Can Little Banks Compete With the Big Guys?

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JPMorgan and Wells Fargo both reported an increase in their mortgage lending businesses this week as consumers take advantage of low interest rates to refinance.

As the big banks do more mortgage business, some of the smaller banks may have a hard time keeping up.

Valley National CEO Gerald Lipkin predicts that the number of banks will drop sharply in the U.S. over time.

"One of the goals of the government is to regulate not the 7, 000 banks that exist today but to bring that number down to below 1, 000, " he said.

The low interest rate environment and increased regulatory costs are also making it more difficult for the smaller and community banks to compete with the larger financial institutions like Wells Fargo and JPMorgan . (Read More: JPMorgan Profit, Revenue Beat Wall Street Estimates .)

Valley National has seen its regulatory expenses rise $40 to $50 million from a decade ago.

Low interest rates are also putting pressure on bank profits. Banks' net interest margins – the difference between what a bank charges clients and what it pays depositors – are coming down. While all banks are feeling the pinch, community banks in particular are getting squeezed, Lipkin said.

"It's very difficult to make money in this environment on a net interest margin basis, " the executive said.

Wells Fargo CFO Timothy Sloan told CNBC that the country's fourth-largest bank is confident it can grow profits in a low interest rate environment as fee income makes up 50 percent of its earnings.

"The important thing to think about with Wells Fargo is we have a diversified set of businesses, " CFO, "We feel very confident about our ability to grow earnings in this low interest rate environment." (Read More: Wells Fargo Shares Drop as Revenue Comes in Light .)

While small banks may not have Wells Fargo's diversity, they still need to be agile.

"We have to recognize the pressures that are being placed on us by our net interest margin and accordingly we have started to increase our fee income business, which in our case is our residential mortgage business, particularly refinance activity, " Lipkin said.

The Valley National CEO said that it processes nearly 1, 500 mortgages a month compared with 100 a couple of years ago.

Other small banks are also seeing assets being sucked out of their investment portfolios as the refinance boom continues. Banks that held mortgage-backed securities are seeing these prepay and those funds are being re-lent by larger banks, Lipkin said.

With smaller banks under pressure, Guggenheim Securities' Marty Mosby told CNBC investors should "look for those banks that have capital that can use that capital to expand their franchises."

Some deals are already happening. In August, Buffalo-based M&T agreed to buy New Jersey bank Hudson City Bancorp for $3.7 billion.