Banking conditions remain stable in KC Fed region

Banking conditions in the Federal Reserve Bank of Kansas City region remained stable in the third quarter even as bankers shifted their holdings to account for more unrealized losses, according to a recent report.  

Loan activity continued to be strong. District commercial real estate and commercial and land development concentration levels increased to 172 percent and 54 percent of Tier 1 capital and allowance, respectively, according to the report. “Asset quality metrics remain stable, with a continued low level of past due, nonaccrual, and restructured loans,” said Mary Bongers, Senior Risk Specialist at the Kansas City Fed. “Allowance levels are steady at 1.29 percent of loans, as banks have increased provisions in response to elevated levels of loan growth.” 

Net interest margins at district banks increased 30 basis points in the third quarter to 3.58 percent. Bongers attributed the increase to rising interest rates and a changing balance sheet mix. Adjusted for Paycheck Protection Program numbers, loans grew 3.5 percent from the previous quarter and nearly 14 percent from 2021. Cash and balances due fell 15 percent over the quarter and by nearly half since the third quarter of 2021.

“Strong loan growth was funded by lower-yielding liquid assets,” she noted. “Rising interest income offset only moderate increases in interest expense. As a result, net income increased to 1.33 percent of average assets, despite an increase in provision expense and continued declines in noninterest income.” 

The size of bank balance sheets remained stable, Bongers said, while deposits continued to fall in the third quarter as the drawdown from pandemic-era stimulus continued. “Banks instead took on more borrowings and non-core deposits to fund loan growth, primarily short-term FHLB borrowings, as well as brokered deposits and federal funds purchased,” Bongers said. She noted that the overall drop in balance sheets has benefitted capital positions. The district’s leverage ratio increased to 9.63 percent. 

Bongers noted that unrealized losses totaled $11 billion or 22 percent of Tier 1 capital in the third quarter. “Banks continue to hold large unrealized losses within available-for-sale securities,” she added. “In response, banks have shifted more heavily into held-to-maturity holdings and continue to shorten maturities of holdings.” Also, banks reportedly sought to liquidize sources outside of securities, including interest-bearing bank balances to fund deposit runoff and loan growth.