ByGary S. Corner , Michelle Clark Neely
Community banks, both nationally and in the Eighth Federal Reserve District, faced an improving economic climate in 2013, but continued to experience challenges in building on the gains they had made since the financial crisis. The following is a more detailed look at 2013 performance over a few key metrics.
Although asset quality continued to improve, earnings growth stalled overall. Return on average assets (ROA) for District community banks averaged 1.01 percent at year-end 2013, unchanged from its third-quarter level and down just 1 basis point (bp) from year-end 2012. Nationally, community banks posted slightly better results, with ROA averaging 1.06 percent at year-end 2013, down 1 bp from the third quarter, but up 7 bps from year-end 2012. Within District states, ROA at year-end 2013 ranged from a low of 0.84 percent at Illinois banks to a high of 1.31 percent at Arkansas banks.
Net interest margin (NIM) compression—a challenge for most community banks these past few years—eased somewhat in the fourth quarter, with margins remaining unchanged or up slightly from their third-quarter levels. NIM at District community banks averaged 3.86 percent at year-end 2013, up 3 bps from the third quarter, but still down 11 bps from year-end 2012. The trend nationally among community banks was much the same, with average NIM rising 3 bps in the fourth quarter to 3.79 percent.
Rising interest income and declining interest expenses boosted margins at community banks both nationally and in the District in the fourth quarter. With most bankers still reporting tepid loan demand, it is doubtful margins will rise significantly anytime soon. Loans as a percentage of assets hovers close to 60 percent on average at District banks, which is about 10 percentage points below its precrisis level. Further, net noninterest expenses have crept up in recent quarters, putting added pressure on earnings.
The net noninterest expense ratio—noninterest expenses less noninterest income divided by average earning assets—ticked up 5 bps year over year in the District to 1.97 percent. A combination of declining noninterest income and rising noninterest expenses—a trend mirrored in most District states—caused the increase. Nationally, the noninterest expense ratio for community banks was up 6 bps year over year in the fourth quarter; a slight increase in noninterest income was more than offset by a 7-basis-point increase in the ratio of noninterest expenses to average earning assets.
Falling loan loss provisions continued to boost earnings, though the effect lessens with each passing quarter. The ratio of loan loss provisions to average assets declined 1 bp between the third and fourth quarters in both the District and the U.S. Compared with one year ago, the loan loss provision ratio is down 18 bps at District banks and 20 bps at community banks across the nation. Most analysts believe loan loss provisions have bottomed out, and a number of institutions have recorded negative provisions in recent quarters.
The worst of asset quality turbulence appears to have subsided for community banks. The problem assets ratio—defined as the ratio of nonperforming loans and other real estate owned to total loans and other real estate owned—declined 86 bps year over year and 25 bps in the past quarter at District community banks. National peers, by comparison, experienced a slightly larger year-over-year improvement of 94 bps in the average problem assets ratio, but the measure remains 8 bps higher than that of the District average. With the problem assets ratio reduced to 2.75 percent, District community banks are now near the percentage found at the end of 2008, early in the financial crisis. While still not at a precrisis benchmark, the level is more than 200 bps under its peak in early 2011.
Similarly, nonperforming loans as a percentage of total loans declined 47 bps at District community banks over the past year and 14 bps in the past quarter. This improvement places the nonperforming loan ratio at a much more manageable 1.65 percent. While community banks nationally experienced a larger decline of 68 bps during the year, their average nonperforming loan ratio remains nearly 36 bps higher than that found at District institutions. The pace of improvement has slowed both in the District and nationally, as nonperforming loans and problem assets revert to their more normalized percentages.
With a range of 9.8 percent to 10.8 percent, tier 1 leverage ratios are relatively strong at community banks across the United States. Generally high levels of investor participation in the Treasury’s Troubled Asset Relief Program auctions provided a signal that confidence in the community banking sector has rebounded.
Despite the improvements in earnings and asset quality since the end of the financial crisis, significant challenges remain. One important long-term challenge for community banks is to achieve a satisfactory return for their investors. Though return on equity has rebounded from its depressed level at the peak of the financial crisis at most community banks, it may remain below that of an attractive long-term rate. Most community banks have seen their credit-related costs return to a precrisis level and have trimmed operating expenses where possible. However, generating additional revenue, whether found in the expertise to achieve profitable loan growth or the skill to generate new sources of noninterest income, is a challenge.
Today, we find most community banking organizations moving from crisis management to planning for the challenges ahead. While 2013 may have been a year to clean up the remaining problems from the financial crisis, it appears as though 2014 will be a year of planning and transition for many community banking organizations. Those that plan well and appropriately manage risk will be in stronger competitive positions than their peers.