The Federal Reserve Bank of St. Louis published a remarkable article last month on "Lessons from Banks that Thrived During the Recent Financial Crisis." Here's the statistic that jumped out at me: 702 community banks maintained a composite CAMELS rating of 1 during the six years beginning 2006 through 2011.
A community bank was defined as any bank having total assets of less than $10 billion as that's the cut for a different level of supervisory treatment under Dodd-Frank. While I don't normally think of defining a community bank as one approaching $10 billion in assets, more to the point in the study was the fact that of the 702 banks, 95% of them, all but 36, were less than a $1 billion in total footings.
Looking at the "thrivers"
The authors of this study--you can read an bankingexchange.com summary here--labeled the elite 702 as the banks that "thrived" rather than merely "survived." How did they do it?
After all, this represents about 10% of all insured depositories and 13% of all banks with total assets of less than $10 billion, so what they accomplished is no ordinary "business as usual" sort of result. The authors of the study described this as a real world stress test of the community bank business model.
The thriving banks came from 40 of the country's 50 states and across a spectrum of local business environments ranging from Michigan, that suffered a 10.2% decline in its gross state product, and Ohio, that suffered a decline of 5.7%, to Texas with a gain of 18.7%.
No doubt oil and gas production and a prospering agriculture segment of our national and regional economies helped in some states. But these differing local circumstances do not account for the fundamentally different results within these same markets.
It will come as no surprise to experienced bankers that the thriving banks exhibited several metrics over the study's time frame that most industry participants would agree are conservative. These include favorable returns on assets and equity, lower mean efficiency ratios, and significantly lower levels of problem assets.
The study includes financial comparisons of over 4,500 community banks, thrivers and survivors, as well as the results of interviews conducted with many of the thrivers' managements. All information pointed in the same direction and was broadly supportive of the conclusion that the thrivers shared and exhibited a list of certain characteristics in common.
Seeking commonality among thrivers
In trying to find a common thread that would be applicable to all or most of the thrivers, it occurred to me that most of them were privately or closely held banks with owners and directors tied closely to the their local communities. This was borne out in the personal interviews with 28 of these banks' managements. The interviewees reported that they had patient and conservative ownership that believed that returns on investment should be attractive but not necessarily spectacular. Paradoxically, during this six-year period of the study, the 702 thriving banks had a mean ROE of 12.5% compared to the 4,525 surviving banks' results of 7.3%
Most of the thriving banks when compared to the surviving banks had lower total loans to total assets ratios, a slightly higher level of core deposit funding, slightly lower loan to deposit ratios and a generally lower proportion of CRE loans as a ratio of total loans. Significantly, though, 16% of the banks in the thriving category had CRE concentrations in excess of the joint interagency guidelines published in late 2006.
All 28 of the interviewed banks confirmed the idea that their banks' performance was due more to actions taken before the financial crisis hit in 2007 and that their policies did not vary from the policies and procedures that had previously been in place. The conservative practices that they identified included avoiding opportunities for which they did not have the requisite expertise, avoiding out of area lending, and an explicit reliance on direct due diligence of credit requests rather than relying on credit scores in making underwriting decisions.
One bank reported that it required each of its lenders to review all charged off loans and reassess the fundamentals of the credit as they appeared to be at the time of origination. Then the lenders reported to management in writing either why they would or would not make that loan today based on those fundamentals.
More than meets the eye
While many observers may simply view the results of this survey as confirmation of their bias toward conservative management as being the most reliable course of action over time, I think it suggests a great deal more.
There are elements here of a template for community bank business models that have in fact endured through the stress test of the last several years. A bare bones outline includes these very important and prominent features:
• Patient ownership
• Commitment to the local community
• Nuts and bolts competence in underwriting credit
• Frugality in fiscal matters
• Loyalty to the banks' roots and constituencies
Does any of this sound revolutionary? Hardly. Yet, do you think the London Whale would find this a hospitable environment?
The shoe fits where the shoe fits
Let's keep in mind that this blueprint doesn't fit every bank. I've worked for publicly traded companies that would flog the staff and the customer base for a basis point or two of incremental ROE. I have worked elbow-to-elbow with lenders who worshiped at the altar of incentive compensation and career opportunism.
But we're talking here about community banks, a perceived endangered species of the banking industry.
They are not dinosaurs and they have acquitted themselves admirably in the difficult environment of the last several years. The big banks should pay attention. They have no bragging rights over this segment of our industry.
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