Too small to fail: while the behemoths of Wall Street stumble and fall, humble local banks are doing just fine, thank you. Their surprising resilience holds a key lesson for twenty-first-century global finance.

AuthorLongman, Phillip
PositionWall Street

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When Paul Hudson, the chairman and CEO of Broadway Federal Bank in Los Angeles, speaks of the current financial crisis, he sounds altogether placid. 'It s going to be difficult, because everybody participated in this low-cost-credit, high-value-asset scenario," he says. "But I'm not overly stressed." It helps that his own bank is doing fine. Broadway Federal, founded in 1946 to provide loans to the growing African American community of Los Angeles, is a small institution with five branches located in middle-class, largely black neighborhoods of the city. It has eighty-four employees, assets of $390 million, and a loan portfolio divided more or less equally among single-family homes, apartment buildings, churches, commercial real estate, and small businesses.

Aesthetically, Broadway Federal's branches are more evocative of 1972 than of 1946--copious concrete, cheap terrazzo, fluorescent lights, clunky logo. But in 2008, an old-fashioned look--even one from the '70s--can be an advantage, for it suggests old-fashioned banking. While Broadway Federal may have been less adventurous or less profitable than some of its competitors over the past few years, today it enjoys the traditionalist's compensation of being both sane and solvent. In fact, according to data from the Federal Deposit Insurance Corporation, Broadway enjoys a substantially higher return on equity and assets than J. P. Morgan does. (It also has a lower proportion of nonperforming loans.)

Broadway Federal's story isn't exceptional. Easily overlooked amid the crisis of big banks today, small-scale financial institutions are, for the most part, holding steady--and sometimes even better than steady. According to FDIC data, the failure rate among big banks (those with assets of $1 billion or more) is seven times greater than among small banks. Moreover, banks with less than $1 billion in assets--what are typically called community banks--are outperforming larger banks on most key measures, such as return on assets, charge-offs for bad loans, and net profit margin.

One reason community banks are doing so well right now is simply that they never became too clever for their own good. When other lenders, including underregulated giants like Ameriquest and Countrywide, started peddling ugly subprime mortgages, community banks stayed away. Banking regulations prevented them from taking on the kind of debt ratios assumed by their competitors, and ties to their customers and community ensured that predatory loans were out of the question. Broadway Federal, for its part, got out of single-family mortgages when they stopped making sense. "A borrower comes and asks, 'Do you do interest-only, no-downpayment, option ARMs?'" recalls Hudson, with a chuckle. "No!" The bank focused instead on expanding its reach to niche borrowers, such as local churches.

Today, however, even as many financial institutions are refusing credit, Broadway Federal quietly continues to extend it. One recent recipient was a nonprofit called the Domestic Violence Center of Santa Clarita Valley, which needed $40,000 as a bridge loan in the midst of state budget holdups. Nicole Shellcroft, the executive director of the center, says that no large bank had been willing to lend the money. Under the terms worked out with Broadway Federal, though, the domestic violence center was given a three-month loan for a fee of $900 in interest. "Our board was really happy with the terms," says Shellcroft. "It was actually better than a line of credit." Beyond offering special loans, Broadway has been attracting customers by being accommodating and personalized. "I can proudly take in my money daily, deposit it, and get access to my money directly," notes Angela Dean, founder of DeanZign, a local fashion company. Dean recently switched over from Washington Mutual to Broadway Federal for her business checking. She's not alone. In 2007, before the crisis had properly struck, Broadway Federal experienced $7 million in net deposit growth. This year, as of June 30, says Hudson, net deposit growth was at $25 million.

Community banks come in different forms. Some are "country club" banks for the wealthy. Others are "community development banks," such as Chicago's South Shore National Bank, formed as part of an idealistic effort to serve the "unbanked" in blighted neighborhoods. And many, like Broadway Federal, are small-scale banks, credit unions, and thrift institutions, often with origins back in the Progressive era and earlier, when working-class men and women began pooling their savings together and making loans to one another in order to overcome the discrimination they faced from...

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