2019 Risk Review | 3

Section I: Executive Summary

Consensus forecasts suggest U.S. economic growth 

will slow in 2019 from recent highs, as the economic 

expansion enters its tenth year. Economic growth 

strengthened to above trend in 2018, thanks primarily 

to tax cuts and increased consumer spending. Strong 

labor market conditions also supported the economic 

expansion, as hiring continued and wages improved. 

Business investment increased in 2018, reflecting 

the health of the overall economy. Tariffs on traded 

goods reduced U.S. exports, and uncertainty about 

global trade may contribute to slower future growth 

if consumers and businesses delay purchase or 

investment decisions. Other factors affecting the 

outlook include ongoing political risks in Europe and 

a global economic slowdown that began in 2018. 

Financial markets reflected expectations for slower 

economic growth, and volatility returned to financial 

markets in 2018 and early 2019, following several 

years of steady, positive performance. The U.S. 

Treasury yield curve flattened significantly in 2018 as 

the Federal Open Market Committee raised the target 

range for the federal funds rate four times during 

the year. The average net interest margin improved 

for the banking industry in 2018, as average asset 

yields generally increased more rapidly than average 

funding costs. However, 31 percent of banks reported 

a decline in their net interest margin in 2018, as their 

average funding cost generally increased faster than 

their average asset yield. Asset yields have declined 

for a number of banks as the yield curve flattened.

Growth in the leveraged loan market accelerated over 

the past two years as demand from yield-seeking 

investors increased. Concerns about reduced 

underwriting standards escalated with an increase in 

the prevalence of loans with weak covenants and less 

rigorous documentation standards. The stock market 

was adversely affected by price volatility in 2018, and 

several indices ended the year with negative annual 

returns. Despite strong earnings reports, bank stocks 

were volatile and underperformed relative to broader 

indices as interest rate expectations dampened the 

market outlook.

FDIC-insured institutions performed well in 2018. The 

strong financial condition of banks contributed to a 

declining number of institutions on the Problem Bank 

List and no bank failures during the year. Net income 

for FDIC-insured institutions increased 44 percent 

from 2017 to a record $236.7 billion in 2018, driven 

by higher net operating revenue and a lower effective 

tax rate. Loan growth continued and loan performance 

metrics remained strong for both the banking industry 

as a whole and community banks. However, slower 

growth in the broader economy is beginning to affect 

the banking industry. Loan growth has slowed over 

the past three years, particularly in real estate-related 

portfolios. In addition, agriculture loan noncurrent 

rates are rising amid low commodity prices and farm 

incomes. Still, banks held more and higher-quality 

capital than they did during the financial crisis, in part 

because of post-crisis regulatory capital requirements. 
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Consolidation within the banking industry accelerated 

in 2018. The pace of net consolidation rose in 2018 

for the first time since 2015 and remains relatively 

high by historical standards. Net consolidation is 

primarily driven by voluntary inter-company mergers. In 

2018, 230 charters were merged out of existence and 

seven were acquired by credit unions. Consolidation 

activity was partially offset by new chartering activity: 

eight newly chartered and insured institutions were 

established in 2018, the most since 2010. 

Community banks continue to report lower 

consolidation rates than noncommunity banks. When 

acquisitions have occurred, community banks have 

typically been acquired by other community banks.3

In the ten years ending 2018, the share of community 

banks that were acquired by other community banks 

was 68 percent. Community banks also reported lower 

rates of attrition compared with noncommunity banks: 

4.7 percent of community banks that reported financial 

results at year-end 2017 exited the industry in 2018, 

compared with 5.4 percent of noncommunity banks.

3 The FDIC identifies community banks not by total asset size, but instead by a broader set of criteria related to traditional lending and deposit gathering 

activities and limited geographic scope. See FDIC Community Banking Study at https://www.fdic.gov/regulations/resources/cbi/report/cbi-full.pdf.
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Key Risks to Banks 

Past banking crises have been frequently associated 

with economic activity related to a specific sector or 

geographic area. While the discussion of risks in this 

report is organized by topic, it is important to bear in 

mind that the confluence of risks facing institutions 

exposed to multiple sectors or geographies may 

present challenges that are difficult to foresee and 

therefore warrant attention.

Credit Risk: After ten years of economic growth, loan 

performance metrics at FDIC-insured banks remain 

strong. However, institutions with concentrations 

of credit have greater exposure to market sector 

changes. Competition among lenders has increased 

as loan growth has slowed, posing risk management 

challenges. Market demand for higher-yielding 

leveraged loan and corporate bond products has 

resulted in looser underwriting standards.

• Agriculture: The agricultural economy is now 

in its sixth year of low commodity prices and 

farm incomes, and agricultural exports have 

reflected pressure from trade uncertainties 

and slowing global growth. A slowdown in 

the agricultural economy is an important risk 

to the FDIC because farm banks are a large 

source of financing for the agriculture industry 

and represent about one-fourth of banks in 

the United States. Farmland values have been 

relatively resilient to the downturn in farm 

profits and have partially insulated borrowers 

and lenders from more serious credit quality 

deterioration. While asset quality metrics at 

farm banks are beginning to weaken, loan 

restructuring has helped keep credit problems 

at bay and loan delinquencies below levels 

experienced during the 1980s farm crisis. 

Farm bank liquidity has declined as farmers 

have shifted from being net depositors to net 

borrowers. 

4FDIC Community Banking Study, December 2012, 5-13, https://www.fdic.gov/regulations/resources/cbi/report/cbi-full.pdf. The study covers the 

period from 1984 to 2011. The study defines CRE lending specialists as banks that hold construction and development loans greater than 10 percent of 

assets or total CRE loans (C&D, multifamily, and secured by other commercial properties) greater than 30 percent of total assets. 

• Commercial Real Estate: Commercial real estate 

(CRE) market fundamentals remain favorable 

as the economic cycle matures. However, 

outstanding CRE loan balances are rising, and 

competition among lenders to maintain market 

share in the face of slowing loan growth is 

increasing. Vacancy rates are low, and property 

prices and rents continue to grow for CRE in 

general. But, overbuilding in some multifamily 

and industrial segments and oversupply of 

outdated retail properties may weigh on CRE 

fundamentals going forward. During the last 

crisis, banks considered to be CRE lending 

specialists failed more than twice as often as 

the average community bank.4 In the current 

environment, CRE loan growth has slowed, and 

bank portfolios are more concentrated in existing 

property loans rather than historically vulnerable 

construction loans. Competition among banks 

for quality CRE loans poses challenges for 

institutions lending to the CRE sector as loan 

growth has slowed. FDIC examination findings 

since mid-2017 noted opportunities for 

improvement in risk management practices for 

CRE-concentrated institutions, particularly in the 

areas of board governance and oversight and 

portfolio stress testing. Despite the competitive 

pressures, CRE credit quality metrics at insured 

institutions remain satisfactory in early 2019.

• Energy: U.S. oil production reached record 

highs in 2018, but the energy industry is 

susceptible to volatility that has produced past 

boom and bust cycles. Banks most exposed to 

this geographically concentrated industry are 

vulnerable to future downturns. Banks in oil- and 

gas-concentrated areas were resilient to the 

2014 to 2016 energy industry stress. Indeed, no 

banks in those areas failed during that period. 

However, asset quality deteriorated, particularly 

in the portfolios of large and regional banks, as 

reported in the 2015 to 2017 Shared National 

Credit reviews. Improved economic conditions in 

the energy sector in 2018 led to strengthened 

prospects for energy credits at banks, but energy 

sector high-yield debt remains elevated.
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• Housing: The housing market began to slow in 

2018 as concerns about affordability intensified. 

Banks with concentrations in this portfolio 

could be vulnerable to the slowdown, but credit 

quality has been resilient so far. Rising home 

prices, low inventory, and rising mortgage rates 

reduced affordability in many markets and led 

to a decline in home sales in 2018. While 

mortgage rates came down in 2019, the housing 

market continued to slow. Residential mortgage 

loan concentrations have declined from postcrisis peaks but remain elevated at community 

banks in some areas. Credit quality metrics for 

residential mortgage loans are relatively strong.

• Leveraged Lending and Corporate Debt:

Nonfinancial corporate debt as a share of 

gross domestic product (GDP) has reached a 

record high level. The increase has been driven 

by growth in corporate bonds and leveraged 

loans, which have become increasingly risky 

as the share of low-rated bonds has grown 

and lender protections in leveraged loans have 

deteriorated. Partly in response to low interest 

rates, corporate debt levels reached a record 

high 46.9 percent of GDP in 2018.5 Investors 

reaching for yield increasingly funded leveraged 

loans to highly indebted companies that lacked 

traditional lender protections. Direct bank 

exposure to corporate debt is concentrated in 

revolving leveraged loans, traditional commercial 

and industrial loans, and commercial mortgages. 

In contrast, indirect exposures are opaque and 

could transmit corporate sector stress into the 

banking system.

• Nonbank Financial Institution Lending: By lending 

to nondepository financial institutions, banks 

are increasingly accruing direct and indirect 

exposures to these institutions and to the risks 

inherent in the activities and markets in which 

they engage. Bank lending to nondepository 

financial institutions, which is primarily driven by 

noncommunity banks, has expanded seven-fold 

since 2010 and now exceeds $400 billion. 

5Nonfinancial business debt, including loans to both corporate and noncorporate borrowers, reached 73.2 percent of GDP in 2018, nearing the all-time high 

of 73.7 percent set in 2009.

Market Risk: The current interest rate environment 

presents earnings and funding challenges to banks 

and could pressure liquidity at some institutions. 

• Interest Rate Risk and Deposit Competition:

Banks have enjoyed several years of abundant 

low-cost deposit funding, but they could be 

challenged if deposit competition intensifies. 

After a delayed response to the rising interest 

rate cycle that began in fourth quarter 2015, 

consumer preferences have shifted toward 

interest-bearing deposits, which are becoming 

increasingly expensive for both community and 

noncommunity banks. Community banks are 

especially vulnerable to this trend because 

of competitive pressures with noncommunity 

banks. The effects of increased competition on 

deposit costs have not yet affected aggregate 

net interest margins. However, nearly one-third of 

banks have seen a decline in their net interest 

margin since fourth quarter 2015, generally due 

to an increase in funding costs but also partly 

because of a decline in asset yields at some 

banks. Many rural community banks face added 

deposit retention challenges associated with 

long-term demographic shifts and the recent 

downturn in the agriculture industry.

• Liquidity: Short-term liquidity at smaller banks 

has declined in recent years, potentially reducing 

these institutions’ ability to manage a future 

downturn. Steady loan growth has resulted in a 

decline in short-term liquid assets and increased 

reliance on wholesale funding sources for banks 

with total assets of less than $100 billion. 

Institutions with additional risk factors, such 

as higher loan concentrations, also generally 

have lower liquid assets and higher wholesale 

funding, sometimes significantly so. A turn in the 

credit cycle could be detrimental to institutions 

with low levels of liquidity or high levels of 

wholesale funding, particularly if a sale of 

securities is required to meet liquidity demands 

or if access to certain types of funding is limited.