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Quarterly Report: Profits Up at District Banks, but Problem Assets Cloud the Outlook


Michelle Clark Neely
Thursday, January 1, 2009

A modest improvement in profitability that began in the second quarter continued into the third quarter for District banks. Return on average assets (ROA) climbed 6 basis points to 0.25 percent. (See table.) While that result would not be cause for celebration in normal times, it is certainly a piece of good news for an industry that has been walloped by a housing crisis and a deep economic recession.

For U.S. peer banks (banks with assets of less than $15 billion), the results were also somewhat encouraging as ROA rose by 4 basis points to -0.29 percent. As in the second quarter, losses were concentrated at larger institutions. Excluding banks with assets of more than $1 billion, ROA hit 0.58 percent at District banks and 0.11 percent at U.S. peer banks.

The improvement in earnings was not driven by earning assets. The net interest margin (NIM) at District banks rose by just 1 basis point from the second quarter and remains 12 basis points below its year-ago level. What helped profits this quarter was a 6 basis-point decline in noninterest expense and a leveling off in loan loss provisions. Loan loss provisions as a percentage of average assets increased by just 1 basis point, the smallest quarterly increase in several years.

The smaller additions to loan loss provisions, however, do not portend an improvement in asset quality. Nonperforming loans continue to rise at District and U.S. peer banks. The ratio of nonperforming loans to total loans at District banks rose 18 basis points to 2.62 percent in the third quarter; the ratio increased 25 basis points at U.S. peer banks, reaching 4.02 percent.

Also troubling is another decline in the nonperforming loan coverage ratio at both sets of banks. At the end of the third quarter, District banks had 68 cents reserved for every dollar of nonperforming loans. U.S. peer banks had an even thinner cushion, with
an average coverage ratio of just 52 percent. Further, other real estate owned as a percent of total assets has almost doubled at both sets of banks over the past year, averaging 0.76 percent at District banks and 0.68 percent at U.S. peers at the end of the third quarter.

Problem loans remain concentrated in the real estate portfolio, and increases in nonperforming rates are occurring in residential and commercial real estate lending. (See “Commercial Real Estate Lending Challenges Banks in District” for a more detailed analysis of commercial real estate lending.) At the end of the third
quarter, nonperforming real estate loans as a percent of total real estate loans topped 3 percent at District banks and hit almost 5 percent at U.S. peer banks. Because real estate loans now make up about 75 percent of all loans at these banks, troubles in the real estate sector have a profound effect on bank performance.

The nonperforming loan rates for consumer and commercial and industrial loans increased very modestly in the third quarter and remain below 2 percent at District banks. Across all categories of loans, District banks had lower nonperforming rates than their U.S. peers did. For both sets of banks, larger banks (those with average assets of $1 billion to $15 billion) had higher nonperforming rates than smaller institutions in most loan categories.

Meager earnings and problem assets have had little effect on capital ratios thus far. The average tier 1 leverage ratio increased 11 basis points to 9.06 percent in the third quarter at District banks. U.S. peer banks’ average leverage ratio also rose, hitting 9.10 percent.

No Turnaround in Sight

  3Q 2008 2Q 2009 3Q 2009
Return on Average Assets
District Banks 0.67% 0.19% 0.25%
Peer Banks 0.43 -0.33 -0.29
Net Interest Margin
District Banks 3.79 3.66 3.67
Peer Banks 3.83 3.57 3.61
Loan Loss Provision Ratio
District Banks 0.60 0.94 0.95
Peer Banks 0.78 1.52 1.5
Nonperforming Loans Ratio
District Banks 1.68 2.44 2.62
Peer Banks 2.2 3.77 4.02

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 nonaccrual status.