Garnet Capital Advisors Blog

Millions of banking customers have received notices in the last few years regarding a change in the name of the company that they bank with. Bemused, many of these banking customers simply filed this information away in the back of their minds and move on with their day. Most banks have become very adept at transitioning into a new entity with little to no disruption to their current banking customers. The reality is, the pace of bank mergers continues to deplete the absolute number of banks. We want to provide the hard data that proves this fact, and that is what we intend to share with you here today. 

Regulation Has Forced the Hands of Many Banks

The years 2008 and 2009 were particularly perilous for the financial system in the United States and around the world. Massive risks in the economic infrastructure were exposed, and it became increasingly obvious that something needed to be done to repair some of these issues right away. Congress acted and passed the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Unfortunately, this legislation was passed in a hurry as Congress felt the pressure to do something in response to the unfolding crisis. This meant that many pieces of the legislation had consequences that were unintended and unexpected. Businesslawtoday.org explains how regulations contained within this law resulted in unforeseen burdens for community and local banks: 

During the years of implementation of Dodd-Frank, it became clear that the regulatory tightening in response to the crisis was becoming onerous especially for smaller community banks. In response, Congress, led by Senate Banking Committee Chairman Mike Crapo, passed the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018, Pub. L. 115-174 (the Crapo Act). As a result of the relief provided by the Crapo Act, in addition to the current market environment for smaller banks, the industry expects to see increased merger and acquisition activity for both regional and community banks. 

In other words, the original legislation created such enormous regulatory hurdles to get over that subsequent legislation had to be passed to attempt to fix those issues. Despite that, we continue to see overhangs from the original legislation that force small and mid-sized banks to implement compliance measures that are too costly to maintain long term. This ends up driving many of those banks to either merge,  find a buyer, or go out of business. 

The constriction of the number of banks available is felt not only in the minds of consumers, but it is evident in the FDIC's own reporting. Their data shows that the number of commercial banks in the United States has fallen from 14,000 in 1980 to just about 4,900 today. This is despite a population increase and a greater reliance on the banking system for everyday activities. 

Efficiency Issues at Smaller Banks

Smaller banks are faced with a multitude of issues as they try to compete with the larger players. Not only do the smaller banks have to comply with regulations set up for all banks, but they must also try to do so with a tighter budget and fewer resources. They have to build brand loyalty even as their names are not nearly as well-known as the larger banks. Additionally, they must deal with a so-called "brain drain" that is pushing many of the top employment talents to the largest banks. Large salaries, great benefits, and corporate expense accounts are enticing many of the best recruits into working for the big banks. Smaller banks must battle over the remaining employment pool. 

Large banks have numerous automated processes throughout their systems. They are incredibly efficient at getting certain routine procedures accomplished day in and day out, and this helps them bolster their ability to efficiently serve as many clients as they do. It is something to marvel at, and it is something that continues to keep the smaller banks from flourishing. Large banks use their massive number of talented employees as well as their tremendous economies of scale to consolidate a larger portion of the industry under their own control. Smaller banks remain less efficient and less omnipresent in the lives of everyday people. 

Profitability Issues Make Consolidation Appear Attractive

When a bank is pressed up against the wall and given the option to either sink into financial ruin or allow itself to be purchased by or merged with another, the choice becomes clear for most. They would rather take their chances of being consolidated into another bank rather than fail. In fact, government and the industry itself encourage banks to consolidate rather than suffer a failure. The FDIC backs up depositors, and it would rather not have to pay out those depositors when it can work to merge two banks into one instead. 

Taking a look at some of the raw numbers of banks lost per year may be encouraging, but there are some hidden facts contained within these numbers that we need to discuss. First, the raw numbers:

Number of banks lost per year 

• 1993-1997: 3,012
• 1998-2002: 1,569
• 2003-2007: 820
• 2008-2012: 1,451
• 2013-2017: 1,413
• 2018-present: 721

A quick look at these figures might suggest that the number of banks being consolidated is decreasing over time. This is only true in the sense of raw numbers though. The reality is that as more banks merge together, there are fewer overall banks, and thus each new bank lost is a greater percentage of the total. Overall, the percentage of the total number of banks that are lost each year continues to be fairly consistent. That number is around 4% of the total, and that means that the large banks are continuing to swallow up any of the remaining community banks that they can find. Thus, it is best to still consider ourselves to be in a period of banking sector consolidation. 

Banks Looking to Merge Need to Clean Up Balance Sheets 

With the economic and political situations being what they are, it is increasingly important that small to mid-sized banks do what they can to clean up their balance sheets and show strong financial performance. This means selling off risky assets, booking high-quality performing assets, and focusing on the core of the business. Larger banks that may decide to come in and purchase a small to a mid-sized bank are likely looking for an outperforming bank with little to no red flags in their portfolio. They want to add strong assets to their balance sheet, and that means only buying those banks who have proven that they know how to handle their own business. Now is the time to assess what moves put the bank in the best merger position. 

Please contact us for the latest market feedback on this and other topics, as well as prices for distressed assets or options to add new high-quality loans to your portfolio.