Fed official: Conditions will challenge net income

While Minnesota banks reported small improvement in loan growth, profits and asset quality in the third quarter, the outlook for income will become more serious if weak loan demand and small net interest margins continue, said Ron Feldman, senior vice president for supervision, regulation and credit at the Federal Reserve Bank of Minneapolis. Feldman discussed banking conditions at a briefing at the Minneapolis Fed on Nov. 20..Feldman described Minnesota's median bank as having "small to middling improvement" in the third quarter. Past-due loans have declined to 11.54 percent, an improvement of 1.19 percent from last quarter and 3.78 percent from last year. Fueled by improvement is asset quality and less provisioning for loan losses, the median bank reported 0.99 percent return on assets, up 5 basis points from last quarter, and 20 basis points over third quarter 2011. The median Minnesota bank had loan growth of 0.4 percent..Mirroring agriculture's outperformance of the rest of the economy, the agricultural banks of the state continue to outperform Twin Cities banks in every key metric. In terms of asset quality, while the state as a whole has reached the 20-year median, the Twin Cities median bank has non-performing assets near 16 percent of capital. The Twin Cities also lags the state in earnings and loan growth. While the median state bank has reached the 20-year median of 1 percent ROA, only 25 percent of Twin Cities banks have reached the 20-year median. And, while more than 50 percent of banks in the state have positive loan growth, only the top 25 percent of banks in the Twin Cities have positive loan growth. .For the 361 commercial banks in the state, Feldman described weak loan demand as becoming a more eminent problem for income. Even though asset quality has returned to historic norms and banks have higher earnings in the short term from setting less aside for loan losses, now earnings must come from loan growth. Unfortunately, loan growth is stubbornly below historic norms and, with rates as low as they are, banks can't make up in price what they are missing in volume.."Banks have addressed asset quality issues, but profits are not returning," Feldman said. "The issue for banks is: how are they going to make money going forward?".Despite the gloomy forecast for income, Minnesota banks continue to gain strength. Loan growth had considerable improvement from a year ago when loan volume declined by 4.14 percent. The third quarter also was the sixth consecutive quarter in which the number of banks with positive loan growth increased. Also, Minnesota banks with a CAMELS rating of 3, 4 or 5 stands at 34 percent. "That means nearly two-thirds of the banks in the state are healthy and ready to make loans," Feldman said.