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Banking & Finance AN EIGHTH DISTRICT PERSPECTIVE SPRING 1986 Eighth District Bank Performance in 1985 For many Eighth District banks, 1985 was a strong year for reported earnings, as the positive impact of lower interest rates and profitable investment decisions more than offset the negative effects of steadily increasing loan losses. For some Eighth District banks, however, 1985 was characterized by loan problems that depressed earnings as well as return on assets. This article examines the recent Eighth District banking experience and highlights profitability distinctions among District states. banks primarily accounts for the declining returns on assets and equity. Banks in Kentucky and Mississippi, on the other hand, outranked the other District states, posting the highest returns on assets and equity. Asset Quality Because the quality of an institution’s assets eventually is reflected in its earnings stream, the composition of the asset portfolio is an indicator of the future earnings of an organization. Asset quality is sensitive to both national and Earnings international conditions and particular regional trends that affect the quality of a bank’s loan portfolio. As the financial In assessing earnings performance, both the size and the composition of items in a bank’s portfolio must be appraised. strength of certain borrowers deteriorates, their ability to The quantitative aspect of earnings is evaluated through an satisfy loan obligations is impaired. analysis of a bank’s return on assets (ROA) and return on Changes in asset quality can be monitored by two shareholders’ equity (ROE). The ROA ratio, calculated by indicators. The first, loan loss rates, have direct impact on dividing a bank’s net income by its assets, gauges how well bank profitability since they represent actual charge-offs a bank’s management is employing its assets. The ROE ratio, against income. As loan loss rates rise, banks increase their obtained by dividing a bank’s net income by its total equity loan loss provision account, thereby reducing profitability. The second indicator, loan delinquency (nonperforming) capital, indicates to shareholders the earnings on their investment. rates, indicate the potential for loan losses and, therefore, provide a rough indication of future losses. As indicated in table 1 on the next page, Eighth District banks earned a 0.89 percent ROA and an 11.05 percent ROE Credit or loan quality, as measured by the loan loss ratio, in 1985, compared with 1984 averages of 0.87 percent and deteriorated during 1985. As indicated in table 2, data for the Eighth District and individual states reveal increases in 10.93 percent, respectively. The higher profitability ratios are due, in large measure, to a wider spread between interest the ratio of loan losses to total loans. Illinois banks, with income and interest expense. With a decline in interest the agricultural loan problems experienced during 1985, expense as a percent of bank assets, net interest margins posted a significant increase in their average loan loss ratio. improved. In general, banks benefit from periods of declining Nonperforming loans as a percent of total loans increased interest rates because their cost of funds declines more slightly at the District level during 1985. Arkansas, Illinois rapidly than the interest rates they charge and M ississippi experienced rising borrowers. delinquency rates in 1985. The remaining Returns on assets and on equity were up District states saw lower nonperforming loan in all Eighth District states except Illinois, ratios last year and, as a result, may realize where lower reported earnings by banks with THE lower loan loss rates in 1986. FEDERAL less than $100 million in assets, hampered Because of deteriorating average loan RESERVE BANK of the profitability ratios. It should be noted, quality experienced during the past several ST. I X H IS however, that only banks in southern Illinois years, most banks in the Eighth District have are within the Eighth District’s borders so increased their loan loss reserves as a share of their total loans. This action has been taken that the performance of small agricultural SPRING 1986 FEDERAL RESERVE BANK as a precautionary measure to absorb potential future loan losses. As a percent of total loans, Eighth District banks’ loan loss reserves increased from 1.20 percent in 1984 to 1.30 percent in 1985. Summary data generally point to improved average performance. Returns on assets and equity increased in 1985 in most District states. In terms of returns on assets and equity, Kentucky and Mississippi posted the highest ratios for the seven states examined. Reported earnings were retarded somewhat, however, by larger provisions for loan losses. While some Eighth District banks continue to experience a variety of difficulties, such as rising loan loss rates, state —Lynn M. Barry Table 1 Percentage Returns on Assets and Equity at Insured Commercial Banks (by state) Return on Assets Eighth District Arkansas1 Illinois Indiana Kentucky Mississippi Missouri Tennessee Return on Equity 1984 1985 1984 0.87% 0.78 0.89 0.93 1.04 1.01 0.84 0.73 0.89% 0.85 0.77 0.98 1.12 1.21 0.90 0.90 10.93% 9.55 10.43 10.87 12.35 12.28 11.07 10.27 1985 11.05% 10.29 9.06 11.22 13.37 14.41 11.72 12.77 1 Certain 1985 ratios for Arkansas have been adjusted to negate the effects of substantial losses which occurred when a now defunct government securities group was unable to honor obligations of a large commercial bank. The unadjusted 1985 ratios for Arkansas are as follows: Return on Assets 0.52% Return on Equity 6.36 SOURCE: Federal Deposit Insurance Corporation, “ Consolidated Reports of Condition and Income for Insured Commercial Banks,” 1984-85. Table 2 Indicators of Asset Quality at Insured Commercial Banks (by state) Net Loan Loss -r Total Loans Eighth District Arkansas1 Illinois Indiana Kentucky Mississippi Missouri Tennessee Nonperforming Loans -r Total Loans Loan Loss ReservedTotal Loans 1984 1985 1984 1985 1984 1985 0.60% 0.69 0.80 0.51 0.52 0.75 0.53 0.61 0.88% 0.97 1.55 0.79 0.66 0.89 0.69 0.93 2.49% 2.57 2.88 2.05 2.35 1.89 2.42 2.99 2.50% 3.30 3.19 1.78 2.06 2.02 2.35 2.47 1.20% 1.10 1.04 1.11 1.37 1.11 1.25 1.23 1.30% 1.40 1.23 1.15 1.34 1.28 1.27 1.31 1 Loan losses for Arkansas in 1985 have been adjusted to negate the effects of substantial losses which occurred when a now defunct government securities group was unable to honor obligations of a large commercial bank. The 1985 unadjusted loan loss ratio for Arkansas is 1.05 percent. SOURCE: Federal Deposit Insurance Corporation, “ Consolidated Reports of Condition and Income for Insured Commercial Banks,” 1984-85. Banking & Finance—An Eighth District Perspective is a quarterly summary of banking & finance conditions in the area served by the Federal Reserve Bank of St. Louis. Single subscriptions are available free of charge by writing: Research and Public Information Department, Federal Reserve Bank of St. Louis, P.O. Box 442, St. Louis, Missouri 63166. Views expressed are not necessarily official positions of the Federal Reserve System. Digitized for2 FRASER FEDERAL RESERVE BANK OF ST. LOUIS SPRING 1986 EIGHTH DISTRICT BANKING DATA LARGE WEEKLY REPORTING BANKS1 Rates of Change Level Current Quarter Current Year 1/1986 ($ millions) IV/19851/1986 1/19851/1986 Sam e Periods Previous Year IV /19841/1985 1/19841/1985 S e le c te d A s s e ts & L ia b ilitie s Total Loans & Leases Commercial Loans Consumer Loans Real Estate Loans Loans to Financial Institutions All Other Loans $16,028 5,434 3,749 3,570 796 2,479 Total Securities U.S. Treasury & Agency Securities Other Securities Total Deposits Non-Transaction Balances MMDAs $100,000 CDs Demand Deposits Other Transaction Balances2 9.7% 6.6 15.8 13.9 -3 8 .8 25.0 7.8o/o 0.3 22.7 7.0 -2 3 .4 22.8 19.3o/o 8.6 24.1 14.5 -1 5 .4 90.3 13.8o/o 12.2 13.8 11.3 8.4 26.5 3,836 2,113 1,721 6.7 -1 6 .2 46.9 5.6 - 3 .8 19.9 3.5 - 4 .7 17.8 - 2 .0 - 9 .3 11.6 18,905 11,765 2,442 3,718 5,393 1,733 -0 .8 1.2 29.6 - 1 .3 - 7 .4 21.9 2.7 0.8 13.5 - 4 .4 2.7 16.1 4.1 6.6 32.1 4.3 - 5 .7 22.8 7.4 12.0 11.4 17.0 - 2 .2 9.4 SMALL WEEKLY REPORTING BANKS3 Rates of Change Level 1/1986 ($ millions) Current Q uarter IV /19851/1986 Current Year 1/19851/1986 Previous Year IV /19841/1985 S e le c te d A s s e ts & L ia b ilitie s Total Loans & Leases Commercial Loans Consumer Loans Real Estate Loans All Other Loans U.S. Treasury & Agency Securities Other Securities Total Deposits $5,060 1,509 1,001 2,077 473 O.70/0 - 5 .5 -1 3 .4 8.1 25.8 4.4% - 3 .2 - 0 .4 8.4 29.1 8.2% 9.5 10.3 8.2 - 2 .2 1,951 - 3 .0 - 0 .6 13.3 742 22.5 8.4 3.0 7,671 -2 3 .3 - 0 .2 10.2 1 A sample of commercial banks with total assets greater than $750 million. Historical data have been revised to incorporate adjustment factors that offset the cumulative effects of mergers and other changes involving weekly reporting banks during 1985. These adjustment factors, which are computed each year, are used to construct a consistent time series for which year-to-year growth rates can be calculated. Adjustment factors are available upon request from the Statistics Section of the Research and Public Information Department. Rates of change are compounded annual rates. 2 Includes NOW, Super NOW, ATS and accounts permitting telephone or pre-authorized transfers. 3 A sample of commercial banks with total assets less than $300 million as of January 1984. 3 EIGHTH DISTRICT BANKING DATA Bank Performance Ratios RATIOS IV/1985 IV/1984 IV/1983 77.32% 58.55 73.82% 59.11 66.02% 57.10 1.45 1.22 1.39 1.12 1.48 1.04 3.80 5.13 3.87 4.95 5.21 4.68 0.64 1.03 0.42 0.70 0.43 0.68 January 1986 Year Ago March 1985 Loans to Deposits Large Banks4 Small Banks5 Loan Loss Reserves to Total Loans Large Banks Small Banks Delinquent Loans to Total Loans Large Banks Small Banks Net Loan Losses to Total Loans Large Banks Small Banks EIGHTH DISTRICT INTEREST RATES6 March 1986 Super NOWs MMDAs Time CDS 92 — 182 days 1 — 2 1/2 years 2 1/2 years and over February 1986 5.52% 6.53 5.70% 6.83 5.72% 6.85 6.89% 7.76 6.96 7.65 7.99 7.30 8.08 8.43 7.32 8.10 8.49 8.79 9.50 9.77 4 All Eighth District banks with total assets greater than $750 million. Ratios are derived from Call Reports. 5 All Eighth District banks with total assets less than $300 million. 6 Average interest rates paid on new deposits by a sample of District commercial banks.
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