ViewPoint: State of the District

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State of the District

Asset Quality :: Balance Sheet Growth :: Bank Failures :: Capital :: Earnings Performance :: Liquidity
Asset Quality

Continued economic uncertainty has not curtailed the improvement in asset quality. Asset quality problems that arose during the financial crisis in the Sixth District declined slightly in the first quarter of 2012. The level of decline has slowed over the past three quarters, but the amount of loans that banks are having to charge-off and take losses on is declining at a much faster pace. The ratio of noncurrent loans to total loans was 4.7 percent in first quarter, on par with levels last seen in 2008, before the financial crisis engulfed banks (see the table).

Noncurrent loans (see chart 1) declined in nearly every loan type with the exception of other consumer loans, like automobile loans.

The decline in noncurrents has helped stabilize the coverage ratio of the allowance for loan losses as a result of noncurrent loans (see chart 2).

In the first quarter, the coverage ratio reached its highest level since the fourth quarter 2008. Charge-offs in the first quarter fell to their lowest the level in nearly four years (see chart 3).

The level of charge-offs reflects declining mortgage delinquency rates in the first quarter. Delinquency rates reached the lowest level seen since 2008. Charge-offs are often lowest during the first quarter as many banks charge off their worst-performing loans during the fourth quarter.

Balance Sheet Growth

Sixth District banks are starting to see stronger growth in their commercial and industrial (C&I) portfolio, which is the portfolio many banks have focused on growing for the past year (see chart 1).

According to the April 2012 Senior Lending Officer Opinion Survey, a third of the banks that participated in the survey reported stronger demand for C&I loans for firms of all sizes. On an aggregate basis, C&I loans grew by $5.2 billion, a 21 percent increase over the prior year (see chart 2).

Based on the survey results, banks have maintained their same level of credit standards for approving applications for commercial loans or credit lines, meaning there has not been any significant tightening of credit from the banks' point of view. While credit standards for C&I loans remained unchanged to the prior quarter, banks eased some of their loan terms such as the spreads over cost of funds and the use of interest rate floors. Given that only a third of the banks are reporting higher demand, much of the growth appears to be the result of shifting some commercial customers away from commercial real estate loans (CRE) and into C&I loans. During the first quarter, the amount of CRE loans declined by $1.7 billion, though this category remains the largest loan portfolio on bank balance sheets. As existing customers renew loans, especially with smaller community banks, those banks appear to be changing the type of collateral required for the loan from real estate to other business assets. In changing the type of collateral accepted, it shifts the categorization of the loan.

In addition to C&I growth, Sixth District banks also had growth in their closed-end first and junior lien residential mortgages, perhaps signaling that some housing
markets in the district are healing. On an aggregate basis, residential mortgages increased by $1.7 billion over the prior year. Although there has been growth in some parts of the loan portfolio (both residential and C&I loans), overall loans declined in the first quarter. The strong growth in C&I loans was almost completely offset by the decline in construction and development loans. The increase in mortgage lending does not seem to be translating into real estate development projects at this time. With the overall loan decline, loans remained at 62 percent of total assets on the balance sheet of banks versus a high of 70 percent prior to the crisis (see chart 3).

Loans now represent 62 percent of total assets on the balance sheet, down from 70 percent at the start of the crisis (see the table).

Without loan growth, banks are still turning to their securities portfolio in order to generate a yield and improve the net interest margin. In the first quarter, banks' securities portfolio grew by just over 9 percent while the loan portfolio declined by nearly 2 percent.

Without loan growth, banks continue to increase their securities portfolio, which have grown nearly 5.5 percent as a share of assets since the start of the crisis. While banks would like to get a higher yield on their securities, they are reluctant to invest in longer-term products because of the possibility of a rising rate market and having the liquidity to make loans when demand returns.

For more detailed information on small business conditions in the Sixth District, see the Federal Reserve Bank of Atlanta's Small Business website.

Bank Failures

Beyond the increase in earnings, the reduced level of bank failures so far in 2012 provides a clear indication that conditions have improved. Through May 16, 2012, a total of 23 failures have occurred this year nationally, with Georgia once again leading the nation with four. As a result of banking, real estate, and economic conditions in the state, Georgia has been slower to recover than other parts of the country. By comparison, there were 43 failures in 2011 and 72 failures in 2010 through the same point in the year. The continued reduction in the number of Sixth District banks with the highest Texas ratios also points to fewer failures in the district this year (see the chart).


Even with the recent improvement in earnings and asset quality, capital levels in Sixth District banks have remained fairly stable in recent quarters. Capital ratios have also been helped by the relative lack of loan growth. In the first quarter of 2012, the median tier 1 leverage ratio for community banks was 9.59 percent, a 19 basis point improvement over the same quarter in the prior year (see the chart).

The median tier 1 leverage ratio in the Sixth District remains slightly below the median ratio of 9.72 percent for out-of-district banks, but the gap is the smallest it has been since the second quarter of 2010.

Earnings Performance

Earnings for Sixth District community banks (assets less than $10 billion) increased to an aggregate net income of $1.9 billion, compared with a net loss of $454 million in the same quarter of the prior year (see chart 1).

The improvement was the result of sharply lower loan loss provisions and stronger noninterest revenues. On an aggregate basis, ROAA for the first quarter 2012 was 0.64 the strongest it has been since the second quarter of 2008 (see table 1).

Still, the Sixth District has a larger percentage of community banks reporting negative ROAAs than banks outside the district (see table 2).

Net interest margin improved as the level of noncurrent loans has declined over the past six quarters, though banks have yet to experience any significant loan growth. At the same time, interest expense has declined as low-cost core deposits are reaching their highest level in nearly 20 years. Despite the numerous concerns expressed by community banks about the impact of new financial regulations, such as the Durbin amendment, community banks are still experiencing noninterest income growth.

Banks were also able to generate one-time gains on the sale of securities, which also pushed ROAA higher. Generally, the securities gains are not seen as being a part of the banks' core earnings. Overhead expenses also continued to increase as banks are the process of resolving remaining problem loans. Over the past two years, legal fees, appraisal fees, and taxes on ORE (other real estate, classified as property held for reasons other than conducting bank business) have added to the banks' costs. Provision expense continued to decline even as the overall coverage of noncurrent loans increased slightly for the quarter. Returning provision levels closer to historical norms has aided banksâ?? return to profitability.


At the beginning of the financial crisis, the level of liquidity in banks became a focus of concern. Part of the concern was businesses trying to draw credit lines because of disruptions in the market. In order to ensure enough liquidity remained available, the Federal Reserve lowered the discount rate to record lows. Four years later, with loan demand still tepid, banks are having difficulty determining how to effectively deploy all of the funds that flowed into the banks as a result of economic uncertainty. In the first quarter 2012, core deposits represented just over 66 percent of assets in the Sixth District, its highest level since the early 1990s (see chart 1).

Out-of-district banks are also seeing near record levels of core deposits. The increase in core deposits in the district has sharply curtailed the reliance on noncore funding, which is seen as a volatile funding source. The median net noncore funding dependence ratio in the Sixth District in the first quarter was 17.48 percent, higher than the same ratio for out-of-district peers at 10.42 percent (see the chart).

At the same time, the ratio of loans-to-deposits has dropped to roughly 83 percent from a peak of 128 percent for large banks. Given that core deposits still represent a cost, banks are seeking higher returns on other asset portfolios. However, banks have to be careful not to commit the additional funds into assets with longer maturities. With the Transaction Account Guarantee (TAG) program, which guarantees unlimited insurance on noninterest-bearing transaction accounts, expiring at year, some analysts are wary of some run-off in bank deposits. An estimated $1.2 trillion in deposits could be affected by the expiration of the program.