Arkansas’ community bankers face tough terrain

story by Michael Tilley and Kim Souza
mtilley@thecitywire.com

Editor’s note: This story first appeared in Talk Business & Politics magazine.

In addition to the challenge of increased regulation, an interest rate environment that compresses margins, and ever-changing technology, Northwest Arkansas bankers Mary Beth Brooks and Rob Husong also are in the business of providing lawn care on property they’d rather not own.

It’s been well documented that Northwest Arkansas was by far the hardest hit Arkansas metro area when it was learned around 2006 that the subprime emperor had no clothes or collateral. Benton and Washington County home sales in 2005 totaled 8,565, only to begin a tumble in 2006 that saw the combined sales reach a low of 5,292 – a face-slapping 38.2% drop – in 2008.

Statewide, home sales in the four largest metro markets totaled 24,789 in 2005, before reaching a low in 2010 of 17,710 – a decline of 28.5%.

Although the residential real estate market began to recover in 2012, the 2013 sales in Northwest Arkansas totaled 7,230, up 15.2% above 2012 but still more than 15.5% below the 2005 pace. Several banks – ANB Financial and Metropolitan National Bank, for example – did not survive the residential real estate and commercial losses resulting from an almost 40% drop in the regional market.

The ongoing residential recovery has reduced pressures on banks operating in Northwest Arkansas, but plenty of angst remains.

‘NOT FAST ENOUGH’

The City Wire in early 2013 reviewed 18 Northwest Arkansas community banks. The cumulative assets classified as “other real estate owned” – or OREO – totaled $444.24 million. A year before that the same 18 banks held $462.84 million in OREO on their books. The 4% decline compared to a more than 15% increase in area home sales during 2013 provides an example of the struggle to reduce OREO.

“Not fast enough for me,” said Mary Beth Brooks, president of Bank of Fayetteville, when asked if non-performing assets were moving off the books faster than originally thought. “We have had good luck selling the few houses we have taken back and have had relative success at selling commercial properties. There has also been some good demand for residential lots. Raw land, on the other hand, has not turned over as well for us.”

OREO held by Bank of Fayetteville fell from $8.948 million at the end of 2012 to $6.482 million at the end of 2013. The bank’s return on assets improved from 0.55% in 2012 to 0.70% in 2013.

Rob Husong, Northwest Arkansas regional president for First National Bank Centerton-Lowell-Rogers, said a good sign in the market is that “desirable” lot inventory “dramatically decreased” in Benton County in recent years. What remains, however, are bank-owned lots that are less desirable because of location, lack of utilities and other factors. Overall, he’s pleased with the trends.

“Yes, I believe they have been moving faster than originally thought,” Husong said. “Most banks have focused their marketing efforts on the pieces of OREO they feel they can move the fastest and recover a larger portion of their costs, while having certain OREO earmarked as longer term asset disposals in hopes the market improves over time to lessen the loss. … But even these perceived longer term dispositions have started getting more interest from the marketplace, which I think is a positive sign for an improving real estate market.”

As part of Fort Smith-based First Bank Corp., Husong’s region does not have a definitive OREO report. However, the FDIC report for First National Bank of Fort Smith – which includes Benton County operations – shows that OREO did see a big decline from $20.014 million in 2012 to $9.457 million at the end of 2013. The parent company’s return on assets improved from 1.29% in 2012 to 1.58% at the end of 2013.

Brooks and Husong said they are eager to shed the ancillary costs of owning property.

“Owning a subdivision and covering property taxes and mowing gets really expensive,” Brooks noted. “The regulators have been pretty understanding on the OREO front, however, and they realize that some properties will truly take many years to sell.”

REGULATION GROWTH
When they are not cutting grass, Brooks and Husong work to cut through a growing field of regulations brought about by new rules – primarily the Dodd-Frank law – intended to prevent anything approximating the near-financial collapse of the U.S. banking system in 2007-2008. The irony is that a bulk of the regulations are intended for banking operations with assets in excess of $10 billion, but just about any banking industry expert will testify that the rules could especially squeeze the community banks below $200 million in assets who may not be able to afford the time and people to feed the paperwork monster that has become Dodd-Frank.

Regulators say they are trying to “minimize” the burden on community banks.

Amy Friend, senior deputy comptroller and chief counsel for the federal Office of Comptroller of the Currency, testified April 8 before the Financial Services Committee of the U.S. House of Representatives. Republican committee members have pressured federal regulators to go easy on the rulemaking, especially with the smaller vulnerable banks.

Friend noted that banks of all sizes “grapple with an evolving regulatory landscape and difficult business environment,” and admitted that such evolution carries a potential threat for smaller banks.

“These changes can strain the more limited resources of community banks. As I will discuss next, the OCC is committed to addressing these concerns wherever possible. We have instituted a number of initiatives to do so and will continue to re-evaluate and look for additional ways to minimize burdens on community banks,” Friend noted in written testimony to the committee.

SQUEEZING OUT SMALLER BANKS
Gaines Dittrich, a banking analyst and founder of Joplin, Mo.-based Dittrich & Associates, has said that closely-held banks – like First National and Bank of Fayetteville – are the most vulnerable to acquisition in what he predicts will be the next wave of consolidations. The consolidations will in large part be fueled by the increased compliance costs and potential community limitations resulting from Dodd-Frank and the international Basel III rules.

Husong said Dittrich is on point with his prediction.

“I think Gaines is correct with regard to the headwinds from regulatory pressure and the smaller banks ($250 million and less) will feel the burden to the point of looking for ways to exit, merge, or acquire in order to get enough critical mass to absorb the cost of additional oversight and still retain profitability goals,” Husong said.

Brooks said said the smaller banks can survive if they “continue to invest in technology to stay relevant,” and double efforts to build and maintain community relationships. However, financial assumptions may have to change.

“I think those (smaller community) banks can survive but the owner or shareholders just have to adjust their expectations on returns,” Brooks said.

A report – “Community Banks Remain Resilient Amid Industry Consolidation” – released April 9 by the FDIC suggested that community banks have survived past industry changes and “ they will continue to carry out these important functions for the foreseeable future.” The 11-page report only briefly mentions Dodd-Frank and Basel III, and in doing so suggests that the new rules could benefit the community bank sector of the financial industry.

“To the extent that bank risk managers and bank supervisors are successful in creating a more stable banking environment in the years ahead, failures may contribute much less to consolidation than they have since 1985,” noted the FDIC report.

A COMMUNITY FOCUS
Husong, who in 2005 was one of the bank officers who launched Fayetteville-based Signature Bank, agreed that community relationships will be a key to bank success.

“I keep going back to what community banks have traditionally been good at which is being relationship driven. In years past this typically meant having a customer’s checking accounts, loans, safe deposit box, etc., simply because a community bank had more flexibility to help customers with trusted professionals giving advice and guidance when asked. Unfortunately, regulations have made it very hard to retain that flexibility.”

Continuing, Husong said: “I believe community banks need to re-evaluate what it means to be relationship driven. Although I still believe it’s very important, if not imperative, to have brick-and-mortar and the best customer relationship employees, community banks need to make sure they offer the same product array of competitors as well as find new ways to be part of our customers lives.”

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The FDIC report included a section that mirrored Husong’s assessment, noting that community banks are managed by “relationship bankers” whereas large banks are managed by “transactional” bankers.

“Because of this expertise, community banks tend to base credit decisions on local knowledge and non-standard data obtained through long-term relationships and are less likely to rely on the models-based underwriting used by larger banks,” noted the FDIC report.

Brooks said technology branding is how the Bank of Fayetteville is pushing its community connections in a way that reaches across several generations.

“We are constantly working to reinforce our community focus. One of the ways we are doing this is to include local imagery on our website, iPad apps, and even on our instant issue debit cards. This use of local imagery works to reinforce the customer’s tie to the community,” Brooks said. “The growing emphasis on technology will force smaller banks to make sure they are doing all they can to equip the customer; however, in a market like Northwest Arkansas, the sense of community will ensure that even technology savvy Millennials rely on local banks.”

And when Brooks and Husong get the grass cut and deal with the increased regulations, they then get a chance to face competition from non-regulated financial companies – like the world’s largest retailer based just up the road in Bentonville.

“Between the regulatory burden and the necessity to offer the latest greatest competitive products (which customers are demanding), smaller banks have a challenge ahead of them,” Husong said. “We continually see new non-bank competitors as well which just adds to the pressure. Between insurance companies, brokerage houses, large retailers, and online retailers, banks are constantly seeing the progression of traditional bank products being offered by non-regulated entities.”

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