Community Banks Act Local, Invest Global

As digital transformation has swept through financial services it has forced bankers to continue asking: what does it mean to be a community bank? Being a community bank was a lot more straightforward when your branch in the center of town was the hub for commerce. Now, most consumers and businesses bank digitally, at least in part.  

All community banks have digital experiences. Some launched national brands. Many have become infrastructure for fintechs, who are not in their community and serve national and global customers. Technology has enabled community banks to evolve, deliver expanded value to customers, and compete against new local and global threats.

The trends show that the evolution has not been universally positive for community banking as the number of banks and credit unions continues to contract. That does not mean, however, that being a community bank is a losing strategy. There continue to be countless examples of banks that are deeply embedded in their communities, leveraging their technology and geographical advantages to maintain strong relationships with business and retail customers (checkout the Alloy Labs membership for examples!). Their unique knowledge about the locality, the industries, and the businesses can continue to serve as an advantage over national and digital-only challengers, as long as community banks remain competitive on cost and experience. 

The competitive landscape was much more straightforward when your only threats were the institutions down the street who were executing the same strategy. National banks have deeper pockets to invest in R&D and acquisition and can achieve better economies of scale across larger client pools. Neobanks can tap venture capital to scale while unprofitable. Vertical software supercharged with embedded finance can reach scale while serving niche segments with alternative value propositions and business models. If “being in the community” is the community bank advantage, then community banks must maximize it and overcome the risks that come with being concentrated in specific geographies. Disaster recently struck Southern California with wildfires, turning thousands of homes and businesses to ashes; the impact on the region will be felt for years. Last year, hurricanes led to flooding and devastation across communities in Florida. And now, the southeast United States is experiencing winter weather on par with northern states. Communities across the country are at risk of a wider range of weather events that place these regions under new forms and levels of strain. 

Capstack is a bank-to-bank loan marketplace that enables financial institutions to share participation in single assets or buy & sell whole loan portfolios to diversify their asset mix. 

In a participation, when a bank originates a loan, rather than funding the entire asset off their own balance sheet, they can list the opportunity on Capstack and invite other regulated financial institutions to invest on the terms offered to the customers. The participating bank gets the benefit of investing in an asset originated by an FI that will continue to service the loan and maintain their “skin in the game”. This newly formed loan club could also share in the deposits and/or other cross sell opportunities.  

In a whole loan trade (where the market is roughly $1.5 trillion), the originating bank can list the loan(s) on Capstack, where it is visible to more than 200 banks, credit unions, and non-depository institutions currently. Interested parties can then negotiate directly on the platform to reach a mutually agreeable price without a broker.  Growth and/or liquidity can be solved much more quickly and less expensive.  

Here's an example of a successful transaction originated by Alloy Labs member Coastal Community Bank:

In this transaction, two previously unconnected banks utilized Capstack's platform to fulfill their respective needs. One bank sought to optimize its liquidity by reallocating capital, while the other aimed to achieve growth. The transaction was seamlessly executed on the platform, with executives, credit teams, and back-office staff collaborating and leveraging Capstack's credit library and loan maintenance tools.

What makes Capstack exciting is the potential unlock it brings to the community bank business model. First, it creates opportunities for banks to address the hyperlocalization risks, like the ones discussed above. Community banks can continue to invest and originate locally, while also inviting participation from other banks and then reciprocating participation in assets across geographies. 

Capstack could also help banks overcome their biggest impediment to growth: slow deposit growth. Capturing new deposits is not a new challenge (it’s not actually a challenge at all as the real challenge is acquiring customers and then encouraging them to deposit with your bank, but that’s a separate discussion).  Long before Silicon Valley Bank failed and deposits rushed to the largest banks, before COVID and the CARES act injected trillions into businesses, community banks had been searching for new sources of deposit growth. Without it, their ability to grow has been stymied and their customers’ needs may continue growing without the bank able to service them.

Capstack offers banks a path to continue growing and serving these clients, by originating more loans, selling portions of existing assets or inviting participation for new assets, while maintaining and expanding the customer relationship, even if the asset exposure to a customer hasn’t increased. It also allows smaller banks to service larger customers or underwrite larger loans that might historically go to regional or national bank. A community bank can support a company from incorporation to national scale.

Thinking more broadly,  Capstack is a tool for dealing with concentration risk of any kind. Banks with geographic, industry, or asset type concentration can diversify their exposure and build a more resilient portfolio. Similarly, assets that are sought out but inaccessible for financial institutions can become unique opportunities for community banks properly positioned within those geographies or industries. This would enable more banks to execute niche strategies, like focused neobanks or vertical SaaS providers. 

Capstack is a simple marketplace connecting banks but what it enables could lead to rapid evolutions in bank business models. We’re proud backers via the Alloy Alchemist Fund.