Survive and Thrive

Four strategic ideas to prepare for change and ensure a long, independent future

By Philip K. Smith

Can your community bank survive?

“Yes,” is my answer, but perhaps my first bit of advice is to stop panicking. Community banks may, in fact, face different types of challenges going forward, but community banks can and will survive. But let’s briefly explore some of the ways community banks can improve what they are doing in order to ensure their survival.

Remember the panic over the removal of interstate branching restrictions? Remember the alarm over the wearisome corporate governance rules in the Sarbanes-Oxley Act? Remember the threat over Wal-Mart attempting to acquire a bank charter? Remember the panic over previous presidential elections? In some ways, now is no different—community banks can and will find ways not just to survive but also to thrive. Let’s briefly explore four strategic ideas that community banks should think about to improve what they are doing to ensure their bright futures.

1 Focus on core profitability.

Do not be fooled in the coming months or years by increased profitability in your community bank that results only from a lower allocation to the allowance for loan losses. Instead, continue to focus on core profitability and require your bank’s management to set specific goals and targets to increase net interest margins and seek out new sources of fee income. Our industry’s business models are still the same, and core operational profitability is the key to maintaining independence.

At its simplest form, increased profitability will be achieved by doing more of what you are currently doing or doing something different that adds to the bottom line. This should involve your community bank’s board of directors discussing whether management should be pursuing organic, internal growth or looking for new sources to grow revenue in new lines of business.

Alternatively, though, think in terms of profitability from what the expense side of the balance sheet is showing you. Does your community bank have unprofitable lines of business that have never made a dime for the organization? If so, why do you keep them?

It is time to analyze individual product and service profitability, along with individual branch profitability. If you find deficiencies in any of these areas, sever ties, become leaner and more efficient and drive bottom-line profitability.

2 Get in the right structure.

Many smaller community banks, particularly on the West Coast, have an organizational structure that is not conducive to promoting long-term profitability and independence. In particular, smaller institutions that are publicly traded or quasi-publicly traded rarely receive any significant benefit from that structure. Relatively new SEC rules allow organizations with fewer than 2,000 stockholders to be privately traded rather than publicly traded. Those that already are public, by jumping through a few hoops and having fewer than 1,200 stockholders, may be able to achieve private-company status.

If a community bank is organized properly, it can have just as much liquidity as a publicly traded company without all the structure’s headache and cost. If your bank holding company structure is managed appropriately, the corporate entity should be the purchaser of first resort of shares, thereby creating its own market and providing instant liquidity, which allows the organization to serve as its own transfer agent. That is a much simpler and conducive way of creating liquidity—as opposed to being on some type of small exchange with a “false” sense of liquidity, which occurs when there are rarely any trades in the shares. So consider whether or not you should change your community bank’s structure.

Additionally, for institutions with the fewest number of stockholders, more and more community banks will need to take advantage of Subchapter S corporation opportunities. Particularly if we see a further modification of tax rates and higher corporate taxes or a higher-dividends tax rate, the Subchapter S corporation structure might be a viable alternative. Under special Subchapter S corporation rules, up to six generations of one family can count as one stockholder, thereby allowing more community banks to meet the 100-stockholder limit to qualify for Subchapter S status.

3 Plan for board succession.

If your community bank would like to maintain its independence but has a board gripped with paranoia and a fear of the coming regulatory and profitability battles, then perhaps it’s time to begin thinking about board transition planning. The future banking marketplaces may not be for everyone, and your bank will need an aggressive board willing to lead and direct the organization—without micromanaging—in a way that continues to return shareholder value. That may require a new way of looking at your bank’s operations, a new strategy, new lines of business or moving into new markets, and all of those changes may require your bank to have new board members.

When looking to transition to new board members, consider establishing board qualifications or criteria for service. Does your community bank require its directors to have a certain educational level? Is a certain financial commitment required from them? Do your bank’s directors need to have specific legal experience, business backgrounds or financial acumen? Does your bank want at least one board member from another regulated industry?

Don’t forsake board succession planning in the new banking environment; prioritize the recruitment of new, qualified directors.

4 Survival will not be determined by asset size.

Too many folks are preaching that community banks must become bigger to survive. That is nonsense for most community banks. However, many banks might need to become more profitable to remain sufficiently competitive. In addition to focusing on improving your community bank’s core profitability, look at its overall efficiency and effectiveness. Question whether your bank needs to continue to have unprofitable branches or whether it would be more profitable to reduce those overhead costs. Question why your bank continues to offer products and services that are historically a drain on its earnings, just because your bank wants to claim to be “full service.”

The reason many people advocate that community banks must become bigger to survive is because of the perceived economies of scale and efficiencies that are created. While there is some truth to that line of thinking, the first focus for community banks should not be on growing to achieve efficiencies, but rather simply becoming more effectual with what they have, reducing their unprofitable locations and lines of business, and being the cleanest, most efficient organization they can become.

Community banks can and will not only survive, but also thrive—but it may require a new way of thinking. Community banks cannot continue to fall back on the notion that they are simply the “nice guys” in town or that they must adhere to a less-accountable “family environment.” Consider the possibility that many in the next generation of consumers may, in fact, not want the things we think are a community bank competitive advantage. The fact that we know everyone by name and greet our customers at the door when they walk in may be a turnoff to someone who demands mobile banking, quick and impersonal service. Certainly the momentum in deploying even more technology to serve customers may require fresh, critical thinking about your bank’s perceived strengths to maintain its independence in the future.

So use these four ideas as a starting point to look at things differently.

Philip K. Smith is president of Gerrish McCreary Smith PC Consultants and Attorneys in Memphis, which serves community banks nationwide.