ViewPoint: State of the District

Introduction | Spotlight: Banking and Emerging Cybersecurity Risks | Spotlight: A Dodd-Frank Milestone: Enhanced Prudential Standards Adopted | Spotlight: The Dwindling Size of Small Business Lending and the Impact of Bank Failures | State of the District | National Banking Trends

Asset Quality :: Balance Sheet Growth :: Earnings Performance :: Liquidity

Asset Quality

Asset quality seems to have reached a stabilization point. Noncurrent loans have fallen to their lowest level, as a percentage of total loans, since 2008. Charge-offs have declined to their lowest level since the second quarter of 2007, just prior to the beginning of the crisis (see the chart).

Demand for Commercial and Industrial Loans

In terms of other real estate owned (OREO), a combination of factors including rising real estate values, a shrinking inventory, historically low interest rates and an abundance of capital that needs to be deployed by institutional investors are helping banks dispose of both problem commercial and residential loans. Even with the improving conditions, the Atlanta market has the highest level of noncurrent loans (or OREO) on banks' balance sheets. Though asset quality appears stable, some loan portfolios still need to be monitored for potential problems. In the Sixth District, there has been an increase in delinquency with credit cards for prime borrowers. Delinquencies for subprime continue to decline as it is already difficult for subprime borrowers to obtain credit, and delinquency levels remain unchanged for super-prime borrowers (those with outstanding credit scores). Delinquencies started trending upwards in 2010 and have gradually increased over the past four years.

Balance Sheet Growth

Consistent and sustained levels of loan growth are critical to supporting community bank revenue growth. However, following the end of the recession, loan growth had remained elusive until late in 2013. Even though loan growth has returned, it has not matched the level of growth banks experienced prior to the real estate crisis. In the first quarter, once again banks experienced a slight growth in loans—4 percent versus 2 percent in the first quarter of 2013—a rate that was lower than the previous two quarters (see the chart).

Loan Growth Dipped Slightly

Growth continues to be driven by three categories: commercial and industrial (C&I), consumer, and commercial real estate (CRE) (see the chart).

C&I Drives Loan Growth

Since loan growth turned positive again, C&I lending has been the most consistent growth portfolio as banks have targeted commercial clients. Year-over-year growth of C&I is 14 percent for the current quarter, representing 60 percent of total loan growth for the quarter. For nearly two years, the Fed's senior loan officer opinion surveys have indicated that banks are easing credit standards in order to attract C&I loans. In addition to C&I loans, community banks in the Sixth District have once again ramped up their CRE lending. CRE lending increased nearly 7 percent year over year.

Banks have been increasingly willing to make new CRE loans for multifamily properties. Since the recession, homeownership rates have drifted downward as potential buyers continue to face a variety of problems, which increased interest in building and owning apartment complexes. Interest is especially strong in South Florida, which has low vacancy rates and rental rates are growing sharply. The final growth portfolio, consumer, has primarily taken the form of indirect automobile lending and student loans. On a national basis, the number of auto accounts now exceeds the number of mortgages (see the chart).

Auto Loan Growth Slows at Community Banks

Since banks have been scrambling for new loans and rules surrounding mortgages have put more controls over real estate lending in place, required credit scores for auto loans have been lowered. While wanting the additional loan growth, banks remain wary of construction and development (C&D) and HELOC lending. C&D lending declined overall in the first quarter by 1.5 percent, though C&D lending has been positive for residential single family homes (see the chart).

C&D Components


When the new capital standards required under Basel III were introduced, banks in the Sixth District reported a median tier 1 leverage ratio of 10.01 percent, the highest the ratio had been in since the start of the crisis (see the chart).

Capital Levels & Growth

While the largest institutions started reporting under Basel III this quarter, community banks still have until next January before they are covered by the new capital rules. In the meantime, community banks in the Sixth District continue to raise additional common equity in order to meet the new capital requirements.

Earnings Performance

Both aggregate and median return on average assets (ROAA) at community banks in the Sixth District continued to improve in the first quarter, increasing slightly from the prior year (see the chart).

Aggregate Return on Assests Increases

More banks are experiencing positive earnings growth as the percentage of banks in the District that were unprofitable declined to 9 percent, half of the level from the prior quarter. The source of the improvement remains the same: a tight control on expenses rather than an expansion of income. Surprisingly, the cost of funding continues to decline at a time when the expectation that interest rates will rise in the not distant future is increasing.

Banks also continue to squeeze savings from the provision expense, which, as a percentage of average assets, was 9 basis points lower than the first quarter of 2013. As a result of the continuing decline in the provision expense, banks have pushed allowance for loan losses as a percentage of total loans back down to the precrisis level banks had in 2008 (see the chart).

Sixth District Loan Loss Reserves

At the same time, the coverage ratio is improving as a result of the decline in nonperforming loans. In terms of aggressive expense control, banks have succeeded in shrinking their noninterest expense, which has declined 10 percent from the prior year. Improved asset quality has helped bring more expenses under control as well as continuing to run the bank with fewer staff.

In terms of income, though the net interest margin (NIM) was 9 basis points higher year over year in the first quarter, it declined slightly from the prior quarter because interest income declined faster than interest expense (see the chart).

No. of Banks Increasing/Decreasing Q/Q NII and NIM

Banks had been able to generate additional interest income through extending duration on its securities portfolio, but concern about interest rate risk is making that option look more unattractive. Banks now are increasingly counting on loan growth to supply the additional interest income. However, given the uncertainties about the economic recovery, banks face a major challenge to rebuilding revenue streams via loan growth.

Over the past three years, noninterest income at community banks in the Sixth District has barely grown, although it's been one of the goals to grow this income. Building that fee income will be even more challenging now that the refinance activity for mortgages is not providing the same level of income as a result of rising rates. In addition, traditional sources on noninterest income—service fees on checking accounts—are being pressured by changing consumer behavior and regulation.


Historically, high core deposits in Sixth District banks have provided greater on-balance sheet liquidity during the past four years (see the chart).

Noncore Funding Reliance

The deposits have provided banks a lower-funding-cost base at a time when interest rates are at their lowest in more than two generations. However, the concern for banks and regulators is how sustainable the deposit mix will be if the economic conditions improve. Increasingly, the mix is shifting away from time deposits to other products such as money market funds, which could signal the beginning of customers pulling their deposits out of banks and placing them elsewhere. At a time when Basel III is pushing banks to hold more liquidity, a general improvement in the economy that produces a deposit runoff may increase reliance on noncore funding such as Federal Home Loan Bank advances.

At a national level, borrowings have moved back into positive territory. The increase was driven primarily by smaller community banks. Year-over-year growth in borrowings has reached the 10 percent threshold in recent months. One potential reason for the increase could be banks' concerns about the potential for interest rate increases, which is driving them to lock up longer-term funding at a low rate.

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. The Federal Reserve Bank of Atlanta also produces a variety of publications dealing with other economic and financial topics. These materials appeal to a wide range of readers, including bankers, businesspeople, economists, students, and economics teachers.