LakeHouse Review December 2023

At LakeHouse, we diligently track key metric trends following each quarterly release. Our analysis focuses on Community Banks with asset sizes ranging from $100 million to $5 billion, categorized by ownership type (Mutual, Stock, and SubS Banks). A summary of the metrics we examine is provided in Appendix A.

This article will specifically concentrate on the trends of three Profitability metrics (Return on Average Assets, Net Interest Margin,and Net Overhead) in our Community Banks Benchmark group. We will then provide a case sample on how banks can contextualize their results within the Community Banks Benchmark peer group and a Local peer group. By illustrating ways to put your metrics in context, this article will assist you in evaluating your 2023 results.

Profitability Overview

In 2023, industry trends saw both quarterly Return on Average Assets (ROAA) and Net Interest Margin decline compared to their values in December 2022 and December 2018. The drop in ROAA can be primarily attributed to the decrease in Net Interest Margin, which was influenced by the sharp increase in interest rates during 2022 and 2023.

Meanwhile, Net Overhead remained stable compared to its 2022 value. An encouraging trend across all peer groups is the improvement in net overhead from 2018 to 2023. This suggests that community banks are effectively working to control their non-interest expenses.

Review of a Sample Bank: LakeHouse Bank

While your bank's specific outcomes are crucial, they might not provide a complete picture. Understanding how your bank compares to your peers is equally essential, revealing your strengths and weaknesses relative to the industry average. In this case, our focus is on how well the sample bank, LakeHouse Bank (LHB), navigated the rising interest rates from 2022 to 2023.

LHB is a publicly traded institution with assets ranging between $4 and $5 billion. In 2023, LHB's quarterly ROAA decreased from 1.17% in 2022 to 0.94% in 2023, resulting in a 23 basis point (bp) drop in ROAA, a 19.66% year-over-year (YOY) decrease.

Upon initial examination, there are two main concerns about LHB’s performance:

1. A significant YOY decrease in ROAA, nearly 20%.
2. The ROAA has fallen below 1%, which is the minimum recommended value for a healthy bank.

However, as depicted below, LHB’s Benchmark peer group (Stock banks with assets between $100 million and $5 billion) experienced a larger decrease in ROAA, resulting in a December 2023 ROAA of 0.84%. LHB's ROAA is actually higher than the average ROAA of their Benchmark peer group.

Therefore, when compared to the other banks in the peer group, LHB's relative position in ROAA remains in the top 42% of all banks in the peer group.

An analysis of LHB's quarterly Net Interest Margin paints a less optimistic picture. In 2023, LHB saw a decline in their quarterly Net Interest Margin, dropping from 3.63% in December 2022 to 3.06% in December 2023. This represents a 57 bp decrease or a YOY decrease of 15.66%. LHB's decrease in Net Interest Margin is nearly double that of their Benchmark peer group, which decreased from 3.71% in December 2022 to 3.42% in December 2023, reflecting a 0.29 bp or 7.82% YOY decrease.

Consequently, LHB’s relative position within their peer group, in terms of Net Interest Margin, slipped from the top 43% of all banks in 2022 to the bottom 34%.

To find out why LHB underperformed their peers in maintaining net interest margin, we must take a close look at LHB’s Cost of Funds (COF). As seen below, LHB’s COF is much higher than the Benchmark peer group:

Deposit costs significantly contribute to the overall COF. These costs are influenced by local market conditions. Regions having many operating banks often requiring higher interest rates compared to areas with less competition. Therefore, creating a peer group consisting of LHB's local competitors can offer a more accurate evaluation of their performance in this context. If market conditions necessitate higher deposit interest rates, all banks in this group would feel the impact. Indeed, the average deposit costs of LHB’s Local peer group (2.14%) are 23 bps or 9.2% higher than the Benchmark peer group (1.91%). However, LHB's cost of deposits (2.30%) surpasses even that of their Local peer group.

By examining LHB’s Local peer group, we noted that in 2023, LHB witnessed a near 10% decrease in transaction account balances, whereas the Local peer group experienced a 4% increase. The precise cause of the decline in LHB's transaction accounts is unclear, but one potential factor might be that LHB's competitors offered notably higher interest rates for transaction accounts (1.87%) compared to LHB's rate (0.65%), representing a difference of 122 bps.

LHB replaced their lost transaction account balances with more costly Time Deposits. It appears the LHB deposit pricing strategy needs to be adjusted.  See below for a summary of balance trends by category.

So how did LHP maintain an above average Return on Average Assets when compared to their Benchmark peer group? They did this by effectively managing their Net Overhead, defined as the difference between noninterest expense and noninterest income. LHB was able to reduce their net overhead by 4%, while banks in their Benchmark peer group observed an increase (albeit slight) of 1% in net overhead in 2023.

Contrasting LHB against both their Benchmark Community Bank group and Local Bank group unveils critical insights into LHB’s strengths and weaknesses, which might otherwise evade detection. Through this comparison, we discovered that while LHB excels in managing overhead and operational expenses, their deposit pricing strategy falls short, revealing a significant weakness in their approach. Deposit pricing and mix will also have an impact on the LHB’s ALM model results- which likely deteriorated showing a higher level of interest expense and a lower economic value premium from deposits.

This begs the question, which underlying trends are to be found with your bank’s data? Sign up today to put your metrics in context and get the full picture of your data.

Appendix A:

Profitability

• Return On Assets

• Net Interest Margin

  • Yield on Earning Assets

• Cost of Funds

  • Net Overhead

Productivity

• Loans/Employee

• Assets/Employee

• Non Brokered Deposits/Employee

• Revenue/Employee

• Salary and Benefits/Employee

• Efficiency Ratio

Funding

• Non Brokered Deposits/Total Deposits

• Funding Methods

  • Deposits

    • Brokered

  • Non Brokered Borrowings for Assets

    • Fed Funds Purchased

    • Other Borrowings

Asset Quality

• Nonperforming Loans

• Non Current

• Net Charge off

• Texas Ratio