A few months ago I mentioned that while the five largest banks in the US witnessed virtually zero revenue growth last year, the 6,100 institutions that the FDIC considers “community banks” grew their revenues by more than 6% on average on strong mortgage, construction, and small-business loan growth, while their profits rose by more than 9%.
Further, in my analysis on the 10 Fastest-Growing Banks in America, I also found that seven of the 10 banks — which each grew their annual revenues by a staggering 60% or more in 2014 — held assets of less than $10 billion, suggesting that community banks and smaller bank holding companies were definitely doing something better than their larger counterparts.
How could this be? Sure, it’s often true community banks have the “local” advantage in having deeper businesses relationships with the owners of the neighborhood mom-and-pop shops and entrepreneurs that need loans, but US regulators have unintentionally handed small banks a much larger weapon than that one.
The Critical $10 Billion Asset Threshold
A major reason why community banks are outperforming in the industry is because their assets fall below the critical $10 billion mark — the point at which regulators begin to enforce a much higher level of scrutiny.
For starters, the $10-billion-plus banks (which I will refer to as large banks through the rest of this post) are often the largest targets of lawsuits; litigation costs were a major reason why many of the US’s largest banks didn’t grow last year.
Banks that are above the $10 billion asset mark are also subject to asset “stress testing” performed by bank regulators, which under the Dodd-Frank law is designed to absorb industrywide bad-loan risks. While the intent is arguably good, stress testing essentially shackles the amount of money larger banks can lend beyond a certain percentage of their total assets until they have sufficient amounts of cash on hand to absorb bad-loan debts.
Additionally, large banks are hit with a cap on the amount of interchange fee income (related to card-based transaction payments) they can collect, which can add more headwinds to top-line growth. Earlier this year, for example, when Montana-based First Interstate Bancsystem prepared to cross the $10 billion line, it expected to lose some $5 million after taxes annually — an amount equal to 5% of its 2014 profits — from newly realized interchange income restrictions.
$10-billion-plus banks are also beholden to a new regulator, the Consumer Financial Protection Bureau, which acts as a kind of mass online forum for consumer complaints on large banks, as well as for perceived “deceptive or abusive” business practices.
But perhaps the largest potential blow for larger banks is the merger and acquisitions disadvantage, which was revealed with the Federal Reserve’s recent approval of the merger between $97 billion M&T Bank and $36 billion Hudson City Bancorp.
Apparently, the approval of this merger between two major banks — which took more than three years anyway — was a major exception. As this article from the American Banker reported (emphasis mine):
“Central bank officials went out of their way to say that they had taken the ‘highly unusual step’ of shelving the application while Buffalo, N.Y.-based M&T addressed concerns around its anti-money-laundering and Bank Secrecy Act compliance. … The Fed vowed not to be that generous again.“
In other words, large banks are usually required to deal with their pending lawsuits and regulatory compliance violations before even submitting an application for a merger deal. Otherwise, they have to formally withdraw the application, deal with their outstanding issues (which could involve months and millions of dollars spent on court cases), and resubmit their request.
Smaller bank and bank holding companies, on the other hand, have no such restrictions on acquisitions and mergers, which gives them an enormous advantage for fast growth. The $4 billion Yadkin Financial Corporation, which holds North Carolina-based Yadkin Bank, for example, saw its revenue swell by 76% to a record $163 million in 2014 after its acquisitions of VantageSouth and Piedmont Community banks more than doubled its loan assets and deposit business.
The Bottom Line
Despite the fact that smaller banks are often outgunned by their larger counterparts’ array of services and nationwide branch networks, they have been given advantages for growth with relatively lax regulations in an otherwise highly regulated industry.
While the advantages may have been given unintentionally after lawmakers vowed to crack down on banks that were “too big to fail” after the financial crisis, they are real and could allow community banks to financially outperform their larger counterparts for some time.
That is, until they hit the $10 billion mark.
More related articles that you may like:
The Top 10 Fastest-Growing Banks In America
The Top Five Hottest States For Banking
Five Global Banks Drowning in “Postcrisis” Lawsuits
Christian Hudspeth is a company analyst for Dun & Bradstreet who researches and reports on more than 1,000 banks and financial firms for Hoover’s company database subscribers. Before joining Dun & Bradstreet, Christian was a managing editor, senior financial writer and analyst for a financial publishing company. His financial articles have been featured on MSN Money, Business Insider, Nasdaq.com, and several other well-known online publications. Before he was an editor, Christian worked in the commercial banking industry for seven years.