A Slow Recovery in the Banking Sector
As the banking sector recovers from the financial crisis and the subsequent recession, its recovery has mirrored the slow and fragile recovery of the general economy. According to the most recent data from the Federal Deposit Insurance Corporation (FDIC), assets at FDIC-insured institutions grew 1.4 percent in the second quarter of 2011 and are up 3.0 percent on a year-over-year basis. However, despite the growth in total assets, loans and leases at depository institutions actually fell from the fourth quarter of 2010 to the second quarter of 2011, declining 0.8 percent. Moreover, on a year-over-year basis, loans and leases at FDIC-insured institutions fell 1.1 percent, suggesting that the recovery in the banking sector has stalled.
In addition to stagnant loan growth, another sign of weakness in the banking sector is the large number of problem institutions in the system. Problem institutions are FDIC-insured banks and thrifts with substandard examination ratings. According to the FDIC, year-to-date there are 865 problem institutions with $372 billion in assets compared to 884 problem institutions with $390 billion in assets for all of 2010. While there has been a slight improvement in this number, the continued high level of problem depository institutions is another indicator that this sector of the financial system remains very fragile.
One promising sign that the banking sector is on the mend is the decline in the amount of nonperforming loans (loans 90 days or more past due and nonaccuring). Nonperforming loans spiked in 2009 to $395 billion, representing 5.4 percent of total loans and leases. Real estate loans—commercial and primary residence—drove the increase in nonperforming loans through the end of 2009, accounting for 80 percent of total nonperforming loans. According the FDIC’s second-quarter data, nonperforming loans have fallen nearly 6.5 percent since the end of the first quarter, going from $342 billion to $320 billion. Their share within total loans has been steadily declining since the end of 2009, coming in at 4.4 percent at the end of the second quarter. However, it is important to note that while the total amount of nonperforming loans has declined since 2009, the share of real estate loans within the total has increased to 85 percent, suggesting that real estate loans are still having a deleterious impact on asset quality.
While nonperforming loans have been steadily declining, the percent of noncurrent loans seems to have stagnated at a high level. Again the problems in noncurrent loans stem from real estate loans, which accounted for 81 percent of total noncurrent loans in the second quarter of 2011. Primary residence loans accounted for the largest proportion of noncurrent loans, representing 55 percent of the total. Moreover, primary residence noncurrent rates declined only 70 basis points from 2009 to the second quarter of 2011 (10.3 percent to 9.6 percent). The only other loan category where noncurrent rates fell less was agricultural loans, which declined 10 basis points (3.1 percent to 3.0 percent). As long as noncurrent rates continue to remain elevated for primary residence loans, it is likely that the banking sector will continue to have a slow and fragile recovery.
For all loan categories, losses as represented by net charge-offs (loans charged-off less recoveries) as a percent of loans declined in the second quarter of 2011. Net charge-offs declined the most for consumer loans, falling 50 basis points from 2009 to the second quarter of 2011 (1.4 percent to 0.85 percent). Net charge-off rates for commercial real estate loans and primary residences seem to have leveled off after falling significantly from 2009 to the first quarter of 2011 Meanwhile, net charge-offs related to commercial and industrial loans continue to fall at a relatively high rate, declining nearly 50 basis points from 2009 to the second quarter of 2011.
Finally, despite some encouraging signs that the deterioration of loan quality is slowing and loan performance is stabilizing, concerns remain about the ability of FDIC-insured institutions to absorb loan losses going forward. From the fourth quarter of 2005 to the fourth quarter of 2009, the coverage ratio, which measures the ratio of loan loss reserves and equity capital to nonperforming loans, fell from 23.9 to 4.2. Since then, the coverage ratio has improved to 5.5; however, the coverage ratio at FDIC-insured institutions remains less than half of the average coverage ratio of 12.6 over the past decade.
So, even though there have been some improvements in loan performance at FDIC-insured institutions, the amount of nonperforming loans, noncurrent loans, and net charge offs remain relatively high and the ability of banks to cover the losses from those loans remains relatively low. This combination suggests that the banking system is still very fragile, three years after the financial crisis.