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Community banks face fight of their lives against big players

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A massive prize fight is brewing in the banking industry. This epic dual, though, is lopsided, pitting scrappy community banks against some of the nation’s largest financial institutions.

As the economic recovery starts to take shape, the core bank concept of service will be pitted against price. If local relationships matter as much as lenders invariably attest, small banks have a chance of holding or even augmenting their positions.

But if businesses continue to cherish low costs above all else, big banks are likely to invade all sorts of new ground and increase their market share in the post-TARP era.

Small outfits prepping for the slugfest include most of the 50-plus banks doing business in the Indianapolis area. The list sweeps in such institutions as First Internet Bank, Greenfield Banking Co. and Hendricks County Bank & Trust Co. Also Salin Bank & Trust Co., Indiana Business Bank and Heartland Community Bank.

Carmel-based bank consultant Mike Renninger anticipates a wave of consolidation among community banks. Otherwise, he said, small lenders will struggle to keep up with the enormous, diversified financial institutions that maintain branches around the corner.

“Community banks have to find a way to remain competitive,” Renninger said. “They should be getting together [via mergers]. Their competition isn’t the next small bank in the next small town. It’s the big banks that can drive them out of business.”

Consider New York-based JPMorgan Chase Bank—as big and strong a juggernaut as banks come, and the lender with by far the largest Indiana footprint. Chase has a total market value of $165 billion. With 187 branches, it dwarfs all but a handful of the other 200 banks doing business here.

By way of comparison, all the bank deposits originating in Indiana, including the $12 billion held by Chase, amounts to just $94 billion.

Last June, at its earliest opportunity, Chase paid back the $25 billion it borrowed from the federal Troubled Asset Relief Program. Chase went on to book a $5.6 billion profit on $112 billion in revenue for 2009, a difficult year to make a profit of any kind. In November, Chase announced it would expand small-business lending in 2010 by $4 billion.

That kind of firepower has always allowed Chase to be choosy about its borrowers while remaining extremely competitive on price. Chase last year approved about the same percentage of loans it considered in each of the last three years, said Timothy Oliver, Chase senior vice president and market manager for central Indiana business banking.

The difference: volume. Loan demand is soft, Oliver said, except for refinancings. Most companies are still trying to cut costs, Oliver said, and not borrow new money to buy equipment or buildings. Meanwhile, all banks are far stricter in their loan analysis than before.

Chase builds a “fortress balance sheet” through exhaustive due-diligence, Oliver said. While Chase used to stand out as one of the most conservative lenders in the market, other banks have adopted similar citadel approval standards.

Eventually, businesses will have to begin borrowing again. And banks with plenty of resources, like Chase, will be in a superior position to help them.

“The joke I tell people is, the duct tape is going to wear off eventually,” Oliver said. “[That’s when] they’ll pull the trigger on a new piece of equipment or a building.”

Struggling to compete

At the other end of the spectrum, even the best-managed community banks are struggling to compete. Take Jasper-based German American Bancorp, which has 29 branches and a $179 million market value. Shortly before Christmas, President Obama began openly criticizing the nation’s biggest banks, including Chase. Obama also generated publicity when he invited 12 community bankers—German American’s Chairman and CEO Mark Schroeder among them—to meet with him personally.

Schroeder said he explained to the president that German American, which booked a $12.8 million profit on $86 million in revenue last year, is ready and willing to lend. But, like Chase, it’s seen soft loan demand from customers still skittish about expansion.

As the economy picks up, Schroeder said, businesses will need to borrow again. But all bankers will face a technical challenge. Companies have been shedding assets, like buildings and equipment, to cut costs in the short run.

Eventually, they’ll have less collateral as security for new loans. And much of what they still hold will have depreciated in the recession.

Without enough physical collateral, banks must set aside extra money to satisfy regulators. That makes community bankers particularly skittish and reluctant to make all but the most rock-solid loans.

All lenders have to protect their dry powder. However, unlike the mega-banks, community banks don’t have other business lines, like credit cards, investment banking or treasury management to offset the occasional soured deal.

Meanwhile, small-business borrowers are caught in a vicious circle, Schroeder said. They need working capital to expand machinery and equipment. But they’ve lived off their balance sheets. So, when they look to banks for additional funds, the deal can’t be done.

Schroeder hopes Obama will maintain his anti-recession lending incentives, such as the Small Business Administration’s elimination of fees and increased credit guarantees through 2010 and perhaps 2011.

Playing to strengths

Big banks avoid many of the smallest towns, where community banks are strong, because they can’t take advantage of their size and economies of scale.

Even when they skirmish on the front lines, Renninger pointed out, community banks have a real opportunity to test whether profound knowledge of their own territory offers a real business advantage over economies of scale of their bigger brethren.

In theory, small banks’ deeper long-term relationships should make it possible for them to use guerrilla tactics to pounce on prospects big banks miss.

“Banking is all about people,” Renninger said. “Relationships probably mean more to the customer than the lowest cost. If you’re a small business and need money, it doesn’t matter that your bank has the slickest systems and lowest-cost services. What matters is if they’ll make you that loan.”

Despite the squeeze of the recession, community banks have opportunities, said attorney Thomas Maxwell, who worked for the Federal Deposit Insurance Corp. before joining locally based Barnes & Thornburgh LLP.

Borrowers have long memories. They’ll remember which banks defended their customers’ interests during the recession, Maxwell said, and which instead staged Pyrrhic victories that merely bolstered their own bottom lines.

“The community banks will tell you they’ve been there all along making loans when some of the bigger banks weren’t,” Maxwell said. “For community banks, that’s good in the long term.”•

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  • Business Banking
    "bankalchemist", you prove the point exactly! 35% from fees. Doesn't that mean customers pay more?

    Community banks work with their clients and get to understand their customers. Big banks just look at the numbers.

    Community banks make money, but not at the expense of being fair or taking advantage.

    Prior to this downturn, I was constantly challenged by low-rate, poor service banks (think 5/3rd etc). How customers have been treated for the past 2 years shows the value of having real relationships. Fear is a better motivator than greed. Customers truly no longer trust that the big bank won't put them out of business.

    I like our chances better than any time in the past dozen years!
  • Strongly Disagree
    #1 To sell the product you should know the product. To say"Meanwhile, small-business borrowers are caught in a vicious circle, Schroeder said. They need working capital to expand machinery and equipment. But theyâ??ve lived off their balance sheets. So, when they look to banks for additional funds, the deal canâ??t be done" is not a the correct banking approach A fixed-asset base loan is used to finance the purchase of machinery and equipment not a "working capital loan". Bankers need to know business models better in order to make intelligent lending decisions. They need to get out of their offices and into their customers factories.
    #2 Community banks are in a better position then ever to grow and prosper. They have unpressidented opportunty to beat the pants off of sper large banks including super regionals. You will always just be a number to the big guys and a loyal friend to the community bank. Smaller banks need to learn how to grow through cross-selling and the offering of additional products and services.
  • ah yes duct tape
    aka Oklahoma Chrome...Bankers will need more than duct tape to hold it together going forward because most have forgotten how to enter new business lines unless its a loan. The Big Banks over time fare much better because 35% of their income is in fees. BANKALCHEMIST.

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