Big Banks, Small Banks

Lee Kyriacou, head of bank industry research

Interesting piece by Meredith Whitney in American Banker today on bank stocks, basically saying that in the current weak revenue environment, large banks (which are precluded from M&A) must improve returns by getting smaller, while smaller banks must improve returns by getting bigger. I agree more or less, but there’s an additional layer of complexity. Let’s break the problem into industry issues, and then look at M&A specifically.

The industry issue is not weak revenue or even low net income – in fact, both are at or near record levels. Rather, the core issues are: (1) ROA and ROE remain well below par, (2) top-line revenue growth has been lacking, and (3) huge fixed branch costs are no longer sustainable.

The first is largely about low interest rates and high capital usage; the second about lack of loan demand and one-time regulatory “hits” to fees; the third about technology and customer behavior catching up to free checking.

These industry issues require banks – both large and small – to:
(1) out-compete for superior loan growth or fee revenue,
(2) dramatically restructure their branch costs while investing in e-channels, and
(3) reduce their excess capital.

Now let’s translate these issues to large and small banks, and then add M&A. Large banks can do all three: win lending, restructure branch cost, and reduce capital. In fact, without M&A the large banks must live or die on how well they can out-compete – some will thrive, others will suffer. The mid-sized banks that thrive will create shareholder value by turning to M&A. However, for many smaller banks, the hunt for loans and branch cost reduction may prove too difficult, and as a result the exodus of the smallest banks will likely continue.

I’ll be publishing more on the different challenges of large and small banks this quarter, and I look forward to discussing this on our free webinar Thursday at 2pm ET on trends and issues for 2013. You can pre-register online here.