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Lydia Rodriguez
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Shrinking Yields

Community banks have had to struggle during the long economic recovery to eke out enough revenue while contending with historically low interest rates.

Ever since the financial crisis of 2008 sent the country into an extended recession, the Federal Reserve has employed a monetary policy designed to push interest rates down in an effort to induce more borrowing from businesses in hopes of boosting economic growth. While this may be good for some businesses, it has put the squeeze on community banks, which derive a majority of their revenue from interest income, mainly from loans.

Unfortunately, the Fed’s interest-rate strategy has exacerbated a concerning trend for community banks: The interest lenders are earning on loans has been declining at a faster rate than the interest they are paying out for deposits — which are used to fund the loans.

As a result, profit margins for community lenders are being pinched, forcing some community banks to go under while others have had to sell out to larger competitors.

Community banks are the “mom-and-pop” shops of the financial sector and are generally defined as lenders with less than $10 billion in assets that operate mainly in their home community. Thus, their financial health is tied closely with the communities in which they operate.

Jim Goudge, president and CEO of Broadway National Bank, says the key to community banking is that all decisions are made locally. The large banks have local leaders, he says, but their boards of directors are elsewhere.

“Every decision that we make can be made in this building,” Goudge says. “We don’t have to go anywhere else for approval.”

Fortunately, in San Antonio, the situation has been somewhat brighter for the community banks, thanks in part to a more stable economy and the recent influx of cash coming in from the Eagle Ford Shale.

Paul McSween III, president of Jefferson Bank in San Antonio, says his institution has been fortunate to have the benefit of the oil boom in South Texas.

“We have seen a ripple effect in the construction industry with our customers building on new pad sites and operating with bigger crews and more employees,” McSween says. “We have also seen strong sales among our auto dealer customers.”

There has even been an uptick in new-home mortgages because of the Eagle Ford Shale and all of the new businesses moving into the area, he says.

Still, the steady squeeze in net interest margins — defined as the spread between interest income (such as interest earned on loans) and interest expense (such as interest paid on deposits) ­— has been a major concern for all community banks in recent years, McSween says. It has sent Jefferson Bank and many other community institutions on a quest in recent years to find ways to generate more non-interest income to help boost their bottom line.

“Our cost of funds reached the bottom about two years ago and can’t drop any lower,” he says. “While we’ve had strong deposit growth over the past three to four years, it has been difficult to loan that money out. Even though loan demand is now starting to come back, we are not going to compromise our underwriting standards to make more loans quickly.”

So Jefferson Bank, like many other community banks, has turned its focus to non-interest income sources to make up the difference. These include residential mortgage lending, insurance, trusts and wealth management. In 2009, when the bank had total assets of $689 million, those four areas made up about 22 percent of Jefferson Bank’s operating net income. This past year, that had grown to 37 percent while total assets had grown to $1.2 billion.

Regulatory burden

It has been much the same story at Broadway Bank, the largest community bank in San Antonio with total assets of more than $2.8 billion.

Broadway’s Goudge says most community banks get 70 percent to 75 percent of their earnings from net interest margins.

“We rely on our net interest margin more than the larger banks,” Goudge says. “One way to get by in a low-interest environment is by growing our loan portfolios. But while the economy has picked up, it is not what anyone would call ‘robust’ and many banks are surviving by stealing customers from one another rather than finding new ones. That makes it challenging for everyone.”

Another area of concern for community banks is the plethora of new regulations that have come down in the wake of the financial crisis. Many of these new rules, meant to dissuade the kinds of abuses that contributed to the financial crash, are causing hardships for the small banks. In many cases, the smaller banks do not have adequate staffing or resources to comply with the new rules and are forced to drop different lines of business.

That was the situation facing McSween and Jefferson Bank a few years ago, when he says the institution seriously considered pulling out of the mortgage lending business because of all the new rules and regulations.

“In 2010, we were at a crossroads and had to decide whether to stay in that market with all the pressure from new regulations like Dodd-Frank,” McSween says. “We hired some consultants and talked to the banking regulators and ultimately decided that it could be a new opportunity for us. Many banks had ceased their residential mortgage lending at that time or went out of business altogether.”

McSween says that today a bank needs at least $1 billion in assets to be able to afford to hire the compliance teams needed to do mortgage and consumer lending. He says Jefferson had to decide whether they still wanted to compete in this highly-regulated market that had become more expensive for everyone.

“So what we viewed as a market under turmoil was actually a great opportunity for us,” McSween says. “We took several months to find a chief compliance officer and then beefed up our compliance staff. We think this is a great growth niche that fits with our model.”

Goudge says the biggest problem with the new regulations that have been handed down is that they take away or limit the discretion community banks have in making lending decisions.

“Under the new rules we don’t have a lot of discretion,” he says. “If someone we may know extremely well comes into the bank, we are not allowed to treat them any differently than if they were a total stranger. That takes away a lot of the benefit of being a community banker. If we are not allowed to use our discretion and make exceptions based on personal relationships, then it becomes a concern for us.”

Karen Neeley, a senior attorney with Cox Smith Matthews in San Antonio and general counsel for the Independent Bankers Association of Texas (IBAT), says that while the new regulations are applied evenly across the board, the cost of compliance weighs most heavily on the smaller community banks. A recent survey by IBAT showed that many member banks were going to stop making loans or would only make the very rigid, qualified loans allowed under the law.

“This is a real dilemma for customers who are not served by the really large banks,” Neeley says. “Community banks tend to look more at relationships when making loans and that doesn’t always fit with the new rules. Many of the banks are becoming discouraged by the way the laws are being applied.”

Belt tightening

One local community bank that already went through a significant downsizing in recent years is the former San Antonio National Bank, now called Vantage Bank.

Guy Bodine has served as president of Vantage Bank of San Antonio since 2009. He says around the time that he came on board, the bank was dealing with “asset quality and earnings problems,” prompting a remediation process.

After a significant bit of belt tightening and cost cutting ­— reducing the number of bank branches from 13 to 6 — the bank was able to once again turn a profit in 2012 and 2013. Bodine says he expects even better profitability in 2014.

“The biggest challenge was developing relationships with customers who have the capacity to borrow and repay big loans,” Bodine says. “While there is a lot of competition, we think this is a vibrant market with a lot of great opportunities.”

With total assets of $325 million and 78 total employees, Vantage does not have the resources to hire a full-blown compliance team that would allow them to compete in the residential mortgage field. So they focus instead on small and medium-sized commercial lending, he says.

“There is a lot of competition today,” Bodine says. “The difference for us is that we will take the time to listen and understand what our clients are trying to do and bring solutions to the table.”

Bodine says there is still tremendous pressure on banks today that is driving margins down. The ever-changing and growing regulatory landscape has been hard on community banks without the resources to staff large compliance offices, he adds.

“The cost of compliance is very high for community banks,” he says. “But we are fortunate to be serving San Antonio and South Texas where the economy is good and is attracting meaningful new relationships to our bank.”

Resource: Mike W. Thomas covers technology/telecom, military, finance, regulatory issues as well as nonprofits/education. - http://www.bizjournals.com/sanantonio/print-edition/2014/04/18/shrinking-yields.html


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