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An Open Letter to Elizabeth Warren on the Future of Community Banks

Dear Sen. Warren,

As a career academic, you must respect data and facts.

You recently argued that Dodd-Frank legislation has not hurt community banks. You cited as evidence the fact that community banks' earnings were up in the third quarter of 2014, compared to one year earlier.

You appear to believe that the banking industry and community banks in particular are better off since Dodd-Frank legislation was signed into law in July 2010. But data drawn from the latest Federal Deposit Insurance Corp. reports challenges this contention.

First, there are now 1,342 fewer community banks in the U.S. than there were in June 2010. The number of banks with assets below $100 million shrunk by 32%, while the number of banks with assets between $100 million and $1 billion fell by 11%.

Consequently, it should come as little surprise that since Dodd-Frank, the share of U.S. assets held by banks with assets above the $10 billion threshold has increased by 4%. By contrast, banks with assets below $100 million have seen their share of U.S. assets decline by 40%. Banks with assets between $100 million and $1 billion lost 21% market share during this time.

Moreover, a more complete analysis of bank profitability requires a wider lens than year-to-year comparisons. Yes, bank profits are up. But missing from the analysis is the influence that loan-loss provisions have had on bank profits since Dodd-Frank.

As regulators and prudent bankers clamped down on lending during and after the financial crisis, total loans held by U.S. banks fell from a peak of nearly $8 trillion in 2008 to $7.2 trillion in 2012. It was not until Sept. 30, 2014 that total U.S. bank loans reached pre-crisis levels.

The decline in bank lending, combined with low interest rates and a fairly stable economy, has meant that banks do not need to set aside as much money to cover future loan losses as they have historically. As a result, the loan-loss provision rate hit an all-time low in the past two years. To be precise, the provision expense for past year was 0.2% of assets, compared to a 31-year average three times that rate. In other words, this is as good as it gets.

Business cycles have an enormous influence on bank profitability and loan-loss provisions. When the economy slips, as it inevitably does, it is only a matter of time before banks’ loan-loss provision revert to historic averages. When that happens, community banks will be forced to cut expenses in order to maintain profits, prompting more of them to opt for mergers.

Another key point is that Dodd-Frank and increased bank regulation have added costs to banks while bringing uncertain benefits. One of the most important measures of bank profitability is the efficiency ratio. This calculation determines how much expense is needed for a bank to create $1.00 in revenue. The best-performing banks in the country shoot for an efficiency ratio of 0.5, which is to say that the bank spends 50 cents to create a dollar of revenue.

In the 26 years before Dodd-Frank, banks with assets less than $100 million spent 71.2 cents to create a dollar of revenue while banks with assets between $100 million and $1 billion spent 67.9 cents.

After Dodd-Frank, the smallest banks are now spending 78.2 cents; the next group is spending 70.8 cents. These are increases of 10% and 4%, respectively.

That may not sound like a big difference, but the change is materially moving in the wrong direction. That alarms long-term investors in community banks, who will be more likely to push banks to sell.

Facts should be the foundation for forming opinions. To suggest that community banks are doing just fine after Dodd-Frank is contrary to facts.

Richard J. Parsons is the author of Broke: America’s Banking System. He is writing a new book about the future of U.S. banking.

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