More of A Good Thing

Posted on January 7, 2020 Published by

Like many people of my “seasoned” generation, we grew up on what is now considered classic rock. And we always want More of A Good Thing! One of my favorite bands from the 1970s was the Doobie Brothers. They experienced a lot of success in the early through mid-70’s before breaking up in 1982. For you movie aficionados, you may recall Michael Douglas’s disappointment in the movie “Romancing the Stone” when he reads in Rolling Stone magazine that the Doobie Brothers broke up! Well the good news is the band is getting back together with many of the original musicians for a 50th anniversary tour.

So, what does this have to do with financial services?

As I recall some of the Doobie Brothers hit songs, I see a parallel to the continued strength in the financial services sector as reported in the FDIC Quarterly Banking Profile for the period ending September 30, 2019. Three songs come to mind that speak to the performance: “Long Train Running,” “China Grove,” and “Black Water.”

I find myself humming “Long Train Running” as I consider how financial institutions are still continuing to see success. For the 3rd quarter of 2019, the number of FDIC insured institutions dropped from 5,303 to 5,256 as four banks were added. 46 banks were absorbed through mergers, though.

More of A Good Thing

There were no bank failures for the quarter. Performance remained strong although growth slowed from the previous year. Aggregate net income totaled $57.4B for the 3 months ending September 30, 2019. This was down $4.5B (7.3%) from 3Q 2018. However the decline was driven by $4.9B in non-recurring events at three large institutions. These events resulted in higher non-interest expense and realized securities losses. These results drove down ROA for the quarter from 1.41% in 3Q 2018 to 1.25% in 3Q 2019.

Net interest income grew $1.7B (1.2%) from 3Q a year ago, the slowest growth since 4Q 2014. That said, nearly 71% of banks reported year-over-year increases in net interest income. That is very good, given the extraordinary performance over the last two years. Net interest margin reduced slightly from 3.45% in 3Q 2018 to 3.35% in 3Q 2019. Increases in funding costs exceeded increase in yield on earning assets driven in part by two Fed rate reductions.

Continued Strong Financial Health

While loan loss provision increased $2B from a year ago, the provision increase was not broad-based. Only 38% of banks reported increase in provision for the third quarter and the increase was primarily in banks over $250B. A big shout-out to our community bank brothers and sisters!

The growing economy and low unemployment put pressure on non-interest expense. This increased $6.4B (3.7%) from 3Q 2018. This increase was broad-based with 71% of banks reporting increases. Salary and employee benefit growth was the largest driver of the increase totaling $2.7B (5%) and goodwill impairment charges up $2B.

While net charge-offs increased $1.9B (17.2%) from year ago to $13.1B (if not “Black Water,” it’s definitely a bit gray), the overall charge-off rate remains at historically low levels. The drivers of the increase in charge-offs were from the commercial and industrial (C & I) portfolio (up $1B) and the credit card portfolio (up $514MM).

So What Does This Mean?

As indicated in the discussion above, this really is the “Long Train Running”. Financial institutions enjoy continued good health, although the strong performance since 2017 makes it more difficult to keep growing year over year. The following select ratios illustrate how impressive this performance really is:

ROA                           avg 2014 – 2017: 1.02%                                    avg 2018 -2019: 1.34%

ROE                           avg 2014 – 2017: 9.04%                                    avg 2018 – 2019: 11.89%

Noncurrent assets + ORE               2014: 1.2%                            2019: 0.56%

NOI growth          avg 2014 2017: 1.89%                                       avg 2018 -2019: 25.06%

% Unprofitable banks                      2014: 6.27%                         2019: 3.46%

# of Problem banks                            2104: 291                               2019: 55

# of Failed banks                                  2104: 18                                  2018 & 2019: 1

Our happy place – or “China Grove” – was clearly in the community bank performance figures. The 4,825 community banks reporting in the 3rd quarter of 2019 delivered net income of $6.9B, up $466.2MM (7.2%) from 3Q 2018 as higher net interest income, non-interest income, and realized gains on securities more that offset growth in non-interest expense, provision expense and income tax expense.

More Good News

Nearly 62% of community banks reported annual net income growth. Quarterly pre-tax ROA rose 3 basis points to 1.51% marking the highest pretax ROA ratio reported by community banks since third quarter 2006.

Net operating revenue totaled $24.1B, up $1.5B (6.4%) year over year. Growth in both net interest income and non-interest income contributed to the increase. The increase in net interest income was attributable to growth in earning assets (up $115.9B, of 5.9%). It appears that in the community bank segment, any “China cloud” from the uncertainty of ongoing trade negotiations was being shrugged off in this “China Grove.” In addition to increases in earning assets, community bank deposits increased 5.9% to $1.8T (yes, that is trillion, with a T).

Non-current rate for total loans and leases was 0.77%, down 3 basis points year-over-year but up 2 basis points quarter-over-quarter. The quarter-over-quarter increase in the non-current rate was driven by growth in commercial real estate and C & I portfolios. The “Black Water” in this category is really in “black dirt” – the agricultural loan portfolio with a non-current rate of 1.27%, which remains the highest among major loan categories at community banks. This rate increased 11 basis points year-over-year, marking the 15th consecutive quarter with an annual increase.

Time to Celebrate!

Like the Doobie Brothers getting back together to celebrate their 50th anniversary tour, the banking industry is enjoying continued success in its own “Long Train Running,” and it’s difficult not to let a bit of euphoria into our happy “China Grove.” The challenge is to beware of “Black Water” seeping into the portfolio in the form of future losses.

All lending and credit partners need to remain vigilant and disciplined. Be responsive to any early warning signs including missed projections, earnings declines, covenant defaults and delinquent financial reporting. It is much easier to respond to negative events in a positive market environment.

Now, let’s turn up some of that classic rock!


Richard Rudolph is Senior Consultant at Enlighten Financial, a specialized consulting firm that focuses on loan review and risk management services to community banks and credit unions. Enlighten Financial has made it our business to shed light on the complex financial landscape, and lead clients in the right direction. We work with financial institutions and other providers to mitigate risk. To talk to Rick directly, please call: 920.445.8133

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