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Long a source of funds for local businesses, community banks have been hit hard by new regulatory requirements.
Helen Shaw, CFO Magazine
October 1, 2005
Four years ago, Bill Bambrick was looking for a little seed money. Literally. A horticulturist living in Augusta, Georgia, Bambrick had recently formed his own company, Loblolly Bay Landscape. Like most start-ups, Bambrick's needed cash to pay the bills and a line of credit to help nurture the business.
So the entrepreneur turned to Georgia Bank and Trust Co. Eventually, officers at the bank okayed equipment financing for the fledgling company, along with a $10,000 line of credit.
Dan Blanton, Georgia Bank & Trust's president and CEO, says he had a good feeling about the loan. "Bill always knew he wanted to be a horticulturist," he explains. Blanton should know. Back in their grammar-school days, he and Bambrick used to walk to classes together.
Basing a lending decision on personal knowledge of the loan applicant is something you'd expect from George Bailey, not from the CEO of a bank with $805 million in assets. But industry watchers say community banks, which make up 90 percent of U.S. banking institutions, service a lot of companies that wouldn't get a second look from multinational banking institutions. Even Blanton grants that it is highly unlikely that a deep-pocketed financial-services giant would "bank a guy who works out of his pickup truck or give him a $30,000 loan for equipment."
Trillion-dollar balance sheets do have their advantages, however. Some observers say smaller community banks could be headed for tough times. Thinning margins, they note, threaten the profitability of overextended lenders. So, too, does an industrywide obsession with building more branches. And global banks continue to steal away retail customers. Some proof: the top 10 U.S. banking organizations held 16 percent of industry deposits in 1985. Today, the big banks hold 40 percent of deposits.
On top of all that, local banks are struggling mightily to comply with a slew of new reporting regulations. Officers at scores of publicly traded community banks say they simply can't cope with all of these requirements, particularly those mandated by Sarbanes-Oxley.
The burden of being publicly traded has become so great, in fact, that some community banks have simply scrapped their stock-market listings. The 113-year-old American Savings Bank of Portsmouth (Ohio), for one, voluntarily removed its shares from Nasdaq because of Sarbox-related costs. According to president Bob Smith, the bank's bill for such costs was close to $200,000 — a number Smith expected would only increase in the future. That's a substantial hit for a business with about $180 million in assets. "It's 10 percent of our bottom line," says Smith. "[It's money] we could pay to shareholders in dividends."
Delightful, Delovely, Delisted
While statistical evidence is hard to come by, it appears that about 40 local banks have already ditched their listings on major stock exchanges. More telling: a Grant Thornton LLP survey found that 21 percent of executives at small and midsize public banks say they are contemplating taking their institutions private in the next three years. Most of the respondents blamed compliance burdens and costs for driving them off the big boards.
Although delisting (which is preceded by deregistering with the Securities and Exchange Commission) may get a bank out from under the more onerous provisions of Sarbox, it's not necessarily a good thing for its customers — at least not in the short term. To delist, a bank typically buys out record holders. According to sources, the process can cost a small bank anywhere from $100,000 to $3 million. For a community bank, a $3 million outlay could dramatically reduce the amount of capital available to clients. One local bank reportedly scrapped plans to open a new branch because it needed the money to buy back shares.
In addition, delisting from a major exchange makes it nearly impossible for a bank to fund future growth through equity issues. Moreover, Lana Chan, an analyst at New YorkÂbased investment bank Harris Nesbitt, says such a move effectively caps a bank's lending limits, which are geared to its access to capital.
The lack of available capital could have serious consequences for small-town America. As Chris Cole, regulatory counsel for the Independent Community Bankers of America, points out, loans from community banks account for more than a third of all borrowing by small businesses. "Because they are the leading supplier of small-business credit," notes Cole, "community banks play a very important role in local economies."
Case in point: the Southern Ohio Growth Partnership (the parent agency of the Portsmouth Area Chamber of Commerce) has partnered with local banks on two-thirds of the outstanding loans it has made to area businesses since 1996. According to Bob Huff, president and CEO of the Ohio partnership, the loan program has helped more than 50 local businesses.
There Go the Free Calendars
This is not to say that all smaller businesses are better served by community banks. Some local outfits, especially ones that are starting to break into the "M" of the SMB space, can benefit from a regional bank's wider array of offerings and cheaper prices. And commercial credit unions are currently lobbying Congress to expand their lending power. If passed, such legislation would give small companies more options when lining up funding.
Still, many large financial institutions simply aren't interested in dealing with non-Fortune 2,000 customers. Dr. Darrin VanScoy, a member of a Hurricane, West Virginia-based medical group, says his firm had a positive, long-term relationship with a national bank. That all changed last year when the financial institution ceased providing loans to companies below a certain revenue threshold. "Suddenly, it had a different philosophy on how much it wanted to extend itself to smaller businesses," says VanScoy, who declined to name the bank.
Industry observers say mergers are often behind such abrupt changes in corporate policy. Community banks are not immune from this phenomenon, either — particularly as regional banks gobble up smaller rivals. Managers at Treasury Strategies, a closely held consulting firm, decided to find a new lender after their local bank was acquired by a larger one. The company stuck with a community bank. "We were not looking for privileged treatment," says Cathryn Gregg, partner and director of the Chicago-based business. "We wanted someone to understand why we didn't look plain vanilla."
Of course, some fast-growing local businesses simply outstrip a lender's ability to provide adequate capital. Even then, community banks have looked for ways to retain their customers. A few years back, Eagle Place Industries Inc., in Winchester, Virginia, needed a loan that exceeded the amount its bank could supply to one customer, says Jim Gibson, the construction company's CEO. To keep the business, Eagle Place's bank relied on an informal syndicate it had formed with other local lenders. "As small businesses grow, community banks must be able to [band together] to grow with them," says Gibson.
In truth, community banks are nothing if not adaptable. Gary Townsend, an analyst at Friedman Billings Ramsey, in Arlington, Virginia, points out that a host of community banks started out as thrifts or savings and loans. Not surprisingly, many were seared by the S&L scandal of the late 1980s.
After the crisis, small S&Ls began looking for new identities. Most settled on the "community bank" rubric. (Unlike "savings and loan association," the term "community bank" does not denote any legal standing.) "Everyone [started] calling itself a community bank," recalls Townsend. "'Thrift' or 'S&L' had a bad connotation."
For managers at small businesses, "community bank" now has its own association. "Smaller banks — community banks — have been much more open in dealing with us," notes VanScoy. "The big thing with community banks is their good working knowledge of your business."
The personal touch plays in Peoria. And in West Virginia, too. Says Keller of Insurance Systems: "You like to feel important. And you like to do business with the people you go to church with and see at the country club."
Helen Shaw is a staff writer at CFO.com.
Giving Back to the Community
Any way you slice it, it's been a rough two decades for local banks. The savings-and-loan crisis, industry consolidation, and regulatory burdens have all conspired to substantially reduce the number of small players in the financial-services sector. How substantially? According to the Federal Deposit Insurance Corp., there were 14,000 community banks in 1985. Today, that number is closer to 7,000.
The thinning ranks of community banks have not gone unnoticed by lawmakers in Washington, D.C. In May, a bill was introduced in Congress that would offer some relief to the beleaguered industry. Dubbed the Communities First Act, the legislation would provide community banks (those with assets below $5 billion) with a 20 percent tax credit on income (a reduction that can't exceed $250,000).
Not surprisingly, industry representatives applaud the bill. Says Chris Cole, regulatory counsel for the Independent Community Bankers of America: "It would give some good tax relief to community banks, particularly since we have to compete with credit unions, which are tax-exempt."
Managers at those commercial credit unions, which are pushing to extend their own lending capabilities, are not as effusive about the bill. That's understandable, since among other things, the law would repeal the alternative minimum tax for banks with assets under $5 billion. In addition, the proposal would allow the banks to be treated (for tax purposes) as limited liability companies.
If passed, the legislation would no doubt be welcomed by small-business owners. Why? Because the bill, sponsored in the House by Rep. Jim Ryun (R-Kan.) and in the Senate by Sen. Sam Brownback (R-Kan.), would also exempt banks with up to $1 billion in assets from the internal-controls section (404) of the Sarbanes-Oxley Act. That section, says the Independent Community Bankers of America, cost community banks an average of $200,000 last year in consulting, auditing, and vendor fees. By cutting small banks loose from 404, the bill would likely free up some of that money for customers.
At press time, Ryun's bill had yet to come up for a vote. But even if the bill fails to pass, community bankers still have a possible lifeline: the Securities and Exchange Commission is currently looking into providing smaller businesses with some relief from certain oft-criticized provisions of Sarbanes-Oxley. —H.S.