Many analysts are predicting that the pace at which community banks disappear will increase. We are already down to less than 7,000 banks from 12,000 not that long ago. While community bank consolidation will continue, the pace may be slower than expected and at the end thousands of community banks (and their community oriented credit union brethren) will continue to demonstrate their value to consumers and businesses.
Multiple factors are pushing toward consolidation: * The value of scale. Years ago some experts suggested that scale was unimportant in banking. In fact in many areas achieving economies of scale is critical to operating efficiency, particularly as IT and compliance costs rise.
* Limited and oftentimes slow-to-market product offers. Community banks lack the scale, capital, and staff to hire an experienced product development staff. They need to depend upon their vendors for products; unfortunately, in some cases the vendor rather than the bank determines the product set and the timing of technology-based offerings.
* Lack of growth. In the past, many community banks depended upon commercial real estate for asset growth. Both CRE and consumer earnings have been reduced, leaving many smaller banks struggling to determine how to grow and without the resources to do so.
* Age. Both the owners and the customers of most community banks are baby boomers or older. Many community bank family owners note that the next generation has no interest in taking on the responsibility of a bank or even in living in the rural or small town in which many community banks operate.
* Poor management. Today’s competitive environment features more demanding customers, revived big banks, new non-bank competitors, and continuous technology improvements. Facing these challenges requires a different breed of manager, someone who is highly engaged and more sophisticated than in the past. Many current community bank managers lack the experience and savvy required for the future; they started the bank when the industry was very different and the pace of change has stretched their capabilities.
* Non-profit motive. In recent months I have had the opportunity to speak with the heads of many community banks. Often their leaders talk about why they formed the bank; in most cases profit was not the sole or even the main motive. The goal of serving the local community and providing local decision making often takes precedence over the bottom line. I have even heard owners describe their banks as a place to employ their families. Many community banks remain paternalistic; they are great places to work for locally based personnel, but, frankly, would not meet the needs of the highly ambitious or those motivated by the need for money. Those banks generating marginal profits will struggle to remain profitable at all, given the higher costs and capital requirements that banks face.
One other factor, one that many bankers usually mention first, concerns the negative regulatory environment. The government and regulators proclaim that they love community banks but, whether implicitly or explicitly, they are doing all they can to stick a knife into the heart of these banks. Not all regulators are running wild, but enough are. Every bank we know has had to increase its compliance and legal costs, no matter their past performance. Big banks have the scale to take on these additional costs with less bottom line impact; smaller banks do not. That said, yesterday at an airport I ran into a senior banker at a top ten bank (with an excellent track record) who commented on what he viewed as the unreasonable demands of the regulators. Community banks simply cannot meet the increasing demands of regulators without suffering reduced profits.
Will community banks simply disappear? Many of the smallest ones are already seeing the need to bulk up for survival. Whether the minimum size for profitability requires assets of $250 million or $1 billion, those below this level will slowly strangle in the face of increased costs and an inability to compete. However, many investors will remain involved with their local banks because of their commitment to their community and belief that a community bank can provide a style of service unavailable from bigger players. Community banks view the top 10-15 banks as providing a continual prospect pool.
While massive consolidation will occur, its timeframe may be longer than most analysts project. One indication of this comes from a poll of bankers at the recent Bank Directors conference that revealed that far more community bankers saw themselves as buyers rather than sellers. While many of these bankers were deluding themselves, these results indicate that a reality gap exists at many banks. Further, with improving risk performance at many banks, no immediate pressure for sale exists. Slow growth community banks can go to sleep for a significant period of time; community banks with rising bad loans cannot.
The better community banks are acting: looking at acquisition opportunities; selectively building lending skills in new areas; linking up with third-party product provider; actively cooperating with their fellow community banks to create scale. They are both getting bigger and becoming more specialized in order to compete. Thousands of smaller banks will disappear over the next five-ten years. However, at the end of the consolidation tsunami, thousands of other community banks, more competitive and better managed, will remain.