What Can We Glean from Q1 Bank Financial Data?

By Joseph Jalbert June 13, 2023

On a quarterly basis, and roughly one month after Call Reports are due to be filed, the Federal Deposit Insurance Corporation (FDIC) publishes a Quarterly Banking Profile  summarizing financial highlights of FDIC-insured institutions.  Since the highlights from the first quarter of 2023 were recently released, let’s take a look at some of the key takeaways to see how the industry performed during the quarter and how it measures against our expectations.

Earnings are up

 Is anyone else surprised by this one?  With funding costs still on the rise through the first quarter and few loan or security gains to be found, it would be reasonable to expect earnings to decline as a result.  As with everything, however, the devil is in the details.  While the FDIC’s press release noted earnings were up 16.9% in the first quarter of 2023 as compared to the fourth quarter of 2022, earnings would have remained relatively flat quarter over quarter if not for the recognition of significant gains related to acquisitions of two failed banks.⁽¹⁾  Consistent with expectations (this author’s anyway), the press release further notes that earnings of community banks (as defined by the FDIC) decreased by 4.2% in the first quarter of 2023 as compared to the fourth quarter of 2022, due primarily to lower net interest income and noninterest income, despite decreases in provision and noninterest expenses.

The margin squeeze continues

 The data related to net interest margins is consistent with what you are all painfully aware of: the battle for deposits rages on.  This is apparent in the FDIC data which shows that deposit levels across the industry have declined for the fourth quarter in a row, down another 2.5% from the fourth quarter of 2022.  As a result of institutions paying a premium for deposits, of which there are fewer to go around, net interest margins contracted an additional 7 basis points in the first quarter of 2023 as compared to the fourth quarter of 2022.  Although yields on loans increased 32 basis points during that same time, it wasn’t enough to keep pace with the rapid rise in the cost of deposits, which saw a quarter-over-quarter increase of 43 basis points.

Worse yet, the community bank-specific data painted an even bleaker picture.  From the fourth quarter of 2022 to the first quarter of 2023, yields on loans rose only 16 basis points while the cost of deposits shot up 39 basis points, resulting in further quarter-over-quarter margin compression of 22 basis points.

Is the end of deposit rate increases near, or have we perhaps reached it?  The answer to that will largely be dictated by the actions of the Federal Reserve and the level of competition for deposits among financial institutions primarily driven by these institutions’ ongoing liquidity and funding needs.  While the Federal Reserve has signaled that they may pause on any additional rate increases in the near-term, they left the door open for such a move depending upon incoming inflation and employment data over the coming months.

Unrealized securities losses are on the decline

 ….at least for now, but we’ll take any good news we can get, right?  According to FDIC data, unrealized losses on available-for-sale and held-to-maturity securities decreased 16.5% in the first quarter of 2023 as compared to the fourth quarter of 2022, the second quarter in a row of declines.  In its press release, the FDIC cited declines in medium- and long-term interest rates as the primary driver of this decrease.  Another contributor, however, is the securities held by Silicon Valley Bank and Signature Bank (which, as we know, had some sizable unrealized losses) that were transferred to the FDIC during the first quarter and are therefore no longer reported as bank-held securities.

Looking forward, as rates (hopefully) begin to stabilize, expect to see the trend of declining unrealized losses continue.  While this trend will be welcomed by the industry, there is a long way to go: unrealized securities losses as of March 31, 2023, as reported by the FDIC, were at a staggering $515.5 billion, more than six times the levels seen in 2018 (the last time the Federal Reserve raised the fed funds target rate).

Asset quality holds steady

 As of March 31, 2023, the FDIC reported that loans 90 days or more past due or on nonaccrual increased to 0.75% of loans, up a mere 2 basis points from December 31, 2022.  Net charge-offs as a percentage of loans increased to 0.41% in the first quarter of 2023, up 5 basis points as compared to the previous quarter, driven largely by higher credit card charge-offs.  On the flipside, loans 30-89 days past due decreased to 0.52% as of March 31, 2023, a 4 basis point decline from the previous quarter.

Community banks reported similarly favorable metrics, with loans 90 days or more past due or on nonaccrual increasing only 1 basis point from the fourth quarter of 2022 to 0.45% of loans.  In contrast to the increases seen across the industry as a whole, net charge-offs for community banks decreased 2 basis points as compared to the fourth quarter of 2022, coming in at 0.09% of loans in the first quarter of 2023.  Although the changes were not disclosed, the FDIC noted that community bank loans 30-89 days past due increased slightly as compared to the fourth quarter of 2022.

By most measures, asset quality has generally been favorable across the industry for a number of years – but for how long will that continue?  One possible source of industry sentiment is the level of reserves for credit losses.  As of March 31, 2023, the vast majority of FDIC-insured institutions were required to apply the guidance in Accounting Standards Codification Topic 326 (you know it as “CECL”), which requires institutions to incorporate a forward-looking estimate of losses when determining the allowance for credit losses.  The FDIC data shows that allowances for credit losses across the industry grew at a faster pace than noncurrent loan balances (i.e. loans 90 days or more past due or on nonaccrual) which also resulted in an increase in the reserve coverage ratio.  This could suggest that institutions are anticipating deterioration in credit quality even though it hasn’t yet materialized, but this is also difficult to evaluate given the large number of first-time CECL adopters in the first quarter of 2023.

The road ahead

 There are a number of micro- and macroeconomic factors in play that will impact the industry outlook as a whole as well as individual institutions’ own path forward.  Although the financial institutions industry is no stranger to change and uncertainty (and the anxiety they induce), institutions will be well-served by re-evaluating their risk management frameworks which serve as a critical underpinning to weathering the storm under any conditions.

 

⁽¹⁾ Although the press release did not specifically identify the two failed banks, the only two banks that failed during the first quarter of 2023, as published by the FDIC, were Silicon Valley Bank (March 10, 2023) and Signature Bank (March 12, 2023).