central banker - spring 2009

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T h e F e d e r a l r e s e r v e B a n k o F s T . l o u i s : C e n T r a l T o a m e r i C a ’ s e C o n o m y ™

CenT ral

n e w s a n d v i e w s F o r e i g h T h d i s T r i C T B a n k e r s

S p r i n g

2 0 0 9

F ea tured i n th i s i ssue: Growth in Noncore Funding | Collapse o the Shadow Banking System

By Kim Nelson

In just a little over a year, the Fed-

eral Reserve’s discount window has

become a popular option or many

banks interested in temporary alterna-

tive unding sources.

I you’re thinking o tapping into a

temporary unding program or your

nancial organization, here is a quick

review. The purpose o the discount window is to act as a saety valve to

relieve pressures in the market or

reserves. Normally, the discount

window relieves temporary liquidity

strains or depository institutions and

the banking system; it is not intended

to provide longer-term unding (with

the exception o the very small sea-

sonal credit program). However,

because o the signicant stress in

the nancial markets that started inAugust 2007, the Fed’s Board o Gover-

nors expanded discount window credit

programs to provide longer-term

liquidity to the nancial system.

The Fed introduced several tempo-

rary programs or banks rst. These

included Term Primary Credit, which

makes unding available or 90 days,

and the Term Auction Facility, which

makes unding available or up to

84 days. These programs are avail-

able only to nancial institutions that

are in “generally satisactory” nan-

cial condition. The loans come with

essentially the same requirements as

a traditional discount window loan,

How To Use the Fed’s Discount WindowTraditional and New, Temporary Lending Programs Fit Specic Needs

although loans exceeding 28 days

must have an excess margin o col-

lateral or contingency short-term bor-

rowing purposes.

Ater introducing the temporary

programs or banks, the Board o Gov-

ernors in March 2008 began exercising

its authority under Section 13(3) o the

Federal Reserve Act, which allows theFed to extend credit to individuals,

partnerships and corporations dur-

ing what the Board determines to be

“unusual and exigent circumstances.”

Generally, an “unusual and exigent

circumstance” presents risk o sys-

temic insolvencies. No loans had been

made under this provision since the

Great Depression era o the 1930s.

The Fed established two Section 13(3)

programs to help with the resolution o

specic nancial entities: Bear Stearns

and American Insurance Group (AIG).

Other Section 13(3) programs were

continued on Page 6



By Michelle Neely

A dismal banking environment and

a very weak economy continuedto wreak havoc on bank balance sheetsand income statements in the ourthquarter, resulting in an awully poor

showing in earnings and asset quality at District banks and their U.S. peers.

At District banks, return on averageassets (ROA) ell 22 basis points to 0.45

percent in the ourth quarter. ROA wasdown 49 basis points rom its year-end2007 level. (See table.) Protability atU.S. peer banks (banks with averageassets o less than $15 billion) plungedin the ourth quarter, resulting in year-

end ROA o just 0.15 percent, a 29 basispoint drop rom its third quarter leveland a stunning 90 basis point declinerom its year-end 2007 level.

The double-digit declines in ROA in

the ourth quarter at both sets o banks

were due to large increases in net non-interest expense and loan loss provi-sions; the average net interest margin

stayed fat at 3.79 percent or Districtbanks and 3.82 percent at peer banks.

Loan loss provisions as a percent o average assets climbed to 0.74 percentat District banks and 1.03 percent at

U.S. peer banks. The LLP ratio hasmore than doubled at District banksand has almost tripled at peer banksover the past year.

Despite the large increases in provi-

sions, the coverage ratio (the loan lossreserve as a percentage o nonperorm-ing loans) has tumbled signicantly atboth sets o banks over the past two

years. At year-end 2006, District bankshad $1.78 reserved or every dollar o nonperorming loans; at year-end 2008,the coverage ratio stood at just 84 cents.U.S. peer banks had just 65 cents

reserved or every dollar o nonper-

orming loans, down dramatically rom$1.83 at year-end 2006.Increases in loan loss provisions

and declines in coverage ratios can be

traced to continued deterioration inasset quality at District and U.S. peerbanks. The ratio o nonperorming

Q u a r t e r ly r e p o r t

Perormance Ratios Go rom Badto Worse at District and U.S. Banks

Fm B W

Q4 2007 Q3 2008 Q4 2008

RetuRn on aveRage assets

District Banks 0.94% 0.67% 0.45%

Peer Banks 1.05 0.44 0.15

net inteRest maRgin

District Banks 3.89 3.79 3.79

Peer Banks 3.99 3.82 3.82

Loan Loss PRovision Ratio


Peer Banks 0.35 0.77 1.03

nonPeRfoRming Loans Ratio


Peer Banks 1.26 2.19 2.63

SOURCE: Reports of Condition and Income for Insured Commercial Banks

Banks with assets of more than $15 billion have been excluded from the analysis. All earningsratios are annualized and use year-to-date average assets or average earning assets in the

denominator. Nonperforming loans are those 90 days or more past due or in nonaccrual status.

loans to total loans rose to 1.76 percentat District banks and 2.63 percent at

peer banks in the ourth quarter. Inthe District, increases in nonperorm-ing commercial and industrial loans

and commercial real estate loans werethe main contributors to the rise in the

composite nonperorming loan ratio.More than 5 percent o District banks’outstanding construction and land

development (CLD) loans were nonper-

orming at the end o the ourth quar-ter. At U.S. peer banks, the decline in

quality was even more pronounced, with almost 9 percent o outstandingCLD loans in nonperorming status.

Despite the dreary earnings andasset quality numbers, District banks

remain on average well-capitalized. Atthe end o the ourth quarter, only oneDistrict bank (out o 700) ailed to meet

at least one o the regulatory capitalminimums. District banks averaged a

leverage ratio o 8.99 percent.

Michelle Neely is an economist at the Federal

Reserve Bank o St. Louis.

Cl Bk Sg 2009 | 3



By Rajeev Bhaskar and Yadav Gopalan

Noncore unding sources have

always played an important und-

ing role or banks; however, in the lastdecade, reliance on them has increased.

Noncore unding sources include

ederal unds purchased, Federal HomeLoan Bank (FHLB) advances, subor-

dinated notes and debentures, CDs o

more than $100,000 (jumbo CDs) and

brokered deposits. Aside rom a blipduring the 2000-01 recession, reliance

on these noncore unds has increased

e C o n o m i C F o C u S

Noncore Funding Growing in Importanceamong Most Types o Banks

steadily at banks o all sizes over the

last decade. (See Figure 1.)As the nancial services industry

has evolved over the past 10 to 20

years, depositors have had the oppor-tunity to invest in the stock market,

mutual unds and money market

unds. As such, there has been a shitin core deposits away rom banks to

these alternate investment vehicles,

which have potentially higher return.

Banks, meanwhile, have experiencedtremendous growth in loans over the

same period. To keep up, banks haveturned to more nontraditional noncore

sources o unds.

As a percentage o assets, noncoreunds are more important to large

banks than community banks. Still,

the growth in noncore unding hasbeen much aster at community banks.

a u.s. Bk

For all U.S. banks, average noncoreunding as a percentage o total assets

has grown by 11 percentage points

over the past 12 years. The ratio was43 percent at the end o September

2008, compared with 32 percent at the

end o September 1996. For the largerU.S. banks, which are weighted heavily

in all bank averages, oreign depos-

its make up the largest component o noncore unding, ollowed by other

borrowed money (OBM) and jumboCDs. Since the credit crisis began,both OBM and brokered deposits have

risen sharply. Other borrowed money

is a broad category and includes Fed-eral Reserve discount window loans

and FHLB advances. The growth in

this category is not surprising, givendeterioration in the nancial sector

and banks’ sudden inability to access

unsecured market sources.

Cmm Bk

For all U.S. community banks—

banks with $500 million or less in totalassets—average noncore unding as a

percentage o total assets has doubled

over the period, rising rom 14 percent

43

38

33

28

23

18

13

1 9 9 6

1 9 9 7

1 9 9 8

1 9 9 9

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

All U.S. banks

All Eighth Districtbanks

U.S. community banks

Eighth Districtcommunity banks

35

30

25

20

15

10

5

0

Total noncorefunding

Jumbo CDs

Forgeign deposits Brokered deposits

Other borrowedmoneyFed funds purchased and repos

1 9 9 6

1 9 9 7

1 9 9 8

1 9 9 9

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

NOTE: Data were captured on Sept. 30 of each year.

NOTE: Data were captured on Sept. 30 of each year.

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navigate the Fiacial Crisiswith new St. Louis Fed Web Site

Don’ g os d h sos, vns, uos,

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The Financial Crisis: A Timeline of Events and Policy

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at the end o September 1996 to 28 percent at theend o September 2008. Despite the tremendousgrowth, this ratio is still much lower than that o all U.S. banks. Jumbo CDs make up the bulk o this unding, ollowed by OBM. Like the trendsat all U.S. banks, there has been a noticeableupsurge in brokered deposits and OBM sincemid-2007. However, the growth in jumbo CDs

has remained fat over this period.

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At most Eighth District banks (mostly commu-nity banks), the noncore-unding ratio remainsabove that o U.S. community banks but less thanthat o all U.S. banks. Noncore unds as a per-centage o total assets rose 12 percentage pointsrom 21 percent in September 1996 to 33 percentin September 2008. Here, too, jumbo CDs com-

prise the largest component o noncore unds.Figure 2 shows the breakdown o the noncore-unding ratio by component at Eighth Districtbanks over the past 12 years. During the past

year and a hal, the jumbo CD share has beendecreasing while the importance o OBM andbrokered deposits has been rising.

Trends at Eighth District community bankshave paralleled those at U.S. community banks.In the past, the District’s community banksrelied on noncore unds (as a percent o assets)slightly more than their peers did. (See Figure 1.)However, peer banks caught up over the past ew quarters. The trend lines have merged: Noncoreunds to total assets now stands at 28 percent orboth U.S. and Eighth District community banks.

As is the case with most banks, both OBM—romthe Fed and the FHLB banks—and brokered depos-its have spiked during the recent credit crisis.

Rajeev Bhaskar is a senior research associate and Yadav

Gopalan is a research associate, both with the Bank-

ing Supervision and Regulation division at the Federal

Reserve Bank o St. Louis.

Cl Bk Sg 2009 | 5

http://www.stlouisfed.org/timeline

http://www.stlouisfed.org/timeline



Changing economic conditions arepresenting new challenges or

those working in community develop-

ment. Financing, particularly in mod-erate- and low-income areas, is getting

more dicult, and understanding how to leverage limited resources is moreimportant than ever.

The Federal Reserve Bank o St. Louis is hosting an April 22-24

conerence in St. Louis to addressnancing, resources and other com-munity development topics. The 2009

Exploring Innovation in Community

Development conerence, “Innovationin Changing Times,” will be o interestto bank senior management, directors,loan ocers and Community Reinvest-ment Act ocers.

Katherine D. Siddens, U.S. Bank inSt. Louis, attended the rst Explor-

ing Innovation conerence, in 2007 “Asthe community development manageror U.S. Bank, I ound the Exploring

Innovation conerence to be extremely benecial to me, but also truly believe

it would be a worthwhile experienceor any bank representative who is

interested in better understandingcommunity needs,” Siddens says. “Theinormation helped me uncover new opportunities to ulll our CRA obliga-tions and provided armation that

bankers can serve as important con-

nectors between the nancial industry

and the community at large.”

Loura Gilbert, a mortgage ocer with Commerce Bank in Clayton, Mo.,

who also went to the 2007 conerence,

says “The regulators are continually

urging banks to be innovative in their

response to CRA guidelines. And I

welcome any opportunity to meet with

other bankers and experts to brain-

storm ideas about these issues.”

This year’s conerence will bring

together high-level leaders rom across

the industry to explore best practices,

innovative policies, and thinking in

community and economic develop-

ment. Topics will include:

expanding economic opportunities•

through nancing innovations,

building wealth in urban•

and rural areas,

accelerating regional•

development, and

examining the uture•

o community development.

For more inormation, visit the con-

erence web site at www.exploring

innovation.org. For an invitation, con-

tact Cynthia Davis at 314-444-8761 or

[email protected].

Bankers Invited To Explore Community Innovationand Financing in Changing Times

established to “unreeze” securities

markets. These programs include the

Primary Dealer Credit Facility, the

Residential Mortgage-Backed Securi-

ties Facility and the Collateralized Debt

Obligations Facility.

Finally, the Fed created additional

Section 13(3) programs to ocus on

supporting money market liquidity.

These programs include the Asset-

Backed Commercial Paper Money

Market Mutual Fund Liquidity Facility,

the Commercial Paper Funding Facil-

ity and the Money Market Investor

Funding Facility.

All o these programs are temporary

and will be unwound when the Board

determines that current market tur-

moil has ended.

Inormation regarding traditional

discount window programs is available

at www.rbdiscountwindow.org. Addi-

tional details regarding Section 13(3)

programs are available by e-mailing

the Federal Reserve Bank o New York

at [email protected].

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Kim Nelson is a vice president in the St. Louis

Fed’s Banking Supervision and Regulation

division.

Discount Windowcontinued from Page 1

6 | Cl Bk .ssd.g



the securities included nationally and internationally active investmentbanks, hedge unds and some insur-

ance companies. Most o these entities were not required to be supervised by banking regulators.

It is this part o the lending mar-ket that has collapsed. According toFederal Reserve data, total householdloans outstanding (mortgages andother consumer credit) decreased dur-ing the six months ending Sept. 30,2008. This marked the rst six-monthdecline since at least 1952, when com-

prehensive data rst became available.To the extent that the underpinnings

o the shadow banking system wereunsound, we should not expect that sys-tem to return anytime soon—especially the market or securitized subprimemortgages. For other segments, returno the securitized market will depend oninvestor condence and a move towardincreased transparency or investors.

Julie Stackhouse is senior vice president o

Banking Supervision, Credit and the Cen-ter or Online Learning. Bill Emmons is an

ofcer and economist at the Federal Reserve

Bank o St. Louis.

350

300

250

200

150

100

Issuers of private-labelasset-backed securities

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i n - D e p t h

The Credit Crunch Refects Collapseo a “Shadow Banking System”

By Julie Stackhouse and Bill Emmons

Many consumers and business

owners are wondering: Havebanks stopped lending?

The answer depends on the statuso nancial institutions. Most banks,especially in the Eighth District,

remain in generally sound nancialcondition and continue the economicnecessity o lending to customers with

good credit quality. However, somebanks are acing severe nancialdistress, creating a need to preservecapital—which gives the appearanceo a credit crunch. To improve theirregulatory capital-to-asset ratios, some

banks are reducing their total assetson the balance sheet by reducing theamount o loans outstanding. Somebanks are improving ratios by rais-ing more capital either privately or

through recent government programs

i eligibility requirements are met.In large part, the reduction in credit

availability can be attributed to the

partial collapse o the “shadow bank-ing system.”

In its simplest sense, the shadow banking system represents creditinstruments that exist outside o

the traditional commercial bankingsystem, especially those related toconsumer credit. Older parts o theshadow system include nancial assetsissued through government-supported

institutions, such as Fannie Mae andFreddie Mac.

More interesting is the growth inassets in the nongovernment-sup-

ported and nongovernment-insuredsectors. As shown in the chart, theseso-called private label assets grew ata three-old rate over the past eight

years. Some o these nancial instru-

ments, including the vast majority o

the subprime mortgage market, werehigh-risk in nature as well. The secu-rities created rom these assets wereoten complex, with poor transparency

and sometimes questionable suitability or unsophisticated customers. Theintermediaries issuing and trading

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Cl Bk Sg 2009 | 7



Federal Reserve Bank of St. Louis

P.O. Box 442

St. Louis, Mo. 63166-0442

FIRST-CLASS

US POSTAGE

PaiD

PERMIT NO 444ST LOUIS, MO

Let Us Know What You Thinko the New Central Banker

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Snd ou ds nd suggsons o Sco K,

Central Banker do, [email protected]

o c h 314-444-8593.

Central Banker

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central banker - spring 2009

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