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James B. Thomson |

Author

James B. Thomson

James Thomson is a former vice president and financial economist in the Research Department of the Federal Reserve Bank of Cleveland. He retired in February 2013.

06.01.2010

Economic Trends

Current Banking Conditions, FDIC-Insured Institutions

James B. Thomson

The latest financial data for depository institutions insured by the Federal Deposit Insurance Corporation (FDIC) show signs that the banking and thrift industries may be turning the corner. The first-quarter financial results for these firms, however, are at best mixed. The $18 billion in earnings reported for the quarter were the best quarterly results in over two years. Moreover, the on-balance sheet assets of FDIC-insured institutions increased by nearly $249 billion since the end of 2009, driven in part by a $220 billion increase in on-balance sheet loans. The small increase in on-balance sheet assets and loans reflects a change in accounting rules. The rule change resulted in the consolidation of $300 million of certain credit card receivables, which were previously carried off of banks’ books, back onto the balance sheet. Without this change in accounting rules, assets and loans on the books of FDIC-insured institutions would have fallen slightly.

Another sign of weakness in the banking sector in the first quarter of 2010 is the increased number of institutions on the FDIC’s list of problem institutions, the total of which now stands at 775. Problem institutions are FDIC-insured banks and thrifts with substandard examination ratings. Assets in problem institutions hit $431 billion—their highest level in more than a decade. Moreover, 41 banks with more than $22 billion in assets failed during the first quarter, setting the stage for 2010 to exceed the 140 bank failures in 2009.

Asset quality remains a concern, as noncurrent loans (loans 90 days or more past due and still accruing interest, plus nonaccruing loans) totaled $409 billion, or around 5.45 percent of total loans. Problem residential real estate loans—commercial and primary residence—account for 80 percent of noncurrent loans. There are some signs, however, that asset quality may be stabilizing, as the increase of noncurrent loans in the first quarter of 2010 was only 4 percent. The increase in noncurrent loans in the first quarter of 2010 was driven primarily by problems in the residential real estate sector, which accounted for 70 percent of the increase in problem loans.

Problems in the real estate sector have had a particularly deleterious impact on asset quality for two reasons. First, loans for commercial real estate and primary residences collectively account for roughly 57 percent of loans held by FDIC-insured institutions. Second, the share of primary-residence loans and commercial real estate loans that were noncurrent at the end of the first quarter of 2010 were 7 and 9 percent, respectively—more than double the share of commercial and industrial loans that were noncurrent.

For six of the eight loan categories, losses as represented by net charge-offs (loans charged-off, less recoveries) as a percent of loans declined in the first quarter of 2010. Losses on agricultural loans increased slightly, from just over 0.4 percent to nearly 0.7 percent of agricultural loan balances. Of more concern are the rising losses on commercial real estate loans. Net charge-offs on these loans increased from over 5 percent at the end of 2009 to an annual rate of more than 7 percent of loan balances in the quarter.

Despite some encouraging signs that the deterioration of loan quality is slowing and loan performance is stabilizing, concerns remain that the balance sheets of FDIC-insured institutions may continue to weaken. A major factor underpinning these concerns is the reduction in the ability of FDIC-insured institutions to absorb losses. The coverage ratio has fallen from nearly $23.92 of loan-loss reserves and equity capital per dollar of noncurrent loans at the end of 2005 to $4.21 of coverage at the end of first quarter of 2010. This decline in the coverage ratio occurred despite the fact that FDIC-insured institutions have been increasing their loan-loss reserves and equity capital lately. Unfortunately, the rate of the increase in noncurrent loans has swamped the ability of banks and thrifts to build up capital and loan-loss reserves.