District Banking Conditions
Conditions Corner - December 2017
Banking & Policy Studies
Published December 20, 2017 | December 2017 issue
In this issue of Banking in the Ninth, we begin a regular column that will highlight information about banking and economic conditions in the Ninth District. This article focuses on the health of banks in the District as measured by their examination ratings. We show that by this measure, the industry has returned to its precrisis state after suffering severely during the financial crisis. The key reasons for this turnaround have been strong capital accumulation along with improvement in asset quality.
One measure that provides a holistic assessment of a bank’s condition is the supervisory ratings that are assigned to banks after official examinations. These ratings incorporate both financial and nonfinancial characteristics of a bank and focus on six broad areas: Capital adequacy, Asset quality, Management capability, Earnings quality and level, Liquidity adequacy, and Sensitivity to market risk. Each of these areas—along with a composite rating for the overall institution—is assigned a score during the examination ranging from 1 to 5 (lower scores indicate better conditions). The composite rating is commonly referred to by the acronym CAMELS.
Currently, more than 95 percent of banks within the Ninth District have a CAMELS rating of 1 or 2, which we classify as being in “satisfactory” condition. The following figure shows the percentage of Ninth District banks rated in satisfactory condition back to 2001. The low point occurred at the end of 2010, when only 75 percent of the District’s banks were deemed to be satisfactory. This measure rose steadily during the 2011-15 period and is now back to levels typically seen in the precrisis period.
What factors have driven the significant improvement in the conditions of District banks since 2010? First, Capital adequacy at Ninth District banks has steadily increased over this period. For example, the median bank in the District currently has an equity-to-asset ratio (a broad measure of capital) of 10.7 percent. Contrast this with the median bank level of 9.7 percent that was measured at the end of 2010.
Second, Asset quality (the quality of a bank’s loan portfolio and credit administration program) has also improved considerably during this time frame. Asset quality can be assessed in a number of ways, but one simple metric is to measure the amount of “problem loans” (those in which the borrower has missed a payment) relative to the amount of resources available to cover such losses. Lower values for the metric indicate better asset quality, and the measure at the median bank in the Ninth District currently stands at 6.8 percent. During the financial crisis, the same metric soared to 22 percent. The improvement in asset quality is broad-based. All major lending categories (residential real estate loans, commercial real estate loans, commercial and industrial loans, and agricultural loans) have seen their problem loan measures decline to some of the lowest levels recorded in the past 25 years.
Overall, the vast majority of banks within the Ninth District are in satisfactory condition. Supervisory ratings for a number of firms have returned to their precrisis levels. Recent improvement in capital levels and asset quality provide solid support for this conclusion, as both are stronger today than at any time before the crisis. One potential area to watch would be the quality and level of earnings, though. Many banks continue to struggle in the low-interest rate environment, and most measures of earnings performance continue to lag behind their precrisis levels.