What a difference a major economic meltdown makes.
Not long ago, the conventional wisdom about the future shape of the banking industry was clear: assets were going to concentrate, barbell-like, at the extreme ends of the asset-size spectrum, as large banks and community banks exploited their specific competitive advantages to the detriment of the midsize ones.
But now, community banks are struggling to compete as they contend with increased regulatory requirements. And their larger brethren face serious challenges of their own as new restrictions on interchange fees, proprietary trading and, potentially, size itself, threaten their profits.
The result is that the banking industry has a new sweet spot, and it's right in the middle. Banks with between $1 billion and $10 billion of assets are large enough to absorb increased regulatory costs, but small enough to avoid many of the restrictions facing the largest banks.
They are also, according to analysts, well-positioned to take advantage of an expected wave of consolidation among smaller banks. With more than 800 mostly small banks now on the Federal Deposit Insurance Corp.'s problem list, the number of potential takeover targets is large and growing.
Andrew Stapp, an analyst at B. Riley & Co. in Haverford, Pa., follows midsize banks almost exclusively and he says it's the banks in the $1 billion-to-$10 billion-asset range that are attracting the most attention from investors these days. "Investors are sensing that we are getting closer to the point of consolidation in the market in the sector," he says.
It took a combination of multiple factors to bring the industry to this point, says Donald M. Raftery, a managing director with Greenwich Associates in Stamford, Conn.
In addition to the negative press surrounding large banks that accepted money from the Troubled Asset Relief Program, and the added scrutiny they'll face under the recently passed Dodd-Frank Act, Raftery says many large institutions are not delivering the type of service that small- and medium-size business customers expect.
"What we are seeing right now is that many companies are moving away from the largest banks and toward super-community or small regional banks," Raftery says.
"Many of those organizations, as times got tough, had to make cuts and they cut deeply-especially in their client-facing staff," he says. "Many of these largest institutions have tremendous efficiencies they have created, but the amount of touch and true relationship management they offer is very modest compared to the smaller banks."
Also, he says, customers are beginning to see changes in pricing at larger institutions. Prior to the economy's plunge in 2008, businesses that carried significant balances or generated sufficient transaction volume had some fees waived. But as balance and transaction volume cross below certain thresholds, he says, fees start to kick in.
"Business owners are saying, 'these fees are starting [to come] through at the time when I can least afford it.' That is reinforcing some of those trust issues," says Raftery.
While community banks are still providing that high-touch service to small businesses, they are facing their own problems.
The constant complaint of the community banker is that regulatory burden is overwhelming, and while many industry observers have taken those claims with a grain of salt in the past, today they are becoming hard to ignore.
Chris Cole, a senior vice president and senior regulatory counsel at the Independent Community Bankers of America predicts a new "tsunami of regulation" will arise from the Dodd-Frank Act, further weighing down small banks with compliance requirements.
But a potentially larger problem, he says, is the difficulty of attracting new capital amid investors' concerns that increased compliance costs will eat into returns.
"The examiners have downgraded so many banks that the community banking industry has really taken the heat on this. In many cases they have demanded that the banks raise capital, and many privately held banks have found that going back to their shareholders is tougher," Cole says.
Jack Hartings, the chief executive of The Peoples Bank Co. in Coldwater, Ohio, says that investors looking to buy into community banks are going to have to adopt a new set of assumptions going forward.
"Community bank shareholders have to decide if they are going to accept a [return on equity] that is different than it was," says Hartings, whose bank has roughly $350 million of assets. "There is certainly a regulatory environment today that squeezes our margins. Making loans is our niche in the business and as you see more regulation and less differentiation in product, it becomes more difficult to look at that business model."
Another issue working against community banks trying to attract investors is the relatively high concentration of real estate loans on their balance sheets.
All these factors combined could wind up forcing scores of small banks to merge with larger ones.
Greenwich Associates is predicting a 25 percent decline in the total number of banks in the United States between now and 2015, with as much as half of that drop occurring before the end of 2011. The vast majority of the banks that disappear, according to Greenwich, will be small institutions that find it impossible to survive under new market conditions.
"Especially as deposits fall from post-crisis highs and inflation erodes bank profitability," Raftery wrote in a recent report on the state of the industry, "many of these small players will be consumed by larger banks on the hunt for scale and efficiency."
Jay Sidhu, the former CEO of Sovereign Bancorp and current chairman of New Century Bank in Pennsylvania, appears to have spotted the trend. Through a series of acquisitions, Sidhu has quickly taken New Century from just over $200 million of assets to $900 million, and clearly intends to continue the company's rapid growth.
"The days of being able to successfully run a bank under $1 billion in assets are gone," Sidhu said a recent interview with American Banker.
Still, conditions are bound to improve at some point. Is it possible that, once the financial crisis recedes into memory, that the old order might reassert itself?
Raftery has his doubts. He predicts that increased use of remote deposit capture and "computer-to-computer video conferencing" will allow midsize institutions to increasingly compete outside of their traditional boundaries.
For large institutions, he says, many of the challenges are really "staffing and training" problems that might be overcome.
However, he says, "There would have to be a commitment to client focus and to consistent quality with small and midsize business owners that larger banks have lacked."
So maybe the industry won't be shaped like a barbell after all. Barring further economic upheaval-double-dip recession, anyone?-it looks like it's is about to get fat around the middle once more.