Profits and Balance Sheet Developments at U.S. Commercial Banks in 1999

Federal Reserve Bulletin, June, 2000 by William F. Bassett, Egon Zakrajsek

William F. Bassett and Egon Zakrajsek, of the Board's Division of Monetary Affairs, prepared this article. Thomas C. Allard assisted in developing the database used in this article and was responsible for maintaining it. James E. Cypert, Jr., provided research assistance.

The U.S. commercial banking industry posted record earnings in 1999. The industry's return on assets and return on equity both rose above the already high level of recent years (chart 1).(1) Profitability was concentrated at large banks--particularly among the 100 largest--and was driven upward by a surge in noninterest income and a significant slowdown in the growth of noninterest expense. Other sources of improved profitability were a stabilization of net interest income, which had been weakening in recent years, and lower loan loss provisioning permitted by generally good asset quality. On the negative side, 641 banks lost money in 1999; these institutions accounted for 7.4 percent of all domestic commercial banks in operation last year but for only about 1.5 percent of the industry's assets.

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Components of bank credit and bank deposit liabilities that had been boosted by the financial turmoil of 1998 declined early last year as financial markets calmed. Nonetheless, demand for household and business credit remained strong because of the rapid pace of economic activity. At the end of 1998, long-term private interest rates started to trend up, and from June to November 1999 the Federal Reserve increased the intended level of the federal funds rate three times in 25 basis point increments (chart 2).

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Consolidation within the banking industry slowed significantly in 1999. The net reduction in the number of banks, 195, was only about half the decline in each of the preceding two years. Among the 450 banks that ceased operations last year, 8 failed, and the remaining 442 merged with other banks, were purchased outright, or otherwise changed their charters. Meanwhile, 255 new banks were created--the most in one year since 1987. At the end of 1999, 8,620 banks were in operation, down from 12,728 a decade ago (chart 3). The share of industry assets held by the 100 largest banks moved up just 1/2 percentage point, to 70 percent, after having jumped an average of 4 percentage points per year between 1995 and 1998.

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Consolidation slowed even more dramatically among bank holding companies (BHCs) in 1999, perhaps in part because of the poor performance of their equity prices. The number of mergers between BHCs last year, 211, was the lowest since 1994; and the number of BHCs declined a net of only 27, to 5,953, by year's end. The percentage of BHC assets controlled by the 50 largest organizations remained steady at about 76 percent.

BALANCE SHEET DEVELOPMENTS

The growth of total bank assets slowed from 8.2 percent in 1998 to 5.4 percent in 1999 (table 1). The deceleration was most evident in securities holdings, in large part because, for a significant share of these assets, price declines associated with a rise in interest rates must be marked to market. In addition, core deposit inflows virtually stopped, leading banks to fund asset growth primarily through the issuance of relatively expensive managed liabilities.