If one bad apple can spoil a bunch, can a single bad loan ruin a portfolio? For many CEOs at the nation's most successful larger community banks, the answer is yes, which explains why they're watching credit quality at least as closely as return on average equity, efficiency ratio and other key profitability indicators.
The $3.1 billion-asset Gulf Coast Bank & Trust in New Orleans ranked No. 14 on American Banker's annual list of the top-performing midsize banks — those with $2 billion to $10 billion of assets — after ranking No. 15 in 2022. Gulf Coast produced a 19.32% three-year return on average equity, according to data from Capital Performance Group. That is just shy of the 20% ROAE target the bank shoots for, according to CEO Guy Williams. (See
For Williams, though, the starting point is a clean loan book.
"Banking is a low-margin business," Williams said. "We can't afford to charge off loans, so credit quality is vitally important."
Fortunately for Williams, Gulf Coast has managed to keep its charge-offs largely buttoned down. Credit losses totaled 0.33% of the bank's loans leases for the quarter ending March 31 and 0.13% for all of 2022, according to the Federal Deposit Insurance Corp.
The same pattern played out for virtually all of the other top 20 midsize banks. (The annual ranking is based on a three-year average ROAE calculated by the consulting firm Capital Performance Group, which used year-end 2022.)
The $2.2 billion-asset Capital Bancorp in Rockville, Maryland ranked No. 5 in 2023, a jump from the No. 10 spot it occupied in 2022. Capital's three-year ROAE totaled 23%. Net charge-offs for 2022 totaled 0.34%. Year-end nonperforming loans totaled 0.45% of total assets.
Still, CEO Ed Barry said he remains mindful that a handful of problem credits could result in a 180-degree change in Capital's performance.
"When you look at the amount of leverage banks deploy…It doesn't take too much on the bad-credit side to really wipe out your earnings, and turn really great results into horrible results," Barry said.
"It's of tantamount importance how you manage your asset quality," Barry added.
Of the top 20 midsize banks, 17 reported nonperforming loans below 1% of total assets. Most came in well below the 1% threshold, including several that reported truely de minimis numbers. The $3.6 billion-asset West Bancorporation in Des Moines, Iowa, the No. 18 bank, reported a 0.01% ratio of nonperforming loans to total assets at Dec. 31, 2022. The No. 11 bank, the $2.4 billion-asset Horizon Bank in Austin, Texas, reported zero nonperforming loans altogether.
The median 2022 ROAE for the top 20 midsize banks was 20.2%, down from the 2021 median of 20.7%. That modest decline is "notable," given that it came against a challenging backdrop of rising rates and tougher competition for deposits, Claude Hanley, a partner at Capital Performance Group in Washington, D.C., wrote in an email to American Banker.
Asset quality among these larger community banks has been excellent generally, Hanley wrote. Indeed, the median nonperforming assets to total assets for all the banks in this asset size came in at 0.32%. That's a bit lower than the 0.38% figure for the top 20 banks on the list.
For instance, at the $4.2 billion-asset Hingham Institution for Savings, which fell from the No. 14 ranking in 2022 to No. 29 this year, nonperforming loans amounted to five basis points of total assets at the end of 2022. Hingham "is good at keeping operating costs low and making a lot of safe loans at moderate yields," prominent independent bank analyst and investor Ian Bezak wrote in a recent research note.
For Barry, knowing customers rests at the foundation of Capital Bancorp's pristine credit and its top-tier profitability. "You can't replace a really good, granular understanding of the business or the real estate project or what this consumer is trying to do," Barry said. "I think we do a good job of not trying to fool ourselves and really go deeper than the numbers to get to a better understanding of what we can do."
"We study customers constantly," Williams said.
According to Hanley, the combination of deteriorating asset quality along with decreasing liquidity will make 2023 challenging for midsize banks. Barry acknowledged that many banks are tightening credit standards and "starting to pull back," but he added that there are still opportunities for growth.
"Whether they're seeing problems or they're facing capital issues, liquidity issues or there are just broader concerns, [banks] are kind of making wide-swath decisions that are affecting both their good customers and their bad customers. We're seeing an opportunity to grow smart."