central banker - winter 2009

8/9/2019 Central Banker - Winter 2009

1/12

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

Ce nT 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

Winter2009

Featured i n thi s i ssue: A Four-Part Examination o CRE Lending and Debt Problems

continued on Page 4

By Michelle Neely

The importance o commercialreal estate (CRE) lending to U.S.banksespecially community banks

is dicult to overstate. According

to Federal Reserve data, the nations

commercial banks hold almost hal

o U.S. CRE debt outstanding. CRE

lending has especially edged up insignicance at the nations community

banks as other types o consumer and

business lending have been lost to

competitors. Now that conditions in

commercial real estate sectors have

deteriorated, banks ace the possibility

o signicant losses.

Unlike the last commercial real

estate crisis in the late 1980s/early

1990s, problems this time stem rom

a lack o demand rather than mas-

sive overbuilding that was spurred by

tax law changes, among other ac-

tors. Coming on the heels o tremen-

dous losses in residential real estate,

the downturn in CRE markets is the

proverbial second blow o the one-two

punch that has staggered the nations

banking industry.

Though not as severely aected

as banks elsewhere, Eighth District

banks have not been immune to real

estate woes. Earnings have reboundedsomewhat over the past ew quarters

(see Prots Up at District Banks on

Page 3), but continued increases in

nonperorming rates across all cat-

egories o CRE loans (i.e., construction

Commercil Rel Ese Ledig

Chlleges Bks i Disric

and land development, multiamily,

and nonarm nonresidential) threaten

urther improvement. As o Sept. 30,

CRE loans made up 43.5 percent o

total bank loans at District banks yet

accounted or 63.4 percent o all non-

perorming loans.

The rapid deterioration in CRE

portolios over the past two years is

illustrated in the gure. The ratio o

nonperorming construction and land

development (CLD) loans to total CLD

loans (which includes residential aswell as commercial construction) has

skyrocketed since September 2007

and is approaching double digits. (Its

near 14 percent or U.S. peer banks.)

10

9

8

7

6

5

4

3

2

1

0Construction andLand Development

1.88

8.59

0.74

2.69

0.84

1.83PercentNonp

erforming

Multifamily

20072009

CRE Loan Type

Nonfarm Nonresidential

W dfc two Y Mk:nopomg Cre Lo dc Bk

Source: call rpts. Figs a fm thid qat 2007 and thid qat 2009.

O Pg 5-:

P | Back t Bascs

P 3 | Trbed Debt

Restrctrg

P 4 | TraserrgPrbem Assets

CREanD DEBtPROBLEMS

P A R T 1


2/12

News and Views for Eighth District Bankers

Vol. 19 | no. 4

www.stlouisfed.org/publicatios/cb

e d i t Or

Scott Kelly

314-444-8593

[email protected]

Central Bankeris published qurerly by he

Public airs deprme o he Federl

Reserve Bk o S. Louis. Views expressed

re o ecessrily ocil opiios o he

Federl Reserve Sysem or he Federl

Reserve Bk o S. Louis.

Sig up or Central Bankere-mil oices

www.slouised.org/publicios/cb/.

to subscribe or ree o Central Bankeror

y S. Louis Fed publicio, go olie o

www.slouised.org/publicios/subscribe.cm.

to subscribe by mil, sed your me, ddress,

ciy, se d ZIP code o: Cerl Bker,

P.O. Box 442, S. Louis, MO 63166-0442.

the Eighh Federl Reserve Disric icludes

ll o arkss, eser Missouri, souher

Illiois d Idi, weser Keucky d

teessee, d orher Mississippi. the

Eighh Disric oces re i Lile Rock,

Louisville, Memphis d S. Louis.

C E n T R A l v i E w

too Big to Fil Istoo Big to Igore

In the wake o the global nancial cri-sis, Congress and the administrationare reviewing a number o proposals

to reorm the structure and regulation

o the nancial industry. In addition,

nancial regulators are taking action to

reign in certain activities to ensure these

practices do not undermine the saety

and soundness o the banking system.

To be sure, the Federal Reserves

actions and many legislative initiatives

seeking to curb suspect banking prac-tices aim to restore the strong and stable

oundation on which our nations nan-

cial system was built. Yet one issue that

does not seem to have gained the same

level o attention within the legislative

debate is the question o how to deal

with extremely large, nancially related

and interconnected organizations, whose instability can

signicantly disrupt operations o the global nancial system.

Dealing with the too big to ail issue, or TBTF, is crucial to

meaningul reorm o our nations nancial system.

Without question, the inability to deal eectively withTBTF organizations is the problem that jeopardized the

unctioning o our global nancial systemit is that critical.

As o this writing, it is simply too early to tell what substan-

tive legislative proposals will take hold and win passage, but

it appears that regulatory oversight and reorming con-

sumer protection are getting the most attention. This ocus

is understandable, as many nancial institution customers

have in some way been adversely aected by the recent

nancial turmoil.

However, this crisis uncovered the susceptibility o world

economies to the condition o nancial institutions that

were not only too big, but too big to ail quickly. The lack

o clear resolution strategy to manage the rapid deteriora-

tion and eventual resolution o TBTF organizations let

governments and regulators worldwide scrambling to piece

together plans or rescue operations or these rms, nan-

cial markets and national economies.

Reorm eorts must deal with this issue and in a substan-

tive manner. I we learned nothing else rom this crisis,

it is that i these kinds o institutions ail suddenly, panic

ensues, in much the same way the panic during the Great

Depression shuttered some 7,000 banks. We need to ocus

on several channels: enhanced regulatory oversight thatis implemented responsibly, development o a resolution

regime that insulates taxpayers and the macro economy

rom damage, and global cooperation in managing the

oversight and resolution o TBTF rms with international

operations. It is a large task, but one that is too big to ignore

and one we cant aord to get wrong.

Joel H. James isassistant vice presi-

dent for external

relations and public

policy for the Fed-

eral Reserve Bank

of St. Louis.

| Cl Bk .stsed.rg
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3/12

By Michelle Neely

Amodest improvement in protabil-ity that began in the second quar-ter continued into the third quarter

or District banks. Return on average

assets (ROA) climbed 6 basis points to

0.25 percent. (See table.) While that

result would not be cause or celebra-

tion in normal times, it is certainly a

piece o good news or an industry that

has been walloped by a housing crisis

and a deep economic recession.For U.S. peer banks (banks with

assets o less than $15 billion), the

results were also somewhat encourag-

ing as ROA rose by 4 basis points to

-0.29 percent. As in the second quar-

ter, losses were concentrated at larger

institutions. Excluding banks with

assets o more than $1 billion, ROA hit

0.58 percent at District banks and 0.11

percent at U.S. peer banks.

The improvement in earnings was

not driven by earning assets. Thenet interest margin (NIM) at District

banks rose by just 1 basis point rom

the second quarter and remains 12

basis points below its year-ago level.

What helped prots this quarter was

a 6 basis-point decline in noninterest

expense and a leveling o in loan loss

provisions. Loan loss provisions as a

percentage o average assets increased

by just 1 basis point, the smallest

quarterly increase in several years.

The smaller additions to loan loss

provisions, however, do not portend an

improvement in asset quality. Non-

perorming loans continue to rise at

District and U.S. peer banks. The ratio

o nonperorming loans to total loans

at District banks rose 18 basis points

to 2.62 percent in the third quarter; the

ratio increased 25 basis points at U.S.

peer banks, reaching 4.02 percent.

Also troubling is another decline in

the nonperorming loan coverage ratioat both sets o banks. At the end o

the third quarter, District banks had

68 cents reserved or every dollar o

nonperorming loans. U.S. peer banks

had an even thinner cushion, with

an average coverage ratio o just

Q u A R T E R ly R E P o R T

Profs Up Disric Bks,bu Problem asses Cloud he Oulook

52 percent. Further, other real estate

owned as a percent o total assets has

almost doubled at both sets o banks

over the past year, averaging 0.76 percent

at District banks and 0.68 percent at U.S.

peers at the end o the third quarter.

Problem loans remain concentrated in

the real estate portolio, and increases

in nonperorming rates are occurring

in residential and commercial real

estate lending. (See Commercial Real

Estate Lending Challenges Banks in

District on Page 1 or a more detailedanalysis o commercial real estate

lending.) At the end o the third

a Glmm o hop?

3d Q 2008 2nd Q 2009 3d Q 2009

RetuRn on AveRAge Assets

Distit Banks 0.67% 0.19% 0.25%

P Banks 0.43 -0.33 -0.29

net InteRest MARgIn

Distit Banks 3.79 3.66 3.67

P Banks 3.83 3.57 3.61

LoAn Loss PRovIsIon RAtIo


P Banks 0.78 1.52 1.50

nonPeRfoRMIng LoAn RAtIo


P Banks 2.20 3.77 4.02

Source: call rpts

Nt: Banks with assts f m than $15 billin hav bn xldd fm th analysis.

All anings atis a annalizd and s ya-t-dat avag assts avag

aning assts in th dnminat. Nnpfming lans a ths 90 days m

past d in nnaal stats.

quarter, nonperorming real estate

loans as a percent o total real estate

loans topped 3 percent at District

banks and hit almost 5 percent at U.S.

peer banks. Because real estate loans

now make up about 75 percent o all

loans at these banks, troubles in the

real estate sector have a prooundeect on bank perormance.

The nonperorming loan rates or

consumer and commercial and indus-

trial loans increased very modestly

in the third quarter and remain below

continued on Page 7

Cl Bk wter 009 | 3


4/12

The nonperorming rate or multiamily

loans has more than tripled, while the

rate or nonperorming nonarm non-

residential loans has more than doubled

over the same time period. CRE charge-

o rates have similarly escalated, as has

CRE other real estate owned (OREO).

According to orecasters, CRE mar-

ket conditions are still a year or two

away rom turning around, which is

typical o post-recession periods. Like

unemployment, CRE vacancy rates are

lagging indicators o economic activ-

ity. Further, unemployment and CRE

vacancy rates tend to move together

because demand or commercial realestate is highly dependent on employ-

ment growth.

The table shows third quarter 2009

vacancy rates or oce and industrial

space or six metropolitan areas in

the District plus a national average.

Also included are orecast peaks in

these vacancy rates and the associated

time period.

Oc sco

Third quarter oce vacancy ratesvaried widely across the District, rom

a low o 6.2 percent in Little Rock to

17.6 percent in Memphis, and rates in

all District metro areas except Mem-

phis are at or lower than the national

average o 15.7 percent. Fayetteville

is the only District metro area where

the third quarter oce vacancy rate

(15.7 percent) was near its orecast

peak (15.9 percent, occurring in the

rst quarter o 2010). For the other vemetro areas in the table, peak oce

vacancy rates are at least a year away.

il sco

The industrial sector is weaker than

the oce sector in most District metro

areas. All metro areas have industrial

availability rates at or greater than

the national average o 13.2 percent.

As with oce space, peak availability

rates or industrial space are at least a

year away in the District. Springeld

is the exception here; its rate peaked

in the third quarter and is expected

to start coming down, while Memphis

and Fayetteville have industrial avail-

ability rates in excess o 20 percent,

and improvement is orecast to be

more than one year away.

Mlmly sco

Third quarter and orecast multi-

amily vacancy rates are available or

Louisville, Memphis and St. Louis.

Louisville and St. Louis currently haverelatively low rates o 6.1 percent and

8 percent, respectively. Although the

vacancy rate is near its expected peak

in Louisville, the rate in St. Louis is

orecast to rise to 11.3 percent by year-

end 2011 beore starting to decline.

The multiamily vacancy rate in

Memphis is substantially higher at

11.4 percent but is not expected to

rise much above 12 percent.

Retail markets are weak everywhere.

Though up-to-date retail data and

orecasts are not available or District

metro areas, anecdotal inormation

suggests that this sectors overhang

wont be absorbed or some time.

The trends occurring now in CRE

markets are typical o post-recession

periods. The degree to which the

banking industry in the District and

elsewhere ultimately suers depends

on how well problem credits are dealt

with and how quickly jobs-producingeconomic growth picks up.

Michelle Neely is an economist at the Federal

Reserve Bank of St. Louis.

Vccy r a hg Clmbg

MSA 3Q 2009 of Fast Pak of 3Q 2009 Industial Fast Pak Industial

Fayttvill, Ak. 15.7% 15.9% (1Q 2010) 20.1% 21.0% (2Q 2011)

Littl rk 6.2 11.9 (4Q 2011) 16.0 16.7 (3Q 2010)

Luisvill 12.7 14.3 (4Q 2011) 14.2 15.3 (1Q 2012)

Mmphis 17.6 21.9 (2Q 2011) 20.7 22.8 (1Q 2011)

St. Luis 15.4 19.6 (1Q 2011) 13.2 15.9 (4Q 2010)Spingfld, M. 13.3 16.6 (1Q 2012) 14.2 14.2 (3Q 2009)

Natinal Avag 15.7 18.4 (1Q 2011) 13.2 15.4 (4Q 2010)

Source: cBre enmti Adviss

Ledig Chllegescontinued from Page 1

4 | Cl Bk .stsed.rg


5/12

By Sam Ciluffo and Carl White

Banking organizations exposureto commercial real estate (CRE) issubstantial. Thereore, banks should

get back to basics and ensure that a

proactive risk management strategy

is in place, which is critical to manage

CRE credits.

Total outstanding commercial and

multiamily debt is $3.5 trillion, with

$1.6 trillion or approximately 45 per-

cent held in U.S. commercial banks.

Due to the weakness in securitization

markets and limited ability to place

CRE debt in these markets, renance

risk in banks is high and increasing.

Projections indicate that $300 to $500

billion in CRE debt will mature in

2010. Increasing capitalization rates,

coupled with increasing vacancy rates

and decreasing net operating income

(NOI), have resulted in a valuation

problem. Bankers are expressing agrowing concern that income-produc-

ing properties will lack sucient NOI

to cover break-even debt service cov-

erage (DSC), even on an interest-only

basis in some cases.

With these concerns in play, how

do banking organizations get back to

the basics in managing CRE loans?

Here are some best practices to keep

in mind.

First, enhance policies and proce-

dures to address todays emerging issues.In general, credit policies should:

articulate clearly the banks prac-

tices or identiying, monitoring

and reporting troubled debt restruc-

tures (TDRs);

provide specic guidance regarding

loan modications and restructures;

cover procedures or loans made to

acilitate the sale o other real estate

owned (OREO) (terms and condi-

tions, approval process, etc.); and

address procedures or determining

when to obtain a new appraisal to

understand the collateral value and

credit risk implications or a particu-

lar credit.

i n - D E P T h

Ge Bck o he Bsics o CREExaminers Oer Six Best Practices To Help Banks

Second, CRE portolio monitoring isimportant. Common practices include

segmenting CRE loans by property

type, maturity and geographic area

to obtain a clearer understanding o

the risk.

Third, key sta must also become

active in the monitoring o the cred-

its. Site visits are a key; they should

include taking pictures to determine

the condition o properties, vacancies,

etc. Lease and nancial inormation

needs to be obtained and analyzed

to determine the propertys current

perormance and uture prospects.

Furthermore, the lender should review

documentation or completeness and

ensure that property taxes are paid.

Fourth, other best practices include

talking with the borrower to determine

his or her plans to obtain or retain ten-

ants. How will these plans aect the

propertys cash fow? In addition to

analyzing market conditions, lenders

should determine i any new competi-tion has come into the borrowers mar-

ket area and what aect it has on the

borrowers NOI and ability to retain or

obtain tenants.

Fifth, most, i not all, o these CRE

loans have guarantors. Thereore, a

robust guarantor analysis is needed

to assess the value, suciency and

liquidity o a guarantors net assets

and the magnitude o ongoing cash

fow that considers both actual and

contingent liabilities. The analy-sis o a guarantors global cash fow

should consider infows, as well as

both required and discretionary cash

outfows rom all activities. This may

continued on Page 9

Banks should ensure

that a proactive risk

management strategy is

in place, which is critical

to manage CRE credits.

CREanD DEBtPROBLEMS

P A R T 2

Cl Bk wter 009 | 5


6/12

i n - D E P T h

Deb ResrucurigIs It a Simple Renancing or Troubled Debt Restructuring?

By Jim Warren

Given current economic conditions,borrowers o all types are expe-riencing declines in income and cash

fow. As a result, many borrowers are

seeking to reduce contractual cash

outlays, the most prominent being

debt payments. Moreover, in an eort

to preserve net interest margins andearning assets, institutions are open

to working with existing customers

in order to maintain relationships.

Both o these matters lead to the

question: Is a debt restructuring a

simple renancing or a troubled

debt restructuring (TDR)?

To answer this question, we need

to know the three actors that must

always be present in a troubled debt

restructuring.

First, an existing credit agreement

must be ormally renewed, extended

and/or modied. Inormal agreements

do not constitute a restructuring

because the terms o a note have

not contractually changed.

Second, the borrower must be

experiencing nancial diculty.

Determining this actor requires a

signicant amount o proessional

judgment. However, accounting litera-

ture does provide some indicators onnancial diculties, including:

The borrower has deaulted on

debt obligations.

The borrower has declared or is in

the process o declaring bankruptcy.

Absent the restructuring, the

borrower cannot obtain unds

rom another source at market rates

available to nontroubled debtors.

The borrowers cash fow isinsucient to service existing

debt based upon actual or projected

perormance.

Third, the lender grants a con-

cession that it would not otherwise

consider. Concessions can take many

orms, including the lowering o the

eective interest rate, interest and/or

principal orgiveness, modication or

extension o repayment requirements,

and waiving nancial covenants to

enhance cash fow.

I all three actors are present,

a troubled debt restructuring has

occurred, and various issues mustbe considered and appropriately

accounted or. Some o these issues

include the Statement o Financial

Accounting Standards (SFAS) 114 por-

tion o the allowance or loan and lease

losses, revenue recognition and inter-

nal credit risk grade. Under SFAS 114,

a troubled debt restructuring is con-

sidered to be impaired, and an impair-

ment analysis must be perormed.

While three impairment measure-

ment techniques are available, the

valuation technique generally pre-

scribed is the discounted cash fow

method. This method results rom the

act that the lender and borrower have

established an expected stream o cash

fows. I these underlying cash fows

are separate rom collateral liquida-

tion or loan sales, then the air market

value techniques are not available.

Co i icom rcogoAnother measurement to consider

is interest income recognition. Gen-

erally, i a credit was on nonaccrual

prior to the restructuring, regulatory

guidance indicates that the credit

should remain on nonaccrual until

the borrower displays a willingness

and ability to repay. I the credit was

on accrual, income may continue

to be recognized, provided that a

documented analysis o the borrowerindicates that perormance is assured.

Lastly, troubled debt restructurings

should generally remain within an

institutions criticized or classied

internal credit risk ratings until

repayment is reasonably assured,

CREanD DEBtPROBLEMS

P A R T 3

6 | Cl Bk .stsed.rg


7/12

well-dened weaknesses have sub-

sided and loss is not anticipated.

u so rk Mgm

Sound risk management practices

are an important aspect when consid-

ering the issues and risks associated

with troubled debt restructurings. The

oundations o these practices include

the development and implementation

o appropriate policies, procedures and

limits; sound management inormation

systems; and adequate internal con-

trols. An institutions credit policies

and procedures must provide a clear

understanding o what a troubled debt

restructuring is, how it is to be han-

dled, who has the ability to authorize

such transactions and what associated

limits are in place (authority as well as

risk tolerance limits). From a manage-ment inormation systems perspective,

procedures must be established to

ensure that restructurings are cor-

rectly reported in regulatory as well as

nancial lings. In addition, reporting

should keep senior management and

the directorate apprised o the extent

o this activity and its relative success.

Moreover, eective internal con-

trol systems are needed to eectively

identiy and manage associated risks.

Two very important control unctionsare internal loan review and inter-

nal audit. An eective loan review

unction will report on compliance

with established policies and proce-

dures, assist in the identication o

troubled debt restructurings, attest to

the appropriateness o restructurings,

and ensure that appropriate internal

credit risk ratings are maintained.

Sound internal audit unctions veriy

that appropriate reporting proceduresare in place and reporting is accu-

rate. They ensure that troubled debt

restructurings are included within

the SFAS 114 portion o the allow-

ance or loan loss analysis and that the

impairment measurement technique

used is correct. Finally, they attest

that sound revenue recognition prac-

tices have been established and are

being ollowed.

Jim Warren is a supervisory examiner in

safety and soundness in the Banking Supervi-

sion and Regulation division at the Federal


> > M O r e O n L i n e

St. ls Fed Saet & Sdess

Spers Gdace

.stsed.rg/bakg/saet_

sdess.cm

SFAS

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2 percent at District banks. Across all

categories o loans, District banks had

lower nonperorming rates than their

U.S. peers did. For both sets o banks,

larger banks (those with average assets

o $1 billion to $15 billion) had higher

nonperorming rates than smaller

institutions in most loan categories.

Meager earnings and problem assets

have had little eect on capital ratios

thus ar. The average tier 1 leverage

ratio increased 11 basis points to 9.06

percent in the third quarter at District

banks. U.S. peer banks average lever-

age ratio also rose, hitting 9.10 percent.

Michelle Neely is an economist at the Federal


Qurerly Reporcontinued from Page 3

Cl Bk wter 009 | 7


8/12

i n - D E P T h

Whe Problems ariseThe Transer o Problem Assets rom Banks to Holding Companies

By Patrick Pahl and Tim Bosch

Agrowing portolio o problemassets will unavorably impacta banks earnings perormance and

capital adequacy. Asset workouts can

take time and, thereby, aect nan-

cial perormance or several report-

ing periods. For this reason, some

banking organizations are consideringthe sale or transer o problem assets

rom the bank to the parent holding

company. Assets could include whole

loans, loan participations, securities

and other real estate owned (OREO).

I youre considering such a move or

your organization, you should keep in

mind the ollowing:

i t Lgl?

The Federal Reserve Systems Boardo Governors Regulation Y states that

a bank holding company should be a

source o nancial and managerial

strength to its subsidiary banks and

not conduct bank holding company

operations in an unsae and unsound

manner. Thereore, i handled prop-

erly, a bank may transer problem

assets to its parent, as long as the bank

clearly benets rom the transaction.

how Wol Bk Bf?

Problem loans, securities and OREO

typically are nonearning assets. By

removing nonearning assets rom the

banks balance sheet, earnings per-

ormance indicators should improve at

the bank level. Asset quality should

also improve by reducing the volume

o problem assets and replacing them

with cash and/or perorming assets. I

replaced with cash, then liquidity will

also improve.

W a rgloy

Coo?

The Board o Governors Regula-

tion W stipulates that a bank may not

be disadvantaged as a result o any

covered transaction with its parent

company. Regulation W also requires

that the terms and conditions o any

covered transaction are consistent

with sae and sound banking practices.

Thereore, the transer o assets rom a

bank to its parent company must be at

air value. Fair value should be estab-

lished prior to the transaction and besupported with appropriate documen-

tation. You should use a third-party

valuation or the transer o real estate.

The transer o loans or securities

rom a bank to its parent company

may constitute a nonbanking activity

or the parent company. The transer

would require prior approval under

Regulation Y i the parent company

had not previously received approval

to engage in lending activities and

intends to engage in lending on an

ongoing basis. No prior Federal

Reserve System approval is required

i the parent company is a nancial

holding company in compliance.

W a accog

Coo?

There are two simple methods or

transerring assets rom the bank to

the parent company:

Dividend in kind involves a dividend

o the assets to the parent company.

The assets should be booked at air

value, and the bank should ully

recognize any gain/loss versus book

value. The bank should consult with

its regulator or any possible divi-

dend limitations, restrictions or ling

requirements.

Sale or transfer involves consider-

ation paid by the parent company to

the bank. The transaction must be atair value, and the bank should ully

recognize any gain or loss. The bank

should not und the parent companys

purchase o the asset rom the bank.

With respect to assets acquired in

satisaction o debts previously con-

CREanD DEBtPROBLEMS

P A R T 4

8 | Cl Bk .stsed.rg


9/12

tracted, the required divestiture period

is not altered by virtue o the transer

rom bank to parent company.

I you have any questions or would

like additional inormation, contact

Patrick Pahl at 314-444-8858 or Tim

Bosch at 314-444-8480.

Patrick Pahl is a senior coordinator for new

member banks, and Tim Bosch is a vice presi-dent over safety and soundness examinations,

both in the Banking Supervision and Regula-

tion division at the Federal Reserve Bank of

St. Louis.

involve integrating multiple partner-

ship and corporate tax returns, busi-ness nancial statements, K-1 orms

and individual tax lings. Anything

short o a comprehensive global cash

fow analysis diminishes condence in

the assessment o guarantor strength,

even in the ace o signicant liq-

uid assets, because liquidity may be

needed to und contingent liabilities

and global cash shortalls.

Sixth, senior management and

directors should develop enhanced

capital analysis and planning pro-

cesses or measuring the appropriate-

ness o the capital structure, given the

risk prole o the organization. Good

analysis takes into consideration

asset quality and asset concentrations,

as well as the composition o those

concentrations.

Sam Ciluffo is a senior examiner and Carl

White is a supervisory examiner in the Bank-

ing Supervision and Regulation division at theFederal Reserve Bank of St. Louis.

Bck o Bsicscontinued from Page 5

explo innovav idas fo rvalzngh LiHtC Mak

Egt Dstrct bakers terested

te ca rk t ter cmmtes te l icme hsg Tax

Credt (lihTC) prgram sd ceck

t Innovative Ideas or Revitalizing the

LIHTC Market. Reeased nember,

te pbcats sx srt artces ere

prepared b te St. ls Feds Cmm

t Aars departmet ad te Federa

Reseres Bard Gerrs ad pres

et res deas t stregte te

lihTC market.Te artces csder:

te St. ls Eqt Fds strateges t cte deepg

lihTC prjects despte te market dtr,

as te Cmmt Reestmet Act cd be atered t

attract creased estmet lihTCs b faca sttts,

a prpsa t restre te market r lihTC prjects trg

edera cestmet te tax credt,

a case r sg ate as t expad te lihTC estr

p t dda estrs,

a secdar market st t brg addta estrs t

te market, ad

a mde r a eaced strctre r a lihTC d tat

d prde eqt r gqat prjects.

Dad te pbcat at .ederaresere.g/ese

ets/press/ter/ter009a.pd.

Mssou Homownshp PsvaonSumm S fo Januay

wat are recsre treds Mssr? wat ca r cm

mt d t redce recsres, stabze egbrds admata te tax base? wat ep ca prde r cstmers

ad cmmt?

T ep aser tese qests, bakers cetra Mssr

sd csder attedg te Mssr hmeersp Presera

t Smmt Ja. Jeers Ct, M. Regstrat ee s $5.

Tpcs cde crret recsre, rad ad a perrmace

treds ad e csmer prtect ad resdeta edg as.

See detas ad regster at .stsed.rg/esrm/

eets/?d=0. Fr mre rmat, ctact te St. ls Feds

Matt Asb, ser cmmt aars specast, at 889 r

[email protected].

r e g i on a L SPo t Li g H t

Innovative Ideas for Revitalizingthe LIHTC Market

Cl Bk wter 009 |


10/12

the groups were perorming at a simi-

lar level o protability, with an ROA o

about 1 percent or higher. Since then,

there has been a striking dierence

in perormance. Banks in the major

MSAs have been hardest hit, with a

weighted ROA o -0.6 percent as o

June 30, 2009. Banks in the micro and

mid-tier metro areas have also experi-

enced challenges, though not as severe.

Micro-area banks have perormed

consistently better than the other twogroups through this downturn, with

a weighted ROA o 0.6 percent, while

protability o mid-tier metro area

banks alls between the two groups,

with an ROA o 0.2 percent.

On other aggregated metrics, such as

nonperorming loans, loan losses and

net interest margin, the conclusion

is similar. Banks in micro areas are

perorming better than banks in mid-

tier metro areas, which, in turn, are

perorming better than banks in major

metro areas.

d Mc rvl sml Gp

What aects the perormance o

the dierent groups o banks? When

we aggregate ratios such as ROA,

larger banks weigh more heavily than

smaller banks within a geographic

group. To overcome this size issue,

we looked at the median bank peror-

mance metrics or the three groups obanks. The median banks in the three

groups are similar in ROA size: $187

million in the major metro areas, $171

million in the mid-tier metro areas

and $143 million in the micro areas.

Although some dierences in size

still exist, or practical purposes these

median banks are all small-sized com-

munity banks.

The table shows the median statis-

tics and bank perormance measuresor the three groups o banks. Even

at the median level, banks in micro

areas perormed best, ollowed by

mid-tiered metro area banks and then

the major metro banks. However, the

perormance range narrows when

E C o n o M i C F o C u S

Bks i Smller MrkesHve Ouperormed Lrger Mero Bks

By Gary S. Corner and Rajeev R. Bhaskar

Data rom call reports paint ableak picture or banks in largeEighth District cities. In aggregate,

banks in the larger metropolitan areas

are perorming worse than banks in

smaller markets.

Why are smaller banks doing better?

The reasons are not yet clear. We used

various metrics to help discover why

2

1.5

1

0.5

0

-0.5

-1

6/04 12/04 6/05 12/05 6/06 12/06 6/07 12/07 6/08 12/08 6/09

Major MSAMid-Tier AreasMicro Areas

rOa o t df Goup o Bk

by reviewing three groups o District

banks: banks in the our major met-

ropolitan statistical areas, or MSAs

(St. Louis, Little Rock, Louisville and

Memphis), banks in 18 mid-tiered

metro areas (population between50,000 and 500,000) and banks in 60

micropolitan statistical areas (popula-

tion between 10,000 and 50,000). To

gauge the perormance o banks in

these three groups, we looked at aggre-

gate numbers or health o the overall

industry and then looked at the median

numbers or the health o the average

banks. The total number o banks in

each o these areas is similar: 145 in

the major areas, 139 in the mid-tier

metro areas and 175 in the micro areas.

Mc sow Mco a Bk o top

The gure shows the aggregate

return on assets (ROA) or the three

bank groups. Until the end o 2006, all

1 | Cl Bk .stsed.rg


11/12

switching rom aggregate to median.

The median (50th percentile) ROAs

now range rom 0.54 percent in major

MSAs to 0.91 percent or the micro

market banks. This narrowing o

the perormance band shows that the

perormance o larger banks in the

major and mid-tier metro markets

pulls down the averages. Sizable di-

erences still exist in the average bank

protability or dierent size markets

ater accounting or outliers. This di-erence in perormance holds or most

o the metrics we analyzed, including

the ratio o nonperorming loans, net

interest margin and coverage ratios.

(See the table.)

B Pom o slow

to rcogz rk?

All the actors infuencing this

perormance dierence may not be

ully understood today. However, our

experience with commercial bank

examinations raises some possible

explanations. One distinguishable

actor is the level o commercial real

estate (CRE) lending. The proportion

o CRE loans to total loans at a micro

area bank (18.3 percent) is 3.9 per-

centage points less than at a mid-tier

metro area bank (22.2 percent) and

10.5 percentage points below a major

metro bank (28.8 percent). CRE, which

is under severe stress in the currentenvironment, could be a possible rea-

son or the dierence in perormance.

Another possible explanation is that

smaller market banks may lend more

on a relationship basis compared with

transaction lending in larger banks.

Economic actors, such as higher

unemployment rates in the larger mar-

kets, could also be at play. It is also

possible that the smaller market banks

could be somewhat slower to recognize

troubled assets. I this is true, then the

perormance gap should close in time.

Smaller community banks have out-

perormed their larger market breth-

ren during this economic downturn

both at the aggregate and individual

level. In the ensuing quarters, thereasons will become clear. We may

conclude that banks in smaller mar-

kets have indeed been more conser-

vative and managed risk better. Or,

we may nd it takes varying amounts

o time or risk recognition to work

through all sizes o banking markets.

As Paul Harvey amously stated, Stay

tuned or the rest o the story.

Gary Corner is a senior examiner and

Rajeev Bhaskar is a senior research associatein the Supervisory Policy and Risk Analysis

group of the Banking Supervision and

Regulation division at the Federal Reserve

Bank of St. Louis.

M scl a Bk Pomc o Ju 30, 2009

Maj Mt Aas Mid-Ti Mt Aas Mi Aas

Numb Banks 145 139 175

Mdian Assts $186.7 millin $170.7 millin $143 millin

rtun n Assts 0.54% 0.67% 0.91%

Nt Intst Magin 3.53 3.82 3.86

Nnpming Lans / Ttal Lans 1.88 1.46 1.08

Lan Lss rsvs / Nnpming Lans 77.29 97.87 115.63

Lan Lsss / Ttal Lans 0.31 0.36 0.23

Ti 1 Lvag rati 9.28 9.08 9.10

cre t Ttal Lans 28.84 22.21 18.32

SourceS: call rpts. Nmbs in d indiat nfavabl diffns whn mpad with th mdians

f th sizd makts.

> > M O r e O n L i n e

Pres MSA bakg cdt reprts

stsed.rg/pbcats/cb/artces/?d=66

stsed.rg/pbcats/cb/artces/?d=6

Cl Bk wter 009 | 11


12/12

FIrST-cLASS

uS PoSTAGe

PAID

PerMIT No 444

ST LouIS, Mo

r e G u L a t i O n s

Seera Regat Zad E CagesCmg 00:

Qests abt

Repamet hgerPrced Mrtgages

Secd Pase CredtCard Act Prss

Decg oerdratPrtect ttPeat

Fed isses ExecteCmpesat Prpsas

Ageces Prpse

Sbstate Cages tAcctg Stadards

lmts Sgt Faca istttReprtg Brde

Fa Res issed rMrtgage las Mdfedder hAMP

t O O L s

h hae TARPFds Bee used?

Ser Spersrs rmSee Ctres PbsFaca Crss lesss

Bard oers Fe Tps rhme Eqt le Freezesr Redcts

Sg up T ReceeFed Pbcats,

Aerts ad Reprts

> > O n L Y O n L i n e

Read tese eatres at.stsed.rg/pbcats/cb/

Central Banker onlines e e t h e O n L i n e V e r s i O n O F t h e W i n t e r 2 0 0 9

Centra l Ba nker F O r r e G uL a t O r Y s P O t L i G h t s

a n d F e d n e W s .

Reder PollIs h vccy o commci

s (ofcs d sos, o xmp)

i you p o h eighh Disic high

ow h y go?

Mc g. i see mre acaces ta eer bere.

Oly b g. it ks ke aca

ces ae eeed . t m. Te amt acaces i

see s deret ta t as a ear ag.

Low. im seeg eer empt cm

merca bdgs ta a ear ag.

Take the poll at www.stlouised.org/publications/

cb/. Results are not scientifc and are or inorma-

tional purposes only.

P.O. Box 442

St. Louis, MO 63166

central banker - winter 2009

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