Community banks across US regions posted generally lower year-over-year returns, worse efficiency ratios and slower deposit growth rates in the second quarter.

Banks faced a liquidity crunch during the quarter amid rising Federal Reserve interest rates to quell inflation, worsened by a series of high-profile bank failures early in the year. As a result, community banks with less than $10 billion in assets posted weaker median results on a year-over-year basis in most operating metrics, according to S&P Global Market Intelligence data.

The numbers were based on the community banks' reported earnings as of July 28.

Trends by region

Returns on average assets were generally worse for community banks in all five regions covered in the analysis for the second quarter, and so were efficiency ratios and year-over-year deposit growth rates.

Community banks in the South Central region posted negative 2.1% growth during the quarter.

Only community banks in the Southeast region showed an improved year-over-year median net interest margin, while the rest posted declines in the metric.

For year-over-year loan growth, community banks in the Midwest, South Central and the West booked lower median rates, while those in the Northeast and Southeast logged median rates better than a year ago.

Net charge-offs as a percentage of average loans were likewise worse for those in the Northeast, South Central and Southeast regions, while those in the Midwest and Western regions saw no change in their median rates from last year.

'Worse than dismal'

In its most recent community bankers' sentiment monitor, the Conference of State Bank Supervisors (CSBS) reported that the community bank sentiment index dropped to another record low in the second quarter.

"Community banker pessimism on the outlook for the US economy appears to have fallen into a dark abyss," CSBS chief economist Thomas Siems wrote in a blog post on the group's website. He described community bankers' general sentiment as "worse than dismal."

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Largest community banks

Newark, Ohio-based Park National Corp. topped the list of 20 largest community banks by total assets in the second quarter. However, its efficiency ratio deteriorated to 64.31% from 59.99% a year ago and from 63.33% at the end of 2022.

Seattle-based HomeStreet Inc., the parent company of HomeStreet Bank, recorded the highest efficiency ratio among the 20 largest community banks during the quarter, at 93.21%. The company posted a net loss of $1.67 per share in the second quarter from an EPS of 27 cents in the linked quarter and 94 cents in the year-ago quarter. The loss was mainly from a noncash goodwill impairment charge.

HomeStreet is now reportedly mulling a sale among possible options after losing about two-thirds of its market value this year.

Many community banks are in the same boat. Based on S&P Global Market Intelligence estimates, US community banks are likely to struggle to grow earnings over the next few years, prompting them to consider mergers to boost returns.

To stay afloat amid a challenging operating environment, many community banks opted to shift gears. Some have put more of a premium on earnings than on growth and probably will continue to over the next five years. Instead of aggressively aiming for growth, some community banks chose to focus on their best borrowers and on depositors that stick with them, market participants say.