National, Regional Banking Conditions Detailed in Latest “ViewPoint”

June 30, 2021

Asset Quality :: Balance Sheet Growth :: Capital :: Earnings Performance :: Liquidity :: National Banking Trends 

Asset Quality

Unlike their concern over credit deterioration in the first quarter of 2020, most banks reported satisfactory asset quality conditions with small pockets of stress, primarily with hospitality and retail credits, in the first quarter of 2021. Changes to loan modification requirements made under the CARES Act helped many borrowers at the beginning of the pandemic and aided banks in constraining nonperforming assets. As the economy has recovered, banks indicated far fewer loans needed to be modified, with the exception of some hospitality- and retail-related credits. Comments from banks suggest that many of the borrowers exiting forbearance programs have stayed current in their payments.

Still, a modest increase in problem loans is expected as stimulus payments subside. Banks reported that the percentage of loans reported as past due between 30–89 days decreased slightly, to 0.32 percent, from the prior quarter and was less than the percentage reported in the first quarter of 2020 as the pandemic initially disrupted the economy. In addition to a smaller number of loans being reported as past due 30–89 days, fewer loans are migrating to 90 days or more past due. In some cases, borrowers have recovered, either through stimulus programs or other opportunities, and in others banks are more actively engaged in mitigating problems earlier in the process. On an aggregate basis, past due 90 days represents less than 1 percent of the total loan portfolio, down to just 20 basis points. The percentage of loans in nonaccrual status also declined, consistent with the 30–89 days past due category. As a result, over the last two quarters, nonperforming loans (made up of loans past due 90 days or more and nonaccrual loans) have declined to their lowest level since before the financial crisis 2008. The strong loan performance has pushed net charge-offs down and improved the reserve coverage ratio (see the chart).

On a median basis, the ratio reached 2.3x in the first quarter, the highest it has been in over a decade. Properties repossessed in foreclosure have also declined, in part due to the current credit and real estate environment, and to government moratoriums on foreclosures.

Balance Sheet Growth

Balance sheet growth remained strong in the first quarter of 2021, driven by an increase in deposits related to stimulus efforts. During the first quarter, deposit balances surged by 25 percent on a median annualized basis as additional stimulus arrived in January and March. This increase is reflected in the spike in savings rates (as a percentage of disposable income) in 2020 and thus far in 2021. On a median basis, total assets increased 21 percent in the first quarter, the fourth straight quarter of double-digit increases (see the chart).

Looking back over 16 years of data, balance sheets have not expanded this rapidly at community banks in the Sixth District since 2005. In the absence of stronger loan growth, balances in cash and securities swelled 24 percent on banks’ balance sheets during the quarter and remained the top asset-growth portfolios. In the securities portfolio, banks have boosted investments in both agency securities and municipal bonds. Exposure to government securities now exceeds banks’ exposure to consumer loans. Banks are increasingly looking at other types of debt securities to further bolster yields. Early data from the second quarter suggest deposit growth has moderated, which would likely slow balance sheet growth and provide banks an opportunity to adjust their balance sheet composition. However, it’s unclear if direct deposits from the U.S. Treasury resulting from early child tax credit payments will drive another round of deposit growth later in 2021.

Except for commercial and industrial (C&I) loans, lending in major segments of the loan portfolio remained down year over year (see the chart).

The Paycheck Protection Program (PPP) once again drove C&I lending at community banks in the first quarter as the program was renewed in January 2021. The PPP is scheduled to end in the second quarter of this year. Already, the Small Business Administration has announced that the current PPP had exhausted the $292 billion allocated, except for $8 billion specifically allocated to community financial institutions. Without an additional round of PPP, C&I loan balances are expected to decline at most banks during the next four quarters. Outside the C&I portfolio, growth in the 1–4 family portfolio slowed to its lowest level since late 2013, dropping below 1 percent despite a very competitive housing market. Although banks reported easing credit standards across most housing loans, slower loan production (as a result of operational challenges and increased competition from nonbank lenders) and higher repayment amounts (as a result of refinancing) have contributed to the reduction in growth rate for the portfolio. Consumer loan growth remained muted in the first quarter even as banks eased credit standards. However, preliminary data from the second quarter suggest that growth might return to the portfolio in 2021.


Capital levels at community banks in the Sixth District remained healthy in the first quarter due to improved earnings and stable asset quality. Additional retained earnings also drove improvement in capital levels, offset by other comprehensive income declining (see the chart).

A large number of community banks in the Sixth District—roughly 40 percent—reported using the community bank leverage ratio (CBLR) as a gauge of capital strength in the first quarter. This ratio is calculated by dividing tier 1 capital by quarterly average assets. The median CBLR in the first quarter of 2021 was 10.52 percent, well above the required 9 percent threshold. (An expired provision in the CARES Act temporarily lowered it to 8 percent.) Banks using risk-weighted assets saw little change in capital ratios in the first quarter of 2021 as assets added in recent quarters had lower risk weights. The improving economic outlook and stability within the banking system has allowed many more banks to resume their capital actions, including paying dividends. Several publicly traded banks announced plans to repurchase Treasury stock, following the lifting of temporary restraints put in place due to the pandemic. In 2020, banks reported that the ability to raise equity capital was extremely limited. Now, banks are considering adding to their capital base, either in the form of additional stock or subordinated debt. Additionally, banks are also reconsidering potential acquisitions as economic conditions improve.

Earnings Performance

As economies across the Sixth District continued to reopen in the first quarter of 2021, a majority of banks reported stable to improving financial performance. Less than 4 percent of banks in the District reported a loss in the first quarter, the lowest level since the third quarter of 2019. Impressively, the median return on average assets (ROAA) increased from 0.97 percent in the fourth quarter of 2020 to 1.06 percent in the first quarter of 2021, approaching the 1.10 percent level seen in the first quarter of 2019 (see the chart).

Consistent with national trends, reductions in provision expense drove the improvement in ROAA, especially at many larger community banks (see the chart).

The low interest rate environment remains challenging for most banks. Approximately 65 percent of banks reported a decline in net interest margin (NIM) in the first quarter of 2021, continuing an ongoing trend over the last five quarters after the Federal Reserve lowered the fed funds rate to near zero in March 2020 (see the chart).

The decline in the margin is not solely the result of a low interest rate environment. Additional growth in deposits and limited demand for loans have also squeezed NIM. Although the influx of deposits has lowered funding costs in recent quarters, the inability to place the funds in higher-yielding instruments such as loans had a negative impact on NIM during the quarter. Banks have noted that long-term rates began rising toward the end of the first quarter, and expectations are for NIM to stabilize across the remainder of 2021. As interest income has declined, noninterest income has increasingly represented a larger share of total revenue for community banks. Noninterest income has rebounded over the last two quarters as a result of increased card usage and the reinstatement of many service charges waived during the pandemic. Service charges and other depository fees still represent a majority of noninterest income at community banks in the Sixth District. Interchange income has risen as more people venture back out into the economy. At the same time, retailers continue to complain about usage fees, which could eventually have an impact on revenues if interchange rates are reset. The efficiency ratio also increased slightly in the first quarter. Though banks have reduced some noninterest expenses related to costs generated as a result of the pandemic, other expenses have increased, such as additional loan processing staff to handle PPP requests.


Many banks showed liquidity still growing in the first quarter as they gained even more deposits than the prior year-end. This resulted from another round of stimulus funding in March and restrained spending by depositors. The median on-hand liquidity ratio among community banks in the Sixth District rose to 29.5 percent, a 15-year high. The ratio has more than tripled since the second quarter of 2008. The level of short-term borrowing to provide liquidity has also dropped sharply over the last four quarters as a result of weak loan demand and an influx of new deposits. Overall, deposit growth continued to outpace loan growth in the first quarter of 2021, spiking in mid-March, partly as a result of the stimulus funds provided under the American Rescue Plan. With the increase in deposits, banks are aggressively reducing funding costs. Most of the deposit growth was in transaction accounts (see the chart).

Lower interest rates have pushed customers out of certificate of deposits (CDs), which now represent just 13 percent of assets, compared with nearly 40 percent over a decade ago, before short-term rates were initially dropped during the financial crisis of 2008. So far, there is little evidence that CD holders are moving deposits to other banks, as the difference between rates at local banks is not as significant as when interest rates were higher. With the high level of deposit growth, larger banks are encouraging commercial customers to move balances into money market accounts. Money markets, as a percentage of total assets, dipped in 2020 but have rebounded to 24 percent in the first quarter of 2021.

National Banking Trends

Earnings across most banks improved year over year as of the first quarter of 2021. On an aggregate basis, return on average assets (ROAA) increased by 133 basis points, climbing to 1.39 percent from 0.36 percent as reported at the first quarter of 2020, when the pandemic drove profitability sharply down (see the chart).

The rebound for community banks was not as strong, but they generally have retained a higher ROAA throughout the pandemic than the industry as a whole. Profitability in the first quarter of 2021 was primarily driven by multiple institutions reducing their provision expense following the buildup in reserves in 2020 as the pandemic hit. Still, institutions face significant revenue pressure in 2021 due to elevated deposit growth, a slowing mortgage refinance market, and lower commercial loan demand. Anemic lending levels have weighed on net interest income over the last four quarters as demand has contracted (see the chart).

Indications are that the decline in interest income may have reached the bottom for larger banks in the first quarter of 2021, but that community banks will continue to experience a decline into the second half of 2021.

Bank balance sheets expanded in the first quarter of 2021, despite weak loan production, on the strength of deposit growth. Expansion was stronger than in the last two quarters of 2020, but was significantly less than the growth experienced in the second quarter of 2020, when companies drew down credit lines to protect against the pandemic. Banks mainly added to their cash balances and securities portfolios as loan demand continued to sag. The lack of loan demand, along with early repayments, has again pushed the percentage of loans to total assets downward in the first quarter, continuing a postpandemic trend, although loans still make up more than 60 percent of assets at community banks. The loan-to-deposit ratio now sits at 53.9 percent, on an aggregate basis, the lowest the ratio has been in approximately 30 years, according to historical data. Residential mortgages and Paycheck Protection Program (PPP) loans once again provided most of the loan growth during the quarter. For smaller community banks, nearly all loan growth over the last four quarters has stemmed from PPP loans. According to the April 2021 Senior Loan Officer Opinion Survey, banks would like to increase the amount of credit they extend on certain loan portfolios, primarily construction and multifamily properties.

Despite a year of economic uncertainty due to the pandemic, asset quality metrics remained relatively unchanged from the prior quarter. In terms of nonperforming loans, the percentage of loans past due 90 days or more has held remarkably steady, around 13 basis points, at community banks over the last 10 quarters. Adding in nonaccrual loans lifts the nonperforming ratio to 80 basis points, consistent with levels seen since the first quarter of 2019 (see the chart).

Concern over the pandemic and resulting economic shutdowns, along with the adoption of the current expected credit losses methodology at larger banks, pushed loan-loss provisions to extreme heights a year ago. Provisions began declining in the second half of 2020, a trend that continued into the first quarter of 2021 (see the chart).

Banks have not experienced a spike in net charge-offs, and deferrals have steadily declined across most loan portfolios. Since the initial wave of deferrals, bankers noted that far fewer borrowers have asked for additional deferrals on loan payments.

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