A trade-off for state banks

Performance on loans, profits mirrors economy, experts say

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The conservative nature of Connecticut-based banks has caused them to lag the nation in areas such as return on equity and interest margin, but outpace the country in loan quality, according to a Fitch Ratings report released this month.

“Connecticut lags on some traditional bank measures,” Christopher Wolfe, managing director of Fitch’s Financial Institutions division, said. “Loan quality tends to perform better, but profitability and capital seem to be below the national average.”

While Connecticut has closed the gap between 2013 and 2017 — the years analyzed for the report — on return on average assets, it continues to trail by a large margin in return on equity. In 2017, the national average return on equity was 8 percent compared to 5 percent percent for Connecticut.

Anthony Giobbi, chief banking officer at Newtown Savings Bank, and Richard A. Muskus, Jr., president of Stamford-based Patriot Bank, said Connecticut’s competitive banking market also results in smaller profit margins.

“The main reason why smaller community banks in Connecticut may face smaller margins as compared to larger regional or national banks is competition,” Muskus said. “This stems to both deposits and loans where deposit acquisition is facing pressure from a rate perspective, so higher rates are needed to attract those deposits.”

Muskus said competitive loan rates and “multiple banks in the mix” can put pressure on net interest margins and “potentially force banks to seek yield in other places, potentially increasing risk as a result.”

Financial technology companies entering the commercial lending market add a new type of competition, Muskus said.

“It’s competitive dynamics,” Wolfe said. “If there are alternatives then banks may have to accept lower rates, making the margins thinner.”

Giobbi pointed out there are 60 banks offering services in Connecticut, including 41 based in the state.

“There are 1,182 bank branches in a state with between 3.5 and 3.6 million people,” he said. “When you do the math, there’s a lot of banks.”

Giobbi said Connecticut’s high cost of living and of doing business affect the bottom line, as well.

Wolfe agreed, noting that lower profits stem from charging less to borrow and paying more for the money to lend.

Michael Sheperd, associate director at Fitch Financial Institutions, said shareholders typically look for a 10 percent return on equity. The national average is 8 percent, while Connecticut banks’ return on equity is about 5 percent, up from 3 percent in 2013.

“Even the national banks are below that hypothetical threshold, but Connecticut banks are even lower,” Sheperd said.

The trade-off to lower profits are higher-quality loans with fewer defaults and charge-offs, or debts that likely will not be collected. The report found that Connecticut outperformed other banks in net charge-offs and Fitch NPA (non-performing assets) Ratio.

In 2013, Connecticut banks’ net charge-off percentage of 0.13 far outpaced the national average of 0.31 percent. Last year the gap had closed to 0.12 percent for Connecticut and 0.17 for the other banks.

“There is a lower rate of problem assets because banks in New England in general, and Connecticut in particular, are a little more conservative,” Giobbi said, adding that the region withstood the 2008 real estate bubble burst better than the nation. “The problems happened to a lot lesser extent in Connecticut. As a result (of the conservative nature of banks in the state), we have better-performing portfolios. You have to look at banks on a riskadjusted basis. If there’s lower risk, there’s lower return.”

Giobbi said his bank will rarely lower its rate to the point of being risky, despite the intense competition in the state.

“We hold the line on price,” he said. “We aren’t going to chase a deal based on price.”

Muskus added: “At Patriot we maintain very structured underwriting guidelines that manage

risk extremely well. Most of our Connecticut peer banks share the same general credit philosophy and approach, and as a result are able to enjoy higher-quality loan portfolio metrics and lower defaults.”

Wolfe said Fitch’s outlook for U.S. banks is stable with little upward or downward movement for the rest of 2018. Fitch does not rate

individual states, but Wolfe expects Connecticut to hold course, as well.

Don Klepper-Smith, chief economist and director of research at DataCore Partners, said the report mirrors Connecticut’s economy.

“The two go hand in hand. Connecticut ranked 43rd in job performance last year, up only 0.1 percent, while consumer spending power as measured by real disposable income actually fell fractionally,” he said. “That said, it makes sense that Connecticut bank profits were challenged in the process due to lackluster economic activity.

“On the plus side, we’re still at the top on income per capita metrics and greater overall wealth,” he said. “That would imply better loan quality, and that’s exactly what we saw.”

Cathy Zuraw / Hearst Connecticut Media Above and below, People’s United Bank, based in Bridgeport, is the largest bank in the region with $12.1 billion in deposits from about 65 branches in southwestern Connecticut as of 2017.