John S. Carusone is president of the Bank Analysis Center in Hartford. He has been following "http://www.lanepl.org/lib//#cheap_">cheap banking industry for more than 25 years. We asked him to update us on where the cheap banking industry is headed.
How are Connecticut banks doing?
In the last several years Connecticut banks have recovered significantly from the recession and the banking panic, with higher profits, greater capital strength, and a lower level of non-performing loans. Most of them have returned to profitability, many of have registered [increased] year-to-year profits fairly significantly over prior periods, the overall trends in the industry are strong and positive.
How does that look compared to other places?
Connecticut has lagged the rest of New England slightly because of the pretty considerable downturn in real estate values that didn’t affect the rest of New England as much as it did Connecticut. In general the condition of the industry in the rest of New England is strong, with Connecticut playing a little bit of catch-up.
Ten years ago, we would have predicted that the region would be dominated by national banks by now. Instead, it seems the local banks are on the ascendant.
I think that’s right. The large national banking franchises fell from a position of grace during the banking panic, and a lot of small businesses and retail banking customers turned to community and regional banks as an alternative. It wasn’t a dramatic switch, but it is statistically demonstrable, yes. Farmington Bank [for example], with an abundance of capital is able to be pretty aggressive in pricing. It continues to pursue market share through attractive pricing for customers. In general I think there was just public disaffection with the large behemoth banks that were involved with some of the notorious derivative securities and sub-prime lending that was the instigator of the banking panic of ’08, ‘09.
We hear about the impact of regulatory burdens on more local banks — we even heard it in the October 3 presidential debate. Is that politics or is it fact?
That’s fact. Banks as an industry are probably the most highly regulated industry in the country. The regulatory burden on banks falls disproportionately on smaller institutions than it does on larger institutions. The regulatory burden has increased considerably over the last decade. There are for example the Basel Agreements [an international standard of banking rules] that require higher capital standards for banks.
Do smaller banks have to increase capital as well as larger banks?
That’s the proposal out of Basel 3.
Why is it necessary for local banks to have the same capital requirements as national banks? They’re not really in the same kind of business.
They arguably have a lower risk profile but they’re being held to the same standard, with very modest and minor exceptions.
Isn’t it typical for local institutions to have relatively higher levels of capital than larger banks?
That’s true. But in addition to the higher capital standards, the regulatory burden also has increased in terms of reporting requirements, increased auditing expenses, increased consulting fees. If you ask any community bank president, they’ll tell you their regulatory expense has doubled or tripled in the past dozen years.
We hear from business owners who feel they have a good business but are still having difficulty borrowing. Then we’ll talk to a bank about it and they’ll say, ‘Our doors are open.’ But somehow things aren’t coming together. Why?
Community banks have to subject themselves to a safety-and-soundness examination by the regulators annually. The regulatory emphasis is always on conservatism and more capital and that has a dampening effect on the ability for the bank to be creative and flexible in terms of underwriting standards for borrowers. The community bank is always trying to satisfy two masters: the customer and the regulator. In satisfying those two masters the bank is pulled in opposite directions.
That’s always been the case, but is there a pendulum swing — are lending standards more stringent now due to a backlash over the collapse of the big banks?
I think bankers would conclude that the regulatory burden is now excessive, and is inimical to the customer. It causes a higher expense burden which is disproportionately penalizing to small banks that have to bear a large burden. The other big regulation that has impacted these banks besides Dodd-Frank was Sarbanes-Oxley, which required an enormous amount of disclosure and restrictions. The regulatory burden has been escalating exponentially.
With what a depositor is getting on a certificate of deposit today, considering inflation, it's as if they're paying the bank to hold the money. But when we look at where commercial loans are priced, it would seem like a pretty good spread. How does this compare to relative history?
Banks can borrow from the Fed for about a quarter of 1 percent, but the real funding comes from the deposit costs, which represent money market rates, CD rates, regular saving rates, and if you blend it all together, it’s on average of 1 to 1.5 percent.
Is the spread historically similar, or is it greater now because of the economy and the Fed action?
The spread is greater now than it was three or four years ago, but historically the net interest margin for banks, which is the real driver of profitability, has declined by about 20 percent, from 4.5 percent to 3.75 percent. It’s been harder for the banks to make money over the past couple decades because the spread has narrowed for a lot of factors: greater competition with banks for lending, technological advances, greater consumer sophistication and the willingness to shop banks.
We see many local banks that are doing well. How sustainable is this? Looking forward, will we see a new round of consolidations, or will the larger banks get smaller to the benefit of the smaller banks?
I think we’re in the fourth quarter of the banking industry’s consolidation process, which has been going on since the mid-1980s. Twenty years ago we had 12,500 banks [in the U.S.], and now we have 7,500 — that’s a 5,000 differential [attributable to] both bank failures and bank mergers. There are fewer buyer banks than there were 20 years ago, and many of the buyer banks right now are preoccupied with digesting banks they recently acquired. Number two, the economy is weak, and some of these smaller banks that would otherwise be considering a sale are [burdened] with non-performing loans, which depresses their sale price and they want to put that behind them before they sell. So they have higher aspirations than the market is willing to pay, from a buyer’s bank perspective.
How do you perceive the value of Connecticut’s public banks? Do you look at their stock prices?
Banking industry performance in the stock market has generally lagged the overall performance of the broad-based market indices like the S&P 500 or the Dow.
You see People’s United, for example, paying a really good dividend. Why aren’t banks like that really attracting investors?
Notwithstanding those high yields, investors are concerned about the future — the future of the regulatory burden on banks, the softness of the economic recovery, banks that have a higher level of non-performing assets are suspect in the eyes of investors. So a lot of factors weigh against investing in bank stocks even if the bank provides a pretty high dividend yield. But if it’s a clean bank, has a high dividend yield and is trading a discount to book value, there are real opportunities for investors who are willing to do their homework and understand the risks. There are attractive investments to be made in the banking industry, but you have to look beyond the headlines in the newspaper to understand the dynamics of their business and that particular institution’s performance.
So we’re in the fourth quarter of consolidation and the big guys who were buying everything are not likely to be doing it too frequently…
The stock price is depressed — banks like Bank of America or Citibank, not all of them. Traditionally New England has had a lower economic growth profile than the other six or seven regions in the country. It has a very competitive banking market. Which is not to say other regions don’t have a competitive banking market as well, but New England is notoriously competitive.
The last new bank in greater New Haven was Start Bank. The president said he had trouble in formation even though they had capital, because of fear on the part of the regulators to add more banks. How do you see the pace of new bank formations over the next few years?
It’s very difficult to obtain a new bank charter. There’s no official prohibition against new charters, but regulators seem to just sit on their hands and delay the approval process to the point where it’s just difficult for the organizing group.
Are they just protecting the existing banks?
No, I think the amount of capital they want is discouraging to the formation of new banks. A lot of the regulations have not yet been fully constructed and architected and defined — particularly in Dodd-Frank, for instance, only about 50 percent defined. That probably weighs on the reluctance of the FDIC and the OCC and the Federal Reserve to grant new charters.
We’ll hear this a lot in political discussions about regulation taking down Main Street. But these small banks lend to small businesses because there’s no other source of [capital] for them.
Correct. The community bank’s purpose and rationale for existence is to act as a source of financial strength to a community to help a community grow. That puts them in a position of intermediating money between local depositors and small businesses.
Do you follow the credit-union industry? Haven’t they started to look like other community banks, just not public ones?
They’re certainly trying to look like a bank and take market share away from community banks, and they have one enormous advantage — they don’t’ pay corporate tax, and this allows them to be very aggressive in terms of deposit loan pricing. The credit-union lobby and the banking lobby are the Hatfields and the McCoys of financial lobbyists. There’s no love lost between them, and it’s largely because of the favored tax status of the credit unions.
Do you think as they look more like community banks they’ll be able to maintain that tax status?
For the most part credit unions, particularly for consumers, are full-fledged competitors with banks. I think it’s going to be hard going forward to maintain the tax-exempt status of the credit union because the federal and state governments are fiscally strained. They’ll be looking for revenues that have been sacred cows in the past and [credit unions] may fall victim.
Is there a banking trend or issue in Connecticut or nationally that readers should be aware of?
Readers should take comfort in the fact that the industry is stronger today than it was several years ago. [There’s] some variability between institutions, but overall it’s demonstrating higher profit margins and lower non-performing asset profiles, and a strong capital position. I think the days of bank closures are largely behind us, at least based on the present economy. And the days of monthly announcements of mergers and acquisitions is behind us, largely because the takeover multiples have declined from twice book value to about 50 percent of book value.
If there were a change in administrations in Washington, would the momentum for all the regulation change?
With the banking panic and severe recession we had, it resulted in a pretty severe increase in regulatory burden. It’s part of our current political dialogue. There’s certainly a place for regulation of the financial-services industry. I’d make a case that one of the reasons we had a banking panic in 2008 is because there was a lack of regulatory oversight that was necessary. Or inadequate regulatory oversight or discipline on the part of the large banks. But there’s also a balance that needs to be struck between financial entrepreneurship and growing the economy.
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