A minor dip in profitability this past year belies the promise of what's ahead for publicly traded banks and thrifts with less than $2 billion of assets.
The median return on average equity for the 633 institutions that fit the criteria for our annual ranking fell by 58 basis points in 2017, to 6.95%.
By comparison, the institutions that ranked in the top 200 posted a more comfortable median ROAE of 9.89%. But that is still a drop of 47 basis points from the previous year.
Kevin Halsey, a consultant at Capital Performance Group, blamed the decline on a particular one-time item, rather than any performance issues. Because of corporate tax reform, many banks had to write down deferred tax assets in the fourth quarter, hampering overall profitability.
"It was actually a decent year for the banking industry, even among the community banks, which have traditionally underperformed their larger counterparts," Halsey said.
With the help of rising interest rates, lower corporate taxes and reduced regulation, "it's going to be an even better 2018," he added.
But community banks still have serious challenges ahead, particularly in the competition for low-cost deposits against the more digitally savvy megabanks.
“The larger banks are doing a much better job of banking millennials, a segment that all of a sudden now has jobs and has money,” Halsey said. “They’re much better positioned than the community banks with their marketing budgets and with their digital presence to really grow core funding from the consumer base.”
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The top performers in our ranking — which is based on ROAE across three years — posted a median ratio of core deposits to total deposits of 75.63% last year, up 85 basis points from a year earlier, according to an analysis by CPG. The overall peer group also boosted core deposits, with its ratio of 73.88% improving by 70 basis points.
But that growth rate is roughly a third of what it had been in the previous year.
“I don’t know if I would use the word ‘scary’ — credit quality going south would be scary, I’m not sure this is scary,” Halsey said. “But I think it highlights the struggle that community banks have today gathering deposits.”
Even so, price competition remained muted.
Though the Federal Reserve raised interest rates several times last year, the median cost of funds for these small banks barely budged, rising 3 basis points for the top 200, to 0.49%, and 4 basis points for the peers, to 0.52%.
This helped efficiency ratios improve at an accelerated pace compared with a year earlier (160 basis points better for the top 200, for a median of 62.06%, and 239 basis points better for the peers, for a median of 68.76%).
Halsey also cited continued asset growth as a key factor contributing to the efficiency gains, a trend we’ve highlighted previously.
Of the institutions that qualified for this ranking last year, 20 had pumped up their asset size to more than $2 billion as of Dec. 31, including nine from the top 200.
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