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Fitch Ratings has completed a peer review of five rated large community banks. The following banks were reviewed as part of the Community Banks Group: Central Pacific Financial Corp. (CPF), Community Bank System, Inc. (CBU), CVB Financial Corp. (CVBF), First Midwest Bancorp, Inc. (FMBI) and Independent Bank Corp. (INDB).
Fitch revised ratings and/or Outlooks for CPF and CBU. All other ratings and Outlooks were affirmed and maintained respectively for the remaining banks. A complete list of rating actions follows at the end of this release. Furthermore, please see the separate and related press releases put out today for each bank listed above.
CPF’s Long-Term Issuer Default Rating (L-T IDR) and Viability Rating (VR) were affirmed at ‘BB+/bb+’. Fitch also affirmed CPF’s Short-term IDR (S-T IDR) at ‘B’. The Rating Outlook was revised to Positive from Stable. The rating actions reflect continued significant asset quality improvement, strong reserves and the recent executed succession plan that should keep the company focused on its core competencies within its primary operating market of Hawaii.
CBU’s L-T IDR and VR were upgraded to ‘BBB+/bbb+’ from ‘BBB/bbb’. Fitch also affirmed CBU’s Short-term IDR (S-T IDR) at ‘F2’. The Rating Outlook remains Stable. The rating actions reflect CBU’s consistently strong operating performance over time that aligns with a higher rating. Fitch observes that the company has maintained and stayed true to profitable and conservative, long-term strategies evidenced by low volatility in earnings performance and asset quality. CBU has some of the strongest returns and asset quality in Fitch’s rated universe over multiple economic and rate cycles.
Fitch’s Community Bank Peer Group is mostly defined by banks with less than $10 billion in assets that typically operate in a limited number of markets and, in general, are conservative, traditional on balance-sheet lenders for local communities.
Community banks typically lag larger peer groups by geographic footprint and product/revenue diversification. As such, community banks are more susceptible to idiosyncratic risks such as geographic or single name concentrations. The majority of institutions within this group have retail branch networks which reside in contiguously located counties and are typically in just two to three states. Fitch believes these factors limit the group’s ratings to ‘BBB+’ and below.
Those institutions within Fitch’s community bank group generally have homogenous business strategies. The institutions are relatively more reliant on spread income from loans and investments. On average, non-interest income continues to represent less than 30% of total revenues within the community bank group while larger banks generate over 40% of revenue from non-interest income. With limited opportunity to improve fee-based income in the near term, Fitch expects that community banks will continue to face core earnings headwinds into 2016. Through the first half of 2015, the average community bank ROA within Fitch’s rated universe was 100bps up from 90bps last year but still lagging the average ROA for large regionals.
Fitch continues to believe that regulatory exhaustion and an inability to improve returns on equity have led many banks with assets under $1 billion to sell, particularly as transaction multiples have improved and the appetite for core deposits has increased in the current low rate environment. Fitch expects community bank deals to continue to outpace those deals of larger institutions.
However, Fitch also believes that there could be a marginal increase in deal activity involving larger banks (over $50 billion in assets) acquiring those that are nearing the $10 billion asset mark, such as the August 2015 acquisition announcement between BB&T Corp. and National Penn Bancshares.
Increased regulatory scrutiny — including more complex, costly stress testing and supervision by the Consumer Financial Protection Bureau – for banks that cross the $10 billion asset mark are forcing management teams and board directors to make strategic decisions about the economics of crossing the threshold. Banks also become subject to the Durbin Amendment when crossing over $10 billion in assets which limits debit interchange fees, potentially reducing fee income meaningfully.
These headwinds have been instrumental in shaping the strategies of many banks who are left with a couple of choices: either slow growth ahead of surpassing $10 billion in assets in order to find a buyer or make an acquisition themselves to move meaningfully beyond $10 billion which presents its own integration and strategic challenges. Fitch believes that few banks will make the decision to breach the threshold through measured, organic growth given the profitability challenges that would be the likely result. Within Fitch’s rated universe, FMBI, CBU and CVBF are the closest to crossing over $10 billion.
Fitch observes that asset quality continues to improve within the community banks group albeit at a much slower pace than in recent years. Fitch anticipates further asset quality improvement to be nominal as nonperforming loan (NPL) reductions level off and credit begins to normalize across the industry.
Fitch remains concerned about the smaller banks’ exposure to C&I lending, as this generally represents a relatively new asset class and some institutions may not have the requisite back-office infrastructure or experience to adequately identify, monitor and mitigate any ensuing credit risk.
Fitch observes that community banks have historically focused on real estate lending which has a more favourable credit loss history compared to C&I over the long-term. Fitch observes that the long-term NCO rate for C&I lending is between 90 and 100 bps based on FDIC data. This compares unfavourably to almost all real estate lending classes outside of construction and development. However, those community banks that were hit hard by being overly concentrated in commercial real estate have felt the need to diversify loan portfolios. While Fitch generally views loan portfolio diversification (by both asset class and geography) a positive for banks, growth C&I lending is viewed with caution, especially given current interest rate levels and the amount of competition surrounding this lending space.
Fitch generally believes that the community bank group is reasonably capitalized relative to its range of ratings. However, Fitch will continue to monitor and potentially take action on banks that manage capital at more aggressive levels in light of relatively weak earnings profiles and above average loan growth.
The community bank group’s funding profile is considered a rating strength providing a stable source of liquidity as core deposits are stable and sticky. Moreover, Fitch recognizes these banks’ ability to borrow from the Federal Home Loan Banks and the Federal Reserve Discount Window as funding advantages relative to nonbank financial institutions. Although community banks are not typically price leaders for either loans or deposits, most hold good market positions in their respective footprints. Nonetheless, Fitch believes that the groups’ market share positions could be challenged should loan demand pick and competition for deposits intensifies, particularly under a rising rate scenario and with larger banks needing to comply with the liquidity coverage ratio (LCR).
For further information regarding Fitch’s Large Community Bank peer group, please see the special report published today titled ‘U.S. Banks: Periodic Large Community Bank Peer Review (Strategic Risks Elevated as Asset Size Threshold Nears)’ by clicking on the link below.
Additional information is available on www.fitchratings.com.
U.S. Banks: Periodic Large Community Bank Peer Review (Strategic Risks Elevated as Asset Size Threshold Nears)