Before we move on from the state of the Trade of the Decade update, we need to talk about the latest battle between community banks and the White House. In the face of calls to change the Dodd-Frank Wall Street Reform and Consumer Protection Act to make it easier for the industry to deal with the costs, the Obama administration did something unexpected. The White House Council of Economic Advisers released a report entitled "The Performance of Community Banks Over Time," which concluded that Dodd-Frank had no negative impact on community banks. If anything, according to the White House wonks, Dodd-Frank made them more competitive against bigger banks and protected them from nonbank lenders and other potential competitors. The costs of implementing the legislation haven't been a problem. Indeed, Dodd-Frank is basically the best friend the industry ever had.
It seems, though, that someone forgot to tell the bankers that regulations are not a problem or a cost issue. It has been a core complaint of almost all of the U.S. bankers I have spoken to over the past several years. Almost all report an increase in compliance costs as Dodd-Frank has been implemented. For many banks, compliance costs affect decisions on remaining independent, and even thriving banks have to factor compliance issues into their growth plans. Denying it's a problem does not mean it is not a problem.
American Bankers Association President Rob Nichols sent a letter to the White House expressing disbelief. "Having thoroughly reviewed the report I must admit to being baffled by your findings," he wrote. "You are correct that community banks are resilient and have endeavored to provide the vital financial services critical to the success of their communities. It is also true that consolidation is not a new phenomenon affecting the banking industry. But the notion that the Dodd-Frank Act, and its 24,000 pages of proposed and final rules, has had no impact on community banks is simply untrue."
The House Financial Services Committee released its response to the report, which consisted primarily of quotes from bankers and credit union officials. A representative quote came from Les Parker, president and CEO of United Bank of El Paso del Norte in Texas. "As I see it from my standpoint, we will see community banks continue to decline," he said. "We simply cannot afford the high costs of federal regulation. And as one banker I will tell you this, my major risks are not credit risks, risks of theft, risks of some robber coming in with a gun in my office; my number one risk is federal regulatory risk. And I have a greater risk of harm to my bank, my stockholders, from the federal government than I have [from] anything else in this whole world. That is obscene."
Not long after the report was issued, Stephen Steinour, CEO of Huntington Bancshares (HBAN) , told Bloomberg News that it is "harder to grow earnings, grow revenue in the environment we're operating in, for all of the banks. And there's still more regulatory expectations and more burden, if you will, coming. Those factors will influence more combinations over the foreseeable future."
Bankers and bank stock investors say you need to get to $1 billion of assets to absorb regulatory costs and survive. To thrive you need to get close to $5 billion. Most investors won't buy shares of small banks because the smaller banks are not really liquid, and you can't trade them based on charts and statistics. The smartest thing you could possibly do with your investment dollars is buy banks that have less than $1 billion in assets and trade for book value or less. The average deal multiple in the second quarter was about 1.39x book value, so there is a healthy upside to the potential takeout price from that level.
I am also a huge fan right now of banks like Eastern Virginia Bankshares (EVBS) and Charter Financial (CHFN) that have just hit the $1 billion mark and have their eyes fixed on the $5 billion mark, which is the industry sweet spot. They are either going to grow or get bought by someone else with the same plan. It is pretty much a win-win for investors who buy right and exercise the most valuable investing tool available -- patience.