'Old-fashioned' banks manage to avoid credit crisis

U.S. financial giants can apparently learn a thing or two from little banks in places such as Danvers, Mass.; Hudson City, N.Y.; and San Juan, Puerto Rico.

Citigroup, c Merrill Lynch merand Morgan Stanley msare choking on more than $70 billion of bets on shaky mortgage loans. Shareholders in these money center banks have suffered in what's been called the biggest banking crisis since the Great Depression.

Outside of Manhattan, a handful of smaller banks stuck to traditional banking, and their shareholders are being richly rewarded. Led by CEOs who in many cases answer their own phones, the smaller banks steered clear of the risky loans, even though it made them look old-fashioned and backward.

Of the 707 banks tracked by Standard & Poor's Capital IQ, 31 mostly smaller firms have stock prices that are 6% or less below their 52-week highs, a USA TODAY analysis of the data found. Meanwhile, the Select Sector SPDR Financial, which mirrors the performance of S&P's financial stock index, is off 30%. Most of the smaller banks also managed to increase earnings in 2007, a year when the S&P 500 financial sector's earnings fell 34%.

The outperformance shows staying cautious during an unprecedented housing bubble was the right thing to do. "The formula is so simple any kid could do it," says Ron Hermance, CEO of Paramus, N.J.-based Hudson City Bancorp, hcbkwhich reported 9% higher fourth-quarter profit, boosted its dividend 6% and has seen its stock rise 4% this year. "It's the old-fashioned way."

That comes in many forms, including:

•Playing it safe. CEO Gerard Brandi of Reading, Mass.-based Massbank masbrefused to lower standards for borrowers. "We saw (lending) standards we just couldn't stomach," he says. Massbank's mortgage business shriveled up. To try to make up for the lost business, Massbank, which gets nearly all its business by lending to individuals, invested in high-quality bonds and stocks, Brandi says.

Similarly, San Juan, Puerto Rico's Oriental Financial ofgCEO Jose Rafael Fernandez says he was stunned by how reckless some large banks were in the mortgage business. Oriental largely withdrew from mortgages and focused on fee-based services such as brokerage, trust and retirement planning and checking accounts.

•Exiting the business. Richard Evans, CEO of San Antonio-based Cullen/Frost Bankers, cfrdidn't like what was going on in residential mortgages and got out completely in 2000. Then, 10 large banks controlled 80% of the business, and they competed on price and nothing else, he says. Those banks would buy and sell mortgages looking to make a quick buck. That didn't fit Cullen/Frost Bankers' strategy of sticking with customers from home buying to retirement planning, Evans says. Cullen/Frost now focuses on commercial loans.

•Keeping costs down. For each $1 it earns, Hudson City hcbkspends 25 cents in overhead and other costs — about half the industry average. By controlling costs, the bank can keep its certificate of deposit rates above average and draw in deposits, Hermance says.

•Avoiding the subprime hot potato. Many larger banks got into trouble investing in repackaged subprime mortgages originated by other lenders. Danvers, Mass.-based Danvers Bancorp dnbk lent money to suitable borrowers and kept the loans on its books, CEO Kevin Bottomley says.

Some smaller banks even hope to steal share while the bigger banks retrench. Muncie, Ind.-based First Merchants frmehas been training new staff expecting stronger demand for its traditional 30-year, fixed mortgages, says CFO Mark Hardwick. "We've been criticized for having a belt-and-suspenders approach to banking," he says. "But we've never felt that way."