The state of the community bank

By Dick Hughes  

DECEMBER 22, 2011 1:51 p.m. (0)

Community bankers say the real estate collapse and its unrelenting aftermath are forcing change in their business.
“The game has changed significantly and permanently,” said Art Seaver, chief executive officer of Greenville First and Southern First Bancshares.
In separate interviews, Seaver and CEOs Dennis Hennett of Greer State Bank, John Poole of Carolina Alliance in Spartanburg, Larry Miller of Independence National Bank of Greenville and Thornwell Dunlap of CountyBank of Greenwood agreed community banks will have to adjust to be viable going forward.
They also see the need for community banks to become larger and leaner.
And, they say, there will be fewer banks standing when the dust settles. Some will fail and some will be absorbed in mergers with healthier ones seeking to scale up.  
For those hit hardest, survival is quarter to quarter.  For healthy banks, expenses are high and returns low, making it a challenge to break even. Where the ink is black, it is faint.
“Unfortunately, we are going to see some additional failures, but more of the consolidation is going to be driven by the necessity to merge because of the lingering credit problems some banks are faced with,” said Dunlap, president of the Independent Bankers Association of South Carolina and a third-generation community banker.

Back to the Future
When Greenville First opened in 1999, there were 24 banks in Greenville, Seaver said. Today, there are 34.
“The pendulum is going to quickly swing the other direction in the next three to five years to about 20 banks operating in the Greenville market, and that’s fine,” he said, adding that is a sufficient number “for a good level of competition.”
Of the state’s 84 banks, 19 are on the unofficial list of FDIC’s troubled banks, all of which would classify themselves by size and mission as community banks.  Seven that had been on the list have failed, taken over by healthier banks.
The picture is worse in some of South Carolina’s regional neighbors, namely Georgia, where 68 banks have failed since 2008, and Florida, where 57 fell.  Most were small to medium in size.
While there’s a lot of national angst over the “too-big-to-fail” banks, the question that community bankers puzzle over is what’s too small to survive.
Southern First Bancshares has reached $760 million in assets, but Seaver said the bank needs to grow to have sufficient scale.
“Not to survive but, frankly, to thrive,” said Seaver.

What’s the Right Size?
Dunlap is not sure what’s the right size but agrees banks will have to grow.
“I remember for the last 15 to 20 years being told that community banks had to be $500 million in assets to survive, and there are many who have survived in a size smaller than that in that same period of time,” said Dunlap.
But today, he said, with the cost of new regulations that $500-million threshold may be a reality.   “You could make a strong case that that is going to have to happen,” he said.
Poole knows well of the cost of regulation.  Out of 35 people employed at Carolina Alliance, he figures the equivalent of eight or nine full-time positions are tied up with regulatory matters.
Poole agrees consolidation is inevitable “but it doesn’t have to be bank A buying bank B. It could be a situation where bank A, bank B and bank C come together in some form and retain their independence but share some services and spread the cost of those services.”
Untangling the Red Tape
Miller of Independence Bank said “there truly is a need for someone who is an expert in compliance” because banks cannot afford to make mistakes in navigating increasingly complex regulations. But he is not sure regulators would allow a collaborative service agency.
Compliance has become so complex it takes specialized experts, and they are few and far between, Poole said.
“Can every community bank hire one of those? Probably not because there are not going to be enough of them to go around, and they are going to be awfully expensive.”
The biggest drag on banks is their nonperforming assets.  Borrowers are not paying interest or principal.
Seaver calculates that nonperforming assets constitute, on average, more than 5 percent of the loan portfolios of South Carolina banks. “It used to be that if you had 5 percent nonperforming assets, you are going to fail,” he said.
Loans Go Underwater
“What is hurting banks so much now is that the real estate markets are in the tank, and the appraisals on real estate are abominable,” said Hennett.
“We have a real estate development loan that in 2005 appraised for $9.5 million, and we have a $4.5-million loan on it.  The most recent appraisal on that development was $1.825 million. There are many stories just like that.”
The smaller the bank, the more difficult it is to overcome.  In the popular parlance, the developer is underwater, owing more than the property is worth, but so is the bank that holds the loan.
What had been an asset worth, say, $4 million to the bank in the original appraisal now is worth $1 million.  The bank has to write off $3 million.
Bigger banks can shrug it off, but that’s a lot of money for a small bank, and it means less cash is available in the community for good loans to help a contractor buy a back hoe and for the bank to recoup some earnings.
Community banks also are being squeezed by today’s low-interest environment.  They make money on the difference between what they pay for money and what they charge borrowers in interest, and that margin dwindled dramatically in the recession and only slightly has improved.
Typically the margin these days is 3.5-3.7 percentage points, which is better than a year ago when it was between 2.75 and 3.

Whither Community Banking?
“Even before the financial crisis, when prime was below 4 percent, it was very hard for a community bank to be profitable because a community bank’s net overhead is about 2.5 to 2.6 of the margin if you are running pretty lean,” said Hennett.
With projections of the need to get larger, there is some concern that bigger may not be better for communities that historically have relied on bankers who live in town, know what their communities need and make decisions locally and swiftly.
“To some extent, if you buy into the concept that you need to be $500 million or a billion or bigger, then it almost changes what a community bank is,” said Hennett.