Gains on the sale of securities keep second-quarter earnings virtually unchanged at $1.7 billion.
Earnings remain strong despite a $252 million decline in net interest income.
Asset quality improved slightly after several quarters of deterioration.
Source: SNL Data Source
Source: SNL Data Source
Economic Conditions Continue to Favor Mortgage Lenders
Since the onset of recession in early 2001,
economic conditions have been less than ideal for many households,
businesses, and commercial lenders. Job losses and business
bankruptcies have pushed loss rates higher on consumer and business
loans alike. However, due to a combination of generally favorable trends, the economic climate has been supportive of high earnings for the nation's 10 largest thrift companies (hereafter, the "10 Largest"), which specialize in mortgage lending.
The most positive factors have been the decline in short-term interest rates and the steepening of the yield curve. The Federal Reserve cut interest rates a record 11 times in 2001, lowering the federal funds rate from 6.50 percent in early January 2001 to 1.75 percent by year-end. In response, the median cost of funds (COF) for the nation's thrift institutions has also fallen. In the 12 months ending in May 2002 the COF fell by 152 basis points to just 3.38 percent-the lowest level in the 22-year history of this series.1
Meanwhile, long-term interest rates have been declining in a much less pronounced fashion. The Freddie Mac Contract Rate for conventional, 30-year mortgages, which stood at 7.38 percent in December 2000, has fluctuated between 22 and 89 basis points below that level during the last 19 months. More important than the amount of their decline, however, is the fact that long-term mortgage rates have been bouncing around near their lowest levels in 30 years. This has prompted recurring waves of mortgage refinancing during both 2001 and thus far in 2002.
The interest-rate environment has affected savings institutions' earnings in several ways. Earnings were reduced by lower values for mortgage servicing rights caused by prepayments of existing mortgages. Earnings benefited from declining rates that lifted the values of fixed-rate securities and the refinancing activity stimulated fee-producing origination volume.
Earnings for the 10 Largest rose slightly in the second quarter.
Amid these generally favorable conditions, second-quarter earnings for the 10 Largest rose to $1.7 billion, a $24 million increase from first-quarter earnings. Within the group, 7 companies reported higher earnings during the quarter while 3 reported lower earnings. The weighted average return on assets (ROA) was 1.34 percent, up from 1.27 percent in the first quarter. On the basis of ROA, 6 companies showed improved profitability over first-quarter results, while 4 showed a decline.
The most important factor that boosted second quarter earnings was the gains recognized on the sales of securities. Gains on sales of securities were $183 million in the second quarter, up from losses of $259 million last quarter. These represent a $441-million swing in earnings from the first quarter.
Net interest income declined $252 million, or 6 percent, from the first quarter. While 6 companies reported increases in net interest income, the remaining 4 companies reported declines that offset these improvements. The largest decline was $296 million at Washington Mutual Inc. Noninterest income fell $169 million (11 percent) as 7 companies received less from noninterest sources. Operating expenses increased by $78 million (3 percent) as 7 companies reported higher expenses.
Second quarter results for the 10 Largest appeared much stronger when compared to the second quarter of 2001 because of falling interest rates. Earnings were 20 percent higher than a year ago, while the ROA of 1.34 percent was an 11 basis point improvement. Of the 10 Largest, 8 reported higher earnings in dollar terms than a year ago, while earnings for the other 2 declined for some specific reasons. Golden State Bancorp Inc. reported a year-over-year decline in earnings because of a provision taken against the declining value of its mortgage servicing rights this quarter. On the other hand, People's Bank failed to match last year's earnings largely because of one-time gains from the sale of a credit card operation that occurred last year.
Persistently low long-term interest rates take a toll on net interest margins, which declined in the second quarter.
Long-term interest rates have remained low since the end of 2000 and the refinancing activity generated by this environment has taken its toll on average asset yields at the 10 Largest. Long-term interest rates have remained in a 67-basis-point range since the end of 2000. Mortgage refinancings have replaced many higher-rate or adjustable-rate mortgages in thrifts' portfolios with lower-yielding fixed-rate mortgages. The net interest margin of the 10 Largest as a group declined by 16 basis points to a still-healthy 3.31 percent. Only 3 of the 10 Largest reported higher net interest margins during the quarter.
Loan origination volume remained strong in the second quarter.
Since the onset of recession in early 2001, the volume of mortgage loans held by all lenders has increased dramatically. The total mortgage indebtedness of U.S. households increased by $525 billion in the 12 months ending in March 2002, helped by low interest rates, strong home sales, and a golden opportunity to refinance mortgage debt and consolidate other debt into home loans. The weekly volume of mortgage originations during 2001 and 2002 has averaged a level that is approximately 2.4 times the average weekly level for 1991 through 2000, a period that includes previous refinancing booms in both 1993 and 1998.2
The 10 Largest have been active participants in the recent wave of mortgage originations. There were 6 companies out of the 10 Largest that reported total loan originations with a volume of $56.1 billion for the second quarter. For the same set of companies, the origination volume hit a peak of $57.8 billion in the first quarter. Year-ago volume was just $44.0 billion for these companies.
Hedging activities limited the effect that falling valuations for mortgage servicing rights have had on noninterest income.
Strong loan originations have boosted fee income even as the prepayments associated with refinancing have reduced the value of mortgage servicing rights (MSRs). Even so, several of the 10 Largest have mitigated their losses on MSRs through hedging activities. These trends produced lower mortgage servicing revenues at 4 of the 10 Largest. Golden West Financial simply stated that mortgage banking revenues were down, while the other three companies reported taking provision expenses for the reduced value of their MSRs. These charges amounted to $1.2 billion.
Hedging gains that offset the falling value of MSRs were reported in two places on the income statement: noninterest income and gains on the sales of securities. Commercial Federal Financial reported the smallest charge, at $16.6 million, which was partially offset by a hedging strategy that included the sale of securities at a gain. Golden State Bancorp Inc. took a $100 million charge for MSRs. Washington Mutual Inc. took the largest charge, of $1.1 billion, but this was partially offset by a hedging strategy that included gains from derivatives contracts. These gains were included in noninterest income and helped limit the decline in the group's noninterest income to $169 million.
Noninterest expenses increased 3 percent as efficiency ratios worsened.
Noninterest expenses rose by $77 million, to $2.6 billion. This increase, combined with the fall in revenue, led to a worsening efficiency ratio.3 Operating expenses amounted to 48.3 percent of net operating revenue, up from 43.5 percent last quarter. There were 6 companies that reported worsening efficiency ratios during the second quarter.
Asset quality improved after several consecutive quarters of deterioration for the 10 Largest.
Nonperforming assets fell in the second quarter by $239 million to $3.9 billion or 0.78 percent of assets. This was an improvement over the first quarter when nonperforming assets were 0.81 percent of assets for the group. The median ratio of nonperforming assets to assets was just 0.52 percent because a few large companies have higher proportions of troubled loans. A year ago, nonperforming assets were just $2.8 billion or 0.60 percent of assets, while the median ratio for these companies was very similar at 0.53 percent. The improvement in asset quality allowed the 10 Largest to reduce provision expenses by $47 million, to $220 million. Net charge-offs also fell, by $9 million, to $180 million or an annualized 0.23 percent of average loans. Net charge-offs were 0.25 percent of average loans in the first quarter and 0.20 percent a year ago. Since provisions exceeded net charge-offs, reserves rose $36 million to $3.2 billion.
Assets of the 10 Largest fell mainly because of the sale of securities by one company.
Assets of the 10 largest thrift companies fell $11 billion, even though a majority of companies reported increases. Washington Mutual Inc. sold $8.9 billion in securities during the quarter. Deposits grew by $1.8 billion as several companies reported marketing efforts to attract new deposit accounts. Only 3 companies reported declines in deposits. Loan growth remained strong at an annualized rate of 5.1 percent for the second quarter with 7 companies reporting higher loan balances.
A financial holding company
announced its intention to purchase the third largest thrift company
in a deal that is expected to close in the fourth quarter of this
Citigroup, Inc. announced plans to purchase Golden State Bancorp Inc. ($51.9 billion in assets) by the end of the year for $5.8 billion. This would nearly triple the savings institution industry assets held by Citigroup, Inc., which already owns Citibank FSB ($31.9 billion in assets). Charter One Financial, which had been the fourth largest company, ($38.2 billion in assets) converted to a commercial bank charter during the second quarter as expected.
The market capitalization of the 10 Largest increased by $7.5 billion (12 percent) in the second quarter.
In line with rising earnings and a generally favorable operating environment, the stock price of all 10 companies increased during the quarter. This compares to a decline of almost 14 percent in the S&P 500 composite index during the quarter.
Equity capital rose $2 billion to $37 billion or 7.32 percent of assets. For the 6 companies that reported a tier 1 leverage ratio at the beginning and the end of the quarter, the unweighted average held steady at 7.09 percent.
Current economic trends appear to point to more of the same in the third quarter of 2002. With the Freddie Mac Contract Mortgage Rate falling in July to 6.49 percent-the lowest level in its 31-year history-the refinancing boom appears to be gathering momentum in the third quarter. Meanwhile, mixed signals about the pace of the apparent economic recovery give no indication that short-term rates will rise dramatically in the near term, which implies that net interest margins should also remain strong during the third quarter.
* * * * *
The FDIC has assembled information from public data releases compiled by SNL DataSource for the 10 largest thrift companies to obtain an early look at the performance of these firms. Highlights are summarized in the narrative. In addition, attached tables contain financial data for each of the 10 largest thrifts. Summary indicators for the group are presented on page 9.
This report only includes organizations primarily involved in lending permitted by a thrift charter for which timely information is available. The thrift subsidiaries of these 10 companies hold approximately 39 percent of the savings institution industry's total assets. Excluded from this report are: thrifts owned by bank holding companies that are primarily commercial bank operations, thrifts owned by financial service companies, and thrifts owned by manufacturers.
Notes to Readers
The Division of Insurance and Research prepared this report. In addition to providing details on the performance of individual companies, the aggregate results provide an early indication of the savings institution industry's overall performance in the most recent quarter.
The report is based on publicly available information obtained via SNL Securities' DataSource4 , as well as press releases and media accounts. Geri Bonebrake provided design expertise and Chau Nguyen assisted with technical details.
The report covers the 10 largest thrift companies for which timely quarterly results are available. FDIC-insured savings institutions operated by these companies comprise 39 percent of the savings institution industry's total assets. Large savings institutions owned by bank holding companies that are primarily commercial bank operations are not covered here -- see the Twenty-Five Largest Banking Companies' report. Large savings institutions owned by companies with large commercial operations as their primary focus were also excluded from this report. Large thrifts owned by financial services companies where brokerage or insurance activities predominate were also excluded. Any large privately held thrift was excluded because earnings reports were not available.
The earnings announcements on which this report is based are preliminary, and companies have some flexibility as to content and format not available to them in later, more detailed regulatory filings with the SEC and the banking agencies.
Prior Period Comparisons:
Caution should be exercised when comparing results between different time periods because acquisitions or accounting changes may distort comparability. Efforts have been made to adjust prior periods appropriately, when possible.
Use of the information in this report is subject to the following disclaimers.
The views expressed herein are those of the authors and may not reflect the official positions of the FDIC. The FDIC does not endorse any of the financial institutions discussed in this report for any purpose.
The FDIC has taken reasonable measures to ensure that the information and data presented in this report is accurate and current. However, the FDIC makes no express or implied warranty regarding such information or data, and hereby expressly disclaims all legal liability and responsibility to persons or entities who use this report, based on their reliance on any information or data that is available in this report.
The content of this report is not designed or intended to provide authoritative financial, accounting, investment, legal, regulatory or other professional advice which may be reasonably relied on by its readers. If expert assistance in these areas is required, the service of qualified professionals should be sought.
Reference to any specific commercial product, process, or service by trade name, trademark, manufacture, or otherwise does not constitute an endorsement, a recommendation, or a favoring by the FDIC or the United States government.
This general disclaimer is in addition to, and not in lieu of, any other disclaimers found in this report. In addition, the terms of this disclaimer extend to the FDIC, its directors, officers and employees.
Financial information appearing in this report was acquired from SNL Securities, Inc., Charlottesville, Virginia. The following definitions are listed in the order in which they appear in this report.
The sum of nonaccrual, renegotiated and loans and leases acquired through foreclosure. (Delinquent loans and leases still accruing are excluded.)
Total loans and leases removed from the balance sheet due to their uncollectability minus amounts recovered on loans and leases previously charged-off.
Return on assets
Annualized net income (including gains or losses on securities and extraordinary items) expressed as a percentage of average total assets.
Annualized income before income taxes and extraordinary items minus the after-tax portion (the assumed tax rate is 35 percent) of gains on sale of investment securities and nonrecurring income items as a percentage of average total assets.
Return on equity
Annualized net income (including gains or losses on securities and extraordinary items) as a percentage of average total equity capital.
Net interest margin
The annualized difference between taxable-equivalent interest and dividends earned on interest-bearing assets and interest paid to depositors and other creditors, expressed as a percentage of average interest-bearing assets.
Noninterest expense minus foreclosed property expense minus amortization of intangibles, expressed as a percentage of the sum of net interest income plus noninterest income. This ratio measures the proportion of net operating revenues absorbed by overhead expenses -- the lower the ratio the greater the operating efficiency of the institution.
Loan growth rate
The annualized change in total loans and leases (net of unearned income and gross of reserves) from the previous quarter, expressed as a percentage of total loans and leases at the end of the previous quarter.
NPAs / assets
Nonperforming assets expressed as a percentage of total assets for the current quarter.
NCOs / average loans
Annualized net charge-offs expressed as a percentage of average total loans and leases.
Tier 1 capital**
Common equity capital, plus noncumulative perpetual preferred stock, plus minority interests in consolidated subsidiaries, minus goodwill and other ineligible intangible assets. (The amount of eligible intangible assets included in Tier 1 capital is limited in accordance with supervisory capital regulations.)
Tier 1 leverage ratio
Tier 1 capital expressed as a percentage of average tangible assets (total assets minus intangible assets).
This figure is derived from the amounts of both on-balance and off-balance assets that institutions report in the various risk-weight buckets (0%, 20%, 50%, 100% or 200%) of call report Schedule RC-R. The consolidated amount is the product of the sums in the various categories multiplied by their respective risk weights.
Tier 1 RBC ratio
Tier 1 capital expressed as a percentage of risk-based assets.
Tier 2 capital**
The sum of allowable subordinated debt and limited life instruments (discounted by their years to maturity), plus cumulative preferred stock, plus mandatory convertible debt, plus loan reserves (limited to 1.25% of gross risk-weighted assets). (Tier 2 capital cannot exceed Tier 1 capital.)
Tier 3 capital**
The amount of regulatory capital required to offset market risk of the company.
Total RBC ratio
The sum of Tier 1, Tier 2 and Tier 3 capital expressed as a percentage of risk-based assets.
Market cap. ($ millions)
The market value of the company's stock, derived by multiplying the stock price by the number of shares outstanding at the end of the period.
* This document is based on publicly available information provided by the companies it covers. It is intended for informational purposes only. It does not represent official policy or supervisory guidance from the FDIC.
** Denotes items which do not appear in the Top Ten Thrift Companies, but are parts of some of the report's ratios.
1 The national median cost of funds ratio for SAIF insured institutions from the Office of Thrift Supervision.
2 Mortgage Bankers Association of America, Weekly Volume Index of Mortgage Applications.
3Noninterest expense minus foreclosed property expense minus amortization of intangibles, expressed as a percentage of the sum of net interest income plus noninterest income.
Data excerpted from SNL DataSource is subject to copyright and trade secret protection and may not be reproduced or redistributed without license from SNL Securities LC.