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Central Banker | Winter 2008

Quarterly Report

Gloomy Times Continue at District Banks

By Michelle Clark Neely

In response to tight credit markets and a still-weakening economy, earnings and asset quality at Eighth District and U.S. peer banks continued their descent in the third quarter.

In the District, return on average assets (ROA) declined another 14 basis points in the third quarter to 0.67 percent. ROA was down 39 basis points from its year-ago level. (See adjoining table.) U.S. peer banks (banks with average assets of less than $15 billion) fared even worse, with ROA declining to 0.45 percent in the third quarter compared with 1.18 percent one year ago.

The decline in ROA in the third quarter was due to a slight increase in net noninterest expense and a more substantial increase in loan loss provisions. The trend in earnings components was similar at U.S. peer banks. Once again, the average net interest margin (NIM) stayed flat at 3.79 percent at District banks. Loan loss provisions (LLP) as a percent of average assets hit 0.60 percent at District banks and 0.76 percent at U.S. peer banks.

The LLP ratio has almost tripled at District banks and has more than tripled at peer banks over the past year. The coverage ratio (the loan loss reserve as a percentage of nonperforming loans) has sunk over the same time period at both sets of banks. At the end of the third quarter, District banks had just 84 cents reserved for every dollar of nonperforming loans compared with $1.28 reserved one year ago.

Increases in loan loss provisions 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 1.68 percent at District banks and 2.19 percent at peer banks in the third quarter. In the District, increases in nonperforming real estate loans—especially construction and land development (CLD) loans—and commercial and industrial loans drove the uptick in the composite nonperforming loan ratios. Almost 5 percent of District banks’ outstanding CLD loans were nonperforming at the end of the third quarter, compared with less than 2 percent one year ago. At U.S. peer banks, the decline in quality is even more pronounced, with almost 7 percent of outstanding CLD loans in nonperforming status.

Despite the bleak picture painted by the earnings and asset quality numbers, District banks remain on average well-capitalized. At the end of the third quarter, just three banks (out of 707) failed to meet one of the regulatory capital minimums. District banks averaged a leverage ratio of 9.07 percent.

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