WASHINGTON Shedding new light on the credit pullback that began late last year, the Federal Deposit Insurance Corp. reported Wednesday that noncurrent commercial loans last fall reached their highest level in six years.
The agencys latest Regional Outlook, a quarterly snapshot of the impact of economic conditions on the banking industry in eight sections of the country, said that noncurrent credits those that are 90 days past due at commercial banks rose to 1.52% of business lending as of Sept. 30. Noncurrent commercial and industrial loans surged 46% from a year earlier, to $15.6 billion.
Banks with over $1 billion in assets have experienced most of the recent deterioration, the report said. Several indicators suggest that banks could experience substantial further deterioration in business loan quality in the near term.
One of the key reasons for the decline was the more liberal underwriting standards used by banks during the height of the recent economic expansion from 1996 to 1999, the report said. In addition to dealing with intense competition and the robust economy, several banks moved aggressively into riskier lending to combat narrowing interest margins and declining investment-grade yields, the report said.
FDIC Chairman Donna Tanoue whose dour economic forecasts and credit quality warnings in recent months have been echoed by some regulators and undermined by others said she was concerned about the reports findings, but cautioned that overall the banking industry is still going strong.
Signs of a slowdown in the economy raise concerns about the possible severity of commercial loan problems, a situation we will be watching closely in the coming months, Ms. Tanoue said in a press statement. However, it is important to note that continued strong earnings and capital provide a significant buffer for banks to weather the effects of higher levels of nonperforming business loans and business loan losses.
Industry representatives said that bankers are concerned about the report but not surprised by it.
Its fairly dismal news, but this is something we have been hearing from the regulators and in particular the FDIC for quite a while, said Robert Strand, senior economist with the American Bankers Association. But I have to point out that the banking industry is probably in as healthy a state as it ever has been.
Still, the report contained sharp warnings for bankers. Increased tolerance for risk, relaxed underwriting standards, weaknesses in key industries, and a rise in leverage at several nonfinancial companies contributed to a continued significant deterioration in business credit conditions, the report said.
Further, several regions are showing increased vulnerability to a slowing economy, it said. In particular, the San Francisco region is encountering severe difficulties because of the recent bubble burst in tech stocks and layoffs by several Internet start-ups, the report said.
The San Francisco region reported increased personal bankruptcy filings, and the regions rate was higher than the national average. Its banks also reported worries that the economic slowdown will weaken credit quality at institutions with large unsecured or subprime consumer loan portfolios.
An economic downturn could result in increased job losses and reduced stock market and home values, the report said. Consequently, consumers in the region may find it more difficult to liquidate or leverage assets to service debts, and bankruptcy rates could rise.
In the Memphis region, banks and thrifts reported increasing credit exposure, and the aggregate loan-to-asset ratio reached an all-time high at the end of the third quarter. Pressured by rising competition, banks and thrifts have appeared willing to accept greater levels of credit risk to improve asset yields and maintain net interest margins, the report said.
Several regions, including Boston, New York, Chicago, and Atlanta, have reported increased exposures to troubled industries, including the manufacturing and high-tech sectors, the report said.
In Chicago, the largest institutions said that commercial and industrial loan growth jumped to 16% in the 12 months that ended Sept. 30 the largest increase in five years. Those banks reported higher loan-loss reserves but said the increases were not keeping up with the growth in nonperforming loans, the report said.
Banks in New York and other regions reported a shift into higher-risk, higher-yield loan categories. The credit risk profile of the areas new banks was also rising because of growing commercial real estate loan portfolios and increased use of noncore funding.