Meet the Author

Ed Nosal |

Senior Research Advisor

Ed Nosal was formerly a senior research advisor in the Research Department of the Federal Reserve Bank of Cleveland.

Meet the Author

Saeed Zaman |


Saeed Zaman

Saeed Zaman is an economist in the Research Department of the Federal Reserve Bank of Cleveland. His current research focuses on inflation measurement and forecasting, including nowcasting methods, and he contributes to the development of macroeconomic forecasting and policy models at the bank. His research interests also include inflation and prices, macroeconomic forecasting, monetary policy, and banking and financial institutions.

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Economic Trends

Fourth District Community Banks

by Ed Nosal and Saeed Zaman

Most of the 283 banks headquartered in the Fourth Federal Reserve District as of September 30, 2007, are community banks—commercial banks with less than $1 billion in total assets. There are 259 such banks headquartered in the District, a number that, as a result of bank mergers, has declined since 1998, when there were 337.

Total asset growth for Fourth District community banks decreased 0.68 percent in the third quarter of 2007 (annualized rate), but this number has fluctuated in the past few years. A decline in the community banking assets within the district does not necessarily mean that any banks closed shop or left the district. A community bank might no longer be included among the Fourth District’s banks if it is acquired by bank holding company that is headquartered in another district  or if it merges with another Fourth District bank and the total assets of the merged institution push it above the $1 billion cutoff. For example, community bank assets declined sharply in 2000 and 2004—years in which a great number of institutions consolidated or left the population of Fourth District community banks.

The structure of the market has changed since 2000, when the majority of the community banks in the district had less than $100 million in total assets. Since then, banks in the mid-size category ($100 million to $500 million) have constituted the majority.

The income stream of Fourth District community banks has been deteriorating slightly in recent years. Return on assets (ROA) fell from 1.7 percent in 1998 to 1.3 percent in the third quarter of 2007. (ROA is measured by income before tax and extraordinary items, because one bank’s extraordinary items can distort the averages in some years.) The decline is in part due to weakening net interest margins (interest income minus interest expense divided by earning assets). Currently at 3.63 percent, the net interest margin is at its lowest level in over eight years.          

One probable cause of concern is the elevated level of income earned but not received. At 0.68 percent, this figure is at its highest level in 10 years. The last time it was close to this figure was in 2001. If a loan agreement allows a borrower to pay an amount that does not cover the interest accrued on the loan, the uncollected interest is booked as income even though there is no cash inflow. The assumption is that the unpaid interest will eventually be paid before the loan matures. However, if an economic slowdown or other some other factor forces an unusually large number of borrowers to default on their loans, the bank’s capital may be impaired.         


Fourth District community banks are heavily engaged in real estate-related lending. In the third quarter of 2007, 51.4 percent of their assets were in loans secured by real estate. Including mortgage-backed-securities, the share of real estate-related assets on the balance sheet was 58.4 percent.       


Fourth District community banks finance their assets primarily through time deposits (about 77 percent of total liabilities). Brokered deposits which are a riskier type of deposit for banks because they chase higher yields and are not a dependable source of funding—are used less frequently. Federal Home Loan Bank (FHLB) advances are loans from the FHLBs that are collateralized by the bank’s small business loans and home mortgages. Although they have gained some popularity in recent years, FHLB advances are still a small fraction of community banks’ liabilities (7.8 percent of total liabilities) and remain an important source of backup liquidity for most Fourth District community financial institutions.

Problem loans include loans that are past due for more than 90 days but are still receiving interest payments , as well as loans that are no longer accruing interest. Problem commercial loans rose sharply in 2001 and have returned to their 1998-2000 levels in recent years. Currently, 2.52 percent of all commercial loans are problem loans. Problem real estate loans are only 1.21 percent of all outstanding real estate-related loans, but they are at their highest level in over 9 years. Problem consumer loans continued their downward trend in the third quarter of 2007. Currently, 0.43 percent of all outstanding consumer loans (credit cards, installment loans, etc.) are problem loans.

Net charge-offs are loans that are removed from the balance sheet because they are deemed unrecoverable minus the loans that were deemed unrecoverable in the past but are recovered in the current year. As with problem loans, there was a sharp increase in the net charge-offs of commercial loans in 2001 and 2002. Consumer loans followed a similar path but have remained slightly elevated since the recession. Fortunately, the charge-off level for commercial loans has retuned to its pre-recession level. Net charge-offs in the third quarter of 2007 were limited to 0.66 percent of outstanding commercial loans, 0.71 percent of outstanding consumer loans, and 0.13 percent of outstanding real estate loans.

Capital is a bank’s cushion against unexpected losses. The recent trend in capital ratios indicates that Fourth District community banks are protected by a large cushion. The leverage ratio (balance sheet capital over total assets) was above 10 percent, and the risk -based capital ratio (a ratio determined by assigning a larger capital charge on riskier assets) was about 11 percent in the third quarter of 2007. The growing ratios are signs of strength for community banks.

An alternative measure of balance sheet strength is the coverage ratio. The coverage ratio measures the size of the bank’s capital and loan -loss reserves relative to its problem assets. As of the third quarter of 2007, Fourth District community banks had almost $15 in capital and reserves for each $1 of problem assets. While the coverage ratio declined considerably following the high charge-off periods of the early 2000s, balance sheets are still strong.