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Today we are announcing preliminary earnings for commercial banks for the first quarter of the year, and for the first time in the industry's history quarterly earnings exceeded $20 billion.
As chart one shows in the first three months of the year, commercial banks earned $21.7 billion.
That's 9.6% more than the previous quarterly record of $19.8 billion just one year ago. The driving force behind this performance was net interest income, particularly at large institutions.
The improvement in the large bank margins can be seen in chart two. It's been more than four years since banks had a better net interest margin. In the first quarter the industry's net interest margin rose to 4.19% up from 3.83% at this time last year. The last time the margin was higher was in the third quarter of 1997 when it stood at 4.24%.
Another bright spot was the industry's return on assets. For the quarter, return on assets for all banks was 1.33%, the third highest quarterly return on the assets ever reported. The last time the industry had a return on assets of less than 1% was in 1992.
There are a couple of blemishes on this otherwise rosy picture, however. Earnings would have been even higher but for increased expenses for loan losses and lower market-sensitive revenues. Chart three shows the rising level of loan-loss provisions, and the lower relative contribution of non-interest income as well as a favorable trend in non-interest expenses. Gains on security sales, trading revenues, investment banking income, venture capital revenues and net income from international operations were all lower than a year ago.
In the past, several of these activities actually helped banks achieve record income while their core business functions were not as strong. For the first time in five years loan volume declined in the banking sector. While many banks saw their loans grow in the quarter, declines at large institutions caused industry totals to fall.
For the fifth consecutive quarter, commercial and industrial loans declined. These loans were down $15.5 billion in the quarter and during the five-quarter period C&I loans are down a total of $84.1 billion, or 8%. Other loan categories that registered declines during the first three months of 2002 include residential mortgages, consumer loans and agricultural production loans.
Even though they declined, C&I loans continue to be a concern; you can see the continued increase in non-current C&I loans in chart four, a trend that began back in 1999. Roughly one out of three banks reported an increase in non-current C&I loans during the quarter. At the end of March, 2.61% of banks' C&I loans were non-current, the highest level since the middle of 1993.
Banks saw a tenfold increase in non-current loans to foreign governments and official institutions during the quarter, going from $31 million to $325 million.
Non-current C&I loans accounted for about 75% of the $2.2 billion increase in total non-current loans in the quarter. Net charge-offs were down from the record pace of the fourth quarter of 2001, but charge-offs of C&I loans were up substantially from the year-go levels in the first quarter.
The silver lining in all this is that reserves are keeping pace with non-current loans, and capital remains at historically high levels. The coverage ratio for non-current loans remained at $1.31, $1.31 in reserves for every $1 of non-current loans and the industry's equity to asset ratio rose from 9.09% to 9.30%.
Finally the number of commercial banks on our problem list increased from 95 to 102. The last time we had more than 100 banks on our problem list was year-end 1995. The assets of the banks on the list inched up by $1 billion to $37 billion.
All in all, the banking sector remains strong: record earnings, high capital, adequate reserves and
encouraging signals on core business functions. But there are still those blemishes that the regulators will need to continue to monitor.
I'll be happy to answer questions.
Question: Chairman, banks earn more money on fewer loans. What does that tell you about the state of the banking business and where their money is coming from? And, also, there seems to be an increase in bum loans from the quarter. What does that tell you about the state of the business economy? The first issue, banks are earning more money, and loans have been going down? Thank you.
Answer: That says two or three things. First of all, the margin is better. So, volume is one component of earnings and so is margin, and margin has been very strong. The second issue is that they're controlling expenses, I believe, better than they have in the past, and non-interest income has been an important component. What was the second part of your question?
Question: The number of bum loans has been going up. What does that say about the state of the economy?
Answer: Well, I think it's two things. Number one, I think banks have been quicker to recognize problem loans than they have in the past. And I think that's a very positive approach that the banks have been doing. And they're also providing for those problem loans, as we said in our report, the coverage ratio is keeping pace. In fact, it's increasing its pace along with problem loans.
Question: On the matter of margins, how are banks making more money while making fewer loans? Where is the extra margin coming from?
Answer: Well, I think the extra margin is coming from what their assets are earning -- the spread is wider than it has been in the past. Interest-bearing liabilities, the cost of those has been going down, and the rate on the interest-earning assets has been going down at a less rapid pace.
Question: It's the Fed that keeps lowering interest rates that makes it possible for this to happen?
Answer: It's the margins.
Question: [inaudible] How will the BIF ratio be affected this quarter?
Answer: I'm not sure. I haven't seen those numbers yet, but I think it's another indication of why deposit insurance reform is very important, managing the fund. As I -- managing, as I indicated, I think we're seeing an industry that is strong. Record earnings, increasing capital, lots of diversity and an industry that is recognizing the problems. That doesn't mean that there won't still be problem banks out there.
As you know, the fund, the Bank Insurance Fund is right at that 1.25%. Should we have an increase in deposits at a stronger pace than it has been in the past or we have some institutions that fail, we could dip below the 1.25, and we do not have a choice. We obviously have to assess premiums to the industry. That's the reason why deposit insurance reform is so important that if we had had -- If deposit insurance reform passes as now in the House bill and with some of the considerations in the Senate, we wouldn't have to do that.
Question: What would the effect be on bank earnings as interest rates inch up, as most observers think they will?
Answer: Well, that's an assumption that I'm not sure that all would agree with, but should, in fact, that happen, I think the banking industry is -- will recognize that that's always a probability and a possibility and part of risk management is to make sure that in case we have interest rates that increase, especially at a rapid level, that they have procedures in place that will recognize it. And I don't think -- again, it depends upon the pace -- I don't think we'll see that much of a squeeze on institutions.
Question: Is credit card debt a matter of concern?
Answer: Credit card debt is some concern. Credit card debt, bankruptcies, spending outpacing income -- those are all issues that I think we'll be watching as time goes on.
Question: For bad debt?
Answer: Yes, bankruptcy, bad debt. Again, I think we're spending at a pretty fast pace, and our income needs to keep up with that, and most of that spending is in the form of debt, and so we need to manage the debt. It's something we watch.
Question: [inaudible] Regulators have recently issued Financial Institution Letters advising banks on loan securitizations. Are banks trying to prop these things up or doing things that you guys find to be unsafe and unsound?
Answer: Well, I think we as regulators are always -- that's a particular issue. Securitization is one Issue, and it's really an accounting issue of how banks recognize and how they account for securitizations and those receivables. I think it's perhaps separate from credit card debt out in the marketplace, per se, but as you know, some institutions align their business as subprime credit cards and obviously those call for a greater oversight than those that are not.
Answer: I'm not sure exactly which one you're talking about. John, do you know exactly which one he is referring to? Number two, covenants and another one about trying to prop up securitizations. Maybe capital -- go ahead, John.
This is John Lane with the Division of Supervision. And the two pronouncements, one of them talked about unsafe and unsound covenants and securitization documents, and that was to basically address situations where we may take supervisory actions and those could not become triggers and if they're embedded as covenants in the securitization documents, then we're going to say those are unsafe and unsound. The second had to do with all securitizations and how they are accounted for on particular transactions.
The first one, I forgot about that. That's the one where if certain covenants were out there, such as if an institution goes under enforcement action and triggers the payment, as John said, that's what we spoke to.
Question: Do you think the problems banks have had over the last several quarters with commercial and industrial loans -- has that bottomed out, and it's starting to improve? Or do we still have several quarters where that will be an issue?
Answer: As you know, banks just mirror the economy and depending on what the economy does, I think there's some -- there's really not consensus among economists as we go forward, but clearly I think the industry is in great shape. Lots of capital, record earnings to withstand problems should there be any bump in the road.
Question: [inaudible] Have you seen any signs that difficulties in obtaining disaster insurance since 9-11 have reduced bank lending for large real estate projects?
Answer: You guys? I'm not aware of any pattern that would fit that. I think we've seen a slowing in the rate of growth in construction loans that seems to have more or less followed, you know, the general economy. Again, in specific instances, it's certainly a possibility but we're not aware of that driving the trend. We wouldn't be able to detect that in the data unless there was an abrupt change, and we haven't seen any abrupt changes.
Question: Chairman Powell, how do you make sense out of the fact that you had these great bank earnings in the midst of a recession? It just -- I mean, I see the data, but how would you make sense of it? Is it something like the housing sector that has had unprecedented growth during the recession?
Answer: Well, I think -- I think two or three things. I think bankers have learned from past mistakes. I think there's lots of diversity in the banking industry. I think also some of the high risk credits are outside the banking industry. I believe also that bankers have better control of their expenses than they had in the past. They're more productive. They're reliant more on non-interest income than they have been in the past. So other income besides credit risk. So I think all those are combined together with the margin that we mentioned a moment ago as one that's upbeat.
Question: There were six failures as noted here in the first quarter and there so far haven't been any in the second quarter. I'm sorry. There were six failures, bank failures during the first quarter and there haven't been any so far in the second quarter. That's good. [laughter] Is there -- are we basically past the point? Why were there so many in the first and so far none in the second?
Answer: I'm not sure we know the answer to that. I think they were more or less random events as far as the timing. I think the best indicator we have of a trend is the direction of the problem banks and while it's still going up, you know, the rate of growth has slowed in that regard, so I don't -- you know -- I don't think that the six and -- it's obviously not a trend since we haven't had any since. There's some fraud associated with some of those failures too.
Question: How concerned are you that the problem bank list is over 100?
Answer: I'm not concerned. You know, it's something we watch. But going forward we don't want it to increase. But I don't think it's a big concern. You look at the last recession: Coming out of the last recession, we had over a thousand banks on the problem list. In comparison, 100 looks relatively mild.
Question: One last question.
Answer: One last question. You bet.
Question: I'll ask you about deposit insurance reform.
Answer: I'm for it. [laughter]
Question: It's passed the House. Have you had conversations with Senator Sarbanes or are you aware of progress that's been made in the Senate?
Answer: We're beginning to visit with Senator Sarbanes' staff, encouraging him to move that bill forward, and I'm optimistic that his leadership will prevail and we'll hopefully have a mark-up on the bill relatively soon. It's good public policy.
Question: Just a follow-up on that. Does he support indexing deposit insurance, because he hasn't made any public statements as to whether he supports increasing or indexing it.
Answer: He hasn't shared with me any more information on that.
Question: Did you have any chats with Senator Gramm about deposit insurance?
Answer: Yes, I have.
Question: Do you think -- a lot of people seem to think he is the main obstacle for it being passed in the Senate. Do you agree with that?
Answer: Senator Gramm is a smart, courageous man. Yes, I read the same thing. He has mentioned to me his concerns about coverage, but I also believe that Senator Gramm recognizes good public policy. I think most of this bill -- it's more than coverage. It's got lots of good stuff in it -- that I'm confident that Senator Gramm will support.
Okay. Thank you.
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