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Financial Crisis Inspiring Community Bank Resurgence

POV By Gabrielle Sheshunoff Bekink on 03/18/2009

The image of community banking got an unintended black eye when the financial crisis reached critical mass in September. The image of community banks has become tarnished as politicians and the media used the words “bank” and “bank failure” to describe what was happening to non-banks. Although community banks had nothing to do with creating the current financial crisis, they have been taking a pounding nonetheless.

Sometimes dismissed as conservative and “stodgy,” hometown banks now have the opportunity to reposition themselves as smart, savvy, and safe as Americans watch their home values drop and their assets in pension plans and Wall Street investment products whittled away by the stock market plunge and liquidity freeze-up.

Community banks continue to feel the strains of the ongoing crisis. In particular, many smaller banks suffered investment losses after the government put Fannie Mae and Freddie Mac into conservatorship, wiping out the value of their highly rated preferred shares. Some banks in high-growth areas, where the commercial real estate environment was especially overheated, were hurt by speculation when the housing bubble burst.

The third quarter of 2008 has been especially difficult. Nevertheless, most small and medium-sized banks remain stable and have money to lend. Indeed, the American Bankers Association estimates that fully 95 percent of commercial banks are well-capitalized and have an aggregate cushion of $1.3 trillion in reserves as protection against losses.

Tough Times for Competitors

Within the commercial banking industry itself, much of the turmoil is confined to the largest U.S. banks and a handful of community banks who participated in aggressively speculative real estate lending.  Most of the major banks and other financial companies are reporting deep third-quarter earnings losses. Wachovia posted a loss of $23.7 billion, the largest ever quarterly loss for a bank (although its acquisition by Wells Fargo is reportedly still on track).

By contrast, the relative calm and stability in the community bank arena reflect the customer-driven market philosophy and the steady, risk-averse way these banks are managed.

While large banks struggle to right themselves, community banks are positioned to leverage their own traditional strengths and recapture business they may have lost in recent years, not only to the nationwide and super-regional banks, but also to investment companies, stock brokers, and other non-bank financial firms.

We have seen the beginning of this consumer backflow already. According to a Nielsen Claritas study of consumer reaction to the financial crisis, which surveyed 3,000 adults between October 4-7, 2008, about one-quarter of the respondents indicated they may end their relationship with their primary financial provider because of safety concerns. More than one-fifth of the respondents are very or somewhat likely to move some of their funds from their current provider, presumably into insured accounts.

Of particular interest is the finding that the respondents rated “safe and secure” and “trustworthy” as their top two considerations in choosing a financial institution — above customer service and price.

Who Needs Rescue?

Even community banks whose performance has been steady throughout the crisis have felt the repercussions. When the federal government announced what was originally called a “bailout,” community bankers scrambled to explain to their customers that most of the entities in trouble were not commercial banks at all but large investment banks. They worried that their reputations would be tarnished when the news media used the word “bank” to mean all sorts of financial companies. And they had to deal with their customers’ reactions when the collapses of Bear Stearns, Lehman Brothers, and AIG were called “bank failures.”

As ABA president Yingling noted in his congressional testimony, “[The rescue package] is a solution that these banks did not seek for a problem they did not cause, and yet all of it is often labeled the ‘bank bailout.’”

When the initial emergency stabilization plan did not have its desired effect to loosen credit, the federal government announced a Capital Purchase Program (CPP) under the Troubled Asset Relief Program in which it will directly invest in banks by purchasing up to $250 billion in bank stock. Nine large banks immediately signed on — albeit not without some arm-twisting — but many community bank executives around the country resisted and were even angered by the idea.

The prevailing attitude is that most community banks do not need a bailout and it is unfair to save troubled institutions from the consequences of their risky behavior. A community banker interviewed for a front-page article in the October 15 Washington Post called the capital infusion plan a subsidy for reckless competitors, and another said his bank did not need a bailout and that neither would other financial firms if they had managed their companies like they should have.

The Treasury sought to overcome opposition to the CPP among community bankers by strongly urging all healthy banks of every size to participate, even if they don’t issue preferred shares or need the capital. According to Treasury, the CPP is an investment, not a taxpayer expenditure, and its primary purpose is to increase confidence in the U.S. banking industry and release the brakes on lending. It’s not meant to be a bridge for failing banks, Treasury insisted.

Still, one is fairly certain that the government’s emergency actions would not have been needed if other entities in the financial services marketplace had adhered to the rock-solid business model favored by community banks and vindicated by recent events.

Finding Opportunities in Crisis

As the safe and sound image of community banking emerges, a unique opportunity presents itself to catch the wave of customers who are rediscovering what they had forgotten about the many virtues of hometown banking. And judging from the level of trauma many customers are feeling, their financial habits and preferences may remain changed for a long time to come.

Here are some practical ideas, gleaned from our experienced staff of community banking experts, for capturing the opportunities that are out there now.

  1. Reassure Existing Customers
    A number of community bankers are having success with letters to their existing customers stating: “We are safe and sound,” “We are well capitalized,” and “Your money is safe with us.” The letters explain that the Federal Deposit Insurance Corporation has increased deposit insurance to $250,000 per account in insured depository institutions through December 31, 2009, and has permanently and significantly expanded coverage for revocable trust accounts. The letters, reinforced with advertising, should also emphasize the bank’s willingness to make good loans and capacity to serve all types of needs, from savings and checking accounts to small business loans and payroll, mortgages, electronic banking, investments, cash management, trust accounts, and estate services. Finally, to ensure that employees have positive interactions, hold special training sessions to explain the bank’s condition and teach them how to honestly and accurately reassure customers that their funds are safe. You may also wish to consider, on a case-by-case basis, the wisdom of restructuring loans to assist customers through these turbulent times. There has been much talk about renegotiating mortgage loans at the federal level. For those customers who have been particularly hard hit by the crisis (lost jobs, falling business revenues), it might make sense to renegotiate your loans and other deals with them so they can keep up with their payments and hold on to their homes, automobiles, and businesses. You will be rewarded many times over with fierce customer loyalty in the future.
  2. Reach Out to Former (and New) Customers
    The financial crisis opens a good opportunity to contact former customers and invite them back. This strategy may be most effective for customers who left your bank to do business with one of the firms caught up in the worst of the crisis, but it is also effective for new customers who have been ignored or surrendered by out-of-area financial organizations. The Nielsen Claritas study revealed that, of the 3,000 customers surveyed, 922 were affected by the takeovers or acquisitions of Washington Mutual, Wachovia, Merrill Lynch, Lehman Brothers, IndyMac, and others. A majority of affected customers are looking to move their accounts. Crisis-sensitive advertisements may be particularly effective with this group. Recently, we have seen ads selling a community bank as “Your Comfort Zone” or “Here for You.” If it fits your business model, you may wish to focus part of your outreach efforts on remote capture of new business through electronic channels. The spate of failures and takeovers have unmoored an enormous number of customers who prefer electronic banking but feel abandoned by a distant and impersonal financial services provider or one that no longer exists.
  3. Consider Suitable Acquisition Opportunities
    For community banks with strong capital ratios and reason to believe they will not face a near-term decline in profitability, now may be a great time to acquire other local-market banks or financial businesses that fit their business model. As Warren Buffet reiterated recently by his words and actions, downturns can provide good investment opportunities for those well-positioned to take advantage of them. A strong word of caution, though, in the current environment: you should consult a bank merger and acquisition expert to be sure the deal is financially solid and is a good match for your bank’s culture and management philosophy. 
  4. Devise a Strategic Plan
    Now more than ever, it behooves all banks to pursue opportunities in a deliberate, tactical, and measured way. It is no time to make mistakes. Regardless of what avenues you choose to pursue, you should meet with your management team and devise a formal strategic plan that prioritizes the opportunities and includes a detailed action plan with assignments and accountabilities for implementation and a method for tracking outcomes.

The New Value Proposition

Community bankers are rightly proud of their stable performance during the financial crisis. Indeed, if it weren’t for community banks, the crisis would have been much worse as it might have engulfed the entire banking industry. Community bankers also feel vindicated that their approach to management was the right one all along and will be the right one as the financial crisis plays itself out.

Community bankers now contemplate a window of opportunity that is likely to stay open for at least 3 years and as long as a decade. As they avail themselves of these opportunities, a resurgence of community banking in America is likely as the nation is reminded of what makes our banking system unique — its local character and leadership.