The first full quarter of COVID-19 brought ballooning deposits and compressed net interest margins for most U.S. community banks.
Deposit growth surged year over year for most community banks, partly due to various government stimulus programs. But the Federal Reserve slashing interest rates and participation in the Small Business Administration's Paycheck Protection Program weighed on net interest margins for many smaller lenders. While PPP loans boosted year-over-year loan growth for the quarter ended June 30, banks are being more conservative with underwriting practices due to the economic uncertainty.
"Deposit growth was really big and because of that, it ballooned balance sheets. That has good things and bad things associated with it," Christopher Marinac, an analyst for Janney Montgomery Scott LLC, said in an interview. "There's a lot of excess cash and that has a depressing impact on NIM but the sheer dollars being larger creates more net interest income."
About 72% of community banks — for this analysis, that group includes institutions with less than $10 billion in assets — reported improved year-over-year deposit growth in the second quarter. Deposit growth contributed to the higher-than-expected pretax, preprovision earnings for some banks, according to Marinac.
"Clearly, customers are more comfortable carrying more liquidity, given the unknown facts that face our economy," Veritex Holdings Inc. CFO Terry Earley said on the Dallas-based community bank's second-quarter earnings call.
Some community lenders are looking to improve efficiencies to offset NIM compression, like Indiana, Pa.-based S&T Bancorp, Inc., which reported an efficiency ratio of 49.80% for the second quarter.
"We know we're going to have margin pressure next year so we're continuing to look for ways to kind of squeeze expense out of the organization and manage to that low 50 number," CEO Todd Brice said on the company's second-quarter earnings call.
In the analysis, 65.4% of community banks reported an improved efficiency ratio year over year during the second quarter. The median efficiency ratio for community banks was 57.87%.
"Most companies need the earnings. They're trying to defend dividends and capital ratios and build capital, and expenses are a lever they can pull," Marinac said.
Banks' efforts to control expenses went better than expected, according to Brett Rabatin, head of bank strategy for The Travillian Group.
"Banks are starting to adopt better expense control before the real work of shattering the old mode of branch networks really begins in earnest," he said in an interview.
Loan growth improved for 66.4% of community banks year over year for the second quarter. For some, PPP loans contributed to the increase, such as Bethesda, Md.-based Eagle Bancorp Inc., which reported that about 90% of its loan growth was due to PPP loans.
Excluding PPP loans, banks are being more cautious with underwriting given the economic environment. At Stuart, Fla.-based Seacoast Banking Corporation of Florida, the commercial pipeline was down by about 32% for the quarter due to its more conservative approach, CFO Tracey Dexter said on the company's second-quarter earnings call.
"Looking forward, we expect loan outstandings to continue to be carefully managed lower in line with lower production expectations due to our conservative posture and declining PPP balances as the forgiveness process begins in the third quarter," she said.
Normal loan growth levels are unlikely to return soon, according to Jeffrey Rulis, managing director and senior research analyst at D.A. Davidson.
"It's pretty flat to down organically outside of PPP balances," he said in an interview. "It's going to take a while before a normal loan demand returns so that will be a headwind for the industry to try to put that liquidity to work."
