Ranks of Tiny Banks Shrinking as Challenges Mount

It's not easy being the smallest kid on the block, which is something the country's tiniest community banks understand.

Banks, especially those with just tens of millions of assets, are facing mounting challenges. Regulation and compliance have become more complicated and costly. Succession planning can be tricky and lending limits can make it tough to serve some customers, particularly farmers.

Still, many tiny community banks continue to fight to remain independent, often getting creative to address these challenges. Others see the value in economies of scale, opting to sell.

"We're choking the life out of community banking," says David Dickinson, president of Banker's Compliance Consulting. "The regulatory burden is so great we are seeing many mergers."

There were 2,118 U.S. banks with less than $100 million of assets at Sept. 30, down from more than 3,000 at the end of 2008, according to the Federal Deposit Insurance Corp. Last year, roughly a third of the industry's 230 mergers involved sellers with less than $100 million of assets, according to Keefe, Bruyette & Woods.

Regulatory costs are likely the biggest issue for tiny banks, industry experts say. To be sure, all banks are struggling with regulation. But smaller banks are often ill-equipped to hire a full-time compliance officer. Instead, they must use outside vendors to help them understand and implement new rules.

"There are no magic bullets out there," says Jeffrey Gerrish, chairman of Gerrish McCreary Smith Consultants. "Banks are not only worried about the cost of regulation but also the potential of making a mistake."

Changes to mortgages, such as the qualified-mortgage rule and new disclosures that go into effect in August 2015, are particularly worrisome, Dickinson says. Though there are exceptions for small lenders, some community banks are still electing to exit the business entirely, he says.

There are thousands of pages of new regulations, so "how are small banks supposed to read all of that?" Dickinson says. "Small banks … don't have a full-time compliance officer to read through all of that and keep the bank open."

The $72.5 million-asset Bank of Bennington in Nebraska uses a "committee approach" where different senior executives are put in charge of digesting and implementing new regulation, says Leslie Andersen, the bank's chief executive. The bank ran the idea of using a committee for compliance matters by regulators who said "it sounded like a good idea for a bank our size," she says.

"Getting ready to be compliant with all of the new regulation is the hottest fire right now," Andersen adds. "If our executives are becoming experts on regulations ... they aren't out making loans or helping our community."

Compliance is taking a toll on succession planning, making it more difficult for the smallest banks, especially those in remote markets, industry experts say. Compliance is often viewed as one of the hardest areas to fill at small, rural banks, Dickinson says.

"As compliance gets more complicated it's hard to find someone who has gone away to college with" compliance expertise, says Bob Wray, president and chief executive of Capital Corporation. "The kids of the guy running the bank used to want to take over … but now they grow up, go to college and move away. So when dad retires there's no one to take over the bank."

Some smaller banks, especially those that primarily serve farmers, are also dealing with lending limits. The price of farmland has soared in the last decade, causing a rise in borrowers' needs. As "the family farm goes away, the borrowing needs of the local customer go beyond the capability of the local bank," Wray adds.

"Some of the agricultural credits now exceed the lending limits of many" smaller banks, says Douglas Duey, former owner of the $16 million-asset Eagle State Bank in Eagle, Neb., and the $51 million-asset Cass County Bank in Plattsmouth, Neb. "It's not uncommon for good tillable farmland to sell for $9,000 to $10,000 per acre, so a purchase of farmland can require a substantial lending limit."

All of these factors are forcing more banks to consider selling.

Duey says he sold his banks because he didn't have a successor. It was important to him to find buyers that were concerned about the community and understood the needs of small towns.

"That was No. 1 for me — that they would address the needs of the community," Duey says. "These are banks that my family had owned for so many years and I had hoped that the tradition of community service would continue."

There are banks that are interested in buying smaller institutions with $30 million to $60 million in assets, Wray says. Often the biggest hurdle involves addressing regulatory concerns about a bank having too much control over a market, he says.

Banks can solve this problem by completing a concentration study, which usually shows that customers in that particular geography have access to other financial institutions and products beyond brick and mortar, Wray says. There are also exceptions to concentration rules if the county's population is small enough.

Bankers should also be willing to discuss their findings with regulators before making a deal public, Wray says.

Banks with a solid agricultural portfolio are attractive takeover targets, says Robert Edelman, president of Edelman & Co. "There is clearly an appreciation for good loans," he says.

"Ag is considered a good place to be," Edelman adds. "There are people who are actively interested in ag even out of what would normally be considered their core market or adjacent areas. People are willing to take a bit of a geographic leap for it."

Bank of Bennington, a unit of BBIG Holdings, is hoping to grow through an acquisition, Andersen says. The bank would like to diversify its loan portfolio by buying a bank focused on agriculture in a nearby market.

"The ag economy has been going gangbusters," Andersen says. "We know how to make ag loans and are very comfortable in a small-town environment."

With the number of tiny banks decreasing, some people are concerned that certain communities will be left without a financial institution that can meet their needs. Community banks are required to ensure a thriving local economy and provide loans to those looking to start small businesses. For instance, Dickinson says he would have never been able to start his consulting business without receiving a loan and guidance from his local bank more than 20 years ago. Now he employs a dozen people.

"Community banks are the heart and souls of their communities," Andersen says. "If you drive through a thriving community, especially a rural area, I guarantee you there is a thriving bank."