When I described a speech last month by retiring Kansas City Ferderal Reserve Bank president Thomas Honeig as his "parting shot," I spoke too soon. In a recent breakfast diatribe in Denver, Hoenig kept the hits on Dodd-Frank coming.
He isn’t a big fan of increased government regulation, either. He called the Dodd-Frank Act “2,300 pages of complexity. I don’t find Dodd-Frank satisfying.”
Though Dodd-Frank was intended to rein in large financial institutions, “community banks and regional banks will suffer the most” from its enactment, he said. “It gives the largest financial institutions a competitive [cost of capital] advantage.”
Hoenig said the largest financial institutions don’t need the government to help them get a competitive advantage.
In 1913, when the Federal Reserve was created, the five largest financial institutions controlled the financial equivalent of 2.5 percent of the U.S. gross domestic product, he said. In 1980, they controlled about 14 percent of GDP.
After the financial crisis in 2008, the five largest financial institutions now control the equivalent of 60 percent of the U.S. GDP, Hoenig said.
“So they are 20 percent larger after the crisis,” he said. “This says the consequence of bad management is that they’re 20 percent larger and too big to fail.”
He called the growth of large financial institutions “a threat to capitalism. You have to break them up. Commercial banks need to be separated from investment banks.”
Hoenig's words about the threat to the future of community banks seems to be supported by what's happening in Florida, one of the states most devastated by the economic collapse. According to Florida investment banker Benjamin Bishop Jr., "[a]s many as 50 of Florida’s 225 community banks could disappear by the end of 2012," doomed by either too many toxic loans or by the fact that they're too small to save.
The result, according to a report by Raymond James & Associates, Inc., is an expected step up in assisted acquisitions over the next few years. As many potential sellers among community bank owners remove their heads from the sand on pricing, I expect that unassisted acquisitions will also increase.
The growing presence of larger banks with more resources will impact community banks’ abilities to compete, Bishop said.
Rising expenses for regulatory compliance, including the cost of exams and insurance premiums paid to the Federal Deposit Insurance Corp., also will pressure community banks. Offering more personal service traditionally has been a selling point for community banks, but Bishop questioned whether that would remain a high value as older community bank presidents retire.
Bishop said the most vulnerable community banks are those at which the value of a bank’s nonperforming assets equals or is greater than its tangible common equity and loan loss reserves — the so-called Texas ratio, a controversial measure of financial stability. There were 48 Florida banks that met that criteria as of March 31, according to a Ewing report, while the Raymond James report put the number even higher, at 70.
Community bankers who understand the pressures will “put into their business plans a recognition that they have to be part of a larger banking organization,” Bishop said. Organic growth, or expansion due to increased customers or sales, is tough in the current economic climate, leaving M&A as the remaining option for growth.
That might sound like an investment banker drumming up M&A business, and it is. It's also a pretty savvy analysis of what's in store for community banks in Florida and elsewhere.
Dodd-Frank: the gift that keeps on giving. Unfortunately, as always, only the rich (and lawyers) will get richer.