The community banking sector maintained its steady path forward during the third quarter of 2019. The continued strong economy – including a generally favorable interest rate environment – and the fiscal and operational discipline of the sector as a whole are reflected in steady or improving performance across all of the key performance indicators (KPIs) monitored by Baker Tilly. This favorable performance positions the community banking sector with one of the most successful years in recent history and for continued success well into 2020.
Some of the more notable observations in this quarter’s KPIs are:
Return on average equity
The sector’s return on average equity increased to 10.02% in the third quarter from 9.82% during the second quarter of 2019. Although the relative increase is not necessarily noteworthy, it is important to recognize that the combination of strong credit quality and performance, improved operating efficiency, and a steady net interest margin provides the foundation for both current and sustainable double-digit returns to shareholders.
The effective deployment of technology solutions, enhanced productivity from bank staff and management, and measurably improved compliance management programs are reflected in the continuing improvement in the sector’s efficiency ratio. During the third quarter, the community banking sector’s overall efficiency ratio decreased to 69.49% in comparison to 69.66%. Although the improvement is relatively modest, it does demonstrate the commitment across the sector to efficient operations and strong internal controls.
The loan portfolios of the banks within the community banking sector continue to perform at an exceptional level. Although there have been some isolated indicators of credit softening, nothing has elevated to a level significant enough to be reflected in increased levels of non-performing assets or the need for increase in the allowance for loan losses as a percentage of loans outstanding. As noted above, the strength of the economy and broad-based discipline in credit underwriting and administration appear to be resulting in the sustained high levels of credit quality and performance.
Insights for community bank M&A
The results of the third quarter and the continued strength of community bank balance sheets provide the basis for our expectation of a continued steady pace of consolidation in the sector. As the larger banks within the sector achieve higher capital levels, develop sustainable and repeatable operational frameworks, and effective credit risk management, we expect to see these organizations become more active in seeking acquisitions. As we have written in previous editions, scale does matter in relation to price and performance, therefore community banks and both buyers and sellers, are likely to remain motivated to pursue the appropriate time and terms of mergers and acquisitions that will maximize the value for the sector as a whole.
Baker Tilly has 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.
For more information on this topic, or to learn how Baker Tilly’s Value Architects™ can help, contact our team.