National, Regional Banking Conditions Detailed in Latest “ViewPoint”

April 2, 2021

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

Asset Quality

Based on reported credit metrics, asset quality was considered healthy at community banks in the Sixth District as of the fourth quarter of 2020. Key metrics include loans past due, nonaccrual loans, and charge-off ratios. Based on call report data, the percentage of loans reported as past due 30–89 days increased slightly, to 0.39 percent, up 7 basis points (bps) from the prior quarter but down 23 bps from the fourth quarter of 2019. The percentage of loans past due 90 days or more also dropped to a record low level. Nonaccrual loans increased slightly from the prior quarter but remained 10 bps lower than the prior year-end, at 0.36 percent. Banks reported their lowest level of new nonaccrual loans since the first quarter of 2018. Net charge-offs usually increase at year-end as banks clean up their balance sheet to begin a new year, but the net charge-off ratio was lower—0.2 percent—in the fourth quarter 2020 than a year earlier (see the chart).

Stable asset quality metrics reflect the aid provided to borrowers in 2020, through stimulus, government programs like the Paycheck Protection Program, and suspension of negative credit reporting through the CARES Act. Aid provided to customers included forbearance programs that allowed borrowers to delay payments or reconfigure payment amounts. The first wave of forbearance programs began winding down late in 2020. Banks report that borrowers exiting programs have resumed payments as expected. Still, concerns remain, with the largest challenge likely to be commercial real estate loans, particularly in the retail and hospitality industries. Reserve levels at community banks in the District have held steady since last spring despite nonaccrual loans not rising as rapidly as expected. As a result, provisioning slowed significantly in the quarter, but reserve levels remained elevated as banks hope the reserve cushion built during the first half of 2020 will absorb any loan losses that may still unfold due to the effects of the pandemic. Reserves have generally been set according to economic scenarios that appear to be worse than what has actually unfolded, especially after unemployment rates across most the states in the District declined significantly from last spring (see the chart).



Balance Sheet Growth

Despite weak demand for loans, median annualized asset growth at community banks in the Sixth District exceeded 18 percent in the fourth quarter 2020, the second consecutive quarter that growth was above 10 percent (see the chart).

An ongoing surge in deposits is fueling asset growth as banks deploy deposits. On an annualized basis, deposit growth was just under 20 percent in the fourth quarter of 2020. Given current economic conditions, it’s unclear when customers may start reducing their balances, making it hard for banks to determine an appropriate use for the elevated levels of deposits. Some banks are trying to limit their risk in the current environment by using the deposit influx to either buy additional securities, hold larger cash balances, or repay other borrowings. While security portfolios usually expand and contract based on the lending cycle, cash and due from accounts typically make up a very small portion of the balance sheet. However, the percentage is growing as bank managements struggle to find appropriate ways to deploy the deposits. Despite maintaining elevated cash balances and repaying borrowings, some banks have indicated they will issue debt, if rates stay at their current near-zero levels, to better position themselves for when the economy improves.

Though loan demand remained weak through year-end, especially among commercial customers, loans remained a key asset growth driver, increasing 9 percent year over year on a median basis. A number of banks are diversifying their lending efforts outside traditional product lines or markets (see the chart).

For many community banks, commercial real estate (CRE) remains the largest exposure on the balance sheet. Smaller community banks usually lend on CRE properties connected to the retail industry, however, pandemic restrictions are having an adverse impact on foot traffic, negatively affecting sales and reducing cash flow. As a result, banks are increasingly limiting their exposure to retail, dragging down potential growth. Since the start of the pandemic, community banks have turned to commercial and industrial (C&I) lending, which has primarily centered on the SBA’s Paycheck Protection Program (PPP). New originations for the first round of PPP loans ended in early August and as a result, C&I loans declined quarter over quarter in the fourth quarter of 2020. Much of the decline in loans was due to paydowns or loan forgiveness. A new round of PPP funds was authorized in late December. Other growth has occurred in residential mortgages, given lower interest rates and the intense competition in the housing market. However, banks are competing against other lenders, such as nonbanks and credit unions, to originate residential loans. Residential loan growth at other lenders has been much stronger than at banks, suggesting both caution by banks in the current market and consumer preference for options provided by other lenders. The rapid rise in house prices could provide more opportunities to originate new home equity lines of credit, though many banks remain hesitant, given the amount of charge-offs in the last economic downturn.


Capital

When the pandemic started affecting economic conditions, protecting capital was a key concern for both banks and regulators. Banks limited repurchases of shares and monitored dividend levels closely, especially as earnings declined in the second quarter. The Federal Reserve adopted measures to ensure the largest banks maintained high levels of capital resilience. At year-end, capital ratios remained satisfactory for a majority of community banks within the Sixth District. Most banks in the District are eligible to use the community bank leverage ratio (CBLR). On a median basis, the CBLR was 10 percent in the fourth quarter, well above the lower 8 percent threshold set for 2020 by federal banking agencies as a temporary measure under the CARES Act. The CBLR is still set to gradually return to a 9 percent level by 2022. From a risk-based capital perspective, on a median basis, the tier 1 common equity capital was still above 10 percent (see the chart).

Risk-weighted asset growth continued to decline as banks shifted away from the loan portfolio into less risky assets such as cash and agency securities. Both types of assets receive lower risk weights, with cash at 0 percent. Additionally, many of the loans added to the balance sheet in 2020, particularly Paycheck Protection Program (PPP) loans, have government guarantees. The guarantee allows management to risk-weight the loans well below the 100 percent weight that many loans typically receive. With asset-quality metrics remaining healthy, provisions for loan losses declining, and capital ratios holding steady, many banks have resumed capital actions, including paying dividends and repurchasing shares.


Earnings Performance

Consistent with national trends, earnings among Sixth District community banks held steady at year-end, as management focused on matching funding costs with interest income and stable asset quality limited provision expense. Median return on average assets was 0.97 percent, basically unchanged over all four quarters in 2020 and down 13 basis points from the fourth quarter of 2019 (see the chart).

The vast majority of banks reported positive earnings in the fourth quarter with only 5 percent of community banks in the District reporting a net loss, down from 6 percent in the fourth quarter of 2019. The low interest rate environment continues to challenge bank earnings. Nevertheless, a greater number of banks reported an increase in net interest income than reported a decrease in the fourth quarter (see the chart).

With loan growth slowing, banks have turned to the securities portfolio in an effort to find higher-yielding assets, typically agency securities and municipalities. Although yields on securities portfolios are lower than on the loan portfolio, the investments have helped banks manage margin pressures in the short term. At the same time, the overall cost of funds has declined significantly as large balances of liquid assets allowed banks to continue to reduce deposit rates. For example, the cost of savings deposits has dropped to the lowest levels seen since the end of the recovery from the Great Recession. Given net interest margin compression, banks have become more focused on generating noninterest income and controlling noninterest expense. In the fourth quarter, noninterest income represented 20 percent of total revenue for community banks in the District, up from 15 percent in 2018. Service charges and fees represent a significant portion of noninterest income, especially for smaller community banks. After waiving many fees during the spring in response to initial job losses, which had a negative impact on noninterest income, most banks had reinstated fees by the end of the fourth quarter (see the chart).

The median efficiency ratio increased during the quarter as banks still faced higher costs associated with operating during the pandemic. Management is evaluating which costs are essential to operating safely and which costs can be targeted for reduction as a part of greater expense control.


Liquidity

Liquidity remained strong in the fourth quarter as deposits continued to grow. The median on-hand liquidity ratio among community banks in the District rose to 27.8 percent, the highest level in more than 16 years (see the chart).

Credit-line drawdowns, federal aid payments, and a general slowdown in consumer spending have contributed to higher balances in transaction and savings accounts. Low-cost transaction accounts now make up 38 percent, on a median basis, of total deposits, and savings and money market accounts make up 23 percent (see the chart).

Growth in transaction and savings deposits has more than offset overall declines in time deposits as rates have dropped. Deposits have remained surprisingly strong into early 2021. Prior to the second round of direct stimulus, banks were beginning to see increased withdrawals from deposit accounts; however, with new stimulus payments starting in March 2021, deposits will likely remain at record levels. Banks have placed greater emphasis on digital banking, particularly via mobile apps, in reaction to shifts in customer behavior. As a result, several of the Sixth District’s largest banks have announced plans to reduce ranch footprints. A handful of banks have indicated that the pandemic has accelerated strategic moves from in-person to online banking. Still, most of the banks closing branches stressed that retaining in-person banking in some capacity remains important to maintaining customer relationships.


National Banking Trends

Even with the continuing economic uncertainty connected to the pandemic, many banks reported higher earnings in the fourth quarter of 2020. On an aggregate basis, return on average assets (ROAA) climbed 14 basis points (bps), quarter over quarter, to 1.10 percent, but was still down 9 bps from the fourth quarter of 2019 (see the chart).

Improvement in the aggregate ROAA was due to a combination of better expense control, higher noninterest income related to mortgage refinancing, and lower provision for credit losses. Overall, net interest margin (NIM) stabilized at 2.58 percent, the same as the prior quarter, primarily the result of lower funding costs (see the chart).

Banks with assets less than $10 billion experienced a slight improvement in their NIMs but continue to search for higher-yielding assets given surging deposits and the low interest rate environment. Despite the heightened uncertainty, banks were able to either maintain or reduce their level of provision for loan losses in the fourth quarter as current economic support programs have reduced credit quality pressures in the near term. Banks that have adopted the current expected credit loss model were most likely to report a decline in provision expense.

Balance sheet growth accelerated in the fourth quarter, with an annualized growth rate of 12 percent. However, in contrast to the period before the pandemic, loans did not drive growth, as the annualized loan growth rate turned negative for the quarter. Smaller community banks experienced the sharpest decline in loan growth (see the chart).

Banks reported quarterly decreases in both commercial real estate and commercial and industrial loans. Much of the decline in loans was the result of paydowns or loan forgiveness connected to the Small Business Administration's Paycheck Protection Program. Consumer loan originations have also decreased dramatically, reversing trends experienced over the summer. Only closed-end, first-lien residential loans have experienced a noticeable increase, due to the shortage of available homes and a sharp increase in prices. Yet, in some cases, banks’ overall residential loan balances declined because mortgages continued to prepay and exceeded new loan production. Slower loan growth, coupled with healthy deposit growth, led to higher balances in cash accounts and the securities portfolio.

Despite significant concerns about loan repayments because of high levels of unemployment, asset quality stayed strong at most banks. The percentage of loans past due 90 days or more remained basically unchanged from the prior quarter and the prior year. Noncurrent loans as a percentage of total loans remain just above 1 percent, below levels reported when the recovery from the Great Recession began. Among the three groups tracked, only banks with assets above $10 billion have experienced a slight increase in noncurrent loans over the last three quarters (see the chart).

Customer loan payment performance continued to improve overall, with some banks reporting extremely low past-due loan levels. However, retail delinquencies were still elevated in comparison to other commercial borrowers. So far, banks are reporting that the majority of consumer and mortgage borrowers that have transitioned out of forbearance have stayed current in their payments.

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