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San Francisco, CA November 20, 2012 Call The Fed The U.S. Economy and 12th District Banking: Conditions & Outlook Gary C. Zimmerman, Senior Economist Gary Palmer, Senior Manager Colin Perez, Senior Analyst Federal Reserve Bank of San Francisco Overview 1. 2. 3. 4. 5. 6. Goals of U.S. monetary policy Current U.S. economic conditions Regional indicators U.S. economic forecast (FRBSF) Risks ahead Monetary policy transparency and actions These remarks represent my views and not necessarily those of my colleagues in the Federal Reserve System and the Federal Reserve Bank of San Francisco. No audio recording, video recording, or photography is permitted without the permission of the presenter. This presentation may not be reproduced in any form without the express, written permission of the presenter. 2 1. GOALS OF MONETARY POLICY 3 U.S. Monetary Policy Goals Congress has set these two goals for the Fed: 1) Promote maximum sustainable output and employment 2) Promote stable prices FOMC regularly reports to Congress and the public via: • Testimony and Reports, FOMC Statements and Minutes, Chairman’s press conference, speeches • Economic forecasts (Summary of Economic Projections) 4 2. CURRENT ECONOMIC SITUATION 5 Economy Is Growing at a Moderate Pace • Beige Book: Economy expanding modestly • Marginal increase in the unemployment rate from 7.8% to 7.9% in October, lots of labor market slack • Inflation has been subdued • Inflation expectations have remained stable • Financial conditions are a bit more accommodative • Important downside risks remain: fiscal cliff and European situation 6 Although Output Has Surpassed Pre-Recession Levels, It Remains Well Below Potential as a Result of the Long and Deep Recession and Moderate Recovery 7 Modest Wage Growth Anchors Costs/Prices 8 TIPS Inflation Expectations Remain Anchored (An Important Factor for the Inflation Outlook) Source: Federal Reserve Board. 9 Labor Market: The Economy Is Adding Jobs at a Quicker Pace in Recent Months (from the Payroll Survey) 10 October Unemployment Rate Rises Marginally to 7.9 Percent as People Returned to the Workforce (from the Household Employment Survey) SPF Natural Rate Range (≈ 5-7%) SPF = Survey of Professional Forecasters, FRB Philadelphia. 11 Low Rates: Interest Rate Sensitive Consumption Spending on Durables Has Rebounded 12 Housing and Construction: The Housing Sector Remains Depressed, but Is Now Showing Positive Signs of Growth 13 House Prices Appear to Finally Be Stabilizing and/or Rebounding as Policy Actions Support Housing 14 3. REGIONAL ECONOMIC CONDITIONS – REFLECT NATIONAL RECOVERY 15 In 2012, Payroll Jobs Are Growing in Each Twelfth District State – AZ, CA, UT, & WA Show Fastest Growth 16 Unemployment Rates (%) During the Recovery Have Fallen in All Twelfth District States, Except Nevada 17 In 2012, Case-Shiller House Price Indexes Are Increasing 18 Recording Fewer Past Due and Foreclosed First Mortgages Is Another Sign of Improvement in the Financial and Household Sectors – September 2012 Source: LPS Analytics 19 Recording Fewer Past Due and Foreclosed First Mortgages Is Another Sign of Improvement in the Financial and Household Sectors – September 2012 Source: LPS Analytics 20 4. NATIONAL FORECAST FRBSF ECONOMIC FORECAST (FEDVIEWS) NOVEMBER 8, 2012 http://www.frbsf.org/index.html 21 FRBSF FedViews Forecast: Additional Monetary Policy Stimulus Is Expected to Support a Stronger Recovery (Real GDP Growth Rates of 2.5% for 2013 and 3.5% for 2014) Fedviews November 8, 2012 Additional Monetary Policy Stimulus Should Bring the Unemployment Rate Down a Little Faster – Expect Unemployment to Fall to the Low 7% Range by the end of 2014 Sept. 2012 (released on 10/5/12) Fedviews September 14, 2012 Both Overall & Core Inflation Are Projected to (with monetary policy stimulus ) Remain Below 2% Goal in 2013 and 2014 Fedviews 24 November 8, 2012 5. RISKS AHEAD 25 The European Sovereign Debt and Banking Crisis Remains a Cause for Concern in Global Financial Markets and also May Impact the U.S. Economy through Exports and Trade Greece Spain Germany 26 Approaching the Fiscal Cliff Federal Deficit Projections % of GDP 8 7% of GDP 7 6 5 4 Fiscal Cliff 3 FISCAL CLIFF 2011 2012 2013 2 1% of GDP 2014 Source: Congressional Budget Office 2015 2016 2017 1 2018 2019 2020 0 2021 6. RECENT MONETARY POLICY ACTIONS 28 Traditional Overnight Federal Funds Rate Tool Is Not Sufficient to Stimulate the Economy (because of the Zero Bound on Interest Rates) “Implied” Fed Funds Target Rate 29 Transparency and Forward Guidance: FOMC Statement (10/24/2012) Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee remains concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions. Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook. The Committee also anticipates that inflation over the medium term likely would run at or below its 2 percent objective. 30 Large Scale Asset Purchases LSAP 1 (often referred to as QE1) 11/25/2008—announcement of purchases of up to $100 billion in agency debt and up to $500 billion in agency MBS. 3/18/2009—announment of purchases of up to an additional $750 billion of agency [MBS], $100 billion in agency debt, and $300 billion in Treasury securities. LSAP 2 (often referred to as QE2) 11/3/2010—announcement of purchases of $600 Billion in longer-term Treasury Securities Maturity Extension Program (MEP or called “Operation Twist”) Announcement of purchase $400 billion in long-term Treasuries, to be financed by sales of short-term Treasuries. June 20, 2012: Extension of maturity extension program through yearend. Main objective: Reduce long-term interest rates 31 Recent Policy Actions Announced on 9/13/2012 Were Continued on 10/24/2012 Purchase additional agency-backed mortgage-backed securities (MBS) at a pace of $40 billion per month (QE3) If outlook does not improve substantially, will continue or expand Large-scale Asset Purchases (LSAP 3 or QE3), and employ other policy tools as appropriate Extended forward guidance from “late-2014” to “mid-2015” 32 Unconventional Monetary Policy Actions: Maturity Extension Program Was Extended through the End of 2012, and $40 Billion in Monthly MBS Purchases Will Expand the Balance Sheet Again MBS = Agency Mortgage-backed Securities 33 Forward Guidance on “LIFTOFF”: FOMC Target Fed Funds Rate Projections by Year of Increase for Each FOMC Participant September 2012 Meeting YEAR: 2012 2013 2014 2015 FOMC Projections Sept. 13,2012 Longer run 34 BREAK FOR QUESTIONS BEFORE BANKING CONDITIONS TOPIC Call the Fed Gary C. Zimmerman, Senior Economist Federal Reserve Bank of San Francisco 35 Banking Conditions & Outlook 12th Federal Reserve District Focus Featuring 3Q12 First Glance 12L http://www.frbsf.org/publications/banking/index.html Gary Palmer, FRBSF, Banking Supervision & Regulation (with Tom Cunningham, Colin Perez) 36 COMMERCIAL BANKS Focus will be on trends among the 410 commercial banks headquartered within the 12th Federal Reserve District. Bank Supervisors’ Hot Topics also will be covered First Glance 12L – Nov. 2012 FRB-SF 37 CAMELS Upgrades Continued to Outpace Downgrades Pct. of 12th District Exams Each Quarter that Resulted in CAMELS Composite Rating Upgrade or Downgrade (downgrades are shown as negative percentages) 19% 20% 10% 6% 10% 10% 9% 4% 14%14% 22% 25% 19% 16% 4% 2% 1% 2% 3% 1% 1% 1% 1% 0% -9% -9% -15% -31% -37% -43% FRB-SF First Glance 12L – Nov. 2012 9/12 3/11 12/10 9/10 12/09 9/09 3/09 12/08 9/08 6/08 3/08 12/07 -70% 6/09 -59%-61%-58% 6/12 -60% 9/07 -5% % Upgrades % Downgrades 3/12 -50% 12/11 -40% 9/11 -27% -32% -37%-37% 6/11 -30% -2% -12%-14% -15% -19% 6/10 -20% -6% -3% 3/10 -10% Includes any change in composite CAMELS rating for commercial banks; quarterly trends based on examination completion dates (mail dates); preliminary 9/30/12 figures; updated 11/9/12 38 Pct. of 12th District Banks Rated CAMELS 3, 4, or 5 Fell for Eight Consecutive Quarters Percentage of District Banks Rated CAMELS 3, 4, or 5 60% 60% CAMELS "3" CAMELS "4" CAMELS "5" Nation "3", "4", "5" 50% 39% 40% 44% 32% 30% 25% 20% 4% 10% FRB-SF First Glance 12L – Nov. 2012 Sep-12 Sep-11 Sep-10 Sep-09 Sep-08 Sep-07 Sep-06 Sep-05 Sep-04 Sep-03 Sep-02 Sep-01 Sep-00 Sep-99 Sep-98 Sep-97 Sep-96 Sep-95 Sep-94 Sep-93 Sep-92 Sep-91 Sep-90 0% Trends for all commercial banks based on examination completion dates (mail dates); preliminary 9/30/12 39 figures; updated 11/9/12 Financial Slides – A Note on Aggregates vs Averages 12th District Banks as of 9/30/12 Return on Avg. Assets YTD annualized Noncurrent Loans / Total Loans Total CRE Loan Concentration Ratio 192% 1.30% 4.5% 1.2% 4.0% 150% 3.0% 0.8% 2.6% 0.67% 100% 97% 2.0% 0.4% 50% 1.0% 0.0% 0% 0.0% Aggregate Average Aggregate Average Aggregate Average Following slides mainly show District bank ratio averages (“trimmed means” ). FRB-SF First Glance 12L – Nov. 2012 12th District commercial banks, aggregates include Wells Fargo Bank (60% of District Loans), preliminary 9/30/12 data 40 Earnings: District Bank ROAA Continued to Recover & Narrow Gap with Nation - Still Well Below Historical Averages Average Return on Average Assets – annual (%) 1.40% 1.13% 1.22% 1.2% 0.90% 0.75% 0.8%0.65% 0.4% 0.44% 0.67% 0.34% 0.0% -0.4% District 12 Nation -0.8% 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 FRB-SF First Glance 12L – Nov. 2012 Sep-11 Sep-12 -1.00% -1.2% Based on commercial banks, excluding De Novos; trimmed means; Sept. ratios are YTD annualized; preliminary 9/30/12 data 41 Just 17% of District Banks Lost Money YTD 2012, Compared to 61% in 2009 Percentage of Commercial Banks Reporting Net Losses in 2009 12th District: 61% (2009) Percentage of Commercial Banks Reporting Net Losses through Sept ‘12 12th District: 17% (9 mo. ending 9/30/12) 63% 0% 22% 66% 0% 25% 69% 83% 57% First Glance 12L – Nov. 2012 21% 38% 63% 80% FRB-SF 14% 0% > 60% 40% - 60% 15% - 40% < 15% 14% 14% 30% Preliminary 9/30/12 data for all commercial banks, excluding De Novos 42 Large and Mid-Sized Bank Profitability Almost Recovered Small Bank Profits Lag, but Improved Average Return on Average Assets – 12th District Commercial Banks (%) 1.7% 1.5% 1.2% 1.5% 1.3% 0.9% 0.3% 0.2% 0.0% 1.1% 0.9% 1.3% 1.2% 0.5% 0.2% Small - Assets < $1B Mid-Sized - Assets $1B - $10B Large - Assets > $10B -1.0% -1.1% -1.5% '05 '06 '07 '08 FRB-SF First Glance 12L – Nov. 2012 '09 '10 '11 9/11 9/12 Based on commercial banks, excluding De Novos; trimmed means; Sept. ratios are year-to-date 43 annualized; preliminary 9/30/12 data District Bank Net Interest Margins Remained Depressed District Banks Have Managed a Stable NIM Despite Declining Asset Yields Net interest income (tax equiv) / average earning assets (NIM) (quarterly NIMs annualized %) 5.5 Effective Fed funds rate (quarterly average annualized %) 8.0 5.3% 5.1% 5.0 4.7% 12th District NIM (left axis) 4.5% 4.5 4.1% 4.0 U.S. NIM (left axis) 6.0 4.0 3.8% 3.8% 3.9% 3.5 2.0 Fed funds (right axis) 3.0 0.0 3Q01 3Q02 3Q03 3Q04 3Q05 3Q06 3Q07 3Q08 3Q09 3Q10 3Q11 3Q12 FRB-SF Based on commercial banks excluding De Novos; trimmed First Glance 12L – Nov. 2012 means; quarterly ratios are annualized; prelim 3Q12 data. Effective Fed funds rates from FRB-St Louis. 44 Average Bank Efficiency Measures Improved Moderately in 2012, Especially at Large and Small Banks District Banks’ Efficiency Measures - overhead / (net interest income + noninterest income) (this metric measures the cost to produce $1 of revenue) 85¢ 85 82¢ 76¢ 83¢ Nation 80¢ 70¢ 75 65¢ 67¢ 65 66¢ 65¢ 64¢ 56¢ 54¢ 55 47¢ 53¢ 47¢ 45 52¢ 61¢ Small Banks (<$1B) Med. Banks ($1-10B) Large Banks (>$10B) 35 25 2007 2008 2009 FRB-SF First Glance 12L – Nov. 2012 2010 2011 Sep-11 Sep-12 Based on commercial banks excluding De Novos; trimmed means; preliminary 9/30/12 data (year-to-date) 45 Noninterest Income has been Difficult to Grow Small Banks Have Fewer Fee-Generating Options than Larger Banks Median Noninterest Income/Avg. Assets 2.5% Small - Assets < $1B Mid-Sized - Assets $1B - $10B Large - Assets > $10B 2.42% 2.0% 1.5% 1.0% 1.39% 1.14% 0.83% 0.79% 0.50% 0.79% 0.74% 0.5% 0.42% FRB-SF First Glance 12L – Nov. 2012 9-11 9-12 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 0.0% Based on commercial banks, excluding De Novos; median ratios; preliminary 9/30/12 year-to-date data 46 Core Profitability (pre-provision) and Pre-Tax Earnings Rates Edged Higher But Still Well Below Historic Averages 12th District Bank Profitability Ratios - (%) Core Profitability 2.13% (Pre-tax pre-provision income/avg. assets) 1.71% 0.98% 1.02% 1.11% 1.0 -0.5 -1.0 Small (<$1B) 0.94% Mid ($1B-$10B) 1.65% Large (>$10B) 2.04% 0.50% -0.17% 0.53% Pre-tax income/avg. assets First Glance 12L – Nov. 2012 2008 2007 2006 2005 2004 2003 2002 2001 FRB-SF 9/12 -1.20% -1.5 2010 0.0 0.79% Avg. District Core Profitability by Bank Size – 9/30/12 2009 0.5 0.88% 9/11 1.5 1.86% 2011 2.0 2.16% Based on commercial banks, excluding De Novos; trimmed means; 9/30/12 ratios are annualized; preliminary 9/30/12 data 47 Bank Supervisors’ Hot Topic: Earnings Trends Good, but Mainly due to Sharply Lower Provisions for Credit Losses Loss Provisions/Net Charge-Offs (x) District Nation 7.0x 7.0 6.0 5.0 However, ALLL coverage of total loans remained relatively high at 2.4% on avg. 1.9x 4.0 1.5x 3.0 1.4x 1.1x 0.9x 0.8x 2.0 1.1x 1.1x 1.0 0.7x First Glance 12L – Nov. 2012 Dec-06 Dec-04 Dec-02 Dec-00 Dec-98 9/12 '11 '10 '09 '08 '07 '06 FRB-SF Dec-96 0.0 0x 1.5x Sep-12 1x 1.0x Dec-10 2x District Nation Dec-08 3x 3.2x 3.0x Allowance for Loan and Lease Loss (ALLL) coverage of noncurrent loans (x) ALLL: Allowance for Loans and Lease Losses; Based on commercial banks, excluding De Novos; trimmed means; preliminary 9/30/12 data 48 43% of District Banks Reported Zero or Negative Loss Provisions in 3Q12 Percentage of District Commercial Banks Pct. that reduced 57% ALLL / Loan ratios 60% in the quarter 49% 50% 44% 40% 30% 21% Pct. with zero 33% provisions in the quarter 10% 0% 4% However: Examiners expect welldocumented justification for such decisions Reductions in ALLL coverage should be aligned with: Improving credit quality 20% 11% Drawing down of reserves is a sign of improving credit quality with negative 10% Pct. provisions 5% Reserving needs on new loans FASB is proposing an expected credit loss model for ALLL accounting 3Q10 3Q11 3Q12 FRB-SF First Glance 12L – Nov. 2012 ALLL = Allowance for Loan and Lease Losses Based on all District commercial banks excluding De Novos. Prelim 3Q12 data 49 Loan Quality: Average 12th District Bank Noncurrent Loan Rate Continued to Descend 30-89 Day Past Due Loan Rate Approaching Pre-Crisis Lows Average Noncurrent Loan Rates Avg. Past Due 30-89 Day Loan Rates 4.8% District 12 District 12 4.0 4.0 Nation 3.0 3.0 2.4% 1.0 2.6% 1.8% 0.7% 2.0 1.4% 1.0 0.9% 0.3% Sep-01 Sep-02 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 0.0 FRB-SF First Glance 12L – Nov. 2012 0.0 0.9% 0.9% 0.5% 0.4% Sep-01 Sep-02 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 2.0 Nation Based on commercial banks, excluding De Novos; trimmed means; Noncurrent = 90 Days past due or on nonaccrual; preliminary 9/30/12 data 50 By Loan Type: Noncurrent Rates Trending Down Across Types 12th District Bank Noncurrent Loan Rates (Pct. of loans 90+ days past due or on nonaccrual) 16.1% 16% 14% All Loans Constr & Land Devel Resid mortgage C&I Consumer CRE (Nonfarm Nonresid) 12% 10% 8% 6% 6.5% 2.8% 4% 2.2% 2.1% 1.4% 0.1% 2% FRB-SF First Glance 12L – Nov. 2012 Sep-12 Mar-12 Sep-11 Mar-11 Sep-10 Mar-10 Sep-09 Mar-09 Sep-08 Mar-08 Sep-07 0% Based on commercial banks excluding De Novos; 51 trimmed means, preliminary 9/30/12 data By State: Noncurrent Loan Rates Dropped Broadly, Especially in CA, HI, and ID 6.0% NV 3.4% AZ OR 2.5% CA 2.5% UT 2.3% AK 1.4% 1.3% 0.9% 0% Other High Noncurrent Loan Rates: 9/30/12 4.9% 2.9% WA HI 4.0% 3.3% ID 7.5% 3.8% 3.6% 3.7% 3.2% GA FL NC SC NJ 4.8% 4.4% 4.0% 3.7% 3.4% Nation 1.8% Sep-12 Sep-11 2.8% 2% 4% FRB-SF First Glance 12L – Nov. 2012 6% 8% Based on commercial banks, excl. De Novos; trimmed means; Noncurrent = 90+ days past due or on nonaccrual; preliminary 9/30/12 data. Industrial bank avg. 9/12 52 noncurrent rates were 1.4% in NV and 0.9% in UT Bank Supervisors’ Hot Topic CRE Income Property Loan Quality & Vulnerability High concentrations / vulnerability Property values down >30% from peaks* - some borrowers left with little or no equity Loans being extended, renewed; concerns: some maturing loans with inadequate cash flows and insufficient collateral values; are TDRs underreported? Current low interest rates have helped keep CRE loans performing, so far. Average 12th District Bank CRE Income Property Loans (% of Total Loans) 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Extensions must be well supported * Based on Moody’s/RCA Commercial Price Property Index for core sectors (office, retail, industrial) in nonFRB-SF major markets First Glance 12L – Nov. 2012 18% Nonfarm Nonresidential Secured (Nonowner-occupied portion 52% of total at 9/30/12) 1% Multifamily 4% 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Sep12 Examiners finding most CRE loans performing and adequately collateralized; new appraisals have been obtained and efforts to remargin loans sometimes have succeeded. However, Based on all 12th District commercial banks; trimmed means, preliminary 9/30/12 data 53 Loan Growth: Turnaround Continued Avg. Loan Growth 2.8% YoY with Fastest Growth at Large and Mid-Sized Banks Average District Year-Over-Year Loan Growth Rates (%) Avg. Annual Loan Growth 9/11 9/12 17.9% Small Banks (<$1B) Med. Banks ($1-10B) Large Banks (>$10B) 15.016.5% 14.2% 10.0 All 12th Dist. Banks -4.8% 2.8% All Banks Nationwide -2.0% 1.2% 6.4% 6.1% 5.0 1.8% 0.0 -2.0% FRB-SF First Glance 12L – Nov. 2012 9/12 3/12 9/10 3/10 9/09 3/09 9/08 3/08 9/07 3/07 9/06 -10.0 9/11 -6.9% -6.9% 3/11 -5.0 Based on commercial banks, excluding De Novos; trimmed means; preliminary 9/30/12 data 54 CAMELS Rated 1, 2, and 3 Banks Continued Loan Growth CAMELS 4/5 Rated Further Reduced their Loan Portfolios Loan Growth Rates – Year-over-Year Averages within CAMELS Rating Groups 5% 2% 5% 4% 7% 8% 3% 0% -1% -2% -5% CAMELS 1s/2s CAMELS 3s 1% CAMELS 4s/5s -5% -10% -15% -15% -13% -11% -10% -10% Jun-12 Sep-12 -20% Sep-11 Dec-11 Mar-12 Based on a panel of District commercial banks; excludes banks with significant mergers, loan sales or loan purchases over the FRB-SF period; Averages are trimmed means. First Glance 12L – Nov. 2012 CAMELS: rating system used by banking supervisors 55 Switching to Loan Growth Aggregates: C&I Continued Strong YoY Growth, Followed by Residential 1st Lien, and Ag 12th District Bank Aggregate Loan Growth Rates - 12 months ending 9/30/12 Commercial & Industrial 16% 1-4 Family First Lien 11% Ag + Farmland Secrd 5% Consumer 3% 3% Multifamily Nonfarm Nonresid HomeEquity + Jr Lien 2% CRE (Nonfarm NR) Owner-occ: -7% Nonowner-occ: 9% -7% Construction & Land Dev -16% All Loans -20% FRB-SF First Glance 12L – Nov. 2012 6% -10% 0% 10% Based on a panel of District commercial banks; excludes banks with significant mergers, loan sales or loan purchases over the period; prelim 9/30/12 data 56 Focus: C&I -– Growing Percentage of Banks Increased Commercial & Industrial Loans Annual C&I Loan Growth Rate Statistics – 12th District Banks (%) 44% 25% 15% 75th Percentile ratio: 25% of all banks grew C&I loans by 22% or more through 9/30/12 75th Percentile Median 25th Percentile 39% 17% 22% 6% 1% 0% 3% -10% Median: 3% (most banks increased C&I lending) -12% -22% FRB-SF First Glance 12L – Nov. 2012 Sep-12 Sep-11 Sep-10 Sep-09 Sep-08 Sep-07 Sep-06 -25% Based data for all District commercial banks, includes only banks with material volume of these loans (4%+); preliminary 9/30/12 data 57 Banks with High Rates of C&I Loan Growth One Quarter of District Banks (and over 40% of Large Banks) Grew their C&I Portfolios by 20% or More Pct. of District Banks with 20%+ Growth in C&I Loans in Year Ending 9/30/12 All District Banks: • 25% had 20%+ growth • 9% had 40%+ growth 40% 35% 30% 25% 20% 41% 15% 19% 10% 25% 5% 0% Large (>$10B) FRB-SF First Glance 12L – Nov. 2012 Mid ($1B-$10B) Small (<$1B) Based on a panel of District commercial banks with at least 4% of loans in C&I as of 9/11, excludes banks with significant mergers, loan sales or loan purchases over 58 the period; preliminary 9/30/12 data Bank 1-4 Family First Lien Loan Growth Significant Portions of Banks Had Significant Residential Loan Growth Pct. of District Banks with 20%+ Growth in 1-4 Family First Lien Loans in Year Ending 9/30/12 All District Banks: • 31% had 20%+ growth • 17% had 40%+ growth 40% 35% (mostly small and mid sized banks) 30% 25% 40% 20% 15% 31% 29% 10% 5% 0% Large (>$10B) FRB-SF First Glance 12L – Nov. 2012 Mid ($1B-$10B) Small (<$1B) Based on a panel of District commercial banks with at least 4% of loans in 1-4 First Lien Loans as of 9/11, excludes banks with significant mergers, loan sales or loan purchases over the period; preliminary 9/12 data 59 Bank Supervisors’ Hot Topic Expansion into New or Unfamiliar Lending Areas 12th District Bank Aggregate Loan Growth Rates - 12 months ending 9/30/12 24% C&I Large Bks (>$10B) Portfolio rebalancing may reduce earnings volatility and improve diversification, but… 7% Mid Sized ($1B-$10B) 17% 23% Multifamily 1% Small Bks (<$1B) Banks are targeting growth in areas such as C&I, 1-4 family residential, and multifamily Different loan types require different underwriting skills 9% 1% 1-4 Fam 1st lien 20% High competition in some areas e.g., small C&I loans Historical loss rates on C&I are higher than on CRE 8% 0% C&I 5% 10% 15% 1-4 Fam 1st Lien FRB-SF First Glance 12L – Nov. 2012 20% 25% Multifamily Management must establish and maintain robust risk management processes around all products Based on a panel of District commercial banks; excludes banks with significant mergers, loan sales or 60 loan purchases over the period Liquidity: Banks Flush with Short Term Assets Loan Demand Remains Weak / Investors Wary of Equities are Parking Money in Banks Short-Term Investments/Assets (average %) Loans/Assets (adj. average %) 12th District Nation 75.8% 75 12 70 10 66.4% 12th District Nation 12.5% 66.7% 9.1% 63.7% 65 8 6 60 59.0% 4 50 0 FRB-SF First Glance 12L – Nov. 2012 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 9/12 2 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 11 9/12 55 5.1% Based on commercial banks, excluding De Novos; trimmed means; preliminary 9/30/12 data 61 Bank Supervisors’ Hot Topic Market Risk: Lengthening Asset Maturities Loans and Securities Maturing or Repricing in Five Years or More / Assets – District Banks Under $1B Vulnerability to rising interest rates Rising rates would have a negative cash flow impact on many borrowers 24% 20% 15% 10% 5% Also, “excess” liquidity could disappear 0% quickly if customers decide to move cash into higher yield investments and bank loan growth keeps strengthening FRB-SF First Glance 12L – Nov. 2012 13% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Sep-12 District banks extended maturities on assets reaching for yield Based on aggregate data for 12th District banks with assets < $1 billion; includes commercial and industrial banks; 9/30/12 data is 62 preliminary Capital Adequacy: Tier 1 Common Equity Ratios also are Up Sharply from Pre-Crisis Levels for Banks of All Sizes Average District Bank Tier 1 Common Equity / Risk Weighted Assets Ratios Small - Assets < $1B Mid-Sized - Assets $1B - $10B Large - Assets > $10B 16.0% 14.0% 15.5% 15.4% 15.2% 12.0% 12.0% 10.6% 11.8% 10.0% 8.0% 9.4% 9.4% 10.1% FRB-SF First Glance 12L – Nov. 2012 Sept-12 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 6.0% Based on commercial banks, excluding De Novos; trimmed means; preliminary 9/30/12 data 63 95% Exceed “Well Capitalized” thresholds, but… Percentage of District Commercial Banks “Well Capitalized” under PCA framework* 9/09 9/10 9/11 9/12 88% 92% 94% 95% Well Capitalized: Main ratio criteria is the Total Risk Based Capital Ratio >= 10% 9% of District Banks hold a CAMELS Capital ratings of “1” (strong) Capital must be sufficient to absorb unanticipated losses & declines in asset values Examiners consider**: • • • • • • the level and severity of problem assets interest rate exposure; liquidity, funding, and market risks the quality and level of earnings concentrations of credit risks from nontraditional activities effectiveness of loan and investment policies, and management’s ability to monitor and control financial and operating risk FRB-SF First Glance 12L – Nov. 2012 Capital categories based on Prompt Corrective Action framework, using Call Report data. ** From Commercial Bank Examination Manual, Section 3020.1, Federal Reserve System 64 Other “Hot Topics” First Glance 12L – Nov. 2012 FRB-SF 65 Bank Supervisors’ Hot Topic Earnings Challenges EARNINGS ISSUE Low interest rate environment – narrow margins Modest loan demand / intense competition for quality borrowers Limited opportunities to grow fee income, esp. for smaller banks Higher overhead (fraud prevention, IT systems, compliance costs) Not likely to see high rates of C&LD lending anytime soon DURATION? Temporary Temporary Permanent? Permanent? Permanent? Relationship Between Construction & Land Development Every 10 pctg point increase in a Lending and Earnings – 12th District Banks 2005 bank’s 2005 C&LD ratio was associated with a 25 bp increase in 6% pretax core earnings / avg. assets 2005 Pretax Pre-provision 4% “Core” Earnings / Avg. Assets (District Avg.) 2% • Avg. C&LD ratio ’07 peak: • Avg. C&LD ratio now: y = 0.025x + 0.0173 Correlation Coefficient: 0.40 0% FRB-SF 0% 20% 40% 60% 80% 2005 C&LD Loans / Total Loans First Glance 12L – Nov. 2012 21% 5% Earnings scenario based only on lower C&LD lending in the future: • Avg. Core earnings ’04-’07 2.00% • Avg. ROAA ‘04-’07 1.30% Outlook? • Core: 25 bp lower • ROAA: 16 bp lower 1.75% 1.14% 66 Bank Supervisors’ Hot Topic Assorted Other Issues Capital planning / stress testing expectations of banks Fiscal Cliff – Impact on U.S. credit ratings & economy if we go over the cliff Information security issues – e.g., denial of service attacks Liquidity management: • Potential impact of planned expiration of the Transaction Account Guarantee (TAG) program at YE2012 – depositors may chose to move funds elsewhere Regulatory compliance challenges and costs from Dodd Frank Act Proposals in Basel III, e.g., running unrealized gains/losses on AFS securities through capital • Concern that banks might move large blocks of securities into Held to Maturity portfolio; this would reduce liquidity; potential for "tainting" the portfolio if a HTM security must be sold • Rule would create volatility in capital ratios from interest rates fluctuations First Glance 12L – Nov. 2012 FRB-SF 67 Summary Banking recovery is advancing – but still a ways to go Challenges include slow growing economy, profitability challenges Questions? 68