Southern community banks perform well, despite lingering risks

Competition weighs on banks that picked up mortgage lending activity

Home values and housing activity picked up in various Southern communities, benefiting community banks in the region. But these trends are in large part due to the area's vibrant oil and gas industry and other positive economic indicators, the Office of the Comptroller of the Currency said in a Wednesday report.

In fact, when looking at other areas—such as mortgage lending—community banks in the nine key southern states continue to face lingering risks in the form of competition and rising interest rates.

The OCC released a report on these institutions, saying community banks need to define and implement strategies that will allow them to thrive in the face of lingering credit stress, low margins and competitive pressures.

In particular, OCC examiners are focused on the impact of rising interest rates as many banks extend loan and investment maturities in search of yield. The Wednesday update came from OCC comptrollers working specifically in the Southern District.

More importantly, Southern District OCC deputy comptrollers said the mortgage market recovered at a faster pace when compared to other business lines, leading to nontraditional risk for community banks.

For instance, some institutions brought on mortgage originators or created new divisions to handle mortgage banking as activity picked up in that sector.

However, with refinance activity now slowing, institutions that ramped up mortgage banking are facing more risks when compared to others that stuck to traditional lines of business, explained OCC Southern district deputy comptroller Gil Barker.

Consequently, community banks are now facing competitive issues given the environment is now a borrower's market.

"All institutions are trying to maintain loan relationships that have been with the banks for long periods of time, so the best borrowers hold the cards now and they are in a position to take their lending needs to different institutions," Barker said.

He continued, "Community bankers have to make tough decisions about underwriting standards to keep and retain customers, as well as draw in new business because there isn’t a lot of loan demand that exists right now."

The issue is that while credit risk is slowly declining, community bank earnings are under pressure as loan demand subsides along with investment alternatives.

"Good strategic planning and effective risk management processes are increasingly important in the current bank environment," Barker said.

He added, "Examination activities will assess the adequacy of the strategic plan or business model, with specific emphasis on managing risk associated with new products and services."

These factors have substantially increased community bank vulnerability as they seek to bolster income through new products, services, business line expansions and cost reductions — especially in control functions such as audit and compliance.

Nonetheless, it’s hard to overlook the fact that community banks continue to improve financially.

For instance, approximately 80% of southern district banks were in satisfactory condition at the end of the second quarter of 2013, with the number of banks considered in 'troubled condition' still on the decline.

As a result of loan defaults, earnings improved because of reduced expenses for loan loss provisions and real estate-owned properties.

Going forward, pressure on bank earnings will continue to increase because of low loan demand, excess liquidity and declining investment yield, the district comptrollers said.

"Most banks with asset quality issues are having success reducing problem assets which has resulted in a significant decrease in the number of problem banks and a reduction in enforcement actions in 2012 and 2013," Barker pointed out.

3d rendering of a row of luxury townhouses along a street

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