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Matthew Koepke |

Research Analyst

Matthew Koepke

Matthew Koepke is a former research analyst in the Research Department of the Federal Reserve Bank of Cleveland.


Economic Trends

A Slow Recovery in the Banking Sector

Matthew Koepke

Ever since the National Bureau of Economic Research called an end to the Great Recession in June 2009, the U.S. banking system has been engaged in a slow and fragile recovery. The most recent data from the Federal Deposit Insurance Corporation (FDIC) shows that while the system is on the mend, FDIC-insured institutions still face headwinds. According to the FDIC, after growing at an average quarterly rate of 1.0 percent through 2011, asset growth at FDIC-insured institutions slowed to 0.3 percent in the first quarter 2012. However, total growth in 2011 (3.8 percent year-over-year) was not driven by growth in net loans and leases. They grew only 2.8 percent over the same period. Moreover, balances of net loans and leases fell for the first time in three quarters, falling 0.7 percent in the first quarter of 2012.

In addition to slow loan growth, the continued elevated level of problem banks points to a fragile recovery in the banking sector. According to the FDIC, year-to-date there are 772 problem banks, with assets of $292 billion, already close to figures for all of 2011—813 problem institutions with $319 billion in assets. These problem banks represent banking institutions with substandard risk scores. After peaking in 2010, the number of problem banks has steadily declined but still remains significantly above the pre-recession levels seen in 2007.

Contributing to the slow recovery in the banking sector is the high level of nonperforming loans (loans 90 days or more past due or nonaccuring). Prior to 2008, nonperforming loans averaged 1.1 percent of total loans; however, since 2008 nonperforming loans have averaged 4.3 percent of all loan balances. Nonperforming loans peaked in 2009 at $396 billion, representing 5.4 percent of total loans and leases. While nonperforming loans declined in 2010 and 2011, they have held steady in the first quarter of 2012 at $305 billion, representing 4.1 percent of total loans.

Loans for primary residences continue to make up the largest share of nonperforming loans, accounting for 63.0 percent of the total. Furthermore, over the past quarter, the amount outstanding on primary residence loans that are nonperforming has risen 4.1 percent to $192 billion. Comparatively, with the exception of agricultural loans, nonperforming loans have fallen for every other loan category. In the face of continued weakness in the housing sector it is likely that the level of nonperforming primary residence loans will at best decline slowly.

The slow decline in nonperforming loans has caused noncurrent loan rates to remain persistently high. Noncurrent loan rates represent all loans that are past due as a percent of total loans. Not surprisingly, real estate loans are the largest contributors to total noncurrent loans, with commercial real estate and primary residence loans accounting for 83 percent of all noncurrent loans in the first quarter of 2012.

Primary residence loans accounted for the largest proportion of noncurrent loans, representing 61 percent of the total. Moreover, it is most likely will remain high. After declining 60 basis points from 2010 to 2011, noncurrent rates increased 20 basis points in the first quarter of 2012 to 9.8 percent. Out of all the loan categories, primary residence and agricultural loans were the only to loan categories to see an increase in noncurrent loan rates. Further signs that the banking recovery may be faltering is that while noncurrent loan rates have been improving for nearly all loan categories, the rate of improvement appears to be slowing down. The longer noncurrent loan rates remain elevated, the more fragile the recovery will be for the banking sector.

For nearly all 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 2012. Net charge-offs have fallen the most for commercial real estate loans, which declined 13 basis points in the first quarter of 2012. Overall, net charge-offs have declined modestly despite improvements across nearly all loan categories—declining 5 basis points from 0.34 percent of total loans to 0.29 percent. The decline in net charge-offs in most loan categories has been offset by modest increases in primary residence loan net charge-offs, which rose 1 basis point to 0.33 percent, and agricultural loan net charge-offs. Like noncurrent loan rates, net charge-offs have been improving overall; however, the rate of improvement appears to being slowing, suggesting that the recovery in the banking sector may be slowing.

Despite the fact that nonperforming loans, noncurrent loan rates, and net charge-offs remain elevated, banks’ abilities to absorb future losses have not improved significantly. In 2009, the coverage ratio, which is the ratio of nonperforming loans to loan-loss reserves and equity capital, plummeted to 4.2 from a decade high of 23.0 in 2006. The coverage ratio has improved slightly since 2009, increasing to 5.7 at the end of 2011. Through the first quarter of 2012, the coverage ratio stood at 5.7, far less than the average coverage ratio of 13.2 seen over the last decade. Given that problem loans continue to haunt FDIC-insured institutions and these institutions have not improved their ability to deal with the further deterioration of their balance sheets, it is unlikely that we will see a speedy recovery in the banking sector soon.