Why Regional Banks are the Right Size Right Now

If all you knew about banking was how much of it rests on customer relationships and efficient management of costs, then the existence of large regional banks would be puzzling.

You would wonder how an institution with a regional footprint could on the one hand outmaneuver community banks (any of which in theory should have a better grip on its local market) and on the other hand compete with the national brands, with their deep pockets for advertising and technology.

You would surmise that the small number of U.S. banks with assets of $20 billion to $350 billion-there are only about three dozen of them, in an industry with more than 7,000 institutions-never intended to be in that bucket. Some, you would suppose, were essentially community banks that had grown too big for their britches, while others were aspiring national players with growth plans (or exit strategies) that had somehow stalled out.

But this view would ignore many, more nuanced realities of banking, some of which convinced regionals a long time ago that they had a rightful home in the industry ecosystem, and others of which are just beginning to give new validation to that idea.

More than just surviving, many regionals are thriving now. In the post-crisis era, they've achieved a Goldilocks compromise on size: not too big and not too small.

They are able to handle new compliance burdens more easily than community banks can, and able to ward off many of the legal, reputational and regulatory challenges hampering the biggest banks. As Fifth Third CEO Kevin Kabat observes, "No one is talking about breaking us up."

Regionals also are benefiting from a democratization of technology, and some are using their nimbleness relative to the biggest banks to show real innovation in products and processes. What's more, the healthiest of the regional banks are poised to be effective consolidators of smaller banks as the ranks of willing sellers begin to thicken. And while they scour the lower end of the size scale for buying opportunities, the regionals can continue to capitalize on the mistakes of the national banks, which in many ways have failed to live up to expectations about the efficiencies their breadth and heft might bring, Bernstein Research analyst Kevin St. Pierre says.

"You had decades where the bigger guys could have gotten their act together. They had lower capital ratios and should have been able to price for market share gains, and they really didn't do it. So now we're in a whole new world where the bigger banks are going to be holding more capital, and to earn the same spreads they're going to have to price down on deposits and price up on loans relative to banks that are going to be running with 50 basis points to 100 basis points less on capital," says St. Pierre.

The banks in the next tier, the midsize to large regionals, have, St. Pierre says, "enough scale to weather the regulatory changes and compliance with the Dodd-Frank Act-it doesn't hit their profitability nearly as much as a small bank-and they still have plenty of runway to roll up some of the community banks, as those banks realize it's not just the low-rate environment that's hurting them. It's a good sweet spot."

The conclusion is one that regional bank executives have been pushing for some time. But their case has been bolstered in recent years.

Fifth Third's Kabat says he has altered his line of thinking about how his bank stacks up against what he calls "the trillionaires"-banks with $1 trillion or more in assets. For starters, he says, "technology has become scalable. It's no longer a key differentiator in terms of size. .. And our model and our businesses are less complex than the trillionaires', and in this regulatory environment, that's an advantage."