Banks Can Weather Highs, Lows to Deliver Sound Returns

There are two types of high-performing community banks.

Some can be counted on to provide consistent returns, while others ride the highs and lows of the economic cycle and customer demand. This year's list of top performers, based on a three-year average of return on equity, has a balance of both types.

Investors typically prefer consistently high returns, though occasional swings in performance aren't necessarily a cause for concern.

"Not all income statements are created equal," said Doug Schaller, president of Schaller Equity Partners in Winston-Salem, N.C. "You can see a lot of strange stuff."

A handful of high-performing banks reported annual returns that swung by double-digit margins, influenced by investment in technology or dramatic shifts in loan demand.

Investors want to know if a change in return on equity is "truly a one-off" or symptomatic of a longer-term trend, Schaller said. "It's all about looking at the financial statements on an individual basis," he added.

Federal Savings Bank in Chicago, the highest-performing community bank from 2012 to 2014, generated an average return on equity of 46% over that period, based on data compiled by Capital Performance Group. But the $216 million-asset bank's annual returns were erratic: 114% in 2012, 9.3% in 2013 and 15.6% last year.

Federal Savings' business model differs from most, if not all, of the other institutions on Capital Performance's list. The bank is primarily a mortgage lender that makes most of its revenue from selling originations. It has a national lending platform and partners with other community banks to make loans.

Federal Savings' return on equity plunged because of sizeable technology investments, including upgrades to the bank's loan-origination and cybersecurity systems, said Chairman and Chief Executive Steve Calk. "We made significant capital investments primarily in infrastructure, and that involved hiring and technology," Calk said.

The investments were designed to support Federal Savings' future growth, Calk said. The bank in March bought the $76 million-asset Baytree National Bank, which operated in Chicago's northern suburbs. Federal Savings is also making plans to expand into new business lines, including insurance services.

Calk, along with his brother John, acquired Federal Savings in 2011 as part of a rare bank foreclosure in Kansas. The brothers recapitalized the bank and relocated it to Chicago. The move was aided by commitments from the City of Chicago, which promised tax incentives — and $10,000 for each employee the bank hired.

The No. 4 bank on the list, Main Street Bank in Bingham Farms, Mich., also reported a large variation in returns. The $176 million-asset bank's three-year return on equity was 25%. The annual returns were 42.7% in 2012, 18.1% in 2013 and 14.7% last year.

Stagnant regional growth was responsible for the decline, said Jeff Kopelman, Main Street's president and chief executive.

Main Street experienced a temporary surge in loan demand in 2012, after the Detroit auto industry began to recover from the financial crisis. But originations since declined, as the housing market has cooled down.

"In 2012, the residential housing market in this area recovered dramatically," Kopelman said. "Our residential mortgage operation took off."

Main Street's noninterest income more than doubled in 2012, to $12.7 million, compared to $5.1 million a year earlier, mostly from higher mortgage banking revenue. Fee income has fallen steadily since then, to $9.1 million in 2014, as the demand for mortgages has subsided.

"It was phenomenal," Kopelman said, describing the temporary spike in lending. "In 2013 and 2014, [originations] came down some, because the market wasn't quite as strong."