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Dick Bove: Big banks are losing lending business to smaller competitors and here's why

June 13,2018 19:14

The second was that their millennial consumers did not want to do business at bank branches. They wanted banking services on their mobile phones. The big banks, therefore, complied with what they thought were consumer preferences and signed up tens ...


Cooper Neill | Bloomberg | Getty Images
A customer enters Comerica Inc. Bank headquarters in Dallas, Texas.

When the first quarter reports about bank loans became available, there was a big surprise. The biggest banks in the country were losing market share to their smaller competitors.
In the 12-month period from March 2017 to March 2018, the four big universal banks grew their loan portfolios by 3.1 percent. Conversely, the 39 mid-cap regionals grew their loans by 15.7 percent, and 56 community banks grew their lending by 14.7 percent.
Savvy investors took notice. Through June 8, shares of the big universal banks fell 1.6 percent, while the mid-cap regional bank stocks were up 7.8 percent and the community banks stocks were up 12.1 percent.
The big banks may be losing touch with their customers due to the excessive use of "hi-tech" banking, while the smaller banks have continued to follow a policy of "hi-touch" service.
The FDIC tells us that from the financial crisis in 2008 to 2017 banks net closed 3,900 branches, or about 5 percent of the total in this country. Virtually all of these closures were being done at the big bank level.
The big banks made two decisions. The first was that operating costs were much too high. The second was that their millennial consumers did not want to do business at bank branches. They wanted banking services on their mobile phones. The big banks, therefore, complied with what they thought were consumer preferences and signed up tens of millions of mobile banking customers.
The small banks did not have the money to implement advanced technology. They bought some products from third party fintech companies, but in the main they did business through their branch systems.
For a period, it appeared that the big banks had made the right decision. Their operating costs fell in absolute terms in many cases. Plus, consumer banking was soaring due to the increase in employment. Credit card loans rose more than 8.5 percent annually in 2016 and auto loans were up even more than that.
At the same time, loans to businesses were plummeting. By mid-2017 business loan growth at the big banks was down to 0.5 percent year-over-year from what had been over 10 percent.
The nature of loans being sold is important here. This is because consumer loans are handled primarily by computers. They are the essence of hi-tech banking. Business loans are handled by people. They require hi-touch service.
The pro-business actions taken by the new president and Congress changed the rules of the game. Taxes were cut, health care requirements for small businesses were changed, lending regulations were eased and there was a hint of change in infrastructure building and tariffs. Ultimately, even Congress got involved easing the lending pressure on small banks by lifting more regulations.
The result is that the nation's small businesses began to expand. Year-over-year, lending jumped from 0.5 percent to 3.6 percent and it is still growing. Meanwhile, consumer lending began to top out. It dropped to below 8 percent on credit cards and to 2.5 percent year-over-year on autos. Moreover, losses were beginning to mount in both of these consumer areas while they stayed at record lows on business loans.
This shift in the market is what caused small and middle market bank loans to rise at much faster rates than big bank loans. Small businesses require help from people at branches, and they are receiving it from small banks. Big banks are now scrambling in some cases to open new branches in new markets to get at the "action" in the business loan market.
It is not well–recognized by most investors, but banks are the same as any other company. They need to sell something to push revenue and earnings higher. That something is loans. Right now the "edge" here is to the smaller regional and community banks.
This edge is going to get much bigger. The growth in small and middle market companies is beginning. Their need for banking services is growing. Small banks have been deregulated to a great extent, so they can capture the new growth.
For investors the answer is clear. The gains in bank stocks are to be found where the banks are selling products. This is in the mid-cap banks not the giants. Today and, in my view, for the next few years, mid-cap bank stocks are where money should be invested in banking.

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