Second quarter performance for the banking industry was similar to 1Q in a variety of ways. However, 2Q is significant as it also marks a plateau. Gains in asset sales and loan loss provisions were offset by asset write downs and margin compression. Today, we take a look at how the industry is doing, with emphasis on the $10B bank and smaller, in order to highlight several trends that may help your community bank in strategic planning.
Starting with our favorite, ROE, the industry produced about a 7.50% return (down slightly from the 7.73% in 1Q). For a couple of years leading up to 4Q 2010, size and performance were inversely correlated to return. However, like 1Q, in 2Q size and ROE performance were positively correlated, as the $100mm community bank averaged about a 4.53% ROE, while the $10B group produced an 8.71%. This positive correlation for 2Q holds true for virtually every asset band within the industry.
NIM was not a large driver of earnings, as it was flat at approximately 3.58% for 2Q compared to 3.61% in the 1Q. Here, most asset classes were around the average, with the exception of the $3B to $5B bank that outperformed the rest of the industry. This asset class has consistently had a higher NIM, as it is also the asset segment with the lowest percentage of residential mortgage loans in its portfolio. Yields on earning assets were stable at 4.32% for the industry and most asset classes were plus or minus 5bp around their 1Q average. Of note, while loan credit spreads continued to compress in 2Q (by approximately 12bp), banks in almost all asset bands increased their longer term fixed rate holdings of loans, thereby taking on more interest rate risk. This longer asset duration is derived from not only the addition of longer fixed rate loans, but also the lower forward curve has extended the duration of loan floors significantly. On the other side of the equation, bank cost of funds were stable, as the industry came in at 74bp, with almost all asset bands finally breaking the 1% mark (the exception were banks in the $100mm to $500mm band that averaged 1.07%). While funds flowed into core and short-term CDs (shortening duration), banks tried to increase the composition in longer term CDs (no doubt in an attempt to offset some asset duration), but added liability duration at only about 40% of the increase in asset duration. While call report data is certainly rough, banks appear to be more asset sensitive, as asset duration grew, while liability duration shrank.
The biggest story in earnings was the continued decrease in non-current loans to total loans. Here, the industry decreased from 4.81% in 1Q to 4.37% in 2Q. This improvement allowed for a reduction of ALLL from 2.97% to 2.80%. Earnings improved, boosting capital and better loan performance dropped the Texas Ratio from 37.0% to 33.5% for the industry.
Elsewhere, non-interest income was stable at about 31% of total revenue. It is interesting to note that the $1B to $3B bank continued to outperform on a relative basis for two reasons. One is size, where many banks started adding investments or insurance subs that contribute a relatively larger portion of earnings. The second is also the point of inflection where fee deposit pricing becomes more sophisticated compared to their smaller brethren, so service fees from deposits had a relatively larger impact. In terms of expenses, salaries, employees and premises costs remained stable and efficiency ratios at banks averaged 62%, up from 61%. Finally, while gains on asset sales composed about 15bp of earnings in 2010, that number is down to 6bp for 2Q.
In summary, the industry continued to return to normal and we believe reached a point of equilibrium. Earnings gains going forward will have to come from better management of profitable customers, as composition changes, asset gains and NIM improvements will be very hard to come by.