What’s happening to community banks?

Interest rates and red tape push consolidation

With its affluent population and thriving economy, New Hampshire has become a highly competitive marketplace for financial services. But, as lingering low interest rates narrow profit margins, community banks are hard-pressed to generate sufficient earnings and growth to meet the mounting expenses of regulatory compliance and technological investment, signaling the prospect of further consolidation of the industry. 

In 2013, Meredith Village Savings Bank (top left) and Merrimack County Savings Bank (middle left) allied to form NH Mutual Bancorp. In December 2017, the Savings Bank of Walpole (bottom right) entered an agreement to join the organization.

Consolidation is already underway. In 2013, Merrimack County Savings Bank and Meredith Village Saving Bank allied to form NH Mutual Bancorp, the first multi-bank mutual holding company in the state. And in December 2017, the company announced that the Savings Bank of Walpole entered an agreement to join the organization.

In 2014, Eastern Bank of Boston, the oldest and largest mutual bank in the country, acquired Centrix Bank & Trust of Bedford. In 2016, Bank of New Hampshire acquired Community Guaranty Savings Bank of Plymouth, then the state’s smallest bank, and Bar Harbor Bankshares of Maine announced the acquisition of the Lake Sunapee Bank Group of Newport. And last October First Colebrook Bancorp, the parent company of Granite Bank, entered a merger and acquisition agreement with Bangor Bancorp of Maine. 

“The question is how to grow,” said Bank Commissioner Jerry Little, who added that “the longer interest rates remain low, the more damaging they become to profits. If profitability is weak, what is the impact? On growth — that is what is driving consolidation.”

Industry snapshot

In 1989, there were 102 state-chartered banks, including those owned by multi-bank holding companies. Now there are just 17 — a dozen mutual banks and five stockholder-owned banks. All are “community banks” based on their assets, deposits and branches as well as the extent of the markets they serve. Altogether, these banks operate 111 branches. There is also one federal savings bank with four branches headquartered in the state.

Three of the 12 mutual banking organizations have assets of more than $1 billion: NH Mutual Bancorp, with $1.7 billion, Mascoma Mutual Financial Services Corp., $1.6 billion, and Bank of New Hampshire, $1.5 billion. Bank of New England of Salem, Northway Bank of Berlin and Optima Bank & Trust of Portsmouth, all stock banks, have assets of $939 million, $883 million and $500 million, respectively. All the remaining state-chartered banks have assets of less than $500 million, and three of them less than $300 million.

Meanwhile, another 22 banks based in other states operate 270 branches in New Hampshire. These include four of the biggest financial institutions in the country — Citizens Financial Group, TD Bank, Bank of America Corp., and People’s United Financial Inc. — which, according to SNL Financial, together hold nearly two-thirds of all bank deposits in the state.

There are also 10 state-chartered credit unions with 79 branches, including Service Credit Union, with more than $3 billion in assets, making it the largest financial institution headquartered in New Hampshire. And there are 26 trust companies with 46 offices, which together manage nearly $480 billion in assets. 

Competition, said Little, is especially intense where the economy is most robust — in the Seacoast, Upper Valley and Merrimack Valley, where prosperity and growth have drawn banks with regional and national footprints as well as community banks from neighboring states. Local banks based in less dynamic regions, like Northway Bank of Berlin and Granite Bank of Colebrook, which have served the North Country for more than a century, have also branched into these same crowded markets. 

State of competition

Phil Emma, president of Concord-based Merrimack County Savings Bank, said that in an environment overshadowed by low interest rates, pricing rates on deposits and loans as well as service fees is extremely competitive.

Emma added that, not long after NH Mutual Bancorp moved its Mill River Wealth Management subsidiary to new offices on Main Street in Concord, Bank of New Hampshire located a similar operation directly across the street. “And Charter Trust is just a few doors away,” he said. 

Emma was among several to note that competition between large banks and community banks was less for borrowers than depositors. “Big banks want to loan to big businesses,” he said. 

“I think we’ve got all the competition we’d like to have,” said Clay Adams, CEO of Mascoma Savings Bank. He noted that the bank has enhanced its presence in the market through Mascoma Community Development LLC, an entity certified by the federal government that provides New Markets Tax Credits and Historic Tax Credits to finance redevelopment projects and business expansion in both rural and urban communities.

Rick Wallis, president and CEO of Piscataqua Savings Bank, a mutual that opened its doors in Portsmouth in 1878, said that 16 banks — two locally owned — are currently operating in the city of less than 22,000 residents.

He said that by serving individuals and families with retail banking and trust services without seeking commercial business, the bank has secured a customer base stretching for generations by keeping its traditional character. At the same time, Wallis said the bank’s long presence in an expanding market has contributed to its success. 

By contrast, Optima Bank & Trust — the only other bank headquartered in Portsmouth — was formed on the eve of the recession when it opened in 2008. While two other banks that began about the same time — Hampshire First Bank and The Nashua Bank — were quickly acquired, Optima has grown to $500 million in assets and four branches.

CEO Dan Morrison said that the bank splits its business evenly between commercial and residential accounts and applies advanced technology to the traditional community banking model. Other community banks offer the stiffest competition for loans, he said, while the big banks, as their market share indicates, compete most aggressively for deposits.

Low interest rates

While bankers accept competition from one another, they have long chafed at the competition they face from credit unions, which, unlike banks, are exempt from federal and state corporate taxation.

“We don’t feel like there is a level playing field,” said Christiana Thornton, CEO of the NH Bankers Association, who stressed the exemption, which dates back to 1934, is a federal issue.

Since 2002, the share of financial assets held by credit unions has more than doubled, from 16 percent to 38 percent, while their deposits have nearly tripled, from little more than $2 billion to just less than $6 billion.

The exemption was intended as an incentive to serve those with meager and modest incomes. However, several studies have found that customers of credit unions are as or more affluent then those of banks, which are bound by the Community Reinvestment Act to serve economically disadvantaged individuals and communities. 

A 2012 study undertaken for the NH Bankers Association described the exemption as a subsidy and calculated that only a quarter of it was passed to customers in higher deposit rates and lower loan rates, while half was added to earnings and to balance the operating costs.

Credit unions, according to the study, were more profitable than community banks. That was before 2017, when the National Credit Union Administration loosened regulations that restricted credit unions from commercial lending, opening another arena of competition with banks. 

The competitive landscape is overshadowed by a prolonged period of unprecedentedly low interest rates. “These are very unusual times,” said Bank Commissioner Little.

In an environment overshadowed by low interest rates, “margins are tight,” says Phil Emma, president of Concord-based Merrimack County Savings Bank.

Unlike big banks with diverse balance sheets, the profitability of community banks stems overwhelmingly from the interest income on loans, which represent the bulk of their assets. In the low-rate environment, the diminished interest income from loans has exceeded the lower interest paid on deposits.

“Margins are very tight,” Emma said. “Increasing net income requires making more loans, and the market is very competitive.” 

Compliance and technology

According to the Federal Reserve Bank the state-chartered savings banks posted a net interest margin of 3.39, return on assets of 0.54 and return on equity of 4.91 at the third quarter of 2017, while the ratios for the stock banks — 3.54, 0.85 and 7.67 — were somewhat higher. All three ratios were shy of pre-recession levels and short of industry benchmarks.

Since retained earnings are the major source of capital for community banks, particularly mutual banks, the pressure on profitability weighs on their capacity for growth. “Banks are not accruing earning to capital at a high rate,” said Gregg Tewksbury, president of the Savings Bank of Walpole, “and that is driving consolidation.”

Meanwhile, these banks face rising costs of compliance and technology.

Emma said that the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act imposed regulatory and reporting requirements on all banks, regardless of their size. “Compliance requires more people, which adds to non-interest expenses,” Emma said. 

Thornton said that legislation in the U.S. Senate would lighten the regulatory burden on community banks by tailoring regulation and supervision to the size of the institutions as well as the level of risk carried on their balance sheets. She emphasized that community banks, which represent more than 90 percent of all banks, are not engaged in the complex financial transactions and risky trading programs pursued by their large counterparts and do not require the same level of oversight. 

“Right-sizing regulation is an appropriate approach,” said Little, “and is especially good for our community banks.” 

Along with compliance, keeping pace with the technological changes sweeping the industry is the major source of non-interest expense.

“Lobby traffic is shrinking by 10 percent a year,” said Tewksbury, who explained that the digital and electronic alternatives to conventional banking represented a significant and recurring investment. Emma noted that while enhancing services to customers and efficiency of operations, investment in technology is also required to meet the escalating need for cyber security.

“Banks are not accruing earning to capital at a high rate, and that is driving consolidation,” said Gregg Tewksbury, president of the Savings Bank of Walpole.

At Optima, where personal bankers and applied technology have replaced teller lines, Morrison said “bricks and mortar still have a role,” noting that the bank operates at seven locations. “We’re building branches to open accounts,” he said.

Tewksbury suggested bankers must strike a balance between satisfying the technological appetite of the millennial generation while catering to the traditional preferences of the older population. “The older generation is where the money is now,” he remarked, “but we must capture the young by investing in the future.” 

Size matters

Community banks enjoy capital positions sufficiently strong to sustain their independence in the near term. At the same time, the reduction in the corporate tax rate and incremental increases in interest rates promise to ease the pressure on earnings. 

But, as Tewksbury noted, across the country the number of banks has fallen from more than 8,000 to less than 6,000 since 2000, a reflection of “consolidation at an unprecedented pace.”

Many community banks,” he said, “have found they are too small to be competitive in the long-term.”

He recalled that when NH Mutual Bancorp approached the Savings Bank of Walpole, “We were forced ask what our future looks like.” 

He described the economy in southwestern New Hampshire as “not a dynamic market — the pie is not getting bigger and growth amounts to increasing market share.” By affiliating with the holding company, he explained, the bank will retain its local management and independent identity while drawing on the resources of the holding company to defray the costs of regulatory compliance, technological investment and backroom operations.

“We see it as having our cake and eating it too,” he said. “We are the stewards of mutual banking in New Hampshire.”