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The first quarter of 2019 showed some modest but nonetheless interesting movements in the metrics monitored in Baker Tilly’s banking industry key performance indicator (KPI) report. Generally, the first quarter of 2019 results reflected a sustained strength in the community bank sector of the banking industry. Capital and earnings remained at continued high and increasing levels. Likewise, credit quality remained encouragingly strong throughout the sector, with little to suggest reversing trends in the near term. Of note, however, are some modest shifts in lending volumes and net interest margin that may be indicative of some softening of the favorable performance community banks have enjoyed for the past three years.

Both Tier one capital and the return on average equity increased modestly in comparison to the fourth quarter of 2018. The increase in capital levels appears to be principally a result of the favorable earnings trend in that there was only a limited level of capital sourcing completed by community banks during the first quarter of 2019. Further, it appears that the benefits of the trend in consolidation that began over three years ago are beginning to be reflected in both the capital ratios and earnings levels. In many instances, the premiums paid to complete the acquisitions have been effectively absorbed and the efficiencies in operations are beginning to take hold. Also contributing to the continued favorable earnings was the sustained high levels of credit quality. Both non-performing asset and allowance for loan and lease losses remained at historical lows, which reflect the current strength of the economy served by community banks.

Although banks continue to enjoy strong credit quality, it appears the demand for loans in this sector may be subsiding. Despite there not appearing to be any systemic contributors to the reduction in both the loans and leases to assets and loans to deposit KPIs, both of these metrics declined slightly during the first quarter of 2019 in comparison to the fourth quarter of 2018. Some indicators suggest this is the result of continued and growing concerns over global trade issues and/or uncertainties as to the ability of community banks to continue to access funding at favorable pricing levels. The recent communications by the Federal Reserve indicates it to be more likely to decrease than increase the benchmark rate in the near term. The first quarter of 2019 reflected a slight decrease in net interest margin, most likely due to the continued high levels of competition for core deposits being precipitated by the emergence of more readily accessible mobile banking solutions led by the large and regional banks.

Insights on mergers and acquisitions

In comparison to 2017 and 2018, the current year is off to a relatively slow start with regard to mergers and acquisitions within the community bank sector. This slowdown is believed to be a function of a decline in the overall market value of community bank stocks, which is inhibiting buyers to pay the desired acquisition prices and the current favorable earnings landscape which is allowing potential sellers to “wait-it-out” until acquisition multiples return to the levels experienced during 2017 and 2018. If the factors noted above with regard to lower lending volumes and declining net interest margins persist, we anticipate sellers will be faced with the critical decision of taking a lower price in the face of the potential of decreased profitability and a decline in credit quality.

For more information on this topic, or to learn how Baker Tilly’s Value Architects™ can help, contact our team.

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