Mamas, don't let your babies grow up to be bankers/Don't let them build branches and lend in the clutch/Make them be doctors and lawyers and such.
Like the cowboys in Patsy and Ed Bruce's classic country song, community bankers are a vanishing breed. They continue to occupy a special place in our collective memory, but their numbers and market share have declined to levels that may soon render them insignificant in macroeconomic terms and unworthy of inclusion in the public policy debate.
I take no pleasure in this observation, having spent much of my career managing community banks and profiting handsomely from the experience. But we have to face facts. The community bank business model is broken, irretrievably so.
How else does one explain the decline in the number of U.S. banks, from 9,616 to 7,358 in the past 10 years?
How else does one explain the relentless loss of 300 or more charters per year through mergers and failures with virtually no new bank formations to replace them?
Most of the remaining 7,000 community banks in the U.S. are quite healthy. They persevere, serving customers and creating jobs and wealth in their communities. They are not threatened with imminent demise. But a majority of these banks will be unable to attract the necessary capital – financial and human – to survive more than another decade or two.
The reasons for this predicament are clear: concentration of market share among the largest U.S. banks; a crushing regulatory burden; higher capital requirements; and the dwindling base of traditional community bank customers.
Is this the kind of environment likely to attract new capital?
Is this a profession you would encourage your sons and daughters to pursue?
Market share is concentrated in the hands of fewer and fewer institutions of unprecedented scale. The top 10 U.S. banks now control 60% of the market, up from 45% ten years ago. Over the same period, banks under $1 billion in assets saw their market share decline from 30% to less than 15%.
Large banks enjoy decided advantages of operating efficiency, marketing power, technological innovation and access to capital markets. They are perceived to be too big to fail, giving them an advantage over community banks in times of economic crisis.
New laws and regulations are created weekly, not just in Washington, but in 50 state capitals and in Basel, Switzerland. These laws can dictate how products are priced and delivered, rendering them uneconomical with the stroke of a pen. Even regulations targeting large institutions filter down to community banks in the form of "best practices" adopted by regulatory authorities.
Community bankers understand that regulation is the quid pro quo for deposit insurance and the high level of financial leverage that we enjoy. But the pace of regulatory change is accelerating and the cost of compliance continues to grow much faster than revenue.
A bank with a leverage ratio (equity divided by assets) exceeding 5% was once considered "well capitalized". Now, regulators expect 8%. Higher capital levels may be needed to mitigate the risk that taxpayers will have to bail out the FDIC, but it comes at a huge cost to community banks and their stockholders. As capital levels rise, returns on equity decline, making a community bank's stock less attractive.
Large banks and non-banking companies use their marketing advantages, access to capital markets and economies of scale to dominate consumer banking. Competing for business customers is tough, too. Mom- and- pop stores on Main Street have given way to chain stores. Family-owned businesses have been replaced by bigger enterprises managed by professionals who demand access to more credit and a broader array of financial services than most community banks can provide.
We are left to fight over what remains – loans to small businesses that are not well-established and loans to developers and real estate investors. These loans are riskier and frequently targeted for criticism by bank regulators.
How high would the return on investment have to be to compensate investors for the cyclicality of the banking business, the rising cost of regulatory compliance, higher capital requirements, limited growth potential and the illiquidity of the investment itself? Eight percent? Ten percent? More?
Community banks may achieve a 10% return on common equity in a good year, but in bad years returns are much lower, even negative. In the past, investors could make up for any shortfall in operating earnings with capital gains when the bank was sold. But the price at which banks are sold, expressed as a multiple of earnings per share or tangible book value per share, has been declining.
Many of my peers expect these multiples to return to levels last seen in the late 1990s. But what if they don't?
Is it any wonder why community banks have difficulty raising capital without excessive dilution of existing shareholders? Is it any wonder why so few new banks are being formed?
When I was graduating from college, a career counselor gave me some good advice. Select an industry that is growing, she said. Then look for a company that is well-positioned in that industry. If you choose the right industry and company, and you work hard, there will be so many opportunities for growth and upward mobility that it won't really matter what your starting position is.
Community banking today is a shrinking business. There are fewer opportunities for upward mobility. And it is likely that the bank you go to work for today will be sold or merged out of existence in a few short years. Is this the kind of environment that attracts the best and brightest?
Community bankers continue to pursue strategies that worked brilliantly in the 1980s and 1990s. We can debate whether our past successes were the result of business acumen or simply being in the right place at the right time. But we should be able to agree on three things: the world has changed, the environment for community banks has become more challenging and models that we forged 20 years ago will no longer work.
Some community banks can afford to ignore these developments. They are content to remain small, closely held and isolated from competition in very small, often rural, markets. Or they exist for the purpose of feeding legal, insurance or other business to members of their boards. Each of these banks tends to have strong social bonds among board members and executives, as well as passive shareholders.
The rest of us will need to change to survive. As we search for an effective business model, we won't find it by looking backwards. We won't find it in the offices of investment bankers and lawyers who are eager to dispense self-serving advice, much of it wrong. We won't find it from regulators who are far too busy fighting the last war, or in the halls of Congress where the declining numbers and popularity of bankers eviscerate our political muscle.
A better starting point would be to ask ourselves two questions: In a technological age where "community" is no longer defined by the physical proximity of our customer to our branch, how do we define "community"? How can we reimagine our bank to serve that community better than anyone else?
We have not yet invented a new business model for community banks, one that produces sufficient risk-adjusted returns to attract new capital. Until we do, don't invest your hard-earned money in the shares of community banks.
And until we find a way to attract the best business minds in America with challenging and lucrative career opportunities, don't let your babies grow up to be bankers.
Stephen N. Ashman is the chairman of Capital Bank in Rockville, Md.