Identifying Thriving Small Banks Using Federal Reserve, FDIC Data

by: Matt Hylland

One of the most discussed and successful bank investments in recent history is Warren Buffett's stake in Wells Fargo (NYSE:WFC). Buffett initially started investing in Wells Fargo in 1989, and now a couple of decades later it has become his largest holding, valued at more than $19 billion (according to Berkshire's 13-F filing). At the time of Buffett's first purchase, Wells Fargo had just a $56 million in assets and was not much more than a well run community bank. However Buffett spotted the good management and great fundamentals and bought. 20 years later we can see the investment has been one of his most successful ever.

Just what are the characteristics that make a small bank so great, so that it has a potential to become one of your best investments?

The Search for the Perfect Small Bank

To start the search for a small bank investment opportunities, I used 3 studies by the Federal Reserve and the FDIC:

All studies point to the one advantage small banks have today over the "big five". The ability to be in touch with rural America. Small banks in rural segments of the United States:

  • Have higher Return on Assets (ROA) than banks headquartered in metropolitan areas,
  • Have lower default rates on loans than urban banks,
  • Have longer relationships with their customers, and
  • Lend more to local small businesses compared to their large national counterparts.

This is a significant competitive advantage for a small bank. More importantly, this means a potential for significant long term growth for investors if they find the right banks.

Narrowing the Field

Currently there are 6,941 commercial banks in the United States. That is way more financial statements than I want to go over!

In order to limit the field, we look into the three studies and find qualities and characteristics of successful small banks.

The first study, "The Future of Community Banks", gives an abundance of fundamental data on successful small banks. The study breaks banks up into 2 different classes; "Thriving Banks" and "Surviving Banks". Part of the differentiation between "thriving" banks and "surviving" banks is based on the Federal Reserve's CAMELS rating system, which is confidential and not available to the public. However, the study also gives loads of financial ratios that all thriving banks (CAMELS rating of 1) had in common. That information we can use and start to screen out the thousands of banks and come up with a few to delve deep into.

The 2011 study classifies 702 banks as thriving (keep in mind, many of these may not be publicly traded banks or holding companies - our goal is to find the few that are):

Those thriving banks averaged significantly better fundamental ratios than surviving banks (click to enlarge images):

Asset Ratios of thriving small banks

The study also evaluates other factors, such as management quality, community growth, and risk management at thriving banks. The study finds that in general, thriving banks:

  • Had a strong and localized customer service focus with high community visibility,
  • Operated in a thriving (i.e., growing) community,
  • Practiced forward looking risk management,
  • Demonstrated balance between growth and risk and,
  • Had patient and conservative ownership.

To evaluate the banks' non-fundamental factors, we can use one tool that comes from the FDIC. Because of the Community Reinvestment Act (CRA), the government periodically reviews banks to ensure they are lending to all segments within the community. The law was designed to prevent banks from denying credit to lower class families and minorities. However, these reviews also tell potential investors a lot about the bank's involvement in the community and customer satisfaction with the bank. To ensure that banks meet the study's non-fundamental characteristics of thriving banks, we will screen any banks to only include "Satisfactory" CRA rating or higher. A satisfactory rating should help us ensure the bank has a favorable view in the community and decent customer service.

FDIC CRA ratings are found here.

To start whittling away at the nearly 7,000 banks, we use a simple stock screener. For this screen I used a few of the fundamental ratios given by the Federal Reserve's study on thriving small banks. The screen included banks with:

  • Return on Assets greater than or equal to 1.5%
  • Return on Equity greater than or equal to 12.7%
  • Market Cap less than $10 billion

For those curious, at the time of Buffett's purchase of Wells Fargo in 1989, (WFC) had a ROA of 1.25% and a ROE of more than 20%.

This simple screen alone knocked the list of 7,000 down to 12 publicly traded banks.

  • Penns Woods Bancorp (NASDAQ:PWOD)
  • C&F Financial Corp (NASDAQ:CFFI)
  • American National (NASDAQ:AMNB)
  • Taylor Capital (NASDAQ:TAYC)
  • Mercantile Bank (NASDAQ:MBWM)
  • Westamerica Bancorp (NASDAQ:WABC)
  • Hanmi Financial (NASDAQ:HAFC)
  • Preferred Bank (NASDAQ:PFBC)
  • Bank of the Ozark (NASDAQ:OZRK)
  • Republic Bancorp (NASDAQ:RBCAA)
  • First Financial (NASDAQ:FFIN)

All 12 banks above had Satisfactory or better CRA ratings.

The Second Round of Cuts

At first glance, each of the 12 banks above have stellar fundamental ratios. However, just that is not enough to survive the competition with the big national banks. We want to find banks that have a certain competitive advantage over the big national banks based on some of the characteristics given by the Federal Reserve above.

The second study, "Big Banks in Small Places", tells us a few more things to consider:

If the community banking model is to remain viable, it is likely to be in rural markets with (NYSE:I) a relatively high percentage of informationally opaque borrowers and (ii) relatively low costs of acquiring qualitative information about potential borrowers… The evidence suggests that well-managed community banks remain competitive, at least in rural markets, where their niche is most likely stronger than in urban markets.

Using that and keeping in mind the other factors discussed previously as a guideline, several more banks were eliminated:

  1. Westamerica - One of the larger banks that made it through the screen, Westamerica serves northern California, primarily the San Francisco Bay area. 89.5% of the bank's deposits come from metropolitan areas of northern California (San Francisco, Fresno, Sacramento, etc) and 94.3% of loan activity comes from those same metropolitan areas as well. Although the bank may be doing quite well, this article focuses on rural community banks where small banks have a competitive advantage over the competition, something that I am not convinced Westamerica has. Since so little of the bank's activity comes from non-metropolitan areas, it has been excluded from the list.
  2. Preferred Bank - Like Westamerica, Preferred Bank operates in metropolitan California. Preferred Bank is based in Los Angeles, and although it is carving out a special niche in the Chinese-American market, Los Angeles, Orange County and San Francisco are hardly my idea of rural America. For the purposes of this article, this bank has been excluded from the list.
  3. Republic Bancorp - Republic Bancorp operates mainly in the Louisville and Lexington Kentucky metropolitan areas, with slight exposure to non-metropolitan areas nearby. In these non-metropolitan areas Republic holds less than 2% of the area's deposit market share. In the larger metropolitan area of Louisville, Republic controls just over 3.5% of the deposit market share. Because of the rural deposit share being low along with metropolitan deposit share, this bank has been excluded from the list in favor of banks that seem to sport better competitive advantages over its competitors in rural markets.
  4. Taylor Capital Group - Operates out of the Chicago metropolitan area, and like the others on the list, is excluded so that we can focus more on rural banks.
  5. Hanmi Financial Bancorp - Operates out of Los Angeles, California. Another bank excluded from the list so that we can focus on rural banks.
  6. Bank of the Ozarks - Out of Little Rock Arkansas, Ozarks has a wide footprint across the southern U.S, with presence in Arkansas, Georgia, Texas, Alabama, South Carolina, North Carolina and Florida. However, with this diversification in operating areas comes lack of focus in any specific rural area. Ozarks only has 10% deposit market share in a few counties in all the states it operates, and none contribute a significant amount to the company has a whole. Realistically, a bank as large as Ozarks ($1.7 billion market cap) is too large to be able to focus on small rural areas. Although the company does well financially, it does not meet the criteria set forth be the Federal Reserve as a thriving community bank as much as other listed below.

We have cut the list down even further. Now after starting with over 6,900 banks, only 5 remain. At first glance, these banks appear to best suit the qualities described by the Federal Reserve as banks that can thrive in today's environment. Now that we have a manageable list of stocks to look into, lets really delve into the companies' numbers.

For the banks below, deposit share data comes from the FDIC's website, or the specific bank's investor relations website.

Loan market share data comes from either the latest FDIC CRA report, or the company's latest 10-k and 10-Q filings.

Market Cap, P/E, ROA and ROE come from Yahoo Finance.

1. Penns Woods Bancorp -

Market Cap ($) P/E ((ttm)) ROA (%) ROE (%)
217 million 12.55 1.74 16.8

Penns Woods (Holding company for Jersey Shore Bank) holds high market share in 2 main areas in Pennsylvania: Lycoming County and Clinton County, with slight exposure elsewhere.

  • Lycoming County:

- Population of 116,000 (-3% from 2000 census)

In Lycoming County, Penns Woods Bancorp holds:

- 18% of deposit market share (highest of any bank in the area)

- 16% of home mortgage market share (highest of any bank in the area)

- 13% of home mortgages by dollar amount (highest of any bank in the area)

  • Clinton County:

- Population of 38,000 (+3.5% from 2000 census)

In Clinton County, Penns Woods Bancorp holds:

- 31% of deposit market share (highest of any bank in the area)

- 18% of home mortgage market share (highest of any bank in the area)

- 16% of home mortgages by dollar amount (highest of any bank in the area)

Conclusion on Penns Woods:

The bank has carved out a nice dominating presence in several small towns and rural areas of Pennsylvania. The concerning element for me is that they dominate in communities that are not growing.

The bank also has small market share (~7.5%) in the State College area (location of Penn State University). Gaining market share in this faster growing, more competitive environment would be a great sign.

If the bank can get a stronger foothold in faster growing areas, this may be a bank to watch. For those willing to wait it out and see, the bank pays its shareholders a handsome 4% dividend yield.

2. American National -

Market Cap ($) P/E ((ttm)) ROA (%) ROE (%)
186 million 11.73 1.61 12.78

Based out of Danville, Virginia, the bank operates in southern Virginia and into northern North Carolina as well.

  • Danville, VA:

- Population of 43,000 (-11% from 2000 census)

- American National holds 31.5% of deposit market share in the city of Danville.

  • Pittsylvania County, VA:

- Population of 63,000 (+3% from 2000 census)

- American National holds 18% of deposit market share in Pittsylvania County.

  • Alamance County, NC:

- Population of 151,000 (+15% since 2000 census)

- American National holds 15.2% deposit share in Alamance County.

- Alamance County is responsible for 24.3% of the bank's loan activity.

Conclusion on American National:

The lack of growth in the company's foothold of Danville, Va is concerning, however the company is expanding through acquisitions into faster growing areas of North Carolina and other parts of Virginia. If the growth and market share dominance continues in those areas, American National could shine. American National also sports a nice 3.9% dividend yield for those willing to hold the stock in the meantime.

3. Mercantile Bank Corporation -

Market Cap ($) P/E ((ttm)) ROA (%) ROE (%)
164 million 11.64 2.45 25.77

Based out of Grand Rapids, Michigan, Mercantile Bank is predominantly focused on commercial real estate loans (according to the latest 10-k report, 91% of loans are in commercial real estate).

Loan market share data below comes from a report from the FDIC in November 2012.

Mercantile Bank has significant market share in the following areas:

  • Kent County:

- Population of 602,000 (+5% from 2000 census)

In Kent County, Mercantile holds:

- 7.6% of loan market share, but has a 20.6% share by dollar amount.

- 7.2% of deposit market share.

  • Ottawa County:

- Population of 263,000 (10.7% increase from 2000 census - one of the fastest growing areas in the state)

In Ottawa County, Mercantile holds:

- 2.8% of loan market share, but a 6.6% share by dollar amount.

- 1.5% deposit share in the county.

Conclusion on Mercantile:

Mercantile struggles to gain market share for deposits in the area, and I considered eliminating from the list early on. However, I thought the 20% share by dollar in Kent County was worth noting. The dependence on commercial real estate concerns me as well, but as long as investors know the bank's exposure and risk involved, the company seems to be doing well in the areas it operates.

4. C&F Financial -

Market Cap ($) P/E ((ttm)) ROA (%) ROE (%)
187 million 11.62 1.71 16.63

C&F Financial operates out of eastern Virginia, in some fast growing areas on Hampton Roads area. The company has several locations in the larger metropolitan areas like Virginia Beach, where it struggles with less than 1% deposit market share. However the bank does hold significant marketshare in some smaller, nearby counties:

  • James City County:

- Population of 67,000 (+39.3% since 2000 census)

- C&F holds 11% deposit market share in the James City County.

  • King William County:

- Population 16,000 (+21.2% since 2000 census)

- C&F holds 40% deposit market share in King William County.

  • Middlesex County:

- Population 11,000 (+10.3% since 2000 census)

-C&F holds 22% deposit market share in the county.

  • New Kent County:

- Population of 13,000 (+36.9% since 2000 census)

- C&F holds 91% market share in New Kent County!

Conclusion on C&F:

Although several of the counties C&F dominates are very small, they are also growing at a very rapid rate. Seeing the market share and population growth above, this bank has potential to grow very quickly if the market share dominance continues.

5. First Financial -

Market Cap ($) P/E ((ttm)) ROA (%) ROE (%)
1.83 billion 24.0 1.64 13.73

First Financial operates in non-metropolitan areas of Texas, in fact the company specifically states in its latest 10-K filing:

We have largely foregone the larger metropolitan areas of Texas.

That should be music to a community bank investor's ears. The bank sees where it has a potential for a competitive advantage and focuses on those areas only.

The results of this focus on non metropolitan areas is obvious. The bank has recorded 26 years of consecutive earnings increases and consistent stellar ROA.

First Financial hold significant market share in many counties of Texas:

  • Tom Green County:

- Population 110,000 (+6% since 2000 census)

- First Financial holds 18.75% deposit market share in Tom Green County

  • Johnson County:

- Population 150,000 (+19% since 2000 census)

- First Financial holds 19.5% deposit market share in Johnson County

  • Erath County:

- Population 37,000 (+14.8% since 2000 census)

- First Financial holds 34% deposit market share in Erath County (Best of any bank in the county)

  • Palo Pinto County:

- Population of 28,000 (+4% from 2000 census)

- First Financial holds 33.5% deposit market share in Palo Pinto County (Best of any bank in the county)

  • Taylor County:

- Population of 131,000 (+3.9% from 2000 census)

- First Financial has 48% of deposit market share in Taylor County.

Conclusion on First Financial:

In my opinion, First Financial is a posterchild to the potential success and competitive advantage community banks can have based on the Federal Reserve reports. The bank purposely leaves large competitive metropolitan markets to others to fight over, and has focused on more rural, fast growing areas where it is dominating. It is tough to argue against the company's stellar past results of earnings growth.

As a sidenote, reading through the company's latest 10-Q I found this bit:

Our policy is to pay dividends between 40% and 55% (as a payout ratio).

Most recently, the company had a payout ratio of 42%, so shareholders may be hopeful of a dividend increase shortly if the earnings growth continues.


Small community banks are under attack by the large banks. The number of small banks in America is on the decline and small, rural banks are facing the brunt of that attack.

A small bank's competitive advantage lies in its ability to reach out to rural customers that are off the radar of larger national banks, and that is exactly what these banks highlighted above do.

Because of this competitive advantage, small banks represent a great opportunity for individual investors. Small community banks can capitalize on specific community growth much faster than their large national counterparts, and remain largely out of the sights on Wall Street analysts.

The banks highlighted above possess that certain competitive advantage that the big national banks can never have. If ran and managed correctly, community banks can be more profitable than their national counterparts and reward shareholders with long term growth rates that investors in today's large national banks could never see.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.