National, Regional Banking Conditions Detailed in Latest “ViewPoint”

January 8, 2021

Asset Quality :: Balance Sheet Growth :: Capital :: Earnings Performance :: Liquidity :: National Banking Trends 

Asset Quality

On the surface, asset quality metrics reported by community banks have remained healthy. The percentage of loans reported as past due 30–89 days held steady from the prior quarter and was down 17 basis points on a year-over-year basis, at 0.31 percent. Loans past due 90 days or more, as a percentage of total loans, also dropped. Nonaccrual loans dropped to their lowest percentage of total loans since the third quarter of 2007 (see the chart).

Asset quality ratios have improved as borrowers received forbearance in the first and second quarters. Forbearance provided multiple ways to aid borrowers, including delaying payments for a specified period. Borrowers who missed payments could make them up over time periods of varying lengths, sometimes even adding the payments to the end of the loan term. Borrowers began exiting forbearance plans at the end of the third quarter, with few borrowers needing extensions through next year. The majority of loans that have remained in forbearance are commercial real estate (CRE) mortgages, with a significant portion belonging to hotel and retail borrowers, two of the hardest-hit commercial property sectors. Community banks in the Sixth District continued building their allowance for loan losses in the third quarter, although not as sharply as the prior quarter, as concerns eased about the potential depth of losses. One concern is that, with banks in the District having a high CRE loan concentration, they could be vulnerable if economic conditions lead to a CRE downturn. Already, valuations of some office, hotel, and retail properties are declining, diminishing the value of collateral. Revenues for hotel properties are not expected to recover fully for at least another 24 months. Should CRE borrowers exit forbearance plans and not perform, it could cause asset quality metrics to deteriorate quickly and result in higher losses for banks (see the chart).

Balance Sheet Growth

Community banks in the Sixth District continued to experience strong asset growth in the third quarter of 2020, even as economic uncertainty remains heightened due to COVID-19. On an annualized basis, median asset growth was 16 percent for the second consecutive quarter (see the chart).

Loans drove a majority of asset growth, increasing 11 percent year over year. Despite the increase, loan growth was virtually nonexistent outside of residential mortgages and Paycheck Protection Program (PPP) loans. For the year, many Sixth District community banks reported that their commercial and industrial (C&I) portfolios more than doubled as a result of the PPP and led to these banks gaining an increased share of the small business market. However, new originations for PPP loans ended in early August, and banks have shown little interest in further increasing their C&I portfolios in the current economic environment without government guarantees.

Residential mortgages continued to grow as consumers looked to either take advantage of lower interest rates or find houses with more space to accommodate working from home. Despite the rapid rise in house prices resulting from the lack of inventory, banks remained hesitant about originating new home equity lines of credit (HELOCs), preferring instead to remain in a first-lien position. Many banks had to completely charge off HELOCs during the last economic downturn and have limited the growth in this portfolio as a result. Commercial real estate (CRE) has remained the largest exposure on the balance sheet. Median annualized growth was muted in the third quarter, down 130 basis points from the median over the last five years, at 5.1 percent (see the chart).

Community banks in the District have traditionally held a higher concentration of CRE loans than their larger peers. The economic outlook remains troubling for retail, office, and hotels heading into the winter, with many restaurants uncertain whether they can operate in the cold-weather months.

On the liabilities side of the balance sheet, deposits increased by 17 percent. Banks have seen an influx of deposits as high levels of economic uncertainty, along with other factors related to COVID-19, have pushed savings rates to their highest level in 45 years over the past two quarters. Elevated levels of deposits and weak loan growth led banks to dramatically increase their holdings of Treasuries and other securities. Although current economic conditions have raised concerns about state and local government finances, banks also increased their exposure to municipal bonds, many of which carry higher yields than Treasury and agency securities. Banks also held a significant amount of cash in low-yielding interest-bearing accounts.


Capital ratios remained at satisfactory levels at most community banks within the Sixth District, with a tier 1 common equity capital above 10 percent (see the chart).

Although bank balance sheets in the District swelled in 2020, the growth has been concentrated in assets with low- or zero-risk weights, such as Paycheck Protection Program loans, Treasury securities, and cash balances. Management also reduced the level of share repurchase activity this year due to overall economic uncertainty, which further supported higher capital ratios. Despite higher provision amounts dragging down earnings in the first two quarters, a majority of banks have added to their capital base with retained earnings. Still, banks mostly kept their existing dividend payouts, even when it exceeded the current year’s earnings, knowing their importance to investors. Some banks have issued additional subordinated debt to protect capital in the short term. Most banks in the District are eligible to use the community bank leverage ratio (CBLR). While strong deposit growth in 2020 has affected leverage ratios, perhaps reducing the benefit of using the CBLR, under Section 4012 of the CARES Act, the federal banking agencies temporarily lowered the CBLR to 8 percent. The CBLR will gradually return to 9 percent by 2022.

Earnings Performance

Sixth District community banks’ earnings appeared to stabilize in the third quarter as asset quality remained steady and interest rates didn’t change significantly. Just over 5 percent of community banks in the District reported a net loss. The interest rate environment and economic uncertainty remained the biggest challenges to bank earnings in the third quarter. Median return on average assets was 0.97 percent, nearly identical to the prior two quarters but down 23 basis points from the third quarter 2019 (see the chart).

Improvement in provision expense, which declined slightly, was offset by lower interest income (see the chart).

A majority of banks reported lower net interest margins (NIM) in the third quarter, continuing a four-quarter trend. Lower-yielding Paycheck Protection Program loans remained on originating banks’ balance sheets despite many stakeholders expecting that the loans would be forgiven by the end of the third quarter. Banks also had difficulty finding creditworthy, higher-yielding assets, such as loans, to drive interest income. Banks would likely not gain much incremental income by reaching farther out on the credit risk yield curve. Instead, banks have added more securities and kept higher cash amounts on the balance sheet, negatively affecting NIMs (see the chart).

Interest expense continued to decline as costs for deposits remained extremely low, and higher deposit balances allowed banks to reduce other borrowings. Banks pulled back on provision expenses during the quarter as they continued to assess potential delinquencies as a result of COVID-19. Loans continued to exit forbearance plans, and most performed under the modified loan terms. Noninterest income was down as banks have not been getting the same level of interchange fees from people using their debit cards. With the end of the third quarter and economic uncertainty due to the coronavirus pandemic lingering, noninterest expense cutting again became a hot topic among senior management. Management wanted to reduce ongoing expenses, such as closing branches as more customers move to digital platforms.


Traditionally, liquidity has been a key concern for banks. With the outbreak of COVID-19, banks have received an influx of deposits due to lower consumer spending, businesses conserving cash flow, and funds from the Paycheck Protection Program being deposited. The increase in deposits has provided banks with more challenges in managing their liquidity positions to protect net interest margins. On the positive side, the sharp deposit growth over the last two quarters has significantly reduced the reliance on borrowed funds and dropped the loans-to-deposits levels. Low-cost transaction accounts now make up 37 percent, on a median basis, of total short-term deposits, compared with 15 percent in 2009. However, because of a lack of lending opportunities, cash and securities balances have increased on the asset side of the balance sheet. New investments in the securities portfolio have primarily been in shorter-maturity products as banks considered the elevated deposit growth to be short term (see the chart).

Additionally, banks seemed more hesitant to invest in longer-term securities at historically low rates. Increased deposits and securities have put more liquidity on the balance sheet at most community banks in the District. On-hand liquidity at Sixth District community banks remained slightly higher than banks located in other regions. The median on-hand liquidity ratio among community banks in the District rose to 23.5 percent, the highest level since March 2013.

National Banking Trends

Despite continued economic uncertainty due to COVID-19, banks’ return on average assets (ROAA) rebounded in the third quarter of 2020, due to lower provisioning expense (see the chart).

On an aggregate basis, ROAA jumped to 0.96, slightly down from the third quarter 2019 but three times higher than the first and second quarters of 2020. As the Federal Reserve continues to keep its benchmark rate near zero percent, net interest margin (NIM) remains under pressure at most banks. In the third quarter, NIM dropped an additional 12 basis points, on an aggregate basis, to 2.58 percent. By comparison, NIM was 3.24 percent in the third quarter of 2019. In addition to the lower benchmark rate, banks have changed their asset mix to lower-yielding holdings, putting further downward pressure on NIM (see the chart).

Provisions for loan losses declined during the third quarter to 0.47 percent of average loans, on par with levels in 2019. The majority of the larger banks—those with assets exceeding $10 billion—adopted the new current expected credit loss (CECL) model for credit losses in 2020, which drove most of the higher provision expenses in the first two quarters. Through the end of the year, earning levels are expected to be less affected by additional COVID-related provision expenses and more by lower NIMs and noninterest income.

The COVID-19 pandemic has had a significant impact on banks’ balance sheets. On an annualized, aggregate basis, total assets increased 14.9 percent in the third quarter. Prior to the pandemic, loans were the primary growth driver for a majority of banks. In the third quarter, annualized loan growth was 5.9 percent, a little more than a third of total asset growth (see the chart).

Loan growth was the lowest in 10 quarters for banks with assets greater than $1 billion. Lending during the pandemic has generally been weak, outside of residential mortgages and a surge in commercial borrowing under the Paycheck Protection Program (PPP). The aggregate loans-to-deposits ratio has fallen to just 51.4 percent. The latest October 2020 Senior Loan Officer Opinion Survey shows that banks continued to tighten underwriting across nearly every loan category in the third quarter, which is one reason for the restricted loan growth. Since March 2020, assets on banks’ balance sheets increased primarily in the form of cash and securities, mostly Treasuries and agency securities. The combined effect of smaller increases in loan balances, along with holding larger balances in cash and securities, has resulted in a significant increase in liquidity on banks’ balance sheets.

Although economic conditions have caused concerns about asset quality, nonperforming asset ratios remained healthy (see the chart).

The percentage of loans in forbearance continued to decline. Only a few banks reported that either commercial or residential loans in forbearance exceeded more than 5 percent of their total loans. The percentage of loans past due 90 days or more remained basically unchanged from the prior quarter and prior year. Noncurrent loans as a percentage of total loans was slightly above 1 percent but remained below levels reported three years ago as the economy finally recovered from the 2008 crisis. At the same time, current capital levels (along with an elevated allowance for loan loss) have bolstered banks’ ability to absorb potential losses. The change in asset mix improved banks’ risk-based capital ratios. Loans with higher risk weights, such as commercial and residential real estate mortgages, are rolling off the balance sheet at a slightly faster rate than usual due to lower interest rates driving more prepayments. Banks are replacing them on the balance sheet with less risky assets such as cash, Treasuries, and agency securities.

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