Thursday, September 2, 2010

Quarterly Banking Profile, Part II

Let's turn our attention to loan quality:
Insured institutions added $40.3 billion in provisions to their loan-loss allowances in the second quarter. While still high by historic standards, this is the smallest total since the industry set aside $37.2 billion in first quarter 2008 and is $27.1 billion (40.2 percent) less than the industry’s provisions in second quarter 2009. Fewer than half of all institutions (41.3 percent) reported year-over-year reductions in quarterly loss provisions. Only 40 percent of community banks (institutions with less than $1 billion in assets) reported year-over-year declines. Reductions were more prevalent among larger institutions. More than half (56.2 percent) of institutions with assets greater than $1 billion had lower provisions in the second quarter.

The FDIC divides banks according to asset size, focusing on the lines between above and below $1 billion. Notice that over 50% of largest institutions had lowered loan-loss reserves. This is a good development as the US banking system is fairly concentrated. However, only 40% of smaller banks reported a drop in the loan-loss reserve, indicating this part of the industry is still under pressure.

Net charge-offs totaled $49 billion in the second quarter, a $214-million (0.4 percent) decline from a year earlier and the first year-over-year decline since fourth quarter 2006. Charge-offs were lower than a year ago in most major loan categories except for credit cards and real estate loans secured by nonfarm nonresidential properties. Charge-offs on loans to commercial and industrial (C&I) borrowers were $3.1 billion (37.0 percent) lower than a year ago, while charge-offs on real estate construction and development (C&D) loans were $2.7 billion (34.6 percent) lower. Charge-offs of one-to-four family residential mortgage loans were down by $1.4 billion (16.0 percent). Credit card charge-offs were $8.6 billion (86 percent) higher than in second quarter 2009. Most, if not all, of this increase was attributable to the inclusion of charge-offs on securitized credit card balances, which were not included in reported charge-offs in previous years. The change in reporting was the result of the application of FASB 166 and 167. In contrast, the $1.8 billion (107.2 percent) year-over-year increase in charge-offs of nonfarm nonresidential real estate loans reflected further deterioration in commercial real estate portfolios. Almost half (49.1 percent) of insured institutions with more than $1 billion in assets reported lower net charge-offs, while only 43.6 percent of community banks reported year-over-year declines.

The decline in charge-offs is also extremely good news, as is the breadth of the lowered charge-offs. This indicates improvement in the general loan picture.

The amount of loans and leases that were noncurrent (90 days or more past due or in nonaccrual status) declined by $19.6 billion (4.8 percent) during the second quarter. This is the first quarterly decline in noncurrent loans since first quarter 2006. Noncurrent levels declined in most major loan categories during the quarter. The sole exception was nonfarm nonresidential real estate loans, where noncurrents increased by $547 million (1.2 percent), the smallest quarterly increase in three years. The largest reduction in noncurrent loans in the quarter occurred in real estate C&D loans, where noncurrents fell by $5.9 billion (8.3 percent). This is the third consecutive quarter that noncurrent C&D loans have declined. Noncurrent C&I loans also declined for a third straight quarter, falling by $2.7 billion (7.3 percent), while noncurrent residential mortgage loans declined by $4.7 billion (2.5 percent) and noncurrent credit cards fell by $4.2 billion (19 percent). Slightly fewer than half of all institutions (48.9 percent) reported declines in their noncurrent loan balances during the quarter. Noncurrent loan balances fell by 5.3 percent at institutions with more than $1 billion in assets and rose by 0.3 percent at community banks.

decline in non-current loans -- both its occurrence and the breadth of its occurrence -- is very good news. It is important to caution this is the first decline we're seen in a few years, so some caution going forward is warranted (one quarter does not make a trend).
Total loan-loss reserves of insured institutions fell for the first time since fourth quarter 2006, declining by $11.8 billion (4.5 percent), as net charge-offs of $49 billion exceeded loss provisions of $40.3 billion. Almost two out of three institutions (61.7 percent) increased their loss reserves in the second quarter, but a number of large banks reduced their loss provisions, producing net declines in their reserve balances. In particular, some institutions that converted equity capital into reserves in the first quarter in accordance with the requirements of FASB 166 and 167 reported lower provisioning in the second quarter. Although the industry’s ratio of reserves to total loans fell from 3.50 percent to 3.40 percent during the quarter, it is still the second-highest level for this ratio in the 63 years for which data are available. The industry’s “coverage ratio” of reserves to noncurrent loans improved for a second consecutive quarter, from 64.9 percent to 65.1 percent, as the reduction in noncurrent loans slightly outpaced the decline in loss reserves.

Again -- these are are healthy developments.

Here are the relevant charts:

Notice the pace of quarterly charge-offs appears to be topping -- we've seen more or less the same level for the last 5 quarters.

Charge - offs are higher than loan loss provisons

The drop -- so far -- is only one quarter of data coming from a very high level. While this is an encouraging development, we need a few more quarters of data before declaring victory.

Non-current rates on residential mortgages appear to be topping, although at high rates.

These levels are sky high.

The non-current rate for larger institutions is dropping, but was also at a higher rate than that for smaller institutions. Also note the rate for smaller institutions also appears to be toppin.