Performance Gap | By Jarius DeWalt
There has been a lot written regarding the “tale of two cities” performance division between community banks and mega bank/regional powerhouses.
Although we agree that the market power of these players overhangs the competitive environment for community banks, we find a more fundamental “best of times, worse of times” dichotomy facing community banking firms – a wide gap in the performance from the highest 10 percent to the lowest 10 percent on a number of key driving forces, as well as the recognition that a number of areas that once were great strengths are becoming areas of potential weakness and increasing risk as a result of the changing economic environment, competitive landscape and regulatory climate.
The Federal Reserve’s objective of returning to “normalized” long-term rates and the concurrent transition to Basel III and Dodd-Frank regulatory rules over the next few years are coupled with “shadow” banks and other non-banking entities moving more aggressively into the retail market for both funding sources and borrowing customers.
In preparing for a presentation to the Independent Bankers Association of New York State (IBANYS) western regional meeting using Ratio-based Strategic Risk Indexing (RSRI), Paradigm reviewed the wide spectrum of performance across a number of driving factors for the first half of 2013 on both national and New York state levels for community banks with total assets of $5 billion or less. We noted a number of strategies where community banks have shown great strengths during the period since 2008, which are now exhibiting warning signs of growing potential for adverse regulatory actions for a number of firms, given elevated safety and soundness concerns.
Risk is the primary focus of regulators, but senior management and board of directors of community banks must balance risk and opportunities. Banking has never been and is not now a risk-free endeavor, but risks can be managed and mitigated. This review using RSRI tools provides an overview of the performance gaps between the highest performance and lowest performers, nationally and for New York state, on return on average equity (ROAE) as the measure of successful implementation of strategies for community banking entities.
Return on equity is the ultimate measure of the return to the providers of risk capital for your institution. The wide spread on ROAE from the average for the highest 10 percent to the average for the lowest 10 percent illustrates the divergence in performance during the first half of 2013. The spread averaged 3659bps for the quarter ending March and 3876bps for the quarter ending June, averaging 3768bps for the first half of 2013 for the national universe of community banks. The spread was less wide for New York state banks, with a March spread of 2368bps and a June spread of 2377bps, resulting in a first half average spread of 2373bps. The ROAE for the highest 10 percent nationally averaged 22.85 percent for the first half of 2013, while the average for the lowest 10 percent was a negative 14.83 percent. New York state banks had a first half average for the highest 10 percent of 16.98 percent, while the lowest 10 percent averaged a negative 6.75 percent. The average for the 134 New York State banks for the first half of 2013 was 5.85 percent, while the national average was 6.82 percent. In both cases, the ROAE for the average community bank was significantly below the 10 percent threshold typically anticipated as a minimum return for investing in a banking enterprise.■
Jarius DeWalt is chief strategist at Paradigm Asset Management Company. He may be reached at firstname.lastname@example.org.