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Quarterly Report: District Banks Face Challenging Environment


Michelle Clark Neely
Tuesday, April 1, 2008

After many years of strong profits and few asset quality problems, Eighth District banks now face a decidedly different banking environment as the economy slows and credit markets tighten. This more challenging backdrop is reflected in recent Call Report (Reports of Condition and Income for Insured Commercial Banks) measures of profitability and asset quality, which have deteriorated over the past year. (See table below.)

Return on average assets (ROA) at District banks fell in the fourth quarter and was down 17 basis points from its level one year ago. ROA was brought down by a falling net interest margin (NIM) and a rising loan loss provision (LLP) ratio.

While the earnings trends are basically the same at U.S. peer banks (banks with assets of less than $15 billion), they remained more profitable than District banks in the fourth quarter, with an average ROA of 1.08 percent-a difference of 10 basis points. A higher average NIM and a lower average net noninterest expense margin account for the edge.

Going forward, asset quality will be a paramount concern for District banks, as well as their national counterparts. Loan loss provision ratios are already on the rise in response to higher levels of nonperforming loans.

In the District, all major loan categories showed increases in nonperforming loans in the fourth quarter, with the exception of commercial and industrial loans, which showed a slight decrease. The ratio of nonperforming construction and land development (CLD) loans to total CLD loans more than quadrupled over the past year, jumping from 0.72 percent in the fourth quarter of 2006 to 3.78 percent in the fourth quarter of 2007. Nonperforming 1-4 family home loans have also risen over the past year at District banks, as housing markets weaken, and borrowers and lenders deal with spillovers from the subprime mortgage crisis.

Despite these hits to earnings and asset quality, District banks remain on average well-capitalized. At the end of the fourth quarter, every District bank except one met or exceeded all three regulatory capital ratios.

Tougher Times for District Earnings and Loan Quality

  4th Q 2006 3rd Q 2007 4th Q 2007
Return on Average Assets
District Banks 1.15% 1.06% 0.98%
Peer Banks 1.26 1.17 1.08
Net Interest Margin
District Banks 4.03 3.91 3.91
Peer Banks 4.06 4.02 4
Loan Loss Provision Ratio
District Banks 0.17 0.23 0.32
Peer Banks 0.18 0.25 0.32
Nonperforming Loans Ratio
District Banks 0.73 1.02 1.4
Peer Banks 0.67 1 1.24

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 in the denominator. Nonperforming loans are those 90 days or more past due or in non-accrual status.