With six veteran loan officers out hustling, Mercantile Bank of Western Michigan has had no trouble finding customers in Grand Rapids prosperous small-business community.
The trouble has been finding enough money to lend to them. Demand has outstripped the 3-year-old banks ability to fund its loans with local deposits. And because most of its loans are commercial, it cannot borrow from the Federal Home Loan Bank System. So Mercantile has turned to deposit brokers.
Our local deposits have been growing, but they havent been able to keep pace with our loan growth, said Michael Price, president and chief executive officer of Mercantile Bank Corp., the banks holding company. In the quarterly report filed Aug. 11 with the Securities and Exchange Commission, Mercantile reported that 66% of its $362 million of deposits came from outside its market, primarily through deposit brokers.
Mercantile is hardly the only bank relying on broker deposits. According to the Federal Deposit Insurance Corp., brokered de-posits totaled $141 billion on June 30, twice the year-earlier total, and 4.3% of all bank deposits, up from 2.2%.
Most of that money has gone to large institutions and credit card banks, but community banks are using their share. At banks with less than $1 billion of assets, brokered deposits totaled $12.8 billion on June 30, up 35% from 1999 and 106% since 1997.
The reason for the bump is simple: With more and more money flowing into stocks and mutual funds, it is hard to attract deposits.
The whole industry is having trouble funding itself, said Tom McGrath, managing partner at Bank Earnings International in Orange, Va. This has been going on for decades, but it is finally catching up with the industry.
But broker deposits can be controversial. First National Bank of Keystone, W.Va., for example, funded much of its rapid growth with brokered deposits and failed last year.
If that was the only way to grow the bank, then Id lean toward not growing the bank, Mr. McGrath said.
Brokered money generally comes in the form of certificates of deposit and because investors are looking for high interest rates, brokered deposits are more expensive than locally generated deposits.
It is a tradeoff that Mr. Price and Gerald Johnson Jr., Mercantiles chairman, are willing to accept. If you do things right, it is a very acceptable way of doing business, Mr. Price said.
Mercantile has amassed assets of $440 million, including $368 million of commercial loans. Despite its rapid growth, asset quality has remained good. During the first six months of 2000 it charged off just 0.02% of loans significantly less than the 0.30% average for with $300 million to $500 million of assets, according to the FDIC.
Our business plan called for rapid growth, but we had to grow with good assets, said Mr. Price. We could not afford to put nonperforming assets on our books.
Mercantile also became profitable more quickly than most community banks. After losing $133,000 in 1997 and $951,000 in 1998, it reported net income of $2.5 million for 1999 and $1.8 million for the first six months of 2000.
Mercantiles management is so confident of its business plan that it is beginning to look for banks to buy. In a recent SEC filing, the company reported that it has held discussions with several unnamed institutions. Mr. Price, 43, said he thinks Mercantile can eventually extend its franchise statewide and throughout the Midwest.
Still, if asset quality problems do crop up, broker deposits are going to pack up and head for the door, said Mr. McGrath. From a traditional banking standpoint, its a fundamentally flawed way to run a bank.
Such skepticism stems from the role that broker deposits played in the savings and loan debacle of the late 1980s. Arthur Wilmarth, a professor at George Washington University Law School, said the funds were used as vacuuming devices to direct money into savings and loans, which used the money to fund questionable development projects or buy junk bonds.
The practice did play a significant role in funneling money to high-risk thrifts, said Mr. Wilmarth.
In 1989, Congress passed a law that allowed only well-capitalized banks to buy broker deposits.
Regulators are not raising any red flags, but they are keeping a close watch on the increased use of broker deposits. The concern, said FDIC spokesman David Barr, is that banks could easily lose the funds if depositors found better rates elsewhere.
There are more safeguards in place today to help protect the system from the ups and downs of broker deposits, said Mr. Barr. But because of what happened in the 1980s, its always in the back of [regulators] minds.
Bert Ely of Ely & Associates, an Alexandria, Va., consulting firm, said it would be a mistake to link broker deposits with bad banking practices. As he sees it, they can be an important source of funding for small banks that do not have ready access to the capital markets.
They can represent a way to get funding without distorting the local deposit market by bidding up rates, Mr. Ely said. To me, brokered deposits are no different than deposits you might get over the Web or from newspaper ads, in that you are drawing in funds from outside your market. That is not necessarily a bad thing.
Even Mr. McGrath, a determined foe of brokered deposits in principle, conceded that he could not argue with the Grand Rapids banks success.
If these guys are making money, they are pretty good, he said. The typical bank doesnt make any money for three years.
Alan Kline contributed to this story.