Asset Quality
Despite the length of the current credit cycle, asset quality at Sixth District banks generally remained strong. Other-real-estate-owned (OREO) and total nonperforming assets are at the lowest levels seen since the financial crisis. New nonperforming assets represent just over 2 percent of total loans. Delinquencies for 30–89 days have increased slightly from the prior year, but the percentage of loans past due 90 days or more is less than half than the share from the second quarter of 2018 (see the chart).
Fewer loans are transitioning from 30–89 days delinquent to 90 days or more delinquent. Charge-offs as a percentage of total loans increased slightly, 6 basis points, year over year. A lower nonaccrual loan base, along with a lower charge-off ratio, have contributed to improving the median coverage ratio to 1.7 percent, three times the level seen during the depths of 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 in second quarter, median annualized asset growth for community banks in the Sixth District was 4.45 percent, the highest rate of asset growth in six quarters. Securities growth continued to trend negative, which started in the fourth quarter 2018, around the time of the interest rate increase by the Federal Reserve, as market volatility affected valuations. Most of the asset growth in the quarter came from net loans. Loan growth was stable, above 5 percent. Commercial real estate (CRE) continues to be the largest exposure for community banks in the Sixth District, though the level of exposure has been declining since the third quarter of 2017 (see the chart).
Banks have noted for several quarters that stiff competition for CRE loans from nonbanks has eroded underwriting standards and affected new loan growth. After median commercial and development growth exceeded 10 percent for six quarters, annualized growth slowed to just above 7 percent in the second quarter. Banks have also noted customers’ concerns about current and short-term economic conditions, which are contributing to a decline in the number of construction projects under way. In the April 2019 Senior Loan Officer Opinion Survey, banks discussed the possibility of reducing certain lending such as CRE, including construction loans, given economic uncertainty. (see the chart).
Commercial and industrial loans had another quarter of good growth, just over 6 percent. As with the CRE portfolio, concern has been growing about exposures to highly indebted businesses, because these businesses face increased risk of bankruptcy earlier in any downturn. Consumer loans have declined consistently over the last four quarters. Concern over the health of the consumer and rising delinquency rates could be driving the decrease, though the drop started around the same period as consumer rates (such as those on credit cards) began increasing.
Capital
Capital levels have kept pace with banks’ growth due to sustained earnings, stable asset quality, and manageable dividend payouts. Sixth District community banks had a median tier 1 common capital ratio of 15.6 percent in the second quarter, basically unchanged from the prior year (see the chart).
Although median risk-weighted asset growth in the second quarter slowed year over year, growth increased over the prior two quarters. Net income and changes in other comprehensive income also contributed to the capital growth in the second quarter. Treasury stock transactions slowed during the quarter as banks had fewer stock repurchases (see the chart).
Close to 99 percent of community banks in the District are considered well capitalized based on their current capital ratios. On an aggregate basis, the dividend payout ratio increased year over year in the second quarter of 2019, rising to 37.9 percent from 29.1 percent in 2018.
Earnings Performance
On an aggregate basis, second-quarter earnings for Sixth District community banks were stable and reflected national trends. The percentage of banks with net losses has reached its lowest level since the financial crisis, with only 4.6 percent reporting a net loss (see the chart).
Compared with the prior year, earnings increased by 1 basis point to 1.4 percent, despite concerns about declining interest rates. The key earnings driver, net interest margin (NIM), remained above 4 percent, little changed from the prior year. Changes in loan yields helped keep NIM stable for the quarter. Still, an increasing number of banks reported a decline in their NIM. Through the second half of 2019, smaller community banks are expected to face margin compression as the cut in interest rates negatively affects loan yields, while competition for deposits continues in the short term, preventing funding costs from repricing as quickly as assets (see the chart).
Provision expense was relatively flat compared with the prior year, given continued healthy asset quality. Noninterest income increased, but as a percentage of total revenue, continues to decline as loan volumes have pushed interest income higher in recent quarters. Banks also continue to closely monitor noninterest expenses. The efficiency ratio dropped below 56 percent in the second quarter. Banks are increasingly employing new technologies that have improved efficiencies and lowered costs.
Liquidity
Overall, liquidity remains strong. At the beginning of the year, many banks were concerned about losing deposits if interest rates continued to rise. The recent increase in merger activity is, in part, a reaction to the need to secure more low-cost deposits. However, the recent rate cut by the Federal Reserve may help banks hold deposits over the short term and reduce the potential to rely more heavily on borrowed money to fund future loan growth. Deposit growth for community banks in the Sixth District remained above 3 percent on a median basis, while dependence on noncore funding remained extremely low compared with historical levels (see the chart).
In general, deposits have kept pace with asset growth. The loan-to-deposit ratio has stayed just over 80 percent during the last 12 quarters. Smaller community banks are increasingly using data analytics to target specific communities to aid in deposit gathering and improve their ability to compete with larger banks. Transaction accounts represented 32 percent of total deposits in the second quarter 2019, a significant increase over 2008, when transaction accounts represented just 16 percent of deposits. Median on-hand liquidity for community banks was slightly higher—18.6 percent—than the ratio for banks outside the District, which was 16.8 percent (see the chart).
National Banking Trends
Nationally, the return on average assets (ROAA) for community banks with assets less than $10 billion improved slightly year over year, increasing 7 basis points, while ROAA for larger banks remained the same as the prior year (see the chart).
Net interest margin (NIM) remained little changed from the previous year. NIM at community banks increased by 2 basis points; NIM at banks with assets greater than $10 billion increased by 7 basis points. A variety of factors are influencing NIMs. For example, competition is putting intense pressure on loan pricing, which is helping drive NIM lower (see the chart).
Banks continue to see non-interest-bearing deposit balances move lower as yields have risen on other products. The shift in non-interest-bearing deposits is helping to keep deposit rates stable at a time when long-term rates are declining. Additionally, many see the current interest rate environment as more volatile than at any point since the financial crisis.
Balance sheet growth persisted in the second quarter of 2019, aided by lower loan rates. Overall, annualized asset growth was 4.5 percent, consistent with the prior quarter. Loan growth was stronger, increasing 6.4 percent on an annualized basis. Loan growth for community banks turned positive for the first time in three quarters on an aggregate basis (see the chart).
Banks have noted for several quarters that stiff competition from nonbanks was affecting new loan growth. Some banks have discussed pulling back on lending over concerns about a possible downturn over the near term, consistent with information reported in the April 2019 Senior Loan Officer Opinion Survey. Banks have also noted customers’ concerns about current and short-term economic conditions.
Credit quality remained strong in the second quarter. Nonperforming loans as a percentage of total loans declined from the prior quarter and prior year (see the chart).
The allowance for loan loss, as a percentage of noncurrent loans, is the highest in 10 years. Charge-offs ticked up slightly from the prior quarter but declined by 6 basis points year over year. In recent quarters, credit card delinquencies spiked as interest rates rose but started to return to lower levels within a few quarters. Although banks generally have maintained strong underwriting practices in the current credit cycle, there are some indications that loan competition may be pushing banks into riskier or poorly structured loans. More banks are reporting loans with fewer covenants, which reduces their protections during a downturn in the economy.
Regulatory capital ratios are healthy, reflecting current earnings levels and strong credit quality. The dividend payout ratio has increased in recent quarters, as banks have not seen asset growth accelerate as quickly as in other late credit-cycle periods. In general, stock repurchases are exceeding stock sales for banks. Still, the total capital ratio for banks is greater than 11 percent, which would be considered well capitalized. The number of banks under some regulatory action similarly continues to decline.