September 29, 2022

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

Asset Quality

Nonperforming assets remained at a cyclical low, lower than 1 percent, and nonaccrual loans represent just 0.16 percent of total loans. For the first time in five quarters, community banks reported measurable, new nonaccrual loan activity on a median basis, though it was still a small fraction of prepandemic levels.

Some data from early in the third quarter of 2022 suggest that more loans are entering an early delinquency stage, and more loans could be reported past due more than 90 days by the time banks file their third quarter call reports. The credit quality of borrowers has generally been higher since the 2008 downturn, and the ratio of loan-to-value has been higher.

As of the second quarter of 2022, the median reserve coverage ratio, which represents the amount of nonaccrual loans that the allowance for credit covers, now exceeds 3.5 times, which is the highest level in more than 15 years, despite several banks reducing their provision for credit loss amounts in 2021 (see the chart).

Balance Sheet Growth

After two years of double-digit growth, fueled by pandemic-related stimulus and savings, annualized asset growth dropped to 7.8 percent on a median basis in the second quarter of 2022 (see the chart). That growth rate was still above the 10-year prepandemic average of 2.64 percent (from the fourth quarter of 2009 through the fourth quarter of 2019).

Deposit growth also remained elevated but continues to slow each quarter, starting in the second quarter of 2021, and will likely return to longer-term averages by year-end.

Annualized securities growth slowed to its lowest growth rate in more than a year. Previously, increases in longer-term securities drove growth in the securities portfolio. Also, securities growth rates have been affected by a decline in securities value, pushing unrealized losses higher due to the change in higher interest rates pushing down the value of lower-yielding bonds.

Annualized residential loan growth experienced the strongest growth since the beginning of the pandemic, above 6 percent on a median basis even as mortgage rates reached levels not seen in more than a decade. Construction and development loans also experienced strong loan growth.

Commercial and industrial loans still showed negative growth, but annualized growth rates were affected by Paycheck Protection Program loans that were on the balance sheet in 2021 but have since been forgiven (see the chart).


On an aggregate basis, tier 1 risk-based capital and tier 1 leverage ratios declined in the second quarter of 2022 as changes in asset mix and higher interest rates affected capital calculations. Changes in the fair value of the securities portfolio recorded in accumulated other comprehensive income (AOCI) have a negative impact on capital, particularly for community banks in the District using the community bank leverage ratio (CBLR) (see the chart).

Going forward, if they fall below the 9 percent threshold for the CBLR, community banks using the CBLR can opt out of the CBLR framework and switch to risk-based capital ratios. Community banks had the ability to opt out of AOCI inclusion in risk-based capital in 2015, and most of the Sixth District’s banks elected this option. The rules do not allow them to opt back in and include AOCI in equity capital, except in limited circumstances.

Earnings Performance

Earnings at Sixth District community banks rebounded in the second quarter of 2022 after two quarters of median return on average assets below 1 percent, reaching 1.06 percent, 10 basis points lower than the second quarter of 2021 (see the chart).

The percentage of banks reporting a loss dropped to 4.35 percent. The second quarter was the first full quarter fully affected by recent interest rate increases, pushing up the median net interest margin (NIM) at community banks in the District by 20 basis points, though it remains below prepandemic levels (see the chart).

Most community banks in the District expect to continue to benefit from higher interest rates going forward in 2022, though the amount and length of further increases in NIM is likely dependent on how banks manage their deposits and related pricing. A limited number of community banks in the District have raised their deposit rates through the second quarter of 2022. However, data from beginning of the third quarter of 2022 indicate that banks are starting to slowly increase deposit rates.


In the second quarter of 2022, the median on-hand liquidity ratio declined slightly, to 30.1 percent, but remained above the median measure in the first quarter of 2020 (see the chart).

Liquidity at community banks remained strong, with most community banks in the District still having elevated levels of core deposits due to the amount of inflows during the past two years. Given current deposit levels, banks have more flexibility with deposit pricing before they experience significant runoff to the point where they need other liquidity sources. Noncore funding dependence remains extremely low. Community banks would have the option to increase borrowings should the need for more liquidity arise.

Higher unrealized losses in the securities portfolio means that banks will have a negative impact on earnings and capital should the bank sell securities to generate funding. To guard against recording higher unrealized losses, some banks are moving securities to a held-to-maturity portfolio, which places a greater restriction on selling securities from an accounting perspective before their maturity and could have an additional negative impact on earnings.

National Banking Trends

On a national level, return on average assets was basically unchanged in the second quarter of 2022 from the prior quarter after declining during the last three quarters (see the chart).

Earnings benefited from higher interest rates, but banks recorded fewer fees from mortgage originations and overdrafts along with lower gains on asset sales.

Net interest margin rose significantly during the quarter, up 17 basis points at community banks to 3.38 percent, slightly higher than the level reported in the first quarter of 2020, when the pandemic began and interest rates were quickly lowered (see the chart).

On the expense side, provision expense (as a percentage of average loans), rose on an aggregate basis as banks prepare for nonperforming loans to return to historical norms. Many banks were able to lower provision for credit loss expense, beginning in the third quarter of 2020, as delinquencies actually declined during the pandemic due to strong governmental support programs that enabled borrowers to continue to make payments or request forbearance.

Asset growth continued to slow at community banks nationally, remaining negative for the second consecutive quarter as higher interest rates reduced demand and customers relied more on their available deposit balances to cover increased costs associated with higher inflation.

After remaining flat quarter-over-quarter in the first quarter of 2022, aggregate deposits actually declined in the second quarter of 2022 at community banks for the first time since the beginning of the pandemic. The decline in deposits drove an offsetting decline in assets, such as in cash or the securities portfolio.

Annualized loan growth at community banks rebounded during the quarter, especially for consumer products, as customers either pulled forward larger purchases in the wake of higher interest rates or needed the additional funds to cover higher costs. The increase in loans and the decline in overall assets pushed the loans-to-asset ratio at community banks to 63.3 percent, the highest percentage since the first quarter of 2021 and an indication of normalization of banks’ balance sheets (see the chart).

Problem loans at community banks remain near historic lows as the balance of total nonaccrual loans and other real estate owned (OREO) declined for the eighth consecutive quarter and is down 28.8 percent year over year.

Nonperforming loans represent just 50 basis points of the total loan portfolio, on an aggregate basis, as of the second quarter of 2022. Banks are expecting delinquencies to increase as interest rates move higher. Aggregate delinquency transition rates are also moving higher as reported in the latest quarterly report on household debt and credit from the New York Fed.

Additionally, some early indications in the third quarter of 2022 show that near-term delinquencies (those past due 30–59 days) have increased. Banks reported having an allowance for credit losses twice as high as reported nonperforming loans (see the chart).