What Have We Wrought? How Can We Atone?

training.jpgI know, I know, this may not be the time or the venue for industry self-flagellation, but like the twelve-step programs and most religious admonitions, one cannot change or eliminate bad habits or poor behavior without first acknowledging the problem. That one key problem for community banking—both relative to this crisis and the continuation of our business model—is the dearth of classically trained credit talent remaining in our industry.

We know the primary culprit: the big bank fixation on the efficiencies of the hunter-skinner template for credit delivery. Are we not now paying exponentially for those “savings” now? I’ve said for years that I knew of no other industry that has been successful putting people on the street selling a product or service with such limited knowledge or training.  Most devastatingly, adherence to that model has ended the en masse credit training that had been the font of credit talent that ultimately found its way to the community banks. Even without this economic tsunami, our niche of the industry was facing a crisis over how to staff lending functions with people who actually knew credit. These are the people who provide value to both risk management and the borrowing customer—knowledge that is arguably at the heart of community banking’s popularity and viability. Simply put, due to big bank strategies and retirement factors, there’s less credit talent per capita in banking today than ever before.

What can be done? Like the so-called aging infrastructure of America, rebuilding our depleting credit talent pool needs significant investment and high profile support—support at the highest levels of our banks, including boards and CEOs.  Credit training can no longer be seen as just a discretionary non-interest expense item available for the budget balancing axe. Even at Credit Risk Management, L.L.C. (CRM), training revenue has been down about 25 percent since the onset of the crisis in ’08—understandable for the times, but a trend that must be reversed. Credit training, of course, can take many forms: in-bank, trade association-sponsored, and vendor-directed. Each bank needs to devise a strategy that works best for its talent needs.

One initiative that banks should consider is re-invigorating the formal or informal peer group training programs, where costs can be shared and curriculum can be customized. Also, look for schools with graduated levels of complexity in the two primary branches of commercial lending: C&I (commercial & industrial) and CRE (commercial real estate). Community banking in particular needs diversity away from real estate. Focus on schools where the curriculum will be focused totally on credit underwriting and analysis, using case studies, mock presentations, and computer tools—not ancillary issues like loan review or effective officer call programs. And to ensure the cost justification for the bank’s investment in sending students, ensure that the program include at certain stages some testing and certification. 

Even with all the turmoil and economic pain our industry is currently experiencing, I subscribe to the Chinese adage that within every problem lays an opportunity. Our opportunity is to begin now to build the next version of the business model for community banking, and credit training must be a vital part of that re-building strategy. Accordingly, I implore you community banking leaders—executive management and board directors—to first acknowledge this depleted credit talent problem, and then to see some way to budget for training opportunities as not only investments in enhanced risk management, which we obviously need, but as investments, too, in the marketing and survival of our niche in the broader industry.

It Takes More Than a Village Redux: The Decline of the Community Bank


In 2009, Celent predicted the continuing decline of banks below $500 million in assets due to extreme disadvantages in efficiency ratios. These predictions did come to pass. Today the top five banks in the United States now have nearly 35 percent of all domestic deposits. Is this concentration good for the bankers? Is it good for the financial system? Are too many banks simply too big to fail?

The smallest banks in the United States are disappearing. Their count dropped by 5,967 from 1992 to 2010. Their deposit base has dropped even more quickly. Running a bank requires a certain amount of scale, and that floor is rising due to increasing regulatory requirements, channel support, and product support.


Clearly banks below $100 million in assets are under this floor, and banks between $100 million and $300 million are quickly finding themselves at serious cost disadvantages. Banks between $300 million and $500 million started losing deposits in the last two years.


On the other side of the scale, the big are getting bigger very quickly. Where the top five banks had 11 percent of all deposits in 1995, this number had grown to 34 percent of deposits in 2010. FDIC regulations prohibit a bank from having more than 10 percent of all deposits, which puts the theoretical maximum at 50 percent for the top five.


The top two are already near, at, or beyond that limit. The concentration of the top five banks will increase incrementally, within these constraints.


Celent still sees a role for the banks over $10 billion in assets (and even over $500 million in assets) outside the top five largest banks. They will continue to thrive at the expense of the smallest banks. On the smaller end of the $10 billion and above spectrum, these banks will offer personal service while having sufficient scale to support their IT and operations infrastructure. On the larger end of the scale, these banks are likely to be a bit more efficient than the top five, with slightly less complex offerings. This part of the US banking environment is poised to thrive in the upcoming years.

Banks under $100 million in assets will decline in number by about 6 percent per year; those from $100 to $300 million should decline by about 2 percent per year. The future for the smallest banks in the United States is not bright for the next few years.

For more information about this report, review this press release from Celent.

Has Lending Turned a Corner?

One of the more depressing aspects of this long-running post-recession malaise has been the continued shrinkage of bank loan portfolios. Consumers and business aren’t asking for many loans, and many of the people who do ask aren’t getting any. That impacts the economy’s ability to grow, if businesses aren’t investing and consumers aren’t spending.

But loan growth seemed to turn a corner in the second quarter, and interestingly, small and mid-sized banks are leading the way, according to an analysis by investment bank Keefe, Bruyette & Woods, Inc.

Total loans and leases increased 0.9 percent in the second quarter, or by $64.4 billion, according to the Federal Deposit Insurance Corp. (FDIC), the first actual growth in three years. The government’s statistics include all FDIC-insured institutions, both public and private. Commercial and industrial loans (C&I) increased for the fourth consecutive quarter, by 2.8 percent, while auto loans rose 3.4 percent, the FDIC said. Credit card balances rose by 0.8 percent and first lien residential mortgages rose by 0.2 percent.  Loans for construction fell for the 13th consecutive quarter, this time by 7 percent.

A deeper look from KBW of publicly traded banks shows that mid-cap banks had the largest growth in loan portfolios. Large-cap banks saw total loan balances decline by 0.2 percent during the second quarter, while mid-cap and small-cap banks grew their total loans by 5.9 percent and 0.7 percent, respectively.

The investment bank and research firm reported:

  • Among the loan categories at mid-cap banks, C&I loans posted the largest quartertoquarter increase, gaining 13.9 percent.
  • Large-cap banks posted quarter-to-quarter loan shrinkage across all loan categories except C&I, which increased 2.0 percent.
  • Only Puerto Rico and the Southwest saw aggregate quarter-to-quarter loan shrinkage. Total loans fell 4.9 percent sequentially for Puerto Rico, and 1.6 percent for the Southwest.
  • The Midwestern and Southeastern regions posted the strongest quarter-to-quarter loan growth as total loans increased 9.5 percent for the Midwest and 6.1 percent for the Southeast.
  • Loan portfolios still are down from a year ago. On a year-over-year basis, total loans (excluding consumer loans) have declined annually for seven consecutive quarters, most recently falling 0.5 percent in the second quarter, according to KBW.
  • The commercial and industrial loan category, which accounts for 18 percent of total loans, is the only loan category to post both quarteroverquarter and yearoveryear loan growth of 2.7 percent and 4.6 percent, respectively.

Commercial and industrial loans to businesses clearly remain a source of strength, even as real estate is soft. The growth in loan portfolios among small and mid-sized banks is a welcome sign, even though large-cap banks account for 90 percent of aggregate loans, according to KBW. Banks have been giving investors something to be happy about: Higher profits, better loan credit quality and even some loan growth during the second quarter. But with the wild swings in the market and plummeting bank stocks lately, it may be that investors still are too worried about the economy to care.

Community banks will still offer free checking, and here’s why

money-checks.jpgAt the biggest banks in the country, free checking is becoming a little less free.

  • Pittsburg-based PNC Bank, the fifth largest bank in the country by deposits, was the latest to whittle away its free checking account last week. Customers will no longer get reimbursed for out-of-network ATM fees if they don’t maintain at least a $2,000 average daily balance and they won’t rack up points for rewards on a PNC Visa credit card. But PNC Bank has decided to keep free checking, for now.
  • Bank of America hasn’t had no-strings attached free checking in years, according to a spokesman for the bank.
  • Wells Fargo & Co. did away with it in July of 2010. After acquiring Wachovia in 2008, Wells Fargo has been getting rid of free checking for Wachovia on a state-by-state basis as it consolidates the two banking organizations.
  •  Citigroup doesn’t have free checking for new customers, either.

With Congress regulating away tens of billions in fee income from banks in the last couple of years, including a rule that will slash large bank interchange income on debit cards by as much as 85 percent, banks are looking to do away with unprofitable deposit accounts.

Mike Moebs, an independent researcher who tracks account activity for bank clients and federal organizations such as the U.S. Government Accountability Office and the Federal Reserve Bank of Chicago, says the move away from no strings-attached free checking at big banks is opening up a lucrative way for community banks to steal customers from the big Wall Street and regional banks.

Most of the nation’s smaller banks and credit unions still have free checking, he says. They have smaller operating costs than big banks, so they can afford to keep offering it, he says. The average cost of a checking account is about $200 to $250 annually for a community bank, Moebs estimates. That’s compared to a cost of about $350 to $400 for a big bank, which has more branches, more employees and tends to operate less efficiently, he says.

Moebs estimates banks with more than $50 billion in assets controlled 45 percent of all checking accounts as of 2009, but that will drop to 35 percent by the end of this year, he says. That’s a loss of about 13 million checking accounts that will migrate to smaller banks and credit unions, he says.

Some credit unions have even added free checking to take advantage of that switch, Moebs says, going from 75 percent of all credit unions offering free checking in July of last year to 84 percent last month.

Banks with fewer than $50 billion in assets stayed about the same since July, with 62 percent of them offering free checking. Only about half of big banks had free checking last month, down from 64 percent last July.

Moebs said smaller banks can make free checking pay by selling other products such as automobile loans or mortgages. They also can attract small business owners, an important clientele for community banks, using the free personal checking account to nab their loan business.

While community banks may end up stealing some customers from big banks with free checking, the convenience of branch banking still will be a significant hurdle to overcome. A recent survey by J.D. Power and Associates found that advertising and branch convenience remain top concerns for customers looking for a new bank, and fees play a less important role.

Plus, big banks may succeed in holding onto the vast majority of deposits, even as they lose account holders who kept small amounts of cash in the bank.

Free checking may help community banks steal some customers. But it won’t make them profitable. That’s up to the bank.

Profit outlook for 2013: Still hobbled

Size and location will matter

What’s the outlook for community banks for the next few years? Well, not so great. That’s the view of about 30 investment bankers, equity analysts and consultants surveyed by Atlanta attorneys Jim McAlpin and Walt Moeling of Bryan Cave recently.

McAlpin said he was struck by how similar the respondents viewed the future for banking.
Community banks in particular have the worst prospects for profitability, in part because a lot of them relied too heavily on commercial real estate lending. Plus, bigger banks have more diversified income sources.


“We do have some community banks that are doing very well,’’ said McAlpin. “The challenge has been the significant increase in community banks in large urban areas, where it is more difficult to compete. We believe there is going to be opportunity in suburban and rural areas (instead).”

In fact, the consistent view of the industry analysts was that banks with less than $500 million in assets will have a tough time competing anywhere outside a rural area.

“Size and scale will increasingly matter in the world of community banks,’’ the attorneys wrote in their survey summary.

The expectations for profits are more dismal the smaller the bank. The survey respondents on average expect 2013 returns on assets to be:

  • For banks under $500 million in assets: .50 to .85 percent.
  • For banks between $500 million and $1 billion in assets: .7 percent to 1 percent.
  • For banks between $1 billion and $10 billion: 1 percent to 1.25 percent.
  • For banks above $10 billion in assets: 1.25 percent to 1.3 percent.

Industry analysts also expect mergers and acquisition pricing to stay lower for years to come.

“1.5 (times) book will be the new 2.5 (times) book value of a few years ago,” Peyton Green of Sterne Agee wrote in response to the survey.

Nobody expects huge rebounds in earnings and growth, so there’s not much premium buyers will be willing to pay, analysts said.

What was the prediction for pricing in 2013?

  • Banks with less than $500 million in assets: lucky to get book value.
  • Banks with between $500 million and $1 billion in assets: 1.25 times book.
  • Banks with between $ 1 billion and $10 billion in assets: 1.25 times book to 1.5 times book.

Because of the lack of organic growth opportunities in a slow economy, bankers will focus on profitability and cutting expenses, some industry observers said. Core deposits will be significant drivers of value, the attorneys said.

“There will continue to be consolidation but viable communities will always recognize the need for a ‘local’ bank,’” the report said.

For more information, you can read the final report provided by Bryan Cave.

Do you need $1 billion in assets to survive?

Community bankers at Bank Director’s Acquire or Be Acquired Conference this week in Scottsdale are hearing over and over again: you need to have more than $1 billion in assets to survive.

But is that true? And what about those community bankers who think they will survive just fine, thank you, despite the increased costs of government regulation and an earnings environment where big banks seem to have all the advantages.

Bill Hickey, co-head of investment banking at Sandler O’Neill & Partners, caused some consternation Monday morning when he told a crowd of nearly 300 bankers that they needed at least $1 billion to survive, explaining that the costs of regulation following Dodd-Frank’s passage is going to make it tough to make a profit as a small community bank.

A small bank will have to add employees to handle all the compliance issues and added paperwork for everything from Dodd-Frank to existing legislation such as the Bank Secrecy Act, he said later.

Alan Walters, the president of First Commercial Bank, a $275-million asset institution in Jackson, Mississippi, said organizations such as his will survive if they have a good niche.

He said speakers at the conference throwing around the $1 billion minimum are “way off the mark.” His bank will survive by providing a personal touch in competition with bigger banks such as Wells Fargo and Regions Bank, he said. People like it if their bankers know them by name, he said.

Where his bank has trouble competing with the big banks is providing loans at the $15 million range and above, but he said he focuses on small businesses and professionals such as doctors and lawyers with the funding they need to operate their offices.

Many banks are not expected to survive the next few years, in part because of increased regulation but also because many banks want to improve efficiency in the face of increased costs and low margins.

John Duffy, the chairman and CEO of investment bank Keefe, Bruyette & Woods, predicted that there will be 5,000 banks by the end of the decade, about 3,000 fewer than now.

Several bankers also said they thought regulators want the nation to have fewer banks. Former Comptroller of the Currency John Dugan, who also spoke at the conference Monday, said he never heard regulators say they want fewer banks in all his five year tenure at the OCC, which ended last year.

John Freechack, an attorney who advises financial institutions for Barack Ferrazzano, provided some reassurance to small, community bankers.

He said people have been predicting the demise of community banks for 20 or 30 years. In particular, the cost of new technology in banking was supposed to have put many of them out of business by now.

“From a board’s perspective, you need to make a determination of whether or not you’re going to be able to survive,’’ he said.  But he added after the session: “This is a very resilient industry.”

That would be good news for a lot of community bankers. About 90 percent of all the banks in this country have less than $1 billion in assets, according to James McAlpin, a partner in law firm Bryan Cave LLP.

Want to buy a bank? Look for that fatigued banker near you.

Bank directors are fatigued, many aren’t having much fun anymore, and that’s creating an environment where bank acquisitions are going to increase as some bankers just give up, according to investment bank Stifel, Nicolaus & Co.’s managing director Collyn Gilbert and executive vice president Ben Plotkin.

The two spoke today, on the first morning of Bank Director’s Acquire or Be Acquired Conference, which lasts through Tuesday in Scottsdale, Arizona. Close to 700 people have signed up to attend.

“One thing I see diminished is passion for what you are doing,’’ said Gilbert, an analyst for Stifel, speaking to a crowd of about 350 bankers, consultants and bank directors. “If you’re not passionate about what you’re doing, your vision for the business gets crowded.”

But it’s not just a general sense of malaise that’s going to lead to more acquisitions. Loan growth also is slow and banks have lots of capital they aren’t using all that effectively, Gilbert said. Buying other banks is one way to put that money to work.

Plotkin said that prices banks have to pay to buy other banks will go up in the future as the economy gets past its post-traumatic stress. Opportunities to buy at a good price are diminishing.

“I think it’s really that moment of truth in banking,” he said.  

Small banks under $1 billion are the most likely to sell to other banks because it will be so challenging for them to make a profit.

But the string of FDIC-assisted deals is slowing and becoming less attractive for acquiring banks, Plotkin said.  Private equity is competing heavily for those deals and it is taking a long time to close, leading to even further deterioration in the acquired bank’s value, he said.

Commercial real estate may have hobbled many a community bank’s bottom line, but that doesn’t mean the community bank business model is broken, Plotkin said.

Community banks can provide banking services, loans and fee-based products to small businesses, continuing to serve their local communities.

Improving execution of the bank’s strategy will be the key to success, he said.

The Crisis in Community Banking

growth.jpgLost in all the Sturm und Drang surrounding the financial crisis of 2008 – when several large U.S. financial institutions either failed (Washington Mutual Inc.), sold themselves off to avoid failure (Wachovia Corp.), or were simply propped by the federal government (Citigroup) – is the very real crisis facing community banks throughout the country.

The nation’s largest banks – all of which received direct capital infusions from the U.S. government under the controversial Troubled Asset Relief Program (TARP) – are once again profitable, and many of them have long since paid back the money. On the other hand, a great many community banks are still struggling to regain their footing – and for them the long nightmare is not yet over. 

Haves vs. Have-Nots
The disparity in fortunes between the industry’s largest institutions and smaller regional banks is framed perfectly by two bank stock indexes published by Keefe Bruyette & Woods Inc. The KBW Bank Index (BKX), which is comprised of 24 U.S. money centers or super-regional banks, was up 17% on the year through late October, while the KBW Regional Banking Index (KRX) – which is comprised of 50 smaller regional banks – was up just 3% on the year. Clearly institutional investors like what they see in the BKX universe, and that has allowed large banks to raise capital at a reasonable cost and put their troubled past behind them. 
Smaller regionals have had a more torturous recovery – and many of them were actually quite grateful to receive their TARP funds because when that money was being doled out two years ago it was the only available source of capital for most banks. 

Overdosing on Real Estate

But most challenged by far are the thousands of small community institutions that are either privately owned or have thinly traded and highly illiquid stocks and haven’t been able to raise fresh capital to fuel their recovery. For the most part, their downfall has been the result of bad commercial real estate and real estate development loans, including loans tied to the grossly overbuilt housing market in such places as Florida, Nevada and Arizona. 
Although the U.S. housing bubble attracted lenders, investors and buyers like moths to a flame, there is a reason why so many community banks ended up being so overexposed to real estate. After 30-some years of disintermediation and conglomerization, there are only a limited number of ways that community banks can make money. Several large asset classes, including car loans, credit cards, mortgages and home equity loans, are now dominated by giant financial companies that have enormous marketing and efficiency advantages. 

Expanding Their Business Model

Many community banks focus on small and medium-sized businesses because it’s one market where their superior service gives them a competitive advantage over the big banks, but generally they lack the revenue diversification of their larger peers. So when the residential real estate market took off in the early 2000’s and local developers were looking for loans to finance their construction activities, many smaller banks saw that opportunity as manna sent down from heaven. 
As the U.S. economy improves and the real estate market gradually recovers, community banks will rebound as well. Unfortunately, their underlying weakness – the lack of revenue diversification – will remain. And the challenge for community bank CEOs and their directors will be to expand their business models to include a variety of fee-based activities that will make them less reliant on cyclical lending markets like real estate.
Otherwise, the community-banking sector will just be an accident waiting for the next recession to happen.