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The Little Bank That Made Good

The big guys could learn something from a Long Island institution that reported only one new bad mortgage this year.

Brad Rock smiles as he tells the story of his first job at the Bank of Smithtown. Having impressed then chief executive Irving "Buck" Schechter with drive and thoughtfulness beyond his 19 years, Rock was given a summer job that paid $125 a week. "Buck took me into the basement of the main branch," Rock recalls, "and he said, 'All right, clean the basement,' which probably hadn't been cleaned since 1910," when the bank was founded.

Now the chief executive, chairman and president of the bank's parent company, Rock can appreciate -- from his spacious corner office overlooking the expressway that links Long Island to New York City -- how much he learned about the banking business by sifting through old paperwork 38 years ago. "I had to decide what to throw out and what to keep, so I would save interesting records and ask Buck to explain them to me."

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It's a shame that more bank executives don't spend a summer cleaning out the basement. Many of them could learn something from the aplomb and hands-on expertise with which Rock tackles every aspect of his business. And Smithtown Bancorp's performance figures would make even the most stone-faced of executives smile. Not only has the company (symbol SMTB) remained profitable throughout the credit crisis; it reported its 14th consecutive year of record profits in 2008, with earnings up 10%, to $15.7 million, or $1.55 per share. The company's return on equity (a measure of profitability) in 2008 was 17%, compared with an average of 6% for its peers.

Long-term success

Not even stellar results, though, could prop up Smithtown's shares in a market that, until recently, shunned bank stocks the way a hiker sidesteps poison ivy. The stock, which closed at $13 on May 8, has fallen 34% over the past year and now trades for a modest nine times its profits over the past 12 months. Long term, however, Smithtown has been a winner. Over the past ten years through May 8, the stock returned 12% annualized, trouncing Standard & Poor's 500-stock index by an average of 15 percentage points per year.

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The bank has done a marvelous job of not making bad loans. Less than one-half of 1% of its loans are not performing (that is, are in or near default). The average among its peers is five times higher, and Citigroup's comparable ratio is nine times higher. In the first quarter, Smithtown added precisely one mortgage to its roster of sour loans. "The Long Island real estate market has held up better than some places," says Mark Fitzgibbon, an analyst at Sandler O'Neill, and that partly explains the good numbers. Nevertheless, he says, "other Long Island banks have seen non-performers rise dramatically." Smithtown was deemed eligible for $38 million in capital from the federal government's Troubled Asset Relief Program, but the bank elected not to participate. Says Rock: "We're in our best of times."

You won't find any smelly subprime mortgages or ticking-time-bomb credit-default swaps on Smithtown's balance sheet. "The banking business, done right, is a very boring business," Rock says. Interest on loans generated 87% of the bank's $101 million in revenues in 2008. A small investment portfolio, account fees, and Smithtown's small trust, investment and insurance business units generated the rest.

Commercial mortgages account for the largest chunk of the bank's loan book, at 45%, followed by 29% in single-family homes and apartment buildings. A typical loan might be a commercial mortgage to a local small business for $1 million to $10 million.

Rock has spent most of his life in Smithtown, which blends the charm of a small New England town with the sprawling malls of a modern suburb. The town's star athlete in high school, Rock attended Boston College on a full football scholarship before transferring to the University of Connecticut, from which he graduated in 1975. He received his law degree from Cornell University in 1978.

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One summer while in college he decided it was time to get serious about his career. "I knew I wanted to be either a lawyer or a banker," he says. So his father introduced him to Schechter, who was both: president of the Bank of Smithtown, and head, with his brother, of a local law firm located a stone's throw from the bank's main branch, on Main Street.

From age 19 on, Rock shadowed Schechter whenever he wasn't in school. In turn, Schechter allowed Rock to sit in on high-level meetings and soak up everything he could about banking. By his late twenties, Rock had married his high school sweetheart, Tracy, settled down in Smithtown and made partner at the Schechter law firm, where he mostly represented outside banks doing business on Long Island. In 1990, after several years on the Bank of Smithtown's board, directors asked him to take on the top posts.

Back then, the bank's survival was hardly a sure thing. Schechter's health had steadily deteriorated after he was struck by a car a few years earlier. His decline coincided with the savings-and-loan crisis, which would ultimately claim nearly 750 thrifts. By 1990, the Bank of Smithtown had a festering pile of $16 million in nonperforming loans on its books -- an astounding 20% of total loans. Plus, says Rock, now 57, the bank was exceptionally wasteful. Its efficiency ratio, which measures expenses as a percentage of revenues, was "into the 80s," he recalls. "We were very fat and lazy."

So, once again, Rock found himself rolling up his sleeves to sort through messy paperwork. He worked through every bad loan personally. He also called the firm's 151 employees into one room for a town hall-style meeting, to lay out sweeping changes in the bank's compensation scheme. The bank would continue to pay salaries that were roughly average for a bank of its size, he told those gathered, but from that point on every employee would be eligible for substantial performance-based bonuses.

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The catch? Bonuses would be based on a significant team-based component, meaning that subpar performers would soon start feeling the heat from co-workers. The bank offered severance pay and benefits to those who chose to leave, "and basically, all of the dead wood resigned," says Rock. "That was the beginning of us becoming a much more efficient company." In the first quarter of 2009, the bank's efficiency ratio was just below 60%.

Rock has fine-tuned the bonus system over the years. He thinks it's effective at discouraging a "widget production" mentality, in which employees might be rewarded for every new account or new loan. Instead, it emphasizes such things as deposit growth and loan quality.

Shortly after Rock took charge, he also initiated weekly meetings at which the bank's loan officers stress-test all of the loans they're currently considering for approval. Says Rock: "If you do that once a week for ten years, which is about how long our group has been together, then everybody starts to understand what we're looking for and what we think is a weakness" in a property or a borrower.

Explosion in branches

Today, the company headquarters is located in Hauppauge, a short drive southwest of Smithtown, at the entrance to the country's second-largest industrial park -- a 1,400-acre asphalt maze hugged by freeways. It's an impersonal environ, but inside the offices are open and sociable.

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The staff has good reason to be cheerful. Disconnected from the carnage that has devastated banking giants just 40 miles to the west, the Bank of Smithtown seems to be entering its heyday. The company is actually hiring new staff so rapidly that, Rock confesses, he no longer knows the name of each one of his 269 employees. Keeping up with the rapid growth in the number of branch offices is challenging enough. The bank opened four new branches in 2008, and its first office in New York City early in 2009, bringing the total roster to 21. Construction has already begun on the next four branches, and seven more are in planning stages.

Deposits have also been growing at an explosive pace. In 2008, deposits were up 38%. In some newly opened branches, Rock says, deposits have been gushing in at $1 million per day. Much of that, he's noticed, is from customers worried about or disgusted with the megabanks. "Customers vote with their feet," he says.

Rock can wax poetic about customer service with a corniness that would make George Bailey proud. But that works when all of your employees buy into it, as Bank of Smithtown's staff seems to do wholeheartedly. "We try to instill in all of our branch managers a sense of entrepreneurship in their business," says chief retail officer John Romano. That way, he explains, branches can take the initiative in tailoring their approach to meet the needs of a specific community or customer. On occasion, Romano says, his bankers refer potential clients to competitors if Smithtown doesn't have the product a customer wants. "When a customer walks out with a good experience, he will tell a dozen other people about it," he says.

Deposit growth may also reflect the popularity of Smithtown's new branch format. If the buildings didn't have the word bank written on the outside, you'd never guess that's what they were. There are no half-foot-thick glass walls, no tellers and no lines. Instead, you'll find cushy chairs, laptops, gentle lighting and even coffee bars. And you'll never find yourself sitting across a representative's desk. By design, customers always sit next to reps so they can see what's on the computer screen.

Rock admits that he's been approached by larger banks inquiring about buying Smithtown, and more recently by struggling firms hoping to sell themselves. "Rock is certainly capable of running a much larger institution," says analyst Fitzgibbon.

But Rock has waded through too many bad assets in his career to want to assume responsibility for any potential basket cases. And, he figures, even if Smithtown were to merge with another healthy institution, cultural differences might dilute its mojo. "I'm always open to anything I think will produce more long-term value for the shareholders," he says. But looking back on his stock's superb record, he wonders how anyone could make the case that investors "would be better off owning another bank's shares rather than sticking with the ones we've got. Nobody can really match us."

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