Top-performing larger community banks succeeded at minding the gap

The nation's top-performing larger community banks — those with assets between $2 billion and $10 billion — proved yet again timing is everything. 

The top 20 larger community banks were much more positively gapped than their peers, a position that paid handsomely in 2023's rising rate environment, according to Emma Metzler, consultant and project manager at Capital Performance Group. Top 20 banks "benefited more from rising rates," Metzler wrote in an email to American Banker. "This was a large contributor to their higher yield on average earning assets."

For the record, the Federal Reserve hiked its benchmark federal funds rate 11 times between March 2022 and July 2023, including four times in 2023.

A positive gap means banks' rate-sensitive assets reprice more than rate-sensitive liabilities. "In essence what that's saying on a net basis, you had more of your earning assets repricing than your liabilities," Capital Performance Group Senior Partner Claude Hanley said. The Washington, D.C.-based Capital Performance Group, which compiled American Banker's annual ranking of larger community banks, measured the median one-year gap for top 20 institutions at 12.79%. The median one-year gap for all 361 banks in the asset class was substantially more modest at 3.04%. 

It proved to be a key differentiator. 

Top 20 banks produced higher yields on average earning equity, wider margins, more revenue growth and, ultimately, a meatier bottom line. Top 20 larger community banks produced a 5.93% median yield on average earning assets, compared to 4.92% for all banks in the asset class. The median return on average equity for top 20 banks was 19.49%, nearly double the 10.09% median for all banks in the $2 billion to $10 billion cohort.

Hanley said he was struck by the difference in net interest margin results for top 20 large community banks and the entire asset class. A whopping 126 basis points separated the two groups, with the median net interest margin for top-performers at 4.57%. 

"Top performers expanded their net interest margins. Last year when rates were going up so sharply, that was really difficult to do," Hanley said, adding that the top banks' gap was "one of the underlying factors that drove" the margin separation. "These top performers were positively gapped," Hanley said. 

Capital Performance Group built the rankings around a three-year return on average equity, or ROAE, calculation. By that measure, the median for the top 20 larger community banks was 20.63% compared to 11.51% for the entire category. 

In broad terms, 2023 results for all banks in the $2 billion to $10 billion asset class aligned with those of smaller publicly traded community banks with assets under $2 billion. Both groups experienced headwinds in the form of deposit outflows and slowing revenue growth. Among all banks in the $2 billion to $10 billion asset class, revenue actually declined slightly, by 0.30%. The decline in deposits among larger community banks was more pronounced. 

"Both the top 20 and all banks experienced a decline of at least 7.4% in their ratios of core to total deposits," Metzler noted. 

Among the first things to jump out about American Banker's ranking of banks with assets between $2 billion and $10 billion was the list's geography. A quarter of the top performers are headquartered in Texas. No surprise, perhaps, as the Lone Star State has outpaced the nation in growing jobs, population and economic output in recent years. 

A Texas bank, State Bank of Texas in Irving, ranked as the No. 1 larger community bank, posting a three-year ROAE of 26.22%. The company hasn't strayed from its unique business model, concentrating the lion's share of its lending on owners of smaller hotels around the country. "We're pretty much fully concentrated in the hospitality industry," Chief Lending Officer Rajan Patel said in an interview. 

"Our hotels are for the most part in the limited-service sector," Patel said. "We don't concentrate on full-service hotels. We just don't like the aspect of food and beverage." 

Owners of smaller, limited-service hotels are mostly hands-on, operating them as well, Patel added. "During COVID, they would be running the front desk to save money," Patel said. "They would be doing housekeeping. They would be doing the maintenance. Overall, that's a key to success for our entire portfolio."

Full-service properties, by contrast, are frequently operated by third-party management companies. "That's when revenues go down and expenses go up," Patel said. "There's no hands-on presence."

Its simple, straightforward strategy has unquestionably served State Bank of Texas well. It earned $31 million in the first quarter of 2024 after reporting net income totaling $113 million in 2023. Less than five years ago, assets totaled just over $850 million. Growth accelerated significantly during the COVID pandemic, with assets increasing 55% between 2019 and the end of 2021.

According to Patel, the family's deep, long experience with hotels has helped the bank navigate recent pandemic-related turbulence that buffeted the hospitality sector. Patel's family owns hotels, he said. "Our hoteliers, our borrowers, are owner-operators. As bankers, we're owner-operators." 

The No. 6 bank on the larger community bank list, the $9.2 billion-asset Woodforest National Bank, is another Texas institution, headquartered outside Houston in The Woodlands. But where State Bank of Texas runs a lean operation with seven branches, Woodforest has more than 770 locations spread across 17 states. The vast majority are in-store branches. 

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The model is inherently costly from an operating expense standpoint. Individual Woodforest branches, moreover, generally don't produce large deposit or loan numbers, said Achim Griesel, president of the consulting firm Haberfeld Associates in Lincoln, Nebraska. 

What they do is generate fee income from a steady stream of retail deposit customers. "If you want to look at profitability per branch, it would look super-low," Griesel said. Noninterest income is what drives the organization."

A Woodforest representative had not responded to a request for comment at deadline. 

While the in-store branching model is much less common than it was 20 years ago, Woodforest manages to make it work, Griesel said. In addition to generating $476 million in fee income in 2023, the most among larger community banks, Woodforest reported net income of $152.5 million. Profits for the first quarter of 2024 topped $41 million. Capital Performance Group credited Woodforest with a three-year return on average equity of 23.08%.