Community banks are largely expected to discuss more cost-cutting measures as a way of lifting results when they begin reporting in earnest next week.
For most of the past year, smaller banks have relied on improving credit, and lower loan-loss provisions, to boost year-over-year earnings. With most of those opportunities now in the rearview mirror, bankers have fewer levers to counter stagnant loan demand and low interest rates.
Industry observers believe that a handful of banking companies may manage to grow revenue through their balance sheets. The rest may end up outlining plans to cut staff, close branches and purge underperforming assets to boost results.
"Potentially we'll hear about more margin pressure," says Brett Rabatin, an analyst at Sterne, Agee & Leach Inc. "Generally speaking, loan growth is probably going to be minimal. If you can't grow revenue, you've got to cut somewhere."
The research team at KBW Inc.'s Keefe, Bruyette & Woods Inc. is forecasting that year-over-year bank earnings will decline for the fourth consecutive quarter once all the results are in. In a mid-December note to clients, the analysts projected more clarity on job cuts and branch closings.
Such moves might be necessary to offset diminishing returns from balance sheets.
"There are real headwinds that the community banking industry is going to face," says Frank Sorrentino, chief executive of North Jersey Community Bancorp Inc. in Englewood Cliffs, N.J. "The biggest [issue] is shrinking net interest margin."
For community banks, wrestling with historically low interest rates, which the Federal Reserve Board has guaranteed through this year, threatens to overshadow any other positive momentum.
"The current rate …environment makes it very hard for banks to achieve meaningful profitability improvement in the near term," Jefferson Harralson, an analyst at Keefe, Bruyette & Woods, wrote in a Dec. 15 note to clients.
Community banks are having trouble redeploying funds at a time they're flush with deposits, Sorrentino says.
Checking and savings accounts at U.S. banks topped $10 trillion in September as people remain wary of stocks. There are a handful of bright spots for lending, namely commercial-and-industrial loans, and owner-occupied commercial real estate, causing banks to offer highly competitive terms to creditworthy borrowers.
"We're seeing competition from banks that we haven't seen in the market in two or three years," Sorrentino says. "That's driving loan pricing even lower."
To be sure, plenty of community banks have been able to produce loan growth in spite of intense competition.
"Commercial and industrial lending was the real bright spot in 2011," the banking team at Oppenheimer & Co. wrote in a Jan. 5 note to clients, citing Fed data that showed such lending rose 9.8% in 2011, compared to a year earlier.
Community banks that have benefitted from C&I lending include the $2.8 billion-asset Lakeland Financial Corp. in Warsaw, Ind., and the $4.9 billion-asset Pinnacle Financial Partners Inc. in Nashville, Tenn. C&I loans make up roughly a third of all loans at both of those companies, according to research by Stifel, Nicolaus & Co.
Analysts at Keefe, Bruyette & Woods listed First Republic Bank in San Francisco and Signature Bank in New York as companies that should produce solid organic loan growth. Others, such as Park Sterling Bank Inc. in Charlotte and BBCN Bancorp Inc. in Los Angeles, should post loan growth due to acquisitions.
Otherwise, analysts believe there will be limited lending opportunities and that banks will be challenged to further reduce funding costs.
"Many banks had a lot of construction exposure and that market is dead at this point," says Joseph Pucella, an analyst at Moody's Investors Service. "As assets reprice lower, most of these banks have squeezed as much out of their deposits that they can."
A silver lining for smaller banks, compared to bigger financial institutions, is that most have little, if any, exposure to the European financial crisis. Stifel Nicolaus' bank research team wrote in a Dec. 21 note that international loans make of more than 1% of loans at just six of the 121 banks they cover.
For instance, international loans make up just 0.18% of the loans at the $19.4 billion-asset Hancock Holding Co. in Gulfport, Miss. At the $21.6 billion-asset Associated Banc-Corp in Green Bay, Wis., foreign loans make up 0.02% of the overall loan portfolio.
That's not to say that the overall U.S. economy won't be weighed down by European troubles. Analysts at Stifel Nicolaus wrote that it is "quite possible" that exports to Europe could be cut in half this year. That could particularly harm banks in states such as Texas and Washington, they wrote.
Industry observers also expect more community banks to purge bad loans. In the third quarter of 2011, noncurrent loans fell 3.3% from a year earlier, to $309.6 billion, from a year earlier, according to data from the Federal Deposit Insurance Corp. Such delinquencies have declined for six straight quarters.