Second quarter 2002 earnings results for commercial banks show that the
benefits of a steep yield curve continue to outweigh the costs of higher
credit losses. Despite the lingering effects of the recession that began
in March 2001, banks earned a record $23.4 billion in the second quarter.
The industry return on assets (ROA) was 1.41 percent--tying the previous
record posted in the third quarter of 1999. Complete second quarter
financial results are available in the Preliminary
Bank Earnings Report published today.
D
The fact that the banking industry could post such strong results on
the heels of the recession underscores the fact that the industry remains
one of the bright spots in the U.S. economic outlook. Unlike the last
recession, when credit losses depressed bank earnings and contributed to
hundreds of failed or undercapitalized institutions, the banking industry
is currently in a position to serve as more of a shock absorber for U.S.
economic activity. The overwhelming majority of FDIC-insured institutions
display the kind of balance sheet and earnings strength that will allow
them to support the economic recovery by lending to creditworthy
businesses and consumers.
D
The bad news in today's earnings report is that credit losses increased
again in the second quarter. Banks charged off $10.5 billion in bad loans
during the quarter--a 33 percent increase from a year ago. Most of the
damage was done in commercial and industrial loans (especially to non-U.S.
borrowers), credit card loans, and other consumer loans. Rising credit
losses in the commercial sector came as no surprise, considering the high
number of prominent corporate bankruptcies that occurred in the second
quarter. The rise in losses on credit cards and other consumer loans pose
more of a concern given heavy consumer debt loads and the so-far tentative
nature of the apparent economic recovery.
But the key point is this: the recession brought with it an
interest-rate environment that has helped banks more than offset these
credit losses and post record earnings. The average monthly yield curve
spread during the second quarter, as measured by the difference between
the yields on 10-year and 6-month Treasury instruments, was 3.38 percent--a
level that has been surpassed during only eight quarters since 1960 and
none since 1992. The steep yield curve helped banks boost net interest
income by $12.8 billion during the quarter compared to a year ago. The
average margin was 4.13 percent, compared to 3.86 percent a year
ago.
Low interest rates have also stimulated home sales and home refinancing
activity. Residential mortgage loans grew by $30.5 billion during the
quarter, while home equity lines grew by $21.8 billion and holdings of
mortgage-backed securities rose by $45.2 billion. These sources of growth
in lending activity more than offset another decline in commercial and
industrial loans--the sixth quarterly decline in a row. Again, the mix of
loan growth in the second quarter comes as no surprise; banks responded to
strong demand by home buyers and home owners as well as to relatively weak
demand for loans by the corporate sector.
Banks continued to pursue lending opportunities in the second quarter
on the strength of solid growth in savings deposits (up $50.9 billion),
short-term nondeposit borrowings (up $37.4 billion), and Federal Home Loan
Bank advances (up $13.8 billion). Strong loan growth and strong funding
growth are evidence that the banking industry remains a reliable conduit
for financial intermediation despite the turmoil that has occurred in the
financial markets.
As the U.S. economy moves toward recovery, conditions
will likely change for the banking industry. Credit losses will at some
point level off and begin to decline. Some signs of this appeared in the
second quarter as total nonperforming loans increased by only $1.3 billion
(or 2.3 percent), the smallest increase in over two years. Noncurrent
loans to domestic C&I borrowers declined for the first time since the
second quarter of 1998. Further improvements in these figures can be
envisioned as economic conditions improve. Demand for commercial loans
will also likely increase as the economy recovers. However, an improving
economy is also likely to bring with it higher short-term interest rates
and a narrowing of the yield curve spread. In this event, net interest
margins are likely to decline from their currently high levels.
But a further offset to lower margins will continue to be the income
banks are booking from non-interest sources. Non-interest revenues in the
first half of 2002 were $5.2 billion higher than during the first half of
2001. Even as one would expect offsetting fluctuations in credit losses
and interest margins over the business cycle, fee income and loan growth
should continue to represent long-term sources of income growth for the
industry.
For the complete Preliminary Bank Earnings Report (published August 29,
2002), go to: http://www.fdic.gov/news/news/press/2002/pr9202a.html
