The Royal Bank of Pennsylvania was founded in 1963 in an area that was mostly farmland and residential communities.
A lot has changed in the bank's market since then. Now the area is composed of offices and shopping centers, and the bank has changed dramatically as well.
Current management took over the Royal in 1980. It envisioned a bank that is highly community oriented and meets the needs of customers in a friendly manner and by providing access to senior management, two of the main edicts of a super community bank.
Though the bank hasn't been an acquirer, having just announced its first deal, retained earnings since 1980 have grown from $2 million to $70 million, with total assets at $300 million.
During that time, including the down years when the commercial business market in metropolitan Philadelphia crashed, the company has been profitable every year. The best year was 1989, with $8 million net income on $316 million in assets. This year promises to be similarly profitable, with an expected return on assets of 2.6%.
Who says small banks can't survive?
I asked Lee Tabas, the bank's CEO, how he manages to achieve such profitability, year in and year out.
"There is no magic. We watch costs, we operate very economically, and we closely track out noninterest expense," says Tabas.
With an efficiency ratio of 27.9%, rarely found in any bank, the myth of scale economics is put into serious question. But one should not assume this is a lean and mean bank with no geographic coverage.
While the company has only 70 employees, it has nine branches. One of the reasons for the stunning efficiency ratio is the company's primarily commercial business. Also it practices wise pricing and credit underwriting, and has a fairly large average loan size. The average loan at the Royal Bank of Pennsylvania is over $100,000. The bank is just starting to make consumer loans, while outsourcing the operation's back office.
"Given your track record and tremendous success with the commercial market, why move into the consumer market?" I asked.
"We believe we can do so without any additional expense," says Tabas. "We try to outsource as much as we can. We do plan to add other services, including a brokerage service, but we already have the office, somebody who answers the phone, and can add the service without any overhead."
Lee Tabas's philosophy is simple. "Every business has to analyze what its strengths are and to try to match those with the customer base. We like to look at everything during the credit underwriting process, and want to make sure that we can take the time to know our customers."
That seems to have worked extremely well. In its worst year, 1990, nonperforming loans soared, and Royal made $2 million. Tabas points to achieving a good yield on earning assets, as well as some tax-free municipal bonds that the company still has on the books, and some RTC loans that worked out well.
"Why do people bank with you?" I asked.
"We give people access to senior management, and that is perceived as valuable. In addition, we have our own personal investment in the bank, so it gives it a sense of stability and commitment," says Tabas.
"You seem to be satisfied with your current asset size," I said. "Is size important?"
"Size is important to some extent," says Tabas. "Because of the enforcement of rules and regulations, compliance is more important and more time-consuming. Size helps address that issue."
Royal recently signed an agreement to acquire a $100 million-asset private bank.
"It will take us a while to digest it," says Tabas, "but we expect to continue to grow if that works out well. There is a lot more to do in our market area."
With a net interest margin of more than 600 basis points, is that possible? Yes, says Tabas.
"People are not charging what loans are worth these days. We charge a fair rate, and we make more money because of our low overhead. We expect margins to get thinner, and we need to find new ways to do additional business without adding cost to maintain our income level. We can do so by outsourcing certain functions, and adding services which will not add overhead. We'll do the marketing, someone else will do the back office."
The Royal Bank of Pennsylvania is an excellent example of how to run small community bank profitably. While the challenges facing community banks are increasing, and their profitability is no longer unquestionably higher than that of larger institutions, banks like Royal lead the way in demonstrating how to achieve superior profitability without economies of scale.
Ms. Bird is chairman and CEO of Finexc Group LLC, New York, and editor in chief of The Community Banker, a quarterly journal.
