Executives can glean actionable insights from understanding the benchmarks and trends within key performance indicators, or KPI. Here were some of the highlights from 2020 to help you understand trends and benchmark your organization.
Inhibited Earnings Capacity
The coronavirus pandemic, and the resulting changes in fiscal policy and economic behavior have measurably inhibited earnings capacity for most community banks. Bank balance sheets have grown principally due to government stimulus payments, limited capital investment by small and mid-sized businesses and a general flight to quality by consumers.
The fourth quarter of 2020 recorded continued strong capital levels — along with challenges in earnings growth due to historically low net interest margins. Expectations that the pandemic will persist well into 2021, assurances of continued government assistance and the continuation of low interest rates into the foreseeable future mean that change is unlikely in the coming months.
Return on Average Equity
Community bank profitability of 8.90%, in relation to average equity, was relatively stable when compared to the previous three quarters of 2020, as well as the fourth quarter of 2019. For most community banks, continued low interest rates, excess liquidity and limited loan demand all restricted profitability. In addition, cost reduction opportunities arising from technology investments and staff reductions appear to have stabilized. Loan loss provisions continued to be relatively low; credit quality remained favorable, in part due to the benefits of government stimulus.
Non-interest Income to Net Income
Non-interest income grew to 13.17% of total income during the fourth quarter of 2020, compared to an average of 11.60% for the trailing four quarters. This reflects the combination of continued downward pressure on net interest margin, which remained constant at 3.35%, and efforts to expand fee-based income, such as higher fee levels on deposit accounts. Given the Federal Reserve’s intention to keep interest rates low for the foreseeable future and the likelihood of tempered loan demand, this trend should continue throughout 2021.
Credit, Credit Quality
Credit demand for community banks continued to decline through the fourth quarter. Keeping in mind that that the second round of the Paycheck Protection Program (PPP2) didn’t launch until January 2021, the community bank space saw loan to deposit ratios decline to 74.15% at the end of 2020. This compares to 82.09% at the end of 2019, and an average of 79.4% for full-year 2020. The decline is somewhat muted by the first round of PPP (PPP1) loans issued by community banks, although the majority of PPP1 loans were issued by large banks.
Credit quality remains favorable, due to the benefits of government stimulus and limited loan demand. Nonperforming loans totaled just 0.53% of loans. Average loan loss allowance levels held steady at 1.30% of total loans at the end of 2020. In some instances, banks recaptured provisions for loan losses recognized during the first half of 2020. We anticipate a more-normalized loan loss provision curve in 2021, subject to the duration of the pandemic, the effectiveness of government stimulus and fiscal policy.
Cost management continues to be a challenge. Notably, the benefits of technology investments have either been fully realized or limited due to the absence of loan demand. The operating inefficiency of branches in an increasingly virtual environment drove the largest increase in the industry’s efficiency ratio, from an average of 63.35% for the previous two quarters to 66.82% in the forth quarter of 2020. As community banks continue assessing the shift to digital banking and the emergence of nonbank alternatives, we expect more changes to branch networks and technology investments as a way to increase operating efficiency.
Merger and acquisition (M&A) insights
Certainly, 2020 represented the quietest year in recent history as to the number and size of community bank acquisitions. For the most part, both buyers and sellers paused to assess the strategic and economic value of deals, as well as to focus on the uncertainties and operational demands arising from the pandemic and the political and regulatory landscape.
We believe 2021 will represent the restart of the rapid consolidation of the community bank sector based on recent elections, the promise of an economic recovery fueled by continued government stimulus and a successful distribution of vaccines. We believe more appealing pricing dynamics for both buyers and sellers will emerge as the economy stabilizes and small and mid-sized businesses reopen. Lastly, the evolution of fintechs and the broader acceptance of these solutions by consumers, businesses and regulators will likely motivate community bankers to engage in targeted and strategic transactions.
Download the full KPI report
Understanding how your bank measures up within the industry is critical to achieving long-term success. Download Baker Tilly’s most recent banking industry benchmarking report to give you meaning behind the numbers.