July 5, 2022

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

Asset Quality

Two years after the beginning of the pandemic, most banks still report that asset quality conditions are satisfactory. A few metrics indicate that delinquencies are moving back toward historical norms for banks in the District, at least for newly delinquent loans as few loans are currently migrating to longer-term delinquencies. On a median basis, loans delinquent 30 to 89 days (as a percentage of net loans) remained unchanged in the first quarter of 2022 compared with the prior quarter at 2.7 percent, a level roughly half that experienced by banks in the five years prior to the pandemic. The percentage of loans past due 90 days or more also remained unchanged while the percentage of nonaccrual loans actually declined.

Current asset quality conditions allowed banks to reduce their allowance level in 2021 while maintaining a high ratio of allowance to nonaccrual loans. In the first quarter of 2022, the ratio exceeded 300 percent, or three times on a median basis, among community banks in the District, the highest level since 2006 (see the chart).

Some banks returned to positive provisioning in the first quarter as a result of more loan growth and more economic uncertainty surrounding supply chain issues and the impact of the Russian war in Ukraine. Several larger community banks that already adopted the current expected credit losses (CECL) model posted large negative provision expense in 2021, boosting earnings. Since most of the larger community banks are using the CECL model for the allowance credit losses and credit loss provisions, changes in economic projections over the life of the loan provide more input on provision levels. Uncertainties in the forecast will likely lead to higher provision amounts in the current quarter.

Balance Sheet Growth

Data from the call report indicated that median annualized balance sheet in the first quarter of 2022 was lower than one year earlier but remained comparable with growth rates in 2019 (see the chart).

Additions to the securities portfolio, which were up 31 percent on an annualized basis for the second consecutive quarter, drove most of the balance sheet growth as banks have yet to match their deposit base with new loan opportunities. Banks appear to be shrinking the duration of the securities portfolio in anticipation of further increases in rates. Median net loan growth was up an annualized 1.7 percent in the first quarter of 2022, slightly higher than the prior quarter, but down significantly from one year earlier, when the last Paycheck Protection Program (PPP) loans originated. Since the third quarter of 2021, banks have been working with governmental agencies on forgiving outstanding PPP loans, providing the appropriate conditions have been met.

Forgiveness of PPP loans is masking some of the loan growth at the aggregate level seen across portfolios over the last three quarters. After dipping in the fourth quarter of 2021, residential loan growth returned, up 3 percent annualized, as the spring selling season brought more buyers to the market ahead of increasing mortgage rates. In addition to first lien mortgages, banks have also returned to providing home equity lines of credit (HELOCs) after avoiding the product for nearly 10 years. Commercial real estate (CRE) growth was also healthy as retail properties have rebounded in recent quarters and industrial properties are still in high demand. Despite the current CRE growth, banks are becoming more wary of lending on office properties as the level of demand for space is uncertain due to continued remote work arrangements, and demand seems to be centered on newer properties (see the chart).

Although a smaller portfolio, consumer lending had annualized growth of 3.8 percent, the strongest growth in this portfolio in five years. Changes in interest rates and higher prices may be contributing to the increased use of financing through banks. New vehicle loans were one of the drivers of the growth as prices continue to rise, following a similar dynamic as housing since automakers have struggled with supply chain issues. On the other side of the balance sheet, deposit growth continued to exceed prepandemic norms at 7.6 percent, but growth declined from the prior two quarters. Deposit balances are expected to gradually decline at banks in 2022 due to higher interest rates and higher costs for consumers (see the chart).


On a median basis, capital levels remain healthy and exceed the ratios required to be considered well capitalized. Although earnings were not as strong as the prior year, stable asset quality and slower deposit growth kept capital ratios stable (see the chart).

The aggregate level of the community bank leverage ratio (CBLR) indicates that a majority of the banks using the CBLR met the 9 percent minimum required in the first quarter of 2022. Still, the aggregate CBLR declined in the first quarter, as balance sheet expansion over the last two years continued to put downward pressure on the ratio. Downward pressure on risk-based capital ratios has not been as pronounced as risk-weighted asset growth (the ratio’s denominator) turned negative due to the addition of highly liquid assets to the balance sheet, which caused risk-weighted assets to decline.

As the interest rate environment changes, banks are experiencing higher levels of unrealized losses, some of which are captured in accumulated other comprehensive income (AOCI). Smaller community banks had a choice of whether to opt out of including AOCI fluctuations included in the capital calculation in the first quarter of 2015, which would now limit the impact that changes in the securities portfolio’s valuation had on capital in the first quarter of 2022. Common stock dividends also increased year over year as management has had limited opportunities to effectively deploy capital.

Regarding the opt-out election, an institution (except an advanced approaches institution) must make its AOCI opt-out election on the institution’s March 31, 2015, call report. For an institution that came into existence after March 31, 2015, the AOCI opt-out election must be made on the institution’s first call report. Each of the institution’s depository institution subsidiaries, if any, must elect the same option as the institution. With prior notice to its primary federal supervisor, an institution resulting from a merger, acquisition, or purchase transaction may make a new AOCI opt-out election, as described in section 22(b)(2) of the regulatory capital rules.

Earnings Performance

Earnings at community banks in the Sixth District weakened in the first quarter of 2022, following the typical seasonal decline in the fourth quarter of 2021. On a median basis, return on average assets (ROAA) dropped to 0.87 percent, the lowest since 2017. Reflecting this decline, a greater percentage of banks reported ROAAs below 1 percent. Among state member banks in the District, roughly half had ROAAs below 1 percent (see the chart).

Consistent with community banks nationally, net interest margins weighed on earnings, as 70 percent reported a decline in net interest margin in the first quarter of 2022. The median net interest margin for the quarter declined to 3.16 percent. Rising rates, moderating loan growth, and lower deposits were all factors contributing to the decline. Although the Federal Reserve did not begin to raise the fed funds rate until late March, higher rates are still expected to boost margins, likely in late 2022 or early 2023 (see the chart).

The timing for higher margins will be driven by balance sheet composition, such as loan portfolios (commercial and industrial loans tend to have floating rates), the securities portfolio, deposit levels, and deposit composition.

Noninterest income represented 20 percent of total income in the first quarter of 2022. Lower noninterest income also impacted ROAA as larger community banks reassess their fees in the wake of banks with assets greater than $50 billion either reducing or eliminating overdraft fees. Service charges and other depository fees represent a majority of noninterest income at community banks in the Sixth District. Banks will likely continue to charge overdraft fees, but the fees might not produce the same level of revenue as in prior quarters. The efficiency ratio rose in the first quarter of 2022, reflecting the increase in noninterest expense from the prior year. Like other industries, banks continued to struggle with attracting and retaining employees as well as higher costs associated with technology, supplies, and outsourced services. Banks are searching for more technology solutions to both offset some labor shortages and compete with newer firms that provide financial services.


Liquidity for most community banks in the Sixth District remained healthy and a source of strength during a period of rising rates. In general, banks in the District are very liquid, with higher levels of securities, deposits, and cash than was the norm prior to the pandemic. The median on-hand liquidity ratio for Sixth District community banks has nearly doubled since the fourth quarter of 2018 and was slightly higher than the median for community banks outside the District at 34 percent (see the chart).

Beyond the higher balances held at Reserve Banks, the securities portfolio provides a significant amount of liquidity as banks have placed cash received from elevated deposit growth primarily into short-term marketable securities like US Treasuries and other government agency bonds. However, the change in interest rates was pushing valuations down in the current quarter.

Banks retain higher deposit balances than the average over the last 10 years, which has brought improved liquidity to balance sheets. Transaction accounts represent more than 40 percent of deposits and have steadily grown over the past eight quarters. Some of the recent growth could be attributable to perhaps an outflow from equity markets till the volatility declines. With deposits elevated, banks will be slow to raise deposit rates. When deposit rates increase, customers may choose to shift balances back into higher yielding accounts. For example, before the current period of low interest rates, CDs made up nearly one-third of total deposits. Should depositors shift balances to other institutions, banks retain access to additional liquidity through unused borrowing lines as short-term borrowings have also been paid down using the record level of deposits banks have received during the last two years.

National Banking Trends

According to data from the call report from the first quarter of 2022, community banks (those with assets of less than $10 billion) showed emerging strains in the current economic environment with an increasing percentage of community banks—just below 5 percent in the current quarter—reporting losses. The aggregate return on average assets (ROAA) was 1.15 percent, lower than the previous quarter and the first quarter of 2021. Multiple factors drove the decline in ROAA, including a lower net interest margin and higher noninterest expenses connected with increased costs for staffing and other services (see the chart).

Net interest margin for the quarter was 3.17 percent for community banks, down 18 basis points from the prior year as loan demand started to slow and banks have higher levels of cash and securities. Although higher interest rates are expected to eventually improve the net interest margin, the transition has compressed margins in the short term (see the chart).

In addition to a margin compression, efficiency ratios have climbed higher as the costs for labor (such as salaries) and other services have increased rapidly over the last two quarters.

Balance sheet growth declined at community banks in the first quarter. Aggregate balance sheets were down by an annualized 4.3 percent, the largest drop in over two years and the first decline since the third quarter of 2020, when stimulus money started flowing through the banking system. Balance sheet growth has generally been driven by deposits since the start of the pandemic. The influx of deposits has primarily been placed in the lower-yielding securities portfolio, which is starting to experience more unrealized losses as interest rates increase, given that securities held are generally lower yielding than new issuances. After rebounding in the fourth quarter of 2021, loan growth in the quarter was down 6.3 percent in the first quarter of 2022. Community banks have generally struggled with generating loan demand outside of residential real estate since the end of the Paycheck Protection Program. However, consumer lending has rapidly increased over the last two quarters. On the liability side, deposit growth has fallen significantly, with quarter-over-quarter growth flat (see the chart).

As interest rates continue to rise, banks will be able to use deposit pricing to assist in better matching deposit levels with loan demand as depositors have generally sought the best rates on their deposits in the past. Shifts in loan demand and deposit levels have helped stabilize the capital leverage ratios. On an aggregate basis, the leverage ratio improved 4 basis points from the prior quarter and is up 7 basis points since reaching a low of 9.97 percent in the third quarter of 2021. Still, the capital leverage ratio is down 100 basis points since its recent high in the third quarter of 2019.

Nationally, asset quality remained stable in the first quarter of 2022. Charge-offs, as a percent of total loans, represented just 7 basis points, a third of the level prior to the pandemic (see the chart).

Both noncurrent and nonaccrual loans, as a percentage of the loan portfolio, continue to decline, and banks still have an allowance amount that exceeds two times the amount of nonaccrual loans, the highest ratio in more than three years (see the chart).

Despite the healthy metrics, concern remains about how the increase in interest rates and current economic conditions will affect asset quality metrics. Among the largest concerns is loans to commercial real estate borrowers, especially on office and hospitality properties. Employees have yet to return to office buildings at the same level as prior to the pandemic, and business travel remains scaled down compared with activity before March 2020. In addition to commercial properties, banks are closely monitoring the level of consumer lending as vehicle and home prices have increased, stretching consumer budgets more. Changes in variable rates could add additional pressure to consumers and cause delinquencies to rise.