Banking on the Basics

Following the fundamentals is how many of this year’s ICBA top-performing community banks overcame industry challenges

By Kelly Pike

When it comes to financial success, consultants are always warning community banks that they must re-imagine their operations or lose out to growing competition. But just as important as keeping an eye open for new opportunities is paying close attention to the fundamentals of community banking, if interviews with this year’s ICBA top-performing community banks are any indication.

Community banks at the top of the rankings show a dedication to the basics. They maintain strong underwriting standards no matter the competitive pressures. They understand their markets as well as their own strengths, focusing on a few niches for which they are well suited. They find ways to leverage existing relationships. But that doesn’t mean they have remained stagnant.

While sticking to the fundamentals, the industry’s top performers also keep an eye open for opportunities, whether it’s a new branch or the right person to run a complementary business line. They look to diversify revenue streams with everything from mortgages to insurance to investment services—with each step carefully analyzed and executed. And they put lots of resources and effort in meeting technological and regulatory challenges while competing head to head with megabanks, regional banks, credit unions and others trying to lure their customers away.

As a result, this year’s ICBA top industry performers have produced exceptional results, measured by return on average assets (ROA) and return on average equity (ROE).

Last year was a good one for the overall banking industry in general, with earnings of $141.3 billion—a 19.3 percent improvement over 2011 and the second-highest ever reported by the industry after the $145.2 billion earned in 2006, according to the FDIC. ROA rose industrywide to 1.00 percent from 0.88 percent in 2011. The FDIC attributes much of the gains to reduced provisions for loan losses, which fell by 24.9 percent, and an 8 percent increase in noninterest income.

Although a significant share of these gains belong to the megabanks, plenty of successful community banks also found ways to make solid if not enviable earnings gains last year—without reducing loan losses or taking other steps that could skew standard performance measures.

Finding a niche

Like other ICBA industry top performers, Goodfield State Bank in Goodfield, Ill., had a great 2012 thanks to a diverse local economy and the wisdom to focus its efforts where it was bound to have the most impact. Strategically positioned between Peoria and Bloomington, the community bank’s suburban customers have been buoyed by major employers Caterpillar Inc. and State Farm Insurance, both of which are headquartered nearby. Meanwhile, a strong agriculture sector in the $75 million-asset, two-branch community bank’s 30-mile radius has created opportunities to serve farmers and agribusinesses, like fertilizer companies.

Steady employment has helped keep local home values relatively stable, explains Chad Martin, president and CEO at Goodfield State Bank. Mortgage activities also have been strong, especially in the bank’s niche of mortgage and real estate lending in the loan category of one to four family residences. Real estate makes up half of the bank’s loan portfolio, while 30 percent is commercial and 20 percent is agriculture.

“One thing we realize is that we aren’t going to be all things to all people,” says Martin of his Subchapter S corporation bank, which in 2012 recorded an ROA of 4.25 percent and an ROE of 31.75 percent. “We’re not going to compete with new auto loan rates from the credit unions. We pick two or three niche lending areas, whether that’s mortgages, commercial or agricultural, and we try to do them well.”

One part of Goodfield State Bank’s success comes from the bank retaining servicing on many of its mortgages. While it has $75 million in assets, the bank services over $100 million in loans in its real estate portfolio—and it generally doesn’t have any delinquency over 30 days.

Meanwhile, the bank’s investment and wealth management services, a business it started in June 2007, also contribute to its stellar performance. While in retrospect the timing may have seemed poor—opening just a few months before the credit and stock markets came crashing down—that turned out to be an advantage for the bank, too. With many investors angry at the large investment banks and brokerages that caused the financial collapse, the financial downturn created an opportunity for Goodfield State Bank to build on the existing trust and rapport with customers to offer its own fee-based wealth management program.

“It just opened up a whole other area of noninterest income to the bank’s bottom line,” says Martin of the program run by financial consultant Jeff Schumacher. “It seemed like a good complement to what we were already offering.”

While Goodfield State Bank is always looking for alternate sources of fee income, it hasn’t set its eyes on anything other than its mortgage and investment programs—fearing the sort of fee backlash that has plagued the large banks. But looking ahead, the bank would like to grow its lending in the agricultural sector. As part of that effort—and to grow—the bank is planning to open its third retail location in its 93-year history this month in Metamora, a growing suburb of Peoria.

“As we looked around geographically, it made sense to go to Metamora,” says Martin, of the 3,600-resident town with two larger banks but no true community bank. “It’s a similar community—a bedroom community that still has a strong agricultural base to it, and it’s relatively close.”

But Goodfield State Bank plans to grow cautiously, especially when it comes to lending. “We’re selective and not just going to match any rate,” Martin says, pointing out that the bank’s net interest margins run about 4.5 percent. “That is purely just trying to watch our cost of funds, trying to hold those at a minimum, while at the same time being selective about the loans we hold in the portfolio.”

While finding ways to offer the latest technology and dealing with an increasing compliance burden is a challenge, Martin is optimistic about the future of his community bank and the industry in general. “There seems to be this notion that a bank has to have some critical mass of assets to be sustainable going forward,” he says. “I would disagree with that.”

Yet being a highly successful community bank requires tremendous work, Martin adds. “We can’t just sit back and expect it to take care of itself. We must be innovative and stay up with technology. We have to be out there asking for the business.”

Growing loans

One way to seek out that new business is to grow. In 2005, Citizens State Bank in La Crosse, Wis., was the second smallest bank in the state. Today, under new management, the $125 million-asset, Subchapter S corporation bank has four offices, 55 employees and a strong fiscal performance. In 2012 it reported an ROA of 3.45 percent and an ROE of 39.73.

“We’ve seen the right opportunities and taken advantage of them,” says Dennis Vogel, the bank’s president and CEO. Serving western Wisconsin, the bank opened its first retail location in La Crosse and moved its headquarters from Clayton. It added branches in 2008 and 2011 and a loan production office in Eau Claire in 2010.

Vogel says Citizens State Bank has no set expansion and acquisition plan on paper. However, the bank’s leadership stays informally on the lookout for the right opportunities. “It’s just when the stars line up and we see we can get a good return on investment and it benefits customers and employees.”

Loan demand for Citizens State Bank has been brisk, especially in real estate investment property lending generated from its La Crosse branch. The area has strong universities and tech schools, plus a vital health care sector to keep the economy strong. The bank also picked up commercial customers in 2008 and 2009 when large banks decided those businesses didn’t fit in their box anymore. “They were still fundamentally good businesses,” Vogel points out.

Recognizing that every industry has its cycles, Citizens State Bank is trying to diversify, successfully encouraging many commercial customers to use the bank for personal mortgages. It services $70 million in its secondary market mortgage portfolio. But even during the downturn, the bank stayed solid by sticking to standard underwriting.

“We weren’t pressured by the competition to make loans that didn’t make any sense,” says Vogel, a common theme among this year’s top-performing community banks. “We have no credit issues.”

But Citizens State Bank has had to restructure its lending processes and procedures. 2012 saw substantial growth in mortgage refinances, and the bank found the changes they had made four years ago didn’t make sense anymore, Vogel says. Now, it has procedures in place to handle more growth, having streamlined and added checks and balances for accuracy and quality. Everything is centralized.

Now Citizens State Bank is planning to grow another 10 percent organically over the next year, which Vogel feels can be done comfortably, without impacting service for customers. But his biggest concern for the future involves the megabanks with cash stockpiled and ready to lend. “They are throwing out ridiculously low-term, long-fixed rates,” he says. “It’s hard to compete against that.”

Vogel also thinks innovation and reaching out to younger demographics more will be necessary for Citizens State Bank and other community banks to continue to thrive. To that end, the bank has sponsored an exhibit at the Children’s Museum of La Crosse with a mini version of Citizens State Bank, including a working ATM. “We have to think about how that directly impacts the bottom line and can’t get caught up in short-term success.”

To remain operationally efficient and control costs, Vogel continues to focus on staying on top of technology and compliance; thinking nonstop about taking care of customers and employees; maintaining margins and fee income; reducing overhead; and, perhaps most of all, continuing to avoid troubled loans. “It’s gotten more challenging, but I have a passion for it despite all the challenges,” he says. “We’ll shine even more.”

Seeking efficiency

One way all community banks combat those challenges is by finding ways to increase efficiency—either cutting costs or generating more revenue from existing resources. Deep in the heart of Texas, Industry State Bank does just that.

Industry State Bank operates three small-town branches in markets covering a radius of 70 miles between Houston and Austin. The $530 million-asset Subchapter C corporation community bank, headquartered in a town of 300, had a fantastic 2012, recording an ROA of 1.93 percent and an ROE of 18.83 percent.

One reason for the bank’s success last year is its “really low efficiency ratio,” notes James Lindemann, the bank’s chairman. Industry State Bank is part of $2.3 billion-asset Industry Bancshares. The five-bank holding company also oversees Citizens State Bank in Buffalo, Texas; Fayetteville Bank in Fayetteville, Texas; First National Bank of Bellville in Bellville, Texas; and First National Bank of Shiner in Shiner, Texas. Four out of those five banks are ranked among ICBA’s top-performing banks this year.

All of those sibling community banks benefit from sharing the same operational resources—including an IT company owned by their holding company, an umbrella officer and director policy and other insurance, a core data processing system, internal audit and compliance teams, and a human resources department. “When you divide that cost by five banks, that’s a tremendous savings,” says Doak Hartley, Industry State Bank president. “These are the kinds of things that add up when you put them all together.”

Sharing IT and compliance functions has been especially valuable in controlling Industry State Bank’s regulatory costs, Lindemann says. “Compliance issues and dealing with new regulations is a constant burden for us,” he says. “It’s becoming increasingly difficult to serve our customers with all the new regulations the government has passed on.”

That’s doesn’t mean Lindemann and his colleagues aren’t trying—and succeeding relative to other community banks. “We study all the new products and implement the ones people request,” Lindemann says of Industry State Bank’s ability to offer new products through its holding company’s own IT firm. “If people want a loan or deposit product, we’re able to give it to them.”

That includes mortgages. In 2012, Industry Bancshares purchased a mortgage company when the right individual was available at the right time. Currently commercial and residential real estate loans make up the biggest portion of the bank’s portfolio, which includes some consumer and agricultural loans. It holds many loans for homes, farms and ranch land, as well as second home and acreage tracks purchased by people living near Houston, a city enjoying strong economic underpinnings from a booming energy sector. “In addition, our cattle customers have been able to weather the drought conditions very well.”

“We’re close to Houston where the economy is very strong,” notes Hartley, adding the Industry Bancshares family of community banks benefits from the Lone Star State’s largest metropolis nearby but has no plans to open a branch there. “We are close enough to benefit and far enough away to benefit, also.

With a loan-to-deposit ratio of 26 percent, Industry State Bank’s institutional investment portfolio is extremely productive. It invests entirely in mortgage-backed securities and Texas municipal bonds. Like other ICBA top-performing community banks, Industry State Bank puts a high value on loan quality and has no problem loans or assets. It also owns three insurance agencies, which contributed about 44 percent of its noninterest income in 2012.

“We’re sticking with what we’re doing—rural towns in rural Texas,” says Hartley, whose bank added a third branch in Columbus, a town of 4,000, two years ago. “We don’t need to take a lot of risk. We’ll stay out of the big city, we know rural community banking and have done well concentrating on what we do best.”

Finding new markets

In Grand Rapids, Mich., Northpointe Bank found success in the mortgage market—both on the retail side and by serving a niche as an interim source of funding for other institutions.

Founded primarily as a mortgage bank, Northpointe Bank focused mostly on retail mortgages in its competitive western Michigan market until the recession hit. The turmoil inspired the $315 million-asset bank’s management to seek out more diverse sources of revenue. One idea was to parlay its relationship-based approach to mortgage banking into a national mortgage purchase program, says Chuck Williams, the bank’s president and CEO.

Today Northpointe Bank, a Subchapter C corporation, purchases conventional, agency grade mortgages from mortgage banking companies across the country on a short-term basis, typically 15 to 25 days, until these loans are funded in the secondary market. “Essentially our participating banks put their excess liquidity to work by investing in agency-grade mortgage loans through our program, improving our noninterest income without growing our balance sheet,” Williams says.

Just as with traditional community banking, mortgage purchase program competition is strong, with Northpointe Bank facing off against about 75 competitors ranging from very large institutions to small community banks. Williams says his bank’s advantages are being able to provide competitive loan and deposit rates to consumers combined with its high-service approach to nurturing long-term customer relationships.

So far that combination has paid off. Last year Northpointe Bank reported an ROA of 2.15 percent and an ROE of 33.51 percent. It currently holds $150 million in residential portfolio loans, $20 million in commercial loans and $100 million in loans held for sale.

Several factors were involved in that sterling performance, notes Williams. Northpointe Bank continues to work the retail side in Michigan, where it has one banking branch and two loan offices. The bank has also benefitted from fewer loan losses as real estate values and overall economic conditions improved statewide in 2011 and 2012. It also has offices in Columbus, Ohio, and Indianapolis. The loss mitigation and collections team decreased loan losses, dramatically improving asset quality, while the bank attracted new mortgage professionals who increased loan originations and noninterest income without growing the balance sheet.

Williams hopes to build on 2012’s momentum with a three-pronged strategic plan. First, Northpointe Bank wants to continue expanding its mortgage purchase program by adding quality mortgage banking companies and additional community bank partners. Second, the bank wants to grow its noninterest income through organic retail mortgage originations. Finally, it plans to raise its brand awareness and generate core deposit growth within its west Michigan footprint, a very competitive market with credit unions, large regional banks and other community banks.

“We continue to focus on innovative niche business lines that diversify revenue streams in an ever-changing banking environment,” Williams says.

It’s an optimism shared by other executives at ICBA top-performing community banks who say that despite the trials they face as they try to retain their edge in the years ahead—everything from excessive regulatory burden to aggressive competition to changing technology—the community banking industry remains vital and relevant.

“There will still be a need for community banks,” says Martin, of Goodfield State Bank. “It goes back to that trust that each day we’ll stick to the basics. There are challenges, but they are all obtainable.”

Kelly Pike is a freelance writer in Annandale, Va.