The deterioration in the housing market and overall Bermuda economy is feeding through into weakened earnings at the banks, new economic figures on the state of the banking sector show.The figures also suggest there’s a growing “shadow inventory” of housing on the Island, one financial expert says.The National Economic Report released Friday confirmed Bermuda’s banks have tightened up on lending and more borrowers are falling behind on payments.The report said non-performing loans (more than 31 days delinquent) surged to 10.2 percent of total loans as banks increased in provisioning relative to total loans to 2.8 percent (more than double the amount of a year ago) “as a result of prudent efforts aimed at mitigating the impact of future asset impairments”The report also stated:l The banking sector’s total assets declined by almost $2 billion (or 7.7 percent) during the first three quarters of 2012 (and 2.1 percent year-on-year).l Banks return on equity was two percent in the third quarter of last year (down from 5.8 percent at the end of 2011), and compared to 6.1 percent in Q3 2011, 6.1 percent in Q3 2010, and 7.9 percent in Q3 2009.l Money supply contracted by 3.4 percent during the first three quarters of 2012 (and five percent year-on-year) driven by negative lending growth and, to a lesser extent, by a drawdown of cash balances and interbank deposits in the sector.The report also stated: “Rising asset impairments have had a negative impact on the sector’s ability to increase capital buffers through retained earnings. Despite stable interest margins and an 8.3 percent reduction in operating expenses, additional provisioning weighed negatively on earnings as the sector enhanced its risk absorption capacity.“In the third quarter of 2012, the report noted: “Lending conditions became more stringent as the deleveraging of the sector was finally felt in a decline of domestic credit supply. Decreased lending (which fell by seven percent) together with high levels of loan charge-offs (relative to the historical experience) diminished the stock of credit significantly. The decline was most pronounced in BD$-denominated loans and advances (down by 8.4 percent), which comprised more than half of total lending.”Experts said the fact total assets declined by almost $2 billion could be due to various factors including, the poor economy, very low interest rates on deposits, and possibly the quiet exodus of some exempt companies that probably held large balances locally.“The numbers are concerning,” Anchor Investment Management CFO Nathan Kowaksi said yesterday. “They are impeding local banks’ ability to post stronger earnings and are hampering returns on equity. It also shows that there is a growing “shadow inventory” of housing on the island.“Part of the reason for the licensing fee rate reduction (for non-Bermudian home buyers) was to help support the real estate sector. This lowers the marginal cost and is intended to bring in more capital.”Chamber of Commerce economics advisory co-chair Peter Everson said the weakened earnings at the banks was a concern and an indication of how poor the local economy is right now.“The banks face a number of difficulties right now,” he said, including, “Ultra low interest rates in US$ as a result of the US Federal Reserve Banks bailing out the US housing market and US banks; a declining local real estate market because of the contraction of the Bermuda economy.“The solutions are: a) For Bermuda to start to grow the local economy. Here the ending of term limits is a start. b) For foreign capital to flow into Bermuda to reduce the debt burden borne by Bermudians. Here the Budget proposals to cut taxes on Bermuda real estate purchased by foreigners is a start.”Grant Hopkins, portfolio manager of LOM Asset Management said the statistics should not be too alarming though.He said: “They only confirm what we can anecdotally see, and since the results are from Q3 2012, they are nearly six months delayed.“A decline in the money supply is a natural consequence of reduced economic activity.“Lending activity has slowed due to lower property transactional volumes and stricter standards for business and consumer loans (and/or reduced borrower fundamentals). Cash deposits likely declined as individuals and businesses dipped into savings to offset lower incomes and because of minimal interest rates on deposits. We would look for growth in the money supply as early signs of economic recovery.”The report further stated: “The capital position of the banking sector has deteriorated slightly since the end of 2011. The aggregate risk asset ratio (RAR) decreased to 22.2 percent (down from 23.2 percent) on a consolidated basis during the first three quarters of 2012 due to a minimal increase in risk-weighted assets (RWAs) of 2.6 percent and a 1.7 percent decline in capital. The leverage ratio (equity to total assets) improved to 11.9 percent during the same time (up from 10.8 percent).“The aggregate Tier 1 risk asset ratio (RAR) stood at 23.9 percent (down from 25.0 percent), well above the internationally recommended standard for capital adequacy under the Basel III regime but appropriately high given the limited segment and geographic diversification of the sector and the absence of sufficient shock absorbers in the local financial system.”