Monday, July 21, 2014

Will Bigger Lead to a More Efficient Bank?

A friendly competitor of ours, Anita Newcomb, spoke about strategic planning and economies of scale in banking at the recent Maryland Bankers Association annual convention. She led attendees through the increasing regulatory burden and the need for some level of scale to remain competitive.

This got me thinking, if Anita's premise is correct, that bigger is necessary to compete, then what is bigger? And what has changed since before the dawn of Dodd-Frank? So I went to the numbers. As I have often said, it always comes down to a spreadsheet.

I searched for all banks and thrifts that have existed since at least 2007. Any institution that had "NA" in their efficiency ratio for either 2007 or year to date (YTD) 2014 I eliminated. So the sample size was fairly large, nearly all financial institutions in existence today. I then parsed them into seven asset size categories, and compared their efficiency ratios in 2007 and today. The result is the below tables.



For both periods, the lowest efficiency ratios come from the $20B - $100B asset class. In 2007, this asset class had 60% of their members achieve an efficiency ratio lower than 55%. That number has shrunk from 60% to 30% YTD, a dramatic fall from glory. Yet the asset class retains the honor of the highest percent of banks that achieve the under 55% honor.

All asset classes suffered declines in the percent that have efficiency ratios lower than 55%. In 2007, however, you can see the steep dropoff in efficiency between the $500MM - $1B and the $1B - $5B classes. In 2014, the dropoff moved upstream to the larger banks, with 24% of the $5B - $10B banks achieving < 55%, and the $1B - $5B asset class only having 15% under 55%.

So, at least statistically, it appears as though it is becoming more difficult for banks with less than $5B in assets to achieve superior efficiency.  But it is difficult for everybody, not just the under $5B class.

One of my working theories regarding the "you must be bigger" argument was that the number of smaller institutions that achieve superior efficiency is shrinking. So the anecdotes about how this small bank or that small bank do it (achieve superior efficiency) are declining. But the anecdotes about all banks achieving superior efficiency are also in decline, according to the statistics.

Even though only 11% of banks with less than $500MM in assets achieve a sub 55% efficiency ratio, it still represents the greatest amount of banks that achieve the feat. So, if you are sitting around your Board table or in senior management meetings lamenting about rising costs relating to regulation and technology, perhaps instead of calling your investment banker, you should ask how the 11% of small financial institutions do it.

It's a legitimate question, right?

~ Jeff

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