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Time to reinvent the community bank?

Can community banks still hack it? Read the story and tell us what YOU think

 

Time to reinvent the community bank?

 Challenges and frustrations have industry assessing the basics.

Most rule out wholesale change, but many see more than tweaking necessary
 
Steve Goodenow, president and CEO of $613.7 million-assets Bank Midwest, is concerned about the future of his bank and his part of the industry. He knows a college professor who teaches at banking schools. He confided in the professor recently:

“I’ve been asking our vendors what they are working on, in terms of features that will appeal to our future customers.”

The professor told him he was right to be concerned. He’d recently asked students to raise their hands if they banked with a community bank. Few arms were raised. Why so few fans? The professor said the young people were all about mobile banking apps. If you didn’t have that, you weren’t in their world.

“How do you engage Gen Y?” says Goodenow, whose bank serves rural areas of Iowa and Minnesota. “We don’t have an answer yet.”

He points to the PNC Virtual Wallet and shakes his head. This electronic product is a combination of transaction account, short-term savings, and high-yield long-term savings, along with many personal convenience features—with a special version for students.

“We can’t deliver anything as cool as PNC and some of the others do,” says Goodenow, whose family-owned Bank Midwest is a progressive institution with its eye on trends. Even the typical farm borrower has evolved, he notes. “They are much more sophisticated. They are university educated, not scared of technology. They are more remote; they don’t live in town and they don’t drive by the bank every day.”

Goodenow is a young banker and has decades in the business ahead of him, he hopes. However, “at the end of the day, money is a commodity,” he says. “And at the end of the day, information is of value.” His bank and many other community banks need to find a way to continue to be relevant.

What Goodenow speaks of should be challenge enough, but the reality is that community banks must adapt to such ground-shifting cultural and technological changes in the face of vastly increased government regulation and intervention.

“This is a marathon, it isn’t a sprint,” says Robert Jones, president and CEO, United Bank, Atmore, Ala., $481.6 million-assets. “Everybody’s got to be engaged.” 

What do you think?

Does community banking need to be reinvented?

Do you agree with the bankers and experts quoted in this story?

Tell us what you think in the comment section below.
Assessing the headwinds
The list of challenges facing community banks daunts the most optimistic players at times. Take Earl McVicker, a longtime investor in community banks and chairman and CEO of $222.9 million-assets Central Bank and Trust Co., Hutchinson, Kan. He categorizes the headwinds this way: government-owned competition; government-supported competition; and government-endorsed competition. The players include tax-advantaged credit unions; the Farm Credit System; and megabanks that he still sees as “too big to fail” (while he himself feels “too small to save”).

Yet that’s only part of the government challenge. “We seem to be headed towards one-size-fits-all regulation, and that couldn’t happen at a worse time,” says Arthur Johnson, chairman and CEO of $426.3 million-assets United Bank of Michigan, Grand Rapids. “If we’ve learned anything from this crisis, it is that everyone doing the same things is not the way to go. We’re afraid of size, but everything we are doing is making banking bigger in every size category, and that’s trouble.”

Continuing his point, Johnson says he would hate to see “everybody running out and trying to find a merger partner” in the belief that bulking up will solve their problems.

Yet the litany of operational challenges, on top of those regulatory and competitive challenges already listed, will send many to their medication of choice. Johnson ticks them off: pressure on revenues, both fee income and interest income; capital standards that will make it necessary to get by on less leverage; demands for more capital at a time when it can be hard for many to come by any, and when the appeal to invest in banking has paled for many potential players; and compliance costs spreading and growing like spilled red ink.

Bankers’ “favorite”
No inventory of headwinds would be complete without mentioning the Dodd-Frank Act. Last year former ABA President Ed Yingling speculated that the act may be the tipping point that will force many beleaguered banks to sell. A skeptic on this tipping point is Mark Olson, co-chairman at Treliant Risk Advisors, a former community banker and Federal Reserve Board governor. While acknowledging Dodd-Frank’s challenges, he says, “to a degree, I’ve been hearing such things for more than 40 years.” Back in the late 1960s, Olson says, pundits predicted the regulation-caused demise of community banks.

Yet many executives do worry about the law and its fatigue factor. G. Timothy Laney is president and CEO of National Bank Holdings, a new private-equity-backed BHC that, having assembled capital and a blue-ribbon board, has been buying banks opportunistically. He suggests that even banks in the $1.5 billion to $2 billion range may begin finding the costs of compliance prohibitive.

Others say even for smaller banks, compliance will be doable—at a price.

“Most banks will have to outsource it,” says Jim Gray, a veteran community banker whose latest startup, Beach Business Bank, Manhattan Beach, California, is passing $300 million and managing compliance costs nevertheless. He thinks regulators could help by adopting generic policies for many Dodd-Frank rules that community bank boards could review and adopt.

Still, Gray admits, “if I were at a $75 million bank without a lot of growth potential, I’d be predisposed to anguish.”

Add in the price to maintain current technology and to be on the leading edge that many customer segments expect, and the challenge becomes apparent.

Bankers are left to consider key questions:
• Does the community banking model need adjustment or reinvention?

• How large must a community bank be to survive? Is the consolidation of small banks inevitable?

• Where can community banks find efficiencies, cost cuts, and savings?

• Where can they find new, or renewed, revenues?

• What is the role of capital going forward?

Considering the model
No one model fits every bank now, and there’s no reason to think that will change. And there isn’t even agreement on whether wholesale reinvention is necessary.

FinPro, Inc.’s Don Musso, who is also a bank investor and bank director, has major concerns.

“Once mobile banking really hits the industry,” he warns, “brick and mortar will be like Blockbuster Video stores.”

Seattle community banker Laurie Stewart agrees, but only to a point. “More and more of our transactions are becoming electronic,” says Stewart, president and CEO of $345.8 million-assets Sound Community Bank. “But it doesn’t mean that people don’t want a branch.  They will want the branch for something different.”

Many bankers see the need for evolution, but they reject the idea of tectonic change. Art Johnson, who has reinvented his bank’s mission more than once, believes big shakeups shouldn’t necessarily be the rule. He says there’s need for reinvention, now, “but I have a tendency to think that that should be a continuum, rather than an event. But that said, I definitely believe that any bank that isn’t thinking about what they are going to look like five to ten years down the road won’t make it, five to ten years down the road.”

Putting it even more bluntly, Connecticut savings banker Rheo Brouillard declares, “This business is constantly evolving, and has to—otherwise it will go the way of the dinosaur.” Brouillard is president and CEO at $879.6 million-assets Savings Institute Bank & Trust, Willimantic.

Adds Johnson: Community bankers who take comfort in stability should get real: “There’s no scenario I see going forward where we can not change, and instead be stable, for any period of time.”

Futurists such as Brett King (ABA BJ September 2010 and archived podcast at http://tinyurl.com/bkpodcast) see the branch transcending its historical transactional role and becoming focused on consultation and sales.

Mark Long accepts that community banks must evolve further, but insists that some advantages not be left behind in the process. Long, president and CEO at $108.6 million-assets First Commercial Bank N.A., Seguin, Texas, says community banks must keep emphasizing personal relationships with customers and prompt decisionmaking.

In spite of technology, “we can’t let these things change,” says Long.

Agreeing, Mark Olson, bringing the viewpoint of banker, regulator, and consultant, downplays the idea of a makeover. Actually, he is upbeat.

“Reinvention? Not significantly, no,” says Olson. “There’s still tremendous receptivity to community banks. The model itself works. And it will work much better in a normalized yield curve. I don’t think the model is fundamentally broken.”

Earl McVicker thinks the model will continue to work, but will require add ons, in the form of specialties that give a bank’s basic model additional octane. “Specialization doesn’t always mean ‘riskier’,” says McVicker. Getting involved in trust services, insurance, working out purchased portfolios of stressed loans, making SBA loans, financing accounts-receivable, doing equipment leasing, are all forms of expertise that McVicker says community banks have turned to their advantage already.

But what worries more than one banker is whether regulators will grant flexibility to adjust their model. Some regulators frown on too much nichemanship, for instance.

“The big difference today from the past is that we manage our banks for the regulators now,” says Alabama’s Robert Jones. “If you don’t address what they want done, you can’t address anything else.”

Importance of bank size
Besides the model itself, no issue dominates the debate more than the size a bank has to be to prosper.

“As you get smaller and smaller in relation to fixed costs, it gets harder to make money,” says consultant Michael Cleary of Cleary and Co. “There is a ‘dead man walking’ condition around now. They aren’t actually dead, but they aren’t able to do much. Banks between $250 million and $1 billion may fall into this category, he says, depending on their condition and capital. If they don’t have more capital than they need to meet regulatory requirements, such institutions can’t grow and can’t acquire.

Some of those interviewed bluntly say they see no “magic number,” putting much more weight on business plan, execution, management quality, and geographic location. Olson suggests there is no size where a bank leader can entertain complacency. He tells a story.

Back in the 1980s, when interstate banking first began to encroach on the industry, a banker he knew with an institution of about $8 billion took the pundits’ advice that you had to bulk up to about $10 billion to remain independent. He did.

“And within 18 months, his bank was acquired,” says Olson.

“I think it really depends on where you are in the food chain,” says Olson, though he acknowledges that he sees banks under $100 million having to find partners or sell, in time. Much depends on whether a bank is large enough to match its competition, and, hopefully, beat it.

Selling or finding partners, however, won’t be simple. Tim Laney of National Bank Holdings points out that it’s very much a buyer’s market, right now, and that choosy buyers won’t oblige a bank that wants to sell but has an unattractive or uninspiring franchise.

Still, the figure of $500 million gets buzz, bankers say. FinPro, Inc.’s Don Musso has done the numbers and makes this case regarding size.

Right now, he says, a community bank in a typical situation must be at least $150 million in assets to be just profitable. Given the many headwinds, Musso believes this will rise to between $200-$250 million, especially given the capital levels regulators are demanding now. And that will be for basic breakeven performance.   

So, to make a decent return for shareholders, in the face of fixed costs, Musso believes a bank must work up to $500 million or more. A notable exception would be a bank in a rural market—where many are one-office operations who maintain tight credit control through intimate knowledge of borrowers.

Only one out of five banks are in a position to do something about this concept, right now, Musso says, given his analysis of capital holdings. A $300 million bank with $25 million in capital won’t be doing any acquiring, he says.

“This is the year of the haves and the have nots,” says Musso. In time, he believes the industry will settle out to a revised “barbell.” At one end will be banks up to $500 million. In the skinny middle there will be players between $600 million and $5 billion, and they will be prime acquisition targets. Banks above will be stable, relatively.

Some of the feel of smaller community banks will be maintained by broader adoption of the typically southern “city manager” model, where, even without a separate charter, a segment of a bank functions as if it were autonomous. But Musso points out that historically such institutions begin to seek efficiency through elimination of layers.

We’re doing OK, thank you
Bankers from small banks aren’t waving any white flags just yet, despite the predictions.

“On the surface, one would reason that the larger your bank, the more you are able to spread costs,” says Myron Rozell, president and CEO at $45.3 million-assets First State Bank of Mapleton, Iowa. However, he says there is more than one way to meet a need or cut a cost.

Call it DIY, says Rozell. Maybe, instead of hiring an advertising agency or a marketing firm, a smaller bank could find ways to market using means that its own staff executes. And there are some things a bank can simply do without.

Rozell suggests smaller banks like his can dwell not on what they lack, but on what makes them unique.

“When you get down to the customer level,” he says, “you have a hard time thinking that larger banks are able to give the same kind of personal service that small banks do. Most of my staff knows every customer personally, either because they see them in church every Sunday or because they are related.”

“People are drawn to that,” says Rozell. And having intimate customer knowledge cuts costs of credit analysis and other expenses.

Seeking efficiencies
Size alone won’t save a bank, however. “We’re almost $1 billion and it’s not easy for us to absorb compliance costs,” says Connecticut’s Rheo Brouillard.

Michelle Gula, president at Mrae Associates, Inc., says, “the environment has changed, and community banking will adjust.” Survival may hinge more on changing what the bank does and how it does it, rather than how large it is, she believes.

“It is an efficiency game right now,” Gula insists. “There’s no place in a bank that shouldn’t be examined, that you can’t find efficiencies in.”

Community banker Mark Long says he’s found vendors receptive to renegotiating pricing with his bank, for starters.

But regarding internal cuts, players say there are good places to slash ...  and others best left alone.   

Along the lines of rethinking the branch, consultant Mike Cleary believes its changing role will permit banks to shrink the traditional footprint substantially, saving on real estate costs. And his associate Ken Dubuque says gains can be made by outsourcing administrative and control functions. Long’s bank outsources Loan Review.

And then, there are savings on people costs, the big item on bank budgets. But some suggest there are smarter ways to go about this than others. Long, for instance, notes that his bank cut back a bit, including a receptionist’s position. When he found that he was paying high-priced help to answer phones, Long put in a part-timer.

Similarly, Michelle Gula suggests that now that most of the personnel carnage in banking is done, that banks begin rationalizing the teams they retained. Job descriptions and training for those employees now expected to do more for their community banks must be addressed, she says, in order to help make things work. If a bank structured a layoff by seniority rather than temperament, for instance, survivors who aren’t sales-minded need to be trained for it.

Finding new revenue sources
As the saying goes, you can’t save yourself rich, and banks must find new sources of revenue, as well, to survive and thrive.

“Banks that relied heavily on low-hanging fruit, such as late fees, overdraft fees, and such, will have to rethink their approaches to pricing,” warns Mark Olson.

Stepped up regulation of overdraft fees, the Durbin amendment regulations dealing with interchange fees, and hints of more to come make this reevaluation urgent. Banker Rheo Brouillard worries about this trend. “When did we get away from free enterprise?” he asks.

Experts suggest there are activities that banks can expand into with comparatively small up-front commitment that will bring some payoff. Cleary and Dubuque suggest looking at these for starters:

• Annuities—a logical extension of banks’ CD market and relatively easy and inexpensive to get started in.

• Consumer lending—not all loans require staffing up. Large banks and other vendors offer turnkey programs for auto lending and student lending, among other credit areas. These offer fee income possibilities for the local player.

Not every idea out there will be a good fit for every bank. The point is to do something, says Dubuque. “You can’t just sit there like a deer in the headlights.” •
 
The electronic version of this article available at: http://www.nxtbook.com/nxtbooks/sb/ababj0211/index.php?startid=36
 
 
What do you think?

Does community banking need to be reinvented?

Do you agree with the bankers and experts quoted in this story?


Tell us what you think in the comment section below.  
Steve Cocheo

Steve Cocheo’s career in business journalism has taken him to all 50 states and nearly every corner of banking in institutions of all sizes. He is executive editor of ABA Banking Journal, digital content manager of ababj.com, and editor of ABA Bank Directors Briefing. He coordinates the popular Pass the Aspirin and First Person features and wrote the booklet series Focus On The Bank Director. He is the only journalist to have sat in on three federal banking exams, was a finalist for the Jesse H. Neal national business journalism awards, and a winner of multiple awards from the American Society of Business Publication Editors.

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