Banking Profile Press Briefing Second Quarter 2004
Results for FDIC-Insured Institutions
Thursday, August 26, 2004
Overview After posting a string of five straight quarterly earnings
records, the net income of FDIC-institutions fell slightly in the second
quarter to $31.2 billion (Chart 1).
This was the second most profitable quarter in the history
of the industry.
While net income came in $656 million less than the first
quarter, it was $986 million higher than the quarterly record of a year ago.
Net operating income did set a record of $30.0 billion
during the quarter.
It took a decline of almost a billion dollars in gains on
sales of securities to keep net income from also posting a new high.
Higher noninterest expenses at a few large banks also helped
hold down earnings during the quarter.
Return on assets fell seven basis points to 1.31 percent.
Almost 60 percent of all institutions reported higher
earnings in the quarter, while 55 percent had higher ROAs.
Credit Quality Continued to Improve Loan performance continues to improve, particularly in the
commercial loan portfolios of the largest banks.
There is abundant evidence of financial recovery in the
Corporate profits in the first quarter of this year were 28
percent higher than levels of a year ago.
Default rates on speculative-grade corporate bonds, which
tend to lead loss rates on bank commercial loans, continued to fall through the
second quarter (Chart 2).
These trends helped push total noncurrent loans – that is,
loans past due 90 days or more plus nonaccrual loans – down by $4.2 billion in
More than half of the decline was in loans to commercial
During the last six quarters combined, noncurrent loans have
declined by $17.4 billion, or over 25 percent.
The ratio of noncurrent to total loans fell below 1 percent to
0.89 percent – its lowest level in the 20 years this item has been reported to
the FDIC (Chart 3).
Net loan chargeoffs fell by $600 million to $8.2 billion –
their lowest level in over three years.
This chart shows total "troubled loans" – noncurrent plus
chargeoff -- at their lowest level in over 4 years (Chart 4).
For a sixth consecutive quarter, the industry set aside less
in loss provisions than it charged-off, as large banks continued to reduce
their loss reserves.
Effects of Higher Long-Term Interest Rates A sharp rise in long-term interest rates during the second
quarter had a mixed effect on industry earnings (Chart 5).
The yield on 10-year Treasuries rose some 76 basis points
during the quarter.
This increase in long-term rates contributed to a $25
billion decline in the market value of securities carried on the books of
While this market value decline was not reflected in current
period industry earnings, it does show how sensitive portfolios have become to
changes in interest rates.
Gains realized on the sale of securities in the second
quarter slipped by $954 million to $1.65 billion.
At the same time, higher interest rates contributed to a
$1.7 billion increase in servicing income, as the value of mortgage servicing
Net Interest Margins Remain Tight Net interest margins remained historically tight for the
industry, falling four basis points to 3.64 percent (Chart 6).
The decline in margins was somewhat concentrated at large
institutions, as a slight majority of institutions (52 percent) reported
improved margins in the quarter.
Still, narrow margins remain a bigger problem for small
institutions because they rely more heavily on net interest income.
While historically-low short term interest rates have
clearly hurt margins, it is not entirely clear how they will be affected by the
Federal Reserve's ongoing program to raise rates.
The effect of rising rates on margins will depend on the
strategy followed by each institution.
Growing the loan portfolio will tend to help margins in a
rising rate environment.
The more you depend on core deposits to fund asset growth,
the better able you will be to keep interest expenses in check.
On the other hand, institutions that have had to rely more on
wholesale funding will find themselves more vulnerable to rising interest costs
in this environment.
Finally, concentrations in long-term mortgage-related assets
– which have grown significantly in recent years – will tend to hold down
interest income as rates rise.
Instead, the value of these assets tends to decline in a
rising rate environment, as we saw in the second quarter.
Record Loan Growth Boosted Net Interest Income The industry was able to raise net interest income by $1.7
billion in the second quarter on the strength of record loan growth.
Total loans and leases increased by $234.6 billion, or 4.2
percent (Chart 7).
Strong growth was registered in loans to both households and
Home equity loans increased by $39.3 billion (10.4 percent);
Other 1- to 4-family mortgage loans increased by $70.5 billion
Real estate construction and development loans grew by $14.0
billion (4.9 percent);
Commercial real estate loans increased by $18.4 billion (2.6
C&I loans, which had declined in each of the previous 13
quarters, increased by $16.6 billion (1.8 percent).
We have been anticipating an eventual turnaround in C&I loan growth at some point this year (Chart 8).
We reported earlier this week in the FDIC Outlook that the
fundamentals behind commercial loan demand – that is, business-sector inventory
building, investment spending, and merger activity – are all headed upward.
Today's data confirm that a turnaround in commercial lending
is indeed taking place. Expansion in bank C&I lending is now a matter of
Annual data reported as of June 30 also showed that
commercial loans to small businesses increased by $9 billion from a year ago
Small business loans had shrunk by $3 billion during the
Signs point to a heightened degree of competition among
FDIC-insured institutions to make commercial loans.
This is consistent with both the early stage of the current business
cycle and the improvements we've seen in commercial credit quality.
Mortgage lending has cooled off considerably since the
middle of last year – particularly for refinancing.
But moderation in long-term interest rates has kept
origination volumes higher than we might have expected going into this year.
Home Equity Lending Has Accelerated I would like to draw your attention to the rapid increase we're
seeing in home equity lending.
This chart shows that U.S. homeowners liquidated over $300
billion in owner's equity last year through cash-out refinancing and home
equity borrowing (Chart 10).
While cash-out refinancing appears to be down by more than half
from last year, home equity borrowing continues to grow rapidly.
Home equity loans held by FDIC-insured institutions
increased at an annualized rate of over 40 percent in the second quarter (Chart
Clearly, banks and thrifts are aggressively growing this
area of their portfolios.
They are doing so at a time when interest rates are rising,
debt service ratios are at all-time highs, and home values in many areas have been
rising faster than incomes and inflation.
Home equity loan performance for FDIC-insured institutions remains
very good at present.
But this elevated rate of growth, combined with the
introduction of new and more liberal loan structures, suggest that some homeowners
and some lenders may be assuming higher levels of risk.
Industry analysts are studying these trends, and so are the analysts
here at the FDIC. We expect to publish some of our preliminary findings on
this topic before the end of the year.
Also of Note There were 30 new charters added during the quarter, while 62
institutions were absorbed by mergers and one insured institution failed.
The number of institutions on the FDIC's "Problem List" fell
from 114 to 102 during the quarter, while the assets of "problem" institutions
declined by $4 billion.
The Bank Insurance Fund (BIF) ended the quarter with a
reserve ratio of 1.31 percent, down from 1.32 percent at the end of March.
The reserve ratio of the Savings Association Insurance Fund
(SAIF) also fell slightly, from 1.36 percent to 1.34 percent.
Outlook for Remainder of 2004 Economic fundamentals remain positive for the industry. Rising
oil prices are slowing economic growth at the margin, but this may mean that
interest rates will rise more slowly than originally expected.
In terms of the earnings outlook for the industry, it is unclear
how much more overall loan performance can improve before leveling off.
Declining provision expenses played a major role in the
industry's recent string of earnings records, but this positive factor will at
some point diminish in importance (Chart 12).
Commercial lending is set to assume a greater role in
overall loan growth going forward, while mortgage and home equity loans would
figure to play a smaller role.
Rising rates will continue to have a mixed effect on the
In a rising rate environment, it remains especially important
that institutions recognize and address any interest-rate exposures that are
created by concentrations in long-term mortgage-related assets funded by