Are Community Banks an Endangered Species?

ROAA-11-11-15.pngIf there was an endangered species list for U.S. corporations, a lot of community banks would probably be on it. The financial crisis and Great Recession are now distant memories, and the U.S. economy has enjoyed six years of steady, if unspectacular, growth, but many small banks are struggling and will probably have to get larger if they hope to survive, according to Steve Hovde, president and CEO of the Chicago-based Hovde Group, who spoke Tuesday at Bank Director’s 2015 Bank Executive and Board Compensation Conference in Chicago.

The banking industry itself seems to be doing well based on a variety of measures—profitability is still high, credit quality is much improved and tangible capital ratios are stronger than ever. But the news isn’t quite as good for banks under $1 billion in assets. Citing data from the Federal Deposit Insurance Corp. and SNL Financial, Hovde pointed out that the average quarterly return on average assets (ROAA) through the second quarter of 2015 was 1.12 percent for banks over $1 billion in assets versus 0.70 percent for banks with less than $1 billion in assets. The larger banks also had higher levels of noninterest income—1.16 percent versus 0.70 percent—and lower efficiency ratios, at 63.9 percent compared to 73.1 percent for banks under $1 billion. “The bigger banks are simply more efficient,” Hovde said.

Of course, the operating performance of some of the country’s largest banks isn’t all that impressive either, Hovde was quick to point out. In fact, the most profitable banks would seem to be in the $5 billion to $10 billion asset range, where they are large enough to have some economies of scale—particularly in the area of regulatory compliance—but aren’t so large that their size actually makes them harder to manage from a performance perspective. For example, banks in the $5 billion to $10 billion range had the industry’s highest ROAA in each of the last five quarters through the second quarter of 2015. “This seems to be the sweet spot for the industry,” he said.

Hovde expects consolidation in the industry, which has seen the number of banks fall from approximately 15,000 in 1990 to less than 6,500 today. Strikingly, banks under $1 billion in assets account for just 8.3 percent of the industry’s total assets despite accounting for 89 percent of all institutions. This sharp decline in the number of banks, combined with the significant increase in market share for banks over $1 billion, has been accentuated by the dearth of new bank formations since the financial crisis. “If we don’t get de novos going again, the trend line will continue and the numbers will keep getting smaller,” he said.

Hovde’s recommended solution for the challenges that small banks face today were to either grow through acquisition and thereby gain the kinds of efficiency improvements that could improve their profitability, or lobby the U.S. Congress and federal banking regulators to establish a two-tiered regulatory system that reduces the compliance burden for the smaller banks. Otherwise, concluded Hovde, “Community banks under $1 billion will become almost extinct.”


Jack Milligan


Jack Milligan is editor-at-large of Bank Director magazine, a position to which he brings over 40 years of experience in financial journalism organizations. Mr. Milligan directs Bank Director’s editorial coverage and leads its director training efforts. He has a master’s degree in Journalism from The Ohio State University.