During the quarter ended June 30, 2019 the community bank sector continued to reflect a strong capital framework and stable earnings. Although the relative growth in both capital ratios and return on equity has subsided modestly in comparison to other quarters over the past two years, the industry sector has demonstrated the ability to ride the wave of the strong economy while building a solid foundation for future performance.
These ratios which indicate the capital strength of the sector in relation to its asset base remained consistent in comparison to the two most recent quarters. Tier 1 Capital (15.32% at June 30, 2019) remains at historically high levels and is reflective of continued favorable credit performance, growing non-interest income and most efficient operations. In some instances, these favorable results have enabled banks to increase dividend payouts or, for publicly-traded banks, execute strategic stock repurchase plans. The modest growth in the ratio of Tangible Equity/Tangible Assets during the first two quarters of 2019, to 10.97% at June 30 from 10.7% at March 31 and 10.52% at December 31, 2018, is in part reflective of the continued absorption of market premiums paid on acquisitions completed during the previous two years.
This key indicator of the sector’s ability to profitably deploy its capital rebounded during the quarter to 9.8% from 9.55% for the most recent trailing quarter, which represented a slight decline from 9.71% in the fourth quarter of 2018. Stable net interest margins and improvements in both non-interest income and efficiency ratios provided the upward influence on sector earnings. In addition, the aforementioned increases in dividend payouts and stock repurchases have tempered the growth in average equity levels.
This metric remains a bit of challenge for the community bank sector as it faces stiff pricing and product competition from the larger banks for traditional deposit accounts and attempts to address the emerging changes in the payment systems framework arising from financial technology (fintech) companies and efforts to accelerate the flow of funds. The increase in the sector’s cost of funds during the quarter from .79% to .86%, although modest on an absolute basis represents an almost 10 percent relative increase in the cost of funds. This change does not reflect the 25 basis point decrease in the discount rate recently announced by the Federal Reserve, however it remains unclear as to how much of this decrease will find its way into the sector’s cost of funds.
Two positive notes concerning credit quality for the community bank sector. First, the favorable run of modest loan growth and historically strong performance continued. Delinquencies remained extremely low and the established allowance for loan and lease losses, which have remained at 1.2% over the past three quarters, are effectively absorbing what limited losses have occurred. Second, during the quarter the Financial Standards Accounting Board, FASB announced a proposed delay in the implementation of the Current Expected Credit Loss (CECL) standard to calendar year 2023 for most community banks. Although it was not universally clear as to how this standard would have affected the sector had it been implemented according to its original schedule, the proposed delay has given most community banks an opportunity to more effectively plan for this change.
These results are not likely to significantly change the current community bank mergers and acquisitions landscape. Although the strong capital framework and sustained earnings may enable some community banks to remain independent for a while longer, those banks that have developed the ability to effectively assess and execute accretive business combinations are likely building the capital wherewithal to identify and pursue acquisition targets as well as the earnings capacity to absorb purchase premiums within a reasonable period subsequent to any deals. Most investment bankers anticipate the second half of 2019 to remain relatively active with regard to community bank deals.
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