Quarterly Report: Banks Still Ailing in District and U.S.

Michelle Clark Neely

Although the U.S. economy has recently shown a few signs of life, the nation's banking industry is still being battered by weak earnings and increasing problems with asset quality.

Aggregate profits at District banks surprisingly rose in the second quarter, albeit by a modest amount. Return on average assets (ROA) increased four basis points to 0.22 percent. For U.S. peer banks (banks with average assets of less than $15 billion), the news was not even remotely good: ROA declined another 21 basis points to -0.30 percent. For both District and U.S. peer banks, the weakest performers were banks in the $1 billion to $15 billion asset range; excluding them, ROA was 0.65 percent at District banks and 0.15 percent at U.S. peers.

The profitability improvement at District banks was driven by a slight uptick in the net interest margin (NIM), which increased three basis points to 3.66 percent. Net non-interest expense also declined, which more than offset the modest increase in loan loss provisions. The average NIM at U.S. peer banks also rose, but that increase was dwarfed by a large increase in the loan loss provision ratio and a moderate increase in the net non-interest expense ratio.

Loan loss provisions as a percent of average assets increased three basis points to 0.93 percent at District banks in the second quarter. For U.S. peer banks, the hike was more substantial, as the LLP ratio rose 18 basis points to 1.49 percent. Despite the additions to reserves, the coverage ratio fell again at both sets of banks. At the end of the second quarter, District banks had 70 cents reserved for every dollar of nonperforming loans, down 4 cents from the prior quarter and 20 cents from a year ago. At U.S. peer banks, the coverage ratio declined 3 cents from the first quarter and stood 22 cents below its year-ago level.

As indicated by the increasing loan loss provisions and declining coverage ratios, asset quality continues to worsen at both sets of banks. Nonperforming loans as a percentage of total loans hit 2.44 percent at District banks in the second quarter, up 25 basis points from the first quarter and 91 basis points from a year ago. For U.S. peer banks, the picture is bleaker, as 3.77 percent of loans were nonperforming at the end of the second quarter, up 46 basis points from the first quarter and 185 basis points from the second quarter of 2008. All major categories of loans (commercial, consumer and real estate) had higher delinquencies in the second quarter at both sets of banks.

Commercial real estate (CRE) lending continues to be the area of greatest concern. CRE loans make up almost half of total loans at District and U.S. peer banks. Therefore, problems in this sector have a major effect on overall results. Within CRE, construction and land development (CLD) loans are the most troubled. In the District, 7.35 percent of CLD loans were nonperforming at the end of the second quarter. For U.S. peer banks, the ratio topped 13 percent. Poor CLD loan performance is spread among banks of all sizes; District banks with assets of less than $1 billion had a 6.46 percent nonperforming ratio.

This tough environment has not had a substantial effect on regulatory capital thus far. At the end of the second quarter, just six banks (out of 689) failed to meet at least one of the regulatory minimums. District banks averaged a Tier 1 leverage ratio of 8.94 percent, well above the 4 percent minimum for that ratio.

When Will Woes Be Gone?

  Q2 2008 Q1 2008 Q2 2009
Return on Average Assets
District Banks 0.81% 0.18% 0.22%
Peer Banks 0.60 -0.09 –0.30
Net Interest Margin
District Banks 3.79 3.63 3.66
Peer Banks 3.83 3.56 3.58
Loan Loss Provision Ratio
District Banks 0.52 0.90 0.93
Peer Banks 0.72 1.31 1.49
Nonperforming Loans Ratio
District Banks 1.53 2.19 2.44
Peer Banks 1.92 3.31 3.77

SOURCE: Reports of Condition and Income for Insured Commercial Banks

Banks with assets of more than $15 billion have been excluded from the analysis. All earnings ratios are annualized and use year-to-date average assets or average earning assets in the denominator. Nonperforming loans are those 90 days or more past due or in non-accrual status.

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