The Regional Bank Goldilocks Challenge

What are the challenges regional banks currently face as they strive to become the Goldilocks solution for commercial clients? Can they carve out a niche as a banking option that's not too big and not too small, but just right?  


Helpful Links

Pressure's On Regionals to Boost Fee Income (American Banker)

"Grow and grow fast:" The newbie rule for regional banks (American Banker)

The Goldilocks Principle 



Maria Abbe: Hi, and welcome to The Purposeful Banker, the podcast brought to you by PrecisionLender, where we discuss the big topics on the minds of today's best bankers. I'm Maria Abbe, senior communications manager here at PrecisionLender. Today's show features Dallas Wells, PrecisionLender's EVP of strategic initiatives, and Jim Young, our director of content. They're going to talk about the unique challenges that regional banks face and how they're faring. We'll have links in the episode notes to relevant articles and information. Now, on to the show. Enjoy.
Jim Young: So Dallas, let's start off with a little bit of background on this one. The spark for today's discussion is a recent American Banker article ... It's actually their annual rankings for regional banks by ROAE, and in this case, you know, and just to be clear, they're defining regionals as 10 to 50 billion dollars on this, and we'll get to those numbers on that later. But what I was more interested in was the article context they used to introduce those numbers, and it's titled "Pressure's On for Regionals to Boost Fee Income." And my initial reaction was, isn't the pressure on all banks to boost fee income? Or is there particularly more pressure on regionals?
Dallas Wells: Well, I think there is pressure across the board, but I would say it's more so on regionals. They tend to get squeezed a little bit from both sides, where because they're getting pretty large, they typically have smaller net interest margins. I think their community bank competitors would say that's because they don't offer as good of a service. They can't command the same premiums. I think the regional bankers would say, "Hey, we deal with bigger, more solid, more stable credits so there's less credit risk so we charge less." So whatever end of that spectrum you want to end up on.
The reality is that they just do have lower net interest margins, but net interest income still makes up a bulk of their revenue. So their income statement looks generally closer to a community bank than it does to the JP Morgans and Bank of Americas of the world. So they're very reliant on that interest income, and yet they're making less of it than those really small banks. So they're kind of caught in this weird 'tweener zone where it's critical that they figure out how to either improve that number or find some more offsets to it.
Jim Young: Okay. All right. Because that answers my next question, because I was going to ask the, you know, the article talks about that regionals tend to, they said, lack the side businesses. Capital markets, asset management, that sort of stuff that the big banks have. I was thinking to myself, "Well, that would be even more so for a community bank." But if I understand you, what you're saying is this community banks in this case, even though they're even more reliant on that interest income, you're saying that it's cushioned a little bit for them because typically they're going to get higher net interest margin on that.
Dallas Wells: Yeah. As a sector, they do have higher margins. And again, there's multiple reasons for why that would be. Some of it is that they have relationships, they're operating in oftentimes, on average anyway, less competitive markets in more rural secluded areas. So they can command some more premium pricing. They also tend to have good solid core deposit bases that help with that too. Again, not a whole lot of competition in those areas for that, but they're dealing with small businesses. So there's inherent credit risks there. So yes, they are just as reliant on that net interest income. It's just that they make more of it in terms of margin than the regional banks tend to.
Jim Young: So I remember a few years ago when we were talking to, you know, really growing community banks and they all seem to have kind of a similar strategy. If there were going to keep growing, they said basically we're going to blow past that $10 billion barrier and quickly become a full-fledges regional bank. Basically the regulatory burden you get that when you get to 10 billion, it doesn't pay off to be 11, doesn't pay off to be 12, we've got to get past that up to 15, 16, 17 et cetera. I guess what I'm wondering is, is what you just described is, are they arriving at a safe Haven or is that only a temporary status where you got to go big from there? Can you stop, I guess, and be a happy, content, 20, 25, 30 billion dollar regional bank?
Dallas Wells: Yeah. At least what the bank's performance and what their strategies show us is that there might be a slight breather in there somewhere, but there is no stopping point there. So in other words, there are some instant changes at the 10 billion dollar mark. They're not quite as onerous as they once were. Some of those regs have been modified and rolled back just a bit, but it is still a meaningful threshold. And so when you cross it, you don't want to be 10 billion and one dollars, you want to vault past it and be 11, 12, 13. And the reason is is you have to add some overhead. You might as well get a bigger asset base to help spread that overhead across.
Just basically be able to have some scale to consume the new things that you have to pay for, but there's not a whole lot of efficiency to be gained in doing that. So you really do have to keep growing. That between 10 and 50 tends to be pretty ripe for <&A as you see spikes in in transactions as we go through cycles. A lot of times that's one of the hot spots, and it's because there's two 15 billion dollar banks that are saying, "Hey, maybe if we team, up now we have the scale to start adding. Maybe we put in a small capital markets desk, maybe we start doing some of the FX and derivatives business and stuff that we just plain don't do now."
So as you get closer to 50 and beyond, you have the wherewithal to start really diversifying your business and generating a lot more fee income. The sector performance just shows that to be not universally true, but pretty close to it. That's almost always the case, that as you get towards the upper end of that range, more and more fee business starts showing up to help offset the lesser margin and to really help stabilize the business, especially to protect it from some of the economic swings that you'll tend to see.
Jim Young: Okay. But when I talk to regional bankers, I feel like I get some version of this elevator pitch, which is, "We believe we can offer the personal service that community banks can offer, but we can give the suite of products that enterprise banks offer." Basically they're pitching themselves as the Goldilocks bank. You know, this one is too small, this one is too big, and this one is just right.
So, but it sounds like what you're saying, and this is going to sound harsh, but I'll just use it. It sounds like what you're saying is, is more of a jack of all trades, master of none, which is we're kind of communityish but not as communityish, and we're kind of bigger but not really as ... give you all the options of an enterprise. Is that the case or do you think there is a possibility for kind of that Goldilocks approach?
Dallas Wells: Yeah, I think it's a great pitch and there are some regional banks that do pull it off. There is some benefit too to the scale. It's not just additional products, but some of it's just plain balance sheet size. We don't have legal lending limits that are going to start to squeeze you. So if you've outgrown your community bank, come find us, you'll get the same kind of service, but we're not scared of your 25 million dollar credit needs or your 50 million dollar credit needs. So that's part of it, is just having the the size to kind of truly do middle market banking and not just business banking.
But the product sets, they do have more than community banks, but not drastically. Not usually. You kind of have to go to the very top tier of banks to kind of get the full suite of stuff. Especially as you get to dealing with, as you're trying to serve kind of true corporate customers. Once you move up to that scale where you're going to need to be able to do the more sophisticated stuff, the capital markets kind of stuff, there's just not many regional banks that do that. Or at least do it on, again, the scale that those sorts of clients are going to need.
So there is a sweet spot there. It's probably middle market banking, it's just there's only so much of that business to be had, and those regional banks tend to find themselves competing over that business. And it's gotten brutal over the last few years because of that.
Jim Young: Okay. But now finally turning to the tables, American Banker put out there ... Again, encourage you to read the article and take a look at these tables yourself, and I'll have the links to these in the show notes on Explore. But I'm wondering though. We just had kind of frankly a little bit of a somber discussion about the challenges that that regionals were facing, and I'm looking at those three year rolling averages. It's up from 8.27. I think it was averaged to 8.97 at the end of 2018 from 2017, and then you know, you would throw out some of those outliers. You get to 8.03 to 8.55, so I guess I'm wondering is, are we talking about ... Are we nitpicking here? I mean, is this a existential crisis or is this, "Boy, it would be nice if they could get some more fee income?"
Dallas Wells: Yeah, I think we're in one of those situations where when times are good, it'd be nice, but it's not critical. I think what keeps a lot of these bankers awake at night is when you're that reliant on the margin, on net interest income, it tends to be the most vulnerable to economic changes. So if there is a recession, at a minimum, your growth will slow down. And so growing net interest income, you've only got two levers to pull there at the top line. You can either grow faster or you can improve the margins at which you're doing the same level of business. I don't think a lot of them feel like there's a whole lot of room to get extra margin out of stuff, not in the current environment. So if the growth rate slows down, growing earnings next year becomes a real challenge.
So as you look at the tables, there are a variety of strategies that you'll see there where you'll see some banks with really high margins, you'll see some with that clearly are focusing on non-interest income and do it fairly well. You see efficiency ratios that are kind of all over the place from the, gosh, some are in the 20s to some all the way up in the mid 60s. So you see a variety of strategies there. But what you've seen is that the banks that are margin dependent have kind of risen to the top, and it's because times are good. Growth is relatively easy to find. Everybody's growing at a decent clip right now, so those that can survive on margin are doing so and look pretty good. But when times get tough is when you'll see there are some banks that kind of have the ability to weather the storm through some of their fee business.
That's not just a credit cycle, but that's also as interest rates get hard. So you know, the conversations we've had about inverted yield curves and about nominal rates getting really low. Margins have actually been pretty good over the last few years. As the fed finally increased rates, banks got a little breathing room, margins got better, and so some of these kinds of margin dependent banks, their performance shot up. Now that the rate environment changes, the economy gets a little tougher, I think we'll see this list look quite a bit different and you know, maybe next year, maybe the year after that where these things will flip around. And I think that's what these banks are paying attention to is, you know, if I like my spot at the top, maybe I don't want to happen. What can I do to keep performing the way that I am?
Jim Young: Right. Yeah, that makes sense. And by the way, a caveat, if I read out those numbers totally wrong, in conflated median and average on that, understand that I'm the marketer here and not the banker. So apologies. I'm confident that you'll be able to figure it out when you get the tables and get the numbers right on it. Point is, is they all performed better in 2018 but as Dallas, as you pointed out, the smart ones are not looking at past performance as an indicator of future results on this. So anything else that, looking at those tables, that sort of caught your eye?
Dallas Wells: Well, there is ... I think it's logical that the table has a median for all the institutions. So there's right at 80 banks included in this list. So it has a median for all 80, and then it has medians for the top 10, and of course they're ranking these based on return on equity. Return on average equity. So there is a clear trade off between, at least as it stands in this ranking, between growth and profitability. So the median for the top 10, they have lower growth rates in both deposits and in loans, but they have better returns.
So we see a lot of banks out there really chasing growth at what feels like almost any cost, and what you see is here are some really solid, well known, high performing banks saying, "You know what? They can have the growth. We're fine with growing 5% in loans and 2% in core deposits, because we also grew our earnings by 30% last year." Right? Nothing wrong with that. So sometimes doing the slightly different strategy I think makes some sense. Especially when everyone's chasing growth, maybe you don't want to be one more bank doing that just because it's really hard to stand out from the crowd that way.
So interesting stuff in the table. Some interesting things from individual names that's worth taking the time to look at, see how your peers are doing, see how they're generating some of the results that they are. But like Jim said, we'll provide a link and a happy reading on that stuff.
Maria Abbe: And that'll do it for this week show. Now for a few friendly reminders. If you want to listen to more podcasts or check out more of our content, you can visit, or you can just head over to our homepage to learn more about the company behind this content. Finally, if you like what you've been hearing, make sure to subscribe to the feed in iTunes, Google Play, or Stitcher, and we would love to get ratings and feedback on any of those platforms. Until next time, this has been Maria Abbe for Jim Young and Dallas Wells, and you've been listening to The Purposeful Banker.


About the Author

Jim Young

Jim Young, Director of Content at PrecisionLender, is an award-winning writer with experience in a range of positions in media and marketing, from reporter to website editor to content marketer. Throughout his career Jim has focused on the story – how to find it, how to understand it, and how best to share it with others. At PrecisionLender, he manages the many ways in which the company shares its philosophy on banking and the power of relationships. Jim graduated Phi Beta Kappa from Duke University and holds a masters degree in journalism from Columbia University.

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