US banks' balance sheets grew more flexible and formidable in the third quarter.

In addition to a sharp increase in tangible common equity and slower loan growth, the industry relied less on wholesale funding and hoarded more cash and equivalents, S&P Global Market Intelligence data shows.

Asset transformation

Banks took a more cautious approach to balance sheet management in the third quarter. Aggregate quarterly loan growth was 0.6%, down from 1.0% in the second quarter, the data shows. Median loan growth was 1.1%, down 56 basis points from the second quarter and representing the second-slowest rate in the past two years.

Loan categories that experienced decreases on an aggregate basis included commercial and industrial to US addresses, as well as construction and land development. On the other hand, loans increased in the one- to four-family, credit card and commercial real estate sectors.

This analysis, which covers US commercial banks, savings banks, and savings and loan associations, examines third-quarter performance based on aggregate and median change because the sector remains dominated by larger institutions that can skew the results. For instance, the four largest banks held nearly 40% of the industry’s assets at the end of the third quarter.

Most banks were bolstering their cash and equivalents position as the industry waits for a more opportune time to aggressively add loans. The aggregate quarterly change in cash and cash equivalents was $75 billion, or 2.2%, while the median change was 5.4%.

In the regional banking space, Webster Financial Corp. unit Webster Bank NA more than doubled cash and equivalents to $3.20 billion during the third quarter.

"As a result of the substantial deposit growth, we are holding higher cash balances than we have historically," Webster Bank CFO William Holland said during a third-quarter earnings call. The lender's total deposits were up 3.6%, in part because of a seasonal surge in public funds, Holland said.

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Rise in equity

The quarter-over-quarter aggregate change in tangible common equity (TCE) was $80 billion, or 4.1%, and the median change was even higher at 5.8%. The aggregate increase in the TCE ratio was 22 basis points, while the median increase was twice as high. Most of the upward movement was from more favorable fair value marks on available-for-sale (AFS) securities, stemming from the 50-basis-point cut in the federal funds rate in September. Aggregate unrealized losses on AFS securities improved by about $65 billion from June 30, but the rise in rates during the fourth quarter should offset some of the improvement.

Unrealized losses on held-to-maturity (HTM) securities also significantly improved during the third quarter, with the aggregate moving to $225 billion from $309 billion. While the HTM mark is not included in the TCE calculation, it is a component of adjusted tangible book value.

Funding transformation

Growth in total deposits was greater than 1% on both an aggregate and median basis, rebounding from negative 1.0% and 0.0%, respectively, in the second quarter, Market Intelligence data shows.

The quality of the industry's funding base showed a marked improvement during the third quarter. On an aggregate basis, brokered deposits were down 3.6% and total borrowings declined 1.2% quarter over quarter. From a median perspective, brokered deposits are a nonfactor and borrowings were down 1.8%.

Additionally, banks were able to contain rising funding costs. The aggregate change in cost of funds was 7 basis points, and the median change 8 basis points. Both increases failed to keep pace with the yield on earning assets, which led to a net interest margin expansion of 5 basis points from both perspectives.

Like Webster Bank, Flagstar Financial Inc. unit Flagstar Bank NA is a regional bank showing deposit-gathering momentum. Total deposits were up 4.9% quarter-over-quarter and 10.7% higher versus the quarter ended March 31, allowing the bank to substantially reduce its borrowings.

"As far as our executing on our operating plan, this quarter was the second consecutive quarter of really solid deposit growth, both in retail and in the private bank. In the private bank, we're seeing many customers returning to the bank after the disruption earlier this year, and we are winning new relationships. Moreover, the private banking deposits are more moderately priced, having a weighted average cost in the low 2% range, Flagstar Financial President, CEO and Executive Chairman Joseph Otting said during a third-quarter earnings call.

Another regional bank, Comerica Inc. unit Comerica Bank, reduced wholesale funding but grew deposits 1.0% overall. Total borrowings and brokered deposits decreased 22.0% and 13.2%, respectively, compared with June 30.

Credit holding steady

Credit quality showed little sign of deterioration in the third quarter. There was no third-quarter change in the industry median for the net charge-off ratio or the problem loan ratios.

Modest deterioration can be seen when analyzing industry aggregates. The ratio for nonperforming assets and 90+ day loans jumped another 4 basis points in the third quarter to 0.71%, representing the highest level since March 31, 2021, according to Market Intelligence data.

The office sector remains a pain point for several large banks. Wells Fargo & Co. reported that 12.2% of its outstanding office portfolio was nonperforming as of Sept. 30, although that ratio was down from 12.3% on June 30.