REQUIRED READING: Whoever coined the observation that ‘bigger is better’ was obviously not aware of community banks. During the peak period of the recession, when the nation's too-big-to-fail financial institutions required federal intervention to avoid failing, the smaller community banks were not feeling identical pains and did not require financial transfusions from the government to stay afloat.
But this is not to say that the community banks have not felt any recession-era pain. While the sector as a whole remains relatively solid, it is coming out of a rocky 2009 and into 2010 with a number of serious concerns.
According to Dr. Stanley D. Smith, professor of finance at the University of Central Florida (UCF), Orlando, community banks have a busy year ahead of them. In comparing the data from the first half of 2009 to that from the first half of 2008, Smith charts a challenging landscape in regard to real estate finance.
‘If we are defining community banking as bank holding companies with less than $500 million in total assets, the pre-tax net operating income/average assets dropped from +0.74 percent to -0.44 percent,’ says Smith. ‘The following categories accounted for the large decline: provision for loan losses (57 percent), lower net interest income (22 percent), higher overhead expenses (16 percent) and lower non-interest income (five percent). Real estate loans are 55 percent of total assets and 79 percent of the loan portfolio.’
Smith further notes that community banks faced a wave of real estate-induced red ink in the first half of 2009, from both the residential and commercial side.
‘Loan losses increased dramatically,’ he continues. ‘Loan losses as a percentage of real estate loans increased from 0.43 percent to 1.13 percent. The biggest problems were construction and land development loans, where loan losses increased from 0.98 percent to 3.30 percent. Commercial loans are 12 percent of total loans, and the loan losses increased from 0.57 percent to 1.92 percent.’
Smith glumly adds that the even if the worst of the national economic crisis is behind us, the community banks won't be viewing their real estate problems in the rear- view mirror.
‘If we assume the recession ended this summer, then based on past recessions, I expect to see high loan losses in all loan categories for the next two to four years,’ he says.
If the first half of 2009 was a rough road, the second half of the year was marked with the appearance of a major sinkhole: In August, the Federal Housing Administration (FHA) suspended Ocala, Fla.-based Taylor, Bean and Whitaker Mortgage Corp. (TBW) from originating and underwriting new FHA-insured mortgages. Ginnie Mae also terminated TBW as an issuer in its mortgage-backed securities (MBS) program and took control of TBW's nearly $25 billion Ginnie Mae portfolio.
As the nation's third-largest direct-endorsement lender of FHA-insured loans and the eighth-largest issuer in the Ginnie Mae MBS program, the TBW debacle affected many smaller banks that sold their loans to the now-bankrupt company. In fact, TBW was the primary mortgage partner for ICBA Mortgage, a wholly owned subsidiary of the Independent Community Bankers of America (ICBA) that provides community banks with direct and indirect access to the secondary markets.
Â Â Â
Yet according to Dave Petro, president of ICBA Mortgage, the TBW situation has not stopped the origination volumes being generated by community banks.
‘For 2009, we are at about 3.5 times the level we saw in 2008,’ says Petro. ‘Despite the TBW fiasco in August, a lot of loans continued to flow.’
For Petro, community banks continue to play an active role in the residential home loan market with what he dubs ‘commonsense lending’ and a strong connection to the markets they serve. Candee Palmer, assistant treasurer and residential mortgage operations manager at Northwest Community Bank in Winsted, Conn., shares that opinion, adding that the recession has further strengthened the bond between customers and community banks.
‘Overall, community banks are doing very well right now,’ says Palmer. ‘People are looking for stability with community banks – they like to be able to talk to someone, have their fears calmed. People are definitely looking to come back to the community banks and the comfort level they give. They know they can call us if they have a problem with loan, and we can help them through it – and not have to deal with someone on the Internet.’
Palmer notes that her bank's home-loan volume was up in 2009, with an exclusive focus on traditional conforming loans. ‘We haven't changed our way of doing business,’ she adds. ‘Our underwriting standards did not change, and we were not into the predatory lending that the bigger banks did. We're supportive of anything that protects consumers.’
Â Â Â
Of course, not every community bank was as fortunate as Palmer's.
‘If you invested a lot into option adjustable-rate mortgages, you have problems,’ observes Rich Gale, division president of Provident Bank in Riverside, Calif. ‘Some community banks were exclusively commercial lenders, and they're seeing more and more problems. It is all about the quality of the portfolio loans you have. We're selling 100% of our product into the secondary market – we are structured more as mortgage bankers' community bank.’
One trend that proved devastating to this sector in 2009 was the number of community banks that failed and had their assets seized by the Federal Deposit Insurance Corp. ICBA Mortgage's Petro predicts that more community banks will fail this year.
‘I don't see anything that massively changes that,’ he says. ‘There will be more bank failures.’
UCF's Smith concurs, adding that real estate losses will continue to contribute to the problem.Â
‘How much longer will their loan losses occur?’ he asks. ‘Look at the past recession, and you will see there were high loan losses for at least two years. This will be at least as long, or even as long out as four to five years. That's going to put a lot of pressure on these banks as these loan losses continue.’
Rick Seehausen, president of LenderLive, based in Glendale, Colo., believes that broader economic trends and commercial real estate, rather than residential lending, will play a crucial role in the health of community banks.
‘Unemployment remains at top levels,’ he says. ‘We are seeing companies downsize office space to cut costs, but that leaves a lot of commercial real estate vacant. Any community bank with exposure to that is in potential trouble.’
One wild card where community banks may see a previously untapped revenue stream comes in warehouse lending. During 2009, a number of industry leaders attempted to recruit community banks to fill in the void left by the withdrawal of large warehouse lenders.
For Provident Bank's Gale, this situation was more than a little ironic.
‘Most community banks don't have to negotiate warehouse lines,’ he says. ‘They have plenty of liquidity.’
Gale predicts that community banks will not be rushing into warehouse lending. ‘Typically, a community bank is so small that he amount of warehouse lines they could create would be very small,’ he says. ‘One in California came up with $50 million total.’
Smith is surprised that community banks are being pegged as potential warehouse lenders. ‘When I think of that area, I think of bigger banks,’ he says. ‘Smaller operators may get a small warehouse line, but those are risky, too.’
For Smith, the nature of community banking is antithetical to warehouse lending. ‘One thing making it hard is that so much of community banking is based on a relationship,’ he says.
Petro concurs. ‘I have not seen that and do not see that,’ he says. ‘It is not a good fit for their strategy. The definition of a community bank comes in serving the local community. Warehouse lending is not necessarily focused on community in a general market sense.’