COMMENTARY
True Va;ue Hardware or Ace Hardware are collaborative efforts that combine the buying power of a big organization with the comfoprt and services of a local business.

What is proposed here is something different ... an emerging structure so that small organizations can participate in a few big transactions that are more profitable ... money profitable, that is ... then their traditional basic business.

Does this really add anything to the performance of society as a whole ... and I cannot see how it does. In my view, the grouping of community banks into bigger combines to cartelise has little or nothing to do with serving the unmet needs of the 'Main Street' economy.

In the old industrialized economies high productivity enabled profitable business while paying high wages ... but globalization has made it possible to have higher profitability by swapping out high wages in the local economy with lower wages offshore in low wage nations. Now there is a high level of unemployment in the old industrialized economies which is very different from anything that has
Peter Burgess

Think True Value — but for banks

In a city where special-interest pleading and finger-pointing has been developed to a high art form, there are no bigger whiners than the community banks. When they’re not complaining about excessive regulation, misguided monetary policy and inflated deposit insurance premiums, they’re railing against unfair competition from big banks, savings and loans, credit unions, credit card companies, finance companies and other unregulated lenders.

Considering this mountain of injustice that has been heaped upon them, it’s a wonder these bankers are able to get out of bed in the morning, let alone show up smiling at the weekly Rotary luncheon.

The latest woe to befall community bankers, of course, has been the collapse of the housing and commercial real estate markets, which hit particularly hard since that is where they’ve put the vast majority of their money over the past 15 years. But who can blame them? After all, much of their consumer lending business has been stolen away by bigger and more efficient lenders who have easy access to cheaper funding through Wall Street and the “shadow” banking system. In the process, many had become addicted to the higher yields offered by asset-backed securities and loans to local home builders, developers and land speculators.

Now, with their balance sheet weighed down by under-performing real estate loans and underwater securities, community banks find themselves in something of a pickle. New regulations that limit the fees they can charge depositors for things such as debit card transactions, overdrafts and ATM withdrawals threaten to dramatically reduce their fee income.

A relatively flat yield-curve has reduced the “spread” between the interest they pay to depositors and the interest they can charge borrowers. And although they still have money to lend, many now find they have lost the expertise, risk appetite and customer relationships to make to small- and medium-size firms in sectors other than real estate.

A couple of Washington financiers have come up with a clever answer to their prayers. One is Lee Sachs, a former Treasury Department official in the Clinton and Obama administrations. The other is John Delaney, the just-nominated Democratic candidate for Congress from western Maryland and founder of CapitalSource, a commercial lender based in Chevy Chase. Their new venture, BancAlliance, is a cooperative of community banks that aims to make loans to mid-sized and large businesses that none of its members has the size, expertise or risk appetite to make on their own.

After one year, BancAlliance has signed up 44 banks with collective assets of $40 billion and closed on about $100 million in loans. The goal over the next few years is to get to 200 banks with $200 billion in assets and a syndicated loan book of $10 billion. At that, the alliance would have the scale and scope of a super-regional bank, even as its members remain relatively small. Think of it as bringing to the banking business what True Value or Ace has brought to the hardware business.

With Delaney now mostly off campaigning for Congress, Sachs and a crew of about 25 professionals are at work in Chevy Chase looking for new banks and new loans to offer them. Their management company has already raised its own equity capital from outside investors, including BlackRock, Wall Street’s blue chip asset manager.

The equity will be used to warehouse loans before they are approved by the individual bank credit committees, as well as allowing the firm to take a 2 percent stake in every loan it syndicates through the alliance. The management company will charge a fee for evaluating potential loans and overseeing them once they are approved.

The alliance’s first loans have been pieces of larger loans originated by mega-financial institutions such as J.P. Morgan and GE Capital or the finance arm of industrial giants such as Caterpillar. In time, however, Sachs and Delaney hope the alliance can participate, with three or four other large banks, in what are known as “club” loans that are now out of the reach of community banks.

Member banks will turn to the alliance when they have a fast-growing customer who requires a loan too large or too complex for the bank to underwrite on its own.

“It’s a great equalizer,” explains John Lane, president of Congressional Bank based in Rockville, an early alliance member. (No surprise there: Delaney is a big shareholder).

This new model could also be a boon to growing mid-sized businesses, which are finding it difficult to borrow money at a time when banks have become pickier about the risks they are willing to take and less funding is flowing their way through the capital markets and the “shadow” banking system.

The consolidation of the banking business into a handful of megabanks has dramatically reduced the number of surviving regional banks that used to dominate mid-market lending based on the borrower’s cash flow, reputation and long-term relationship with the bank.

Although all the megabanks claim they are still doing this kind of lending, many do not. Decision-making has been centralized at bank headquarters, and many of the big banks focus their lending primarily on standardized loans collateralized with hard assets that can be processed through largely automated underwriting systems.

Given these market realities, the BancAlliance model looks like a no-brainer for community banks looking to move into this under-served market segment while reducing their dangerous over-reliance on real estate lending. Which raises the question of why BancAlliance, along with a similar syndication effort launched by the Ohio Bankers League, have attracted the interest of so few of the nation’s 7,000 smaller banks.

It could be that this new idea still needs to prove itself?

Or could it be — and I realize I’m being a tad cynical here — that rather than take a risk on a new business model, community bankers would prefer to keep whining about unfair competition and misguided regulation, at least until a decent buyout offer comes along?

Hold on a minute. It seems that what is described here is not a new paradigm for enabling community banks to become a source of funding to community businessmen/entrepeneurs but rather a scheme to wrest some business from the 'megabanks' by forming a cooperative of community banks which can act like a megabank.

A community banking cartel, if you will.

Mr. Perlstein raises an important issue about the long-term role of community banks. The challenge for CBs is to arrive at a defensible competitive advantage versus other lenders and providers of financial services. Mr. Perlstein's article does not explain buying participations in loan syndications is the solution. In these arrangements, the loan syndicator rather than the CB manages the customer relationship and possesses all the pricing power vis-a-vis the bank, which provides just a fraction of the the funding for the loan. CBs have seen this story before. Throughout the 1980s and 1990s, CBs purchased participations in nationally syndicated credit in Fortune 500 lines of credit. This line of business was not profitable, and it imposed significant credit risk to the CBs in the event the borrower drew on the line. For the CB, the situation then and now remains the same: when the CB is a small funder of a large syndicate, can a CB evaluate the credit risks of the borrower effectively manage the borrower relationship?

The durable long-term competitive advantage of CBs should flow from their local market knowledge and personal customer relationships, not from renting out their low-cost source of funding. It's worth asking if CBs wouldn't be in a stronger market position if they found these mid-size commercial transactions themselves and then matched it to the most favorable long-term funding sources, e.g., bond financing, FHLB advances or New Markets Tax Credit takeout financing? This would put CBs in the role of managing the customer relationship, which historically is a better fit for the bank and the commercial customer. The CBs that do this hard work and build their own on-staff expertise, rather than ceding this role to others, may have the superior long-term position. RecommendRecommended by 4 readers