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An Update on Emerging Issues in Banking

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For Your Information An Update on Emerging Issues in Banking

November 26, 2002

Quarterly Banking Profile
Commercial Banking Performance, Third Quarter 2002


Profitability of Banks' Domestic Operations Remains Strong
Weaknesses in commercial banks' corporate and overseas business lines were mitigated by beneficial effects from low interest rates and strength in consumer loan demand in the third quarter of 2002, as earnings almost set a new record. Insured commercial banks earned $23.4 billion in the quarter, falling just $11 million short of the quarterly earnings record, set in the second quarter of 2002. The slight decline in net income was caused primarily by sharply lower income from banks' international operations, which fell by $1.2 billion (58.6 percent). Earnings were also held down by higher expenses for loan losses, reduced income from market-sensitive sources, such as trading and investment banking activities, fiduciary income, and venture capital investments, and by lower servicing fees.

The industry's net income from domestic operations was $1.2 billion (5.5 percent) higher than in the second quarter, but much of the improvement was in nonrecurring items, rather than in revenues from ongoing operations. The greatest revenue increase came from gains on sales of securities, which were $1.5 billion (145.8 percent) higher than in the second quarter. Income from securitization activities and from sales of loans and other assets was higher than in the previous quarter, contributing to a $1.0 billion (2.4 percent) increase in the industry's total noninterest income. Net interest income registered a modest improvement, increasing by $765 million (1.3 percent). Although 5 of the 10 largest commercial banks had lower earnings than in the second quarter, most banks registered improvements. More than 60 percent of all banks reported earnings increases compared to the second quarter. The average ROA in the third quarter was 1.37 percent, down from the record 1.41 percent in the second quarter, even though a majority of banks (55.6 percent) saw their ROAs improve. Almost two-thirds of all banks (65.7 percent) had an ROA of 1 percent or better in the third quarter. Quarterly earnings were $6.0 billion (34.8 percent) higher than a year ago, when sharply higher loan-loss provisions at many large banks depressed industry results.

Performance Continues To Outstrip 2001 Results
Through the first nine months of 2002, commercial banks earned $68.6 billion, up $12.9 billion (23.2 percent) from the same period in 2001. The industry's ROA so far this year is 1.37 percent, compared to 1.17 percent in the first three quarters of 2001. Almost three out of every four banks (72.6 percent) reported improved year-to-date earnings. The main source of the earnings improvement has been higher net interest income (up $19.3 billion, or 12.2 percent). Net interest margins are above the levels of a year ago, and interest-earning assets have grown by 6.2 percent during the past 12 months. These improvements, along with a $10.8 billion (9.2 percent) increase in noninterest income, have outweighed a $7.2 billion (25.6 percent) rise in provisions for loan losses. Almost half of the increase in loss provisions this year (46.6 percent) has been in banks' international operations.

Interest-Rate Environment Helps Community Banks' Net Interest Margins
The industry's net interest margin fell for the second consecutive quarter, but a $134.5-billion (2.3-percent) increase in interest-earning assets during the quarter helped lift net interest income above the level of the second quarter. The average margin declined from 4.11 percent to 4.07 percent, although a majority of commercial banks reported margin increases. Smaller institutions rely more on retail (core) deposits to fund their assets, and with interest rates at historic lows, many community banks have difficulty lowering the interest rates they pay to retail depositors when short-term interest rates decline. As a result, margins at community banks have tended to not improve until after rates stabilize. Larger banks rely more on interest-sensitive liabilities, which reprice quickly when short-term interest rates change; their margins have tended to improve when rates are falling, but tend to narrow when interest rates are stable.

C&I Loans At Large Banks Remain A Source Of Asset-Quality Woes
Credit-quality problems continued to grow in commercial and industrial (C&I) loan portfolios at large banks. The industry's noncurrent rate on C&I loans increased from 2.87 to 3.01 percent during the quarter, the first time since the first quarter of 1993 that it has been above 3 percent. Unlike the second quarter, when rising levels of noncurrent C&I loans were caused by non-U.S. customers, most of the $819 million (3.0 percent) increase in the third quarter occurred in loans to domestic borrowers. Noncurrent C&I loans to non-U.S. borrowers were up by only $42 million (0.7 percent). As has been the case throughout most of the period that troubled C&I loans have been rising, fewer than one out of three commercial banks had an increase in noncurrent C&I loans during the third quarter. However, these banks hold more than 40 percent of the industry's C&I loans. Banks charged-off $4.8 billion in C&I loans during the quarter, $1.5 billion (44.3 percent) more than in the third quarter of 2001. Almost a quarter (23.9 percent) of these charge-offs consisted of loans to non-U.S. C&I borrowers. C&I charge-offs accounted for 41.3 percent of all loans charged-off by commercial banks in the quarter.

Loss Rate On Credit Cards Remains High
Charge-offs of credit card loans totaled $3.9 billion in the third quarter, an increase of $1.0 billion (35.6 percent) compared to a year ago, and $133 million (3.5 percent) more than banks charged-off in the second quarter. The annualized net charge-off rate on credit card loans in the third quarter was 6.05 percent, slightly lower than the 6.08 percent rate in the second quarter, but well above the 5.20 percent rate of a year earlier. This is the fourth consecutive quarter that the loss rate on banks' credit card loans has been above 6 percent, a level never previously reached in any quarter during the 19 years that banks have reported credit card charge-offs. Even with the high level of charge-offs, the amount of credit-card loans that were noncurrent increased by $685 million (13.6 percent) during the quarter. Also, the amount of credit cards that were 30-89 days delinquent on scheduled payments increased by $1.0 billion (15.8 percent). Over the last 12 months, noncurrent credit-card loans have increased by $972 million (20.4 percent), and 30-89 day delinquencies are up by $1.4 billion (22.5 percent). Despite the historically high loss levels, the profitability of credit card lending continued to improve, as net interest margins remained well above the industry average, and income from fees and securitization activities increased.

Growth In Equity Capital And Reserves Lags Growth In Assets, Loans
Equity capital increased by $15.5 billion (2.5 percent) during the quarter, but did not quite keep pace with the growth in banking assets, as the industry's equity-to-assets ratio fell from 9.24 percent to 9.22 percent. This level is only seven basis points below the 60-year high of 9.29 percent reached at the end of the first quarter. Retained earnings contributed $8.0 billion to capital in the third quarter, compared to just $3.8 billion in the third quarter of 2001. Reserves increased by $1.2 billion (1.6 percent), as loss provisions of $12.7 billion exceeded net charge-offs of $11.5 billion. However, strong loan growth caused the ratio of reserves to total loans to decline from 1.87 percent to 1.85 percent. Also, the increase in noncurrent loans caused the industry's "coverage ratio" to decline from $1.28 in reserves for every $1.00 of noncurrent loans, to $1.24, the eleventh consecutive quarter that this ratio has declined. At its peak, in mid-1998, the coverage ratio stood at $1.94.

Mortgage Activity Accounts For Largest Share Of Industry Asset Growth
Commercial bank assets increased by $183 billion (2.7 percent) during the quarter, as mortgage lending activity contributed to growth in banks' loans and securities portfolios. Residential mortgage loans increased by $58.2 billion (7.1 percent), while home equity loans grew by $12.7 billion (6.8 percent). Bank holdings of mortgage-backed securities increased by $33.7 billion (5.1 percent). Together, these assets accounted for 57.3 percent of the increase in commercial bank assets during the quarter. Strong growth was also reported in credit card loans (up $17.3 billion, or 6.9 percent), loans to depository institutions (up $10.3 billion, or 8.1 percent), and real estate construction and development loans (up $7.2 billion, or 3.6 percent). The industry's C&I loans declined for the seventh consecutive quarter, falling by $17.0 billion (1.8 percent), even though a majority of banks (50.8 percent) reported increases in their C&I loans during the quarter. Overall, C&I loans have declined by $130.4 billion (12.4 percent) since the end of 2000.

Money Continues To Flow Into Savings Deposits
Domestic deposits continued to grow very strongly in the third quarter. Deposits in domestic offices of commercial banks grew by $120.7 billion (3.2 percent), led by a $92.0 billion (4.5 percent) increase in savings deposits. Deposits in banks' foreign offices declined by $27.9 billion (4.4 percent). Commercial banks also increased their borrowings from Federal Home Loan Banks by $22.8 billion (10.4 percent). Brokered deposits increased by $12.0 billion (5.1 percent), their largest increase in over a year.

Industry Consolidation Slows In Third Quarter
After declining by 112 institutions in the first six months of 2002, the number of insured commercial banks reporting financial results fell by 35 institutions during the third quarter, from 7,968 to 7,933. There were 23 new charters added, while mergers absorbed 58 banks, and one insured commercial bank failed. During the first six months of the year, mergers absorbed 152 commercial banks. The number of commercial banks on the FDIC's "Problem List" increased from 115 to 126 during the quarter, and total assets of "problem" banks increased from $36 billion to $38 billion.

Table I-A. Selected Indicators, FDIC-Insured Commercial Banks

Table II-A. Aggregate Condition and Income Data, FDIC-Insured Commercial Banks

Table III-A. First Three Quarters 2002, FDIC-Insured Commercial Banks

Table IV-A. Third Quarter 2002, FDIC-Insured Commercial Banks

Table V-A. Loan Performance, FDIC-Insured Commercial Banks

Click on a chart image to retrieve the related data points.

Chart 2. Community Bank Margins Improve For Second Consecutive Quarter

Chart 3. Banks' Foreign Operations Are Providing Less Support To Earnings

Chart 4. Loan Losses Remain Concentrated Among Larger Banks

Chart 5. Troubled Commercial Loans Continue To Increase

Chart 6. C&I Loans and Credit Cards Account For Most Of The Industry's Credit Losses

Chart 7. Quarterly Noninterest Income of Insured Commercial Banks

Complete Quarterly Banking Profile: Printer-friendly PDF version, 389 Kb file - PDF Help or Hard Copy

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Last Updated 11/26/2002 fyi@fdic.gov

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