More bank customers think smaller institutions these days

A tiny bank in Happy, Texas, is a century old but hasn't before seen the kind of deposit growth that it's seen in the last three months.

By any measure, it's been an extraordinary year for anyone in the U.S. banking industry. But Happy State Bank, with headquarters in a town with an irresistible name, has been the face of steadfast calm during a period of intense global financial turmoil, drawing $30 million in deposits since September into its 20 branches in the Texas Panhandle, double the rate of deposit growth in a similar period in recent years.

"It's our 100th-year anniversary, and it's a nice way to celebrate," says Pat Hickman, CEO of Happy State Bank, which has $960 million in assets and was established in 1908 in Happy, a town with just over 650 residents in northwest Texas.

This year's financial chaos hit its peak in September when investment bank Lehman Bros. collapsed, the government seized insurance giant American International Group, Washington Mutual became the largest bank failure in U.S. history, and an ailing Wachovia was acquired by Wells Fargo.

But as the top tier of the financial services industry faltered, small and regional banks, as well as credit unions, started seeing their cash deposits rise dramatically as nervous Americans shied away from big banks. Some of these smaller financial firms saw an increase in small businesses knocking on their doors. And despite rampant headlines about a credit freeze and plunging housing market, they have even been writing more home loans this year than last year.

In her 18 years as a banker, Sebrina Verburgt hasn't seen anything like this: new customers with cash in hand, streaming in through the doors of the 11 branches of the United Heritage Credit Union, where Verburgt is senior vice president of operations. Many of them had the same story to tell: They were moving cash from larger banks, afraid that they would fail.

Just ask Clay Strange, a lawyer in Lakeway, Texas, who decided to move $20,000 into United Heritage from his Charles Schwab money market account, after reading that some of the money market funds were unstable because they had invested in bad debt securities of firms such as Lehman Bros.

"I wanted to move my money into something that was clearly insured," says Strange.

In September, United Heritage, in Austin, saw a 52% increase in new checking accounts from a year earlier. That came after 35% growth in July and 43% in August.

"This is unprecedented," says Verburgt, who is seeing the most growth in one of her checking account products that offers an annual yield of 5.01%, far more attractive than the nationwide average of 0.22% on bank checking accounts, according to

An October survey by the Independent Community Bankers of America reveals that 70% of community banks saw an uptick in deposits in the past year. Nationwide, these higher-interest checking accounts saw an 11.6% rise in new accounts in the third quarter this year, vs. the previous year, according to BancVue, which helps set up technology at community banks nationwide.

"People are scared of large, national names, because of the spectacular failures this year," says Joshua Siegel, managing principal of StoneCastle Partners, a New York-based private-equity firm that invests in community banks.

Smaller banks fail, too

It's not as if only large banks failed in 2008. In fact, as the mortgage crisis intensified and home foreclosures surged, some smaller banks also buckled. Of the 25 bank failures this year, 16 have been banks with less than $1 billion in assets. Several were either based in the states with the worst real estate downturns — California and Florida — or had opened loan offices there. Still, compared with Washington Mutual's $307 billion in assets, the rest of the failed banks had a combined total of $65 billion in assets.

Of course, given that the Federal Deposit Insurance Corp. has decided to insure deposits up to $250,000 from $100,000 previously, it's not as if many people will lose their deposits. Rather, the fears on Main Street reflect how shaken the public has become from the financial turmoil. And the government's efforts to save the financial system from collapse by investing in some of the country's largest banks have only spooked Americans further.

Such faith in smaller banks, though, isn't necessarily flawed. The larger banks, with an average size of $10 billion in assets or more, today control more than $10 trillion in financial assets — even though there are only 115 of them.

However, a lot of their assets are made up of toxic financial securities that have lost a lot of value — whether it's the $2 trillion in collateralized debt obligations that are based on subprime mortgages and low-grade bonds, or the $2 trillion in asset-backed securities that are based on car and student loans and credit card debt.

In contrast, there are 8,278 banks that have less than $10 billion in assets and only $3 trillion in assets combined. However, according to StoneCastle Partners' review of FDIC data, these smaller banks have 50% more capital than the larger banks as a percentage of loans, so their ability to absorb losses is higher, a key distinction during a recession.

Smaller banks also have most of their loans secured by real assets such as property, equipment, receivables and even personal guarantees from senior management, which makes for better loan recovery in case of failure. So these banks have had less than half the rate of charge-offs in the last 15 years, compared with their larger, undercapitalized counterparts.

"Most community banks just didn't make subprime loans or get involved in exotic loans," says Burton Zwick, a business professor at Fairleigh Dickinson University.

Happy Bank CEO Hickman, for instance, points out that out of 8,881 loans outstanding, only 17 were 30 days past due. For now, the banks that people trust in their communities are attracting dozens of new customers. Consider:

•First Arkansas Bank & Trust started running ads in the Arkansas Democrat-Gazette and other local newspapers touting its conservative philosophy and safe reputation. Larry Wilson, CEO of the 28-branch Jacksonville, Ark., bank, also publicized his new high-interest checking account, which was offering a 4.4% annual yield. The ads helped boost new accounts more than 900% since last year. "People want higher rates but want to get it from a place they can trust," says Wilson.

•Regional bank Hudson City Bancorp is one of the few banks whose stock price hasn't fallen this year. Hudson City, with assets over $50 billion, is by no means a community bank. However, it has a very localized, community approach with its 127 branches in the tri-state area of New Jersey, New York and Connecticut. "Our loan production is at record levels," says CEO Ronald Hermance Jr.

The Paramus, N.J., bank accepted more mortgage applications during the first nine months of 2008 than in all of 2007, originating $4 billion of mortgage loans, compared with $2.65 billion for the comparable period in 2007. In the same period, deposits grew by $2.14 billion.

•Yakima Valley Credit Union, based in Washington, the state were WaMu was headquartered, saw 433 new members in September, a 57% jump from the same month last year, and 416 new members in October, a 22% jump. "On average, the balances in these accounts are also higher," says CEO Mina Worthington.

•Happy State Bank, too, has made gains in more ways than one this year. Hickman, who had been on the lookout to grow his business, fielded a call earlier in the year from Citibank, which was unloading some of its branches in Texas to focus on its core operations as it worked to shore up its balance sheet. Hickman was offered eight Citibank branches in his area, which he promptly bought in June for about $20 million.

•Red Mountain Bank in Hoover, Ala., also saw a 23% increase in deposits in three months, compared with a 19% increase for all of last year. "We are also seeing small and medium-size businesses seeking us out for loans," says CEO Mike Washburn.

One is Clyde Tillman, president of Press Access, a printing-press business in Atlanta with annual revenue of $30 million. After banking with Wachovia in recent years, Tillman says he was tired of "being just a number" at the large bank, where he had to explain his business each time to a different loan officer.

Making the switch

Tillman says that he runs a profitable company and should be a desirable account. His business sometimes demands large amounts of upfront investments to buy large printing machines, and then weeks go by when he doesn't have to draw on his $6 million credit line at all.

"It's feast or famine for our loans, which is why we need someone to understand our business," he says.

So he took his account to Red Mountain, where the loan officer visited his business to understand his goals and structured a loan program accordingly. "Now I tell people to change to a local bank," he says.

It is these sorts of ties and deep connections that bankers have woven in many communities that is bearing fruit in a year marked by tremendous tumult in banking. People all around the USA have lost trust and are flailing around looking for security. "In some local communities, the two most important people are the mayor of the town and the president of the bank, who sponsors most local charity work and events," says Siegel of StoneCastle Partners.

Happy State Bank's Hickman could pass as just one of those people. Besides sponsoring almost all the athletic teams and activities in the town's one school district, his bank is also the main sponsor of the town's largest celebration of the year, called Happy Days, which starts with a Western dance on a Friday night in August and is celebrated through the next day with a parade and a barbecue.

The bank's six Volkswagen Beetles cruise in the parade that ends with a rodeo at the end of the day. Hickman and his bank's employees are active participants, serving the town's residents barbecue, coleslaw and potato salad.

It might not be a surprise that practically the entire town banks at Happy State, and now folks from nearby towns are joining in.