How Will the Trend Affect Community Banks?
By Pamela M. Green
The FDIC recently released a report which contained a disquieting statistic: from 1984 to 2003, the population of banks in the United States declined nearly 50 percent, from 15,084 banks and thrifts in 1984 to 7,842 at year-end 2003.
At that rate of decline, we ask ourselves what the face of the industry will look like by the middle of this century. Will we have only a handful of behemoth institutions? Can smaller institutions hope to survive, given such a history of decline? Is there a future for community banks?
The FDIC examines these issues in a paper entitled, “The Declining Number of U.S. Banking Organizations: Will the Trend Continue?” released last month as part of its “Future of Banking Study.” The report looks at the last 20 years of mergers, consolidations and failures and makes predictions for the banking population over the next decade.
The period of the FDIC's study – 1984-2003 – was characterized by significant regulatory change such as deregulation of deposits, branching and interstate banking. Other major changes included an increase in the securitization and sale of loans, and the advent of the information technology age. These changes combined to put enormous pressure on community institutions, and many fell victim to a new environment in which they could no longer compete.
Missing in Action
A majority of the banks disappeared through unassisted mergers and acquisitions — 8,122 in all — but an additional 2,262 were eliminated because of failure. Seventy-five percent of the failures came between 1987 and 1991 when an average of 388 banks ceased to exist each year. Not surprisingly, banks in the under-$100 million asset range accounted for the largest decline. After the 1990-1991 recession concluded, the rate of decline dropped dramatically, however. In fact, from 1994 onward, only 66 institutions have failed, not surprising given the economic boom that has characterized most recent years.
Although the industry seemed to be contracting via mergers and failures, the big picture was more complex, because de novo institutions were entering the marketplace at a rate of 163 per year during the two decades of the study. A total of 3,097 new institutions were created from 1984 to 2003. In the early 1990s, de novos such as Maine Bank & Trust, Merrill Merchants Bank and Atlantic Bank debuted in Maine; but in the last 10 years, only one new charter has appeared — Rivergreen Bank in March of 2003. Across the country, the number of new charters has been in a decline since the economic recession of March 2001.
While the number of institutions dropped by half, the total assets of the industry more than doubled during the period of the study, with the largest institutions gaining faster than the small. From 1984 to 1993, the largest banks gained market share by leaps and bounds – from 42 percent to 73 percent. Banks holding less than $1 billion in assets dropped from 28 percent of the market to 14 percent.
In 1984, 42 banking organizations controlled 25 percent of the nation’s domestic deposits. By 2003, only three organizations held a quarter of the market, Bank of America leading the way with $512 billion in deposits, which is 9.8 percent of the industry.
The FDIC looked at various scenarios to try to predict the future population of U.S. banks. Researchers found that a simple linear analysis would predict a pattern of 136 organizations lost each year, resulting in 7,842 institutions at year-end 2003; 7,161 at year-end 2008; and 6,480 at year-end 2013. However, projections that include non-linear data suggest that the decline will be slower than that — more like 7,842 at the end of 2003; 7,435 in 2008; and 7,167 in 2013. This may be the most optimistic scenario.
Researchers’ predictions take into account that the influences of the 1980s that caused so many banks to go out of business — deregulation, the liberalization of interstate banking, and the thrift crisis — are in the past, and since the mid-1990s the rate of decline has been steadily decreasing. Indeed, the study predicts a strong place for the community bank in the years ahead.
There is no expectation that the U.S. banking structure will resemble that of other countries which have a handful of very large institutions, as the report states: “ … in the absence of a new shock to the industry, the United States is likely to retain a structure characterized by several thousand very small to medium-sized community banking organizations, a less-numerous group of midsize regional organizations and a handful of extremely large multinational banking organizations.”
In spite of declining numbers, the number of community banks – defined as independent banks and savings institutions, and bank and savings institution holding companies with aggregate assets less than $1 billion – as a percent of total institutions in the industry is holding steady at 94 percent since 1985. Community institutions have also maintained a proportionally similar presence in all types of markets — urban, suburban and rural, regardless of population changes in those areas.
Community banks’ deposit share, on the other hand, has declined significantly since 1985, falling in rural areas from 72 to 53 percent; in small metro areas from 48 to 28 percent; in large metro suburban areas from 38 to 22 percent; and in urban areas from 19 to 9 percent. Deposits flowed from community banks into the top 25 banks, which tripled and quadrupled their deposit share in each of these geographic areas during the last decade.
Large bank/small bank proportions are slightly less skewed in Maine. According to the “Annual Report of the Superintendent of the Bureau of Financial Institutions to the Legislature” in January — 2004, Maine’s large banks Banknorth, KeyBank and Fleet — hold 41 percent of Maine banking deposits. The two large banks headquartered outside of Maine — Key and Fleet — hold 22 percent of Maine deposits, a lower share than that of out-of-state banks across New England at 29 percent and the United States as a whole at 30 percent.
As a matter of fact, the share of out-of-state banks’ deposits has been declining in Maine for several years. On the asset side, according to the superintendent’s report, assets grew at Maine banks at very strong levels in 2002, accompanied by 12 percent deposit growth; however, in the first half of 2003, the growth slowed to its lowest since mid-1996.
If community banks across the United States are losing deposits to the top 25 banks, they are nevertheless maintaining a stable share of real estate lending to businesses, and they make a disproportionate share of loans to small business and agriculture, according to the FDIC report. Smaller institutions excel at the relationship-based lending practices that larger institutions sometimes ignore: the assessment of creditworthiness on an individual basis rather than on a model. Smaller institutions also have an ability to provide personal service and attention to smaller entities that are often overlooked or passed over by the large banks.
The last decade has seen a stable return on assets among community banks at about 1 percent, which satisfies the regulators. And the fact that 1,200 de novos have come onto the scene since 1992, add up to a continued presence of community institutions in the decade to come.
According to the superintendent’s report to the Legislature, Maine’s institutions are seeing earnings ratios below the peak levels of the mid-1990s, but at their highest level in at least four years. In addition, loan quality ratios are at their best in recent history.
While the FDIC report cites continued challenges of large bank, non-bank and credit union competition, fixed costs of regulatory requirements, and retention of a qualified workforce, it concludes that “the evidence from the recent past about community banks’ market presence, industry share, and earnings performance, coupled with the continued creation of new community banks, points strongly to community banks being a viable business model in the future.”
And Maine will be no exception.
The entire FDIC’s “Future of Banking” series can be found on the Web at www.fdic.gov/bank/analytical/future/ index.html.