As Economy Flounders, Do We See a Rise in Problem Loans?

R. Alton Gilbert , Judith H. Hazen

It doesn't take an economist to conclude that the pace of economic activity has slowed sharply during the past year. We hear about this on the news, see the changes in our businesses and may have even felt the effects of a sluggish economy firsthand. As the table below shows, the annual growth rate of real GDP fell from 5.69 percent to 1.34 percent between the second and third quarters of 2000.

Historically, when the pace of economic activity slows, problem loans of banks tend to rise. This article looks at one measure of problem loans—the percentage of commercial and industrial (C&I) loans that are nonperforming—to see whether there has been an increase in problem loans in the past year, as one might expect.

We identify nonperforming loans as those that are 90 days or more past due or no longer accruing interest. Banks report the amount of loans that are nonperforming on a quarterly basis.[1] The table reports nonperforming C&I loans as a percentage of total C&I loans by bank size over the past decade. To examine both the decade-long trend and some recent changes, we'll look at annual nonperforming loan ratios (the means of the quarterly numbers) for 1991 to 1999, and quarterly rates for 2000 and the first half of 2001.

Going back 10 years, we see that nonperforming loan ratios for banks in each size category were higher in 1991—a recession year—than in any subsequent period. As we recovered from the recession, the data show that banks in each size group reported declines in their nonperforming loan ratios through 1997. Since 1997, banks with total assets above $1 billion have experienced a slight rise in nonperforming loan ratios; however, these ratios remain substantially below the 1991 levels. Nonperforming loan ratios among relatively large banks began rising well before the economic slowdown of the past year.

The rise in the nonperforming C&I loan ratio since 1997 has been especially pronounced among banks with total assets in excess of $20 billion. Much of the increase for this group can be attributed to involvement with syndicated loans. A syndicated loan, identified as a loan included in the Shared National Credit program of the federal bank supervisors, is any loan or loan commitment that exceeds $20 million and is shared by three or more nonaffiliated institutions.[2] Syndicated loans are classified in one of four categories (substandard, doubtful, loss or special mention) if, during routine examination, there is determined to be a relatively high risk of default or other credit concerns. The percentage of loans with adverse classifications has been increasing over the past few years.[3]

At the same time that nonperforming C&I loan ratios at the larger banks began to increase after 1997, non-performing C&I loan ratios continued to decrease among banks with assets below $1 billion—the smallest two categories in the table. This pattern began to change for banks in one of these size categories, however, as the growth of GDP slowed in the last year: Among the banks with total assets between $300 million and $1 billion, nonperforming loan ratios were about 30 percent higher during the first two quarters of 2001, after the economy began to slow, than during the first two quarters of 2000. It appears that the slowing pace of economic activity during the past year has begun to adversely affect the ability of the customers of relatively small banks to repay their bank loans. So far, there has been no corresponding rise in the nonperforming loan ratios among the smallest banks—those with total assets below $300 million.

During economic slowdowns, problem loans at banks tend to rise. As one would expect, we have indeed seen increases in one measure of problem loans at banks of different total asset sizes. Some of these increases occurred before the recent economic slowdown; others occurred concurrently with the slowdown. While the news is not bright for banks affected, it is important to note that the increases in nonperforming C&I loan ratios remain below the levels seen during the last recession.

Percentage of Commercial and Industrial Loans That Are Nonperforming

Total assets of banks

Period Annual Growth Rate of Real GDP Up to $300 million $300 million to $1 billion $1 billion to $20 billion $10 billion to $20 billion More than $20 billion More than $20 billion
1991
1992
1993
1994
1995
1996
1997
-4.47%
3.05
2.65
4.04
2.67
3.57
4.43
4.30%
3.99
3.21
2.52
2.18
2.25
2.13
3.24%
2.85
2.13
1.35
1.05
1.16
1.12
4.06%
3.24
2.17
1.27
0.95
1.02
0.92
5.02%
4.01
2.52
1.36
1.15
0.87
0.72
5.37%
4.63
2.89
1.37
1.19
0.97
0.75
5.37%
4.63
2.89
1.37
1.19
0.97
0.75
1998
1999
2000:1
2000:2
2000:3
2000:4
2001:1
2001:2
4.28
4.09
2.35
5.69
1.34
1.91
1.32
0.31
2.13
2.05
1.85
1.84
1.85
1.73
1.81
1.91
1.01
0.99
0.99
1.00
1.06
0.99
1.30
1.31
0.92
1.00
1.04
1.15
1.23
1.32
1.52
1.58
0.78
1.15
1.21
1.30
1.35
1.56
1.64
1.65
0.84
1.08
1.27
1.43
1.56
1.75
1.95
2.24
0.84
1.08
1.27
1.43
1.56
1.75
1.95
2.24
Note: Nonperforming loan rates are calculated as the sum of nonperforming C&I loans as a percentage of total C&I loans in each size category. Banks are placed in a size category based on their total assets for that quarter. Annual nonperforming loan rates are the means of quarterly numbers.

Endnotes

  1. Nonperforming loans tend to have a seasonal pattern at banks with total assets below $1 billion. These banks tend to charge off more loans in the fourth quarter to "clean up their balance sheets" for year-end accounting statements. Loans charged off as losses are no long reported as nonperforming. [back to text]
  2. Prior to 1999, syndicated loans were comprised of all loans or loan commitments of $20 million or more held by two or more supervised institutions. [back to text]
  3. Fore more information on the shared National Credit Program, see the web site of the Board of Governors of the Federal Reserve System, www.federalreserve.gov/Releases/SNC/. [back to text]

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