Updated Thursday, September 3, 2015 as of 3:13 PM ET

Think 2012 Was Tough for Small Banks? Wait for 2013

If you thought 2012 was a roller coaster ride for community banks, brace yourselves for next year.

Small banks are likely to find little relief in 2013, particularly when it comes to revenue. Indeed, credit quality is improving, but net interest margins are expected to keep shrinking and more regulation is all but guaranteed as Dodd-Frank implementation continues. And the industry seems less than thrilled about the results of the recent elections.

American Banker recently reached out to three banking experts, Jeff Adams at Monroe Securities, Richard Lashley at PL Capital and Joshua Siegel at StoneCastle Partners, to get their views of community banking in the year ahead. The following is an excerpt of their responses.

How would you assess the environment for community banks over the next 12-18 months?

JEFF ADAMS: Community banks continue to recover on the asset quality front, but it remains a slow recovery. As the challenges with problem loans recede, community banks will look for solid loan growth opportunities, but find demand still tepid. Over the past few years, we've seen more evidence of the regionals emphasizing lending to smaller business clients on much better terms than community banks, providing an additional headwind for community banks looking to go on the offensive. 

Margin pressure will continue to weigh on the industry, squeezing spread income. Unlike the larger banks, community banks have little fee income to offset the loss of spread revenue, which will result in a more pronounced impact on earnings.

RICHARD LASHLEY: For most banks, credit issues have been dealt with or will be manageable without requiring capital raises or destroying profitability. The biggest challenge is mitigating net interest margin compression without taking on excessive interest rate risk.

There is also the related issue of growing loans and revenue while dealing with a near-recessionary economy and the most oppressive regulatory and political environment in 25 years. The industry as a whole is earning about two-thirds of the [return on equity] they earned pre-crisis.  Profitability will grind higher, slowly, over time, but not get back to pre-crisis levels due to higher capital levels in the denominator.  About 90% of the industry is profitable, which is almost back to normal.

JOSH SIEGEL: Banks will face a dichotomy of performance metrics. On one hand, over 6,200 banks are profitable, well capitalized and earning an average 9.9% [return on equity] and have been underwriting near-pristine credit quality for at least three years, which foretells of low nonperforming assets and chargeoffs over the next four to five years .

Our sluggish economy, which I would debate never came out of recession, will prove challenging for banks in terms of loan growth and suggests continued low interest rates which will further pressure net interest margins.

What did the election mean for community banks?

ADAMS: Most bankers I work with believed that a change in administration would usher in a change in perspective about the importance of the banking industry to our country. While certain structural challenges face us regardless of who is running the country, I believe the mood change and morale improvement among small businesses would have set the stage for a better business climate.

Uncertainty is more of a threat to economic growth than who sits in the White House. With control of Congress split, I worry that continued gridlock will mean a reticence to make investments for future growth which, in turn,  impedes loan growth and hurts community banks' bottom line.   This means little capital will flow to the smaller names, [with investors focusing on] only the banks viewed as consolidators or those otherwise able to grow tangible book the fastest with the least risk.

LASHLEY: The election was the tipping point for many bank managers and directors. They have been inappropriately blamed and penalized for the financial crisis, when it is clear community banks were not the cause. Most bankers and directors wanted change in Washington in order to get some relief, both in regulatory practice and political rhetoric.

Community bankers and boards are fatigued.  The election may cause many small banks to realize they may not be large enough or sophisticated enough to be relevant and remain independent.  Many will sell to the highest bidder or find a merger partner in order to have the critical mass needed to survive. Anecdotally, I have heard that many were delaying strategic decisions until after the election.

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