A Look at Bank Loan Performance
Tara Sullivan and James Vickery
U.S. banks experienced a rapid rise in loan delinquencies and defaults during the 2007-09 recession, driven by rising unemployment and falling real estate prices, among other factors. More than four years on from the official end of the recession, how do things look now?
The overall performance of loans in banking portfolios has improved substantially since 2009. The aggregate NPL ratio has declined in each of the past fourteen consecutive quarters and now sits at 3.1 percent, compared with its crisis peak of 5.7 percent. Despite this improvement, however, the fraction of nonperforming loans still significantly exceeds pre-recession levels.
Digging a little further into the data, we see notable differences in performance trends by loan type. First, let’s take a look at commercial and industrial (C&I) loans, a category that includes credit lines, plant and equipment loans, and financing for inventory and for other corporate assets (not including real estate). Not surprisingly, C&I loan performance tends to move closely with the business cycle, with peaks in the nonperforming loan ratio associated with each of the last three recessions. The NPL ratio for C&I loans has declined sharply since 2009, reflecting improved macroeconomic conditions and the recovery in corporate profits. The ratio now sits below 1 percent, well below its historical (1991-2013) average.
The fraction of nonperforming consumer loans has also recovered significantly since the end of the recession. This category includes credit cards, auto loans, and other types of personal loans not backed by real estate. Historically, consumer loan delinquency is less correlated with the business cycle than C&I loan performance, as can be seen from the chart below. While the share of nonperforming consumer loans surged from 2007 to 2009, there was no corresponding spike during the two previous recessions.
The consumer loan NPL rate has fallen by more than half since 2009, and now actually lies below pre-recession levels. Only 1.1 percent of consumer loan balances are currently nonperforming, a level last seen in 1995.
What about student loans? The New York Fed’s Quarterly Report on Household Debt and Credit has documented a rise in the fraction of delinquent student loans in recent years, as well as a surge in the amount of student debt outstanding. But although student loan balances are reflected in the graph above, to date they have been only a modest contributor to banking sector loan delinquencies and losses. One important reason is that most student loans are issued or guaranteed by the federal government. Student loans are classified in bank and bank holding company regulatory reports as part of “other consumer loans.” This category, which also includes non-credit-card personal loans and revolving credit plans, accounts for 2.6 percent of delinquent bank loan balances and 9.7 percent of total loan charge-offs as of second-quarter 2013.
The performance of the residential real estate loans held in banking portfolios showed a relatively muted recovery compared with the performance of C&I and consumer loans. Currently, 7.7 percent of residential mortgage debt is ninety days or more past due, only slightly below the 2009 peak. This persistently high delinquency rate likely reflects a range of factors, including the slow resolution and foreclosure process for delinquent loans in many states, as well as the lingering after-effects of the mortgage credit boom and subsequent collapse in home prices. Note that the fraction of nonperforming mortgages is about three times higher for the largest bank holding companies (the six firms with total assets exceeding $500 billion) than for the rest of the commercial banking industry.
Residential mortgage performance since 2007 represents a striking departure from historical patterns. Even though the nonperforming loan ratio has exceeded 7 percent for the past sixteen consecutive quarters, it didn’t even reach 2 percent at any point between 1991 and 2006. Prior to the financial crisis, residential mortgages were often thought to have relatively little credit risk, in part because the loan is collateralized by an asset (a house or apartment) that generally increases in value from one year to the next while the balance on the loan declines over time owing to amortization. Of course, contrary to this pattern, U.S. home prices fell sharply in the late 2000s, compounded by weak loan underwriting standards during the prior mortgage credit boom. Taking a longer historical view, we note that residential mortgage delinquencies and defaults were also high during the Great Depression, the last period during which the U.S. experienced a sustained national decline in home prices.
Completing our look at loan performance since the end of the recession, the chart below plots the performance of commercial mortgages. These loans are secured by commercial real estate, including offices, warehouses, factories, malls, multifamily apartment buildings, hotels, and buildings under construction. As with residential mortgages, the fraction of nonperforming commercial mortgages remains well above pre-recession levels, although it has declined comparatively more quickly since 2009. The peak in the NPL ratio for commercial mortgages is similar to the peak reached during a previous period of elevated delinquencies in the early 1990s. Like residential mortgages, commercial mortgages saw elevated delinquencies and defaults during the 1930s.
To sum up, the performance of loans in U.S bank portfolios has improved significantly, albeit unevenly, since the end of the 2007-09 recession. Differences in performance across major loan categories reflect key features of the recession itself, in particular the central role played by the collapse in real estate prices and fall in personal consumption. In the future, the tighter underwriting standards applied to more recent loan cohorts would suggest that the fraction of nonperforming loans may continue to fall over time, as earlier loan vintages become a progressively smaller share of bank portfolios. As in recent history, however, macroeconomic and financial market conditions are likely to be the main determinant of bank loan performance going forward.
The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.
Tara Sullivan is a senior research analyst in the Federal Reserve Bank of New York's Research and Statistics Group.
James Vickery is a senior economist in the Research and Statistics Group.