Are small banks doing enough to counter margin pressure?

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A number of economic shifts, including a flat-to-inverted yield curve, is putting more pressure on community banks to find ways to boost their bottom lines.

Two interest rate cuts have increased investor concerns about margin compression as banks prepare to report third-quarter results. And reduced commercial loan demand, due in part to the trade war with China, and intense bank and nonbank competition, will likely force more banks to lower loan prices, the Stephens Inc. research team said in a recent report.

“It’s not that we’re seeing a lot of concern about a big slowdown, but there is a deceleration” in activity, said Randy Chesler, president and CEO of the $12.7 billion-asset Glacier Bancorp in Kalispell, Mont. Glacier expects high-single-digit loan growth this year, compared with a low-double-digit increase in 2018.

“It’s pretty quickly become a tough environment,” said Brian Klock, an analyst at Keefe, Bruyette & Woods. “That’s impacting investor sentiment on the bank group.”

The KBW Nasdaq Bank Index is down more than 4% since July 31, when the Federal Reserve made the first of two rate cuts. The second was announced came last month.

Those developments are sparking a debate over what small banks can do to bolster earnings.

Low-cost funding is critical, industry observers said.

"We're going after small-business deposits and other [accounts] where we aren’t paying interest," Melissa Eggleston, chief deposit officer at the $800 million-asset nbkc bank in Kansas City, Mo., said at a recent community banking conference.

Analysts at KBW are looking at certain cities, like St. Louis and Atlanta, where deposit rates are falling faster than in other markets. Boston and Philadelphia had the least amount of decline in deposit rates.

The analysts said they are also watching for banks with sizable holdings of municipal securities and long-duration assets.

The margin “discussion has shifted to which banks can best defend environmental pressures by reducing funding costs and limiting the erosion in earning asset yields, all while combating the challenges of a flat-to-inverted yield curve,” the analysts said in a note to clients.

Meta Financial Group in Sioux Falls, S.D., was one of the companies highlighted by KBW. About 60% of the $6.1 billion-asset company’s deposits are in non-interest-bearing accounts largely linked to its prepaid-card platform. Securities and other investments make up about 30% of Meta’s earning assets, providing an opportunity to replace lower-yielding securities with loans.

Banks with mortgage operations are also in a position to offset some margin pressure with lending volume and fee income.

Atlantic Union Bancshares in Richmond, Va., gained a mortgage business when it bought Access National Bank in Reston, Va., earlier this year. Refinance activity has rebounded in the wake of falling rates.

"We're happy to have that business,” John Asbury, the $17.2 billion-asset Atlantic Union’s president and CEO, said at a conference last month. “This is a favorable environment for the mortgage business. We don't want it to be too large, but that's helping us out.”

“Low rates are great for the mortgage business, which can help us supplement earnings,” Leslie Andersen, president and CEO of the $139 million-asset Bank of Bennington in Nebraska, said at a recent community banking conference.

Acquisition activity, which was relatively muted for most of this year, could also heat up as buyers look for ways to bring in low-cost deposits and other banks opt to sell in the wake of more challenging business conditions, industry observers said.

“Bank acquisition activity for 2019 is now tracking above levels observed over the last three years,” with “a noticeable uptick” in the Southwest and Southeast, the Stephens team wrote in their client note.

Glacier, for example, has announced three acquisitions this year. It recently agreed to buy the $679 million-asset State Bank Corp. in Lake Havasu City, Ariz., for $135 million. The acquisition would triple Glacier’s branch network in Arizona and provide it with more access to fast-developing markets, including Phoenix.

While Glacier is largely focused on integration, Chesler said his team is “always interested in talking” with potential sellers.

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