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What Matthew Yglesias Should Have Said About Small Banks

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In a much maligned Dec. 2 blog post entitled "America's Microbank Problem," Slate's business and economics correspondent Matthew Yglesias claimed that, even with all the banks that have merged or closed, the U.S. still has too many banks: 6,891 by his count. In his opinion, most are tiny, not especially well-run, and tough to regulate. He'd prefer to see the total number of banks be in the dozens rather than the thousands.

This brief, 600-word article has created quite a stir among those in or around the banking business. American Banker has already run two rebuttals.

The publication's Washington bureau chief, Rob Blackwell, wrote the first one on Dec. 3. He pointed out that 515 banks are on the Federal Deposit Insurance Corp.'s "problem bank" list, just a "sliver" of the overall number of institutions. Also, the vast majority of community banks survived the financial crisis, which nearly defeated many of "the best and the brightest" (a phrase Yglesias used with a sarcasm that his detractors seem to have missed). And Blackwell thinks that small banks are in fact easier to regulate. AB Community Banking Editor Paul Davis' article on Dec. 6 gave examples of how specific community banks showed commitments to their communities and strove to innovate, and posited that such commitment and innovation would disappear if all the little banks were gobbled up or closed.

Those who follow banks know that the U.S. has so many of them because of its history, not by choices made in today's modern economy. Like the QWERTY keyboard on my computer, the U.S. banking system was designed for another time, and it's hard to argue that if we were to design either today from scratch that we'd choose what we have.

Of course, we can't redesign the system from scratch. Does it matter that today's system offends Yglesias' sensibilities? That depends. If a community decides to form a bank to serve the needs of local businesses and consumers (or if their descendants decide to keep such a bank intact over the years), they should have the right to do so, even if that means we end up with lots of banks. And the owners are under no obligation to sell if the bank isn't all that profitable; value maximization isn't necessarily a goal.

Fine. But the fact is that the lion's share of banking assets are held by publicly traded banks, not private ones. They exist to earn their shareholders most of whom have no personal attachment to the banks' communities an attractive return. There are currently over 900 publicly traded banks and thrifts with a market capitalization over $10 million. These banks have $12.4 trillion in assets and $1.4 trillion in market cap. Yes, the four largest make up 54% of aggregate market cap, but that still leaves 46%.

The disparity of operating performance across these smaller banks is astounding. Intentionally or not, Blackwell muddles this very important point. Twenty percent of those 900 or so institutions have returns on average tangible common equity over 12.3%. Five percent are over 17.2%. The bottom 30% post returns below 5.7%. Is 5.7% acceptable? Perhaps it doesn't look horrible in absolute terms in today's ultra-low interest rate environment, but it is horrible any way you cut it.

Bank CEOs are competitive people. Some think of themselves the way athletes do, made better through intense competition. But in sporting events, there are clear winners and losers, because there are rules as well as a clear definition of what "winning" is. Consistent losers eventually depart the field.

Is that true in banking? Some weak banks do the same things that strong banks do, but seemingly without understanding why. They undertake acquisitions, but they pay too much, fail to deliver on deal promises, and yet remain convinced of their own prowess. They are willing to discuss a sale, but they hold out for prices unwarranted given their operating performance. They repurchase shares, but without regard to buyback price and with the hope that it will signal optimism, generate EPS growth or improve ROE. Better times are always just around the corner. If only the yield curve weren't lousy, or regulatory compliance costs or consumer uncertainty so high. Or whatever. It's a skill to be able to bend reality to serve your purposes.

It would be a shame if the self-righteous indignation some bankers and their lobbyists appear to be displaying in the wake of Yglesias' imprecise article distracted from these very real issues. The time has come for bank stock investors and public bank CEOs to agree on how to define success, and what should (and just as importantly, shouldn't) happen if it doesn't materialize.

Who will take the first step?

Harvard Winters, a former investment banker, writes research on banks.

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Comments (8)
All these "are there or aren't there too many community banks" articles are written by authors who know nothing about the community banking industry. They have no clue what it is to be the owner of a privately held community bank, nor the culture, climate, nor atmosphere in which over 6,000 community bankers live and work. They wouldn't know a community banker if he/she walked up to this author or Yglesias and smacked them in the face. These authors opinions are tainted by their own motives and self-interests, not on their actual experience within the industry.

It is just another article dripping with arrogance. In a free market system, business owners decide how to measure success. Community bankers have every right to determine their own ROE in exchange for the satisfaction that comes from total return, which by the way, includes quality of life!
Posted by commobanker | Thursday, December 12 2013 at 11:41AM ET
Commobanker is right on target! Congrats!
Posted by frankarauscher | Thursday, December 12 2013 at 12:08PM ET
This is a well reasoned article. The simple fact is, we will continue to see fewer and fewer community banks over time. Wishing it so, or denying its inevitability, is wasted effort.

As a former community banker, I would suggest that if a community bank wants to prosper, it needs to do something better than your competitors that is highly valued by its community. And serving your high net worth senior citizens will only drive you into obsolescence as they pass and the younger generation does not ask for or desire the personal touch community banks pat themselves on the back for.

Far too many community banks do not adapt, innovate, reinvest, or select the right talent. Getting good people is the ultimate key to success, but it is hard to attract and retain them using such as small asset base. This is why the survival effect will continue to obsolete the weak, and drive banks below $1 billion in assets into the history books.
Posted by Capital | Thursday, December 12 2013 at 12:25PM ET
Thanks for the feedback.

Commobanker, as you made no attempt to refute my observation about low ROEs, or to offer possible justifications, I assume you've conceded my point. The fact that you'd rather attack me personally (calling me arrogant, questioning my motives, saying I wouldn't recognize a community banker) implies to me that I'm on to something. And I really don't think institutional bank stock investors spend a lot of time thinking about bankers' quality of life. Nor should they.

No one likes to receive a bad report card, but it seems indisputable that some banks deserve them. Why not fix the problem, rather than argue with the grader?
Posted by Harvard Winters | Friday, December 13 2013 at 3:26PM ET
With regard to low ROE's, look at the 50 years prior to deregulation and you will find no major banking industry needs for taxpayer assistance. With deregulation in the early 1980's, the opportunity to ramp up those ROE's, with the additional RISKS need to do so, have resulted in a number of situations where Congress (representing taxpayers) has had to intervene to bail out the atrocious, irresponsible, and incompetent behaviors which provided high ROE's for the benefit of bank executives via buyout premiums, exec comp, etc. with little but financial set backs and devastation for the average American. Just one specific example - I dealt with the heads of the eight credit card banks that control most of the market. Individually, they knew that were engaged in predatory lending, abuse, and returns beyond historical risk premiums but none were willing to reverse the trend specifically because they were afraid that equity analysts would blast them and it would jeopardize their jobs and compensation. It took the Card Act to stop much (but not all) of the abuse.

Deregulation and consolidation of the banking industry (with higher ROE's) has not been good for the bottom three quintiles of the classes. With 4 banks controlling half the bank market, there is a "defacto" start of an oligopoly which can never be good unless it is heavily regulated especially when it has no benevolence in top management which is required to be solely mercenary as it is dog eat dog in that strata.
Posted by frankarauscher | Sunday, December 15 2013 at 11:12AM ET
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