Bank Earnings Season: What the Big Four Are Telling Us About the U.S. Economy

It's earnings release season and pundits are out in full force reading the tea leaves from banks in their coverage universe. I took a different approach.

I analyzed the earnings releases and the earnings calls of the U.S.'s top four banking companies: JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo. Together, they represent a hard-to-ignore $13.4 trillion of total assets. 

I didn't do it to gauge these banks prospects. Instead, I did it to decipher their financial performance, condition, and their commentary on the U.S. economy and banking sector. Below is a summary of those four banks disclosures, aided by Copilot to help absorb a lot of information.

1. The U.S. Economy: Resilient, Not Reaccelerating

Unambiguous signal:
The U.S. economy in early 2026 is holding together better than feared, but it is not entering a new growth phase.

Across all four banks:

• Consumers are still spending

• Corporate balance sheets remain solid

• Credit deterioration is limited and gradual

• Confidence is cautious, not retreating

Yet no CEO described demand as accelerating. The language was consistent: “Resilient,” “stable,” “cautious,” “selective,” “uneven.”

It would be unusual for a financial institution to clamor about bubbles bursting or economic decline because that happens for multiple reasons, one of which is consumer and business confidence. Why buck the confidence game? The bankers' comments point to a late‑cycle soft‑landing environment rather than a boom or a slowdown cliff.

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2. Where the U.S. Economy Is Strong

A. The U.S. Consumer (Top Half of Consumers Are Carrying the Load)

What banks see:

• Debit and credit card spend volumes are still growing
• Travel, leisure, and services spend remains firm
• Wealth clients are active
• Credit card losses are higher than cycle lows, but below stress thresholds

Important nuance from calls:

• Wells Fargo and JPM both emphasized bifurcation
• Upper‑income households and asset owners are fine
• Lower‑income consumers are under pressure—but not yet cracked

Translation:
Aggregate data looks healthy because the top half of consumers is offsetting softness below. That’s sustainable for a while—but not indefinitely. The highly leveraged are vulnerable. 

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B. Corporate America: Balance‑Sheet Strength > Confidence

Across all four banks:

• Investment‑grade borrowers dominate new lending
• Revolver utilization remains below historical norms
• Cash balances are solid
• Debt issuance is active, especially in investment grade and term markets

What’s missing:

• No surge in utilization
• No capex boom
• No hiring acceleration

Translation:
Firms are financially strong but waiting, not expanding aggressively. Volatile and changing government policies and priorities are keeping us in a hovering mode.

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C. Financial System Health

This may be the strongest message of all.

• CET1 ratios are strong across the board
• Liquidity is abundant
• Funding is stable
• No signs of liquidity strain
• Nonbank exposures (NBFI, private credit, fund financing) are actively monitored and structurally conservative. The fact they had to emphasize this makes me think there is something to the weakness in this lending.

Translation:
Whatever macro risks lie ahead, the U.S. banking system is well positioned to absorb them. At least much more so than 2008.

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3. Where the U.S. Economy Is Weak or Vulnerable

A. Growth Is Narrow, Not Broad

Growth is currently relying on:

• Consumer spending
• Financial services activity
• Capital markets normalization

It is not relying on:

• Manufacturing boom
• Wage acceleration
• Productivity surge
• Broad business investment

This makes the expansion slow and fragile, even if not imminently unstable.

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B. Lower‑Income Consumer Stress Is Real (But Contained—for Now)

Multiple banks independently referenced:

• Higher sensitivity to fuel and commodity prices
• Thinner household and business financial buffers
• More price elasticity in discretionary categories

Credit data has not yet turned sharply—but early warning signals are visible.

Translation:

This is not a recession signal—but it is a reminder that the consumer story rests on a narrower base than headline numbers imply. Bubbles bursting might be a recessionary signal, but air is slowly seeping from would-be bubbles, as it has in the commercial real estate and multi-family markets.

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C. Rates Are a Double‑Edged Sword

• Banks are no longer getting easy net-interest income lift from falling rates
• Asset‑sensitive banks (WFC, BAC) are facing NIM compression
• Rate cuts would help borrowers—but hurt bank earnings power particularly in under-valuing deposits
• Higher‑for‑longer stabilizes income but pressures marginal borrowers

Translation:

Monetary policy is now distributional, not uniformly stimulative or restrictive. The 2Y Treasury is 3.83%, 10Y is 4.34%. Fed Funds, an overnight rate, sits between the 1Y and 2Y.

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What the Four Banks Say About the U.S. Banking Sector

4. Sector Diagnosis: Strong, Profitable, but Entering a New Phase

The earnings collectively show the banking sector has moved from:

Post‑crisis repair → Post‑pandemic stabilization → Post‑rate‑hike normalization

We are now in a phase where:

• Earnings are solid
• Credit is manageable
• Capital is abundant
• Growth depends on execution, balance sheet and revenue mix, and discipline

This is not a leverage‑driven cycle. Which speaks to the ability of balance sheets to withstand recession.

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5. Strengths of the U.S. Banking Sector

A. Capital & Liquidity Are Not the Constraint

Every bank emphasized:

• Excess capital
• Share buybacks
• Ability to support clients in stress-although the temptation to abandon stressed clients is there
• Regulatory clarity improving (Basel, G‑SIB)

This is the opposite of 2008 or 2020.

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B. Credit Underwriting Is Conservative

Evidence across banks:

• High share of investment‑grade exposure
• Structural protections in NBFI lending
• Sub‑60% advance rates in private credit
• Limited CRE office exposure relative to system capital

The industry has learned—perhaps overly learned—the lessons of the last cycle.

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C. Fee Businesses Are Doing the Heavy Lifting

An underappreciated macro point:

• Payments, treasury services, asset management, and markets are now core earnings engines
• This reduces dependence on rates
• It stabilizes earnings across cycles

Citigroup’s Services and JPMorgan’s payments ecosystem are emblematic here. Community financial institutions can learn something here, stop talking about it, and start making the investments necessary for fee businesses to be a larger contributor to revenues and profitability.

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6. Weaknesses and Structural Challenges

A. Earnings Are More Sensitive to Confidence Than Credit

Paradoxically, the biggest risk is not defaults—it’s activity.

Banks need:

• Deal flow
• Markets activity
• Client engagement
• Balance‑sheet utilization

A confidence shock—even without a deep recession—would hit earnings faster than credit losses because bank balance sheets are positioned for moderate credit shocks.

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B. Margin Compression Is Structural

Net interest margins are no longer expanding easily.

• Deposit betas are higher. As pricing becomes more transparent and money movement easier, this is unlikely to change.
• Asset mix is shifting to lower‑yielding products
• Competition is rational but real

This pushes banks toward:

• Cost discipline
• Fee growth
• Balance‑sheet optimization

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C. The Cycle Is Now About Sorting, Not Survival

The era when “banks move together” is over.

• Strong franchises gain share
• Execution matters more than a unique strategy
• Management and markets remain key ingredients

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Bottom‑Line Interpretation

What the Big Four Are Telling Us—Taken Together

About the U.S. economy:

• It is resilient but not robust
• Slow growth is holding, not accelerating
• Risks are asymmetric but manageable
• A soft landing remains the base case

About the banking sector:

• It is healthy, liquid, and profitable
• Credit risk is contained
• Capital is a strategic asset again
• The next phase rewards discipline, not leverage

~ Jeff

Not a Session at Acquire or Be Acquired: Culture

I attended Bank Director's Acquire or Be Acquired conference two weeks ago. The buzzword of the show: Culture.

When Raphael Reznek, CIO of Mascoma Bank, spoke about the biggest challenge to launch online account opening: "our internal culture". When Mike Butler, CEO of Radius Bank, spoke of technology experimentation and implementation: "you have to change the culture in the company". And in a session titled Advice and Counsel for First Time Acquirers, Bob Monroe of Stinson LLP said: "Being able to fit your culture in with the seller's culture is extremely important, because you'll have a flat tire running down the road."

If I asked you to write your definition of culture in the comments, would yours match others? Because when I hear the term, I don't know what people are talking about.

I do recognize that whoever talks of culture, generally thinks their culture is superior to yours. Except Raphael, who at least was reflective about it. I should note that Raphael has not been at his bank very long, and he is not from the banking industry. So it was easier for him to objectively assess the weaknesses in his bank's culture and address them. It is not lost on me that their CEO is also from outside of the industry and relatively new to the bank. 

Mike Butler of Radius, although a lifelong banker, came from outside of the region and implemented a business model and cultural change at his bank with new management and a "fast fail" innovation culture. Mike is from Cleveland. And surprisingly a Yankees fan. In Boston. #resilience

There I go. Culture, culture, culture. What the heck do I mean?

Culture Defined

Merriam Webster defines culture as:

1.  The customary beliefs, social forms, and material traits of a racial, religious, or social group. Also, the characteristic features of everyday existence (such as diversions or a way of life) shared by people in a place or time. Such as popular culture. Or Southern culture.

2. The set of shared attitudes, values, goals, and practices that characterizes an institution or organization. Such as a corporate culture focused on the bottom line.

3.  The set of values, conventions, or social practices associated with a particular field, activity, or societal characteristic. Such as studying the effect of computers on print culture, or changing the culture of materialism over time...

4.  The integrated pattern of human knowledge, belief, and behavior that depends upon the capacity for learning and transmitting knowledge to succeeding generations.

Did you know that "Culture" was Merriam-Webster's 2014 word of the year? Because it was the most searched for term. Meaning so many of you, like me, had to look it up because we had no idea what people meant when they talked culture. In this 2014 New Yorker piece, editor Joshua Rothman wrote: "institutions that drone on about their 'culture of transparency' or 'culture of accountability' often have neither."

Poster Child For Cultural Disconnect

Look no further than Wells Fargo. Their "toxic sales culture" started with Norwest, the actual buyer of Wells Fargo even though they adopted the iconic name when they executed their "merger of equals" in 1998. I have a lot of air quotes in this post. 

In this 2000 CNN Money piece, which I'm confident long-standing Wells execs would wish you didn't click on, Wells is said to have a "flourishing and decidedly 'functional' corporate culture". Driven by Norwest's and the resulting Wells' CEO Dick Kovacevich, who was "obsessed with cross-selling". At the time of the article, Wells averaged 3.4 products per household, and Kovacevich wanted to drive it to eight.

Boom! Fake accounts. 

Do I think Wells' executives wanted the culture that emerged? No. But read the practices that resulted from Kovacevich's obsession. This culture, and the practices that emerged from it, got John Stumpf and Tim Sloan fired. 

Culture Defined Part II

Culture, as I would define it, are the unwritten boundaries that your bank operates under that drives decision making, even when executives or supervisors are not the ones deciding. Meaning that when a branch manager, or a teller, makes a judgment decision, they do so in the context of your bank's culture. 

I think your aspirational culture can be written. And we often see this in strategic plan values statements. But a written description of the culture you are trying to create is meaningless if your leaders don't consistently practice it, hold people (including themselves) accountable to it, and align policies, procedures, and incentives to be consistent with it. Having daily coaching sessions on products sold would be inconsistent with a culture of doing what's right for the customer, right? I'm not smart enough to be the only person that would recognize this.

In kicking off strategy sessions, my firm reviews some inconsistencies we often see between bank practices and strategy. Below is one of my favorite slides.

In 2015 I wrote a post about creating a positive accountability culture. So I am guilty of throwing the term out there. I have never heard a bank state or write that they wanted a culture where employees hated coming to work, or cringed when their boss called them into their office. Yet so often when the boss gives employees feedback, it's negative. In the Navy, we said "one awe sh*t wipes out ten atta boys." That is how a spoken or written cultural aspiration is disconnected from everyday practice.

Psychology weighs in on negative feedback. The Positive Coaching Alliance taught me that in order to fill the emotional tank of players, you should provide at least five positive feedback interactions to one negative feedback to get maximum performance. They called it the magic ratio. 

I grew up in an environment where that ratio was upside down. And I witness it often in banking.

Note that the above slide is meant to highlight what not to do. And, perhaps, with my newfound appreciation for the term "culture", I should change the subheading to Providing Incentives That Are Contrary to Your Culture.

Because your aspirational culture must transcend words. Or it will never be attained.


What is your definition of culture?


~ Jeff

Teflon Tim: You Can't Mess With Wells Fargo

Could the past two years have been worse for Wells Fargo (WF)?

According to an appropriately snarky Gonzo Banker post by Scott Hodgins, Wells' blunders are epic:

September 2016 - Disclosed that they created two million bogus accounts without customer consent to hit the bank's "eight is great" cross-sell targets. That fiasco cost them over $800 million in fines and legal settlements.

September 2016 - Wrongfully repossessed service members' cars. Some of whom were deployed overseas. Thirty million in fines and restitution.

March 2017 - Failed the OCC's community lending test causing "significant harm to customers."

February 2018 - Regulators limit WF growth due to "widespread consumer abuses and compliance breakdowns." 

April 2018 - Agrees to $1 billion in settlements for auto loan and mortgage abuses.

The spate of bad news led to Wells launching a nationwide ad campaign to repair its image.

And since then:

They admitted altering business customer data to address anti-money laundering compliance. Fined by the SEC for pushing inappropriate investment products. Finally got their financial crisis fine. Admitted to 400 wrongful housing foreclosures. And yesterday the Wall Street Journal reported that the OCC notified Wells that "the bank also has failed or isn't expected to meet deadlines on around two dozen technology-focused OCC regulatory warnings... that have been issued since 2014 or earlier."

How many people are in their public relations department? You would think not nearly enough.

Or is it?

I recently addressed a bank client's all officer meeting to discuss industry trends. As part of my comments, I presented the following table of New Jersey Deposit Market Share. I also included the USA deposit market share.

Wells maintained its market share from June 2017 to June 2018 in both New Jersey and nationwide.

In spite of the cascade of bad news, the bank ceded 72 basis points of deposit market share in New Jersey and only 10 basis points nationwide. And this was while they were imposed with a growth

restriction. No wonder why Teflon Tim is smiling in his investor relations pic. I thought it was the green tie. Luck of the Irish. That sort of thing.

So what is it about the bank that has allowed it to endure such bad news, such regulatory scrutiny, and such a mountain of fines and restitution? Superior technology? Nationwide network? The stagecoach?

Wells' challenges are a blinking light for a larger problem. Notice the bigger banks all held serve and maintained leading market share. As community banks, we have not developed a strategy to break through.

So the operative question is, should we be more focused on slaying dragons in our strategic and operating plans? Or, should we be content swatting at gnats? Because the dragon should be wounded.

What do you think?

~ Jeff 

A Time of Reckoning for Your Bank's Core Deposits?

Bye-bye municipal deposits. 

So worries New Jersey Banker's Association CEO John McWeeney since state-owned bank advocate Phil Murphy was elected governor. The state's municipal deposits approximate $20 billion, $13 billion of which are in community banks. A significant source of liquidity.

I got news for you John. We might lose municipal deposits regardless.

And we might lose a lot more than municipal deposits.

According to the Investment Company Institute, money market funds stood at $2.8 trillion this week. And as the chart below shows, these funds are typically paying more than double the community bank money market account rate. 

These rates were at March 29, 2018. I used Wells Fargo because it is a money market fund that I use. By default. When they bought Strong Asset Management. Marcus is Goldman Sachs online bank. FDIC insured. And Mid Penn Bank is a $1.2 billion in assets financial institution based near Harrisburg, Pennsylvania. I had to call Mid Penn for their rate. It is a tiered money market, and the 0.55% is their top tier for accounts greater than $50,000. The next lower tier is 0.35%. 

Mid Penn boasted about their cost of deposits and funds in their 2016 annual meeting investor presentation (pages 21-22). They currently have a 0.58% cost of funds. Can they maintain it? Will their ALCO model betas prove true? Or will customers demand they bridge the rate gap, so vividly portrayed above?

My colleague recently sent me a link for meetbeam.com, a soon to be released banking app that boasts a 2%-4% rate for your cash, FDIC insured (they are partnering with a bank). They haven't launched. But they have over 76,000 customers that signed up already. Could some be your customers?

In strategy sessions the past couple of months, I'm hearing more bankers talk about pressure from large depositors on rate. The old arguments are starting to play out. Not bringing large deposits with their loan deal because rates are too low. Municipalities hemming and hawing. Will the traditional retail and small business depositor be next?

There is an inflection point where our Rip Van Winkle bread-and-butter depositor will wake up to think "hey, I'm getting screwed by my bank!" What sized rate gap will trigger it? I don't know. I'm no futurist. The above rates are still below the inflation rate. So keeping money in any of those accounts will result in a real decline in value. Do you know where your customer inflection point is?

Because a business model based on the sleepiness of your depositors is unsustainable. 

Are you feeling the pressure yet?

~ Jeff

Thank You Mr. Stumpf!

Bank reputations were on the rise. After the financial crisis of 2007-08, led by making mortgage loans to people that had little resources to repay them, banks were climbing from the reputational abyss.

Then came September 8th, when the Consumer Financial Protection Bureau (CFPB), and the Office of the Comptroller of the Currency (OCC) jointly announced the issuance of a consent order to Wells Fargo that included $185 million in fines due to the widespread, illegal practice of secretly opening up customer accounts without the customers' consent. Fifty million of the settlement was to go to the City and County of Los Angeles, which brought a lawsuit against the bank a year ago for the same charge. For further discussion among my colleagues on this subject, click here for our podcast.

And the stench of that little news item is likely to sully the reputations of financial institutions across the country. Don't believe me? How many subprime mortgages did you make where your customers had little hope of repaying? And did the bursting of the housing bubble hurt your bank's reputation? 

Wells Fargo is so large, that many people view them as a proxy for the whole banking industry. Much like Apple or Samsung might be viewed as a proxy for the whole smart phone industry.

What does reputation get you? For Wells Fargo, it gets you $32.9 billion. Or lost them $32.9 billion. That is the decline in market value they suffered from August 31st to this writing. Thirteen percent of their market value, vanished like a puff of smoke in the wind.

According to Cutting Edge PR, sources of information that impact influencers (CEOs, senior business execs, analysts, institutional investors, etc.) are as follows:

Source of Information                          Proportion

Personal experience                                  64%

Major business magazines                        37%

Articles in national newspapers                35%

Word of mouth                                          31%

Articles in trade journals                           30%

Television news                                         14%

Articles in local newspapers                      14%

Television current affairs programs           13%

Is Wells Fargo lighting up the newswire? Yes. Will commentators start dropping Wells Fargo from the discussion and start generalizing that this is typical bank practices? I have little doubt.

I said it before in a previous post on branch incentives, and I'll say it again. Bankers should hold business line managers accountable for the service levels, profitability, and profit trends of their business units. When you begin to drill down and start measuring widgets, employees will gravitate to finding widgets. Which is exactly what Wells Fargo did.

And if you think this culture started recently. Guess again. Google the much lionized former Norwest and Wells Fargo CEO Dick Kovacevich that touted the "eight is great" cross-sell ratio. Stumpf has worked for Norwest/Wells for thirty four years. 

I guess eight isn't so great after all.

And the Schleprock cloud hovers above us all.

Thank you Mr. Stumpf.

~ Jeff             

Banking Is Not Small Business Saturday

The holidays are upon us and the public relations blitz is on so we patronize small businesses for Christmas shopping. Why? Do small businesses have a unique value proposition that larger stores do not? Or are we relying on nostalgia and some David versus Goliath goodwill to drive us into the arms of local shops?

I have news for you. The latter is a failed business idea. For example, in my town, we have two relatively small lumber yards only because the NIMBY's kept Lowes out. If Lowes secured the necessary permits to open shop, bye bye small lumberyards. So the local owners think they perpetuated their business model by keeping out a competitor. How about offering something customers value greater than price, Mr. Lumberyard Owner?

Walk into a Lowes, and you are overwhelmed with the selection, and probably have difficulty finding somebody knowledgeable to help you with what you need for your project. If somebody does help you, there is often a line of people waiting for that worker's attention. Why doesn't the local owner differentiate there? But no. My wife refuses to go to one of the lumberyards because the workers' treat her like she doesn't know what she's talking about. In other words, they chose not to deliver something valued by customers. 

Are we that much different in community banking? Do we rely on some "feel-good" marketing message to drive customers to us instead of Wells Fargo? Do we hope that George Bailey will deliver us from irrelevance? Why should customers bank with you instead of the omni-present Bank of America? Because I got news for you... they haven't. The top 50 banks in the USA, less than 1% of all banks, boast 76% of all banking assets. 

The people have voted, and community banks are losing.

Why? Because we have difficulty answering the question "why bank with us"? Sure, we'll come up with some answer that says "service" or something intangible and, apparently based on the facts, unnoticeable. But have we really identified what differentiates or can differentiate us from the big boys, and built the systems, processes, and people around delivering on that promise?

Or do we keep telling ourselves in management meetings that we have better service than them, and then break into a loan committee meeting to lower our price or terms on a commercial real estate deal we're trying to win from PNC?

Don't rely on your own Small Business Saturday so customers bank with you because they are sympathetic for you.

So I ask you: why bank with you?

~ Jeff


Note: After penning this post I read an article about Small Business Saturday that said $68 of every $100 spent in local small businesses was re-spent in the community. For chain stores and online stores, that stat was $48 and $0, respectively. So there's a good part of the story to build on, in addition to creating a value proposition that customers care about. Also a good lesson for community financial institutions. How much deposit money is re-invested locally compared to the big boys? Don't forget about the in addition to...

Banks Versus Credit Unions: Much Ado About Nothing

Credit Unions don't pay taxes! They're trying to steal our business customers!

I often quote Sun Tzu from his over 2,000 year old book, The Art of War. One of my favorites: "If you know the enemy and know yourself, you need not fear the result of a hundred battles." The frequent and resource sapping waling about credit unions tells me that banks don't know their enemies, umm, competition.

Last year I attended the CUNA Government Affairs Conference (GAC). By the way, it was the trade show beyond all trade shows. Clearly credit unions put heavy resources into lobbying. So I will give banks that point. We had a booth, and my company's tagline is "helping banks perform better". We like the alliteration, and use the word "banks" in a generic way, like Kleenex.

But one would think we would hear about it from CU executives and trustees. And we did hear some quips. But one CEO opined that the rift between banks and CUs was greatly exaggerated by trade associations to keep the masses engaged. I believe her.

Why? Take my home state, Pennsylvania, for example. We do business with both banks and CUs in the state. Admittedly, mostly banks. And we hear plenty about credit unions in strategy sessions. But I pulled deposit market share data for the state, and the results are telling (see table).

Credit Unions boast a 9.5% deposit market share in the state, or $33 billion out of $345 billion total. There are 497 credit unions headquartered in PA, but 447 of them are less than $100 million in deposits (ok, shares for you CU technocrats). All PA CUs combined have the same in-state deposits as Wells Fargo, and half that of PNC. There are only two CUs in the state's top 20 in deposit market share.

Does the banking industry dedicate disproportionate strategic decision-making, marketing and lobbying resources fending off CU competition? Because when I look at the above table, it's clear where a community bank's strategic focus should be. And it shouldn't be on the Locomotive & Control Employees FCU in Erie.

What is this table telling you?

~ Jeff

The Elephant in the Room: Branches

In keeping up with industry reading it is clear to me that we, as an industry, are perplexed at what to do about branching. The recently released FDIC Summary of Deposits showed the second year of branch decline. The most recent ABA study on delivery channel preference showed online banking eclipsing branch transactions for the 55+ set. That's right... old people letting their fingers do the walking.

But the #1 or #2 reason cited by small businesses and individuals as to why they select their bank remains branch location. When I ask executives what makes a branch successful or not, the top two reasons continue to be branch location or personnel, not necessarily in that order. Confusing? Yes.

But the progressive talk about the future of the branch at times lacks common sense, in my opinion. This dates back to an interview I did with American Banker about a community FI that was opening coffee shop branches. I gave a twofold comment: 1) I saluted the FI for being creative; and 2) I doubted it would work, particularly in the locations and relatively conservative markets where they tried it. AB published the first and the second didn't make the editorial byline. The coffee shop experiment turned out to be a disaster, and the FI was later sold.

I recently had a Twitter conversation with a banker about branches that lack tellers. According to feedback from bankers that tried this concept, customers were confused when they walked into the branch. That made sense to me. We like the familiar... i.e. the teller line. But branch transactions have fallen off of the proverbial cliff. Do we need a long line full of bored tellers reading Nora Roberts novels? No. But perhaps we need a couple teller windows to process transactions and bring comfort to those of us that like familiarity.

As we evolve, I envision the comfort of knowing there is a branch nearby to continue. But the people who occupy those branches should evolve to those that can open accounts, troubleshoot problems, advise customers, develop business, and occasionally process transactions. This branch will probably be smaller, and less expensive to build out. Smaller is certainly a theme I am hearing from bankers and industry professionals. If you are of a mind to continue trying to make the branch into a destination to drive traffic, let me introduce you to Sisyphus. Going to the bank is a chore. Boom.

So what about these big branches that we all have? An industry stock analyst told me that big banks have advantages over small banks because they can pay for increased compliance expenses by closing branches. The community FI may not have this luxury. But big banks have challenges here, in my opinion. Many have built palatial branches that have no discernible value except as a bank branch.

The poster child of this concept is Commerce Bank of Cherry Hill, New Jersey which was acquired by TD Bank (see photo). Their brand is wrapped around their number of branches, the primo locations of their branches, and the look of their branches. But if branches become less important, and big banks can consolidate one branch with the one in the next town over, what are they going to do with the palace? These branches are very expensive, are fixed assets on the bank's books, and are 100% risk-weighted for capital calculation purposes. In other words, you have to carry more capital against the branch than a bond in the investment portfolio that might be 20% risk-weighted.

The pictured TD branch is about 100 yards from the Wells Fargo branch pictured below. Sorry for the poor focus but I took the picture with my phone while walking so cut me some slack! If Wells decided to consolidate this branch, it could easily be converted to an office, a hair salon, or a coffee shop. In other words, Wells could sell it and, current real estate market woes aside, can probably sell at a gain. The buyer can convert it to whatever they want. TD, on the other hand, may have to devalue their branch because they can't sell it. Or if they can, it would be for the land and the buyer may have to raze the building to something more functional. Think of all the empty gas stations dotting the landscape.

To be fair, the Wells branch had $52 million in deposits and the TD branch $130 million at June 30th. But the old Commerce was known for large branch deposit sizes because they aggressively pursued municipalities for their banking business. So aggressive, indictments were involved. But I digress. The TD branch does have more deposits, and perhaps this is partially due to the palace.

But as we determine our next step in branching, we can't ignore the trends that are telling us that transaction processing in branches is becoming secondary to something else. As branches decline in prominence, we should plan our next branch with the gas station in mind. We don't want to manage multiple properties of former branches that sit stale on our books eating our capital.

What is your opinion of what the "next" branch should look like?

~ Jeff

The Economy of Scale Myth: Go Big or Go Home

I wrote a post a couple of months ago regarding diseconomies of scale under the premise that at some asset size-point, getting larger does not impact your efficiency and expense ratios in a material way (see link to that post below). Yet in spite of my efforts, bankers and industry experts continue to bang the drum for economies of scale. I decided to take a second look at the data to see if I was wrong in my premise.

I have been wrong in the past, and readily admit to my errors. I do not possess the personality that requires me to be right, especially in the face of evidence to the contrary. My wife and daughters tell me I'm wrong all of the time. So if my investigations into financial institutions' (FIs) economies of scale indicated that size does matter, I will say so.

Clearly size matters to some point. Banking has a step-variable cost structure that requires a certain amount of fixed expense investments that demonstrates excess capacity until an FI grows to some asset size. The devil is in the details of "some" asset size. Empire builders and investment bankers tend to argue for Mega-Bank, which supports many M&A transactions and higher executive compensation. However, as I searched my database for the top 100 return on average assets (ROAA) FIs for the 2nd quarter 2010, only six percent were over $1 billion in assets. Yet strategy sessions, competitor discussions, and CNBC focus primarily on the Mega Banks.

A note on my data collection. I searched for FIs that had greater than an 1.8% ROAA in EACH of the last four quarters. This tended to eliminate those FIs that benefited from one time gains and focused on those with consistent financial performance. I then manually went through the list to eliminate all of the special purpose institutions and subs of much larger institutions to get a more accurate list. Of the top 100, six were greater than $1 billion in assets, 55 were between $100 million and $1 billion, and 39 were less than $100 million in total assets. The table below shows the medians in selected financial ratios.

Countless strategy sessions I have been privileged to attend speak of what Bank of America and Wells Fargo are doing (not in the top 100). Very few speak of WestAmerica Bank in San Rafael, California (2.05% ROAA, $4.7 billion in assets). WestAmerica is primarily a business bank. Greater than 77% of their deposits were in core deposits (non-CDs) and their cost of funds was 28 basis points. So many banks are trying to reduce their dependence on commercial real estate and construction transactions by becoming more of a commercial bank, yet so few look to WestAmerica to see what they are doing to succeed. Instead, we focus on what Jamie Dimon is saying. We should focus more on what David Payne (WestAmerica's CEO) is doing.

If you are a senior executive of an FI smaller than WestAmerica and I am privileged to have your readership, are there smaller success stories? Must you be over $4 billion to be successful?... Yes to the first question and no to the second. Ninety four of the top 100 ROAA FIs were less than $1 billion in assets.

I have spoken and written about niche banking in the past. I offer an example of an FI that is currently succeeding at it: Live Oak Banking Company in Wilmington, North Carolina. Live Oak opened its doors a little over two years ago and yet it has met the four-quarter criteria of having an ROAA greater than 1.8% over the past four quarters. Live Oak opened to provide capital and other services to the veterinary, dental, and independent pharmacy businesses (see its About Us link below). The bank sells a high percentage of the loans it originates but keeps servicing rights to maintain relationships. At June 30, 2010 it had $209 million in assets and a 2.82% ROAA.

Extreme niche banking like Live Oak's may not be in the cards for your FI. But that doesn't preclude you from having a line of business or product set that you are known for, excel at, that delivers superior profits. After all, who wants to be known as "just another bank"?

Let's not be absolutists, claiming that economies of scale are needed, or that being highly specialized is critical. But the evidence clearly shows that there are financial institutions generating superior returns that are not Wells Fargo, PNC, et al. Let's not limit our universe of business models to study to a select few that have rolled the dice with the scale game.

What FIs do you admire that may not be the biggest kid on the block?

~ Jeff

jeff for banks blogpost: Diseconomies of Scale
http://jeff-for-banks.blogspot.com/2010/08/diseconomies-of-scale.html

Live Oak Banking Company - About Us
http://www.liveoakbank.com/AboutUs.aspx