Some of the more notable observations in the year-end review of KPIs are:
Tier 1 Capital — This primary indicator of the overall financial strength of a bank and its ability to absorb unanticipated losses rose slightly during 2019, in comparison to the previous year, principally reflecting the strength of the U.S. economy, continued exceptional credit performance, and moderation in operating costs related to regulatory compliance. The pace of growth slowed in comparison to the prior period, reflecting the challenges of sustaining growth in comparison with the increased capital base.
Return on Average Equity — Community banks in our KPI population continue to generate earnings at a high level. The pace of the growth in community bank returns on investment, which have now been realized for the past 36 months, is however beginning to subside, as shown by the decline from 9.70% in 2018 to 8.96% in 2019. As the pace of the growth in the U.S. economy slowed and competition for quality asset growth intensified, the ability to deploy the higher level of capital became more complex. Further, as discussed in more detail below, the operating efficiency of the community banking industry in 2019 retreated slightly in comparison to the prior year.
Efficiency Ratio — Overall the operating efficiency of the community banking industry remains good, however the slight increase from 66.92% in 2018 to 67.66% in 2019 is reflective of the increasing cost attracting and retaining quality bank personnel and the increasing cost of technology. As for the cost of personnel, most notably the costs associated with specialized skills such as finance, compliance and technology are requiring higher levels of compensation. Technology costs have increased in relation to previous years as most banks have implemented the less-complex technology solutions (e.g., mobile banking) and the more expensive solutions (e.g., Cybersecurity and payment solutions) emerge.
Cost of Funds — The comparative results of this KPI, an increase from .73% to .86%, a relative increase of almost 18%, may be the largest challenge facing community banks heading into 2020. Specifically, community banks continue to compete with large regional and national banks for valuable low-cost deposits. Although local presence and service remain important, a larger percentage of the population is becoming increasingly comfortable with directing larger deposit balance to non-local institutions in search of higher yields. Further, the larger depository institutions have a notable competitive advantage regarding their ability to direct technology spend to deposit and payment system solutions, while paying higher yields on deposits subject to the same levels of FDIC coverage.
Net Interest Margin — The primary result of slowing asset growth and a rising cost of funds is the decline in the industry’s net interest income from 3.83% in 2018 to 3.72% in 2019. As the core driver of the traditional community bank earnings model, a decline in this KPI is difficult to overcome. Coupled with the modest increase in the efficiency ratio (see above), it is expected that the tighter net interest margin will result in lower community bank earnings in 2020.
Credit Quality — Credit performance in the community banking segment remains exceptional and is expected to do so at least through the 2020 election. The delay of the implementation of CECL to 2023 for most community banks has been viewed as a favorable development, although most community banks that had performed a preliminary assessment of the standard had anticipated little or no effect.
Outlook on M & A Activity — Based on the 2019 KPIs and the collective expectation for a modest decline in community bank asset growth and earnings in 2020, we have the following expectations for mergers and acquisitions activity:
Baker Tilly has developed the ability to develop and provide a thorough analysis of these KPIs for individual banking organizations in comparison with any identifiable segment of the industry. Through this analysis, we are able to assist banks in identifying those areas that are indicative of the bank’s value and those that represent areas of needed attention or improvement. Further, we can provide a deeper level of understanding the details behind these KPIs and how those details might be addressed through corrective actions or changes in business approach or strategy.
Understanding how your bank measures up within the industry is critical to achieving long-term success. This report is designed to help.
Banks with an interest in learning more about our abilities to provide meaningful analyses of KPIs or of other critical bank data should contact Baker Tilly banking specialists.