View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

Fall 2010

Central

N e w s a n d V i e w s f o r E i g h t h D i s t r i ct B a n k e r s

F e at u r e d i n t h i s i s s u e : After Financial Reform | 2Q 2010 State-by-State Call Reports Breakdown

The Changing Landscape of
Community Banking
Number of Commercial Banks and Thrifts in the U.S.
4Q 1979 – 1Q 2010

20000
18000
16000
14000
12000
10000
8000
6000
4000

2009

2007

2005

2003

2001

1999

1997

1995

1993

1991

1989

1987

1985

0

1983

2000
1981

T

he U.S. banking industry is unique
among the world’s industrialized
nations as it consists of thousands of
small banks in rural and urban communities. Due to the balance of power
that exists between the federal and
state governments, the dual banking
system has remained in place despite
numerous challenges to its existence
over the years. Restrictive branching
laws and the rural population base of
many states fostered the creation of
an extensive network of community
banks in the more than 155 years of
the dual banking system. In some
ways, though, the shape of the banking industry today still reflects some
legacy effect from an era where vigorous competition was restricted and
bank charters swelled, attesting to the
strength of the dual banking model.
The three-decade trend of industry
consolidation, much involving community banks, has naturally drawn the
attention of the industry and policymakers to the viability of the community bank business model. Today’s
community banks exist in an environment where competition is intense
and financial innovation has stripped
away much of a bank’s cost advantages
in acquiring funds and its revenue
advantages on assets. Other contributing factors include the urbanization of
population growth and the higher cost
of regulation. As illustrated in Chart 1,

Chart 1

1979

By Gary Corner

SOURCE: Call Reports. Commercial banks include industrial banks and co-op banks.
Thrifts include federal savings banks, saving and loan associations and savings banks.

over the past 30 years the number of
bank and thrift charters has declined
by 58 percent, a loss of more than
11,000 institutions. During this period
(as in many others throughout history), the demise of the community
bank business model has been prognosticated by many.
Indeed, over the last decade, some
4,000 community bank-sized organizations have merged, failed or outgrown
their community bank status. However, during this same period about
continued on Page 8

T h e F e d e r a l R e s e r v e B a n k o f St . L o u i s : C e n t r a l t o A m e r i c a ’ s Ec o n o m y ®

|

stlouisfed.org

Central View
News and Views for Eighth District Bankers

Vol. 20 | No. 3
www.stlouisfed.org/publications/cb
Editor

Scott Kelly
314-444-8593
scott.b.kelly@stls.frb.org
Central Banker is published quarterly by the
Public Affairs department of the Federal
Reserve Bank of St. Louis. Views expressed
are not necessarily official opinions of the
Federal Reserve System or the Federal
Reserve Bank of St. Louis.
Sign up for Central Banker e-mail notices at
www.stlouisfed.org/publications/cb/. Follow
the Fed on Facebook, Twitter and more at
stlouisfed.org/followthefed.
To subscribe for free to Central Banker or
any St. Louis Fed publication, go online to
www.stlouisfed.org/publications/subscribe.cfm.
To subscribe by mail, send your name, address,
city, state and ZIP code to: Central Banker,
P.O. Box 442, St. Louis, MO 63166-0442.
The Eighth Federal Reserve District includes
all of Arkansas, eastern Missouri, southern
Illinois and Indiana, western Kentucky and
Tennessee, and northern Mississippi. The
Eighth District offices are in Little Rock,
Louisville, Memphis and St. Louis.

After Financial Reform:
The Road Beyond
By James Bullard

T

he Dodd-Frank Wall Street Reform
and Consumer Protection Act is the
most sweeping change in the regulatory environment for the U.S. financial
sector since the Great Depression.
Proponents of the reforms envision
that the new law will address the root
causes of the financial crisis of 2007-8
and will reduce the likelihood of future
James Bullard
crises. Yet, with nearly 250 new rules
is president and
to be written and more than 65 studies
CEO of the Federal
to be completed, it is simply too early to
Reserve Bank of
know the full impact of the legislation.
St. Louis.
Some things are certain. The Act
establishes a new Bureau of Consumer
Financial Protection and a new Financial Stability Oversight Council; it also extends the supervisory authority of the Board of Governors to systemically
significant financial institutions. It creates an additional
orderly resolution authority for nonbank financial companies and abolishes the Office of Thrift Supervision.
The Bureau of Consumer Financial Protection is an independent bureau within the Federal Reserve System charged
with examining and enforcing consumer compliance laws
and regulations at the largest banks and credit unions. In
addition, it is to collect, monitor and respond to complaints
about consumer financial products or services as well as
provide guidance on consumer financial products to traditionally underserved communities and conduct research on
marketplace developments for consumer financial products.
Financial firms of all sizes, except auto dealers, are subject
to new regulations written by this Bureau.
Less clear is the outcome of new rule-making authority. The Financial Stability Oversight Council and the
expanded supervisory authority of the Board will have the
most impact on the largest financial organizations, including banks with $50 billion or more in assets and nonbank
financial institutions deemed systemically significant. Some
provisions of the Act, such as a new FDIC assessment that
is based on bank assets rather than deposits, consumer
compliance examinations by existing federal banking regulators for smaller banks and credit unions, and the grandfathering of current holdings of trust-preferred securities
as capital likely will benefit or maintain the status quo for
small banks. However, the implementation of other regulatory authority granted to the Bureau of Consumer Financial
Protection has the potential to seriously affect the viability
of community banks.
The Dodd-Frank Act does not address the resolution of
Fannie Mae and Freddie Mac, the two government-sponcontinued on Page 11

2 | Central Banker www.stlouisfed.org

Q u a r t e r ly R e p o r t

More Signs of Improvement for
District, Peer Banks
By Michelle Neely

A

lthough profitability at District
banks dipped slightly in the
second quarter, evidence continues to
mount that banking conditions here
and throughout the country are stabilizing. Return on average assets (ROA)
at District banks fell 4 basis points
to 0.53 percent in the second quarter
(see table), but was substantially above
its year-ago level of 0.19 percent. For
U.S. peer banks—banks with assets
of less than $15 billion—ROA actually
increased 6 basis points to 0.28 percent
in the second quarter. One year ago,
peer banks as a group lost money
and posted an average of ROA of
-0.33 percent.
The profit picture was brighter at
smaller institutions. ROA rose 3 basis
points to 0.79 percent at District banks
with assets of less than $1 billion, and
rose 2 basis points to 0.41 percent at
U.S. peers of the same size.
At District banks, the net interest margin (NIM) was essentially
unchanged in the second quarter at
3.78 percent, making it a nonfactor for
the drop in ROA; net income declined
because of increases in net noninterest
expenses and loan loss provisions. For
U.S. peers, net income received a boost
from two sources: higher net interest
income and lower loan loss provisions.
The NIM at these banks rose 7 basis
points to 3.84 percent, while the loan
loss provision ratio fell 7 basis points.
The most notable result for both
sets of banks in the second quarter is
the decline in nonperforming loans,
the first quarterly dip since mid-2008
for District banks and the first reduction since 2006 for U.S. peer banks.
Nonperforming loans as a percent of
total loans fell 11 basis points to 2.98
percent at District banks in the second
quarter. The drop was twice as large
at U.S. peer banks, where the nonperforming loan ratio declined 24 basis
points to 4.01 percent. In the District,
the declines in nonperforming loans

Progress, Not Perfection1
2Q 2009

1Q 2010

2Q 2010

Return on Average Assets 2

District Banks

0.57%

0.53%

-0.33

0.19%

0.22

0.28

District Banks

3.66

3.77

3.78

U.S. Peer Banks

3.57

3.77

3.84

District Banks

0.95

0.77

0.83

U.S. Peer Banks

1.52

1.14

1.07

U.S. Peer Banks
Net Interest Margin

Loan Loss Provision Ratio

Nonperforming Loan Ratio

3

District Banks

2.44

3.09

2.98

U.S. Peer Banks

3.78

4.25

4.01

SOURCE: Reports of Condition and Income for Insured Commercial Banks
NOTES:

1

Because all District banks but one have assets of less than $15 billion, banks larger
than $15 billion have been excluded from the analysis.

2

All earnings ratios are annualized and use year-to-date average assets or average
earning assets in the denominator.

3

Nonperforming loans are those 90 days or more past due or in nonaccrual status.

all came from the real estate portfolio,
as nonperforming loans fell for one-tofour family, multifamily and construction and land development loans. The
improvement was more broad-based
at U.S. peers: Nonperforming rates
dropped in the consumer, commercial
and industrial, and real estate categories.
While the rise in loan loss provisions
hurt the bottom line somewhat at District banks, it halted the long lasting
slide in the average loan loss reserves
coverage ratio. The ratio of loan loss
reserves to nonperforming loans rose
341 basis points to 65.88 percent in the
District, meaning about 66 cents was
reserved for every dollar of nonperforming loans. Just two years ago,
District banks had almost 90 cents
set aside for every dollar of nonperforming loans. The coverage ratio at
U.S. peer banks also increased in the
second quarter, but remains below the
District average at 55.94 percent.
continued on Page 5
Central Banker Fall 2010 | 3

Ec o n o m i c F o c u s

Bernanke Discusses Findings of 40
Small-Business Lending Meetings
T

he summer issue of Central Banker
discussed a series of nationwide
Fed meetings, including several in
the Eighth District where community
leaders explored small-business lending problems. In mid-July, Federal
Reserve Chairman Ben Bernanke
related preliminary findings from the
40 meetings that began in February.
Speaking at a July 12 conference
in Washington, D.C., to address the
financing needs of small businesses,
Bernanke noted that credit conditions
remain difficult for small businesses.
According to Call Report data for 1Q
2010, loans to small businesses have
decreased by more than $40 billion
since 2Q 2008 ($710 billion down to
$670 billion). Difficult to determine
is how much the reduction has been
driven by weaker demand for loans
from small businesses, deterioration
in the financial condition of small
businesses during the economic
downturn and/or restricted credit
availability, he said.
Bernanke addressed an oftenexpressed concern that bank examiners have prevented banks from making
good loans. “We take this issue very
seriously. The Federal Reserve has
worked assiduously with the other
banking regulators to develop interagency policy statements on this issue,
aimed at both banks and examiners.
Our message is clear: Consistent with
maintaining appropriately prudent
standards, lenders should do all they
can to meet the needs of creditworthy
borrowers,” he said.
“Doing so is good for the borrower,
good for the lender, and good for our
economy. To ensure that this message is being heard and acted upon,
we have conducted extensive training
programs for our bank examiners as
well as outreach with bankers, and we
will continue to seek feedback from
bankers and borrowers,” he said.
Bernanke acknowledged that more
can be done, and that the insights
gained from meeting with small
business owners, lenders, community
4 | Central Banker www.stlouisfed.org

leaders and others has given the Fed a
“more nuanced understanding of the
problem.” Said Bernanke, “Not surprisingly, these meetings confirmed
that facilitating small business financing is not a simple or straightforward
matter. Notably, the term ‘small
business’ encompasses a heterogeneous mix of enterprises, ranging from
pizzerias to start-up technology firms,
and each small business faces a unique
combination of local economic conditions and complex relationships with
customers, suppliers and creditors.
Hence, we should be wary of one-sizefits-all solutions.”
Among the common themes raised
during the meetings were:
• Declining value of real estate and
other collateral securing their loans
poses a particularly severe challenge.
• Business owners cited credit lines
and working capital as their most
critical financial needs, followed
by refinancing products that would
permit them to take advantage of
low interest rates.
• Many owners resort to borrowing
through their personal credit cards
or from their retirement accounts.
Several mentioned the need for
small-value loans in amounts less
than $200,000 as well as the need
for “patient capital” from investors
willing to commit funds for 5 to
10 years without an expectation
of immediate returns.
• Some lenders said that current lending conditions don’t represent credit
tightening as much as a return to
more traditional underwriting standards following a period of too-lax
standards.
Though some lenders said they were
emphasizing cash flow and relying
less on collateral values in evaluating
creditworthiness, some creditworthy
businesses—including some whose
collateral has lost value but whose
cash flows remain strong—have had
difficulty obtaining the credit that they

Eighth District Bank Data 2Q 20101
Compiled by Daigo Gubo

need to expand, and in some cases,
even to continue operating.
“The challenge ahead for lenders
will be to determine how to assess
the credit quality of businesses in
an uncertain and difficult economic
environment,” Bernanke said. “It is
in lenders’ interest, after all, to lend
to creditworthy borrowers; ultimately,
that’s how they earn their profits.
Regulators, for their part, need to
continue to work with lenders to help
them do all that they prudently can to
meet the needs of creditworthy small
businesses.”

2Q 2009

1Q 2010

-0.36%

2Q 2010

Return on Average Assets 2

All Eighth District States

0.33%

0.41%

0.66

0.89

0.79

Illinois Banks

-0.95

-0.08

0.21

Indiana Banks

-0.62

0.22

0.40

Kentucky Banks

0.76

1.07

0.96

Arkansas Banks

Mississippi Banks

0.35

0.48

0.52

Missouri Banks

-0.33

0.37

0.28

Tennessee Banks

-0.66

0.35

0.31

3.45

3.66

3.72

Net Interest Margin

All Eighth District States
Arkansas Banks

3.97

3.96

4.07

Illinois Banks

3.09

3.48

3.61

>> M o r e O n li n e

Indiana Banks

3.55

3.74

3.75

Bernanke’s speech
www.federalreserve.gov/newsevents/speech/bernanke20100712a.
htm

Kentucky Banks

3.93

4.23

4.09

Mississippi Banks

3.81

3.88

3.87

Missouri Banks

3.30

3.35

3.41

Tennessee Banks

3.64

3.72

3.77

Loan Loss Provision Ratio

Eighth District small-business
lending meetings
www.stlouisfed.org/publications/
cb/articles/?id=1969

All Eighth District States

1.39

0.92

0.93

Arkansas Banks

0.75

0.64

0.75

Illinois Banks

1.92

1.30

1.22

Demographics of small-business
lending
www.stlouisfed.org/publications/
cb/articles/?id=1933
More Signs of Improvement for
District, Peer Banks
continued from Page 3

Capital ratios also rose at both sets
of banks in the second quarter. The
average tier 1 leverage ratio increased
13 basis points to 8.96 percent at District banks, and 16 basis points to 9.28
percent at U.S. peer banks. As with the
earnings ratios, coverage ratios and capital ratios remain higher at banks with
average assets of less than $1 billion.

Indiana Banks

1.47

1.01

0.94

Kentucky Banks

0.52

0.52

0.53

Mississippi Banks

0.80

0.79

0.79

Missouri Banks

1.31

0.74

0.87

Tennessee Banks

1.52

0.73

0.81

3.96

3.92

3.79

Nonperforming Loan Ratio3

All Eighth District States
Arkansas Banks

2.40

3.03

2.92

Illinois Banks

6.46

5.35

5.20

Indiana Banks

2.95

3.14

3.21

Kentucky Banks

1.97

2.44

2.42

Mississippi Banks

1.87

2.58

2.77

Missouri Banks

3.15

4.16

3.76

Tennessee Banks

2.99

3.16

3.10

SOURCE: Reports of Condition and Income for Insured Commercial Banks
NOTES:

1

Because all District banks but one have assets of less than $15 billion, banks
larger than $15 billion have been excluded from the analysis.

2

All earnings ratios are annualized and use year-to-date average assets or average
earning assets in the denominator.

3

Nonperforming loans are those 90 days or more past due or in nonaccrual status.

Michelle Neely is an economist at the Federal
Reserve Bank of St. Louis.
Central Banker Fall 2010 | 5

In Depth

Arkansas Community Banker Leaders
Discuss the State of Their Industry
R

ecently, Robert Hopkins, senior
branch executive of the St. Louis
Fed’s Little Rock Branch, talked with
Richard Trammell and Cole Martin
regarding the state of community
banking in Arkansas today following
the July 21 passage of the Dodd-Frank
Wall Street Reform and Consumer
Protection Act. Trammell is the executive director of Arkansas Community
Bankers (ACB), which represents 134
state-chartered banks in Arkansas.
Martin is chairman and CEO of First
Security Bank of Clarksville, Ark.,
a $105 million asset bank, which is
part of a $4 billion holding company.
Martin currently serves as president
of ACB.
Robert Hopkins: How do you define a
community bank in 2010?
Richard Trammell: From ACB’s standpoint it is any bank chartered in
Arkansas that gathers deposits locally,
makes loans locally and makes decisions locally, which in essence defines
most banks in Arkansas today.
Hopkins: How does the U.S. benefit
from having a dual banking system in
2010 and beyond?
Cole Martin: From my perspective, it
provides banks, and ultimately their
customers, balanced and improved
choices. During the financial reform
debates, I was concerned that we
would move away from that and end
up with one super regulator. I’m
pleased we did not end up there. I
think that would not have served the
country well.

Act in meeting the administration’s
goal of ensuring we never have a
recurrence of the recent financial
crisis?
Martin: Our primary position all along
has been that community banks do
not need any new regulations; we did
not create the problems that led to the
crisis and therefore do not need more
regulatory burden. Having said that,
and knowing that reforms were going
to take place, we fought successfully
for a number of things.
Trammell: I don’t think we can answer
that question yet. The first phase was
putting a new regulatory framework
in place; Congress and the president did that with the passage of the
Dodd-Frank Act. The next phase will
be the federal regulators interpreting the intent of the Act’s provisions
and crafting regulations for financial
institutions and others to follow. So, it
is too soon to judge if this piece of legislation ensures their overarching goal
is met. I will say, because they did not
address Fannie Mae and Freddie Mac,
it is doubtful that this legislation alone
will prohibit a recurrence of a similar
crisis.
Hopkins: Some believe that community
banks fared well and were in fact winners as a result of the Dodd-Frank Act.
Do you share that view?

Trammel: The state banking regulators are locally situated and are in a
better position to assess what is going
on in local markets, pick up on issues
or problems earlier and help banks
address them before they become serious problems.

Martin: We went in to the reform
debate determined to mitigate the
impact on community banks, which
did not cause the recent crisis. From
ACB’s perspective, I think we were
largely successful. From a single
community-bank perspective, that’s
less clear to me. Smaller community
banks cannot afford any more regulatory burden, and we are bound to get
more regulation as result of the DoddFrank Act.

Hopkins: What are your overall
impressions of the final Dodd-Frank

Trammel: We focused on the amendment process, knowing that new

6 | Central Banker www.stlouisfed.org

legislation would likely pass. So, we
worked toward getting reforms that
would be beneficial to community
banks. In this context, I think you
can say we had some wins. One of
the positives is an asset-based deposit
insurance process; no longer are the
assessments based on just deposits.
So, community banks will be paying a proportionally smaller share
than in the past. This is fair. We also
now have a resolution framework
to unwind so-called too-big-to-fail
institutions. And they are now going
to regulate non-bank entities (e.g., payday lenders), which has never occurred
before and will level the competitive
playing field for community banks.
Hopkins: How do you see the Act
impacting community bank profitability and customers?
Trammel: It’s certainly going to make it
more difficult when you layer additional cost on for regulatory compliance. Depending on the magnitude,
we may see an acceleration of community banks merging to get the
economies of scale to handle the added
regulatory burden and compete with
larger financial competitors.
Martin: I agree that there will be more
regulatory burden and associated
costs. From a customer perspective,
they likely will see more inconvenience and more paperwork and, perhaps, higher debit/credit interchange
fees and generally higher prices. The
question will be how much the community banks can pass along the
added cost from new regulations to the
consumer. That is, can they remain
competitive while passing on additional cost? That remains to be seen.
Hopkins: How do you see existing community bank business models changing as a result of the Dodd-Frank Act?
Trammel: I recently asked a number
of the ACB board members what they
see as the “new normal.” Four things
emerged: tighter loan underwriting,
less aggressive deposit gathering,
balance sheet and margins shrinking, and increased regulatory burden.
I’m not sure that translates into a new
business model for community bankers, but these are the changes they see
for the foreseeable future.

see following the passage of the DoddFrank Act?
Martin: Until we see the specific new
regulations, I don’t think we know
what new products and services will
result. We will see a continued conservative mindset for the near future.
Hopkins: How do the community banks
you represent see the economic recovery unfolding?
Trammel: Arkansas just recently begun
to feel the effects of the recession. So,
I see slow growth ahead for awhile
longer. This downturn, while severe,
will end and we will see solid growth.
We just need to have more clarity from
the changes recently enacted, which
will build confidence in business and
their customers.
Martin: I think we are in a period of
stagnant growth for awhile. There is
a lot of waiting and watching for signs
of improvement. There is so much
uncertainty related to the Dodd-Frank
Act and the recently passed healthcare
legislation that, for example, banks
and their commercial customers are on
hold until they gain a clearer picture
of the business environment and the
impact from these sweeping but as yet
undefined legislative changes.
Hopkins: Looking out 10 years, what
does the environment look like for
community bankers?
Trammel: My crystal ball is not that
clear. I still think there will always be
a need and opportunity for community banks and bankers because the
small communities across this country depend on them. I think we will
see more community banks merging
going forward in order to gain scale
and remain competitive. Community
bankers have been creative, innovative and resilient. They will figure out
a way to deal with change and do so
profitably.

>> M o r e O n li n e

Current state of the banking
industry
www.stlouisfed.org/publications/
cb/articles/?id=1963

Hopkins: What changes to community
banks’ products and services do you

Central Banker Fall 2010 | 7

The Changing Landscape
of Community Banking
continued from Page 1

one-third have been replaced by a new
(de novo) bank charter. Further, since
the onset of the financial crisis in 2007,
we’ve seen more than 276 banks fail;
220 of them (or 80 percent) were community banks. By most estimates, this
episode of bank failures is not over,
and it is expected that we will see an
even further decline in the number
of community banks in the U.S. in the
next few years.
So, what do these numbers imply
for the future of community banking?
To begin answering this question, it’s
important to first define what is meant
by the term “community bank.” Typically a community bank conducts its
business within a limited geographic
area, is primarily retail-funded and
has its decision makers locally based.
A high level of personal service is
another trait of a community bank.
Commonly, banks under $1 billion in
assets possess most of these characteristics; thus, for simplification, $1
billion or less in assets is considered
our proxy of a community bank for the
purpose of this analysis.

Down but Not Out
As a percentage of industry charters,
community banks still represent 92
percent of all charters, but this is down
from 96 percent a decade ago. And
within our definition of a community
bank, those with assets of $500 million
or less outnumber banks with between
$500 million and $1 billion in assets
by a ratio of 10 to 1. As a portion of
industry assets, the declining trend is
more pronounced: Over the last ten
years, community bank assets have
grown rather modestly and lagged
overall economic growth. By comparison, the nominal compound annual
growth rate of aggregate community
bank assets is 1.75 percent, compared
with the nominal compound annual
growth rate of the overall economy of
3.9 percent. While community banks
hold a seemingly impressive $1.5 trillion of assets, this is only 10 percent of
industry assets today, as highlighted
in Chart 2. A decade ago, community
banks represented 18 percent of industry assets.

8 | Central Banker www.stlouisfed.org

Community banks have traditionally
been an important provider of credit to
small businesses. During the financial
crisis, banks with less than $1 billion
in total assets generally maintained
their small-business loan volumes (as
a percentage of total loans) compared
with larger banks. For example, from
June 30, 2009, to June 30, 2010, small
banks on average saw virtually no
change in their ratio of small-business
loans to total loans (24.85 percent
to 24.86 percent) while larger banks
experienced a decline (7.02 percent
to 6.63 percent). Small businesses
arguably foster economic growth, and
thus, their ability to find credit today
and in the future is of consequence.
Community banks have a comparative advantage in providing credit to
small businesses, particularly in their
ability to properly assess “informationally opaque” borrowers due to their
knowledge of local conditions. Their
focus on relationship-based lending
prevents borrowers without histories suitable for credit-scored lending
models from being completely cut out
of the credit markets. This advantage
is mutually beneficial.
An examination of Call Report data
shows that the loss experience and
yields on commercial and industrial
(C&I) loans at community banks outperform those experienced at larger
banks. For example, C&I yields for
banks with less than $1 billion in total
assets was 6.25 percent as of June 30,
2010, while yields at banks with more
than $1 billion in total assets was 4.36
percent. While this is in line with
what one would expect since community banks are dealing with more
“opaque” borrowers (and should be
able to achieve higher yields as a
result), it is interesting that C&I loss
rates for smaller banks were 1.32
percent as of June 30, 2010, while loss
rates at the larger institutions were
1.96 percent. During the most recent
recession, we’ve again seen how
important relationship lending continues to be for many small businesses.
For well-run and efficient small banks
throughout the U.S., there will arguably always be a demand for their
products and services as the need for
credit cannot solely be allocated based
on “hard credit data.”

Current Challenges Facing
Community Banks
Despite continued demand for the
products and services offered by
community banks, technology and
regulatory costs and standardized loan
products have hurt their market share
and profitability. Because community
banks lack scale, technology and regulatory costs are spread across a smaller
customer base. Also, standardized
consumer, small-business and mortgage loans programs offered by larger
market participants are less profitable
in the low-scale community bank environment. Over the past decade, these
factors have contributed to community
banks seeking revenue in other more
risky asset classes, such as commercial real estate loans. A look at the
material loss reviews of failed banks
(issued by their respective agency
inspector general offices during this
current episode of bank failures) suggests that CRE (commercial real estate)
concentrations developed and proved
disastrous for many community banks
during the economic downturn.
So, how does the community bank
model thrive? The most direct
approach is to drive more efficiency
into core business lines. This strategy
has the advantage of staying within
a community bank’s proven areas of
expertise. According to a 2007 study
by St. Louis Fed, the most important
driver of high earnings in small banks
is control of operating expenses, followed by a high ratio of good quality
and attractively yielding loans-toassets. Of less importance is the percentage of core deposits.
A less proven strategy is to seek out
new strategic businesses and sources
of revenue. As with any new risk-taking endeavor, however, a risk management process should be in place to
provide proper oversight. And finally,
economic conditions matter. Stagnant
local economic conditions and low
population growth test the viability of
the community bank business model.
Under such conditions, community
banks may experience returns, which
are less than their cost of capital. In
some instances, finding a merger partner may be the best alternative.
Financial innovation over the last 30
years has changed the complexion of
banking. Made possible by advances

Chart 2

Community Banks/U.S. Banks Ratio
96

20

95.57

18
95

18.20

16
14

94

12

10.32

93

10

Community Banks Count/U.S. Banks Count (left axis)
Community Banks Total Assets/U.S. Banks Total Assets (right axis)

92.33

92

8
6
4

91

2
90
1999

0
2000

2001 2002

2003

2004

2005

2006

2007

2008

2009

2010

SOURCE: Call Reports

in technology, innovations such as
money market mutual funds, junk
bonds, commercial paper, securitizations and the development of a shadow
banking system, have provided a
greater array of nonbank alternatives
to consumers and the direct access to
the capital markets for many commercial firms. Over time, this has changed
the revenue and funding structure of
all banks. However, for some community banks, the costs and risks to adapt
to these changes were too high. Many
found strategic partners.
Community banks that exist today
have evolved in many ways—some
by reducing operating costs, others
by finding new sources of revenues.
While opportunities will always exist
for well-run and efficient community
banks, many still need to evolve. As the
banking industry continues to adjust
from the fallout of the financial crisis, it
seems likely that some of the consolidation currently taking place will continue
for at least the next few years.
Gary Corner is a senior examiner at the Federal Reserve Bank of St. Louis. The author
thanks Daigo Gubo, research associate in the
Supervisory Policy and Risk Analysis Unit,
for contributing to this article.

Central Banker Fall 2010 | 9

Dodd-Frank Act Changes Begin

A

t this point, federal regulatory agencies are
anticipating nearly 250 new regulatory rules
called for in the Dodd-Frank Wall Street Reform
and Consumer Protection Act. Some of the
changes already underway include the following.

Discount Window Lending Rules Permit Disclosure of Depository Institution Information
According to provisions in the Act, the Federal
Reserve has altered disclosure of discount window lending information. The Fed will now publicly disclose the following information, generally
about two years after a discount window loan is
extended to a depository institution:
• the name and identifying details of the
depository institution;
• the amount borrowed by the depository
institution;
• the interest rate paid by the depository
institution; and

Rulemaking Starts with Proposals on Alternatives
to Credit Ratings in Risk-Based Capital Guidelines
Federal agencies gave advanced notice Aug. 10
for proposed rulemaking regarding alternatives
to the use of credit ratings in the risk-based capital guidelines of the federal banking agencies.
The Act requires each agency to review 1) any
regulation issued by such an agency that requires
the use of an assessment of the credit-worthiness
of a security or money market instrument; and
2) any references to or requirements in such
regulations regarding credit ratings. In developing substitute standards of credit-worthiness,
agencies are supposed to establish, as feasible,
uniform standards of credit-worthiness for use
by the agency, taking into account the entities it
regulates that would be subject to such standards.
See the advance notice and comments instructions at http://federalreserve.gov/newsevents/
press/bcreg/bcreg20100810a1.pdf.

• information identifying the types and amounts
of collateral pledged in connection with any
discount window loan.
See more at www.frbdiscountwindow.org under
General Information > FAQs.

You Can Still Participate in Final CRA Public Hearings in September

T

he final of a series of Federal Reserve public
hearings on proposals to changing parts of
Regulation C, which implements the Community Reinvestment Act, will be held Sept. 15 at
the Federal Reserve Bank of Chicago and Sept.
24 at the Federal Reserve Board in Washington,
D.C. Even though these hearings are being held
far from the Eighth District, you or your officer
overseeing CRA can participate by submitting
comments and watching the hearings.
The four hearings (the previous two were held
July 15 at the Atlanta Fed and Aug. 5 at the San
Francisco Fed) have three objectives:
• Help the Board evaluate whether the 2002
Regulation C revisions that required lenders
to report mortgage pricing data have in fact
provided useful and accurate information about
the mortgage market.
• Provide information to help the Board assess
the need for additional data and other improvements.
• Identify emerging issues in the mortgage mar-

10 | Central Banker www.stlouisfed.org

ket that may warrant additional research.
See www.federalreserve.gov/communitydev/
hmda_hearings.htm for a list of specific topics.
All hearings include panel discussions by
invited speakers. Interested parties able to travel
to the hearings may deliver oral statements as
time permits. Written statements of any length
may be submitted for the record. Submit written
comments to:
• e-mail regs.comments@federalreserve.gov,
• call 202-452-3819 or 202-452-3102,
• follow the instructions at http://www.regulations.gov/search/Regs/home.html#home or
• mail them to Jennifer J. Johnson, Secretary,
Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue, N.W.,
Washington, D.C. 20551.
Please identify your comments by Docket
No.OP-1388. If e-mailing, include the docket
number in message’s subject line.

After Financial Reform:
The Road Beyond
continued from Page 2

sored enterprises that were placed into
government conservatorship nearly
two years ago and still hold or guarantee the majority of residential mortgage debt in the U.S. The Act does not
provide any limit on taxpayer support
for these institutions. How these
institutions are ultimately resolved
will have a significant impact on the
future of mortgage finance in the
U.S. Under the Act, the Treasury is
required to submit by January 31, 2011,
a report to Congress on options to end
the conservatorships.
While the aftermath of the regulatory reform debate has unleashed a
flurry of opinions and commentary on
the “winners” and “losers” from this
year-long process, I believe it is more
important to focus on how the new
environment affects incentives. Will
the new environment generate more
transparent financial contracts? Will
it successfully constrain the ability of
the managers of financial institutions
to engage in inappropriately risky
behavior? Will it end taxpayer bailouts of large institutions whose “bets”
turn out badly? Alternatively, will
it generate imaginative and successful efforts at regulatory avoidance?
The answers to these questions will
become apparent only with time. Only
then will we know if the Act reduces
the probability of a future financial
crisis.

Get the Latest on the New
Financial Reform Law
President Obama signed into law the Dodd-Frank Wall Street
Reform and Consumer Protection Act on July 21. Keep track of
the latest developments, and see what steps were taken toward
reform since March 2009, with the St. Louis Fed’s Reforming the
Nation’s Financial System web site at http://regtimeline.stlouisfed.
org/. You can also use the site to understand how the Act came
to be, using primary documents from Congressional hearings and
various speeches.
Other useful St. Louis Fed sites:
• Tracking the Global Recession (http://research.stlouisfed.
org/recession/) tracks the current economic environment
through easy-to-understand charts of monthly indicators,
such as employment, industrial production, retail sales and
real income; current GDP data breakdowns; data from other
countries; and more.
• The Financial Crisis (http://timeline.stlouisfed.org/) is
designed to help the public better understand the major
financial events and policy actions that the Fed has taken
since the crisis began in 2007.

>> M o r e O n li n e

Systemic risk and the financial
crisis: a primer
http://research.stlouisfed.org/
publications/review/09/09/part1/
Bullard.pdf
Bullard’s speeches, interviews
and papers
http://research.stlouisfed.org/
econ/bullard/index.html

Central Banker Fall 2010 | 11

FIRST-CLASS
US POSTAGE
PAID
PERMIT NO 444
ST LOUIS, MO

Central Banker Online
S e e t h e o n l i n e v e r s i o n o f t h e Fa l l 2 0 1 0 C e n t r a l
B a n k e r f o r m o r e i n s i g h t s, r e g u l ato ry s p otl i g h t s a n d F e d n e w s.

B AN K IN G RESEAR C H

F OR Y OUR STA F F

• Jump in Consumer Loans
Due to New Accounting
Standards

• Fed, International Banks
Cooperate on Remittance
Service to Latin America

• The Alt-A: The Forgotten
Segment of the Mortgage
Market

• Help Your Customers and
Community Avoid Loan
Modification Scams
• Test Access to the
Discount Window for
Contingency/Liquidity
Purposes
• Fed Now Authorized to
Offer Interest-Bearing
Term Deposits

>> O n ly O n l i n e

Read these features at www.stlouisfed.org/
publications/cb/

Reader Poll
What is the main concern for community
banks as the nation emerges from the financial crisis and Great Recession?
• Unusually high numbers of residential and
commercial real estate loan delinquencies
• Negative public perception toward
large banks, which unfairly stigmatizes
small banks
• High unemployment and low
consumer spending
• Effects of the recently passed
financial reforms
Take the poll at www.stlouisfed.org/publications/cb/. Results are not scientific and are
for informational purposes only.
In the summer issue’s poll, we asked
whether the new rules governing debit
cards and overdrafts will make you more
or less likely to use overdraft programs.
Based on 127 responses:
• 13 percent said they were more likely,
because they liked being able to opt in
to overdraft services for debit card and
ATM transactions.
• 15 percent said they were less likely,
because opting in could lead them
to overspend.
• 72 percent said that the new rules
won’t change their spending habits.

C E N T R A L B A N K E R | FA L L 2 0 1 0
https://www.stlouisfed.org/publications/central-banker/fall-2010/fed-banking-research

Fed Banking Research
Jump in Consumer Loans Due to New Accounting Standards
At first glance, the upward spike in consumer loans during March and April 2010 seems to suggest a dramatic
expansion in credit. The spike itself could be seen as a strong signal that banks have loosened credit
standards or originated more consumer loans in the wake of an improving economy.
While there have been improvements in consumer loans recently, the dramatic increases over the past few
months have been caused by a new reporting requirement issued by the Financial Accounting Standards
Board. Financial Accounting Statements 166 and 167 have implications for how banks treat off-balance-sheet
special purpose vehicles. Moreover, these statements have more impact in certain loan categories and on
certain bank types in particular. Read the whole article.

The Alt-A: The Forgotten Segment of the Mortgage Market
This St. Louis Fed study presents a brief overview of the Alt-A mortgage market with the goal of outlining broad
trends in the different borrower and mortgage characteristics of Alt-A market originations between 2000 and
2006. The paper also documents the default patterns of Alt-A mortgages in terms of the various borrower and
mortgage characteristics over this period.

Data from 2007-2010 Reveal Characteristics of Bank Failures
Economists investigate the characteristics of banks that failed and regional patterns in bank failure rates during
2007-2010 in the September/October 2010 Review, the St. Louis Fed’s economic research publication.
The article compares the recent experience with that of 1987-1992, when the U.S. last experienced a high
number of bank failures. As during 1987-1992 and prior episodes, bank failures during 2007-2010 were
concentrated in regions of the country that experienced the most serious distress in real estate markets and
the largest declines in economic activity. The authors found that although most legal restrictions ion branch
banking were eliminated in the 1990s, many banks continue to operate in a small number of markets and are
vulnerable to localized economic shocks.

C E N T R A L B A N K E R | FA L L 2 0 1 0
https://www.stlouisfed.org/publications/central-banker/fall-2010/for-your-staff

For Your Staff
Help Your Customers and Community Avoid Loan Modification
Scams
The St. Louis Fed and the attorneys general of Missouri and Illinois are among those supporting a nationwide
effort by NeighborWorks America to help homeowners avoid loan modification scams. This initiative is
designed to help homeowners in danger of or facing foreclosure protect themselves against loan modification
scams, find trusted sources of help, and identify and report scam activity.
In addition to the advice you already give your customers, you can direct them and community organizations to
www.loanscamalert.org, which contains various contact resources and the six red flags to look for in a scam.

Test Access to the Discount Window for Contingency/Liquidity
Purposes
The Federal Reserve Bank’s primary credit program, available through the discount window, may be a part of
your institution’s liquidity management or contingency plan. Institutions are encouraged to periodically test
their ability to borrow at the discount window to ensure that there are no unexpected impediments or
complications. If your institution already has the discount window in your plans, you can easily complete a test
by calling the Credit and Payment Risk Management Division at 1-866-666-8316 to request a small, one-day
loan.
If the discount window is not a part of your institution’s liquidity management or contingency plans and you are
interested in learning more about establishing a discount window relationship, including necessary
documentation and collateral requirements, call the number above. Additional information can also be found
on the discount window’s web site.

Fed Now Authorized to Offer Interest-Bearing Term Deposits
Reserve banks can now offer term deposits to eligible depository institutions, under a recent change to
Regulation D, Reserve Requirements of Depository Institutions.
The Federal Reserve Board has authorized up to five small-value offerings of term deposits under the Term
Deposit Facility to be conducted in coming months. Term deposits will be made available through an auctionbased TDF that will offer fixed quantities of term deposits for a specified maturity date to eligible institutions.
Term deposit auctions will generally include both a competitive auction and a noncompetitive tender option.

Fed, International Banks Cooperate on Remittance Service to Latin
America

Your bank’s account-holders can now transfer funds easily to an unbanked receiver in 11 Latin American
countries. The Federal Reserve is collaborating with Banco de México (The Central Bank of Mexico), Banco
Rendimento and the Microfinance International Corporation (MFIC) to offer this remittance service.
Funds can be transferred to a bank location or a trusted third-party provider. This “account-to-receiver” service
is an expansion of the Fed’s FedGlobalSM ACH Payments suite, which enables automated clearing house
transactions between the United States and Canada, Mexico, Europe and Latin America. This feature
dramatically improves the ability of U.S. depository financial institutions to enroll new customers who want to
send funds back home to family members without bank accounts. The Reserve Banks work directly with
Banco de México to provide the service to receivers in Mexico and with Banco Rendimento and MFIC to reach
receivers in 10 other countries.