Read this if you are a community bank.
The Federal Deposit Insurance Corporation (FDIC) recently issued its fourth quarter 2021 Quarterly Banking Profile. The report provides financial information based on Call Reports filed by 4,839 FDIC-insured commercial banks and savings institutions. The report also contains a section specific to community bank performance. In fourth quarter 2021, this section included the financial information of 4,391 FDIC-insured community banks. BerryDunn’s key takeaways from the community bank section of the report are as follows:
- The banking industry as a whole saw a $132 billion increase in net income from a year prior despite continued net interest margin (NIM) compression. This increase was mainly attributable to the $163.3 billion decrease in provision expense, supported by continued economic growth and supplementary credit quality improvement. NIM declined to 2.54%, a 28 basis-point decrease from 2020 as the growth rate in average earning assets outpaced the growth rate in net interest income.
- For community banks, full-year net income increased $7.4 billion to $32.7 billion. Despite the increase in annual net income, community banks saw a $719.9 million decrease in net income from third quarter 2021. Higher noninterest expenses continue to place pressure on community banks as inflation rates spike going into 2022. Annual NIM fell 12 basis points from 2020 to 3.27%. The average yield on earning assets fell 42 basis points to 3.58%, while the average funding cost fell 30 basis points to 0.31%. The percentage of unprofitable community banks declined to 3.2%, the lowest level on record.
*See Exhibit B at the end of this article for more information on the fourth-quarter year-over-year change in income.
- Net gains on loan sales revenue declined $1.5 billion (50.6%) from fourth quarter 2020. However, growth in net interest income of $1.3 billion (6.7%) from fourth quarter 2020 overcame the $707 million decline in noninterest income. Net operating revenue increased $588.4 million (2.3%) from fourth quarter 2020.
- Noninterest expense increased 3.4% from fourth quarter 2020. This increase was mainly attributable to higher data processing and marketing expenses. That being said, average assets per employee increased 10% from fourth quarter 2020. Noninterest expense as a percentage of average assets declined 16 basis points from fourth quarter 2020 to 2.51%, despite 69.4% of community banks reporting higher noninterest expense.
- Noncurrent loan balances (loans 90 days or more past due or in nonaccrual status) declined by $1.1 billion to $11.1 billion from third quarter 2021. The noncurrent rate dropped 7 basis points to 0.58% from third quarter 2021, the lowest noncurrent rate on record for community banks.
- The coverage ratio (allowance for loan and lease losses as a percentage of loans that are 90 days or more past due or in nonaccrual status) increased 53.7 percentage points from a year ago to 223.8%. This ratio is well above the 147.9% reported before the pandemic in fourth quarter 2019 and continues to be a record high. The coverage ratio for community banks is 49.9 percentage points above the coverage ratio for noncommunity banks. As a result, provision expense declined $914.9 million from fourth quarter 2020, but remained at $320.8 million for fourth quarter 2021, representing a $39.2 million increase from third quarter 2021.
- The net charge-off rate declined 6 basis points from fourth quarter 2020 to 0.09%.
- Trends in loans and leases started looking up, as community banks saw an increase of $24.3 billion within fourth quarter 2021. This growth was mainly seen in the nonfarm nonresidential commercial real estate (CRE), which held a balance of $16.3 billion. Total loans and leases increased by $34.2 billion (2%) for the year 2021. Growth of $50.6 billion in CRE loans attributed to the increase. A decline in commercial and industrial loan balances of $62.3 billion (20.1%) from fourth quarter 2020 offset a portion of this increase. This decline was mainly due to Paycheck Protection Program (PPP) loan repayment and forgiveness.
*See Exhibit C at the end of this article for more information on the change in loan balances.
- More than 75% of community banks reported an increase in deposit balances for the fourth quarter. In total, deposit growth was 2.8% during fourth quarter 2021.
- The average community bank leverage ratio (CBLR) for the 1,699 banks that elected to use the CBLR framework was 11.2%, nearly unchanged from third quarter 2021. The average leverage capital ratio was 10.16%.
- The number of community banks declined by 59 to 4,391 from third quarter 2021, a decrease of 168 from December 2020. This change includes six banks transitioning from community to noncommunity banks, four banks transitioning from noncommunity to community banks, 54 community bank mergers or consolidations, and three community banks having ceased operations.
Fourth quarter 2021 was another strong quarter for community banks, as evidenced by the increase in year-over-year quarterly net income of 7.1% ($511.6 million). This quarter concluded another strong year financially for community banks. However, NIMs continue to show record lows, as shown in Exhibit A, which shows the trends in quarterly NIM.
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The consensus remains that community banks will likely need to find creative ways to increase their NIM, grow their earning asset bases, or continue to increase noninterest income to maintain current net income levels. In regards to the latter, many pressures to noninterest income streams exist. Financial technology (fintech) companies are changing the way we bank by automating processes that have traditionally been manual (for instance, loan approval). Decentralized financing (DeFi) also poses a threat to the banking industry. Building off of fintech’s automation, DeFi looks to cut out the middle-man (banks) altogether by building financial services on a blockchain. Ongoing investment in technology should continue to be a focus, as banks look to compete with non-traditional players in the financial services industry.
The larger, noncommunity banks are also putting pressure on community banks and their ability to generate noninterest income, as recently seen by Citi, Bank of America, and many other large banks following behind Capital One Bank in eliminating all overdraft fees. According to the Consumer Financial Protection Bureau, the financial services industry brought in $15.5 billion in overdraft fees in 2019. Seen as a move to enhance Capital One Bank’s financial inclusion of customers, community banks will also need to find innovative ways to enhance relationships with current and potential customers. As fintech companies and DeFi become more mainstream and accepted in the marketplace, the value propositions of community banks will likely need to change. Furthermore, as PPP loan forgiveness comes to an end, PPP loan fees will no longer supplement revenues. Although seen as a one-time extraordinary event, this fee income was significant for many community banks’ 2021 and 2020 revenues.
The importance of the efficiency ratio (see Exhibit D below) is also magnified as community banks attempt to manage their noninterest expenses in light of low NIMs and inflationary pressures. Although noninterest expense as a percentage of average assets declined 16 basis points from fourth quarter 2020, such expenses increased 3.4% from fourth quarter 2020. And, inflationary pressures will likely be exacerbated as a result of Russia’s invasion of Ukraine. Inflationary pressure was already seen in fourth quarter 2021, as net income decreased $719.9 million from third quarter 2021, despite only a $39.2 million increase in provision expense from third quarter 2021. Banks with manual processes can improve efficiency and support a remote workforce with increased automation.
Furthermore, many of the uncertainties that we have been discussing quarter-over-quarter, and that have thus become “themes” for the banking industry in 2021, still exist. For instance, although significant charge-offs have not yet materialized, the financial picture for many borrowers remains uncertain. Also, payment deferrals have made some credit quality indicators, such as past due status, less reliable. Payment deferrals for many borrowers are coming to a halt and many community banks had nominal amounts of borrowers that remained on deferral as of December 31, 2021. So, the true financial picture of these borrowers may start to come into focus. The ability of community banks to maintain relationships with their borrowers and remain apprised of the results of their borrowers’ operations has never been more important. This monitoring will become increasingly important as we transition into a post-pandemic economy.
The outlook for office space remains uncertain. Many employers have either created or revised remote working policies due to changing employee behavior. If remote working schedules persist, whether it be full-time or hybrid, the demand for office space may decline, causing instability for commercial real estate borrowers. As noted in a recent FDIC article, “the full effects of changing dynamics in the sector are still developing. Office property demand may take time to stabilize as tenants navigate remote work decisions and adjust how much space they need.” The FDIC article further mentions reduced office space could also have implications for the multifamily and retail markets that cater to those office employees. Similarly, the hotel industry remains in flux and the post-pandemic success of the industry is likely dependent on the recovery of business travel and gas prices for hotels dependent on summer tourism. If virtual conferences and meetings become the new norm, the hotel industry could see itself having to pivot. Even a transition to a hybrid model, which is more likely to occur, could have significant implications for the industry. Banks should closely monitor these borrowers, as identifying early signs of credit deterioration could be essential to preserving the relationship.
The financial services industry is full of excitement right now. While the industry faces many challenges, these challenges also bring opportunity for banks to experiment and differentiate themselves. Bank customers arguably need the assistance of their bank more than ever as they navigate continued financial uncertainty. This need allows community banks to do what they do best: develop long-lasting relationships with customers and become a trusted advisor. If there is anything this pandemic has shown to the financial industry, it is that community banks are truly one of the leaders of their communities. As always, please don’t hesitate to reach out to BerryDunn’s Financial Services team if you have any questions.

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