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Fourth District Community Banks

Most of the 262 banks headquartered in the Fourth Federal Reserve District as of September 30, 2008, are community banks - commercial banks with less than $1 billion in total assets. There are 238 such banks headquartered in the District, a number that, as a result of bank mergers, has declined since 1998, when there were 337.

Total asset growth for Fourth District community banks decreased 4.84 percent (annualized rate) in the third quarter, but this rate has fluctuated quite a bit in the last few years. These fluctuations do not necessarily reflect falling asset values, though this may partially be the case given the recessionary environment of the last four quarters. Another possibility for the decrease in asset growth is that some banks are merging with other Fourth District banks in a way that pushes their assets above $1 billion, and therefore out of our "community bank" sample. A bank's assets may also be bought and transferred to a bank holding company in another state, which would again remove them from our sample.

Annual Asset Growth

The structure of the market with respect to bank size has changed since 2000. Back then the majority of the community banks in the district had less than $100 million in total assets. Since then, banks in the mid-size category ($100 million to $500 million) have constituted the majority.

Fourth District Community Banks by Asset Size

The income stream of Fourth District community banks has deteriorated slightly in recent years. The return on assets (ROA) fell from 1.7 percent in 1998 to 0.76 percent in the third quarter of this year. (ROA is measured by income before tax and extraordinary items, because one bank's extraordinary items can distort the averages in some years.) The decline is due in part to weakening net interest margins (interest income minus interest expense divided by earning assets). Currently at 2.65 percent, the net interest margin for Fourth District community banks is at its lowest level in over a decade, as the deposit interest rate market remains competitive and the prime rate stays low.

Income Stream

One possible cause of concern for Fourth District community banks is their level of income earned but not received, which currently stands at 0.59 percent of assets. If a loan agreement allows a borrower to pay an amount that does not cover the interest accrued on the loan, the uncollected interest is booked as income even though there is no cash inflow. The assumption is that the unpaid interest will eventually be paid before the loan matures. However, if an economic slowdown or other some other factor forces an unusually large number of borrowers to default on their loans, the bank's capital may be impaired. Income earned but not received has been elevated since 2006, but it has not reached the level seen following the 2001 recession, though it could again approach that level depending on the severity of the current economic downturn.

Real estate lending continues to be the primary focus of community banks in the Fourth District. When mortgage-backed securities are included, 59.7 percent of bank assets are tied to real estate. Consumer and commercial loans (as a percentage of assets) have been declining and flat, respectively, over the last few years and account for 9.3 percent of assets. Our last report on Fourth District bank holding companies showed that BHC asset portfolios contain slightly different allocations. Although both types of bank predominantly hold real estate loans, community banks focus more heavily on them, while consumer and commercial loans account for a large share - 25 to 30 percent - of regional bank holding companies' balance sheets.

Balance Sheet Composition

Fourth District community banks consistently finance their assets primarily through time deposits (about 75 percent of total liabilities). Brokered deposits, which are a riskier type of deposit for banks because they chase higher yields and are not a dependable source of funding, are used less frequently. Federal Home Loan Bank (FHLB) advances are loans from the FHLBs that are collateralized by the bank's small business loans and home mortgages. Although they have gained some popularity in recent years, FHLB advances are still a small fraction of community banks liabilities (7.5 percent of total liabilities) and remain an important source of backup liquidity for most Fourth District community financial institutions.


Problem loans are those that are more than 90 days past due, as well as those no longer accruing interest. Problem commercial loans rose sharply in 2001, returned to their 1998-2000 levels in 2005-2006, and have again begun increasing in the last two years. Currently, 2.91 percent of all commercial loans are problem loans. About 1.58 percent of all outstanding real estate-related loans are 90 days or more past due, which is the highest level in more than a decade. The trend in problem real estate loans lately has mirrored that of housing prices nationwide. Problem consumer loans (credit cards, installment loans, etc.) have increased 0.10 percent from 2007 levels, and currently account for 0.56 percent of consumer loans.

Problem Loans

Net charge-offs are loans that are removed from the balance sheet because they are deemed unrecoverable, less any loans that were deemed unrecoverable in the past but are recovered in the current year. As with problem loans, there was a sharp increase in the net charge-offs of commercial loans during and following the 2001 recession. Consumer loans saw a similar increase during that recession, and their charge-off rate has remained near those levels since then. Net charge-offs in the third quarter of 2008 reached 0.57 percent of outstanding commercial loans, 0.55 percent of outstanding consumer loans, and 0.15 percent of outstanding real estate loans. These numbers could rise going forward if the increasing number of problem loans these banks are documenting ultimately translates into more "unrecoverable" loans.

Net Charge-Offs

Capital is a bank's cushion against unexpected losses. The recent trend in the capital ratio indicates that Fourth District community banks are protected by a large cushion. While the leverage ratio (capital over total assets) remained above 10 percent, the risk-based capital ratio (a ratio determined by assigning a larger capital charge on riskier assets) was about 11 percent in the third quarter of 2008. The growing capital ratio is a sign of strength for community banks.


An alternative measure of balance sheet strength is the coverage ratio. The coverage ratio measures the size of the bank's capital and loan loss reserves relative to its problem assets. As of the third quarter, Fourth District community banks had about $11 in capital and reserves for each $1 of problem assets. The coverage ratio has declined over the last few years, as problem loans have increased, but balance sheets remain strong.

Coverage Ratio

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