First of three parts
The midtier bank seemed destined for the endangered species list after the meltdown, but a fresh crop of small-bank survivors are eager to fill the void.
From 2005 to 2010, assets at such banks, loosely defined as having $10 billion to $100 billion of assets, shrank nearly 30%, to $2.6 trillion, according to data from the Federal Deposit Insurance Corp. Larger banks grew by 49% over that time, in terms of assets, and smaller competitors managed to hold their own.
A rising number of industry observers are convinced that the midsize category could enjoy a renaissance of sorts, if smaller banks are able to tap into an economic recovery or grow through acquisition.
As it turns out, size still matters — perhaps even more so now than it did before the industry came under fire. But getting bigger certainly will have its own challenges and risks. Building scale now goes beyond having a pervasive deposit base or expansion into high growth markets. The Dodd-Frank Act is adding a new dimension to the way banks view scale.
"The pendulum of regulation is swinging, and we are entering a world where scale is becoming important in a way that we haven't seen in the last two decades," said Scott Siefers, an analyst at Sandler O'Neill & Partners LP.
All banks must adjust their structure to handle rising costs, but some now on the low end of the midtier scale are uniquely poised to buy smaller institutions that cannot absorb the costs.
"For someone our size, the new regulations become a nuisance, but we already have a significant compliance department in place, so it will become an additional expense," said Monte Redman, the president and chief operating officer of the $18 billion-asset Astoria Financial Corp.
"For smaller shops, it is going to be a major burden," Redman added. "When people used to talk about the need for economies of scale, they were talking about back-office operations. Now it is about dealing with the regulations."
Analysts said that an expected wave of consolidation will not be one-sided. Though smaller banks will search for partners, the remaining midsize banks are just as much in need of ways to offset the additional cost of regulations.
"The midtier banks are not going to be immune to the higher costs," Siefers said. "They are going to need additional revenues, too, and efficiencies are getting tougher to get."
To William Cooper, the chairman and CEO of TCF Financial Corp in Wayzata, Minn., a new regulatory environment is more than just burdensome; it is enough to change his view of banking.
"I've never believed that in a regular operating environment that scale mattered. There was never any data to support that bigger banks had higher return on assets or return on equity," Cooper said. "I've always operated under that theory, but this layers in a cost on to the banking business that makes it subject to economies of scale."
With $17 billion of assets, Cooper considers TCF a small bank that must get larger. He said the target is unclear since much of the costs are still being figured out, but he said banks in the $40 billion to $50 billion range might be in the right position. TCF has largely expanded organically, but Cooper said he is rethinking that, too, if not reluctantly.
"We started most of our businesses from scratch," Cooper said. "All of this does open the question — and I am still not positive of the answer — if acquisitions are becoming more efficient than de novo expansion."
In the pre-crisis days, revenue growth was easy to find. As loan growth remains soft, it is considerably more challenging to grow revenue. Analysts said that acquisitions might be the only way to build assets and revenue.
"All banks are dealing with customers deleveraging and with expenses going up, so you have two arrows moving in the wrong direction," said Peyton Green, an analyst at Sterne Agee & Leach Inc. "Scale was much more organically intended in the past. Now, you increase your market share by getting rid of your competitors."
Redman, who is set to become Astoria's chief executive this summer, said his company is interested in talking to smaller community banks that are looking to sell to a larger institution. He added, however, that organic growth prospects are rosy for the Lake Success, N.Y., company, which specializes in jumbo mortgages.
Since early 2008, Astoria has shrunk by nearly 20%, to $17.71 billion in assets at March 31, due to an increase in the conforming loan limit. As that drops, Astoria is set to recover. The company has also hired a team to expand mutlifamily and commercial real estate mortgages. Redman said the goal is to start lending in that arena by the third quarter and "be a major player" by 2012.
"We are ready to start growing again," Redman said. "And we think there are a lot of opportunities for us out there."
Other banks seemed to share his eagerness. As they describe it, they are in the ideal position to thrive in a new banking environment. Big banks have become bigger and less responsive, and small community banks are hindered by higher liquidity and capital requirements, making the middle of the barbell the sweet spot.
"We believe that we should be able to excel in this environment, and by excel, we mean as a provider of loans and of retail banking products that are in touch with the needs of our customers and the markets we serve," Robert Wann, the chief operating officer at New York Community Bancorp Inc., which has $41 billion of assets, said in an email.
"We have the liquidity and the capital to serve our depositors and borrowers well ... and the capacity to continue growing through acquisitions," Wann added. "The only challenge to us with regard to expansion would be the $50 billion threshold, which would place more restrictions and supervision on us from a regulatory point of view."
Several slightly smaller banks, such as First Niagara Financial Group Inc. in Buffalo, N.Y., and Hancock Holding Co. in Gulfport, Miss., have already catapulted themselves into the midtier through acquisitions. Other acquisition-minded companies that are teetering around $10 billion of assets could make the transition over the next few years, analysts said.
"There are a lot of names that are coming out of the crisis stronger than before, and it is going to push some of the larger community banks into this midrange and it is going to push some of the midrange guys to get even bigger," Siefers said.
With all the opportunities that will be presented to this emerging group of banks, analysts said the companies need to take a more methodical and studied approach to expansion, not only to get the most out of any deal but also to reduce risk.
"Scale before might have been having the most branches and staying open the latest, but we are in a different environment," said Terry McEvoy, an analyst at Oppenheimer & Co.
"They need a more focused strategy. I think they've figured out that they can't be all things to everyone, so they need to decide where they can generate the best return," McEvoy added. "That might be to focus on your own backyard."
Siefers said that the pain of the credit crisis is still fresh and should keep companies disciplined, at least for awhile. "I think everyone has learned some important lessons, but unfortunately we can sometimes have relatively short memories," he said.
