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New York Regional Outlook - Third Quarter 1998

Regular Features Current Regional Banking Conditions Financial institutions in the New York Region report strong profits and solid financial conditions. The Asian crisis poses risk to insured institutions in the New York Region. The New York Region's weak demographic profile suggests banks may eventually struggle for growth in their most traditional consumer business lines. Financial Condition Remains Strong The Region's banks and thrifts reported healthy financial conditions in the first quarter of 1998 (see Table 1). Insured institutions in the New York Region posted strong income figures. However, the high return-on-assets ratio was boosted by nonrecurring extraordinary gains that totaled 11 percent of aggregate net income. The ratio of net operating income to average assets, 0.96 percent, is at its lowest level in two years. Although financial institutions have been able to bolster earnings by increasing efficiency and emphasizing fee income as a revenue source, the continuing trend of lower net interest margins is affecting the bottom line. Capital ratios remain strong but continue the slightly downward trend seen over the past several quarters. Past-due ratios are declining as well, reflecting improvement in commercial and residential real estate loan portfolios. The primary area of weakness continues to be in the credit card loan portfolio. Nonperforming credit card loans as a percentage of total credit card loans are higher than in early 1997 despite continuing high charge-off levels. Further, a larger portion of nonperforming credit card loans are in the more severe "90 days and over past due " category than in previous periods, suggesting a prolonged weakness that will not be quickly corrected. Table 1 New York Region Institutions Continue to Show Strength   3/31/98 3/31/97 3/31/96 Return on Assets 1.13 1.13 0.85 Net Interest Margin 3.40 3.61 3.77 Return on Equity 15.03 15.08 10.99 Tier 1 Leverage 7.09 7.32 7.31 Noncurrent Assets/Total Assets 0.84 0.91 1.11 Past Due Loans (%) 2.59 2.85 2.95 Nonperforming Credit Card Loans (%) 4.84 4.76 4.02 Credit Card Charge-Offs (%) 5.01 5.05 4.08 Source: Bank and Thrift Call Reports The Asian Crisis Brings Uncertainty to Financial Institutions The currency crises in Asia have brought turmoil to that area and uncertainty to the rest of the world. As Asia struggles to recover, the U.S. economy is being affected in a variety of ways (see The Asian Economic Crisis: Implications for the U.S. Economy and New York Region: Asian Crisis and Poor Demographics Pose Short- and Long-Term Exposure). What does the Asian crisis mean for financial institutions in the New York Region? New York's money center banks have felt and will continue to feel the most direct effects. These multinational players, in addition to having direct loan exposure to Asia, also have substantial fee-generating businesses in that area. Industry analysts indicate that a slowdown in advisory business in Asia could translate into dampened earnings throughout 1998 for these banks. However, many banks appear to have learned a lesson about investing in volatile emerging markets from the Latin American debt crisis in the 1980s. Money center banks have comparatively little direct credit exposure to the five most troublesome Asian markets--Indonesia, Malaysia, the Philippines, South Korea, and Thailand. According to industry analysts, these credits equal about one-fifth the exposure money center banks had to Latin America in the 1980s. Perhaps the biggest risk to insured institutions is the uncertainty surrounding the effects of the Asian crisis on the U.S. economy. Banks' financial conditions tend to follow the business cycle. A slowdown in the economy generally does not bode well for the health of the industry. The New York Region's institutions may face pressure on several fronts. Corporate borrowers, especially those with ties to Asia, could experience weakened demand for products, which would cut into their profits and negatively affect capacity to repay debt. Some manufacturers in the Region already are reporting a decline in exports and have given indications of lower future earnings. The Asian crisis also has created a volatile U.S. stock market. The New York Region's economy, with its heavy dependence on the financial services industry, particularly Wall Street, would be significantly affected by any instability caused by a sustained stock market downturn (see New York Region: Asian Crisis and Poor Demographics Pose Short- and Long-Term Exposure). Another area of uncertainty lies with Japan. Analysts opine that Asia can recover only with the assistance of a strong Japan. Yet Japan's economy, which has been in the doldrums for most of the 1990s, has slipped into recession. Many market analysts and economists expect the Asian economies to contract sharply this year and take five or more years to recover. Forecasts indicate that such a prolonged downturn in Asia will reverberate through other economies around the globe. Another aspect of Japan's problems lies with its financial institutions. Japanese banks, which are incurring huge loan losses in an effort to slash the burden of bad debt already on their books from years of domestic troubles, have the largest credit exposure to their Asian neighbors. Japanese banks boosted their lending activities in Asia over the past several years in an attempt to compensate for problems at home. Now, the economic frailty at home and the financial crisis in the other Asian countries pose a double threat to their earnings. Though Asian loans held by Japanese banks represent only 3 to 4 percent of total loans, in some cases that exposure is greater than the banks' core capital. Reserves against these loans are eating away at an already weak capital base. One side effect is that Japanese banks have had to curtail lending, which is contributing to credit tightness both in Japan and elsewhere in Asia. Another result of this turmoil is that Japanese banks have been downgraded by ratings services such as Fitch IBCA and Moody's, which will increase borrowing costs and further hamper earnings. Asian Banks Reevaluating Their Role in the United States Another effect of the Asian crisis is that many Asian financial institutions are altering their strategy in the United States. This effect is particularly important to the New York Region, which holds the majority of foreign banking assets in the country (see Regional Outlook, fourth quarter 1997). The crisis has prompted Asian banks to retreat from the United States. Twenty-one foreign branches, agencies, and representative offices in New York City closed in 1997. Many were offices of Asian banks. Japan, which has the most U.S. bank assets of any foreign country, experienced a 5 percent decline in total assets in the United States in 1997 versus 1996. South Korean institutions, which steadily increased their U.S. presence in 1996 and the beginning of 1997, have since retrenched significantly. Their assets in the United States were down more than 30 percent, from $18 billion at the end of 1996 to $12.6 billion at year-end 1997. The results of these changes are already being felt. Branches and agencies of foreign banks are lending less to U.S. businesses and tightening underwriting standards. In addition, there are reports that they are increasing the cost of credit lines and widening spreads over base rates. The syndicated lending market, in which the New York Region has a significant number of large players, has been particularly affected by Japan's recent retrenchment. This is not necessarily a negative, however. As competition has lessened, domestic banks have been able to widen spreads and raise commitment fees, reversing a trend toward razor-thin margins and minimal fees that have been squeezing banks in the syndicated lending market for some time. Deals that are not priced to reflect investors' heightened demands are finding fewer participants and sometimes require restructuring to stimulate demand. Yet, the general retreat of Japanese banks from the syndicated lending market has not hampered loan volume. According to Securities Data Co., the syndicated lending market, with $227 billion of volume in the first quarter of 1998, is posed to surpass 1997's record $1 trillion. Demographics Indicate a Struggle for Growth in Consumer Lending Slow population growth has hampered this Region's economy, a trend that is likely to continue in the long term. The Region faces a declining population of 25- to 34-year-olds, the prime demographic group for major spending on housing and consumer items (see New York Region: Asian Crisis and Poor Demographics Pose Short- and Long-Term Exposure). In the long term, this trend could create a more competitive environment for the Region's financial institutions. Many factors affect loan demand at any given time. Currently, low interest rates, low unemployment, and a strong economy are spurring the residential housing market. The Region traditionally has significantly less of its total loan portfolio invested in mortgage loans than the rest of the nation (see Chart 1). Mortgage concentration levels are affected by the composition of the Region's banks, especially the number of large national and multinational institutions, which tend to focus on commercial lending and other products instead of residential mortgages. Nonetheless, despite the strong housing markets seen throughout the Region in the past year, the Region's mortgage loan portfolios grew only about half as much as the national average. Growth is not spurred only by a strong economy. Demographics will undoubtedly play a larger part in future growth, especially if the economy falters. Chart 1 Regional demographics will also affect home equity and consumer loans. Younger adults are primary purchasers of such items as cars, home improvements, and other products associated with household formation and raising families. These purchases generally lead to debt. Although other factors undoubtedly affect these loan categories, demographic trends play a significant role in stimulating demand. The New York Region has consistently posted sluggish growth in home equity and consumer loans (excluding credit card loans) over the past five years (see Charts 2 and 3). Chart 2 Chart 3 The Region's changing demographic profile poses a challenge for financial institutions, especially community banks. Larger regional or national banks with vast interstate operations can shift focus to other, faster growing markets with more favorable demographic trends. But community banks with limited branching beyond their own local markets must find new ways to expand and retain an aging customer base. An aging customer base implies weakened demand for mortgages and installment loans. Less demand for such traditional consumer banking products may force banks to weaken underwriting standards or pursue growth through other business lines to maintain or increase market share, leading to a potential increase in bank risk profiles. As baby boomers age and save for retirement, demand for savings and investment products will increase. The competition for these assets is and will continue to be intense. Financial institutions of all sizes must develop clear marketing strategies in order to compete effectively on this front. Banks will have to assess their long-term goals and strategies with the Region's demographics in mind. Risk management will be especially critical as banks attempt to differentiate their products and services. Underwriting standards and other criteria will have to be balanced against the desire for growth. Also, educating consumers about new savings products will be important, as banks expand their business lines to sell mutual funds and other nondeposit investment products. Sound planning and clear policies and strategies will be the most effective way to deal with the Region's long-term demographic changes. Karen A. Wigder, Financial Analyst For More Information "Despite Setbacks, FBO Assets Still Grow. " Thomson's International Banking Regulator. June 1, 1998. "Rating Changes. " Fitch IBCA. May 20, 1998. "Rating Changes. " Moody's Investors Service. May 27, 1998. Regional Outlook Information Return to Regional Outlook main page