ViewPoint: Spotlight: State of the District

Introduction | Spotlight: Banker Outreach | Spotlight: Basel III | State of the District | National Banking Trends

State of the District

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

Generally, an uncertain economic environment and a reduction in underwriting standards would spark a concern about a possible increase in problem assets. While remaining a concern, as of the second quarter asset quality continued to improve. Total noncurrent loans represent 4.37 percent of total loans, just over $8.2 million. The level of decline increased its pace after slowing the past two quarters (see the chart).

Problem C&I loans, which is one of the biggest concerns, declined again for the second consecutive quarter, representing just 0.25 percent of total C&I loans (see the chart).

Problem loans entering delinquency remain at postcrisis lows, and late-stage delinquencies have improved through a combination of loan workouts and charge-offs. Charge-offs increased in the second quarter, to $1.6 billion in aggregate for the Sixth District but remain well below the average for the past four years (see the chart).

Balance Sheet Growth

Sixth District Banks had significantly stronger loan growth in the second quarter, with increases in most portfolios (see the chart).

The commercial and industrial (C&I) portfolio once again led the improvement in loan growth (see the chart).

On an aggregate basis, C&I loans grew by $7.5 billion, a 32 percent increase over the prior year. Many banks have expressed a desire to increase the C&I portfolio, and the growth in 2012 is reflective of their efforts. However, banks say the competition has gotten fierce with limited opportunities. In lending surveys, some banks have stated that they have reduced their margins and the use of interest rate floors in order to attract new commercial loans.

At the same time, many community banks lack the expertise to properly underwrite commercial loans, which means that banks may not be accurately risk-pricing their C&I loans. As a result of the C&I competition, for the first time in several quarters, there was measurable growth in the commercial real estate portfolio. In conversations with some smaller, more rural banks, management has expressed a new comfort level with increasing their lending to businesses with owner-occupied collateral (see the chart).

In fact, according to the July Senior Lending Officer Opinion Survey, nearly 43 percent of respondents in the Sixth District reported that they had eased their credit standards for commercial real estate loans compared to 13 for out-of-District banks. Besides commercial loans, residential lending also saw growth in the second quarter. There have been pockets of stabilization in certain real estate markets, which has pushed up housing demand. More people are taking advantage of government programs to refinance their mortgages. Still, there has not been a broad-based increase in housing prices and banks remain reluctant to extend new home equity lines of credit given the number of borrowers still underwater. The second quarter showed growth in the multifamily portfolio at a time when the market may be becoming oversupplied, as rents have started falling. Surprisingly, there was small growth in consumer lending. While student loans have received a lot of attention in the press, most community banks are not engaged in that type of lending.

For more detailed information on banking trends in the Sixth District, see the Federal Reserve Bank of Atlanta's Regional Economics Information Network web page.

Bank Failures

Bank failures are becoming less of a concern (see the table).

Through the first half of 2012, there has been a significant decline in the number of bank failures compared with the prior year. Through the first week in August, there were 40 failures in 2012 versus 63 in 2011. Georgia is still leading the nation with nine failures so far in 2012. Nationally, improved asset quality, stronger earnings, and higher capital levels have put banks in the best condition since 2007. The Federal Deposit Insurance Corporation problem-bank list has decreased four consecutive quarters, after increasing for 18 consecutive quarters.


Capital levels in Sixth District banks improved slightly in the second quarter after remaining fairly stable over the prior three quarters (see the chart).

In the second 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. Even with the increase in the loan portfolio, which can lower capital levels, the improved earnings have helped push capital ratios higher. Higher capital levels also allow banks more leverage in taking losses on problem assets, which may help explain the increase in charge-offs during the quarter.

Earnings Performance

In the second quarter, aggregate earnings for Sixth District community banks (assets less than $10 billion) declined slightly compared with the first quarter of 2012 but increased significantly compared with the same period in the prior year (see the chart).

Aggregate ROAA declined by 9 basis points (bps). On an aggregate basis, ROAA for second quarter 2012 was 0.55 percent. The decline in aggregate ROAA is at odds with the median ROAA, which increased by 1 bp. The difference suggests that there is more margin pressure at larger institutions. Even with all of the improvements, Sixth District banks' ROAA lag significantly behind the ROAA of banks outside the District (see the table).

Conditions have continued to improve at banks, and there are fewer nonperforming loans causing pressure on the net interest margin. The median net interest margin has increased 3 bps since the end of 2011. Aggregate interest income increased from the first quarter as a result of a decline in nonperforming loans.

Meanwhile, interest expense continued to decline as core deposits now fund a significant portion, over 66 percent, of the banks' balance sheets. Community banks' expressions of concern about the impact of new financial regulation (such as the Durbin Amendment) on noninterest income have largely subsided in recent months, though it remains a risk. Noninterest income has generally improved over the prior year. Although interchange fees may have been affected by financial regulation, banks have instituted a lot of new fees on deposit products and have generated more income from mortgage products. Banks' most significant expense over the past four years—provision expense—has fallen to its lowest level since 2007, but it increased in the second quarter, which caused part of the decline in aggregate earnings (see the chart).

Overhead expenses have remained high, as banks still have a large number of real estate–owned properties on their balance sheets. Banks have also become more aggressive about working out their remaining problem loans.


The growth in loans could not come at a better time for most banks. Banks remain flush with liquidity and have been struggling to find a strategy to effectively use it. Even with low rates on savings and certificates of deposits and higher deposit fees, banks continue to attract new deposits. In the second quarter of 2012, core deposits represented just nearly 67 percent of assets in the Sixth District, breaking the new high since the early 1990s set last quarter (see the chart). Out-of-District banks are also seeing near-record levels of core deposits.

Core deposits have contributed significantly to banks' net interest margin and net income. Banks have been able to lower their cost of funding much faster than the decline in interest rates on loans, providing some relief to margin pressures. Deposit accounts have also been a source of fee income at a time when overdraft and interchange fees have been curtailed. The increase in core deposits in the District has reduced the need for noncore funding, like brokered deposits, which are higher cost and more volatile funding sources. The median net noncore funding dependence ratio in the Sixth District in the second quarter was 18.07 percent, a slight increase over the prior quarter and higher than for out-of-District peers, 11.81 percent (see the chart).

At the same time, the ratio of loans to deposits has dropped to roughly 81 percent from a peak of 128 percent for large banks.