Southwest Business and Economics Journal/2010
Performance of Community Banks in Oklahoma
V. Sivarama Krishnan
University of Central Oklahoma
Abstract
This paper studies the performance of banks in Oklahoma by different asset size
groups with a focus on the performance of smaller banks. The state banking industry has
undergone significant consolidation in the last two decades as a result of the geographic
deregulation and the general consolidation trend seen throughout the country. While
large banks have gained, and small banks have lost, market share, it is far from clear
that smaller banks are destined to wither away. Most of them are profitable and are able
to hold their own against competition from larger rivals. The financial crisis of 20082009 did impact the performance of banks of all sizes, though larger banks appear to
have taken a bigger hit.
Introduction
The structure of banking industry in the United States has historically been driven
by the unique regulatory framework characterized by the dual banking system and near
total prohibition of inter-state banking till the 1980s. The regulatory barriers to nationwide consolidation disappeared in1994 with the passing of the Riegle-Neal Act, which
effectively replaced the 50 separate state banking entry laws with one nationwide law.
This permitted acquisitions across state borders from 1995 as well as de novo branching
across state lines from 1997. The advent of these deregulations prompted some industry
experts to predict a rapid consolidation in the industry. It was also suggested that the
industry structure will be dominated by a small number of national and a few regional
banks. It was conventional wisdom that community banks or small banks focusing on
local markets would find it hard to compete with the giant national and large regional
banks. Recent history shows that while considerable consolidation and merger activities
have occurred, some of these predictions to be way off the mark. Community and local
banks have not only survived but have also held their own in most states. In Oklahoma,
during the last fifteen years 122 mergers have taken place and this has reduced the
number of banks by over twenty percent. It should also be noted that during the same
period 19 new banks were chartered suggesting that industry consolidation will not
eliminate small banks as a competitive factor. There were also seven bank failures during
the period.
This paper analyzes the changing structure of banking industry and the
performance of banks in Oklahoma by different asset size groups in an attempt to identify
the factors that enable community and local banks to succeed. The focus of the paper is
the performance of community banks. Community banks have been unique institutions in
the financial services industry and have played very important economic roles in the
development of many small urban and rural communities. It is hard to find a widely
accepted definition of community banks. It can be safely said that all small banks are
community banks, though all community banks may not be small. Hein, Koch, and
Macdonald (2005) suggest that all banks that have assets less than $1 billion could be
considered community banks. Under this rubric, they could be seen as banks operating in
essentially a relatively small geographic area such as one city or one county or at the
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Performance of Community Banks in Oklahoma
most a few counties but in some cases even a whole state. Community banks are
responsible for generating most of the small business loans and are considered vital to the
economic health of most small and medium size cities and rural towns.
The paper is organized as follows. The first section provides a summary overview
of important literature on the recent developments related to the performance and future
of community banks. The following section presents the empirical analysis and
interpretations. The last section offers concluding comments.
Literature Review
Community banks have been popular research subjects perhaps because of their
amazing ability to survive and compete with the giants of the industry. DeYoung (2003),
in his summary of a conference on community banks organized by the Chicago Federal
Reserve, raises doubts and concerns about their long term survivability. In particular, the
recent trend has shown that the number of small banks to be on a sharp and steady
decline and their market share on an even faster down trend. The more interesting finding
in the conference papers is that the community banking model based on local focus and
relationship lending will survive. Berger, Dick, Goldberg, and White (2005) study
industry consolidation over the period 1982 to 2000 and their findings suggest that most
of the industry consolidation can be attributed to real gains in efficiency. They find that
the large, multi-market banks have increased their market share of deposits from 23
percent in 1982 to 65 percent in 2000. The Berger, et al study suggests that size is not the
only factor that affects performance; geographic dispersion may also matter. Bassett and
Brady (2001) study performance of community banks over the period 1985 to 2000. Even
during this period of industry consolidation, community banks appeared to have done
well.
Hein, Koch, and Macdonald (2005) present an exhaustive analysis of the
performance of banks by different asset sizes and by corporate charter (S- corporations or
C-corporations). The authors suggest that community banks focus on relationship
banking as opposed to transactional banking which is the modus of operation for larger
banks. Relationship banking may be the primary competitive advantage for community
banks. The general presumption that economies of scale afforded to larger banks (see
Berger and De Young (2004), and Berger and Humphrey (1999)) because of technology
and the ability of large banks to process large volume of information may be overstating
the competitive advantage enjoyed by large banks.
Hein, Koch and Macdonald (2005) suggest that because many smaller banks are
organized as S-corporations and they are not taxed on their profits, performance
comparison ignoring the corporate charter could be misleading. Their study, therefore,
divided banks into asset groups and by corporate charter. They also study performance by
classifying banks into loan-driven and deposit driven. Loan driven banks are those, which
have loan-to-deposit ratio that exceeds 60 percent. All other banks were classified deposit
driven. The authors found evidence showing that performance differed by size groups as
well as by the corporate structure. The smallest banks performed well with higher net
interest margins and operated with higher equity capital. The S-corporations generally
show higher return on assets (ROA) and return on equity (ROE).
There are a number of other studies that have looked at the consolidation and the
changing structure of banking industry as well as the impact of the wave of deregulation
that took place from the 1980s to the end of the last century (see for example Jones and
Crutchfield (2005), Berger, et al (2007) and Mester (2005)). Matasar and Heiny (1999)
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looked at the impact of geographic deregulation and interstate banking on the 7th Federal
Reserve district (Chicago Fed’s area) and Laderman (2005) did the same for the 12th
district (San Francisco Fed’s area. All of these studies show two clear facts: industry
consolidation has reduced the number of independent banks and the market share for
larger banks has increased at the cost of the smaller community or single market banks.
Few studies, though, show poorer or inferior performance for the smaller banks in terms
of profitability or risk. In other words, small banks are able to hold their own even though
their market share is shrinking.
Empirical Analysis
Our analysis focuses on banking industry in one state - Oklahoma. We use data
from the Federal Deposit Insurance Corporation’s Statistics on Depository Institutions
(SDI) data base. All the comparative analyses are based on data from 1994 to 2009. We
divide the sample into five groups by asset size: less than $100 million, $100 million to
$300 million, $300 million to $500 million, $500 million to $1 billion, and larger than $1
billion.
At the outset, we looked at the overall trends in terms of number of banks and
relative market share. Figure 1 shows the total number of banks in the state from 1966 to
2009. The number of banks actually increased from 419 in 1966 to 539 in 1984. The
trend has been downward since then to 247 by the end of 2009. The trend can be best
explained by increased efficiency enjoyed by larger banks. Interestingly and perhaps not
surprisingly the number of branches/offices has shown an upward trend throughout (see
figure 2). This has been the national trend as well. Table 1 provides the details of the
number of institutions (both commercial banks and thrift institutions). The share of bank
deposits of Oklahoma to the total national deposits has remained fairly stable at about 1
percent.
Table 2 shows the relative market share by size percentiles for 1996 and 2009.
The largest ten percent of the banks increased their share from about 59 percent to about
65 percent. The top fifty percent banks by asset size increased their share from about 89
percent to about 91 percent. It should be noted that during this period the total deposits in
the state increased by about 124 percent and the smaller banks actually enjoyed robust
growth in terms of their deposits.
Table 3 shows the changing structure of the state’s banking industry. The most
notable feature of the trend is that the number of banks showed a sharp drop only for the
smallest size group (assets less than $100 million) from 338 in 1992 to 123 in 2009. It is
obvious that many of these banks were acquired or merged to form banks in the asset size
over $100 million. The table also shows the percentage of unprofitable institutions. It is
clear that the smallest banks have a higher percentage of unprofitable institutions, while
the largest size groups show unprofitable institutions very rarely. The institutions
between $500 million and $1 billion appeared to have the best record of consistent
profitability till the financial crisis of 2008-2009. The impact of the crisis was felt by
banks of all sizes and lower profitability was seen across the board for the years 2008 and
2009. The larger banks, especially the $500 million to $1 billion asset group fared worst.
Table 4 shows profitability measures for selected years. The smallest banks show
healthy net interest margins, pre-tax return on assets and other profit measures. However,
it cannot be said that they have superior performance compared to other asset size groups.
It appears that banks in the asset size group of $300 million to $500 million generally
performed better than other groups till 2008. It is also interesting that the largest asset
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Performance of Community Banks in Oklahoma
group (banks with assets > $1 billion) seemed to show an improving trend. The
performance of banks in asset classes were affected by the crisis and larger banks did
worse than the smaller asset classes. The $500 million-$1 billion class performed worse
than all the other groups and showed negative profitability for 2009. Overall, the smaller
banks seem to perform quite well and appear to be somewhat less affected by the
financial crisis. While they have consistently lower return on equity, this reflects their
lower leverage.
Table 5 shows efficiency ratios – ratio of non-interest expenses to revenues - for
selected years. Generally, efficiency improves with size and larger banks showed lower
values for the ratio. However, for the years 2008 and 2009, larger banks, especially the
$500 million-$1 billion asset class, were affected more and suffered some loss of
efficiency. The table also shows the ratio of assets per employee. Again, larger banks
carried more assets per employee showing some economies of scale.
Table 6 shows several risk and capital ratios. The smallest size group’s risk ratios
are comparable. Overall, the smaller community banks show very good risk profile with
higher levels of equity. The smallest size group has better capital ratios. For 2008 and
2009, loan losses for all asset classes were impacted negatively. The larger banks and the
$500 million-$1 billion asset class in particular, appear to have suffered more. The latter
group saw the net charge off rise sharply and non-current loans to loans ratio increase
from 1.17 percent in 2007 to 3.86 percent in 2009. It does appear by most measures that
this group fared worst during the financial crisis.
Concluding Comments
The study shows that overall performance of community banks of all size groups
is very robust in terms of profitability, efficiency and risk. In general, smaller banks have
better capital ratios providing protection for their relative lack of diversified assets. While
losing market share, the community banks seem to be well poised to survive and even
succeed in their relatively strong markets. The financial crisis of 2008-2009 affected
banks of all asset sizes. The larger banks appear to fare worse than the smaller banks. The
group that fared worst is the $500 million - $1 billion group.
Industry consolidation is happening at a steady clip through mergers and
acquisitions and the number of banks in the smallest asset class is decreasing at a steady
pace. Economies of scale appears (better efficiency) could be the primary motivating
factor. Smaller banks, however, remain profitable and competitive and appear to have
fared better during the financial crisis.
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References
Bassett, W. F. & Brady, T. (2001). The Economic Performance of small banks, 19852000. Federal reserve Bulletin. (November).
Berger, A.N. & De Young, R. (2004). Technological Progress and the Geographic
Expansion of the Banking Industry, Journal of Money, Credit, and Banking, Vol.
38, No. 6 (September).
Berger, A.N., Dick, A., Goldberg, L. & White, L. (2007). Competition from Large,
Multimarket Firms and the Performance of Small, Single-Market Firms: Evidence
from the Banking Industry Journal of Money, Credit and Banking, Vol. 39, No.
2–3 (March–April).
Berger, A.N. & Humphrey, D. (1999). Bank Scale Economies, Mergers, Concentration
and Efficiency. The U.S. experience. University of Pennsylvania Working Paper.
De Young, R. (2003). Whither the Community Bank? A Conference Summary. Chicago
Fed Letter. May.
Hein, S.E., Koch, T. & Macdonald, S. (2005). On the Uniqueness of Community Banks,
FRB Atlanta Economic Review.
Jones, K. & Critchfield, T. (2005). Consolidation in the U.S. Banking Industry: Is the
“Long, Strange Trip” About to End? FDIC Banking Review, Vol. 17(4).
Laderman, E.S. (2005). Changes in Twelfth District Local Banking Market Structure
during a Period of Industry Consolidation. Federal Reserve Bank of San
Francisco Economic Review.
Matasar, A. & Heiny, J. (1999). The Changing landscape of American Banking: The
Impact of Reigle-Neal. International Advances in Economic Research. Volume 5,
No. 1.
Mester, L.J. (2005). Optimal Industrial Structure In Banking Federal Reserve bank of
Philadelphia Working Paper, appeared in Handbook of Financial Intermediation
2008.
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Performance of Community Banks in Oklahoma
Figure 1
Number of Banks: 1966 - 2009
600
Number of banks
500
400
300
200
100
0
1965
1975
1985
1995
2005
Years
Figure 2
Number of Branches and Offices: 1966 – 2009
1600
1400
1200
1000
Number of Branches
Number of offices
800
600
400
200
Years
70
2008
2005
2002
1999
1996
1993
1990
1987
1984
1981
1978
1975
1972
1969
1966
0
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Performance of Community Banks in Oklahoma
Table 2
Market Share of Deposits for Oklahoma Banks and Thrift Institutions
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Table 3
Oklahoma Banking Industry Structure Over time
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Performance of Community Banks in Oklahoma
Table 4
Profitability Measures for Selected Years
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Table 5
Efficiency Measures for Selected Years
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Performance of Community Banks in Oklahoma
Table 6
Risk and Capital Ratios
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