National, Regional Banking Conditions Detailed in Latest “ViewPoint”

September 30, 2021

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

Asset Quality

Consistent with national trends, banks in the Sixth District reported lower delinquencies and charge-offs compared with prepandemic levels in the second quarter of 2021 across a majority of loan portfolios. Overall, nonperforming assets (made up of loans past due 30 days or more, as well as nonaccrual loans) represent less than 1 percent of total assets. Asset quality metrics remained near historic lows for community banks, with loans past due 30–89 days falling to their lowest percentage of total loans in more than 16 years.

Specifically, banks noted that conditions among commercial real estate exposures continued to improve, aided by the economic reopening of markets most affected by the pandemic. In general, loans that are past due more than 30 days are not progressing to more than 90 days past due. Banks have a small percentage of loans on nonaccrual, but the level of those loans continued to decline in the second quarter of 2021. Amounts reported for properties repossessed or in foreclosure also remain low, in part due to the current credit environment, as well as government moratoriums on foreclosures. Healthy asset quality metrics have kept net charge-offs down and improved the reserve coverage ratio. The median allowance for loan losses to nonaccrual loans reached 2.7x in the second quarter of 2021, the highest level since 2007, before the 2007–09 financial crisis (see the chart).

Some of the improvement in asset quality metrics over the last four quarters is due in part to changes in loan modification requirements made under the CARES Act. However, banks have noted that the determination of when to discontinue reporting a loan modified under the CARES act is unclear. As a result, there may be some diversity in the way banks report modified loans, limiting the usefulness of the data on an aggregate basis. Still, according to data provided by banks, the amount of loans that remain in this program continue to decline. As fewer loans are reported, banks indicate that most borrowers exiting modifications remain current. Given the limitations on loan modifications set forth in the CARES Act, modification programs are ending with the expectation that at least some increase in problem loans will occur. A recent report produced by the Consumer Financial Protection Bureau appears to affirm that expectation.


Balance Sheet Growth

In the second quarter of 2021, median asset growth slowed to 12 percent, down from 16 percent in the second quarter of 2020, but remained elevated compared to the long‐term average. A rapid influx of deposits over the last four quarters among banks with less than $10 billion in total assets in the Sixth District has fueled strong asset growth. The slightly slower growth in the second quarter of 2021 was the result of lower deposit growth, up 14.88 percent year over year in the second quarter of 2021 compared with 16.82 percent in the second quarter of 2020. Stimulus payments directed to consumers came to an end early during the quarter, and consumers increased their economic activity, thus lowering the level of deposits at banks (see the chart).

Deposit growth could accelerate again beginning in the third quarter as many consumers will start receiving child tax credits in the same way they received stimulus payments.

As the Paycheck Protection Program (PPP) loan program closed, median loan growth contracted to less than 1 percent, compared with 12.06 percent in the prior year (see the chart).

Commercial and Industrial (C&I) loans contracted 14 percent with a reduction of new PPP originations and continued loan runoff due to a more streamlined loan forgiveness process from the Small Business Administration. C&I loan balances are expected to decline at banks that participated in PPP through the remainder of the year. Still, banks experienced some increase in business loan demand in the second quarter of 2021, but not enough to replace the level of demand for PPP. Additionally, the median balances in the consumer loan portfolio also declined, continuing a trend dating to late 2018. Consumers have received different types of stimulus payments that have curtailed demand at the same time that community banks have focused more on C&I lending with the PPP program. One of the largest consumer portfolios, vehicle loans, is also being affected by a shortage of new vehicles available to purchase. Two of the other primary loan portfolios, commercial real estate and residential real estate, experienced growth in the second quarter of 2021, although residential real estate was barely positive. Community banks face increasing competition from nonbanks for residential real estate loans but have not significantly loosened underwriting standards, which may explain the slower loan growth in the current housing market.

The commercial real estate portfolio experienced the strongest growth as economies in the District appeared to return closer to prepandemic norms. With deposit levels still elevated and increased runoff from PPP loans, banks increased their securities portfolios to gain additional yield on available liquidity. Year over year, the securities portfolio increased nearly 30 percent on a median basis. Community banks continue to purchase mostly Treasury bonds and agency securities (the latter being bonds issued or guaranteed by U.S. federal government agencies or bonds issued by government-sponsored enterprises), although there has been an increase in municipal security purchases as state and local government finances appear to have stabilized. Government securities represent the fifth largest on-balance-sheet exposure as a percentage of risk‐based capital among community banks in the Sixth District, exceeding both consumer, farm, and multifamily loans (see the chart).


Capital

Along with liquidity, capital levels at community banks in the Sixth District remained healthy in the second quarter of 2021 as earnings held steady, asset growth slowed, and asset quality was unchanged from the prior quarter. A little less than half of the banks use the community bank leverage ratio (CBLR) to calculate their capital. The median CBLR among banks using the ratio was well above the 9 percent threshold required. For banks using risk‐weighted assets, the median tier 1 common capital ratio remained above 12 percent. Across both measures, nearly all of the District’s community banks—97 percent—are considered well capitalized based on their current capital ratios. Retained earnings continued to be the primary driver of changes in capital levels, offset by common stock dividends (see the chart).

Still, on an aggregate basis, the dividend payout ratio in the second quarter of 2021 was 18.8 percent, less than half of the level in the second quarter of 2020. The improving economic outlook and stability within the banking system has allowed more banks to reconsider potential acquisitions. Multiple acquisitions have been announced targeting major markets across the Sixth District, including Tampa and Nashville.


Earnings Performance

Earnings for community banks in the Sixth District continued to rebound following the sharp decline experienced in the first quarter of 2020. Most markets in the Sixth District lifted their COVID‐19 restrictions in response to higher vaccination rates and changing medical guidance. More economic activity helped push the median return on average assets (ROAA) to 1.10 percent (see the chart).

The median ROAA for the quarter matched the same level as the fourth quarter of 2019, the last quarter not affected by the pandemic. More than 50 percent of banks posted a ROAA above 1 percent while just 4 percent reported a loss. Improving the net interest margin (NIM) remains key for banks in the district amid slowing loan growth, especially in the post-PPP environment, and elevated deposit levels. Based on call report data, the median NIM for the quarter was 3.46 percent, down from 3.71 percent reported in the year-ago period (see the chart).

A sizable number of banks reported higher net interest income, the most in nearly two years, yet a greater number of banks reported a decline in the NIM than an increase (see the chart).

Most of the improvement in net interest income was driven by higher volumes of earning assets, primarily securities, as loan growth stalled with the end of the PPP program. Banks continue to reevaluate provisions for credit losses given the current economic environment and levels of nonperforming assets. Although community banks in the district did not release their allowance, provision amounts in the second quarter of 2021 were generally half the level they were in the second quarter of the prior year, when conditions were so uncertain as a result of the pandemic.

Noninterest income as a percentage of total income increased above 20 percent during the pandemic. Banks continued to look for additional revenue sources as interest rates remained near historic lows. Outside NIM, smaller banks typically have fewer sources of noninterest income, including mortgage and overdraft fees. During the quarter, mortgage revenues fell at some banks as they faced more competition from other lenders and home buyers struggled to find new homes due to low inventories. Additionally, greater pressure is being put on banks to curb overdraft fees, which might further affect revenues through the remainder of 2021.


Liquidity

Liquidity remains healthy for the District’s community banks. Continued above-average deposit growth, along with a rapid reduction in loan growth, has provided increased levels of liquidity and reduced the need for noncore funding. Community banks historically receive a large portion of their funding from core deposits, which is the most cost‐effective way to fund asset growth. Deposit growth has occurred primarily in core, noninterest-bearing transaction accounts. The ability to increase deposits in the current environment has kept dependence on noncore funding extremely low compared with historical levels. Overall, transaction accounts represent more than 40 percent of total assets, a significant increase from 2008, when they accounted for 15 percent. Although deposit growth exceeded 10 percent again in the second quarter of 2021, median loan growth was less than 1 percent, dropping the loan‐to‐deposit ratio for community banks in the District below 70 percent, the lowest ratio in more than 20 years. The median on‐hand liquidity ratio exceeded 30 percent in the second quarter of 2021 and was slightly higher than peer banks in other districts. The on-hand liquidity ratio among banks in the Sixth District has more than tripled from its level in the second quarter of 2008, just before the financial crisis (see the chart).



National Banking Trends

Earnings dipped slightly in the second quarter of 2021 compared with the prior quarter, but they remained significantly improved year over year compared with earnings from the beginning of the pandemic. On an aggregate basis, ROAA among all banks was up 92 basis points, to 1.24 percent, compared with 0.32 percent as reported in the second quarter of 2020Q2 (see the chart).

Larger banks, with assets exceeding $10 billion, have experienced greater fluctuations in earnings due primarily to the adoption of the current expected credit loss (CECL) methodology of determining the allowance for credit losses. Across the industry, the percentage of provision expense to total loans jumped above 2 percent in the third quarter of 2020 but has since turned negative, dropping to –0.41 percent in the second quarter of 2021 as the larger banks have released reserves as a result of increased economic activity in recent months (see the chart).

While larger banks have experienced a significant fluctuation in earnings, the aggregate ROAA among community banking organizations (CBOs) has remained fairly stable throughout the pandemic, at 1.34 percent in the second quarter of 2021, almost the same as the second quarter of 2019 and up 22 basis points from the second quarter of 2020. A lower net interest margin, down 14 basis points year over year, has put increased pressure on earnings at CBOs (see the chart).

Given current margins, many CBOs are struggling with whether to sell loans into the secondary market to generate noninterest fee income and boost profitability in the short‐term or retain the loans at lower margins to make more effective use of current deposits.

With the end of the PPP, bank balance sheet growth slowed significantly in the second quarter of 2021 due to ongoing weak loan production. On an aggregate, annualized basis, assets grew by 4.3 percent across all banks. Growth was weakest among CBOs, growing by just 1.6 percent, the lowest annualized growth rate in eight quarters. Annualized loan growth across banks was barely positive, just 0.9 percent across all banks but down 3.4 percent among banks with assets less than $10 billion. Among CBOs, a majority reported a net year‐over‐year decline in total loans, primarily due to fluctuations in PPP loans. Now, CBOs are experiencing a high level of loan runoff due to the Small Business Administration easing the requirements for PPP loan forgiveness. Banks surveyed in the July 2021 Senior Loan Officer Opinion Survey reported easing their underwriting standards for several loan products, suggesting a return to prepandemic credit standards. At the same time, deposits continue to grow, up more than 10 percent from the second quarter of 2020. The elevated level of deposits has contributed to a need to deploy the deposits into earning assets and generate interest income. Early data from bank reports suggest some loan growth will return in the third quarter.

Although loan growth remained anemic, asset quality stayed healthy at banks as of the second quarter of 2021. The percentage of nonperforming loans (loans past due 30 days or more) was less than 1 percent at the end of the second quarter, the lowest percentage since the start of the pandemic (see the chart).

On an aggregate basis, the percentage of the allowance for loan losses to nonaccrual loans exceeded 230 percent in the second quarter of 2021 at CBOs, a significant increase from prepandemic levels. Part of the reason for the higher coverage is the decline in nonaccrual loans. CBOs reported the lowest percentage of nonaccrual loans in more than three years, which has fueled optimism that net losses will not match the losses experienced during the financial crisis that began in 2008. Yet, given the economic stimulus during the last 18 months, which provided a bridge over the pandemic recession and aided in avoiding delinquencies and charge‐offs, the ultimate level of losses may be partially dependent on shifts in stimulus policy.

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