What Is the Future Of Community Banking?

December 9, 2010

Recent Observations

During the past week, I attended a meeting with the OCC and the Oregon Bankers Association Winter Conference. One of the open themes of both meetings was “what is the future of community banking?” When the smoke clears, it seems clear that one of the most lasting legacies of the past 3-year financial debacle will be the consolidation of the banking industry, most heavily impacting community banks.

The Whys and Wherefores

First of all many banks, management and shareholders are simply tired of the battle. Between the obvious regulatory challenges and the continued economic struggle, folks just are looking for an exit strategy. Just as importantly, the business model for most community banks, particularly in the West, will need to change dramatically. No more heavy real estate based lending funded by brokered deposits. A more diversified mix of C&I and SBA loans will be a must for survival. Also size, especially with additional compliance burdens on the horizon, will become a significant factor. The guess is $150-200 million is the new minimum critical mass necessary to absorb growing operating costs. Further, for most community banks, holding companies will become a useless tool, with no more trust preferred or double leveraging – what’s the point of another regulator and corporate entity without any tangible benefits?

Technology, Technology, Technology

Clearly, while there will be some need for brick and mortar, banks will need to continue to invest heavily in technology as the demographics of their customer base continue to change and demands dictate. I think the physical presence of community banks will change, with fewer and smaller branches and more forms of online and remote banking – who knows what the next new age Blackberry or iPhone will look like and allow customers to do remotely? However, community banks must never forget that personal service is their big advantage over the larger banks and must preserve that even in a changing delivery system.

Value, Value, Value

The wild card in community banking is what will be community banks’ long-term value. Let’s face it, a successful community bank will do 1% ROAA and 10% ROE, especially if capital requirements are stiff. Realistically, even assuming demand to purchase community banks recovers, how much can buyers pay for lower returns using less valuable currency?

The Survivors

I still believe that community banks are part of the fabric of this country. However, it is clear that the government would prefer a consolidated industry, and the battle to make money and attract talented bankers will be a challenge. To that end, I doubt there will be even 5,000 banks by the end of this decade. By the mere fact of consolidation, those who choose to survive should gain the benefits of a smaller, less competitive marketplace. Capital will be a key component for those survivors who successfully navigate the changing marketplace and gain critical market share.

If you should have any questions or wish to discuss issues specific to your financial institution please contact any of the following members of the Graham and Dunn Financial Services Team:

Stephen M. Klein (206.340.9648 or sklein@grahamdunn.com),
Kumi Yamamoto Baruffi (206.340.9676 or kbaruffi@grahamdunn.com),
Casey M. Nault (206.903.4808 or cnault@grahamdunn.com),
or Jane H. Kaufman (206.340.9663 or jkaufman@grahamdunn.com).

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