Fourth-quarter earnings reports from small and midsize banking companies showcase some favorable trends, notably that credit deterioration appears to be stabilizing and deposits have bloomed on many balance sheets.
Yet some significant obstacles remain for the sector in the coming year, including further problems with commercial real estate portfolios.
"The clear trend is, credit quality is not getting worse in general," said Kevin Reynolds, an analyst at Wunderlich Securities Inc. "I believe the economy has stabilized and it is beginning a very, very modest recovery and housing markets have put in a bottom."
Typically the fourth quarter is when banks scrub loan portfolios, and last year was no exception. But analysts said the credit cycle may well be turning.
Jefferson Harralson, an analyst at KBW Inc.'s Keefe Bruyette and Woods Inc., said the average of nonperforming assets at 106 bank companies that had reported fourth-quarter results by Friday — 76 of which were small or midsize — had risen by 19 basis points, to 2.81% of total assets, from the third quarter.
"That is less than people were expecting," he said. "The net chargeoffs were reasonable, given the fourth quarter is usually such a cleanup quarter."
The results for those 106 banks showed that the ratio of net chargeoffs to average loans grew by 18 basis points, to 1.46%.
Matt Olney, an analyst at Stephens Inc., said banks wrote off a range of problem loans, moving beyond construction credits to industrial and commercial loans.
"We are now seeing the mix of chargeoffs change," he said. "A year ago the chargeoffs were from construction credits. Now we are seeing other loan mixes being charged off."
Though several companies reported progress in working through problem loans, many were still adding to loss provisions at higher rates than historically would be expected. They are trying to cover themselves in case the economic recovery is slow.
Cullen/Frost Bankers Inc. in San Antonio exemplified this trend.
Dick Evans, the chairman and chief executive officer of the $16.2 billion-asset company, said it brought nonperforming assets down by 18%, to $180 million, in the quarter, charging off $20 million or about half the decrease in nonperforming assets.
"We believe the levels are manageable," he said. "We did build our provision even though trends are very positive."
Some analysts said they expect that commercial real estate loans could do a slow burn that lasts for years. Yet not all observers agree — they say the industry may be getting ahead of itself with this worry.
"I think the concern over that is really overblown," said Thomas O'Brien, the president and chief executive officer of the $1.6 billion-asset State Bancorp Inc. in Jericho, N.Y. "It is an issue we all have to watch, but it isn't the sinkhole that a lot of people have been predicting. There is a lot of fear mongering out there. Everybody is waiting for the next disaster."
Meanwhile, deposits were a definite sweet spot for many banks. The KBW report said that average deposits at the banks grew 8% from the previous quarter and the net interest margin improved. For the 76 small and midsize banks in the sample, the margin improvement was 5 basis points, to 3.73%.
"Net interest margins have been higher than we anticipated," said Mark Fitzgibbon, an analyst with Sandler O'Neill & Partners LP. "As an industry, we have underappreciated the impact of lower-cost deposits. There was a very strong net interest margin this quarter."
Conversely, as deposits grew, loans shrank 3%; banks reported further efforts to reduce loan portfolios' size in order to increase capital ratios or said they found a dearth of lending opportunities in their markets.
"There was very, very tepid or no balance-sheet growth," Fitzgibbon said. "Even from banks that have capital to lend, we are hearing there was not loan demand out there."
MB Financial Inc. in Chicago illustrates how some companies still face serious problems, especially in their construction portfolios. It surprised the industry Friday by announcing a $9.8 million loss after setting aside $70 million in reserves and charging off $82.2 million.
That was still a narrower loss than a year earlier when MB lost $24.8 million.
Jill York, the chief financial officer of the $10.9 billion-asset company, said the construction loan portfolio "continued to have deterioration but other categories held up pretty well."
First State Bancorp in Albuquerque also reported a narrower year-over-year loss. On Monday it announced a $28.4 million fourth-quarter loss, a 24% improvement from a year earlier. The $2.8 billion-asset company has been trying for several quarters to improve its capital ratio to satisfy a regulatory order, and it warned that its survival is in question.
But even H. Patrick Dee, First State Bancorp's president and chief executive officer, said its pool of problem loans has stabilized.
"Our entire universe of identified or potential problem loans has remained very stable," he said, "but there has been a migration within those from performing to nonperforming. That is probably the one bit of pretty good news in our numbers."