Community banks in the Midwestern states continue to benefit from efforts to strengthen bank capitalization levels and overall profitability.

These outcomes are tied to an overall stabilization trend in the region as the number of problem institutions continues to fall, the Office of the Comptroller of the Currency said in a Tuesday report.

Fewer delinquencies, lower loan losses and improved capital levels have helped more Midwest institutions avoid the so-called ‘problem' label, which requires heightened supervision.

"The trends reflect continued improvement, and we expect further reductions in the number of problem banks," said OCC District Deputy Comptroller Bert Otto.  

He added, "As a result of this progress, more of our banks are looking to increase lending activity in their communities. Many have been able to achieve growth in commercial loans as we’ve seen volume pick up there in recent quarters."

Nonetheless, the volume of other real estate-owned properties — residential and commercial real estate properties owned by the bank as a result of foreclosure — is stable, but remains high with more than 80% of the district’s banks and thrifts reporting OREO balances, the OCC said.

One concerning issue is the fact that rapidly growing bank portfolios are straining capital and risk-management system support.

Return on assets for most banks was flat year-over-year, with continued net interest margin compression largely offset by lower provisions for loan-loss expenses.

Nonetheless, the number of troubled banks in the district fell to 84 in June, down from 106 in 2012, and also down from 142 in 2011, according to the OCC.

Meanwhile, the volatile interest-rate environment has impacted community banks’ profitability.

By and large, central district institutions have shied away from having prolonged periods on their balance sheets, but as interest rates spiral down, the temptation is growing for these entitles to dive back into this area to boost profitability margins, said OCC Risk Committee Chairman and District Risk Officer John Meade.

Commercial real estate values are continuing to slowly improve. Additionally, CRE fundamentals remain mixed across the district in terms of vacancy rates and income levels.

For instance, Chicago and Indianapolis markets reflect more favorable performances, while properties in the Cleveland and Detroit markets continue to lag.

"Our examiners will closely monitor credit risk selection and underwriting at upcoming exams, particularly in those banks growing their commercial loans rapidly, to ensure standards aren’t being inappropriately compromised," Meade said.

While credit risk management remains a concern, the OCC is seeing more banks emerge from credit challenges. Their solution for this is focusing on acquisitions, market expansion, products and customer outreach.