Executives and directors often speculate on the optimal asset size for a community bank. The consensus opinion is usually a variation of "We're not sure, but bigger than we are today." The underlying assumption is that bigger means better. However, Capital Performance Group and American Banker's annual
The analysis shows that top performers, as measured by return on average equity over three years, often skew smaller than their overall peer group, with total assets less than the group median. This was the case in 2023 for the midsize tier of banks with total assets between $2 and $10 billion and for the larger $10 to $50 billion-asset tier.
Interestingly, last year's highest-performing banks across all asset tiers had only a few billion in assets and were situated within the midsize tier (banks between $2 and $10 billion). The top performers within this tier outperformed top performers across most metrics in the larger and smallest asset tier, comprising publicly traded institutions with less than $2 billion in total assets. Core deposit runoff among midsize top performers was on par with that experienced by their larger counterparts. It was much lower than the runoff experienced by top performers in the smallest asset tier.
Parsing the midsize tier of banks into asset quartiles provides some insight into the issue of optimal size. While a few top performers resided in the larger asset quartiles, most clustered within the $2.5 to $3.2 billion-asset range. They were characterized by operational efficiency, higher loan growth and net interest margin, enabling them to generate peer-leading profitability. Median performance in one or more metrics declined in the two larger asset quartiles within the tier.
Another example demonstrating that asset size is of secondary importance: The profitability of the top performers in the smallest asset tier was comparable to those of the largest top performers. The former boasted a median return on average equity last year of 15.83% and a median total asset size of just $842.4 million. This was not far below the 16.54% recorded among top performers in the larger $10 to $50 billion-asset tier, with a median total asset size of $17.9 billion.
The additional regulatory limitations that become effective at the $10 billion-asset threshold somewhat hinder the larger group's performance metrics. Most of the top performers in this larger tier had total assets well above the $10 billion threshold, possibly indicating that significant additional growth is required to offset additional compliance costs and caps on interchange fees.
Attaining more significant economies of scale is an oft-cited rationale for becoming larger. Indeed, an increase in asset size correlates with lower operating expenses relative to average assets. However, trend analysis shows that since 2017, noninterest expense as a percentage of average assets has declined among top-performing institutions in all asset tiers. In 2023, there was little difference in the median ratio among the highest-performing banks in the $2 to $10 billion asset tier and that of the larger $10 to $50 billion asset tier. Efficiency and greater operational scale will remain a focus for most banks, but will not ensure top performance. Revenue growth and the factors contributing to it are equally vital.
The North Carolina bank lowered its medium-term target for return on tangible common equity target, reflecting the fact that the financial projections for the merger of BB&T and SunTrust Banks have not come to fruition.
Traditionally, balance sheet growth has been the path that most banks have followed to increase profits. But that does not have to be the case. Rather than solely focusing on asset size, peer-leading community banks and regional banks typically pursue some combination of the following strategies as part of their growth plans.
These banks focus on driving higher volumes in lending businesses that offer reasonable margins and curtailing those lending businesses that do not. They also create greater flexibility in the balance sheet through strategies that optimize the yields on securities with their risk-weightings or growing loan portfolios that can be readily sold or securitized, such as SBA loans.
Top performers also seek to expand beyond their core geographic footprint by exporting lending expertise in select markets, or through technology such as digital marketing, opening online accounts and embedded banking partnerships.
Others operate niche businesses that deliver a differentiated model to specific segments, including industry verticals. They also apply technology to new customer acquisition, onboarding and relationship expansion.
Ongoing digital transformation, including new value propositions, products/solutions, marketing and sales processes, and operational efficiency improvements are other hallmarks of top-performing banks. So is offering new payments or noninterest income solutions to increase noninterest income streams and enhance the value propositions for key segments.
Institutions that consistently employ some combination of these strategies will be best positioned to generate above-average growth and profitability.
