The Future of Community Banks: Lessons from Banks that Thrived during the Recent Financial Crisis The views expressed are not the official positions of the Federal Reserve Bank of St. Louis or the Federal Reserve System. Alton Gilbert, Andrew Meyer, and James Fuchs

To investigate what we can learn about the viability of the community bank business model from the operation of banks that maintained strong performance in recent years. The community banks that will be successful in the future will likely have characteristics similar to those of the community banks that performed well during the recent financial crisis and its aftermath. Our objective: 2 Our thesis:

Identifying thriving community banks Banks in domestic banking organizations with total assets less than $10 billion Maintained a composite CAMELS rating of “1” during the years 2006 through 2011  We tested the robustness of a variety of other measures (such as SR-SABR ratings) but settled on CAMELS ratings because they are easy to explain and provide the best measure of a supervisor’s view of a bank’s overall health Two-pronged approach  Quantitative analysis of the differences between thriving and surviving banks  Qualitative analysis of how the thriving banks maintained their good performance 3

Conclusions About the Future of Community Banks The performance of the thriving banks provides support for the view that there is a future for community banks in the U.S. financial system. The banks that prosper will be ones with strong commitments to maintaining risk control standards in all economic environments. Each community bank must develop a business plan that works in its market. There is no one- size-fits all strategy. 4

Geographic Location of the Thriving Community Banks Located in 40 of 50 states Some in states with sharpest declines in economic activity and banking conditions (for example, 4 in Michigan and 5 in Georgia)  Many banks in states with relatively strong economic growth failed or became problem banks in years Observation: Well-run banks are able to “thrive” in spite of adverse local economic conditions. 5

6 State-by-state percentages of thriving banks ranged from 0% to more than 40%

Asset Size of all Thriving Community Banks in the Nation Number of Assetsthriving banks $1 to $10 billion 36 $300 million to $1 billion101 $100 to $300 million268 $50 to $100 million158 Up to $50 million139 Total702 7

Selected Means for Thriving versus Surviving Banks 8 AttributeU.S. Community Banks Thriving (702) Surviving (4,525)Signif. Under $100MM in Assets50.5%39.6%*** In an MSA57.7%67.5%*** Total Loans / Total Assets54.4%65.0%*** Commercial RE / TL23.3%34.4%*** Const. & Land Development / TL4.6%8.3%*** Nonfarm Nonresidential / TL17.4%23.8%*** Multifamily / TL1.0%1.9%*** Farmland-Secured / TL11.4%7.8%*** 1-4 Family-Secured / TL24.4%23.8%*** HELOC / TL1.2%2.5%*** C&I / TL13.7%14.4%*** Consumer / TL10.5%7.6%*** Agricultural / TL14.1%8.2%*** All Other Loans / TL1.2%0.9%*** Core Deposits / Total Dep83.0%80.7%*** Three stars indicate statistical significance at the 1% level. Means of all quarterly ratios from 2006:Q1 to 2011:Q4.

Percentage of Thriving Banks in Lower and Upper 25% among Peer Banks Percentage of AssetsLowerUpper Interest income Interest expense Noninterest income Noninterest expense Pre-tax income Tier 1 capital

Phone Interviews with Leaders of Thriving Banks Interviewed leaders of 28 thriving banks headquartered in 19 states Asked nine questions aimed at understanding how they were able to maintain strong performance during a period of financial crisis and major recession followed by slow economic growth 10

From Phone Interviews: Main Factors That Led to Good Performance Sound policies in place before the crisis, rather than actions taken during the crisis Maintained conservative lending principles (good collateral, cash flow, etc.) Did not vary lending standards even as competitors were relaxing them In the right place at the right time (e.g. benefitted from strong agricultural or energy sector). Did their own loan underwriting and aggressively followed up on nonperforming loans 11

Conclusions from Phone Interviews All of the leaders of the thriving banks interviewed stressed conservative lending practices. Many emphasized the roles of their management teams and board members. The business plans of the banks interviewed appear to be very diverse. Each thriving bank appears to have found a business plan that works in its market. 12

R. Alton Gilbert and David C. Wheelock “Big Banks in Small Places: Are Community Banks Being Driving Out of Rural Markets” Federal Reserve Bank of St. Louis Review (May/June 2013) 13

14 Bank Size Average Deposit Shares in All Rural Counties

15 Average Deposit Shares in All Rural Counties A. States that Permitted Branching in 1980B. States that Did Not Permit Branching in 1980