Asset Quality
Asset quality is considered strong, especially given the length of the current economic cycle. The median Texas Ratio for community banks in the Sixth District is 7 percent. Both other real estate owned (OREO) and total nonperforming assets remain at their lowest levels since the financial crisis. New nonperforming assets represent just over 2 percent of total loans. Delinquencies for both 30-89 days and 90 days or more have increased slightly from the prior year but are still well below precrisis levels. There has also been a decline in the number of loans transitioning from 30-89 days delinquent to 90 days or more delinquent (see the chart).
Black Knight reports that two states in the Sixth District, Mississippi and Louisiana, rank among the top states in the nation for seriously delinquent mortgages. Mississippi’s seriously delinquent mortgage rate was above 3 percent, the highest in the nation. Looking at data from the state, FICO scores at origination have generally been climbing since early 2016. The median debt-to-income ratio was 32 percent in the third quarter, a decline from 38 percent in the prior quarter, which may suggest that banks are tightening credit. The lower nonaccrual loan base, along with the current provision for loan losses, have boosted the median coverage ratio for community banks in the Sixth District to 1.7 percent, the highest level since the financial crisis. The coverage ratio is a measure of a bank’s ability to absorb losses from nonperforming loans (see the chart).
Balance Sheet Growth
Overall asset growth for community banking organizations in the Sixth District in 2018 was the slowest it has been since 2015. Annualized asset growth was 3.37 percent in the fourth quarter, a decline of 108 basis points year-over-year. Loan growth was stable, above 6 percent, but securities growth continues to decline, as market volatility and rising rates impact valuations (see the chart).
Consumer loan growth, a key driver in growth early in the economic recovery, turned negative in fourth quarter for the first time in four years. The decline in demand coincides with the increase in interest rates, especially for vehicle loans. Commercial Real Estate (CRE) continues to be the largest exposure for community banks in the Sixth District, but declined slightly in the fourth quarter (see the chart).
According to the latest Senior Loan Officer Opinion Survey (SLOOS) results, banks tightened credit for CRE loans in the fourth quarter. A recent change to the definition of High Volatility Commercial Real Estate (HVCRE) narrowed the type of loans requiring a higher risk-based capital requirement. This change may generate more CRE lending, particularly in the type of construction and development (C&D) lending that falls outside of the new definition. Over the last three quarters, median C&D growth has exceeded 10 percent, its strongest sustained growth in over 10 years. Commercial and industrial (C&I) had the next strongest growth, just over 8 percent for the second consecutive quarter. Loans were extended to a variety of businesses in different industries, including agriculture, healthcare, information technology, and manufacturing. Demand for manufacturing loans has grown in Alabama and Mississippi as larger manufacturers have increased production.
Capital
Capital levels have maintained their post crisis levels due to sustained earnings growth and relatively low dividend payouts. Payouts declined year over year in the fourth quarter, dropping to an aggregate of 46 percent, from 81 percent in the prior year. As asset growth has slowed, median risk weighted asset growth has slowed as well, growing under one percent for the quarter. Data from the Call Report shows Sixth District community banks had a median tier 1 common capital ratio of 15.4 percent, the highest level in four years (see the chart).
Over 98 percent of District community banks are considered well capitalized based on their capital ratios. Net income and business combinations were the primary contributors to the improvement in capital levels. The leverage ratio for these banks, on an aggregate basis, reached 10.79 percent, which would qualify as well capitalized under the proposed community bank leverage ratio rule.
Earnings Performance
The change in earnings during the fourth quarter of 2018 for community banks in the Sixth District largely reflected national trends. Return on average assets (ROAA) improved year over year in large part because of the effects of tax reform changes in the prior year. Median ROAA as of quarter end was 1.13 percent, a 43 basis point (bp) improvement from fourth quarter 2017 (see the chart).
Fourth quarter earnings are typically affected by the annual recognition of certain noninterest expenses that cause net income to dip slightly from the prior quarter. Year-end accruals for employee benefits, as well as other expenses for legal and service vendors, tend to drive the increase in noninterest expense. Overall, 94 percent of banks reported positive profitability. The net interest margin (NIM) rose for a majority of banks, as interest rates continued to rise during the quarter, resulting in a 20 bp increase in median loan yields, year over year (see the chart).
However, just over 40 percent of banks reported a lower NIM as competitive pressures pushed firms to boost rates on a variety of products. Provision expense was slightly lower for the quarter as asset quality trends remained positive. Noninterest income growth slowed slightly over the last three quarters as a result of falling loan demand from consumers and businesses who were put off by higher rates and uncertainty in the market.
Liquidity
Liquidity remains healthy at community banks, despite the increased competition for deposits that may drive another round of mergers among banks in the Southeast. The loan to deposit ratio for the smallest community banks has been trending upward over the last 10 quarters, reaching just under 80 percent in the fourth quarter. The change can be primarily attributed to loan growth consistently outpacing deposit growth quarter over quarter. The larger community banks’ loans-to-deposits ratio has been stable at 85 percent. Median on hand liquidity for community banks was slightly higher, at 17 percent, than the ratio for banks outside the District, which was 16.3 percent (see the chart).
For much of the recovery, Sixth District banks had lower ratios than their counterparts. Until recently, banks had been able to maintain lower rates on deposits, even as short term rates increased. However, over the summer, customers started demanding higher rates. Continued competition for deposits will limit benefits from further rate increases. Although loan growth has outstripped deposits in recent quarters, this has yet to increase dependence on noncore funding.
National Banking Trends
The aggregate return on average assets (ROAA) rose to 1.33 percent, a 77 basis point improvement year-over-year (see the chart).
The increase in ROAA is largely attributable to one-time adjustments associated with the change in tax laws in December 2017. Earnings from operations remained stable, supported by strong margins, a slower pace of deposit pricing, and well managed noninterest expenses. The net interest margin (NIM) was 30 basis points higher year-over-year at 3.37 percent; however, margin improvement slowed in the fourth quarter (see the chart).
Short-term interest rates increased again late in the quarter which may lift the margin slightly in the first quarter of 2019. Going forward, slowing loan growth and rising competition are expected to challenge earnings in 2019.
Surprisingly, asset growth accelerated in the fourth quarter after slowing for much of 2018. Loans remain the primary driver. The increase in loans was driven by banks with assets of $1 billion or more; lending at smaller community banks turned negative during the quarter. Growth may be further impacted by both supply and demand. Banks reported tightening credit for firms of all sizes in the fourth quarter and remain cautious about lending in several portfolios. Institutions do not plan to loosen underwriting standards to increase volumes. In addition, demand for loans is expected to fall due to higher interest rates and growing uncertainty.
Asset quality remains healthy. Banks appear to have maintained strong underwriting practices throughout the current cycle. Charge-offs remain at historic lows and nonperforming assets have not increased significantly since the end of the financial crisis. While there were a few notable upticks in nonaccruals, the overall trend is positive (see the chart).
Black Knight and CoreLogic have released data which indicates that overall mortgage delinquency and foreclosure rates are at the lowest point since 2000. Areas affected by natural disasters (such as hurricanes in the Southeast or wildfires in California) are experiencing an increase in the share of mortgages moving into 30-day delinquency; however, that trend is expected to decline over the next quarter.
Regulatory capital ratios remained largely stable, due to healthy earnings and strong asset quality. The aggregate leverage ratio for community banks is over 11 percent, which would be considered well capitalized under the recent proposal to simplify regulatory capital requirements. As proposed, an eligible community bank could elect to use the Community Bank Leverage Ratio (CBLR) framework, which would not require them to calculate the existing risk-based and leverage capital requirements as long as they maintained a ratio above 9 percent. Firms meeting this requirement would be defined as well capitalized in terms of the banking agencies’ prompt corrective action rules.