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FDIC Community Banking Conference
Strategies for Long-Term Success

Panel 1: The Community Banking Model

Moderator:    Kristie K. Elmquist, FDIC Regional Director, Divisions of Risk Management Supervision and Depositor and Consumer Protection, Dallas, Texas

Panelists:

Transcript - PDF

Introduction

This panel focused on community bank business models, key marketplace trends and challenges, and strategies used to meet operational challenges and manage key risks. A central theme of the panelist remarks was the need for flexibility in community bank business models. Community banks often serve customers or markets that are overlooked or underserved by larger banks. As a result, they frequently must take creative approaches to serving these markets in order to stay relevant and profitable. Panelists noted that while community banks are primarily relationship lenders, they will also need to leverage new technologies, including web-based and mobile platforms, to meet the evolving needs of their customers. Engagement with the millennial generation, both as customers and as employees, remains a priority for community bankers as the nation’s demographics continue to shift toward younger cohorts. [1]

Ms. Elmquist opened the session by introducing the panelists. Each panelist briefly described their institution, the markets in which they operate, and their business model. Dr. Scott E. Hein gave a brief synopsis of his involvement in community banking research.

Organizational Profiles

Capital Bank of New Jersey

President and Chief Executive Officer David J. Hanrahan Sr. described Capital Bank of New Jersey as a classic community bank that funds itself with “local, loyal, low-cost deposits” and lends back out to small and medium-sized businesses in the immediate area. Founded in 2007, the bank went through the recent financial crisis as a de novo institution. As such, the bank carried few troubled loans “on the books” through the crisis, and was therefore able to lend more than its more established peers. In addition, the bank has been the beneficiary of merger and acquisition activity that left gaps in which his institution could operate. The bank, with $378 million in total assets, is a privately held, non-SEC registrant with roughly 450 stockholders, almost all of which are local.

Centinel Bank of Taos

Rebeca Romero Rainey, Chairman of the Board and Chief Executive Officer of Centinel Bank of Taos, characterized Taos as a tourism-driven market. The town has a population of roughly 7,000, while the largely rural county in which the bank operates has a population of roughly 35,000. Rainey noted that the local economy faces a number of challenges, as its largest employer is government and unemployment is roughly 9 percent. The bank, with $210 million in total assets, focuses on relationship-based banking with multigenerational local businesses, entrepreneurs, artists, and nonprofits, many of which require a creative approach to lending. The bank, a subsidiary of a one-bank holding company, is a subchapter S corporation with six owners.

Valley Republic Bank

President and Chief Executive Officer Bruce Jay described Valley Republic Bank as a “very traditional, very vanilla community bank.” The bank is located about 100 miles north of Los Angeles at the south end of the San Joaquin Valley, in a county that is first in oil production and third in agricultural production in the United States. Opened in February 2009, Valley Republic Bank, with about $491 million in total assets, is among the newest community banks in the nation. Organized as a C corporation, the bank is publically held by roughly 300 local shareholders and has an application pending to become a single-bank holding company.

Liberty Bank and Trust

Alden J. McDonald Jr. serves as President and Chief Executive Officer of Liberty Bank and Trust. Headquartered in New Orleans, the bank operates a high-volume, low-balance business model focused on the African-American community and serves a primarily low-to moderate-income customer base. The bank is a subsidiary of a single-bank holding company with fewer than 100 local shareholders, and has $605 million in total assets.

Marketplace Trends and Challenges

Nearly all panelists indicated that the prolonged low-interest-rate environment of the post crisis period has posed significant challenges, especially for margins. Similarly, some noted that the relatively slow rate of economic growth during this period has also been an obstacle to balance-sheet growth. Accordingly, the panelists indicated that one strategy to help achieve growth was to target members of the millennial generation, both as customers and as employees

The bankers described a number of strategies they have used to address the challenges posed by low interest rates and slow growth. They stressed the need for flexibility and the willingness to sometimes lend outside of traditional markets or products. Among the examples cited were underwriting mortgages on homes built with nontraditional materials, creating new tuition-payment products, expanding FHA and VA mortgage lending, and expanding Internet banking. Panelists described their efforts to increase profit margins by reducing expenses and stressed the importance of using and understanding their interest rate risk models in a historically unique interest rate environment. Governance was another priority cited by the panelists, who sought to ensure that their management team was on board with the direction of growth and that they maintained a strong relationship with bank supervisors in an evolving regulatory environment.

Dr. Hein noted that the examples discussed by the panelists provided evidence of the resilience of community banks. While each community bank employs a unique approach to serving its market, they each display a high degree of adaptability and creativity in responding to marketplace challenges.

Marketplace Changes

Ms. Elmquist asked the panelists to elaborate on some of the strategies they are implementing to respond to changes they see emerging in their marketplace. The panelists from the two newer banks cited stock liquidity as a particular challenge that could be addressed by conducting stock repurchases funded by low-cost debt issuance. The panelists from the two more-established banks discussed their efforts to integrate new technologies into their banking models by exploring new platforms, delivery channels, and digital marketing. Part of these efforts involved training staff members to be both technologically savvy and sales-oriented. Ms. Rainey’s bank purchased iPads for its staff to help ensure that employees were fully conversant with the bank’s mobile platform. Dr. Hein remarked that the shift toward technology may be at odds with the traditional “soft information” used in community banking, and that embracing technology while retaining the face-to-face aspect of community banking will be challenging. He also noted that the trend toward urbanization is changing the markets and customer bases of more rural community banks.

Questions from the audience focused on emerging marketplace trends. One audience member asked the bankers if they viewed the rise of financial technology (fintech) lenders as a threat or an opportunity. Panelists responded that they viewed the trend mostly as an opportunity. Mr. Hanrahan noted that he saw a specific opportunity when a large bank announced that they were going to outsource all small business loans under $250,000 to a fintech firm. Fintech lenders could well reject some of those small businesses due to a lack of adequate credit history or some other blemish on the application. Those small businesses would then be likely to turn to a community bank that would spend the time needed to understand their unique situation and find a lending solution that works for both parties. Ms. Rainey agreed, and added that there may be an additional opportunity to leverage the technology used by fintech firms. Mr. Jay noted that while fintech providers have a regulatory advantage at present, he expects that to change in the future. He also noted that there is a potential opportunity for community banks to use some of the technology solutions. Mr. McDonald agreed that there were opportunities in this space, noting that fintech lenders will likely struggle in making loans to small businesses using a purely standardized approach. He sees an ongoing need for the relationship banking approach that characterizes community banks, especially when businesses are first starting out and are looking for their initial loans. He noted that his push into technology and digital marketing is aimed at capturing some of the business that might otherwise be inclined to use fintech lenders.

One participant asked about the panelists’ loan-to-deposit ratios and how they expected them to change over the next four to five years. All of the panelists indicated a long-term target ratio of 70 to 75 percent. A second audience member asked for the panelists’ opinions on the FDIC’s Notice of Proposed Rulemaking on assessments that would affect banks with less than $10 billion in assets. [2] Mr. Hanrahan voiced support for the proposed rule, noting that his institution’s assessment rate would decrease by around 30 basis points. He also noted that although he is not enthusiastic in general about many of the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), he did support the mandated expansion of the assessment base from total deposits to total assets less capital and the Deposit Insurance Fund restoration surcharge to large banks.[3]

Best Practices for Managing Risks

Ms. Elmquist invited each of the panelists to discuss their best practices for managing risks. Each panelist discussed different types of risk, some specific and some at the enterprise level. Mr. Hanrahan reflected on the risk of competition with bigger banks. He stated that his approach to mitigating that risk is managing to his organization’s strengths—relationship banking and personalized, high-quality customer service. Ms. Rainey discussed her bank’s focus on internal reporting and cultivating a risk-management culture among employees. She also noted that the bank was working to implement committee structures and other processes for decision-making in gray areas. Mr. Jay discussed focusing on the pieces over which his bank has control, such as hiring top talent, prudent underwriting, and minimizing costs. Finally, Mr. McDonald discussed his bank’s community involvement as crucial to not only staff development, but also the “people-to-people” piece of engagement with the next generation of customers. He also noted that his bank has centralized underwriting and collections, which is especially important given the bank’s low- to moderate-income customer base. Lastly, he mentioned that management extensively uses monitoring reports, dashboards, and models to understand how the bank is performing and to identify emerging trends. Dr. Hein commented that community banks are, in many respects, in a better position to monitor and manage enterprise risks than larger banks.

An audience member asked the panelists about managing risks related to the “talent crisis,” as increasing numbers of banking industry personnel are approaching retirement. The panelists agreed that the talent crisis is a definite concern for the industry. They attributed it in part to an image problem that arose during the financial crisis, but also cited a long-term decline in large-bank training programs that were instrumental in developing banking industry talent. They cited what they saw as a challenge in pitching traditional commercial banking as a fulfilling career choice for millennials, who might see more allure in the startup culture of fintech lenders. Hiring and training young, smart college graduates who are willing to learn continues to be a solid long-term strategy that can benefit from the efforts of banking-oriented college programs. Ultimately, many highly qualified millennials may come to realize the personal rewards of a career based on building relationships with their customers and serving their local communities.

Conclusion

Over the past few years, community banks have weathered the storm of the Great Recession and the relatively slow economic recovery that followed. Each panelist cited strategies for resilience and growth focused on good banking fundamentals, flexibility, and creativity. Banks will face more challenges as the industry changes, with demographic shifts, increased reliance on technology, and an evolving regulatory environment. Panelists agreed that in order to succeed in this changing environment, community banks will have to focus on the core strengths of their business model and continue to look for new, creative approaches to community banking.


Footnotes:

[1] Richard Fry, “Millennials Overtake Baby Boomers as America’s Largest Generation,” Pew Research Center FactTank, April 25, 2016, http://www.pewresearch.org/fact-tank/2016/04/25/millennials-overtake-baby-boomers/.

[2] 12 CFR Part 327 Assessments; Proposed Rule (Federal Register 81, no. 23, February 4, 2016, available at https://www.gpo.gov/fdsys/pkg/FR-2016-02-04/pdf/2016-01448.pdf).

[3] 12 CFR Part 327 Assessments; Final Rule (Federal Register  81, no. 58, March 25, 2016, available at https://www.gpo.gov/fdsys/pkg/FR-2016-03-25/pdf/2016-06770.pdf).