WASHINGTON — Droves of community banks in the last quarter century have succumbed to earnings volatility, consolidation and heightened regulation. But the period has also produced a substantial number of resilient survivors, new Federal Deposit Insurance Corp. research says.
The FDIC's sweeping study of the community bank sector from 1984 to 2011, which was released Tuesday, highlighted well-known threats facing smaller institutions, while noting that their share of the industry's assets has fallen to 14% from 38%.
But the study also shows that many community banks have proven more adept at surviving than larger institutions. Of institutions that started out as community banks, 33% are alive today, compared with just 6% that started out as "noncommunity" banks.
"Amid the waves of new charters, failures, mergers and intracompany consolidations that reshaped the industry over this period, community banks declined in number and, in particular, in terms of their share of banking industry assets," said the study, which is part of the FDIC's broader community-bank project. "Nonetheless, they also showed signs of resilience, remaining by far the most prevalent form of FDIC-insured institution."
FDIC researchers have compiled the data for most of the past year — they unveiled initial results back in February — and the agency says it is the first study about community banking's evolution of its kind. Among the findings is a new definition of community bank not limited to just the $1 billion-asset cutoff typically used by analysts. The study included 330 organizations above that cutoff with common community bank characteristics. Ninety-two institutions below the cutoff were excluded.
"Using detailed balance sheet and geographic data, this study goes further to define community banks primarily in terms of their traditional relationship banking and limited geographic scope of operations," the study said.
Despite the asset consolidation in larger institutions, community banks continue to hold most of the industry's deposits in rural and "micropolitan" areas, the FDIC said. Their proportion of the industry's small loans to farms and businesses — 46% — was over three times the proportion of all assets held by community banks. The study found over 600 counties in the country where the only physical branch offices are those operated by community banks.
"It's not clear that the larger players want to do business in these smaller areas," Richard Brown, the FDIC's chief economist, said in an interview.
Still, the effects of consolidation are significant, the study suggested. Over the 27-year period, the number of banks with less than $25 million of assets fell by 96%. Meanwhile, banks with more than $10 billion of assets grew their share of industry assets to 80% by 2011 from 27%.
Among the factors contributing to consolidation were waves of failures during both the thrift debacle of the eighties and nineties and the most recent financial crisis, as well as the relaxation of restrictions on branching networks.
"It is possible that such forces as financial innovation, technology and regulatory developments could lead to additional consolidation," the study said. "However, it is not clear that these forces would operate on the same scale as the past waves of consolidation that have resulted from the relaxation of branching and geographic restrictions or from failures."
One particular obstacle in recent years to the competitiveness of community banks that rely on their lending portfolio is the narrowing of net interest margins, which have squeezed net interest income, the report said.
"Because of their focus on traditional lending and deposit gathering, community banks derive 80% of their revenue from net interest income compared to about two-thirds at noncommunity banks," the study said. "Accordingly, the narrowing of net interest margins places a significant drag on the earnings of community banks."
But the study also pointed to a shift by many community banks, much more so than larger institutions, away from traditional credits and toward loans secured by commercial real estate and development projects — two sectors hit hard by the recent real estate crash — as a factor in a weakening of their portfolios.
"While these alternative strategies initially provided a small performance advantage for community banks that shifted into them in 2000, they proved to be highly problematic during the crisis period that followed," the study said.
Officials said the results suggest that future strength for community banks may come from sticking to the core business strategies that helped them navigate multiple credit cycles leading up to this point.
"The bottom-line finding is that even with all the of the consolidation that's taken place and the market challenges that exist for community banks, the core community bank model of reliance on relationship banking funded by core deposits remains quite viable," said FDIC Chairman Martin Gruenberg.