REQUIRED READING: Last year, the influential agricultural research blog Farmland Forecast peeked into the cross-section of capital markets and rural economies and declared that the latter looked good, but the smaller community banks suffered from access to capital.
Part of that observation is still true today. With commodity prices running increasingly higher, rural economies dependent on agricultural business are thriving. As for the community banks, the only thing they are suffering from is an overabundance of federal regulations. Otherwise, they are ready, willing and able to lend to single-family home buyers who are not necessarily farmers.
‘Most community banks today have lots of liquidity for lending and are ready to lend to qualified borrowers within their defined market areas,’ says James MacPhee, CEO of Kalamazoo County State Bank in Kalamazoo, Mich.
Eric Nottestad, vice president of Citizens First Bank in Viola, Wis., concurs. ‘Deposits within our community are sufficient to fund loans for this community and its growth,’ he says.
As their name suggests, community banks limit their lending practices to within 20 or 30 miles of the home office. Within the rural regions of the U.S., community banks involved in residential mortgage origination are divided in regard to whether they sell their loans to the secondary market or retain them in their portfolios.
‘We got into selling to the secondary market because we didn't have the ability in-house to fix interest rates [for the] long term,’ says Nottestad. ‘We are a small bank, and the Federal Home Loan Bank gives us the opportunity to have a product that we may not have been able to offer before.’
The Regional Missouri Bank in Marceline, Mo., does not currently sell its loans to the secondary market, but it might in the future.
‘We do not deal in the secondary market,’ asserts Don Reynolds, chairman and CEO. ‘Even though we don't use that source, I am concerned with the possibility of it not being available. We rely heavily on the Federal Home Loan Bank, both for a source of secondary funding and the ability to match maturities.’
In rural areas, community banks are also up against the Farm Credit System, which was founded in 1916 as the nation's first government-sponsored enterprise. But unlike the monolithic Fannie Mae and Freddie Mac, the Farm Credit System consists of 95 private cooperative institutions that can provide home loans to towns with populations of 2,500 or fewer people. These lenders have the option to sell their home loans into the secondary market, but many choose to keep them in their portfolios.
Indeed, individual lenders within the Farm Credit System network can use the secondary market for home loans – and some do and some don't.
‘Other farm credit entities around the country sell their loans through Fannie and Freddie, but we elect not to do that,’ says Bill Medley, vice president of marketing for Louisville, Ky.-based Farm Credit Services of Mid-America. ‘We think it's sound business for us to hold our loans. Besides, we are structured like Fannie and Freddie, so we don't think there is a need for that.’
And unlike many community banks, the Farm Credit System's lenders have access to long-term, fixed-rate funds to create 20-year and 30-year mortgages.
‘Some community banks do these kinds of loans, but they typically provide shorter, adjustable-rate mortgage-type products because they can't do long-term, fixed-rate loans,’ Medley adds. ‘But we can provide those loans.’
Beyond this competition, community banks have other issues when it comes to selling loans.
‘They can sell their paper to reduce risk,’ observes Ernie Goss, professor of economics at Creighton University, based in Omaha, Neb. ‘However, they often keep the paper, because farmers like to make payments to the local community bank.’
Goss adds that due to these concerns, coupled with these banks' locations in the midst of farm country, many rural community banks are more focused on agricultural loans than home loans.
‘The banks are very customer-centric,’ he continues. ‘They know things like when planting should take place, when's the harvest and what are the cash needs of the farmer. Home lending would not be a large share of the community bank portfolio.’
‘Over the past two years, total loans have increased here by about nine percent per year, and much of this growth is farm and commercial,’ notes Reynolds. ‘The largest segment of our economy is agriculture, which is doing well.’
Yet Reynolds notes that rural community banks were more fortunate than their larger, urban rivals. ‘The stronger farm economy softened the blow for some, but we never did get carried away when the overall economy was good,’ he continues. ‘The price of housing never did rise to the levels of other areas, and very few houses were sold for as much as the cost of replacing them. The lenders with problems were not area lenders – the newspapers reported a number of foreclosure notices, and very few are local lenders. I would guess that Wells Fargo would have been better off had they elected to stay in California.’
But there were some rural areas that were not so fortunate – most notably in Michigan, where even the rural areas have been affected by the decline of the urban-based auto industry and all businesses even tangentially associated with it.
‘The southwest Michigan economy is slow,’ says MacPhee. ‘We were hard hit by the recession, but Michigan began its downturn in 2001 as the auto industry melted down. It was further hurt by the subprime debacle, as the overabundance of real estate brought property values down, forcing community banks to take losses on foreclosed properties that normally would have had equity in them.’
Federal burdens
The next big question for the rural community banks is the same one bedeviling the full industry: How can they survive the federal government's zeal to transform financial markets?
‘We have been fortunate to not have a lot of loan problems, so the regulators are not on us for this,’ says Reynolds. ‘But I am concerned that financial reform will have a significant impact on us and other community banks.’
Financial reform has definitely put a strain on community banks, adds Nottestad. ‘We are being forced to do things that may or may not pertain to us just because of the issues that the large banks and investment banks caused,’ he says. ‘There is a cost to all that, and it is going to affect how we serve our community of 600.’
Financial reform paperwork and added personnel costs will have a significant impact, because rural community banks generally work with limited staffing. On the other hand, the community banks escaped some of the more onerous regulations. As the Dodd-Frank Act passed through Congress, community banks with under $10 billion in assets were carved out of most of the new regulatory requirements, including the examinations and enforcement that will be conducted by the upcoming Consumer Financial Protection Bureau.
Further, the Dodd-Frank Act requires community banks – and, in fact, all banks – to pay Federal Deposit Insurance Corp. deposit insurance based on assets minus tangible capital versus deposits as done historically. According to MacPhee, that aspect of the new legislation will save community banks $4.5 billion over three years in insurance premiums and move the cost to the banks that have over $10 billion in assets, which hold almost 80% of the assets in the banking industry.
‘It's a more fair and equitable calculation, and one that rightfully places the cost play on those who are the systemically riskiest and largest banks in the country,’ he says.
MacPhee cautions, however, that community banks did not escape all of the burdens presented by the Dodd-Frank Act – the rural lending sector has major issues with the Durbin interchange bill, which could cut community banks out of the debit and credit card business if the legislation is not reviewed and changed before implementation.
‘The financial reforms are not all bad, and lots of them were needed,’ says Nottestad. ‘Prior to the financial meltdown, my community was targeted by mortgage banks, cash stores and large national banks based in other parts of the country. These institutions teased my community with low rates, loan amounts my community citizens couldn't afford and loans with hidden fees.’
The end result of all that, Nottestad warns, is that his bank is being regulated as if it were one of the banks that attempted to fool consumers this way.
‘I'm here, but those institutions are not, and I'm faced with the regulations they caused,’ he says. ‘If we are going to be treated like large banks, then why isn't there a U.S. Bank office across the street from me? Why are they throwing us in the same pool when they don't even let us come and play in the same sandbox?’
Steve Bergsman is a freelance writer based in Mesa, Ariz.
