bank officers and directors about their publicly trading securities and what is your advice?

Warmenhoven: The most common question I receive is, “What can we do to get our stock price up?” My answer is promote your company the best you can and maximize your return on equity. Those two things will ultimately get your shares trading at a higher valuation.

Padala: The most frequent question we hear from the issuers is, “How do we increase liquidity and reduce volatility in our stock?” First of all, if you increase liquidity, the volatility will reduce along with the added liquidity. The next question is usually, “How do we accomplish the goal of adding liquidity?” The answer is to increase awareness in both the local community and investor community in order to widen the investor base. The best way is to get to know the local brokers in your community that are holding your stock in street name for customers. These brokers can be your lifeline to the investors that you are seeking.

Also, get to know your “market makers.” Small, regional and local bank stocks are never going to trade like a high flying tech stock in that millions of shares can be paired off within seconds. The market maker and the local stock broker are the ones that can identify a previous buyer or seller and reach out to them.

What clients do you represent and what value will you bring to your role as a “corporate broker?”

Warmenhoven: [We] represent institutional and individual bank investors from all over the country. [We] have 20 years of experience trading and researching small banks. [We] know the players that are interested in this space and can bring [our] network of investors to the table. In my opinion, this is the strongest asset a corporate broker can provide.

DeMaria: StockCross Financial is a full service and discount brokerage, wealth management and trading firm that is privately owned and operated and has offices around the country. Our bank trading division specializes as a “market maker” in local community banks stocks. In doing so, we are in extremely close contact with the local bank stock investing community, be it institutional investors, other brokerage firms, along with individual bank stock investors. As a wholesale market maker, we tend to be a destination where customer orders end up after being entered at other brokerage firms, be it online, regional or national wirehouses.

What is your outlook for the U.S. community and regional bank market this year?

Warmenhoven: I am optimistic that banks will continue to perform favorably. We will likely see continued consolidation and improved earnings which bode well for bank stock prices.

DeMaria: Most likely, more of the same. The larger banks have returned to a more normalized environment in terms of multiples and predictability of earnings as the panic of the last several years continues to move farther into the rear view mirror. The smaller regionals and super community banks seem to be firing close to all cylinders now, and things will improve as they continue to move closer to the historical norm in terms of both profitability and trading multiples. The more difficult question would be: What happens with the smaller community banks? While most of the issuers have taken their medicine and returned to form, there are still some laggards that are struggling either with capital issues or the prospect of severe dilution to rectify legacy capital issues.

*FINRA stands for Financial Industry Regulatory Authority.

Why Stress Testing is a Must at Community Banks


5-7-14-credit-risk-management.pngWhile there is a lot of understandable energy being spent by community bankers and advocates to waive various mandates for community banks coming out of the Dodd-Frank Act and the international capital rules Basel III, there is one concept, periodic stress testing, which must be embraced going forward. Although it is not required for banks under $10 billion in assets, stress testing is a crucial tool for banks of all sizes to manage assets and risks. Stress testing is really nothing to fear. It can be done inexpensively. It’s also an integral component of emerging enterprise risk management (ERM) practices at community banks. Here are five reasons why stress testing helps your bank:

  1. Stress testing gives early warnings.
    No more important lesson was learned from the financial crisis than the need to move from a chronicling the past to a more forward-focused, risk assessment mindset. Virtually everything about ERM is about looking to the future, and stress testing helps banks identify early potential weak spots in product and collateral. This enables management to be more proactive. Time is very much the essence in reducing loan losses. And, through the use of unlikely hypotheticals, stress testing helps establish quantified boundaries of acceptable risk as well as quick, red light indicators of possible near-term problems.
  2. Stress testing ties traditional transactional credit risk to modern macro portfolio risk.
    Community banks are still struggling to grasp the benefits of macro portfolio management with its modeling and quantitative disciplines, still foreign to classic credit analysis and underwriting protocols. Stress testing is a perfect bridge between these two equally important credit risk management concepts. Trends emerging at the macro level can inform needed adjustments at the product offering and loan origination level.
  3. Stress testing provides in-depth concentration management.
    Stress testing allows you to understand your product lines in a more intimate manner—both for imbedded weaknesses and potential opportunities. It goes beyond the bluntness of raw concentration exposures to inform qualities of: underwriting, portfolio growth, infrastructure, personnel, training and even pricing.
  4. Stress testing documents defense of strategic/capital initiatives.
    Stress testing is no longer just about a theoretical portfolio loan loss estimate in a vacuum. It has emerged as an important tool in strategic, capital, liquidity and contingency planning by incorporating the impact of potential outcomes during times of stress. Within ERM, it forces not elimination, but mitigation of risk. Given the increase in small bank consolidations, stress testing also provides one of the most informative tools in evaluating strategic M&A initiatives. For example, estimating a targeted loan portfolio’s credit mark can be the by-product of stress testing.
  5. Stress testing engenders confidence in management.
    After reeling from the difficulties and distractions of the past five years, perhaps no benefit is greater than that of stress testing—along with ERM—imbuing bank boards and management with a legitimate sense that they are in command of their own destiny. As it validates the presence of effective planning and controls at community banks, early adopters of stress testing inevitably will improve regulatory and audit relationships. Bankers must get over the fear of being presented negative data: unattended, problems almost always get worse. Even when stress tests point out weaknesses or reduced capacity to withstand losses, it’s always better to have made those assessments on your own—thus beginning your own suggested remediation strategies. Not many people are talking about it, but one provision of Dodd-Frank allows regulators to assign a potentially punitive supervisory assessment of capital beyond the broader increased levels prescribed in the law. If such an assessment occurs, you could presume regulators thought management was unaware of the full scope of the organization’s risks. Active use of periodic stress testing can help immunize a bank from such an unwanted perception.

Stress testing at community banks is as beneficial as it is at the larger banks. An advantage the smaller institutions have is their greater implementation flexibility, given these tools are not specifically prescribed at their level. As long as the approach is practical, documented, and rational, its effectiveness is in the eye of the beholder—perhaps a rare win for community banks.

Has Consolidation Killed the Community Bank?


4-21-14-jacks-blog.pngAn argument that I hear occasionally is that consolidation of the U.S. banking industry has put community banks on a path towards extinction. Two economists at the Federal Deposit Insurance Corp. (FDIC) have shot down this theory in a new research study whose findings are counterintuitive.

On the face of it, the industry’s consolidation over the past 30-plus years has been pretty dramatic. The FDIC says there were approximately 20,000 U.S. banks and thrifts in 1980, and this number had dropped to 6,812 by the end of 2013. A variety of factors have been at work. The biggest contributor, according to the study, was the voluntary closure of bank charters brought by deregulation, including the advent of interstate banking. A lot of the “shrinkage” that occurred between the mid-1980s and mid-1990s wasn’t so much the disappearance of whole banks as it was the rationalization of multiple charters by the same corporate owner to save money.

A couple of recessions—from 1990-1991, and again from 2007-2009—also played a role in the industry’s downsizing. The FDIC says that bank failures accounted for about 20 percent of all charter attrition between 1985 and 2013—a culling of the herd which is painful but ultimately healthy since it tends to eliminate the weaker management teams.

Interestingly, the study did not look at how many bank charters were eliminated through acquisition, although I think we can safely assume that this has played an important role, particularly among the larger banks. In 1990 the 10 largest U.S. banks controlled 19 percent of the industry’s assets; by the end of 2013 their share had climbed to 56 percent. That increase in financial concentration is almost all the result of acquisitions of large banks by even larger banks, much of which occurred in the 1990s.

While the big banks just got bigger, the really small banks mostly disappeared. In what I thought was the study’s most interesting finding, the number of banks with less than $100 million in assets dropped by a stunning 85 percent from 1985 to 2013. For banks under $25 million, the decline was 96 percent. Again, the FDIC doesn’t say why, although I think we can assume that acquisitions, charter rationalizations and failures all played a role.

A central point of the study is that there are still plenty of community banks around, especially if you define them not by an arbitrary asset size, but rather by what they do and how they do it. Community banks, according to the FDIC, “tend to focus on providing essential banking services in their local communities. They obtain most of their core deposits locally and make many of their loans to local businesses.” Most banks in the U.S. would meet this definition of “community,” including a great many that are well over $1 billion in assets.

How might consolidation affect community banks going forward? The FDIC study ends with the upbeat assessment that community banks will continue to be an important source of funding to local businesses, and I would agree in part because I am uncertain about how much more consolidation is likely to occur.

I pointed out in a February 4 blog that there were 225 healthy bank acquisitions in 2012 and 224 in 2013, according to SNL Financial. And I offered a prediction that there would be between 225 and 250 acquisitions this year and perhaps as many as 275 in 2015. That still sounds about right, and it would put the pace of consolidation back to where it was in 2007—or a year before the financial crisis. Many of those deals will likely involve community banks, and while that would lead to a decline in their overall population, it would also create “local” institutions that are larger in size. It certainly won’t decimate the ranks of community banks.

I don’t believe that community banks are facing extinction, but they are facing some very significant challenges in the years ahead—and not from consolidation. The sharply increased cost of regulatory compliance might lead some community banks—say, those under $100 million in assets —to sell out if they can find a buyer; others will respond by trying to get bigger through acquisitions so they can spread the costs over a wider base.

Gaining access to capital will also prove to be a huge challenge for many smaller banks. By “smaller” I am thinking of institutions with $1 billion in assets or less, although the cutoff point might be higher. The higher capital requirement that has been established under the Basel III agreement is a permanent minimum expectation. Traditionally, banks have had the freedom to manage their capital to fit the environment they found themselves in, preserving it when times were bad and leveraging it when times were good and they wanted to grow. Now, banks that want to grow might need to raise additional capital to support a larger balance sheet. But as the banking industry’s capital level has grown, its return on equity has declined (a function of simple math) and not all investors will be interested in a small bank offering limited returns. I believe there will be a great deal of competition between banking companies to attract capital, and there will be winners and losers.

A third challenge is the dependency that many community banks have on commercial real estate lending, a historically volatile asset class that resulted in hundreds of bank failures in the early 1990s, and again during the most recent financial crisis. The most enduring community banks could be those that are able to diversify into other loan categories so they are not at risk when the next commercial real estate crash occurs. But diversification will require the acquisition of talent and skill sets that most community banks do not possess, so it’s a strategy that must be pursued with purpose.

The challenges facing community banks today are real, but consolidation isn’t one of them.

This article originally appeared on The Bank Spot and was reprinted with permission.

How Banks Can Profit from SBA Lending


4-7-14-SBA.pngAll community banks are looking for ways to leverage their staff, maximize profit, minimize expense and build flexibility into their loan portfolios.

One effective way to do this is to participate in SBA lending and to use an SBA outsource provider to provide your bank with a simple and cost effective way to offer this product.

The primary SBA lending program, the SBA 7(a) guaranty loan, allows the bank to make small business loans and receive a 75 percent guarantee from the U.S. government. The guaranteed portions of these loans can be sold in the secondary market, with current gain on sale premiums of 13.5 percent net to the bank. So if a bank makes a $1 million SBA loan and sells the $750,000 guaranteed portion, it will generate a premium or fee income of $101,250.

In addition, when the guaranteed portion of an SBA loan is sold, the investor buys the guaranty at a rate that is 1 percent less than the note rate. In this example, if you have a $1 million SBA loan at an interest rate of 6 percent and the bank sells the $750,000 guaranteed piece, the investor buys it at a 1 percent discount off the note rate and receives a yield of 5 percent. This means that the bank will earn 6 percent on the $250,000 portion that they retained and 1 percent on the $750,000 or $7,500 per year, not accounting for amortization of the loan. If you compare that $7,500 per year in servicing income to the $250,000 that the bank retains on its books, you can see that it represents an additional 3 percent yield on the retained portion. That 3 percent of servicing, plus the note rate of 6 percent, shows that the bank’s gross yield on the retained portion of the loan is now 9 percent. This additional yield is something to consider if your bank is competing for a loan with a larger bank that is trying to undercut your bank on pricing. The added servicing income will enable you to maintain your yield even on loans that have lower pricing.

While SBA lending can be very profitable, it should be viewed as more than just a profit center for your bank.

The SBA loan guarantee can be used to refinance existing loans to mitigate risk in your loan portfolio or to help retain clients who are close to the bank’s legal lending limits. Using SBA lending to refinance existing bank loans can be helpful in reducing real estate concentrations since properties like hotels, mini storage facilities and care facilities are included as investment properties by regulators. If a bank has these types of properties on their books, they can often refinance the loan and sell the guaranteed portion to reduce a concentration and free up capital. Using the SBA guaranty to make loans that fall into an investment property category is a good way of managing portfolio concentrations.

Why does SBA outsourcing make sense?
Outsourcing your SBA lending department eliminates the need to allocate resources and budget for an SBA department since there are no upfront or overhead costs associated with it. Outsourcing eliminates the risk of hiring an SBA team and then not generating sufficient loan volume to support the cost of that staff. SBA personnel costs are high, and it can be difficult to find qualified people. Also, without an experienced and dedicated SBA group, your loan officers will typically avoid handling SBA loan applications for fear of dealing with the complex SBA rules and process.

Outsourcing also enables a community bank to acquire, through the outsource provider, an experienced staff, which in turn enables it to provide an accurate and efficient process to its SBA borrowers. An SBA outsource provider can efficiently process, document, close, sell to the secondary market and service your loans. Typically these services charge between 0.6 percent to 2 percent of the loan amount.

Conclusion
In today’s competitive market, the SBA program offers too many profit enhancement and risk mitigation opportunities to simply ignore its value. In order to maximize success, bankers need to have every tool available to them.