Over the last few weeks, I have heard a number of industry pundits lament about the future of the community banking sector of the financial services industry. To be honest, “whining” is a more appropriate description.
• “We have too much regulation.”
• “We can’t keep up margins.”
• “We do not have enough capital for Basel III.”
I do not mean to sound blasé about significant issues in the community banking realm.
Regulation, interest rates, and capital are all items that impact bank operations and should be addressed strategically.
That said, the reality is the community banking sector of the financial services industry is doing pretty well. It has a darn good future.
So why all the sad noises?
Let’s look at reality
I totally discount all of those “experts,” most of whom are trying to get you to sell your bank, saying your bank cannot survive unless it is “x” size in total assets—“x,” of course, being approximately twice what you are now.
The issue is not and has never been one of survivability. Even the smallest banks in rural areas have survived and will survive just fine.
The question is ultimately one of profitability. Would it be more profitable if we did not have the current regulatory burden? Absolutely. Would it be more profitable if we had a better net interest margin? Of course.
Does that mean community banks will not survive? Absolutely not.
Looking over the history of the community banking sector, it looks like a roller coaster. Great times, followed by less great times, followed by a Great Recession, followed by more great times, which are then followed by less great times . . . you get the picture.
The emphasis by the regulators is likewise up and down—safety and soundness, compliance, no capital, too much capital, no profitability, too much profitability, and not enough growth.
In reality, most of us have worked through those issues over the last 30 years and will continue to do so.
So, the question is not “Will we survive what is going on currently?”
The question is, “How do we improve profitability amidst the changes?”
“So Jeff, why are banks going away?”
Again, my intention is not to downplay issues in the industry.
But there will always be issues. When I began in this business in 1973, there were 14,000+ charters. We are now down to 6,000.
What is causing that consolidation? Is banking a “bad industry”? No.
Consolidation has been primarily driven by changes in state laws. A lot of states went from being unit bank states (that is, there were no branches) to allowing state-wide branching. Likewise, the laws used to prohibit interstate banking, which meant banks could not cross state lines under their current charter. The industry moved to interstate banking consortiums, to full interstate banking, to full interstate branching.
So, of course there has been consolidation. Does that mean we are going to consolidate out of existence? Not a chance.
Let’s look at some “sub-species” of community banks:
1. Subchapter S banks: In the community banking sector, approximately 3,000 of the 6,000 banks currently in existence are organized as Subchapter S corporations. This, by definition, means they are fairly closely held. These institutions are not going to go anywhere as long as there is ownership transition and management succession in place.
By the way, most of these institutions are simply cash cows for their shareholders with return on equity in the teens and lots of excess after-tax cash flow. No “expert” anywhere could convince me those institutions will not survive.
2. Public banks: Even community banks that are public companies will do fine as long as they get some benefit out of that public status. This generally means sufficient market liquidity for their shares and access to the public capital markets. Those institutions will continue to grow, increase their economies of scale, and remain profitable.
In other words, they will be just fine too.
Be careful what you let folks sell you
In my opinion, the whole death/terminal illness of the community banking industry is nonsense.
It seems to be promoted by groups with select special interests that would love to have you combine your bank with some other bank so the group can make some money off of the deal.
Don’t get me wrong—yes, our consulting firm and our law firm advise and consummate a significant number of community bank acquisitions every year.
The difference is, we do not approach those deals with the idea that you must sell.
We approach it with the idea that you need to remain independent. If, however, the sale is simply in the best interest of the institution and its shareholders, then we will do our best to structure a deal that maximizes value for our client.
The bottom line is I strongly believe in community banking. No amount of regulation or downward-pressure on margins will ever convince me that the industry is at death’s door.