Why Midsize Banks Rule Right Now

It's good to be a midsize bank these days.

Large enough to meet customer needs in their markets yet small enough to escape some of the Dodd-Frank Act's most onerous compliance expenses, banks with assets of $2 billion to $10 billion are more profitable, as a group, than their smaller and larger counterparts, according to an analysis by Capital Performance Group.

Banks in the $10 billion to $50 billion asset range are more efficient, and those with assets of less than $2 billion have slightly healthier net interest margins, when compared with the midsize group. But the midtiers are outpacing banks in both of the other size categories in areas like loan and deposit growth, and that's translating into higher returns on equity.

It's a relatively new trend that started to take shape after the Dodd-Frank Act passed in 2010, said Kevin Halsey, a CPG consultant who compiled the data for this ranking.

One advantage midtiers have over smaller banks is that they can spread compliance costs over a larger asset base. And unlike banks with $10 billion of assets or more, the midtiers aren't contending with stress testing or caps on interchange fees. Before Dodd-Frank introduced those changes, the larger banks were more profitable than the midtiers, Halsey said.

For three-year return on average equity — the basis for this ranking — the midsize banks posted a median of 8.79%, besting banks in the $10 billion- to $50 billion-asset range (8.03%) and those with less than $2 billion of assets (7.26%).

Midtiers generally have the scale to compete with larger banks for customers. They might never lend to multinationals, but "in our market, our lending limit is large enough that we can handle most clients that we come across," said Steve Stenehjem, chief executive of the $2.1 billion-asset Watford City Bancshares in North Dakota.

His company, the parent of First International Bank & Trust, earned the No. 1 spot in our annual ranking. It's one of 19 banks that are new to the midtier group this year, having grown above $2 billion of assets, and Halsey said he expects the ranks to continue to swell as smaller banks look to gain scale to help offset increased compliance costs.

Among the midtiers, what helps separate the top 20 from the rest is efficiency. The median efficiency ratio for the standouts was 56.48% versus 62.28% for the overall peer group.

But it is not because the top 20 are penny-pinching. "The top-performing banks aren't afraid to spend," Halsey said. "They typically have much higher expense growth rates than many of their counterparts, but they also have higher revenue growth and that allows them to stay more efficient."

The high performers also generate more income from fees. For the top 20, noninterest income as a percentage of average assets was 1.29%, compared with 0.87% for the peer group.

Still, there is some cause for concern in this year's results. Nonperforming loans ticked up slightly across the board — even at Watford, which has seen delinquencies rise as energy exploration has slowed in its state. "We're chasing people around that move out of the area because they lost their oil jobs," said Stenehjem. "They don't think they have to pay us because they now live in North Carolina instead of North Dakota."

Notes: Ranking is of top consolidated bank holding companies, banks, and thrifts with total assets of between $2 billion and $10 billion as of 12/31/15 and is based on three-year average return on equity for 2013 to 2015. Additional data is for the year ended 12/31/15; year-over-year changes compare 2015 to 2014. Financials are from SEC filings. If unavailable, regulatory financials were used.

Excludes industrial banks, nondepository trusts, foreign-owned banks and bankers' banks, as well as institutions with credit cards to total loans of more than 25%, loans to total assets of less than 20% or loans to total deposits of less than 20%. Excludes institutions with a leverage ratio of less than 5%, a Tier 1 risk-based capital ratio of less than 6%, or a total risk-based capital ratio of less than 10% during any quarter in the ranking period. Excludes institutions that received a tax benefit of greater than 10% of net income or that did not report data for any year in the ranking period. Also excludes institutions that have fewer than five depository branches and are owned by a company not primarily focused on commercial or retail banking. Based on the preceding criteria, 60 institutions in this asset size range were excluded from the ranking. Ties broken using first the 2015 ROAE and subsequently the 2014 ROAE.

* Denotes institutions that operated as a subchapter S corporation for at least one quarter between 2013 and 2015. Their profitability ratios were calculated from regulatory financials and adjusted using an assumed tax rate.
‡ Metro Bancorp was acquired in February 2016.

Source: Capital Performance Group analysis of data provided by SNL Financial
© 2016 American Banker Magazine