National, Regional Banking Conditions Detailed in Latest “ViewPoint”
Asset Quality :: Balance Sheet Growth :: Capital :: Earnings Performance :: Liquidity :: National Banking Trends
At the end of the first quarter of 2020, asset quality ratios were basically unchanged from the prior quarter. On a median basis, loans that were between 30 and 90 days past due increased slightly, while the percentage of nonaccrual loans dropped slightly. However, given the uncertain economic outlook, the credit environment is expected to deteriorate in 2020. Stay-at-home orders have led to concerns about CRE and C&I loans to restaurants, retail stores, and entertainment venues across the Sixth District, especially in larger tourist markets like Miami, New Orleans, and Orlando. Additionally, banks are concerned about energy exposures as a result of lower energy usage and a sharp drop in prices. In preparation for a significant change in asset quality, median reserve levels increased in the first quarter of 2020 after trending downwards in 2019 (see the chart).
Community banks based in Georgia and Louisiana noted that qualitative factors such as higher unemployment levels have driven substantial increases in their allowance for loan losses during the first quarter. Over the short term, call report data might not completely reflect problems with asset quality. The majority of banks in the District have provided assistance in the form of loan deferments across a variety of loan portfolios, including residential mortgages and C&I loans to small businesses. These deferrals allow customers to either make no payments or partial payments over a defined period, usually six months or less. New regulatory guidance indicates that as long as borrowers were current on payments at the time of modification, deferred loans should generally not be considered past due during the deferral period.
Balance Sheet Growth
In the first quarter, annualized balance sheet growth remained strong, increasing by more than 5 percent, consistent with the prior quarter (see the chart).
Balance sheet growth remains primarily driven by increases in lending, as securities holdings have decreased in recent quarters. Banks have slowed reinvestments in debt securities as yields have declined. Median loan growth exceeded 4 percent for the quarter, driven by a significant increase in C&I lending. Although accounting for a comparatively smaller portion of portfolios, community banks in the Sixth District used the Small Business Administration’s Paycheck Protection Program (PPP) and other emergency loan programs to drive growth, as demand collapsed for other loan products. Median C&I growth for the quarter was just over 5 percent and will continue to increase in the second quarter due to a second round of authorized funding for PPP. Banks have indicated that participation in the program has generated goodwill among both existing and new clients, and they hope to gain C&I market share over the long term as a result. Until the COVID-19 crisis, commercial real estate (CRE) was the primary focus for many banks (see the chart).
Annualized growth in the portfolio was above 5 percent, continuing a rebound from a slow third quarter of 2019. As a result of containment efforts related to the outbreak, shifts in CRE are expected, especially in sectors heavily affected by the lockdown, including lodging, restaurants, and retail and office properties. Several large companies have announced that they will allow employees to work from home on a permanent basis. As a result, banks may be more cautious with office lending, which may slow growth in the CRE portfolio. Residential mortgage growth remained steady at 3.5 percent on a median basis as lower interest rates helped drive refinancing activity, while new purchases slowed toward the end of the quarter. Consumer loans continued to shrink, a combination of lower demand and tighter underwriting standards. Median balances declined more than 1 percent across all community banks in the District, continuing a six-quarter trend. Record unemployment and tighter standards are expected to result in a decline in consumer loan balances.
The majority of banks entered the first quarter with healthy capital levels. Banks have reported a median growth of tier 1 common capital (T1CC) between 1 percent and 2 percent per quarter over the last six years. In 2020Q1, T1CC increased by 1.3 percent on a median basis, driven by holding company transactions and capital stock sales, offset by lower earnings (see the chart).
Although current capital levels are generally stronger than those found at the beginning of the Great Recession in 2008, concern exists that heavy use of credit lines may negatively affect capital. Additionally, borrowers hit by the pandemic may expose banks to greater credit risk and the potential for significant charge offs in the coming months. Many publicly traded banks have suspended their share repurchase programs and are closely reviewing dividend levels. Beginning the first quarter of 2020, community banks with less than $10 billion in assets and a small portfolio of trading assets and derivatives were allowed to report capital using the community bank leverage ratio (CBLR), which is calculated as the ratio of tier 1 equity to average total consolidated assets. Though the initial rule required banks to maintain a CBLR of at least 9 percent, as a result of the disruption caused by COVID-19, Section 4012 of the CARES Act directed the federal banking agencies to temporarily lower the CBLR. In April 2020, the agencies issued interim final rules that lowered the required CBLR to 8 percent, with a gradual increase back to 9 percent by 2022.
In the first quarter, the median ROAA for community banks fell below 1 percent for the first time since the fourth quarter of 2017 (see the chart).
However, the percentage of banks reporting net losses decreased. Provision expenses rose sharply in anticipation of a substantial increase in COVID-related delinquencies in the second quarter. Most community banks in the District have not adopted CECL, but even under the existing incurred-loss method, provisions were higher during the quarter. In addition, for the second consecutive quarter, the number of banks reporting a lower net interest margin (NIM) exceeded the number reporting a higher NIM (see the chart).
Interest rates declined significantly in the first quarter, with long-term rates plunging. NIM fell as loans repriced downward more quickly than deposit costs did. The pace at which banks are lowering deposit rates has not been as rapid as the Fed's emergency rate cuts. Noninterest income also declined slightly during the quarter as lower spending reduced bank fees. Second-quarter income is expected to increase because of fees generated by the PPP program as well as more consumer spending as lockdown restrictions ease. On the noninterest expense side, banks reported short-term spending increases related to the pandemic, including bonuses for front-line workers, new equipment for teleworking, and additional janitorial expenses for cleaning and sanitizing. Longer term, banks are considering reducing labor costs partly because of increased digitization.
Most banks entered the first quarter in a strong liquidity position. Over the last three quarters, ending in the first quarter of 2020, median deposit growth has exceeded 4 percent despite a decline in interest rates. Larger banks experienced more significant growth in the first quarter as commercial customers deposited funds from defensive draws on credit lines. Although some banks reported high cash withdrawals during late March and early April, the median on-hand liquidity ratio among community banks in the District rose above 20 percent for the first time since the first quarter of 2014 (see the chart).
Balances continued to grow in the second quarter as lockdown conditions limited spending in many families. However, as a result of COVID-19 and some of the actions taken by governmental authorities to mitigate the impact of the outbreak, banks faced more challenges in managing their liquidity positions. Although the increased deposits benefit banks in the short term, banks’ profitability could suffer if the deposits cannot be turned into additional earning assets. If commercial customers continue to heavily use their credit lines and depositors experiencing credit problems use their cash balances, it could create more liquidity pressure in future quarters. Some banks are already facing additional liquidity pressures related to mortgage servicing. Contractually, servicers are required to advance funds for a period of time even when mortgage payments have been deferred.
National Banking Trends
The first quarter of 2020 presented formidable challenges for banks. Pandemic-related uncertainty damaged businesses and households and drove a variety of actions that will affect banks. Due to the uncertainty and concerns about the economy, the Federal Reserve lowered its benchmark rate to near zero in March. The near-zero interest rates pushed the net interest margin downward in the first quarter, dropping 24 basis points (bps) across banks of all sizes (see the chart).
The overall return on average assets (ROAA) declined by 99 bps in the first quarter compared with a year earlier (see the chart).
Just over 8 percent of banks reported a loss for the quarter. The decline in earnings was sharpest among large banks with assets greater than $100 billion. Provision expense drove a large part of the decrease in earnings by climbing over 100 bps. Many banks raised their provision for loan losses from the prior quarter, citing the significant change in the economic scenario from the coronavirus pandemic. Results in the first quarter of 2020 at some of the larger banks also reflected the current expected credit losses (CECL) accounting methodology, as well as the impact of coronavirus and market-related valuation adjustments.
Data from the call report show banks had annualized asset growth of 34 percent during the first quarter, a significant jump over the prior four quarters (see the chart).
Because of the high level of uncertainty, large drawdowns of credit lines by commercial customers to ensure availability and liquidity for themselves drove first-quarter growth. Banks with a strong commercial and industrial (C&I) portfolio experienced the largest annualized loan growth increase in more than 20 years. Commercial loan growth also accelerated across much of the banking industry as lenders funded thousands of federally backed small business loans under the Small Business Administration’s new Paycheck Protection Program. The increase in C&I lending (banks were prepared to start processing a second round of applications at the beginning of the second quarter) was offset by a decline in most consumer loans. Consumer demand diminished quickly, particularly for personal loans, while banks reduced credit lines and stopped taking applications for new home equity products. Banks report that tighter underwriting standards could cause loan growth to slow or turn negative in the second quarter.
Asset quality ratios remained little changed from the prior quarter, with noncurrent loans increasing slightly but remaining below 1 percent as a percentage of total loans (see the chart).
Banks are anticipating noncurrent loans to rise significantly in the second quarter as the impact of the lockdowns that resulted from COVID-19 hits businesses and consumers. However, the full impact of the COVID-19 closures won’t be known until deferral periods expire and payments are set to resume. Some banks have indicated that second deferrals will be offered upon request, if borrowers qualify, which could further delay recognition of issues. Loans to companies in industries closed because of COVID—particularly hospitality, tourism, and restaurants—are expected to be hit hard. Despite the pressure, some banks are well positioned to navigate a deterioration in credit conditions.