Quarterly Report: Are District and U.S. Banks on the Mend?

Michelle Clark Neely

Profits strengthened at Eighth District banks and their national peers in the first quarter of 2010, an indicator that the industry may have hit a turning point. Return on average assets (ROA) climbed 49 basis points to 0.58 percent at District banks in the first quarter; at U.S. peer banks—those with average assets of less than $15 billion—ROA jumped 58 basis points and into positive territory, hitting
0.24 percent. (See table.)

Smaller institutions continue to be more profitable than their larger counterparts. District banks with average assets of less than $1 billion averaged ROA of 0.76 percent in the first quarter; national peer banks in this size category recorded an average ROA of 0.43 percent.

The increase in profitability is the result of modest increases in net interest income and substantial declines in loan loss provisions and non-interest expenses. The net interest margin (NIM) rose at both sets of banks to 3.77 percent, an increase of 10 basis points for District banks and 12 basis points for U.S. peer banks. At both sets of banks, declines in interest income were more than offset by declines in interest expense, resulting in rising NIMs.

Net non-interest expense shrunk 19 basis points at District banks and 12 basis points at U.S. peer banks. Although personnel and other non-interest expenses fell and non-interest income increased slightly, the primary factor driving down net non-interest expense was a large reduction in impairment losses for goodwill and other intangible assets, especially at institutions with assets of more than $1 billion.

A substantial reduction in loan loss provisions, however, was the dominant determinant for the large uptick in earnings. Loan loss provisions as a percent of average assets fell 30 basis points at District banks and a staggering 46 basis points at U.S. peer banks in the first quarter. Some of that decline no doubt reflects a ratcheting back of normal end-of-year accounting adjustments.

The drop in loan loss provisions does not seem to be related to improvements in asset quality, especially at the District level. The ratio of nonperforming loans to total loans rose 22 basis points to 3.08 percent in the first quarter at District banks and was up 10 basis points to 4.25 percent at U.S. peer banks. Among the three major categories of bank loans—real estate, commercial and industrial, and consumer—only consumer loans showed a drop in delinquency status. Nonperforming loan rates in the real estate portfolio continue to rise, especially in the commercial area. More than 11 percent of all District construction and land development loans were nonperforming at the end of March; for U.S. peer banks, the ratio topped 15 percent.

The large decline in loan loss provisions and continued increases in nonperforming loans put more downward pressure on the District’s coverage ratio (the ratio of loan loss reserves to nonperforming loans). The ratio declined 364 basis points to 62.42 percent, indicating about 62 cents are in reserve for every dollar of nonperforming loans. For U.S. peer banks, the coverage ratio increased slightly, but at 53.76 percent, remains well below the District’s ratio.

The District’s average leverage ratio remained virtually unchanged in the first quarter at 8.83 percent. For U.S. peer banks, the average leverage ratio rose 12 basis points to 9.14 percent.

Earnings Are Up but So Is Loan Delinquency

  1Q 2009 4Q 2009 1Q 2010
Return on Average Assets
District Banks 0.18% 0.09% 0.58%
Peer Banks -0.10 -0.34 0.24
Net Interest Margin
District Banks 3.63 3.67 3.77
Peer Banks 3.56 3.65 3.77
Loan Loss Provision Ratio
District Banks 0.90 1.07 0.77
Peer Banks 1.32 1.58 1.12
Nonperforming Loans Ratio
District Banks 2.19 2.86 3.08
Peer Banks 3.32 4.15 4.25

SOURCE: Reports of Condition and Income for Insured Commercial Banks

Note: 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 nonaccrual status.

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