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Quarterly Banking Profile

Unedited Transcript of February 28 Webcast

Good morning. My name is Don Powell. Welcome each of you to this press conference and today we are announcing preliminary earnings for the fourth quarter of 2001 and for the entire year of 2000.

The good news is commercial banks had a record fourth quarter earnings of $19 billion.

Record annual earnings of $74.6 billion, and that is $3.5 billion more than the previous record of $71.1 billion in 1999.

Nearly half of all the banks reported higher earnings last year than in 2000, which is quite an accomplishment considering the broader economy.

Chart Two -- Sharply lower funding costs helped the industry deliver its record performance, as you can see. As this chart shows, net interest margins shot up at larger asset banks, with assets more than $1 billion, being the red line, and net interest margin at smaller institutions improved as well, that being the blue line.

All of that is very good news.

The news is not necessarily all good news. Looking, again, back at chart one, the industry -- when you look at the industry more closely, you'll see that the record for 2001 was made possible only by a $4.5 billion gain in securities -- in the sale of securities. And, in fact, net operating income, which excludes these gains and other nonrecurring items, was 1.2% lower in 2001 than in the year 2000, or $830 million lower. And without these gains, fourth quarter earnings last year would have been about equal to the fourth quarter earnings in 1999, when such gains played almost no role.

Earnings from core banking operations have somewhat dipped. As we discussed yesterday in our publication FYI, asset quality continues to deteriorate.

Today, I want to stress that concerns about these problems continue to grow. As revealed in chart three, the provision for loan losses in 2001 increased more than at anytime in the past 12 years. Growing from $30 billion in 2000 to $43 billion. Net charge-offs reached an all-time high for the year. Net charge-offs increased 43% from a year ago. At $12.7 billion, they were the highest total quarterly reported by the industry. Charge-offs in commercial and industrial loans accounted for almost half that record. As this chart shows, C & I charge-offs totaled $6 billion, up dramatically from the third quarter.

Even with this dramatic increase, non-current loans continue to rise as well and together this came to almost $30 billion in the fourth quarter. That compares to the low of $7.4 billion recorded in the first quarter of 1997.

Chart Four -- Most of the problems in the C & I lending remain in large banks. Larger banks have experienced a faster decline in asset quality than smaller banks have. In the fourth quarter, troubled C & I loans at larger banks rocketed from 2.6% to 3.18%, that being the red line. The deterioration at smaller banks, the blue line, has been more recent and more gradual.

Banks are recognizing asset quality problems as the figures for loan losses show. And for the first time in eight quarters, loss reserves are keeping pace with their non-current loans. But problem loans are still growing. And if you were to look at the industry figures as if they were returns from one bank, you could conclude asset quality may even be more of a problem in the near future. Chart Six reveals some of this, some of this information.

I really want to make one more point. As this chart shows, there is significant increase in the number of banks on our problem list in the fourth quarter. And in their total assets. The 21 banks going on the list was the largest quarterly increase in problem banks since the third quarter of 1991. And the $22 billion increase in problem bank assets was the largest increase since the fourth quarter of that same year. Last time we had $36 billion in problem loan assets was in 1994.

To sum up our presentation: Today, the banking industry in 2001, again, enjoyed record earnings. Capital levels remain high, and the industry remained strong. But, yes, there are some concerns. The makeup of earnings, the decline in asset quality, the increase in troubled institutions, and these concerns continue to grow.

With me today are two of the analysts who produced the preliminary bank earnings report, Ross Waldrop and Don Inscoe, and we will be happy to accept any questions.

Yes, sir?

A couple of days ago, the National Association of Manufacturers released a study that indicated that pressure by the federal bank regulators is effectively choking off credit, especially to smaller businesses and may even be wiping out the benefits of the interest rate cuts. Can you speak to that problem? Are federal bank regulators putting a lot of pressure on banks across the board to cut the credit ratings of businesses?

No, I don't think that's the case. Regulators review assets, loans, and condition of the bank and also the condition of the economy. I think credit is available to small businesses and to small borrowers. Credit quality problems or real problem assets are concentrated in these larger institutions. I think what we also pointed out, there are some signs of deterioration of asset quality in the smaller institutions. But, again, I think that credit is available to smaller businesses and to individuals.


The number of total assets in problem banks grew -- I mean, nearly tripled, just doing core math. Umm, how can you -- has the FDIC's criteria for what's considered a problem bank changed, or is this -- how do we account for that amount of growth?

The FDIC gathers data from all the banking regulators, Federal Reserve, OTS, OCC. And so this is a summary of those. The FDIC is obviously part of that. But I think it's a reflection of the fact what these examiners have found and the criteria has not changed. Problem banks are designated as 4 and 5 rated.

How do you account for the decline, then? I mean, what are banks getting into that are causing them to decline in camels ratings?

I think it's a combination of several things. Banks are a reflection of the economy. If the economy has some dips and slowness in it, there's going to be some problem in some assets that the banks have on their books. But, again, overall, the industry is very solid. We've talked about record earnings, strong capital. When you look at capital and reserves and earnings, compared to 10 years ago, there's a dramatic difference. Capital ratios are much stronger, earnings are much stronger, and, as I mentioned a moment ago, I think banks are recognizing those problems and making larger provisions to the loan loss reserve. In fact, I said that pace is equal now, providing the same relationship to loan loss reserve as problems of assets are going up. The coverage is larger than it has been in the past. The coverage being dollar coverage in loan loss reserves to problem assets. Correct me, guys, if that's not true.

No, that's true.

Are there any particular types of institutions that are encountering these -- going down in the ratings, large credit card banks, other community banks? I mean, this seems to be larger banks, since the number only grew by 21.

I think, as we indicated, that there is some credit deterioration in the larger institutions, but there's signs in the smaller institutions there has been some deterioration. Individual consumer loans, credit card loans. You know, bankruptcies I think are at an all-time high and that reflects in the bankruptcy also.

How worried are you about this going forward? You say the industry's in good shape, record earnings. Do you expect the problem bank list to grow even further?

I would hope we grow in other ways. There is some cause for concern, but I think when you look at the overall banking industry, capital ratios are very high and earnings are at record highs. And the banks are recognizing the problems. Clearly, there's some weaknesses in the system. But when you have problem banks increase at that rate, that's not good.

Yes, sir?

Are there any banks among the top largest 20 on that list?

Well, that is asset-size-wise, they wouldn't fit in that list, I think is the short answer.

What would be the -- what would be the largest bank that would be there?

I don't think we want to go there -- give you the first initial or anything like that.

You can't tell me what would be the asset size of the largest bank on that list?

No. We're statisticians, we're looking at aggregate data when constructing our charts. For perspective, if you look at the last recession ten years ago, at this stage, you're in '91, there are over 1,000 banks on the problem list. I don't know off the top of my head what the problem bank assets were, but I think in excess of $100 billion on that. But I think things are better now. I think we point out, it really doesn't change much, in excess of 95% of all insured commercial banks are in the highest capital category. I think in terms of perspective, we're still talking about outliers.

Another question. Yes, ma'am?

For Mr. Powell: You say credit's available. But there's growing concerns about a credit crunch. The Fed's survey shows they are tightening credit standards for banks. I wonder, when do you get to the point, when do you establish that, yes, we're in a credit crunch. What are the signs you look out for?

I'm sorry, I didn't get the question. Did you guys get the question? It was slurred.

Can you hear me now?

I can hear you, but I can't distinguish what you're saying.

The question is this -- you say credit is available.


Although Fed's surveys show that credit has been tightening, there are more concerns we could be approaching a credit crunch. I'm wondering, a, do you think we are in a credit crunch? What kind of issues would you be looking for to see -- that would establish that we are, in fact, in one?

I do not think we are in a credit crunch. What criteria would I view that would tell me that we're in a credit crunch? Probably several factors. Low deposit ratio, funding availability within institutions, expansion of credit, all those would be factors.

Why don't you think we're in a credit crunch now? What are the factors that you think determine we're not in one currently?

I think there's money available, willing institutions that are ready to loan money, money's available. Interest rates are at an all-time -- lower than they have been in the last 30 years. We just recently put out an analysis of, you know, broader credit availability. We also have looked at a considerable amount of data. One of the things that was noteworthy to me was that the fourth quarter was the fifth quarter in a row in which funding outstripped loan growth. At the same time, we're not seeing that loan commitments are being drawn down either. I think there's some broader evidence in the data that credit is available.

Can you guys talk about the deposit growth during the fourth quarter? It seems to have been another quarterly record, it looks like, domestic savings deposit. What does that mean for the industry and the bank insurance fund ratio? Normally, the fourth quarter deposits do rise. You guys got the specific information there.

A lot of the data fits with our priors. For example, savings deposits are up fairly strongly, and time deposits are down. We think the story on time deposits is that with low rates, people don't want to lock in so they move over into savings deposits. Also, in the fourth quarter, demand deposits were up, which is a volatile number. If you look at the overall level of deposits, you have to look inside the individual accounts. I think it's good news for banks. It means that pressure's off the funding side of their balance sheets.

Can you speak a little more specifically about the loan commitment data and what you're seeing for the fourth quarter or what are the trends?

Well, we track loan commitments against outstandings in an aggregate way. What we look for when we track that information is bumps up in the percentage of commitments actually being used. And we have seen -- I guess over, about, three quarters, a very slight decline, which means that commitments are growing faster than loans are being used or shrinking slower than loans are shrinking. And we especially look at the C & I component of that. C & I loan commitments are different than other type of loan commitments. Some commitments to build a building are always used. C & I loan commitments often serve as backup sources of credit. And the C & I is following about the same pattern that any of the other categories are following. We've got more data than you could possibly want on this. If you want to talk to us after the news conference.


Deposit insurance reform question: Two bills have been introduced, one in the House, one in the Senate. I know the FDIC -- includes a lot of the FDIC recommendations. Is there anything in either bill that concerns the FDIC or you guys would like to see changed? Or generally happy with both of them?

I think we continue to analyze those bills, Rob. Broadly speaking, I think we're pleased with the legislation that has been introduced. We're more than happy to work with Congress and we'll be working with Congress to offer any of our thoughts or listen to them as they come forth with new thoughts and ideas. Deposit insurance reform is very important, we believe, and it's something we hope the Congress will pass this year.

Yes, sir?

A lot's been reported about Fannie Mae and Freddie Mac and their positions and derivatives. Some people mention Chase Manhattan, JP Morgan. Chase is a large position in derivatives. Is this an issue for the FDIC? Is there any concern? Are you looking at the issue at all, or do you think this is a non-issue at this time?

We only would concern ourselves as relationship to insured institutions, Fannie Mae and Freddie Mac are not. It's an issue that, along with many other issues we look at. But we don't think that there is any cause for concern within the industry as it relates to derivatives.

Yes, Rob?

One more for you. As you know, a lot of data has come out recently, both from the OMB and admissions from the FTIC that the BIF fund seems to be heading closer to 1.25, a lot of people think it's going to break it before the end of the year. How do you think banks will adjust after most of them have not paid premiums in something like five or six years? How do you see that playing out?

You're making an assumption that assessments will be forthcoming. That's a dynamic process. As you know, we're meeting the FDIC board tomorrow, we have a case to address that particular issue. I'd rather not comment on that today because, in fact, it's an agenda item for tomorrow.

Any other questions?

Thank you very much for coming. -- Thank you for coming.

Last Updated 02/28/2002 Questions, Suggestions & Requests

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