Quarterly Report: Slump Persists for District and U.S. Banks

Michelle Clark Neely

Earnings and asset quality continued their downward slide in the first quarter at Eighth District and U.S. commercial banks, reflecting the nation's real estate overhang and economic contraction.

Profitability at District banks fell yet again in the first quarter. Return on average assets (ROA) declined six basis points to 0.34 percent, and was down 59 basis points from its year-ago level. (See table.) U.S. peer banks (banks with average assets of less than $15 billion) actually collectively posted losses, with ROA measuring -0.02 percent. Negative earnings were concentrated at peer banks in the $1 billion to $15 billion size range. U.S. banks with assets of less than $1 billion recorded an average ROA of 0.38 percent; District banks posted an average ROA of 0.73 percent.

In the District, the ROA drop can be attributed to a fairly sharp decline in the net interest margin and an increase in the loan loss provision (LLP) ratio. For peer banks, the ROA decline was due entirely to sharp increases in LLP, as the net interest margin stayed flat and net non-interest expenses declined.

LLP as a percent of average assets rose to 0.88 percent at District banks and 1.25 percent at U.S. peer banks. The LLP ratio has increased at a rapid rate at both sets of banks to replenish loan loss reserves that are being drained by ever-increasing charge-offs of nonperforming loans. Still, the coverage ratio continues to decline. On March 31, District banks had 74 cents reserved for every dollar of nonperforming loans compared with 86 cents at year-end 2008 and $1.78 at year-end 2006. U.S. peer banks had 55 cents reserved for every dollar of nonperforming loans at the end of the first quarter, down from 64 cents at year-end 2008 and $1.83 at year-end 2006.

Increases in LLP and declines in coverage ratios can be traced to continued deterioration in asset quality at District and U.S. peer banks. The ratio of nonperforming loans to total loans rose to 2.19 percent at District banks and an unusual 3.31 percent at peer banks in the first quarter. In the District, increases in nonperforming commercial and industrial loans and all types of real estate loans were the main contributors to the rise in the composite nonperforming loan ratio. Construction and land development (CLD) loans remain—by far—the most troubled part of loan portfolios. At the end of the first quarter, 6.26 percent of District banks' outstanding CLD loans were nonperforming; at U.S. peer banks, an astonishing 11.05 percent of CLD loans were nonperforming.

Despite the poor earnings and asset quality numbers, District banks remain on average well-capitalized. At the end of the fourth quarter, just three banks (out of 695) failed to meet at least one of the regulatory capital minimums. District banks averaged a leveraged ratio of 8.92 percent.

No Turnaround in Sight

  Q1 2008 Q4 2008 Q1 2009
Return on Average Assets
District Banks 0.93% 0.40% 0.34%
Peer Banks 0.8 0.08 –0.02
Net Interest Margin
District Banks 3.79 3.78 3.64
Peer Banks 3.99 3.82 3.82
Loan Loss Provision Ratio
District Banks 0.43 0.77 0.88
Peer Banks 0.58 1.06 1.25
Nonperforming Loans Ratio
District Banks 1.72 1.76 2.19
Peer Banks 1.63 2.69 3.31

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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