After the financial crisis, many consumers closed their accounts at large megabanks and opted to do business locally with a community bank. Today, many of those consumer are once again customers of a large regional or national bank.
That's because big banks are scooping up many of their smaller competitors through mergers and acquisitions. Why are community banks selling out to the big banks? The reason is a simple financial reality of doing business in the post-financial-crisis world.
The big banks keep getting bigger
Beginning in the early 1990's, big banks have increasingly controlled a larger and larger share of total banking industry assets. Today, banks with total assets greater than $10 billion control 81.6% of the industry's assets.
As these large banks have grown larger and more powerful, the total number of banks in the U.S. has declined precipitously. As of the end of the first quarter of this year, there were 6,419 banks under the supervision of the FDIC. Five years ago there were 7,934. Twenty years ago there were 12,362. The vast majority of that decline is in the ranks of small, community banks
Some of those disappeared due to failure. Many more though were absorbed, merged, or acquired by larger institutions. That trend continues today, however it is increasingly driven by regional banks instead of megabank domination.
Since the fourth quarter of 2008, the number of banks with total assets exceeding $10 billion has declined just 1.75% while their share of industry assets has increased by 3.4%. Increased regulation and the political pressure from the "too big to fail" debate has limited large and megasized banks in their M&A activity. Large transactions are proving elusive or impossible, leaving these banks to pursue smaller deals with smaller competitors.
For example, BB&T recently announced a deal to acquire the $1.9 billion Bank of Kentucky. In terms of total assets, this deal is a drop in the bucket for the $189 billion BB&T, but it allows the bank to enter the strategically important Cincinnati market. The deal is also small enough to allay any regulator fears of BB&T growing too quickly.
Smaller banks in search of scale
At the same time, large community banks and regional institutions are grappling with the costs of new regulations, leading them to consolidate with each other to compensate for higher costs and achieve the scale needed to meet profitability goals.
The recent announcement that the Bank of the Ozarks is purchasing Bank of the Carolinas is representative of these kinds of deals. Neither institution is all that large by megabank standards, but their merger makes strategic sense for Bank of the Ozarks and brings a more robust product offering to existing Bank of the Carolinas customers.
Taken together, these two trends are rapidly shrinking the number of small, community banks across the country. Banks with assets between $100 million and $1 billion have decreased by 13%, and banks with assets less than $100 million have decreased by a staggering 42% since Dec. 31, 2008.
Regional banks with assets in between the large bank category and the community bank category -- those banks with total assets between $1 billion and $10 billion -- have actually seen an increase in number of 3.74%, an increase of 21 banks.
The numbers support this strategy from a business perspective
In the post-financial-crisis world, increased regulation of banks is the primary driver of this M&A activity. Higher cost structures make profitability much more difficult for smaller banks while "too big to fail" political pressures are keeping the mega banks away from blockbuster deals.
That means that the banks in the middle are consolidating to grow large enough to overcome new regulatory costs and meet shareholder expectations. Both anecdotal and empirical data support this conclusion.
M&T Bank CEO Robert Wilmers told investors in his 2014 letter to shareholders that M&T spent over $266 million in 2014 alone to expand its compliance programs related to the Bank Secrecy Act. That's a ridiculous sum even for a $98 billion institution.
Industrywide, the impacts of these costs are plain to see. Banks with more than $1 billion in total assets have higher returns on assets and returns on equity than their smaller competitors. This is driven by a lower costs of funds that gives larger banks an advantage in their net interest margins. Larger banks also, generally, report better efficiency ratios, meaning that their costs are lower relative to their revenue. That makes profitability goals easier to achieve and gives the larger banks an advantage in pricing their products, investing in new technology, and in funding organic growth.
Don't expect this trend to change anytime soon
Altogether, these financial advantages give big banks a huge leg up on the smaller competition. They can offer better prices, more products, and generate a better return for shareholders. In this light, it only makes sense that banks are taking steps to consolidate, grow larger, and take advantage of these benefits.
For shareholders, these types of M&A deals are smart business decisions. For consumers hoping to avoid doing business with large banks, the best answer is probably to move to a local credit union, because without significant regulatory relief finding a community bank without M&A ambitions may soon be impossible.