November 5, 2013

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Survival of the Biggest?

The Plight of the Small Community Bank

By Gaylen Webb

November 5, 2013

Bank of American Fork CEO Richard Beard and Lewiston State Bank CEO Anthony Hall were sitting in a conference room along with other bank CEOs, trying to get their heads around how to calculate capital requirements under Basel III—a complicated regulatory standard that is supposed to enhance banks’ safety and soundness.

To Beard’s right, a bank CEO said she had about 100 employees trying to figure out the impact of Basel III on her bank. Down the table on Hall’s left, the CEO of a very small bank confessed, “We don’t even have 100 employees. I don’t know that anyone can even spell it [Basel III], let alone calculate it.”

“That was when Anthony and I decided to get serious about merging our banks,” says Beard. “If you can imagine a small bank trying to digest all of the written and yet-to-be written rules of the Dodd-Frank Act and the requirements of Basel III, it is just overwhelming.”

The merger of Lewiston Bancorp, parent company of Lewiston State Bank in Logan, and People’s Utah Bancorp, parent company of Bank of American Fork, be completed during the fourth quarter of this year, is typical of a banking consolidation process that Beard believes was largely precipitated by strangulation from the regulatory system, including the Dodd-Frank Act and Basel III standard.

In this environment, do small banks have to merge, be acquired or die? Perhaps so.

Competitive Disadvantage

“The number of banks is shrinking and fairly dramatically,” Beard says. “In 1990, there were more than 12,000 banks in the country. Today there are only about 7,000, most of which are community or independent banks. Some experts predict there may only be 3,000 to 4,000 banks left after this latest round of consolidation is complete.”

Beard currently serves as chair-elect on the board of Western Independent Bankers, which is concerned with the shrinking number of independent banks.

With combined assets of about $1.3 billion following the merger, he says the Bank of American Fork/Lewiston State Bank agreement will create an opportunity for the two banks to achieve greater economies of scale while preserving the community banking experience. Still, it typifies the plight of smaller banks under a one-size-fits-all regulatory environment. While the regulations are driving up costs for all banks, they are particularly hard on small banks that may not have the niche markets, broad footprints or expanded product lines to absorb the additional compliance costs.

Further, Beard says the capital requirements seem a bit unfair. Most of the community banks in Utah hold 10 to 12 percent in tier-one capital, he says, while the mega banks run in the range of 7 to 8 percent in tier-one capital.

“You can imagine the disparity in the regulatory system if we are competing for capital and the big banks can leverage their capital at 7 to 8 percent while we are at 10 to 12 percent, and the guarantee is essentially a too-big-to-fail guarantee. It makes it very hard to compete with those big banks,” he says.

An Industry Niche

Competing with the mega banks may not be the right idea, according to Scott Kisting, chairman and CEO of AmericanWest Bank, which purchased Provo-based Far West Bancorp and its 16 branches for $150 million in 2006. Spokane-based AmericanWest Bank has about $4 billion in assets and has found its sweet spot in serving the needs of businesses looking for loans up to about $10 million.

Kisting says that although the entire banking industry got painted with one regulatory brush, “which isn’t fair,” much of the regulatory environment focuses on retail banking—financial services directly focused on consumers. “It’s harder to make money in retail banking,” he says.

The livelihood of community banking is centered on business and retail banking, says Beard. It’s a completely different business model than that of the big banks, yet the community banks have the same regulations applied to them.

“When the regulators expect the same sophistication out of a little, 70-employee bank as they would a 3,000- or 4,000-employee bank, it puts regulatory pressure on the very small banks and makes it difficult for them to do what they do best, which is serve the community,” he says. “So you spend hours and hours meeting reporting requirements or running Basel III calculations, rather than helping a borrower get a home loan or helping her get into a product that will serve her needs. That is the hidden cost of a lot of the new regulations.”

Uneasy Prey

Is the regulatory environment making smaller banks more vulnerable to acquisition? Kisting doesn’t believe so. He says there is still plenty of opportunity for smaller banks to compete, but they have to “perform within the opportunities they are given, stay below the radar of the bigger banks and go after the best customers in the size they are best equipped to serve. You can’t be all things to all people.”

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