Community banks are more than holding their own in the face of heavier competition for small-business loans from large banks and even credit unions.
Dozens of community banks reported record fourth-quarter earnings, which many attributed to rising demand for commercial and industrial loans. Where large banks' commercial loan growth was relatively flat, many small ones checked in with double-digit gains, and analysts expect more of the same for the first half of 2005.
There are exceptions, of course, since a number of banks paid hefty prepayment penalties as they repositioned their balance sheets or took charges to account for declines in their preferred Fannie Mae and Freddie Mac stock.
A big challenge small banks will face is attracting enough deposits to fund loan growth. Business-oriented banks are generally not repricing deposits as fast as they are loans, and though that means a widening of net interest margins, there are signs that depositors are beginning to move their money out of these banks to get higher yields.
Still, Christopher Marinac, an analyst with FIG Partners LLC in Atlanta, said year-over-year loan growth was surprisingly strong in the fourth quarter - about 11% on average for the community banks he follows.
He attributed the gains to an improving economy and aggressive marketing.
"Community banks continue to take away C&I and commercial real estate loans from large banks," Mr. Marinac said. "And in this environment there is a lot of activity in the small-business and middle-market arena, and many community banks are seeing relatively healthy volumes there."
CoBiz Inc. of Denver reported that its loans grew 18%, to $1.1 billion, in the fourth quarter. Though CoBiz' Arizona operations are benefiting from that state's red-hot economy, Colorado's economy is just regaining momentum.
Joseph K. Morford of Royal Bank of Canada's RBC Capital Markets in San Francisco said that any loan growth CoBiz is experiencing in its home state is mainly due to its wresting market share from others.
The $1.7 billion-asset CoBiz said its fourth-quarter earnings rose 38%, to $5.3 million.
Mercantile Bank Corp. of Grand Rapids had no trouble adding loans in 2004, commercial or otherwise. In the first nine months of 2004 the $1.5 billion-asset company's commercial loan portfolio grew 15%, to $351 million. Mercantile reported a solid fourth quarter, too, finishing with $1.3 billion of loans, up 5% from the third quarter and 27% from a year earlier.
Gerald R. Johnson, Mercantile's chairman and chief executive officer said Mercantile is seeing more intense competition for small-business loans from money-center and regonal banks such as Fifth Third Bancorp of Cincinnati, J.P. Morgan Chase & Co. in New York and Cleveland-based National City Corp., but is not ceding any ground. In fact, he said, it gained market share in the last year.
"I think over the past year or two, the big banks have gotten a little tired of banks like us picking away at their business," Mr. Johnson said. "They've gotten very aggressive, but we haven't lost many loans to them."
In the Pacific Northwest, where the economy is finally ramping back up, "everybody is posting 15%-20% annualized growth rates," said James Bradshaw, an analyst at D.A. Davidson & Co. in Portland, Ore.
Loan growth for the $1 billion-asset Cascade Bancorp of Bend, Ore., was particularly impressive: 46.6% for the year, to $859.6 million. Cascade benefited from the economy in its hometown and its entry into Portland and southern Oregon markets. Its fourth-quarter earnings rose a record 29.6% for the quarter, to $4.6 million, and rose 14.7% for the year, to $16 million.
Mr. Bradshaw said it is no big surprise that banks in his region had better fourth-quarter numbers than other banks "We're just showing better percentage growth, because we've had lower numbers to grow from," he said. "We had more of a recession than other parts of the country."
Mr. Marinac said loan growth is also increasing in areas of the Southeast and the Middle Atlantic states.
Sandy Spring Bancorp of Olney, Md., operates in the Washington market, which has one of the strongest economies in the country. The $2.3 billion-asset company's average loan rose a whopping 24% compared with the fourth quarter of 2003. It credited the local economy and more demand from its small-business customers.
Analysts say most banks' margins have expanded because banks are repricing loans faster than deposits as interest rates rise. Mr. Morford said this trend is particularly evident at asset-sensitive community banking companies like the $6 billion-asset East West Bancorp in San Marino, Calif., whose margin rose 10 basis points, to 4.34%, from a year earlier.
John Pandtle, an analyst with Raymond James & Associates in St. Petersburg, Fla., said small banks have more loans to earning assets than large banks and have much fewer securities, so their margins have not been affected as much by the flat yield curve.
"Margins for larger banks have been disappointing relative to guidance," Mr. Pandtle said. "In general I saw more margin expansion and more volume with smaller banks." (See related story page 7.)
Whitney Holding Corp. of New Orleans said its fourth-quarter net interest margin was 4.63%, up 20 basis points from a year earlier. As a result the $8.1 billion-asset company's interest income rose 15%, to $86.3 million.
But analysts say banks' reluctance to reprice deposits has also resulted in slower core deposit growth.
Whitney is a case in point. Excluding deposits from merger completed in 2004, Whitney's 2004 deposit growth was essentially flat, at about 5.8%.
Mr. Marinac said that with the rise in interest rates, rate-sensitive customers will probably move their large deposits out of small, commercial banks, which are not known for offering choice rates.
"The issue is how banks will fund loan growth," Mr. Marinac said. "My feeling is that deposits are becoming more and more of a challenge."
Fee income was less of factor in the fourth quarter than in previous ones.
Jefferson Harralson, an analyst with Keefe, Bruyette & Woods Inc. in New York, said fees on deposit accounts, which had been driving bank earnings in the last year, are starting to level off.
"Free-checking programs lead to bounced-check and NSF fees, but the positive impacts of those programs are hitting their saturation points," Mr. Harralson said.
Also, as refinancing has cooled, other companies, including the $1.2 billion-asset S.Y. Bancorp in Louisville, attributed lower noninterest income to lower mortgage banking fees. Noninterest income fell 3%, to $6.2 million, but interest income rose 4%, to $10.7 million, because of robust loan growth.
A number of banks that reported earnings declines cited balance-sheet repositioning to pay down debt.
Despite healthy loan growth, Sandy Spring reported a net loss of $5.7 million in the fourth quarter; it had net income of $6.8 million in the year-earlier period. The decline was due largely to prepayment penalties relating to the payoff of $195 million of Federal Home Loan Bank advances.
It was a similar story at the $2.2 billion-asset Midwest Banc Holdings Inc. in Melrose Park, Ill., which sold off $324 million of U.S. agency notes and corporate bonds and paid off $115 million in Home Loan Bank advances. The result: a 91% plunge in net income, to $512,000.
James J. Giancola, Midwest's president and chief executive, said in a press release issued Friday, "The fourth-quarter repositioning was painful from a short-term earnings perspective but absolutely necessary for our future."
Likewise, it was a tough quarter for banking companies holding preferred stock in Fannie Mae and Freddie Mac.
The $517 million-asset Riverview Bancorp Inc. of Vancouver, Wash., took an $890,000 charge, or 18 cents per diluted share, in the three months that ended Dec. 31 (its fiscal third quarter) to account for losses on Fannie and Freddie preferred stock it sold.
The companies taking the charge say they are using a conservative interpretation of rules on how companies should account for securities trading below their purchase price. The preferred stock's value has fallen in the wake of accounting troubles at the two mortgage giants.
Ronald Wysaske, Riverview's president and chief operating officer, said "the value will probably return, but we couldn't stomach the volatility anymore."
Todd Spranger, the Chicago financial institutions practice leader for the consulting firm Grant Thornton LLP, said banking companies must take the charge on the securities if they cannot prove that the market price will return to the purchase price in a specific time frame. Since the banks do not have the evidence to show when the prices on Fannie and Freddie secured stock will go back up, he said, they are taking their charges now.
This will not affect most banks' daily operations, but some banks' capital ratings could slip because of the charge, Mr. Spranger said.
John Reosti, Laura Thompson Osuri, Ben Jackson, and Katie Kuehner-Hebert reported this story.
