Right Sizing

Greater scale can be a relative competitive advantage, but community bankers say intangible factors are important too

By Elizabeth Judd

In a world where bigger is often perceived as better or stronger, many banking industry observers were surprised when an FDIC study that found that larger community banks don’t always become more operationally efficient as smaller they grow larger.

The agency’s Community Banking Study, published in December, determined that relatively greater economies of scale larger community banks do not necessarily translate into a particularly important competitive advantage. However, less surprised by the agency’s report were some executives at smaller and medium-sized community banks.

Jack Riddle, executive vice president and chief lending officer at Community Bank Delaware, in Lewes, Del., argues that his $145 million-asset community bank’s ability to concentrate on familiar territory promotes a closer, more responsive relationship with the bank’s customers. And closer relationships can be the strongest competitive advantage for community banks operating in any marketplace, he points out.

Asked whether greater economies of scale accrue as a community bank grows larger, Riddle, who once worked at a regional bank that centralized its loan support and documentation in Philadelphia and Pittsburgh, notes that handling multiple markets from one location is a way to save money. “There are some great efficiencies for institutions [as they grow larger], but not so much for the customers,” Riddle says. “You lose something when you have to consolidate an operation out of the market you’re trying to serve. We don’t do that.”

The FDIC’s Community Banking Study, published in December 2012, an “efficiency” gap during 1985 and 1998 of 3.5 percent on average favoring efficiency ratios of large noncommunity banks compared with community banks. That gap widened considerably between 1999 and 2011 to an average disparity of 9.2 percent, most significantly attributed to the difference to noncommunity banks increasing their noninterest revenues while community banks faced lower net interest margins and correspondingly lower net interest revenue.

However, while primarily evaluating community banks—and not the billions of dollars in government and market subsidies reaped by too-big-to-fail Wall Street institutions as other studies have identified—the FDIC’s Community Banking Study, published in December 2012, found that community banks, regardless of their size, typically perform better than other community banks when they adhere to traditional lending and deposit gathering activities. The study, while evaluating performance factors such as lending, funding costs, capital and staffing expenses, determined that return on average assets can sometimes increase as much as 6 basis points as a community bank’s size approaches $1 billion in assets.

Statistically speaking, the FDIC study found that greater efficiencies in return on average assets when community banks reach about $600 million in assets. Overall, however, the agency decided “assets size offers very limited benefits in determining the financial performance of local community banks.”

Yet many community bankers agree that the greatest competitive success for community banks derives from competitive intangibles, particularly greater customer loyalty earned as a result of providing more personalized and responsive service. Several community bank executives also agreed that while balancing revenues and expenses is always important, providing responsive and flexible service is a franchise for any community bank, regardless of its size.

“As a small community banker, you have to be able to shift from shaking hands and kissing babies to foreclosing on a problem loan,” says Jeff Newgard, CEO of Yakima National Bank, a $120 million-asset community bank in Yakima, Wash.

Structured to serve

Newgard says that Yakima National Bank’s flat organizational structure gives it greater nimbleness and ability in responding to customers’ needs. Customers “feel comfortable going right to the top” when they have a question. “One advantage we have over the big guys is that it’s hard to leave your friend,” he says. “You’ve built such rapport and close ties with customers that it’s tough for them to leave you.”

Admittedly, customer relationships won’t last if a bank’s pricing too high compared with that of other institutions, Newgard admits. “If a big bank is offering 1 percent less on a loan, the friendship may wear thin,” he says. “But I always say I’m worth a quarter to a half a percent extra.”

Robert Hulsey, president and CEO of American National Bank of Texas, a community bank with $2.2 billion in assets, believes that smaller community banks are waging an uphill competitive battle against their larger counterparts. Yet Hulsey admits that the best local knowledge can still provide the strongest differentiating competitive advantage.

“Small banks that know their areas and customers can defeat bankers coming from the outside who try to lend in a much more structured way,” he says.

An institution’s size and scale of operations are not always evident on the Internet—a dynamic that community banks can still use to advantage. Riddle recalls that when Community Bank Delaware was opening its doors seven years ago, one of the biggest concerns was delivering the same online products and services that bigger banks do.

Today, Riddle says, that’s not a concern. The product and service lineup that Community Bank Delaware offers “rivals any of our peers,” ranging from online banking and remote deposit capture to credit cards and merchant card services. He points out that community bank using ICBA’s product and service programs—including the special-purpose credit card bank, TCM Bank, N.A., that Community Bank Delaware uses to issue credit cards—harness “the bargaining power of a lot of banks” to generate greater operational efficiencies.

Richard Meares, president and CEO of $230 million-asset Fleetwood Bank in Fleetwood, Pa., has also invested in electronic-based services to keep apace with larger competitors. “At certain sizes you have to choose where you’re going to focus,” he says. “When it comes to IT applications, we’ve made a point of being very competitive with the much larger banks. This way we can level the field to a great extent.”

Above all, Meares believes that any community bank can triumph if it focuses on providing a well-rounded product and service line that’s supported by superior customer service. Fleetwood Bank can’t offer every loan product or service, but it can provide certain key services exceptionally well. “What matters,” he says, “is management and board focus.

“You have to ask yourself: Who do we intend to be?”

Is size relative?

Bigger isn’t always better. Meares notes that Fleetwood Bank intentionally halted growth a year ago because of an uncertain regulatory environment. “We were leveraging and growing at a rate to double every five years. At two-and-a-half years we’d grown 52 percent, and so we put the brakes on because all the capital rules are changing.

“Until we know what the rules are, it’s foolish to have greater leverage on your balance sheet.”

On the other hand, Dwight Utz, chairman of VantageSouth Bank in Raleigh, N.C., is convinced that achieving greater operational scale can make a huge difference. Utz, who was CEO of The East Carolina Bank, which had just under $1 billion in assets, recently found a strategic partner and became a new entity because scale—as well as access to capital and geographic diversity—were proving critical for survival.

“Scale does have its benefits,” says Utz, noting that more community banks need to generate more alternative revenue streams to stay more competitive with the largest banks. VantageSouth Bank, which has $2 billion in assets, is creating an agricultural services division, a builder finance group and a Small Business Administration financing group.

In the end, exactly what asset levels distinguish a small community bank from a large one is a matter of some debate. Riddle points out that there are multi-billion-dollar banks that try to call themselves community banks and yet have very few ties to the local area.

“If we were sitting in Lewes, Del., and all we did was finance airplanes in Texas but were a $142 million-asset bank, we wouldn’t be a community bank,” Riddle says. “The fact that we serve the people right here, that’s what defines a community bank and not so much size.

“‘Community’ implies that the decision-makers are in the market they’re serving.”

For Robert Hulsey, president and CEO of The American National Bank of Texas, additional size can provide extra competitive muscle. It can give a bank the resources to offer a more robust product line, he says.

Another challenge for some smaller community banks is attracting staff talent, especially at the higher management levels, says Hulsey. “It’s become more difficult for smaller companies to attract the talent than it was several years ago,” he explains. “Friends at smaller banks in rural areas struggle all the time to get talent out there.”

That said, Hulsey believes that smaller community banks can mitigate their human-resource problems by creating a very positive work culture. He notes that his $2.2 billion The American National Bank of Texas has been named one of the top 100 places to work in the Dallas-Forth Worth area, a distinction that helps him compete against the megabanks.

While smaller community banks can use ingenuity and strong relationships to overcome most obstacles, the increasing regulatory burdens are creating a hardship for almost every community bank out there. And greater regulation is one of the few challenges that offers practically no upside. “The regulatory burden is exhausting and expensive,” Riddle says. “We spend a lot of management energy and consulting money trying to make sure our bank complies with every measure that is coming out of Washington. We take it very seriously.”

Yet even with the relatively higher competitive obstacles smaller community banks sometimes must hurdle, almost everyone agrees that the savviest ones can flourish if they stay focused and maintain their asset quality, community bankers agree.

Elizabeth Judd is a writer in Washington, D.C.