OREANDA-NEWS. Large US community banks will face strategic challenges through the medium term from a combination of an increased regulatory burden and normalizing credit costs, says Fitch Ratings.

Earnings pressures are likely to rise and persistent high lending growth could add to asset quality, capital, and liquidity risks down the line.

Fitch published a special report today that assesses the findings of the large community bank peer review we recently conducted. Regulatory challenges remain a key theme for the sector's outlook. This is especially the case for the larger community banks approaching USD10bn in assets, which face a substantial increase in their regulatory burden should they cross over the USD10bn threshold. Combined with a challenging earnings environment, increased compliance burdens have contributed to a rise in M&A activity in the sector, and Fitch believes that a high level of transactions will continue to occur.

The looming normalization of interest rates is another key issue for the sector. The prolonged low-rate environment has contributed to significant uncertainty. Assessing the impact on net interest income from rising rates is difficult owing to the challenge of predicting how depositors and borrowers will react given the current unusually long period of low rates.

High loan growth remains a key constraint on community banks' credit profiles, especially as it has occurred at a time of constrained economic growth, which could point to loosened underwriting standards or expansion into new markets. Ratings could come under pressure should strong lending growth result in asset quality, capital, or liquidity deterioration.

Community banks have increased their issuance of subordinated debt over the past year to support their total capital ratios, and Fitch believes that this trend should continue in the medium term. Continued high lending growth and acquisitions and the desire to increase regulatory legal lending limits will all contribute to further subordinated debt issuance by community banks.

Community banks continue to benefit from strong deposit franchises and reasonably strong capitalization levels relative to ratings and balance sheet risk. All of the banks in Fitch's peer group exceed regulatory well capitalized minimums, with an average common equity Tier 1 capital ratio of 12.9% at end-2Q16.