View from the Sidelines: A Retired Bank Exec Shares Insights about the Economy, Regulation and the Future of Community Banks

By Vito R. Nardelli, Invictus Executive Director

It’s been almost four years since I left the day-to-day responsibilities of running a successful community bank in my home state of New Jersey. Since then I have had time to reflect, contemplate, read, discuss, interview, and at times argue with fellow bank presidents, regulators, accountants, and lawyers about the pitfalls and opportunities for community banks in today’s world. I’ve reached a few conclusions I’d like to share.

Let’s begin with the more stringent regulatory capital requirements, Federal Reserve monetary policy, and the overall economic environment currently faced by financial institutions. It is imperative for C-suite executives and their board of directors to acknowledge the dramatic and drastic impact these changes have made to community banking. Perhaps I see it more clearly, since I am no longer at the helm of a bank. But bankers cannot hide their heads in the sand. I meet bankers every month who have not fully internalized the severity and complexity of the residual impact these significant modifications have forced on our industry.

Never before have we been faced with a Fed monetary policy that has dragged on for 10 long years and three quantitative easements, only to see the Fed minimally raise rates – and then announce less than 45 days later that there likely won’t be further rate action for several more quarters. (The prior hike was in June 2006.)  Some may remember 10 years ago when St. Louis Fed President James Bullard warned that the Fed’s policies could cause a “lost decade”. The reality is that the Fed over the course of this long, painful, and at times, stagnant recovery prescribed monetary medicine to ease the pain, but it did not cure the disease. It was thought that true recovery would be too painful to endure. The question now remains: When will the economic system recover?

I didn’t feel too hopeful when I read a recent piece in the Wall Street Journal about how major department stores will close hundreds of stores to get back to 2006 levels of sales-per-square-foot. We can’t just blame the Internet. Many of these companies had already closed stores to compensate for web sales, and new stores had been built with smaller footprints. This is just evidence to me of an economy that is not thriving.

Yet banks continue to chase too few customers at dangerously low and risky rates. Since 2009 banks have been lending at rates in the range of 3.5% to 4.5%. That’s eight years of extremely low rates. Still, many banks feel compelled to deliver earnings expectations of more than a decade ago, which may not be at all prudent in today’s operating environment.

The regulators for their part—and to a degree in response to political pressure—seek to minimize the effects of the current economic conditions by demanding more capital. Big banks did not fare well on the last “living will” test, and community banks are stuck with a one-size-fits-all capital requirement of between 10% and 15%. So the question remains: How can banks chart a course that will maintain safety and soundness, generate returns that are rational for the environment, and potentially take advantage of a significant opportunity in the market?

Looking from the sidelines, organic growth is not the answer. But there is one glaring target that all banks must consider: mergers and acquisitions. Think about it: One in three community banks today is struggling. Healthy banks, with smart executives and boards, that use the right analytical tools for assessing the benefits of a purchase will fare much better by targeting an M&A deal than by growing organically. M&A offers the smart bankers an opportunity to gain scale, diversify product offerings, expand geographically, gain additional manpower talent and add their own talent and leadership to an institution that may be paralyzed by regulatory constraints or crushed by the high cost of regulatory compliance.

Our industry is at a crossroads.  There have been almost no de novo charters in years, and most banks don’t have great succession plans, either. Taking in the entire landscape of today’s banking opportunities, it’s obvious to me that the only way out of the economic and regulatory quagmire for most banks is through targeted acquisitions.  It is cheaper, safer, more predictable and rewarding than building organically—and it solves many of the problems that are keeping most bank CEOs awake at night.