ViewPoint: Introduction

Introduction | Spotlight: Net Interest Margin Performance | Spotlight: TAG Program | State of the District | National Banking Trends


By Michael Johnson, Senior Vice President
Supervision & Regulation
Federal Reserve Bank of Atlanta

Mike JohnsonAs we close out the year, I am pleased to report that District bank earnings in the third quarter climbed to their highest level since 2007, and capital levels reached a four-year high. Improving bank performance is further highlighted by the positive trends occurring in asset quality as well as the slow but broadening loan growth across bank portfolios. To be sure, issues remain and 2013 will likely present additional challenges, especially in light of the current uncertainty associated with the "fiscal cliff," which only serves to reaffirm the importance of strong risk management practices and a solid financial footing.

State of the District
As you can see in our recurring State of the District analysis, in general, banks in the Sixth District and across the nation are gradually returning to health. For example, during the third quarter of 2012, earnings were the strongest they've been in six years, although much of the improvement was driven by lower provision expenses. Loan growth was evident in nearly every category, with the exception of construction and development loans. Commercial and industrial loans continued double-digit growth, and residential loans grew more rapidly as the housing market begins to recover in many markets. Although earnings and loan growth improved, charge-offs trended higher, suggesting that some banks have more problem loans to work through. Also, although the health of the banking industry is improving, the overhang from the crisis means that more banks will likely fail in the coming year.

In addition to the State of the District section, we also feature more in depth analysis of liquidity and interest rate risk, both of which may be flying a bit below the radar screen in this prolonged period of low interest rates but which remain on our list of potential risk concerns.

Liquidity risk
Despite remaining legislative uncertainty, it appears we will most likely start the new year with the expiration of the FDIC's Transaction Account Guarantee (TAG) program, which provides unlimited deposit insurance on non-interest bearing accounts. This program led to growth in deposit balances across the industry at a time when stability was at a premium. We have been working closely with banks to determine the possible impacts of deposit outflows on liquidity positions and on margins due to a shift in funding toward interest-bearing products or to increased reliance on wholesale funding caused by the expiration of the TAG program. We are not expecting a huge overnight movement of deposits, but being prepared is always best.

Interest rate risk
Interest rate risk in a low interest rate environment has received substantially more attention than TAG, as all banks are challenged to preserve their net interest margin. In fact, we saw many large bank stocks come under pressure recently as net interest margin results for the third quarter were worse than expected. An understanding of interest rate risk warrants extensive and thorough analysis that extends beyond the confines of a single edition of "ViewPoint." Subsequently, we plan to cover this issue in segments over the next few quarters. In this issue, we will focus on the potential implications for banks when all the benefits of lower costs have been exploited and margins become solely dependent on the performance of yields.

Dodd-Frank stress-testing rules
I'm sure that many of you noticed that on October 9, 2012, the Board finalized two rules: the covered company rule and the other financial company rule, implementing the stress-testing requirements of the Dodd-Frank Act. The requirements are scaled according to the size of an institution. The covered company rule applies to bank holding companies (BHCs) and nonbank companies supervised by the Board with $50 billion or more in consolidated assets. The other financial company rule applies to bank holding companies with between $10 billion and $50 billion in total assets and to savings and loan holding companies and state member banks with $10 billion or more in assets. Both rules require the use of baseline, adverse, and severely adverse stress testing scenarios developed by the Federal Reserve, using a specific set of capital action assumptions to ensure comparability across firms. Public disclosure of the results of stress tests conducted under the severely adverse scenario is also required under both rules.

Covered companies are required to conduct semiannual company-run stress tests (as of September 30 and March 31) and are subject to annual supervisory stress tests. For companies that participated in SCAP & CCAR (the 19 largest bank holding companies), Dodd-Frank stress testing begins in the fourth quarter of 2012, with reporting in January 2013 and public disclosure of the results in March 2013. For other covered companies (the CapPR firms), Dodd-Frank stress testing will start in the fourth quarter of 2013, with reporting and disclosure in 2014. Other financial companies must also conduct annual company-run stress tests as of September 30, with a start date in the fourth quarter of 2013, reporting in March 2014, and the first public disclosure of results in June 2015, following the second round of tests. (You can read more about Dodd-Frank Stress Testing requirements here.)

As always, I look forward to hearing from you and any feedback you may have at Here's wishing you all a happy and safe holiday season and the very best in 2013.

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