All across America, big regionals are challenging community banks on their home turf. Here's how the story is unfolding in one mid-sized town in middle America, with the ending very much in doubt.

Fresh from Army service in Italy during World War II, Joseph Waugh Sr. returned to the Midwest dreaming the classic American dream: He hoped to start his own business, one that someday would also provide a living for his children and their families.

Intending to open a frozen food distributorship, Waugh went to the biggest bank in Peoria for financing, but was turned away. Waugh recalls that lenders there predicted he would be bankrupt within a year.

South Side Trust & Savings Bank, a much smaller operation headquartered a couple of miles from Peoria's bustling epicenter, took him on instead. Today, Waugh Frozen Foods is a prosperous business with 33 employees, including all three of Waugh's sons, two sons-in-law and his brother. "This never would have happened without the bank," Waugh says. "They've helped me when I needed it, and we've grown together. Without them, I wouldn't be here today."

Such is the stuff of loyalty. It is the reason why one customer will remain with a bank for decades and encourage his friends and business associates to bank there as well. It's safe to say that Joseph Waugh will continue to bank with South Side--no matter who moves into town offering what services. And it's a good thing, too, because lately there have been a lot of newcomers.

Within the past five years, First of America Corp., Banc One Corp., Commerce Bancshares, and Magna Bank have established significant operations in Peoria through acquisitions of local banks. And then there's a large Wisconsin-based thrift as well as one of the largest credit unions in the nation--Citizens Equity Federal Credit Union, a Caterpillar Co.-related organization that, with some $1.2 billion in assets, is actually the largest financial institution in town. (Bankers big and small contend that CEFCU offers unfair competition, and if they could change any one thing about Peoria's banking landscape, it would be to eliminate that credit union.)

Add all these contestants together and this central Illinois city becomes a viciously competitive banking market. But it is by no means an anomaly. The breakdown of regional barriers to interstate banking over the past few years has drastically changed the financial services landscape from the heartland to the outer banks. Thriving mid-sized cities like Peoria are especially attractive targets for expansion-minded institutions, and the same fierce battle being waged between community and regional banks there is occurring in countless other markets throughout the country.

With a metropolitan area population of 350,000, Peoria has put behind it a painful economic transition resulting from a crippling 18-month Caterpillar Co. strike a decade ago that highlighted the need to diversify. Though Caterpillar remains the area's largest employer by far, Peoria also boasts two medical centers of significant size, a small university, many small businesses and, of course, ties to the agricultural economy that surrounds it.

What was not so long ago the comfortable domain of the local banker is now a magnet for bigger banks looking to tap into the local prosperity. "It is exactly the kind of area we are looking to move into. It will continue to be a growth area, and the work ethic is outstanding," says Peter W. Callow, CEO of $345-million-assets Commerce Bank in Peoria. Kansas City, MO-based Commerce bought First National Bank of Peoria, which had one of the oldest banking charters in the country, in 1992.

Interstate banking is already a fact of life in most areas of the country. Congressional approval of full nationwide banking will only heighten this wallet-share battle between big outsiders that say they can offer more, and the community banks that say they care more.

The ability of community banks to survive--much less grow and prosper--in the face of this onslaught is questionable. What community banks are counting on most is the loyalty of Waugh and others like him, as they struggle to offer services comparable to those offered by their bigger competitors.

For now, community banks are holding their own, even benefiting in some cases from market shake-ups that open a window for luring new customers. But long-term, can they compete?

It is the future that clearly worries bankers like Robert L. Denton, president of South Side Trust. "Short-term, it's been easy competing with the big banks," he says. "But what will happen to community banks in the long run remains to be seen."

As banking becomes more dependent on technology to provide convenience to customers, Denton is well aware that small banks have limited technology budgets. "We're really dependent on service bureaus," he says. Ditto on marketing dollars. "We might be offering the same product or service that the big banks offer, but they have big resources to promote what they're doing," he adds. And if community bankers can no longer compete in Peoria, they won't survive in most other markets, either.

Seizing the Opportunity

For now, Denton is making hay while the sun shines. South Side has enjoyed phenomenal growth in the past decade, to $240 million in assets today from only $85 million in 1985. The bank opened two new branches last year, including one across the street from Bank One in the center of town, bringing its total locations to seven.

(Illinois' branch banking laws have been so restrictive that it was only last year that South Side was allowed to open a branch downtown, less than 20 blocks from its headquarters. Notably absent in Peoria are the large Chicago banks, which still are not allowed to expand downstate.)

Though it has acquired some smaller institutions, much of South Side's growth has come at the expense of the larger banks. Denton has capitalized on its reputation as a home-grown bank to lure a significant amount of trust business, for instance. "The downtown banks all had big trust operations, and when big outside banks took over, they moved management of the assets to their headquarters out of state. A lot of people didn't like that, and we picked up that business," he says. "In 1990, we had only $10 million in trust assets. Today we have $100 million."

Denton believes South Side also has an advantage in pricing and product decisions, in that it can revamp or reprice a product with a quick meeting of a handful of people. Loan underwriting judgments, too, can be made quickly, though the bank might have to seek the participation of correspondent banks for big loans.

Above all, Denton and bankers like him feel that the community bank's biggest edge is in its ability to maintain close, long-term relationships with customers like Waugh. The community bank is still a place "where you can be greeted by name, and that's important to many people," he contends.

Adds Steve Backlund, assistant to the chairman (his father, B. F. "Chip" Backlund) of a group of seven banks in central Illinois that total some $215 million in assets, and whose holding company is headquartered in Peoria: "It's the thing of being a big fish in a little pond, of feeling that someone is taking care of you personally."

Playing this edge for all it's worth, Morton Community Bank appears almost frenetic in the promotion of itself as "the hometown bank." Nowhere is the contrast between big and small in Peoria more apparent than with a glance at the physical differences in two representative institutions: Morton and Bank One, Peoria.

On a corner in the heart of town, Bank One last fall unveiled a new lobby that could easily be located in Manhattan or in Chicago's Loop. Teller operations are subtle, but customers can't miss the personal investment center and other "boutiques" offering various financial services. It is designed to let customers know that every possible banking service is available here, and it is one slick operation.

Just across the Illinois River, Morton Community Bank is tucked behind the McDonald's restaurant at the town of Morton's one interstate highway exit. There is evidence everywhere that MCB's main marketing thrust is its hometown personality, from the signage outside to the pencils, recipe books, jar openers and many other giveaways that also carry the credo. Even the bank's conference room is lined with Norman Rockwell lithographs.

Two days each month, coinciding with the arrival of Social Security checks, MCB offers free coffee and donuts to its senior customers. (Bank One offers no such goodies, but it will allow a certificate of deposit customer to waive interest on a CD for one year in exchange for a free airline ticket in a deal the bank worked out with American Airlines.)

The Morton bank's chairman and CEO, Gordon D. Honegger, and his wife Jean Ann, senior vice president, own 25% of the bank's stock, and other employees own another 25%. "This is truly a ma and pa bank," she says. He adds: "If there was such a thing as a general practitioner in banking, we'd be one."

With $185 million in assets, the bank has three locations other than its headquarters, and it draws its customer base from the community of some 15,000 people. Many of the bank's customers are seniors, enticed by a number of special services the bank offers them, such as sponsored trips and free checking.

Morton has two big advantages over larger competitors, Honegger contends. One is that it is responsive to the needs of individual customers. "If I have a business customer call me for a $300,000 loan, I can tell him right on the phone yes or no." The other advantage is that he and his wife know most of their customers personally, though that is getting harder as the bank grows.

Big Lessons from Small Banks

The Honeggers insist that its hometown roots will keep MCB a viable competitor, that being a "local" bank will continue to be a strong selling point.

South Side's Denton, for one, isn't so sure the local angle will play in Peoria forever. "As time goes on, the situation will settle down, and customers will get to know them like they know us," he says. "NationsBank, for instance, is considered a community bank in many areas now. The advantage to being a hometown bank could begin to disappear."

That's exactly what the big banks are counting on, in Peoria and in other parts of the country where similar market share battles are going on. Big banks already offer a wider array of products and services than do their smaller competitors, both on a retail and commercial basis. Bank One, Peoria, for example, "can just pick products off the shelf of the corporation to offer our customers, whatever meets their needs best," says chairman Stuart Brown Jr. "The local bank is not a product originator or manufacturer. We already have them available to us; we act as sales agents to match them with our customers' needs."

The challenge for the big banks is to offer products and services in the same personal way that community banks have always done. And the fact that the big bank chief executives are keenly aware of this does not bode well for community banks.

"The key to success is the bank's personnel. They have to be able to develop personal relationships with retail, commercial and trust customers," says Robert T. Stevenson Jr., president of First of America in Peoria, the area's largest commercial bank with just over $1 billion in assets. Adds Brown: "What we have to do is out-local the locals."

If the edge community banks have is their ability to personalize banking services, the problem that big banks must overcome is the perception that they can't do so.

"The perception that doing business with a bank that isn't locally owned is somehow different can really work against you," concedes Stevenson. But in reality, the only difference is that the big bank can offer more, he adds.

Indeed, there are a number of myths associated with the situation that occurs when big banks buy into local markets, and one is that "outsiders" then control the banking environment. Though community bankers often insist that these outsiders don't know local customers' needs as well as they do, the truth is that there are really few outsiders brought in. When First of America, the first big out-of-state bank to enter the Peoria market, bought Commercial National Bank of Peoria in 1989, FoA retained most employees.

Likewise at Bank One, Peoria, which was the former Jefferson Bank, the third-largest commercial bank in the market behind FoA and Commerce. The new chairman came from Bank One in Bloomington, an hour's drive away, where his former community bank had been acquired by Banc One a couple of years earlier. At Commerce, only the chairman was replaced, and he was retiring anyway.How They Stack Up Bank Assets ROE ROA Equity/Assets ($ mil.) First of America 1,022 17.52% 1.25% 7.15%Commerce Bank 345 10.28% 1.27% 12.35%Bank One, Peoria 264 14.49% 1.24% 8.56%South Side Trust 241 12.68% 0.93% 7.40%Morton Community 179 14.77% 0.88% 6.98% Year-end 1993 data

The chief executives of the local operations owned by big out-of-state banks are, in reality, usually community bankers themselves. And the banks they run are generally closer in size to the local banks than to the holding companies they represent. Bank One, Peoria, for example, has only $23 million more in assets than South Side Trust.

Calling the Shots

Embedded in the outsider myth is that idea that the big bank lenders can't make decisions on their own, that some anonymous pooh-bah in Columbus or Kalamazoo is calling the shots. Usually, that's not true.

Though Banc One does require its affiliate banks to offer a certain group of core products, such as checking accounts and CDs, most are chosen off the vast Banc One shelf by local executives. Even the required core products reflect local pricing decisions.

Only when a single loan runs into double-digit-millions must officers at local FoA, Bank One and Commerce units call headquarters. But those loans aren't too frequent.

Another myth attached to the invasion of big banks into small towns is that deposits will flow to the bank holding company's headquarters. In reality, the big banks have loan-to-deposit ratios as high--and many times, higher--than the community banks. Bank One, Peoria, for example, has a loan-to-deposit ratio of 88%, the highest of any bank in that area, as well as an outstanding Community Reinvestment Act rating.

When you combine the broad array of products and services that big banks like FoA and Banc One can provide to their local affiliates (backed by the latest technology) with the ability to price and tailor products locally, it paints a grim picture of the community bank's long-term future. "There's certainly a place for community banks, but that place is probably in pursuing niche strategies," says Dan Daly, chairman of Magna Bank in Peoria, which last year took over the $220-million-assets Community Banks of Greater Peoria.

The outlook for community banks is perhaps better in areas smaller than Peoria, where economic conditions can't support the kind of growth big banks seek. "You've got thousands of small banks in towns of 1,000 to 15,000 in population that probably will be able to sustain double-digit growth, because the big banks don't feel that moving in there would be worthwhile," adds Daly. But if the only way that institutions like South Side Trust can survive is at banking's fringe, then they will be reduced to a marginal role.

Meanwhile, the battle for Peoria continues. "Nobody's folding their tent and moving away," says Brown. "We're all here to stay--at least for now."

Where They Bank and Why

Ask Peorians to identify their bank and explain why they do business there and you'll discover two basic reasons that have surprisingly little to do with superior service. Instead, inertia and loyalty rule the day, even after their once-independent bank has been acquired. That's good news for community bankers--as long as they retain those customers.

Ray Heffron, Catepillar painter: "I bank with First of America, because I used to bank with Commercial Bank and I never moved anything when they took over." He said he also has accounts with Citizens Equity Federal Credit Union.

James Maynard, retired military: "Bank One, because I used to bank with Jefferson Bank and they bought it. They do OK, so I've stayed there."

Louise Romans, Catepillar crankshaft grinder: "I moved everything from the credit union to First of America. Their service is very good, and I've had no problems." Romans expressed strong dislike for the credit union because she says it repossessed her car when she was laid off from work for a time a few years ago. She said she feels it is unfair that the credit union allows strikers to delay payments on loans, but not employees who are laid off. To her, fairness is an important characteristic from a financial institution.

Barbara Griffith, Central Illinois Light Co. employee: "I bank at South Side and with the credit union. I worked for South Side for a time right out of high school, so I still have accounts there."

Sherry and Ray Russell, an income tax preparer and a city fire inspector, respectively: "We used to bank at Jefferson Bank, but when Bank One bought it, we moved our business to South Side, because it is a locally owned bank," he said. "I like keeping my money at home."

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.