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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   June 2013

Surviving in the Sea of Banking Changes

Further consolidation of lending institutions likely will swallow smaller banks

Surviving in the Sea of Banking Changes

As the U.S. economy struggles to remain afloat through a sluggish recovery, community banks nationwide present a clear example of the new normal in the banking sector. Burdened by losses and regulatory changes, many of these banks already have been devoured by larger institutions in a trend that is likely to continue in the foreseeable future. 

Are the days of small banks numbered? Certainly the fate of many smaller banks in the past few years, the current economy and the regulatory environment seem to indicate that banks under $500 million in assets face rough waters — and likely mergers with larger institutions. For commercial mortgage brokers, this sort of consolidation may mean lost connections within banks that have been business partners for years. Taking a longer-term view, however, a more vibrant banking system eventually may lead to a stronger environment for funding commercial real estate.

It is ironic that in the wake of Wall Street’s financial collapse, smaller banks were the worst hit, although they were not the ones heavily involved in practices — like selling collateralized debt obligations to unsuspecting customers — that largely contributed to the crisis. In the past few years, the suffering of Main Street banks has ranged from enduring nearly zero-percent interest rates maintained by the Federal Reserve and having a significantly diminished client base that’s suffering the effects of high unemployment to dealing with defaulted mortgages and future uncertainty.

In addition to this tough environment, post-financial-crisis legislation like the Dodd-Frank Wall Street Reform and Consumer Protection Act has brought — and likely will bring — more pain to community banks. As provisions roll out, smaller banks may see new layers of regulation, oversight and compliance, which typically can be much more expensive for smaller banks than larger ones.

The status of small and community banks remains at a stark contrast with banking giants that were deemed not only too big to fail but also too big to prosecute for the malpractices that led to the financial crisis, as Attorney General Eric Holder put it this past March. With that in mind, it is unlikely to see any structural punishment for the larger banks, despite the fact that many only survived because of the federal government’s bailouts in 2008 and 2009.

To understand where community banks are headed, commercial mortgage brokers should look at the changes that have taken place over the past few years. There has been a significant decrease in the number of community-bank charters, in part because of mergers and in part because of bank failures. In fact, 417 banks and thrifts failed from the beginning of 2006 through the end of 2011. Although the pace of bank failure has slowed to just 51 banks failed this past year, many of the survivors still may be at risk as they face the daunting challenge of earning money in a new era of onerous supervisory oversight and record-low interest rates.

Here are some of the several factors that have contributed to the current environment and that will continue to affect the banking community for years to come. 

Interest rates

In response to the financial crisis, the Federal Reserve slashed interest rates, bringing them down to near zero percent. The benchmark federal-funds rate, which governs overnight loans between banks, was cut from 4.76 percent in October 2007 to 0.12 percent in October 2009. This past March, it was 0.14 percent.

Although the shock of collapsing interest margins is over for mos banks, the stagnant low rates have left bank balance sheets awash in cash with many unhappy savers who are not being paid for their funds.

Reduced income

A combination of stifling oversight and lower loan demand has slashed banks’ income. Regulators have pressured community banks, questioning loans and giving close scrutiny to financing secured by commercial real estate. In turn, banks have become more cautious — if not afraid — to lend. Until recently, lenders have been slow to recover from the bubble that burst nearly five years ago. 


Even the few fortunate banks that were not over-leveraged before 2008 and historically infused their deals with cash have to deal with the current borrower’s market. Today, high-qualified investors who seek low leverage on good collateral can name their price — and then get an even better deal as income-starved banks are cannibalizing each other in search for bankable assets.


It has become clear that measuring value as per “mark-to-market” exists nowhere more sensitive than the equities market. When a bank isn’t earning money — despite not losing money — the value of its equity suffers immediately. Raising new capital is challenging for banks, even though some of them have had no issues to overcome after the 2008 fallout.

Throughout the past 30 years, profitable community banks enjoyed high-value premiums as the nation’s bank-branch and cross-state ownership rules were relaxed. The megabanks today have increased their book value dramatically as a result of the aggregation of thousands of local banks. Attracting new capital that is willing to recognize a bank’s book value is a challenge, however.

Small-business confidence

Main Street banks also have been hurt by gun-shy Main Street businesses that have been too worried about being burned twice. After suffering more than most, community banks and many other investment bankers have postponed growth until demand warrants it. This lethargic attitude about the future has deprived Main Street banks of their most competitive lending target and important earning asset: small-business loans.

• • •

Looking ahead, commercial mortgage brokers should expect the trends of smaller banks being acquired or merged into bigger ones to continue. These small banks — many closely held by families — likely will begin to cash out to simply get what they can and avoid the prospect of losing money to comply with new banking regulations. As the institution size rises, the multiples get better: Very small banks that have less than $100 million in assets will sell to small banks with $100 million to $300 million in assets. In turn, these small banks will merge or sell to medium-sized banks with $300 million to $700 million in assets

As the landscape continues to shorten, expect even the medium-sized banks to roll up to become large banks. Only by getting into the range of $2 billion and higher will these banks begin to develop the ability to raise affordable capital to finance real growth created by means other than consolidation

The bottom line is that commercial mortgage brokers no longer may work with the same bank or the same connections, but they are likely to find a more vibrant banking market with real competition for risk. Commercial real estate development is expected to return as fewer, but better, projects financed by banks make a comeback. Commercial real estate financing also will get better as slower inventory growth — slowed as much by lack of demand as financing choices — means valuations inspire more confidence to lend.


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