- Community banks, which represent 90% of all commercial banks in the U.S., have shown robust asset quality and profitability, despite significant exposure to CRE loans.
- In 2Q24, 93% of community banks were profitable, with an increase in net income despite higher loan loss provisions.
- Potential concerns remain regarding unrealized losses on securities, but community banks appear to be managing these challenges better than anticipated.
As reported by GlobeSt, federal regulators have been closely monitoring the banking system, and are particularly concerned about banks overexposed to commercial real estate loans.
Despite this scrutiny, community banks have shown resilience. According to a recent Morningstar report, they’re faring better than expected, even as the sector navigates lending-related challenges.
The Bigger Picture
Community banks, with assets up to about $2.2B, are a critical segment of the banking system. They represent more than 4.1K institutions—approximately 90% of all commercial banks in the United States—and hold 15% of all loans.
In other words, the financial health of community banks is critical not only for the banking system but also for the communities and small businesses they serve.
In 2Q24, community banks recorded a 0.95% return on assets and a 9.60% return on equity, with 93% reporting profits. These numbers have improved significantly compared to pre-pandemic levels, with net income rising from 1Q24.
Morningstar attributed this increase to “positive operating leverage,” meaning that income from interest and non-interest sources outpaced expenses.
By The Numbers
Community banks have a considerable portion of their loan portfolios in CRE, including multifamily residential (7.52%), nonfarm nonresidential (30.54%), and construction and development loans (8.21%).
These segments make up approximately 46.3% of the banks’ loan mix. Given the economic environment—with rising interest rates and inflation—this high exposure has drawn concern from regulators and investors alike. However, the performance of these loans has been unexpectedly strong.
Morningstar noted that the CRE loans have held up better than expected despite higher interest rates and inflation pressures. Factors contributing to this resilience include a deep understanding of local markets, close relationships with clients, and a willingness to work with borrowers facing difficulties.
Quality Metrics
Asset quality has remained a strong point for community banks. The percentage of loans 90 days or more past due was 0.61% in 2Q24, still lower than the pre-pandemic average of 0.96% seen between 2015 and 2019.
Additionally, the net charge-off ratio—a key indicator of loans that banks have written off as a loss—was at a low 0.14%, only slightly higher than the previous quarter.
Unrealized Losses
Despite positive trends in profitability and asset quality, one area of concern remains: unrealized losses on securities. During the period when interest rates were near zero, many banks invested heavily in Treasuries and mortgage-backed securities.
As the Federal Reserve aggressively raised rates to combat inflation, the value of these securities plummeted, leading to unrealized losses. About 97% of community banks reported such losses.
However, the extent of these losses has shrunk, dropping by 1.4% from 1Q24 and by 12.3% compared to 2Q23. Many banks classified these securities as “hold-to-maturity,” allowing them to avoid marking the bonds to their current market value, thereby stabilizing their balance sheets.
Coming Up Next
Despite the headwinds, community banks continue to show resilience and adaptability. Their ability to maintain asset quality and generate profit, even under the pressure of significant CRE exposure and potential securities losses, demonstrates their pivotal role in the U.S. financial landscape.
However, challenges remain, particularly regarding the potential risks from interest rate changes and the lingering impact of unrealized losses.
