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2nd Quarter 2002 |
Recession and Credit Quality
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 Credit quality, sometimes termed asset quality holds a number of managerial
and regulatory issues for banks. From a management perspective, credit must
be priced high enough to cover potential losses, administrative expenses,
etc. yet priced attractively to remain competitive. From a regulatory
perspective, there are potential risks involved and where there are risks,
there are regulations. How does each of these perspectives figure in the
current economic recession?
Falling rates have left bank executives scrambling to play the pricing game. Most community banks responded by dropping rates paid on interest bearing core deposits which provided a welcome relief as longer termed assets re-priced somewhat slower. Cost of funds for Peer Group B with assets between $100 and $300 million
fell from 4.68% in the second quarter of 2001 to 3% in the second quarter of
2002. Over time, the asset side of the balance sheet has also responded to
the falling rates and overall portfolio yields are down significantly. A
year ago, yield on earning assets was 8.16% in the second quarter of 2001
for banks in Peer Group B. In the second quarter of 2002, the same peer
group saw yield on earning assets at 6.9%. Interest margins, however, have
increased slightly over the same time period.
Banks industry wide have tightened credit standards in response to the recession. However, in contrast to previous recessions, historically low interest rates and inflated home values have encouraged consumers to continue borrowing. Add to this factor the influx of deposits from the stock market giving banks the money to lend creditworthy borrowers. The banking business as a whole has thus far escaped the economic downturn affecting many other sectors of the economy.
In summary, while the term recession may bring fear to the hearts of bankers and regulating agencies alike, thus far those fears appear unfounded. Further changes in interest rates, trends in corporate earnings and the looming international political landscape will dictate where interest margins will go moving forward. |
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This
A/L BENCHMARKS Industry Report article was published |
In addition to lower yields on earning assets, the term recession
typically spells out increases in non-performing loans and ultimately
charge-offs. Fortunately we have not seen this trend as of yet. Although
there is usually a delay because consumers have reserves in the event of
unemployment and layoffs do not always happen immediately. Overall, typical
measures of credit quality such as non-performing assets as a percentage of
total assets, allowances for loan losses, charge offs as a percentage of
total loans and loan loss provisions have remained steady over the previous
four quarters. “The percentage of commercial banks’ total loans that were
noncurrent remained unchanged at 1.47 percent, marking the first time since
the fourth quarter of 1999 that the industry’s noncurrent rate did not
increase.” The FDIC Quarterly Banking, Profile Second Quarter 2002. 
From a regulatory perspective, assets quality poses a risk of potential
loss of cash flows due to poor quality borrowers and/or concentrations of
similar assets. Regulating agencies forewarned of an escalation in credit
quality issues with an economic downturn. As we noted earlier, this has not
been the case for banks to date. Significant swings in credit concentrations
have also been absent and regulatory focus has remained on interest rate
risk.