How did these small community banks grow so fast years ago?

This should be easy for someone to answer. During the boom years, some of these little redneck banks grew like crazy in a short amount of time. How?

A coworker of mine, whose close family member is professionally involved with the establishment and growth of small banks, jokingly suggested that they grew by offering stupid loans.

That's all good and well, but my rudimentary understanding of their financials tells me that this doesn't make sense. People seem to think that banks get their money by borrowing from the Federal Reserve, and that may be true, but I've looked at the balance sheets of several banks, and (please correct me if i'm wrong) the vast majority of their money comes from depositors. Come to think of it, I'm not even sure where on their balance sheets you can see this "money from the Fed."

But, you argue, you can attract depositors by offering those stupid loans we were just talking about! Sure, but if you ask me, that sounds like a net outflow of money. We're talking about small businesses for the most part. Isn't a typical small business owner going to take out a $100k SBA loan but only have $15k in a checking or interest-bearing account? That's a net outflow of $85k. Or a consumer might borrow $200k to buy a house, but only have $10k in his checking account. That's a net outflow of $190k.

You can only lend out what you already have, right?

edit: "Access to Federal Home Loan Bank advances has allowed these banks to continue growing rather than restricting growth to the pace of core deposit growth." Guess I was wrong. Can anybody point to an example of a balance sheet (even an old one) that was heavily weighted toward FHLB debt?

 
Best Response

Deposit growth is still an important aspect of growth for community banks. Yes, the FHLB borrowings have allowed some bank to continue to expand their lending capacity, but core deposit growth is still necessary. That is why you see many of these banks looking to make acquisitions with the aim of expanding their customer base/geographic reach, which ultimately increases their deposit base. Growth hasn't been as easy to come by for many of the smaller regional/community banks since the crisis. (Like you said, pre-crisis they were able to grow much more quickly, due to higher loan demand, less conservative lending practices, etc, but that isn't the case in the industry today)

I can try to come up with an example or two that have high FHLB borrowings, but I am not sure off the top of my head. Banks have been cutting back on FHLB over the past few years as they try to tighten up their balance sheets due to Basel III's stricter capital requirements. I don't think FHLB borrowings have had as much of an impact as you may think, they are still a small % of total assets at most financial institutions

EDIT: And to add to your point about net outflows. Banks are in the business of lending money, abviously initially the money is going to be an "outflow", but like you said, now they will be able to make some money on the interest they collect over the life of the loan, as well as the potential for additional noninterest income from fees and such that may be related to the business owner's checking account. They aren;t getting paid by how much is in the client's checking account in comparison to the total amount of money borrowed. They are making money from interest accrued on those loans over time, as well as other additional revenue streams (fees, other services, etc.). Obviously, making stupid loans leads to problems when borrower's default, but thats the reason they keep reserves and maintain the capital levels they do, in order to cover these scenarios.

Also, to your point that banks get their money from the federal reserve, I'm not sure what you're getting at here. Yes, there was TARP and SBLF money, etc, but banks also use equity and debt fo fund their operations and grow, similar to non-financial companies use capital markets.

Hope this helps answer some of your questions and provides some insight into the sector

Array
 

That is helpful, but I guess I wasn't clear enough. You don't simply balloon from $100mm in assets to $2 BILLION in assets simply by accruing interest and collecting various fees.

I am absolutely not talking about 2013, I am talking pre-2008 ONLY. Here is my previous quote, expanded: "some community banks focus on building franchise value via deposits ... In contrast, other community banks build franchise value primarily on the lending side of the business ... Access to Federal Home Loan Bank advances has allowed these banks to continue growing rather than restricting growth to the pace of core deposit growth." That is from a report published by the Federal Reserve in 2005. And yes, I'm talking about then, not 2013.

I don't think this is something that should be trivialized or dismissed: 2 of the top 3 borrowers from the FHLB system were Countrywide and Washington Mutual. http://www.newyorkfed.org/research/staff_reports/sr357.pdf

"banks also use equity and debt fo fund their operations and grow, similar to non-financial companies use capital markets." Right, but usually, 90% of their assets consist of depositors' money. They might issue some equity or debt here and there, but that amounts to pennies vs their balance sheet.

WaMu "held liabilities in the form of deposits of $188.3 billion, and owed $82.9 billion to the Federal Home Loan Bank, and had subordinated debt of $7.8 billion." That is a HUGE amount borrowed from the FHLB! And virtually nothing (by comparison) on the equity and debt side you mention. This is really interesting stuff!

[As far as getting money from the Fed, I'm not sure what I was talking about either, but I've had arguments with guys my age who just took econ 101 and think that this is how banks get their money: "That’s why they call it the “discount” rate. Think of it as the wholesale price for short-term money. Usually, if you buy in volume, you get a good price." http://www.nbcnews.com/id/8566097/ns/business-answer_desk/t/why-cant-i-… But I'm now learning that that is not really a major factor in anything, so you can ignore what I was asking about that]

 

Ok, I see what you're saying. That definitely was the case pre-crisis and some of the banks that still have higher fhlb borrowings are some of the larger institutions.

I was speaking more about community banks, rather than the larger players like countrywide, etc. I haven't been in my position mon enough to speak at length about the space and don't really know a whole lot about pre-2008, but from my knowledge of the crisis, I can agree that lending was the big growth driver for the industry. Subprime lending got seriously out of hand and due to wall streets never-ending appetite for loans to securitize, Main Street kept pumping them out, enabling them to grow (despite the consequences/risks)

Array
 

Reserve ratios. Look it up.

It works like this.

Depositor A deposits 10k in a savings account. Bank A can now lend 100k on this 10k deposit with a reserve ratio of 1:10 Borrower A takes a 100k loan from bank A to buy a house. Depositor B takes 100k from sale of home and puts it into Bank B Bank B can now lend 1mm on this deposit of 100k.

The reserve ratio allows banks to essentially create money with faith that they have enough deposits on hand to meet demand collections from their depositors. While the example I have provided is not exactly 100% accurate as far as the numbers go, the principle is correct.

Follow the shit your fellow monkeys say @shitWSOsays Life is hard, it's even harder when you're stupid - John Wayne
 

I think there is some confusion going on with reserve ratios. 1:10 means 10%. So, if depositor A has a 10k savings account, that means the bank is obliged to keep 1k of those 10k as a reserve. The remaining 9k can be lent out.

Correct me if I'm wrong

Colourful TV, colourless Life.
 

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Follow the shit your fellow monkeys say @shitWSOsays Life is hard, it's even harder when you're stupid - John Wayne

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