Fitch Completes Annual Large Community Bank Group Peer Review
Fitch revised ratings and Rating Outlook for CPF. All other ratings and outlooks were affirmed and maintained, respectively, for the remaining banks in the peer group. For a complete list of rating actions, please see the separate and related press releases published today for each bank listed above.
CPF's Long-Term Issuer Default Rating (IDR) and Viability Rating (VR) were upgraded to 'BBB-/bbb-' from 'BB+/bb+' and its Short-Term IDR was upgraded to 'F3' from 'B'. The Rating Outlook has been revised to Stable from Positive. The upgrade reflects CPF's revised risk appetite, its improved risk management framework, and asset quality metrics that are in line with investment grade rated peers. Fitch also anticipates that the company will achieve some additional improvement in core earnings, though earnings are likely to remain on the lower end of the peer group.
Fitch's Community Bank Peer Group is mostly defined by banks with less than $10 billion in assets that typically operate in a limited number of geographic markets and product segments. In general, these banks are conservative, traditional on balance-sheet lenders for local communities.
Community banks typically lag larger peer groups in diversification, both on a product/revenue and geographic basis. As such, community banks are generally more susceptible to idiosyncratic risks such as a regional economic shock or the default of a large borrower. The majority of banks within this group have branch networks which reside in contiguously located counties and are typically in three or fewer states. Fitch believes these factors limit the group's ratings to 'BBB+' and below.
The institutions in Fitch's Community Bank Peer Group tend to have business models that are relatively more reliant on spread income from lending and investments. On average, non-interest income continues to represent less than 25% of total revenues within the community bank group while larger banks generate over 35% of revenue from non-interest income. Despite this challenge, earnings for the community bank peer group have generally been good, with an average return on assets (ROA) of nearly 1% in the first quarter of 2016 (1Q16), similar to the average ROA for the large regional banks peer group. Earnings have benefitted from low loan loss provisions, as asset quality has continued to improve for the group. Going forward, Fitch expects a modest increase in provisioning as asset quality reverts to longer term historical averages.
Growth is an important aspect of Fitch's assessment of bank risk appetites under the Global Bank Rating Criteria. Loan growth above underlying economic growth can indicate a build-up of potential risks, loosened underwriting standards, or expansion into new products or markets. In Fitch's view, growth is currently a key constraint on the credit profiles of the broader large U. S. community banking sector (defined as banks with $3 billion to $10 billion of assets). Within this group, Fitch has observed median double-digit loan growth for several years, with particularly high growth in the construction, multi-family, non-owner occupied commercial real estate, and auto lending categories.
Additionally, Fitch remains concerned about the smaller banks' exposure to commercial and industrial (C&I) lending. This generally represents a relatively new asset class and some institutions may not have the requisite back-office infrastructure or experience to adequately identify, monitor and mitigate any ensuing credit risk. C&I has been a significant area of growth for the community bank peer group, with average C&I loan balances growing by 8.7% in 2015 and 9.8% in the first half of 2016. While Fitch generally views loan portfolio diversification (by both asset class and geography) a positive for banks, growth C&I lending is viewed with caution, especially given current interest rate levels and the amount of competition surrounding this lending space.
Fitch continues to anticipate a higher level merger and acquisition (M&A) activity in the broader community banking sector (assets under $10 billion) than at larger institutions, driven by several key factors. For smaller community banks (assets under $1 billion), a combination of fatigue from regulatory measures and stagnant returns may lead banks to combine with in-market peers. For larger community banks that are approaching $10 billion in assets, Fitch believes deal activity will be driven by the desire to offset the additional regulatory requirements associated with crossing $10 billion with additional scale. Following FMBI's acquisition of Standard Bancshares, it has now crossed the $10 billion asset mark, with CVBF and CBU the next most likely in the community bank peer group to cross.
Fitch generally believes that the community bank group is reasonably well capitalized relative to its range of ratings. However, Fitch will continue to monitor and potentially take action on banks that manage capital at more aggressive levels, particularly if this comes in response to above average loan growth.
The community bank group's funding profile is considered a rating strength due these banks' strong levels of core deposits which are stable and sticky. Although community banks are not typically price leaders for either loans or deposits, most hold good market positions in their respective footprints. Nonetheless, Fitch believes that the groups' market share positions could be challenged should loan demand pick and competition for deposits intensifies, particularly under a rising rate scenario and with larger banks needing to comply with the liquidity coverage ratio (LCR) which makes retail deposits all the more attractive.