Guest Column: Consolidation trend takes community banks to crossroads

Whether one believes the U.S. economy is showing sustainable signs of recovery, there is little debate that the banking industry is still struggling. Media outlets cover the latest bank closures by the Federal Deposit Insurance Corp. and report that lending is more difficult than in the boom period preceding the downturn.

While every sector of the industry is facing challenges, community banks seem to be weathering the storm better than other institutions.

In a March speech, Fed Chairman Ben Bernanke stated that community banks are performing better than most other segments of the financial system.

First-quarter FDIC statistics reflect this statement: Commercial banks in the U.S. with more than $1 billion in assets recorded a net operating margin of 7.05 percent, while those with less than $1 billion produced a margin of 8.31 percent. The disparity is more pronounced in Missouri, with commercial banks with more than $1 billion posting a net operating margin of -21.9 percent versus 16.87 percent for banks with less than $1 billion.

The community bank's role

Community banks have been a large part of U.S. growth, serving the needs of small businesses and individuals for many years.

Built around relationship banking, they are more likely to provide services based not only on the objective analysis of financial indicators, but also on subjective measures such as character and reputation in the community.

The local focus of community banks enables them to better understand their clients and make faster decisions on loans and other services than larger, more centralized banking institutions.

Face-to-face interaction with senior bank management is another component of relationship banking that makes clients feelthe bank has a vested interest in their success.

This is often true, as senior managers of community banks typically have large amounts of personal capital invested, which directly links the success of the bank to its management team.

Large banks get bigger

Despite the positive performance of community banks, trends in the banking industry have some industry officials questioning their future. These parties cite the consistent yearly decrease in the total number of U.S. commercial banks during the past two decades.

In 1990, there were 12,343 commercial banks, compared to 8,315 in 2000 and 7,085 at the end of 2008. Despite scores of new bank charters being issued each year, the total number of commercial banks has decreased due largely to mergers and acquisitions.

Proponents of the preceding argument contend that merging community banks into larger banking systems creates economies of scale that are necessary to sustain profitability in an increasingly competitive and regulated banking environment.

Banks can no longer afford to stay small, and the consolidation of the industry is the market's way of adapting.

The future of community banking

Industry consolidation through mergers and acquisitions will likely continue once the economy fully recovers, but it is difficult to envision community banking disappearing from the financial services industry.

It is possible the banking industry will settle into a cyclical pattern rather than an exclusive shift to large institutions. There are numerous stories around the country - and in Springfield, including Springfield First Community Bank and OakStar Bank - of seasoned bank executives starting a community bank to replace relationship-banking services lost as a result of market consolidation. In time, startup banks that produce positive results may become attractive acquisition targets for larger bank systems. Unless these acquiring bank systems can provide comparable relationship banking services, demand for new community banks in those markets will likely remain.

If creating and operating community banks becomes too cost-prohibitive, as some predict, another possible trend may be regional bank holding companies filling the relationship banking void. Some of these holding companies have been successful in keeping a community bank atmosphere at their locations by allowing acquired community banks and other branches to keep their local name and staff along with decentralized lending authority.

This structure allows a larger group of scattered local institutions to shoulder overhead costs and centralize regulatory expertise that might otherwise make doing business too costly or burdensome.

[[In-content Ad]]Josh Lewis is a financial analyst for BKD LLP's corporate finance division in Springfield. He may be reached at jlewis@bkd.com.