2017 National Survey of Community Banks: Presentation of Results Michael Stevens and Andrew Meyer October 5, 2017 Conference of State Banks Supervisors and Federal Reserve Bank of St. Louis. The views expressed do not necessarily represent those of the Federal Reserve Bank of St. Louis or the Federal Reserve System.

Small Business Lending Appreciating Relationship Lending

Small Business Lending as a % of Total Lending by Asset Group Anyway you look at it, banks that the states supervise play an outsized role in small business lending: --26% of the total loans at banks with <1B are SBL loans --55% of the total small business loans come from state chartered banks. --44% of total small business loans come from banks that satisfy the FDIC CB definition

Fig. 2: Bankers’ Definitions of Small Business Loans

Fig. 8: Percentage of Small Business Loans Made Due to Prior Banking Relationships

Fig. 9: Importance of Potential Future Relationship to Lending Decisions

The Fundamentals are Important to Lending to Small Businesses The Basics of Credit % Very Important or Important Financial Statements 97 Credit Score of the Business Owner 85 Business Assets Business Conditions 74 Prior Lending Relationship 60 Prior Deposit Relationship 49 Credit Score of the Business 34

Small Business Lending is Secured the Old Fashioned Way Lending Practice % Always or Usually Backed by business collateral 95 Backed by other collateral / guarantees 46 Backed by business owner’s collateral 40

Fig. 17: Frequency of Small Business Loans Backed by the Small Business Administration

What bankers say about small business lending - Positive Regional banks are primary competitors, but products are more rigid Community banks accommodate customers who don’t “fit in a box”

What bankers say about small business lending - Negative SBA takes too long and is too cumbersome Larger banks able to take risk without SBA Too many dollars chasing too few deals Competition is leading to concessions, increasing risk CFPB’s data collection potential rule (DFA 1071)

Competitive Pressure Concession % Always or Usually Interest Rates 20 Fees 16 Extending Maturities 6 Collateral 3

Fig. 31: Greatest Source of Current Competition: Small Business Loans

Fig. 32: Greatest Source of Future Competition: Small Business Loans

Mergers & Acquisitions Activity and Drivers

M&A 2017 2016 2015 Received an offer 11% 10% Made an offer 19% 20% 22%

Drivers for Considering an Offer Reason % Very Important or Important Inability to Achieve Economies of Scale 70 Regulatory Costs 85 Succession Issues 33

Drivers for Making an Offer Reason % Very Important or Important Entry into New Market 66 Expansion within Current Market 64 Exploit Underutilized Potential 52 Talent Acquisition 25

Perspectives on Consolidation 1,444 fewer banks in last five years; 20% less Most common competitor for a community bank is other community banks Consolidation creates “a void where individuals and small businesses will appreciate the services a community bank can provide”

Succession Planning: The Community Bank Case Study Competition Succession planning – internal hires vs. external recruiting Rotational programs  Board composition – Diversity is key  Academic outreach – Case Study Competition  The small bank advantage – attracting talent “Historically, people who were on community bank boards were large customers or ‘who’s who’ in the community or in the market and the movement is much more to skills – so ‘Who’s the financial expert? Who has an understanding of cyber? Who has an understanding of emerging technologies?’ That is an indication of what you’re looking for. It’s really the skills and the background.”

Supervision & Regulation Ongoing Challenges

The smaller the bank, the greater the average compliance costs as a percentage of noninterest expense:

Fig. 28: Greatest Challenge from TILA-RESPA Integrated Disclosure (TRID)

Fig. 30: Percentage of Compliance Costs Due to Specific Regulations

Bankers & Regulation: BSA “…as many BSA staff as lenders” Time consuming…number of dead ends from automated systems is high One more area that requires auditing

Bankers & Regulation: TILA-RESPA “…stranded with children, pets, and a van full of furniture.” “Absolutely exhausting” Fundamentally changing the relationship model Turned a simple transaction into a complicated and standardized product making it harder to differentiate from larger banks Difficult to explain delays to customers Impacting credit availability

Bankers & Regulation: But wait there’s more Current Expected Credit Loss (CECL) HMDA style reporting for small business loans (DFA 1071)

The Double-Edged Sword Technology The Double-Edged Sword

Bankers & Technology: Downside Strong competitive pressure from other banks and non-bank lenders Increasing costs Increased regulatory expectations over IT Significant risk to deploying the wrong solution Balancing staying competitive with safety

Bankers & Technology: Upside Partnership opportunities with FinTech firms has extraordinary potential Creates acquisition opportunities as small firms cannot keep up Do not have to lead, but better follow quickly

Banks & Technology: The 2018 Case Study Competition Understanding how banks are using technology within day-to-day operations. Technology utilization to meet local needs for products and services Effect of technology on customer relationships Technology adoption as part of strategic planning Management’s short and long-term goals Third party technology vendors Integration of vendors in risk management process Emerging trends with third party vendors to expand business lines and streamline processes