Community Bank Performance for 2Q 2015 [Presentation]

Second Quarter 2015 Community Bank Performance

Here is our quarterly report on banking industry trends and insights [link expired]. In a nutshell, banking improved by most measures as the average bank became more profitable. In a somewhat rare occurrence, lending got safer, yet loan pricing on new production improved. For the industry, the average return on equity (ROE) increased from 8.1% to 9.2%. Banks in the $5B to $10B asset range put in the largest improvement, followed by banks over $25B. Community banks held their own producing an 8.5% ROE, up from 8.2% last quarter.


Net interest margin was just slightly up and cost of funds was just slightly down (by 1 basis point). Most of the improvement in profitability came from banks taking on more risk. Increased efficiency (at large banks – see below graphic), followed by deposit leverage were the largest contributors. In addition, increased interest rate risk (increase in fixed assets), and a slightly higher yield on assets also helped profitability. Construction, consumer, and residential mortgage lending increased while C&I decreased thus resulting in a slightly riskier loan mix. From an asset efficiency standpoint, the industry had a return on asset (ROA) ratio of 1.03%, its highest since December of 2013 and a record in the post-recession era. Community banks were similar to the industry posting a 0.99% ROA, up 3 basis points (bps).


Efficiency Ratio Trend Graph


Asset Quality Continues To Improve


In addition to leverage, the biggest story in bank earnings continues to be the improvement in credit quality. Every delinquency category dropped and all major lending categories improved. As a result of better credit quality, loan and lease loss provisions for community banks decreased from 1.36% in 1Q to 1.32% in 2Q. The industry was similar with a drop of 5 bps to 1.39%. Troubled loans relative to capital (Texas Ratio) fell from 14.7% to 13.7% with community banks doing even better, falling from 14.3% to 12.9%. 


Bank Delinquency Heat Map


As can be seen in the chart above, the nation is healing quickly with most states back to green with the exception of Florida and Oklahoma. Both of those states continue to have elevated 1-4 family delinquencies, with Florida having additional stress from agriculture. 




Of some concern was the slowdown in the rate of growth for both loans and deposits. What was running at an annualized 8.0% pace slowed this quarter to a 5.5% pace. Deposit growth for the industry fell just slightly – something that hasn’t happened in more than 8 quarters. Loans increased for the industry at a 2.5% year-to-date annualized pace, with community banks closer to 5%.




While efficiency improved to 60% for the industry, most of the improvement came from scale and operating cost savings at the large banks. Community banks decreased their efficiency ratio from 65.0% to 64.6% largely as a result of being able to hold salaries and benefits stable. Marketing expense increased from 2.4% of total expenses to 2.6% of total expenses, as did legal fees and accounting charges.




Repayments of commercial loans at community banks remained relatively the same around 23% constant prepayment rate, and both loan origination costs and customer acquisition costs remained unchanged. Despite the improving credit quality, pricing increased for new origination but decreased for renewing loans. Offsetting some margin compression was an increase in duration as more banks took on fixed-rate loans (loans with floors) helping margins but increasing their interest rate risk.


As mentioned, every major loan category improved, with commercial real estate (hotels, office and industrial in particular) improving the most followed by consumer lines. The chart below also shows the details.


2Q 2015 Bank Loan Performance




Bank Loan Delinquencies Second Quarter 2015




While credit risk trailed down, banks became slightly more risky from an asset and liability standpoint. However, this was offset by solid earnings contributing to capital accumulation. The industry’s Core Capital Ratio stayed unchanged at a healthy 9.2%, while Tier 1 capital increased slightly to 12.6% from 12.5%. The total risk-based capital ratio improved from 14.1% to 14.2%.  




Other notable trends included a decrease in the relative size of investment portfolios. Also interesting was an increase in fee income slightly from 34.8% of total revenue to 35% for the industry. Community banks improved to 22.7% from 22.3%. Most of the fees were a result of higher service charges on deposits, more SBA fees and non-interest income from ancillary lines of business.


While the relative amount of wholesale funding decreased for the industry, it increased for community banks at a rate not seen in a long time (chart below). Core funding remained stable and interest-bearing deposits decreased slightly. 


Bank Wholesale Funding Performance Chart 2Q 2015


The number of insured commercial banks declined 1% to 6,348. While this included 1 bank failure, mostly it was a result of pure acquisitions, the pace of which increased from last quarter. The average deal price for a bank decreased from 1.4x book value to 1.3x book value. However, on an earnings multiple basis, prices increased from 23.5x for 1Q to 27.3x in 2Q. Core deposit premiums decreased from 6.2% to 4.9%. 318 branches were sold during the quarter, down from the 339 pace from last quarter.  


For more data and analysis, download the board-ready presentation [Link expired] .