Through the lens of the banking key performance indicators, 2018 was a strong and stable year for community banks throughout the U.S. The strong economy and relatively stable interest rate environment enabled this sector of the banking industry to maintain a steady course throughout the year and to make progress on some critical initiatives, mostly related to credit quality, regulatory compliance and technology. As discussed in the first, second, and third quarter reports of 2018, the banking KPI report reflects almost no change or modest improvements from quarter-to-quarter throughout the year (e.g., earnings, credit quality and capital adequacy benchmarks all remained essentially the same). This consistency and managed improvement appears to reflect a notably more stable economic environment, disciplined management of credit pricing and quality, notwithstanding a continued highly-competitive environment and what now appears to be a curtailment of the previously anticipated rise in interest rates.
If there is anything to take away from the stable to improving KPIs throughout 2018, it is that community bankers have benefited from the opportunities emerging from the sustained strong economy. Although credit quality continued to improve this past year, loan growth, reflected in the comparison of the loan-to-deposits ratio in comparison to the prior year, has been somewhat subdued, possibly due to some saturation of the commercial real estate market and the emergence of marketplace lenders for small to medium businesses. The combination of improved credit performance (including the resulting lower ALLL levels), slightly improved margins, and a reduced income tax burden contributed to notably improved capital levels. Some of this improvement was redirected into increased investments in personnel and technology, resulting in a slight increase in the sector’s aggregate efficiency ratio in comparison with 2017. Another observation is that as credit quality and interest rate margins have been well managed, the overall contribution of non-interest income to bank profitability has declined slightly. In addition to being a factor of the improvements in core earnings, there is some emerging evidence that competitive pressures from non-bank companies and consumer preferences are changing the landscape for fee based businesses such as interchange revenue.
Many banking institutions continued to assess consolidation opportunities on both the buy and sell side. Until the market declines that occurred during the last few weeks of 2018, bank equity currency remained quite strong, supporting a continued active consolidation of the industry, at price points that on average exceed 1.5 – 1.7 times book value. Although we expect the consolidation wave to continue into 2019, the price points may not achieve those experienced during 2018 and the bias of transactions may be more toward larger organizations as they aggressively compete for market share and efficiency.
As we head into 2019, we expect more of the same consistency in the KPIs as we experienced throughout 2018. Based on the current views of economic experts and banking industry leaders, it does not appear there will be any significant shifts in either direction arising from changes in economic policy or market dynamics. Other than an increased emphasis on securing and maintaining low cost deposits, we anticipate community banks to maintain a steady upward course throughout 2019.
For more information on this topic, or to learn how Baker Tilly’s Value Architects™ can help, contact our team.