TOP COMMUNITY BANKS: How They Did ...
Part 2
Despite an economy that’s beginning to sour, banks earning less than $3 billion in assets held their collective course. How did the best do it? Besides old-fashioned community banking, many leveraged native strengths with smart moves such as strategic restructuring to stay on a path of solid performance.
By Vanessa Mambrino, senior associate, Capital Performance Group LLC, Washington, D.C. The firm provides advisory, planning, analytic, and project management support to the financial services industry. www.capitalperform.com
Three strategies underscore the excellent performance of the highest-ranking institutions
If a rising tide raises all boats, then the opposite must be true. Yet though the past year was difficult for the financial services industry as a whole, banks and thrifts with total assets of less than $3 billion fared better than their larger counterparts. This has temporarily reversed the gains in profitability that larger banks had made over the past few years. According to the FDIC, 50% of community banks posted earnings gains in 2007, compared with 34% of larger institutions. By comparison, in 2006 the percentage of institutions with earnings gains was roughly the same in both asset tiers. At 3.12%, the average return on average assets (ROAA) for all top performing banks under $3 billion was just over twice the average among top performing large banks, or 1.54%.
This certainly does not imply that community banks were immune to the problems that larger banks were facing. Banks and thrifts of all sizes saw margins compress, deposit growth slow, and credit quality decline. Very few heavy mortgage lenders could be found among either the top-ranked large or community banks in the 15th annual ABA Banking Journal performance rankings.
Last month, Part 1 of these rankings reviewed the performance of the nation’s largest banks, bank holding companies, and thrifts. Part 2 of the rankings highlights the successes of community banks and savings institutions that exhibited outstanding performance in 2007.
This year, we have introduced a new category to the three that were used in our previous rankings. Details on this change and the Ranking Methodology can be found on page 28.
Three strategies in common
Though community banks naturally have significant operational differences, certain characteristics and strategies used to weather last year’s storms were common to all four groups.
In all groups, the top performers were more efficient than their counterparts, posting average efficiency ratios of between 47% and 52%. This efficiency was not achieved through expense control, however—the average ratio of noninterest expense to average assets among top performers of all sizes was not significantly different from the average among all institutions analyzed. Rather, higher revenue was the key. Noninterest income represented a significantly greater percentage of average assets at top performing community banks—a trend also seen among the top performing large banks. For community banks, however, the main source of this income was not fee revenue, but one-time gains associated with sales, typically signaling a company’s withdrawal from a particular market or business.
The decision to make a withdrawal was one of three key strategies applied by the top community banks. Other strategies used included a focus on commercial (rather than residential real estate) lending and a focus on a particular industry sector.
On the following pages, the three strategies are explored in more detail.
1. Gains from strategic restructuring
In 2007, three of the four top-ranked institutions benefited from significant one-time gains that, on average, contributed 84% of noninterest income reported by these banks. In all three cases, the transaction allowed the seller to exit either a market or a line of business and to realign its strategy. Some of these transactions were small: for example, the top performing S-corp with total assets under $100 million, Lone Star State Bank of Lone Star, Tex., sold one branch in Pittsburg, Tex., to another bank headquartered in that state. At banks and thrifts with total assets of under $100 million, smaller restructuring initiatives such as this had as significant an impact on net income as the sale of an entire loan portfolio or line of business, two strategies also used by top performers to generate one-time gains in 2007.
In fact, these two types of transactions drove the performance of many among the pool of institutions with total assets of between $100 million to $3 billion. Seattle Savings Bank—appearing for the second year in a row as our top performing non-S corp with assets between $100 million and $3 billion—closed the sale of its reverse mortgage business to Bank of America in June 2007. Seattle Savings Bank netted a $91.2 million gain on the sale and a $52.9 million gain on the sale of loans (a portion of which were the loans in the bank’s reverse mortgage portfolio), doubling net income compared to 2006 levels. At 97.18%, Seattle Savings had the highest ROAE among non-S institutions. The average ROAE among the top 25 non-S institutions over $100 million was 27.51%, pulled up by Seattle Savings, compared to an average of 7.02% among all non-S institutions of this size.
As improbable as it may seem, the top performing Subchapter S corporation with total assets between $100 million and $3 billion managed to post an ROAE for full-year 2007 that was even higher than that of Seattle Savings Bank. Marshall Bankfirst Corp., Minneapolis, reported an ROAE of 123.53%, moving up from 40th place in 2006. Marshall Bankfirst benefited from the sale of its prepaid card business to Bancorp Inc., Wilmington, Del., in July 2007. As a result, total noninterest income increased from $31.3 million in 2006 to $82.5 million in 2007.
2. Limited residential RE lending
Banks with less than $3 billion in assets increased their focus on commercial and construction lending over the past few years as larger institutions captured greater shares of the residential mortgage and consumer loan markets. In some cases, smaller institutions responded by shifting to a pure commercial focus. For example, at Excel National Bank, Beverly Hills, Calif. (#10 among non-S corps with less than $100 million), commercial real estate and commercial and industrial loans comprised 78% of the loan portfolio. A similar strategy was also used by the top-ranked non-S bank under $100 million—Farmers Bank, Hamburg, Ark. CRE and C&I loans together made up approximately 51% of its loan portfolio. The bank also benefited from a $4.4 million payment from the U.S. Department of Agriculture relating to a disputed loan guarantee.
Top performing institutions were also more likely to hold a large percentage of construction and land development loans on their books. With the exception of S-corps under $100 million, CLD loans made up twice as much of the loan portfolio of top performers relative to the rest of the institutions analyzed. This gap was greatest among non-S corps between $100 million and $3 billion. Among the top 25 institutions in this group, CLD loans accounted for 38% of total loans, compared to 17% among all non-S corps in this asset tier. The institutions that were able to successfully implement this strategy appear to have been those who handled a mix of residential and commercial construction loans and who were experienced with construction lending. America West Bank, Layton, Utah (#5 among S-corps between $100 million and $3 billion) was founded in 2000 by a group of local businessmen that were familiar with the needs of construction businesses and their owners. CLD loans accounted for 89% of the bank’s loans in 2007, compared to 70% in 2006.
3. A focus on agribusiness
Rising commodity prices, including grains and corn, led to a boom in the agriculture industry during 2007, which proved to be a boon for lenders who focused on this industry. This was most evident among institutions with assets of less than $100 million. For example, agricultural production loans represented 14% of loans made by the top 25 non-S corps of this size, compared to 7% of loans made by other small non-S institutions.
Agricultural production loans and farm loans combined accounted for over 30% of the loan portfolio at 20 of the 50 top performers under $100 million. A full 95% of loans made by Nebraska State Bank, Oshkosh, Neb. (#22 among S-corps less than $100 million), fell into one of these two categories. Nebraska State is the largest lender of Farm Service Agency guaranteed loans in the Midwest. The bank also makes direct loans to businesses in the agriculture industry for equipment, livestock, and land.
Other large agricultural lenders among our top performers include First National Bank, Elkhart, Kan. (#24 among non-S corps less than $100 million), at which 60% of loans were either agricultural production loans or farm loans, and Bank of Paxton, Neb. (#3 among non-S corps less than $100 million), at which 58% of loans fell into these two categories. An additional 25% of loans at Bank of Paxton were C&I loans. The bank also benefited from a gain-on-sale that increased noninterest income from $18 thousand to $420 thousand and the termination of a C&D order that restricted the bank’s lending activities for six months.
Looking ahead
Community banks will continue to realign their strategies to adapt to ever-changing market conditions. Banks will increase their focus on industries like agriculture that are performing better than the market as a whole. Lending will also continue to shift away from the residential sector, which for some banks and thrifts will involve a move away from CLD lending as losses on these loans begin to mount.
Finally, we expect that banks will continue to restructure and to move out of businesses and/or markets that are not aligned with core strategic goals in order to better focus their resources in these more challenging times. BJ
The electronic version of this article available at: http://lb.ec2.nxtbook.com/nxtbooks/sb/ababj0608/index.php?startid=28
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