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A Small Problem

Local banks are being gobbled up at a fast clip, but there's still time to grab credit.
Alix Stuart, CFO Magazine
April 1, 2011

Three years ago, Jamie Pennington joined the legions of small-business owners who love local banks. That's when the founder of Atlanta-based Flexible Executives moved most of her company's money to The Bank of Sandy Springs in Sandy Springs, Georgia. The reason? The Bank of Sandy Springs agreed not to put holds on her customers' payment checks, unlike the big bank she had been using. "As a small-business owner, we like doing business on a handshake," says Pennington, who started her firm in 2005 to help source
part-time executives for growing businesses.

Pennington was so impressed by her new bank, in fact, that she stayed with it even when its parent company, Buckhead Community Bancorp, went on the Federal Deposit Insurance Corp. (FDIC) list of "problem" banks amid rumors of its demise. "That bank was so supportive when we started out, if they were going to survive, we wanted to keep our assets there," she says, noting that she protected her deposits by keeping them under the $250,000 insurable maximum. "I wanted to repay the favor."

Such loyalty couldn't prevent Buckhead from failing, though. In December 2009, the FDIC took over the bank, which held $856 million in assets, and sold it to State Bank and Trust, a regional bank with $2.8 billion in assets. Pennington's own assets were safe, but the allure was gone. State Bank "sent a nice letter about wanting to have a relationship with us, but almost immediately, the fees changed, service charges started piling up, and we just didn't know anyone at that bank," she says. Searching for another local option, Pennington moved to the Bank of North Georgia, not realizing it was owned by Synovus, an even larger southeastern bank with more than $30 billion in assets.

Now, Pennington is biding her time. "We need to find another real community bank, but I'm waiting for things to settle out before switching, to see which community banks survive," she says.

Unfortunately, it may be a long wait. Thanks to a variety of factors, experts are predicting more and more consolidation in the banking industry — meaning that friendly local banks will become fewer and farther between. "We think there is going to be a very significant wave of M&A activity. It's starting already," says Joseph Fenech, a banking analyst with Sandler O'Neill. "You'll see regional banks becoming superregional players, $5 billion banks becoming $10 billion banks, and $10 billion banks looking to become $15 billion banks."

The consolidation will accelerate a decade-long contraction in the number of small banks (those with less than $1 billion in assets). All told, 7,657 insured institutions reported results for the fourth quarter of 2010, according to the FDIC, compared with 10,204 in 2000. The number of banks on the agency's problem list grew from 860 to 884 during the quarter. For all of 2010, 157 insured banks failed (the most since 1992) and 197 were absorbed by mergers.

As for new banks, "it's tougher now to form a bank than it has ever been," says Chris Cole, senior vice president and senior regulatory counsel for the Independent Community Bankers of America. Only 11 new banks were chartered last year, he notes, compared with 190 in 2006.

 After a pause, M&A activity involving small banks is trending up.

What does all this mean for the businesses that depend on small banks? Most observers paint a gloomy picture, drawing a direct line between larger banks and reduced access to credit, higher service fees, and fewer handshake deals. "Very rarely do small businesses get more resources in a merger situation," says Chris McDonnell, a vice president with banking research firm Greenwich Associates.

Undercapitalized and Overregulated
So far, bank mergers in the wake of the financial crisis have mostly centered on targets that were distressed or, like Pennington's bank, had failed and were sold with some backing from the FDIC. Excluding the failures, the number of mergers involving banks with assets under $1 billion rose 37% last year, to 153, according to SNL Financial. That was short of the volume seen in prerecession years, but "over time, as acquirers become more comfortable with targets' balance sheets, you will see more," predicts analyst Fenech. Jake Lutz, a partner at law firm Troutman Sanders, agrees: "M&A activity has been mostly opportunistic, but now I'm seeing people talk about more-traditional deals."

Some reasons for mergers depend on the region. In the Southeast, for example, banks that are reeling from the slowdown in real estate lending may be looking to replace those revenue streams through acquisition, notes Fenech. In the Northeast, which had less of a real estate boom and bust, well-capitalized banks are looking to take advantage of the times. Buffalo-based First Niagara, for example, has roughly tripled its asset size since 2008 by making three acquisitions, including the pending purchase of Connecticut-based New Alliance Bancshares.

What's universal, though, is that new compliance and reporting burdens on banks stemming from the Dodd-Frank Wall Street Reform and Consumer Protection Act are making it more expensive for banks to stand on their own. "No matter what size a bank is, it believes it needs to be bigger to digest the cost of the increased regulatory burden that's coming its way," says Michael Clarke, president of Access National Bank, which is based in Reston, Virginia, and has $832 million in assets.


The Dodd-Frank Act "will have an enormous and negative impact on my bank," Charles Maddy, CEO of Summit Community Bank in Moorefield, West Virginia, told the House Financial Services Committee at a recent hearing on the topic. "Already there are over a thousand pages of new proposed rules, and there will be many thousands more." Among other costs associated with the legislation, the bank has "already added one new full-time member to our compliance staff, and that may not be enough," said Maddy.

Dodd-Frank may also indirectly suck revenue from community banks by drastically lowering the interchange, or "swipe," fees that large banks charge merchants when their customers use bank debit cards for payment, said Maddy. Although smaller banks have a "carve-out" from this mandate, they "will almost certainly be forced to adopt the same price level or risk losing business to the largest banks," he said. "We cannot afford to offer financial services if we can't cover the cost of doing so," he warned.

Many banks may simply be too small to shoulder the new regulatory burden. Maddy reported in his testimony that he had heard of bank regulators encouraging those with less than $500 million in assets to merge, which would translate into more than 90% of banks based in his state consolidating, he says. Fenech says he expects banks will need at least $1 billion to $2 billion in assets to sustain the additional costs, since "it's going to be really hard for some of these smaller institutions to make do."

Bigger Banks, Less Credit
Talk of such mergers makes executives like Mark Hagar nervous about future access to credit. "It is a big concern of mine that a community bank will be taken over, especially by a large national," says Hagar, president of Specialized Printed Products, a $2 million business based in Fort Wayne, Indiana. He has always worked with a community bank, and his current one, First Source Bank, helped him acquire five competitors, some out of bankruptcy, in 2008 and 2009. "Even though our business had suffered, we were able to show a good strategy, so our bank was happy to work with us," says Hagar. "But I don't know that other banks would."

Hagar's main concern is that decisions on lending would become "arm's length" and formulaic, with no regard for his credit and repayment history. By contrast, community banks "have ratios they work from, but there's an opportunity to discuss things," he says.

Indeed, 73% of small businesses using a small bank got the credit they sought in 2010, compared with 48% of those using a large bank, according to a recent report by the National Federation of Independent Business. "Many of the large banks right now are probably seeing a migration of small business to the community banks because it's well known that they help small businesses," says Walter Manninen, former CFO of publishing company CXO Media and a senior counselor at a
Boston-area Small Business Development Center.

 the financial institutions that have been the busiest buyers of small banks over the past two years

Credit access isn't the only problem with the shifting bank environment, finance executives say. Sharon Gottlieb, CFO of LogicMark, a
fast-growing maker of personal emergency response systems, with more than $5 million in sales, has seen her bank service fees go up by 30% in the past year, largely due to hikes in checking-account fees and credit-card processing fees at the larger banks she uses. Such fees now consume about 1% of LogicMark's revenues. Unlike community banks, where fees are somewhat negotiable, Bank of America and others "are very polite but very firm about their fees," she says.

Gottlieb can't escape the large banks — Bank of America, for example, has a secure online wiring service that she needs to pay her overseas manufacturers — but she'd like to. "They're charging me more and giving me less," she says. At the community banks she works with, "you have [your banker's] cell-phone number, so when there's an issue you talk to a real person who knows who you are. At the big banks, you have to go through all the layers of the phone menu, and my 'banker' takes three or four days to call me back."

Adds Dr. Michael Lesser, who owns a $6 million specialty veterinary practice in Los Angeles: "I know [large banks] don't really care. I just want someone who will pretend to care." He has grown frustrated with Citibank after banking with them for 9 or 10 years, in part because they held up the sale of his wife's business by forcing him to come up with more than $400,000 in less than a week to replace collateral for a property loan he has with the bank. As soon as a third-party lawsuit involving his real estate is resolved, Lesser plans to roll over his loan to a smaller, more local bank.

Now for Some Good News
Amid the doom and gloom, there is some good news. For starters, banks are jumping on the small-business-loan bandwagon. One measure of that: Small Business Administration lending was up 30% in fiscal 2010, to $22 billion, and the signing of the Small Business Jobs Act in September catalyzed an additional $10.3 billion in loan guarantees (equating to $12 billion in loans) — the largest volume in that quarter on record, according to the SBA.


Banks say the SBA has streamlined the process of applying for the funds, turning around some loans in as little as a week. It has also expanded the definition of "small business" to allow more companies to qualify. The new definition is based on a company's net income or net worth, rather than revenues. "A company we're just about to close an SBA loan with does $230 million a year in revenue, and they can still be considered a small business," says Access National's Clarke, whose bank closed 55 SBA loans worth $35 million in 2010.

That momentum is likely to continue, thanks to the Small Business Lending Fund that was part of September's Jobs Act extension. The fund allows qualified community banks with assets under $10 billion to borrow money from the U.S. Treasury at very attractive rates — but rates that rise if the bank does not increase its small-business lending by a sufficient amount. Some of the glow that surrounded the program may have faded, however. The size of the fund was originally announced at $30 billion, but in February, Treasury projected that the total amount disbursed would be $17.4 billion.

While Access National was still deciding in February whether it wanted to apply for the program (applications were due the end of March), Clarke expected many to take advantage of it. As a result, he predicts, "we'll see community banks heavily promoting loans to businesses in the near-term."

So what can CFOs of smaller companies do in the current banking landscape? Take the money and run is one answer, meaning that companies could accelerate growth plans to take advantage of the current lending window. They can also look for banks that are structured to fend off unwanted takeovers, such as mutual banks that are "owned" by customers.

In the end, though, the best that finance chiefs may be able to hope for is that big banks get smarter about how they gobble up little ones. "Larger banks have more bureaucracy, but if they really empower leadership of local banks and let them keep that brand identity," while offering more services and perhaps a stronger balance sheet from which to lend, says Manninen, the combinations "would possibly be a good thing."

One large recent acquirer, TD Bank, has $175 billion in assets, but prides itself on being organized like a regional bank. The business is divided into eight geographic regions, according to Bill Fink, executive vice president and senior lender, commercial banking, and loan requests generally go through no more than two people before a final answer. "We know there is nothing more painful than a long, long yes," says Fink.

TD Bank acquired a group of banks in South Carolina and Florida last year and is still in the process of integrating them. Fink says that the takeovers, some of which occurred through FDIC-assisted transactions, are a plus for the region.

"People immediately think of [a takeover as], 'What does this mean to me in terms of fees?'" says Fink. "But you need to ask, 'Why is this bank being acquired? Those banks were obviously troubled, and we brought access to new forms of credit [by acquiring them].'"

Alix Stuart is senior editor for private enterprise at CFO.




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