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Surviving in the Middle
BY KENNETH CLINE
BancorpSouth’s Aubrey Patterson says mid-size banks can enjoy “the best of both worlds” by maintaining both technological expertise and personalized service.
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SYNOPSIS |BancorpSouth chairman and CEO Aubrey Patterson says his Tupelo, Miss.-based bank has been able to survive and grow despite competition from super-regionals and community banks by maintaining technological expertise along with personalized service. Strong non-interest revenues from a commercial insurance brokerage operation also help. He says BancorpSouth will continue to expand at a measured pace that doesn’t threaten its operating style or capital position.
Tupelo, Miss., let’s face it, is not the center of the banking universe. With a population of 35,000, the manufacturing town known mostly as the birthplace of Elvis Presley doesn’t quite rank with Charlotte, Atlanta or Birmingham as a southern banking power.
Yet there is a bank headquartered in Tupelo that’s been turning a few heads in the industry lately. BancorpSouth, a $13 billion-asset, eight-state institution was a pioneer in imaging technology and is now leading the charge in cell phone banking, having launched the nation’s first deployment of that service last November. So much for the “barbell theory of banking,” which posited that mid-size banks were doomed to be caught in a fatal squeeze between the mega-banks and community banks.
To find out how BancorpSouth has not only survived in the middle but has flourished — competing against several of those mega-banks in Charlotte, Atlanta and Birmingham — BAI’s Banking Strategies recently interviewed CEO and chairman Aubrey Patterson in his Tupelo headquarters, where the mood is mostly confident these days. BancorpSouth had just completed an acquisition in its eighth state, Missouri, and Tupelo itself was still cheering Toyota Motor Corp.’s decision to locate a $1.3 billion assembly plant nearby.
Obviously, it’s not all sweetness and light. Like most bank executives, Patterson is grappling with the profitability pinch caused by the inverted yield curve, although non-interest revenues from commercial insurance brokerage help alleviate that strain. And some of BancorpSouth’s market is still trying to recover from the ravages of 2005’s Hurricane Katrina.
But Patterson remains optimistic that the bank’s business model of combining technological innovation and expertise with personalized service in a decentralized market delivery system will enable BancorpSouth to keep growing at its historical measured pace. “Some middle-size banks have been squeezed out,” he says, “but those of us who have adapted are enjoying the best of both worlds.”
Q: In 1994, when BancorpSouth was a $2.4 billion bank in one state, you were quoted as saying “those of us in the middle strata, between the little community bank and the big super regional, can’t afford to be drawn into a competitive arena where our services are a commodity because, if we are, we are going to lose out to the guys who are able to get the volume,” i.e., the big banks. Now that you’re a $13 billion bank in eight states, do you still feel like that? Can you still survive in the middle?
PATTERSON: The challenge is still there. If we’re drawn into a commodity marketplace, then obviously scale favors the money-center banks and the large international banks. So our mission is to avoid that, to offer a value proposition to the client that gives them a reason to do business with us in a relationship context.
We’ve grown with that marketplace, as you pointed out. But the fact is, the relativity of our size to the super-regionals, and the ability they have to securitize assets, to find alternative funding that we don’t have, means they can live on a narrower margin than banks like ours. So, the challenge is still there.
I think we’ve answered the challenge. From a standpoint of total shareholder return and competitiveness, our niche has worked out. Actually, it’s not just a niche play because increasingly the larger banks are pushing down into the mid-market and small business arena. It’s been our ability to provide a relationship that has real value to the client. And we’ve been able to grow and diversify as well.
In 1994, we were a one-state system of community banks. Today, we’re in eight states, with $13 billion of assets and almost 300 operating bank locations. So, we’ve achieved some of those same economies and scale that enable us to invest in technology so we can offer both efficiency in back-room functions and diversity of products and services to the client. We have specialty services, like cash management services and remote deposit capture, where we’ve been a leader.
The bottom line is we can offer clients cash management services as robust as they could get from, say, Bank of America or Wachovia, with a lot more personal touch and attentiveness to their needs.
Q: So, the heart of your strategy is to match the large banks in sophisticated services but compete with the community banks in terms of personal service?
PATTERSON: We want to invest in technology and centralization to the extent that it doesn’t negatively affect the customer relationship. We want to centralize the back room and we want to be state-of-the-art in the products, services and diversity in the mix that we offer. But we don’t want that to invade the space between us and the client.
In the mid-1990s, a lot of people were talking about the “barbell theory” of banking, meaning that only the big and the little would survive and that the middle-size banks would be squeezed out. Well, some middle-size banks have been squeezed out, but those of us who have adapted are enjoying the best of both worlds.
If a regional bank gets big enough to be clumsy, centralized, de-personalized and commoditized, then you lose the ability to be profitable and you have to have an exit strategy. On the other hand, if you get big enough, with sufficient capital, technological expertise and diversified products to offer what’s needed by the client in a relationship package, you’ve got the best of both worlds. That’s what we’ve aspired to do and I think we’ve done a pretty good job of it.
Q: This looks like a very delicate balancing act, from a managerial perspective ...
PATTERSON: It is, because it’s not the cheapest model. We’ve invested in new products, new lines of business and new technologies. There are cheaper and simpler ways to do the job.
Q: Speaking of costs, I understand your efficiency ratio is currently 67%, rather high by industry standards ...
PATTERSON: If you look at Citigroup’s, it’s also high because of its mix of businesses.
If you look at our net revenue, 36% comes from non-interest sources: wealth management, cash management services and insurance, which is the largest piece.
Q: Still, right now, there is a lot of emphasis on cost control in the banking industry. Do you face those pressures as well?
PATTERSON: You’ve got to distinguish between the tactical environment and the strategic environment. You’ve got to live in the short-time frame but you’ve got to build for the long term.
If you segment out our non-interest lines of business, then we show a better efficiency ratio for the pure bank, just as Citigroup would. The thing that inhibits continuous improvement of the ratio is a continuing expansion of our branch network, which is the strategic issue. We add seven or eight new branches a year. And when you take roughly three years to break even, which is typical, you’re building for the future but it’s hurting your efficiency ratio. You can’t do that; you’ve got to be relevant long term.
Well more than half our company is now outside Mississippi and that part of the company is growing rapidly. Most of our recent acquisitions have been, and will continue to be, in more rapidly growing markets outside Mississippi.
We really are very effective in mid-size markets, with a good mix of retail and commercial business. Once we go into a market, our acquisition model doesn’t call for huge cost savings. We don’t, frankly, think they typically materialize, so we’re not going to fool ourselves into thinking we’ll get that. Our plan is to maintain the client base that we’ve acquired, and we have a good record of doing that, and then grow a little faster than they could have grown. If we can’t get an acquisition to be accretive to earnings in the first full year after acquisition, we probably won’t look at it.
Q: That’s a major departure from the large banks, which rely heavily on cost savings to justify their deals.
PATTERSON: I think that works for them, but it doesn’t work for us. For us, it’s a matter of franchise value. If we’re going to incur any amount of dilution in earnings, we want it to be something that will grow the value of that addition to our franchise.
Q: BancorpSouth has garnered a lot of press recently for being a pioneer in, first, imaging technology, where you were the first to implement multiple image exchange networks, and then more recently in cell phone banking. Why would a mid-size bank such as yours want to be leading edge in those areas?
PATTERSON: I really think our group is a little more nimble than you’d see in a larger organization. We’ve got a little more flexibility in how our folks operate.
I don’t come from an operations background. I’m more of a financial guy and a generalist in the banking business. So our operations group is usually miles ahead of me; it’s not something we mandated.
I’ve always believed that the pioneers are the ones with arrows in their backs. In a beta site, you run a lot of risks that you won’t have if you buy proven technology. I think that’s true, generally speaking. And you wouldn’t normally think of Tupelo, Miss., as being the Silicon Valley of the regional retail banking business. It doesn’t have that cachet.
But we’ve got some really bright young people who want to figure out ways to do things better. By being early in things like cash management and remote deposit capture, we’ve gained a sizeable competitive edge on a lot of the people with whom we compete, including some of the really big companies.
We’ve been offering services to commercial clients that the top ten banks weren’t offering in our region and it’s proven technology, not just beta site testing. So, I think it’s had value to us and I don’t think it’s added a lot of cost.
We’re not trying to innovate for innovation’s sake. But if we find something like remote deposit capture that has real application to an industry that banks with us, and if we’ve got a really state-of-the-art online cash management system that makes money for them, and strengthens their relationship with us, that works for us. We’re about long-term relationships with our clients.
It all goes back to not wanting to be in a commodity environment. The more relationships we have with our clients, retail and commercial, the stronger we are. If we’re a little bit ahead of some of the bigger, maybe slower movers, so much the better.
Q: Remote deposit capture clearly resonates with commercial clients. But bankers often complain they can’t justify the business case for cell phone banking. Why do you want to be early in a business where profitability is so problematic?
PATTERSON: We don’t have a lot of money invested in the cell phone project. It’s a relatively insignificant amount of upfront cost and trouble. But who would have predicted ten or fifteen years ago what would be done by cell phones today? Most young people today don’t even have a landline in their apartment.
We’ve just scratched the surface of what’s going to be done with cell phone technology going forward. It’s going to be the vehicle for things we can’t even imagine. If a modest investment in cell phone banking technology keeps us tuned in, and if we’ve got the right relationship with the right industry providers to be ready to move to the next level, then I don’t think we’ve overdone our investment.
Who would have made a business case 10 years ago that companies would give you a $200 cell phone if you just sign a contract? They’re buying a stream of revenue; we’re buying a future set of relationships.
Q: Let’s go back to the retail side. You have a lot of com-munity banks in this region offering personalized ser-vice. How can you emulate that model when, relatively speaking, you’re often the large bank on the block?
PATTERSON: It boils down to local decision-making. Most banks, our size or larger, especially larger, have long since taken the underwriting responsibility away from their branches. All of the important decisions are made in a centralized department. People in their branches are business development officers and application takers who submit loan requests to the home office for consideration.
In all honesty, I think that’s a highly efficient system. It solves a lot of problems on pricing and compliance. But when you do that, you lose the ability to tell Joe Customer you’ll take care of his $50,000 loan. That’s an over-simplification, obviously, but there’s still a big market out there of people who care about local decision-making and want to deal with somebody who is a decision maker.
It’s not the cheapest model and it’s not the easiest model. But we’re always in the top decile, and usually in the top 5%, of banks our size on credit quality.
Q: How can you do that without centralized underwriting?
PATTERSON: We’ve got strong loan review, strong loan administration, all the way to the top of the company.
Every six months for example, I attend a meeting on “rated assets,” or “watch-list” loans over $25,000. Each loan in that category gets looked at by this special committee at least twice a year.
Attending those meetings are senior loan administrators and community bank presidents. The key lenders have to write up every rated loan they have and explain what they’ve done since the last meeting and what they’re going to do going forward. You might say it’s a cumbersome system, even overkill, since it involves auditors, loan review, loan administration and line management people. It’s an all-day deal usually, and it takes time to get all the way around eight states.
But you can’t afford to lose a lot of money on loans in our system. You’ve got to have a fairly low threshold at what you look at. And the proof is in the pudding. Our net charge-offs were 0.15% last year. As long as that system works for us, and we don’t outgrow it, that’s the way we’re going to continue to do it.
We don’t have many loans larger than $10 million, by the way. We have a lot of small, individual credits that dis-aggregate our risks considerably.
Q: Is there a certain asset size beyond which you could no longer maintain such a loan review system?
PATTERSON: I’ve been president or chairman of this company for 24 years now and it’s worked until now.
Is it likely that we’re going to become a twenty-state institution with $30 billion in assets? Probably not, realistically. Our growth pattern has deliberately been one of paced growth that maintains our capital model and our structure the way it needs to be. And as we look at the environment for acquisitions today, we look at contiguous markets, what we refer to as a “coherent footprint,” so that when you have a problem, you can get to it.
I think that in a handful of years we can be a $20 billion to $25 billion company. Instead of being in eight states, we can probably be in a dozen. Will our model still work as long as it’s geographically concise? I think so.
Q: So you don’t aspire to attain super-regional status someday?
PATTERSON: We call ourselves the “emerging regional bank of the mid-South,” and that’s probably a pretty good appellation. We stretched “mid-South” a little bit to include Missouri. Unless we did a couple of big mergers of equals, we’re not likely to become a super regional, by virtue of the model we have.
Q: You’re now 64. Do you have any plans to retire soon?
PATTERSON: No plans for any time soon.
Q: So you expect to continue to run the company for a few more years?
PATTERSON: I don’t make public comments about that.
We have an extremely capable team, notably, James V. “Jim” Kelley, our president and chief operating officer. For the last seven years now, Jim has been our number two, he does everything I do, and he’s involved in everything I’m involved in.
Q: Let’s look at current industry issues, such as the inverted yield curve. What’s your strategy for handling this pressure on net interest margins?
PATTERSON: Hopefully, it’s not going to stay inverted forever, because none of us have a strategy that will deal with that.
We picked up three basis points in spread in the first quarter of this year, compared to the previous quarter, so in the short run, we’re dealing with it reasonably well. If you look at our year-over-year numbers, you’ll see respectable loan growth in a slowing economy — not our typical 9% to 10% growth, but 6% to 7% growth, taking out mergers. But there’s been only about 1.5% growth in deposits.
We could have had stronger deposit growth, but we’ve used maturing bonds as a funding source for the loan growth and been much more conservative in our approach to certificate of deposit (CD) pricing. By that, I’m talking about things like public funds, funds that aren’t core deposits. We’ll fight like a tiger to keep individual, retail client CDs, even though it doesn’t exactly make short-term spread sense. But there’s a lot of public funds money that rolls over every 30, 60 or 90 days that you always get another shot at.
The obvious next question is: how long can this strategy for dealing with the inverted yield curve go on? The answer is, it can’t go on very much longer. We can probably continue the better part of this year and then we’ll see increasing pressures on the spread. There’s no magic bullet, obviously.
Q: On the other hand, you do have that non-interest income to balance things out a bit...
PATTERSON: It gives us a big help. Thirty-six percent of our net revenues are non-interest revenues. For example, we’ll have just over $70 million in insurance commissions this year. The last numbers I’ve seen, we were eighth or ninth in the nation among financial services holding companies in insurance commission revenues.
When we decided to go into the insurance business, beyond just branch-based life insurance, we opted for commercial insurance agencies rather than retail. We bought the largest independent agency in Mississippi, the second largest in Arkansas and the largest in Louisiana. Then, over the last three years, we have gradually pulled those together into a more coherent structure. We’ve essentially become a regional brokerage.
And we’ve got operating leverage — revenues are growing much faster than expenses in that line of business. And the whole line of business is growing faster than the commercial bank, so it works well for us.
Q: Do you have a strategic goal of increasing the percentage of non-interest revenues?
PATTERSON: We’ve actually hit our target, which was 35%. We’ll have to raise our sights now, because obviously, the more we can do the better. We’ve become less susceptible to interest rate cycles and less susceptible to spread pressures.
Hurricane Katrina was obviously a horrible disaster to the Gulf Coast. But the rebuilding of Katrina-damaged areas has generated lots of insurance opportunities, both for construction bonds and new policies for new construction. Our agency on the Gulf Coast has done remarkably well. We’re going to continue to push out our footprint in the insurance area.
Q: Speaking of Katrina and the devastation it caused, when are you going to see loan growth as a result of the rebuilding?
PATTERSON: The costs of construction are much higher down there than they were. And there’s a shortage of construction capability. According to numbers I’ve seen, about fifteen years worth of houses were destroyed completely, so it will take fifteen years of maximum construction effort just to replace what was destroyed.
There are also issues with the new building codes, which require a higher elevation. I don’t think we’ll ever see the residential piece on the seashore itself replaced the way it was because of building codes and insurance, although we are seeing a continuation of what had already been an emerging trend, the building of high-rise condos.
I think you’re going to see clusters of development on the coast itself. The delay in building housing, in personal housing, is just going to mean it’s a long-time recovery. There are still tens of thousands of people living in trailers, almost two years later, and will be for a long time.
I think about 5% to 6% of our assets are in the immediately affected area, so our credit losses down there have been negligible. We’re seeing a lot of business opportunity and growth.
Q: And you also have a lot of opportunity in your hometown of Tupelo, with the Toyota factory coming in, correct?
PATTERSON: Yes. Their initial plant will be a $1.3 billion investment and will generate 2,000 jobs initially. Additionally, seven or eight major suppliers will come to the area and you’ll have the multiplier effect throughout the economy of service jobs. Except for San Antonio, which just opened, every new plant Toyota has built in the U.S. has doubled in size in a short period of time. So you’re talking about, let’s say, in an eight-to-ten year time frame, probably about 10,000 jobs.
Q: So both commercial and retail opportunities for BancorpSouth?
PATTERSON: Banking is a reflective industry. My predecessor always used to say, “You can tell whether a community has good banks or not by looking at the community.” Good banks build good communities. But the reverse is true too.
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