According to Harvard’s Kennedy School, community banks account for more than half of small business loan volume and nearly half of commercial real estate lending. It’s not an exaggeration to say that the health of hometown economies depends on having healthy community banks engaged in robust, properly underwritten small business loans.
Those community banks face many challenges, from growing nonbank competition to a difficult economic environment that drives looser underwriting standards. But their CEOs are building strategies for success that leverage community banks’ unique strengths to maintain their leadership in the small business lending franchise.
While community banks have historically been a dominant player in small business, CEOs report rising and aggressive competition from larger banks and a variety of other lenders.
“There’s a new phenomenon that we’re seeing in our market, and that is that the very largest banks have moved their threshold down,” says Charie Zanck, CEO of the $478 million American Community Bank & Trust in Woodstock, Ill. “They’re starting to enter the community banking space in small business lending and looking at much smaller companies.”
The Farm Credit System is also aggressive. Due to its tax-advantaged status, “there’s no way we can compete on price,” says Susan Black, whose bank—Pinnacle Bank, a $230 million institution in California’s Santa Clara Valley—does robust business with wineries. “If Farm Credit is in the mix, we’re not going to get the deal.”
For Shaun Burke, president and CEO of the $628 million Guaranty Bank in Springfield, Mo., credit unions are the big competitor despite statutory limits on the business lending most CUs can engage it. “They’ll do up to a million dollars,” he says, “and it’s at margins that there’s no way we can accommodate, so we lose some transactions to those guys. But if it’s a big enough relationship, we end up getting them back because they can’t service it the way we do as a community bank.”
Service is key to winning small business, adds Curtis Davidson, CEO of First National Bank & Trust Co., a $514 million bank in Ardmore, Okla. While the FCS dominates land deals in his rural Oklahoma market, “we can beat them on service there, so that’s one niche that we’ve been able to get for ourselves.” Burke and Davidson’s point is echoed by the recent Small Business Credit Survey released by several Federal Reserve Banks, which revealed that 75 percent of community banks’ small business borrowers are satisfied, versus only 56 percent for credit union business borrowers.
Small Business Administration programs also help community banks serve their customers. Black’s bank uses SBA to make loans to entrepreneurs. “That’s the only way we can look at pro forma income,” she says. “We love SBA. We use it as a complement for our clients, for the services that we offer. All of our relationship managers are trained on SBA.”
Burke agrees. “Once we get the SBA guarantees, it allows us to take a risk that we wouldn’t otherwise take in this environment,” he says. “But also, you could price those loans up if you got the expertise. So as the economy improves, we see that there’s a tremendous opportunity to pick up.”
Community banks’ edge in attracting, retaining qualified lenders
Attracting and retaining talented commercial lenders can be a challenge, CEOs say, but community banks offer some key benefits. Burke has doubled the size of his business lending team over the past 12 years, mostly by drawing from larger banks. “Those banks are pulling most of the decisions away from those local offices, and most of our lenders are competitive,” he explains. “They like to win. They like to have some say in the game. So when you give them the ability to manage a relationship, they really like it and they’re incredibly loyal.” David Morrow also capitalizes on that desire to win, noting that CresCom Bank—a $1.2 billion institution in Charleston, S.C., where he is president and CEO—has picked up commercial lenders from struggling banks along the way.
Davidson’s general approach is to hire from within. “We like to raise our own,” he says. His exception is when the bank expands into new markets. “I don’t think I could go into a new market cold without knowing the lenders,” he says, reflecting on First National’s expansion into Norman, Okla., and Dallas. “So hire somebody that’s familiar to you.”
Hiring outside, experienced talent for new markets helps jumpstart relationships.
Community banks can also leverage a collaborative culture to keep lenders engaged. “I always tell our bankers, ‘I don’t have a lot of vertical opportunity, so I will add value to your job horizontally,’” says Zanck. “That’s through exposure, involvement and opportunity to make a difference and be involved in decision-making.”
At Zanck’s bank, with 65 employees, team members work across the three business lines: relationship banking, wealth management and commercial banking. “I think that collaboration serves our clients better because we’re all working together on behalf of that single client.”
Burke echoes the point. “We never have a loan get turned down in committee,” he explains. “I mean—it’s all collaborative long before it gets there. They just know what we’ll do and what we won’t do. There are no surprises.”
Black also uses the flexibility afforded to community bank loan officers to attract employees. “When we recruit, we say we’re one of the few places where bankers can still be bankers,” she says. “They know when they are out talking with their prospective client or a client what they’re offering and what they’re negotiating we’ll back up, and so they have a fair amount of latitude.”
Loyalty is a two-way street, Burke adds. Because loans are made in a collaborative way at Guaranty Bank, during the crisis there wasn’t a lot of finger-pointing when loans went bad. “Not overreacting to some of those lenders’ decisions created a tremendous loyalty on their part,” he says. “It was most likely a group decision when it was made.”
The limits of discretion
While loan officers are attracted to the flexibility they have in a community bank, some CEOs warn that their window for flexibility is narrowing—and with it, the ability to maintain an effective small business lending program.
“Discretion is now a dirty word,” says David Lacy, noting that even for highly rated banks regulators frown on discretionary pricing. “We know our customers and we have a relationship with them that is very special. We from time to time use our discretion to loan money outside of a box, and that is the fiber, the fabric of community banking.” Lacy is president and CEO of the $400 million Community Bank & Trust in Waco, Texas.
And if the replacement for discretion in commercial lending is “algorithmic lending,” Zanck adds. “I think it’s the communities and it’s small businesses that lose out. We realize the consumer side has been commoditized. The question is whether or not that will spread into the small business consumer lending.”
“To the extent that regulators in faraway places start creating models and guidelines to take that discretion away from us, they’re doing more to hurt us than anything else they could do,” Lacy adds. “We cannot not have discretion in our business model.”
Robust supply, limited demand drive looser standards
In some markets, bankers are seeing very little demand for small business loans. “It’s not that we don’t want to lend,” says Zanck. “We have bankers on the street every day looking for good-quality loans or loans that qualify, number one, but also looking for borrowers that are willing to borrow.”
The tax burden and regulatory environment have inhibited not just de novo banks but all kinds of small business formation and expansion activities, CEOs say, rattling off burdens like the pending overtime rule and the Affordable Care Act. Their views are echoed by the National Federation for Independent Business’ Small Business Optimism Index, which most recently found that nearly four in 10 business owners cited taxes or regulation as their single greatest challenge—while just two percent said finding financing was the biggest hurdle.
Because there’s so little small business loan demand, CEOs are seeing looser underwriting standards chasing the borrowers they can find. “Rates and terms both have been eased with the level of competition that’s out there seeking the small business loans out there,” says Morrow.
Davidson notes that in Oklahoma, he has seen amortization periods extended. “For years we thought commercial debts should be 15 years,” he chuckles. “Well, maybe it’s 20 years. Now we’re saying 25 years. I saw a deal that was 30 years and I said ‘Good Lord!’”
In the broader Springfield, Mo., market, Burke is worried that just a few financial institutions driving down standards can affect the entire market. “We’re seeing pricing that makes absolutely no sense for a small community bank,” he reflects. “We want just a return on our capital, just a return on liquidity. But when the guy down the street gives your best customer 50, 75 basis points below you, you’ve got to make a relationship decision occasionally.”
“There’s too much liquidity chasing too few good clients,” Zanck adds.
Relationships are key
The ability to build and forge productive, close working relationships remains the bedrock of community banks’ small business loan franchise. “If it’s a small business loan, it’s a relationship in most cases,” Morrow says. “They are relying upon us as bankers to help them meet their financial challenges and to guide them through, quite frankly.”
Likewise, Black is optimistic about leveraging relationships. “What we’re doing is we’re constantly looking for ways to add value to those relationships and deepen them,” she said. “We’re migrating toward a business model that provides additional advice and value-add to those relationships as well because I think that that is a huge challenge as far as going forward.”
Adds Davidson of small business relationships: “That’s really the secret sauce that we have.”
This article originally appeared in the May/June 2016 issue of the ABA Banking Journal.