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Bank Lending and Credit Risk Results through September 2008

By: Tom Hannagan

I reviewed the Uniform Bank Performance Reports (UBPR: (http://www2.fdic.gov/ubpr/ReportTypes.asp ) for selected clients through the third quarter of this year. The UBPR is a compilation of the FDIC, based on the call reports submitted by insured banks. The FDIC reports peer averages for various bank size groupings.

Here are a few findings for the two largest groups, covering 490 banks.

Peer Group 1 consists of 186 institutions over $3 billion in average total assets for the first nine months. Net loans accounted for 67.59 percent of average total assets, up from 65.79 percent in 2007. Loans, as a percent of assets, have increased steadily since at least 2005. The loan-to-deposit ratio for the largest banks was also up to 97 percent, from 91 percent in 2007 and 88 percent in both 2006 and 2005. So, it appears these banks are lending more, at least through the September quarter, as an allocation of their asset base and relative to their deposit source of funding.

In fact, net loans grew at a rate of 11.51 percent for the group through September, which is down from the average growth rate of 15.07 percent for the years 2005 through 2007.  But, it is still growth.

For Peer Group 2, consisting of 304 reporting banks between $1billion and $3 billion in assets, net loans accounted for 72.57 percent of average total assets, up from 71.75 percent in 2007. Again, the loans as a percent of assets have increased steadily since at least 2005. The loan-to-deposit ratio for these banks was up to 95 percent, from 92 percent in 2007 and an average of 90 percent for 2006 and 2005. So, these banks are also lending more, at least through the September quarter, as a portion of their asset base and relative to their deposit source of funding.

In fact, net loans grew at a rate of 12.57 percent for the group through September, which is up from 11.94 percent growth in 2007 and down from an average growth of 15.04 percent for 2006 and 2005.  Combined, for these 490 largest institutions, loans were still growing through September. More loans probably mean more credit risk.

Credit costs were up. The Peer Group 1 banks reported net loan losses of 0.67 percent of total loans, up from 0.28 percent in 2007, which was up from an average of 18 basis points on the portfolio in 2006/2005.  The Group 2 banks reported net loan losses of 0.54 percent, also up substantially from 24 basis points in 2007, and an average of 15 basis points in 2006/2005.

Both groups also ramped up their reserve for future expected losses substantially. The September 30th allowance for loan and lease losses (ALLL) as a percent of total loans stood at 1.52 percent for the largest banks, up from 1.20 percent in 2007 and an average of 1.11 percent in 2006/2005. Peer Group 2 banks saw their allocation for losses up to 1.40 percent from 1.22 percent in 2007 and 1.16 percent in 2006. So, lending is up even in the face of increased write-offs, increased expected losses and the burden of higher expenses for these increased loss reserves.

Obviously, we would expect this to negatively impact earnings. It did, greatly. Peer Group 1 banks saw a decline in return on assets to 0.42 percent, from 0.96 percent in 2007 and an average of 1.26 percent in 2006/2005. That is a decline in return on assets (ROA) of 56 percent from 2007 and a decline of 68 percent from the 2006/2005 era. Return on equity declined even more. ROE was at 5.21 percent through September for the large bank group, down from 11.97 percent in 2007. ROE stood at 14.36 percent in 2005.

For the $1 billion to $3 billion banks, ROA stood at 0.66 percent for the nine months, down from 1.08 percent in 2007, 1.30 percent in 2006 and 1.33 percent in 2005. The decline in 2008 was 39 percent from 2007. Return on equity (ROE) for the group was also down at 7.71 percent from 12.37 percent in 2007. The drops in profitability were not entirely the result of credit losses, but this was by far the largest impact from 2007 and earlier.

The beefed-up ALLL accounts would seem to indicate that, as a group, the banks expect further loan losses in the remainder of 2008 and into 2009.  All of these numbers pre-dated the launch of the TARP program, but it is clear that banks had not contracted lending through the first three quarter of 2008, even in the face of mounting credit issues, cost of credit, challenges regarding loan pricing and profitability, net interest margins,  and the generally declining economic picture. It will be interesting to see how things unfold in the next several quarter

[See my December 5th post about ROE versus ROA.]

Disclosure: No positions.