NEXT CITY-A Site Worth a Visit

One of the traditional advantages of credit unions is their local knowledge.   This includes members’ circumstances, critical business trends in the area and continuing reinvestment to improve collective and individual opportunity.

As credit unions expand their market aspirations and growth ambitions, knowledge of and commitments to local communities can wane.  The local knowledge and the resulting advantage of  loyalty and member trust can be forfeited.

Next City  is a nonprofit news organization that believes journalists have the power to amplify solutions and spread workable ideas from one city locale to the next.

It features actual projects.   Case studies are the core of its reporting.   It publishes an almost daily blog.

Here is a portion of the October 19 email update  featuring mutual financial firms.  It asks a critical strategic question about credit unions.

While reporting a few years ago, I came across this startling fact: In 1986, the number of community banks across the country peaked at 15,717, but today there are fewer than 4,500.

Now I can’t remember the last time I went a whole day without thinking about it. I vaguely recall, as I’m sure many others do, the wave of bank mergers that really took the country by storm in the 1990s.

Maybe some of those mergers made sense, given changes in technology and the world. But the rising tide of mergers went along with a drought in the formation of new banks and credit unions.

I still don’t think we’ve fully processed what this shift in the banking system has meant for our cities and communities.

Even today I don’t think we have a full picture of what was once possible, why it’s no longer possible, and maybe why we should make it possible again. I hope today’s story helps make that picture more complete, if not more clear.

Banks With No Shareholders? The Curious Case Of Mutual Banks

Ponce Bank, founded in 1960 in the Bronx and currently New York’s only Latino community bank, shows the possibilities of lending as a mutual bank.

 

Shouldn’t credit unions be in this reporting?

Looking at Gas Prices: Facts and Interpretations

The St. Louis Federal Reserve’s economic research unit (FRED) has published two brief articles this past week analyzing trends in gas prices, both recent and long term.

Both provide evidence for those who would seek to turn the debate political about the increases.

The first article is the Long Term Trend in gas prices.  The analysis has two conclusions:

  1. Average annual CPI inflation from 1990 to 2021 was 2.4%, while average annual gasoline price inflation was 3.9%.
  2. Increased demand for gasoline is not likely the primary reason for gasoline price increases over the past decade, however. It increased from 62.9 million gallons in 1990 to 80.4 million gallons in 2006 but began to decrease in 2006. In 2019, U.S. motor gasoline consumption was 80.9 million gallons—only 0.5 million gallons more than motor gasoline consumption in 2006.

The macroeconomic result is that expenditures on motor gasoline made up a smaller percentage of GDP in 2019 (1.7%) than they did in 1990 (2.1%).

Feathers and Rockets: The Consumer’s Disadvantage

The second analysis tracks the relation between the price of oil and gasoline at the pump.

The article’s conclusion:   When oil prices shoot upward, gas prices rise with them. And when oil prices fall, gasoline prices also fall; but they can fall at a slower rate. Economists refer to this market dynamic as “asymmetric pass-through.” A more colorful description of the phenomenon is “rockets and feathers.”

The chart in the article is dynamic allowing the user to focus on recent changes.  This phenomenon doesn’t occur every time oil prices fall, but can be seen in recent months: at the beginning of December 2021 and at the end of March 2022.

Why Members Are Angry

How one interprets the charts and data in these articles will probably influence which political interpretation  for higher prices a person is inclined to believe now.

Both articles highlight the reality of retailer market power and consumer search costs as reasons why many members (consumers) feel so frustrated by the seeming monopolistic pricing patterns when paying for gas at the pump.

Their anger is more than high prices.  It is the absence of  “consumer sovereignty” (choice) the supposed  hallmark of a market economy.

 

A Model for Your Annual Meeting

The Woodstock for capitalists had its annual gathering this past Saturday.

Here is Warren Buffett’s opening comments for this six hour marathon interaction with shareholders.

How would your approach compare with this effort?

(https://www.youtube.com/watch?v=4H5OibatT00)

Here’s is Buffett’s answer to a question about the best investment you can make in an era of high inflation.

(https://www.youtube.com/watch?v=NaX-bjJn-AE)

Going Public: Colorado Partner Credit Union, their CUSO and a SPAC

In March  2021 Colorado Partner Credit Union announced that Sundie Seefried, its 20 year CEO would step away to lead a new cannabis banking company called Safe Harbor Financial.

Safe Harbor was a CUSO formed through the combination of the credit union’s cannabis banking arm and its division that licenses those services to other financial institutions.

At December 2021 yearend Partner Colorado reported $575 million assets, six branches and serving 36,000 members.   Its CUSO investment, presumably all Safe Harbor, was valued at $8.2 million up from $3.8 million the prior year.   These valuations were achieved with a  reported total cash outlay of only $750,000.

In February of 2022 there was a new transaction announced: Safe Harbor CUSO’s cannabis industry-focused financial services would be acquired by ”Northern Lights Acquisition Corp, a special purpose acquisition corporation (SPAC).  

special purpose acquisition company (SPAC) is a “blank check” shell corporation designed to take companies public without going through the traditional IPO process.

A $185 million Purchase Valuation

The terms according to one news report were that Northern Lights will pay $70 million in cash and $115 million in stock. Sundie Seefried – who created Safe Harbor – will be the CEO of the new public company.

The full February 14, 2022 press release projected the equity market value of the post-sale closing company to be $327 million.

In an interview the CEO Seefried described Safe Harbor’s competitive advantages in managing the financials for businesses conducting legal marijuana transactions:

“The amount of work necessary to manage that BSA risk is expensive,” Seefried said in July. “And the resources are demanding, in terms of the monetary system that you have to purchase. 

“We did cannabis and we did it thoroughly,” she added. “We think we have the compliance program to a good state of stability here.”

The only financial information I could find about the Safe Harbor CUSO was the following;

The company had almost 600 accounts across 20 states and $4 billion in transactions in 2021. It would appear to be a fee intensive business model in return for its compliance expertise and financial transaction management.

What Does this Example Mean for Credit Unions?

Credit union sale of all or partial ownership of a CUSO business is not a new event.  Several major examples include the sale of CUSO Financial Services (CFS) a broker dealer, with minority credit union ownership, sold to Atria Wealth Services in 2017.

Prime Alliance Solutions was a significant national CUSO offering first mortgage services to an estimated 1,900 credit unions.  It was developed by BECU, the majority owner with a limited number of other credit owners and Mortgage Cadence. The CUSO venture was sold to Accenture, in a private sale, in 2013.

Another industry CUSO model that is a frequent target for acquisition is data processing.  The largest credit union owned processor USERS was sold to Fiserv in the 1980’s.  A number of other regional DP firms have also been acquired by private companies.

What make the Safe Harbor-SPAC transaction unique is that the business will now be publicly traded.

At this time several aspects of the transaction seem noteworthy.

  1. The Safe Harbor sale is unique in that the stock will now be publicly owned.  In the past some credit unions converted to stock banks such as HarborOne, but this is the first CUSO to be traded on a public stock exchange.
  2. The creation and development of this unique financial intermediary is a tribute to the CEO who has worked on this business model since 2015. You can listen to her discuss the intricacies  in  podcasts posted on the CUSO website.  Her biography says she has served in the Credit Union industry since 1983 and became CEO at Partner Colorado in 2001.   She holds a Bachelors in Business Management from the University of Maryland and an MBA in Finance from Regis University.
  3. If the CUSO is indeed wholly owned, the transaction should produce a windfall for Partner Colorado and its members. In the FAQ’s on the Safe Harbor web site this relationship is described as: Yes! Your accounts are held at Partner Colorado Credit Union and will be insured through the NCUA Share Insurance Fund.  This would indicate an ongoing business relationship.

Wall Street Is Discovering Main Street Coops

My biggest takeaway is that this is another example of wall street firms discovering  credit unions as a source of new business.   In addition to this public listing, brokers, hedge funds and investment advisors are actively soliciting credit union purchases of banks, placing subordinated debt financing to enhance capital ratios and increasingly bringing wholesale financing and other funding opportunities to the industry such as fintech startups.

In subsequent posts I will review some of these other activities and what we can learn from them.

The Need for Transparency

One purpose in writing about these events is so they can be fully and openly talked about.   At the  moment most of the investment banking activities  are private with limited or no public disclosure.

For example two credit unions closed on subordinated debt capital  with identical structures in December 2021.   But the rates paid by the two credit unions appear to be significantly different.  Both are sound institutions but even they must rely on what their brokers and advisors privately tell them about the market which may not be indicative of other options.

The second reason is so that member owners, whose funds are used, will know how they  benefit from these transactions.   Rarely have credit unions discussed these transaction with members.

The annual meeting’s business report and election of directors would seem to be an ideal moment  to explain the financial impact and member payback on these investments.  I have yet to hear of this being done.

A Payday for Members?

Hopefully the members will be the big winners in SafeHarbor’s public offering.  The history of this effort was that it was all done with the credit union’s resources.

Partner Colorado valued its CUSO investment on the 5300 report for December 2021 at $8.3 million while reporting  a total cash investment of only $755,000.   With a SPAC cash and stock purchase of $175 million, will the members be in for a big payday?

 

 

Would Your Competitors or Peers Invite You to Talk to their Senior Management Team?

Yesterday Kelly Evans, a CNBC host, reported a meeting last week between Elon Musk and the senior management team at Volkswagon.  And no, it had nothing to do with merger or buying technology.  Here is the opening of her story:

Here’s a headline that should stop you in your tracks: “Tesla’s Musk dials into Volkswagen executive conference.” My first thought, when I saw this, was that it must have been either some kind of quirky Elon Musk prank or a weird fluky accident.

But it was neither. It was, in fact, an invitation by the CEO of Volkswagen for Musk to address a meeting of 200 top Volkswagen executives in Austria, in order to “galvanize [their] top brass for a faster pivot to electric vehicles,” according to Reuters. I’m sorry, what?! Can you imagine, circa 2015, “Microsoft invites Adobe CEO to talk about transitioning to the cloud,” or today, “Facebook invites TikTok CEO to talk about their success in short-form videos and algorithms.” Or maybe, “Jacksonville Jaguars invite Patrick Mahomes to talk about success on offense.”

Anyhow, Volkswagen’s CEO, Herbert Diess, confirmed his invite and Musk’s “surprise” Thursday video appearance on Twitter and LinkedIn. “Happy to hear that even our strongest competitor thinks that we will succeed [in] the transition if we drive transformation with full power,” he wrote. You have to give Diess credit. He sounds like a disgruntled CEO who sees the future but can’t pivot his company fast enough, and is now pulling out all the stops to get there–including inviting his “strongest competitor” to give his own employees a pep talk.

How did this happen? How could the CEO of the world’s largest automaker for much of the last decade be calling a company that won’t even deliver a million cars this year his “strongest competitor”?

The Credit Union Analogy

Would your credit union’s success be such that a bank or other financial institution (mutual fund, insurance  firm or broker dealer) would invite you to share your vision for the future of financial services?

Or, is the bank just inviting you over to see if you would like to buy them out at a multiple of book value?

Unfortunately, banks are unlikely to ask for an Elon-Musk kind of briefing thinking they there is little to learn from credit unions.  They believe coop success is due to an uneven playing field, especially the tax exemption.

A good test of how your competitors, local and otherwise, view your effectiveness is not the dollars they spend lobbying, but rather whether they seek to emulate your credit union’s perceived advantage.

Unlike Volkswagen, I have not heard of any banks trying to become credit unions in practice or by conversion.   But I read a  lot about credit unions buying banks.

Which model do you think has the real competitive edge? And which is most likely to transform financial services as they exist today?

When competitors respect you, then you know you are doing something special in their eyes.

Even when interest in your business initiatives are only from your co-op peers, that is one indication that your credit union could be “driving transformation with full power” using Elon’s criteria for strategic advantage.

 

 

 

 

 

 

What Credit Unions Can Learn from Morris Plan Banks

In justifying whole bank purchases credit union CEOs will reference learning from their competitor’s experiences and banking knowledge. Several areas include expanded commercial loan opportunities, entry into new markets and adding staff with  different expertise.

Trying to beat the competition by becoming the competition has always been a dubious strategy. Moreover, the example of early competition from the Morris Plan banks suggests credit unions will be more successful developing their own unique competencies.

Credit union success was never guaranteed. In fact, one of the earliest and largest competitors for the untapped consumer credit market grew much faster and was far more consequential than the slowly emerging credit union system. That is, until the 1934 passage of the FCU Act ushered in a new era of cu expansion.

Morris Plan Banks

In 1910, attorney Arthur J. Morris (1881–1973) opened the Fidelity Savings and Trust Company in Norfolk, Virginia.

The Virginia lawyer, was troubled that a securely employed workman, seeking a small loan, was denied access to credit from local banks and forced to borrow from loan sharks. Morris thought that a country that denied bank loans to a large part of its population had a “weak spot” in its banking system. Morris studied the various banking laws in the U.S. in the hopes that some type of “banking institution could be evolved that would correct the existing evils and supply credit to the needy”

Under a concept called the “Morris Plan” he offered small loans to working people. In this approach would-be borrowers had to submit references from two people of like character and earnings power to prove the borrower’s creditworthiness. Repayment of the loan was made through the weekly purchase of Installment Thrift Certificates equal to the face value of the loan, less origination and investigative fees.

Morris Plan Banks expanded relying on state charters just as did the nascent credit union movement. By 1931, there were 109 Morris Plan banks operating in 142 cities with an annual loan volume about $220,000,000.

In a November 23, 1931, TIME magazine personnel announcement, the industry’s two decades of success and growth were described as follows:

“Walter W. Head, past president of American Bankers Assn., was elected president of Morris Plan Corp. of America, succeeding Austin L. Babcock. Morris Plan Corp. has large stock holdings in all the Morris Plan banks, the largest industrial banking system in the U. S. In the last 21 years these banks loaned $1,750,000,000 to 7,000,000 people, and now do about $200,000,000 annual business with 800,000 customers.”

Morris Plan banks pioneered the use of automotive financing through arrangements between the Morris Plan Company of America, the holding company for Morris Plan banks, and the Studebaker Corporation. In 1917 through the subsidiary Morris Plan Insurance Society, credit life insurance was offered to pay off any outstanding loan balance if the borrower died. Any insurance left over went to the borrower’s estate.

In their description of Morris Plan banks, authors Phillips and Mushinski offer one explanation for model’s success versus credit unions:

“The Morris Plan structure was more attuned to the individuality of typical Americans than were credit unions.

“It should also be noted that the Morris Plan was not without critics, especially from the Russell Sage Foundation which viewed the lending procedure to be misleading at best, and at worst, an attempt to defraud the borrowers. Hence, many viewed the profit-seeking Morris Plan institutions as little better, and in some respects worse, than loan-sharks.”

Morris Plan Banks vs Credit Unions’ Growth

Morris Plan banks began the same year as credit unions. In just two decades, by 1931, they became the leading provider of financial options for consumers.

The following slides summarize this state chartered, for-profit enterprise.

1. Begun by a lawyer to meet the need for unsecured personal credit.

2. Innovative legal structure incubated in the state chartering system.

3. Loans were made based on character, for a good purpose with at least two cosigners of similar economic standing.

4. Morris plan banks’ annual loan volume in 1931 is estimated at over $200 million. The state-chartered credit union system reported just over $40 million.

5. Morris Plan banks failed during the Depression. Many converted or were sold to commercial banks which took consumer deposits and had broader lending options.

Today the descendant of this banking model is the Industrial Loan Company (ILC) state chartered, FDIC insured banks that primarily serve as specialty lenders.

Morris Plan institutions relied on wholesale funding and stock subscriptions. Credit unions which offered savings options and consumer loans quickly became the preferred option for members and communities in the Depression. Their non-profit cooperative design, self-help appeal and local leadership created a positive reputation and loyal members following numerous failures in the banking system following Roosevelt’s bank holiday in March 1933.

Some Reflections for Credit Unions from the Morris Plan Experience

  • Being first to prove a market need and establishing a dominant position does not guarantee ongoing success. Second movers can create a long-term advantage.
  • Growth requires innovation and staying in touch with a market’s needs.
  • The more flexible the institutional model, the greater the chance of sustainability;
  • The Credit Union system took on a new wave of expansion and credibility when a federal charter option became available—Morris Plan banks were dependent on state-by-state legislation;
  • Values and perceptions matter. Although Morris’ instinct was to serve the unbanked, the for-profit structure created a public perception of conflicting purposes.
  • Dramatic or sudden changes/crises in the economic, social, or political environment can lead to demise of models developed in another era.

Buying Used Up Models?

As credit unions pursue whole bank acquisitions, are they buying “tired” business models built with different values and goals? Are these credit unions giving up the advantages of cooperative design and innovation attempting to purchase scale? Will combining competitors’ experiences (and customers) with the credit union tax exemption create an illusion of financial opportunity that fails to prove out when evaluated years down the road?

Two decades ago, the prophets of cooperative doom were selling charter conversions, first to a mutual option and then later, going public with stock. The pitch was: more capital flexibility, no common bond restraints and expanded asset and investment options. And oh, you could also make a lot of money if the former credit union went public.

Between 30-35 credit unions bought into this vision of future financial nirvana. Today only one institution remains, still a mutual whose growth has trailed its cooperative peers since the conversion took place. But that is a story for another day.

We know the fate of the Morris Plan banking model and the “consultants” siren calls to convert to another financial charter. We don’t know if bank purchases will indeed add value for members or their co-op.

But we can learn one thing from history—if these purchases do not create a stronger cooperative, the credit union’s future may have just been attenuated in this effort to induce growth by paying out members’ collective wealth to bank owners.

Watermelon Flavored Oreos Offer Insights into Individuals’ Behavior

In June 2013, Nabisco’s Oreo, the best-selling cookie brand in the world, introduced a “refreshing” new product extension.

The new Oreo had a watermelon flavor filling to create an association with its summer market launch. The internal flavor coloring aligned well with its Golden Oreo product. Children were a prime target because of their willingness to try new flavors.

One does not have to be a market research guru or have a sweet tooth addiction to suspect this might not be a great consumer success.

On Twitter, responses ranged from, “These sound heavenly,” to “i looked up ‘abomination against nature’ in the dictionary and there was a picture of watermelon oreos.

One media outlet asked its Facebook followers for comment and received a deluge containing one word, “Eww.”

An econlife review opined: If you really want that “fun, summer flavor,” stick with the real thing and dive into an organic watermelon. They’re limited edition summer treats too, with much healthier benefits.

Harbingers of Failure

Marketers study failures, not just success stories.

In a 2015 paper, marketing scholars from MIT, Northwestern, and Hong Kong University of Science and Technology looked at consumer demand for new products. After gathering data on 8,809 new supermarket products, 439,546 transactions, and 77,744 customers, they concluded that success didn’t necessarily equate to sales growth. The explanation was that consumers who liked the items most were not representative of the total market.

Analysis identified these buyers as exhibiting what marketers labelled “Flop Affinity.” These are people who buy something that really doesn’t resonate with the majority of the market, such as Crystal Pepsi or Lemonade Doritos. These individuals are also more likely to buy a type of toothpaste or laundry detergent that fails in the broader the market.

Traditionally, companies want increased demand. But demand is about more than the quantities; it involves knowing who likes your product. If sales increase because “harbingers of failure” purchase something that most would avoid, then a firm can have a flop on its hands.

But just as important, an NBC story on the study found these group preference choices work the other way around. The data found those “who tend to purchase a successful product like a Swiffer mop are more likely to buy other ultimately successful products, like Arizona Iced Tea.”

The Watermelon Oreos Phenomena in other Contexts

Researchers are exploring how widely this “harbingers of failure” pattern applies in other areas, from everyday shopping selections to financial markets.

Is the concept applicable to behaviors other than choosing consumer products? Do credit union leaders tend to join with others around similar performance patterns?

Can the Watermelon Oreo research also identify behaviors or mindsets that exist within organizations; that is, micro-cultures that can compromise or promote purpose and performance?

Responding to External Demands for Change

In addition to ongoing market competition, every institution today is confronting external pressures for change. These range from the operational pivots responding to Covid to the social and political demands for accelerating equity and economic inclusion.

Northwestern’s Kellogg School identified a range of leadership responses ranging from the least to most meaningful when an organization reacts to external demands. Least effective were public statements of support. The most consequential was finding champions for the cause within the organization and tasking these internal believers in the change to develop the organization’s response.

The Watermelon Oreos case suggests that people’s choices, even if popular in the moment, are not indicative of long-term success. Winners tend to align with other winners in their behaviors whether within an organization or in the distribution of consumer preferences.

Effective leaders put those who believe in the required change in charge and not let the doubters harm their brand or organization’s reputation.

The Nose of the Camel?

At FDIC’s December meeting, the Board approved an updated regulation relating to interest rate limits on banks that are less than well capitalized.

The changes are intended to provide flexibility for institutions subject to the interest rate restrictions and ensures that those institutions will be able to compete for deposits regardless of the interest rate environment.

One way this flexibility is enhanced according the explanatory Fact Sheet is:

MORE COMPREHENSIVE NATIONAL RATE – The final rule defines the National Rate to include credit union rates for the first time.

  • “National Rate” is defined as the weighted average of rates paid by all IDIs and credit unions on a given deposit product, for which data are available, where the weights are each institution’s market share of domestic deposits.

The Level Playing Field

Is this what bankers mean by “a level playing field?” To implement this rule, the FDIC camel must poke its nose into co-ops’ tent to track credit union rates on “given deposit products.” Be alert for more “leveling” activities in the future.

AN EYE-OPENER: New Study on Size and Cost Efficiency

This month the FDIC released a 27-page study entitled “Economies of Scale in Community Banks.”

The authors analyze all community banks less than $10 billion in assets from 2000 to 2019 to measure their actual trends in economies of scale and productivity by asset size.

The major findings are below. Over two thirds of the paper present the analytical method and data used to develop their conclusions. The most significant conclusion in my view is:

“. . .our results suggest efficiency gains accrue early as a bank grows from $10 million in loans to $3.3 billion, with 90 percent of the potential efficiency gains occurring by $300 million”

The Relevance for Credit Unions

The average credit union size on September 30, was $345 million. That is the sweet spot for peak operating gains in the study. While credit unions would not mirror the balance sheet and business model of a typical community bank, the overall conclusions seem applicable.

Moreover, it is probable that the greatest gains in efficiency occur at an ever lower average asset range in coops for three reasons. Credit unions have a consumer-focused lending specialty, which the authors cite as a factor in greater efficiency. They do not have to manage the complexity of paying federal or state income tax. Finally, credit unions achieve economies of scale and efficiencies by cooperating in local and national CUSOs that bring members convenience no single bank or firm could duplicate with its own resources.

Credit unions are undergoing some of the same consolidation pressures described for banking. The study provides needed insight for two much talked about issues in the credit union system. One is what is the ideal size for operational competitiveness. The finding that a range of $300-600 million in assets achieves 95% of efficiency gains, is easily within reach for many credit unions’ business models. Secondly, larger size does not create major gains in efficiency.

In fact, there may even be a cap on size ($3.3 billion) after which diseconomies of scale occur, that is increasing expense ratios. An example of this would be the dramatic performance decline in PenFed, the industry’s third largest institution, as it grew by $7.5 billion over the past five years. This is documented in the analysis “PenFed’s Spurious Strategy.”

The Problem We All Share Part I: PenFed’s Spurious Merger Strategy

In the extracts below, emphasized (bolded) text focuses on the most important conclusions presented by the FDIC authors.

Abstract Summary

Using financial and supervisory data from the past 20 years, we show that scale economies in community banks with less than $10 billion in assets emerged during the run-up to the 2008 financial crisis due to declines in interest expenses and provisions for losses on loans and leases at larger banks. The financial crisis temporarily interrupted this trend and costs increased industry-wide, but a generally more cost-efficient industry re-emerged, returning in recent years to pre-crisis trends. We estimate that from 2000 to 2019, the cost-minimizing size of a bank’s loan portfolio rose from approximately $350 million to $3.3 billion. Though descriptive, our results suggest efficiency gains accrue early as a bank grows from $10 million in loans to $3.3 billion, with 90 percent of the potential efficiency gains occurring by $300 million.

Introduction

Economies of scale occur when the per-unit cost of production falls as the number of units produced increases. In the context of banking, scale economies exist when the cost per dollar of loans (or assets) declines as the number of loans (or assets) increases. An efficient bank is operating at the lowest cost per dollar of assets or loans, , , ,

Our estimates are not causal and do not predict how a bank’s costs would change were it to change in size. We find evidence, however, that the overwhelming majority of any gains from increasing a bank’s loan production from $10 million to the cost-minimizing loan portfolio size of $3.3 billion accrue early in the growth process. Our nonparametric results suggest that once a loan portfolio reaches approximately $300 million, a bank has achieved about 90 percent of the potential efficiencies from increased scale; by $600 million, a bank has achieved about 95 percent of potential efficiencies. . . .

Our analysis focuses on community banks—banks with less than $10 billion in assets—as these banks comprise the vast majority of banking organizations. Approximately 97 percent of all banks in the United States have less than $10 billion in assets, and roughly 90 percent of those have less than $1 billion in assets. The consolidation trend in the industry has differentially affected community banks. The number of small institutions—those with less than $100 million in assets—has declined by 92 percent since 1985. Much of the debate about bank consolidation centers on the largest financial institutions, primarily those some argue are “too big to fail.” But as consolidation in the industry has persisted in recent years, some have begun to turn the “too big to fail” designation on its head and question whether small community banks are “too small to succeed.”

Conceptual arguments that support this notion are often based upon the economics of scale. Some have suggested that increased regulatory burden affects small banks in particular because regulatory compliance cost is a relatively larger item in a small bank’s finances. Likewise, banks that operate in limited geographical areas may find expansion into new product lines less profitable. Another possibility is that technological investments, for example in credit scoring and model-based lending, may not offer enough upside to justify the investment cost for small banks to transition from slower, more cost-intensive business practices (i.e., relationship lending).

Consolidation that shifts assets from small to large banks is more than just a rearrangement of resources. Small and large banks are not interchangeable; a single $1 trillion bank is not the same as one thousand $1 billion banks. Small banks are often built around a relationship-lending business model. Bankers acquire costly but valuable private information about their customers and make lending decisions using this expertise. In contrast, large, remote banks often lack personal relationships with customers and knowledge about the local community, instead relying on a standardized approach to lending. Customers that are good credit risks to a small bank may be unable to obtain credit from a large bank that lacks local knowledge.

As the number of small banks has declined, concern about the future of small banks has extended to the future of small businesses. Small businesses generally obtain loans from small banks, especially when the businesses are in their infancy. The report of findings from the FDIC’s Small Business Lending Survey states that large banks are more than five times more likely than small banks to require minimum loan amounts for the primary loan products provided to small businesses and eight times more likely to use standardized small business loan products. Small banks are also roughly five times more likely than large banks to underwrite loans to start-up small businesses differently These businesses are sometimes described as the engine of economic growth in the United States, so a decline in credit availability to such businesses could affect the real economy.

The fate of small banks also portends that of the communities in which they operate: Kandrac (2014, p. 23) finds meaningful feedback from the failure of a bank and local economic performance, stating, “The disruption of banking and credit relationships is an important channel through which bank failures affect economic performance.” Scale economies in banking thus transcend the domain of business policy into that of public policy. . . .

Conclusion

Consolidation and growth have been hallmarks of the banking industry since the 1980s. The number of institutions has decreased by more than two-thirds while the size of the remaining institutions has increased. Although the problem of “too big to fail” has been frequently discussed within the corridors of government, academia, and the media, community bankers have begun to question if a “too small to succeed” problem also exists. Such concerns are commonly motivated by notions of economies of scale, whether due to cost efficiencies, expanded business opportunities, or the allocation of regulatory costs across a wider asset base.

Using financial and supervisory data on banks and thrifts with less than $10 billion in assets, we study economies of scale within the banking industry using nonparametric kernel regression and translog cost estimation. Our estimation period spans both sides of the financial crisis, enabling us to distinguish pre-crisis trends from post-crisis trends. We find that total costs have generally been declining over time. The crisis temporarily halted this trend, at least for some institutions, but the trend resumed in force post-crisis. With economies of scale, lending specializations matter: agriculture banks show less evidence of scale economies than commercial banks, while mortgage banks display the strongest signs of economies of scale.

Tracking FDIC’s Insured Deposit Trends in Your Market

Once per year using June 30 data, the FDIC publishes the total deposits per branch for every bank.

This Summary of Deposits (SOD) report includes an easily searchable database that enables any user to find the totals by any market segment: city, SMSA, county, ZIP code or state.

The tool can be accessed from the FDIC website.

Grand Rapids, MI, FDIC Insured Deposit Report for June 30, 2020

I tested the program by searching all FDIC branches for the city of Grand Rapids.

The repost lists the 22 FDIC insured institutions serving the market in order of deposits. These total $15.4 billion in the 102 branches in the city.

Fifth Third Bank, Ohio headquartered, leads with a 26.5% market share. Seven banks have only one branch in Grand Rapids, all with less than $100 million in deposits.

Where Can I Get Credit Union Data?

For almost a decade Callahan has combined this annual FDIC report with credit union data. This Branch Analyzer database shows all the branches in a selected market. More importantly the analysis provides two year trends in the defined market, changes in market share by institution and even maps showing the geographic layout for all the branches.

Credit unions do not file a branch deposit report like the FDIC. Callahan’s searchable program approximates the deposits at each credit union branch by dividing a credit union’s total shares at June 30 by its number of branches.

The latest edition of Branch Analyzer can be found here:  https://www.callahan.com/market-analysis/