Bank lending, credit risk and profit results for 2008 – part 2

February 26, 2009 by Guest Contributor

By: Tom Hannagan

Part 2

In my last post, I started my review of the Uniform Bank Performance Reports for the two largest financial institution peer groups through the end of 2008.

Now, lets look at the resutls relating to credit cost, loss allowance accounts and the impacts on earnings. Again, as you look at these results, I encourage you to consider the processes that your bank currently utilizes for credit risk modeling and financial risk management.

Credit costs
More loans, especially in an economic downturn, mean more credit risk. Credit costs were up tremendously. The Peer group 1 banks reported net loan losses of .89% of total loans. This is an increase from .28% in 2007, which was up from an average of 18 basis points on the portfolio in 2006/2005.  The Peer group 2 banks reported net loan losses of .74%. This is also up substantially from 24 basis points in 2007 and an average of 15 basis points in 2006/2005. The net loan losses reported in the fourth quarter significantly boosted both groups’ year-end loss percentages above where they stood through the first three quarters last year.

Loss allowance accounts
Both groups also ramped up their reserve for future expected losses substantially. The year-end loss allowance account (ALLL) as a percent of total loans stood at 1.81% for the largest banks. This is an increase of almost 50% from an average of 1.21% in the years 2007/2004. Peer group 2 banks saw their reserve for losses go up to 1.57% from an average of 1.24% in the years 2007/2004.

The combination of covering the increased net loan losses and also increasing the loss reserve balance required a huge provision expenses. So, loan balances were up even in the face of increased write-offs and expected forward losses.

Impacts on earnings
Obviously, we would expect this provisioning burden to negatively impact earnings. It did, greatly. Peer group 1 banks saw a decline in return on assets to a negative .07%. This is just below break-even as a group. The average net income percentage stood at .42% of average assets at the end of the third quarter. So, the washout in the fourth quarter reports took the group average to a net loss position for the year. The ROA was at .96% in 2007 and an average of 1.26% in 2006/2005. That is a 111% decline in ROA from 2007. Return on equity also went into the red, down from 11.97% in 2007. ROE stood at 14.36% in 2005.

For the $1B to $3B banks, ROA stood at .35%. This is still a positive number, however, it is way down from 1.08% in 2007, 1.30% in 2006 and 1.33% in 2005. The decline in 2008 was 67% from 2007. ROE for the group was also down, at 4.11% from 12.37% in 2007. The drops in profitability were not entirely the result of credit losses, but this was by far the largest impact from 2007.

The seriously beefed-up ALLL accounts would seem to indicate that, as a group, the banks expect further loan losses, at least through 2009.  These numbers largely pre-dated the launch of the Troubled Asset Relief Program and the tier one funding it provided in 2008. But, it is clear that banks had not contracted lending for all of 2008, even in the face of mounting credit issues and a declining economic picture. It will be interesting to see how things unfold in the next several quarters.