Profits and balance sheet developments at U.S. commercial banks in 2001

Federal Reserve Bulletin, June, 2002 by William F. Bassett, Mark Carlson

Despite the economic slowdown in 2001, the profitability of the U.S. commercial banking industry remained high (chart 1). The weak economy contributed to a sharp rise in provisions for loan and lease losses, as did, in the fourth quarter, the collapse of Enron and the economic turmoil in Argentina. However, the rise in provisioning was offset in large part by realized gains on investment account securities; these gains developed as banks' portfolios benefited from declining short- and intermediate-term market interest rates (chart 2). Profitability was also supported by reductions in noninterest costs and by a small rise in net interest income.

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In response to the slowing economy, the Federal Reserve eased policy eleven times last year and short-term interest rates moved down considerably. During the first half of 2001, interest rates on residential mortgages remained well below the average for 2000, and their further decline during the third quarter of last year significantly boosted an already high level of refinancing activity in that market. Investment-grade corporate bond yields also fell well below their average level in 2000 and prompted an increased volume of corporate bond issuance. Favorable conditions in the corporate bond market led to a substantial paydown of commercial paper last year; however, a considerable number of corporate debt downgrades and investors' increased aversion to risk also contributed to the runoff. The terrorist attacks and revelations of corporate accounting irregularities also heightened investors' perceptions of risk last year, and yields on below-investment-grade corporate bonds rose throughout much of the year and were somewhat volatile.

Aside from loan losses, the economic slowdown and changes in market interest rates had a number of other effects on banks' balance sheets last year. Lower short-term interest rates spurred a sharp increase in core deposits, which provided banks with plentiful, low-interest-rate funding, even as their asset growth slowed between 2000 and 2001. Loan growth was restrained, largely because of reduced demand for commercial and industrial loans associated with the sluggish economy and a paydown of such obligations with the proceeds of bond issuance. However, a strong residential real estate sector continued to generate substantial credit demands, which banks helped meet both by direct lending and by accelerating acquisitions of mortgage-backed securities. Substantial retained earnings and the increased share of government agency securities (which have lower capital charges than loans) in banks' portfolios contributed to an increase in risk-based capital ratios.

According to the FDIC, four banks failed and required government assistance to dispose of their insured deposits and assets last year, down from seven in 2000. Although the amount of assets held at the time of failure, $1.8 billion, was a tiny percentage of total industry assets, it was more than four times greater than the previous year. The number of commercial banks that merged, were bought outright, or otherwise changed their charters fell from 475 in 2000 to 376 in 2001. Meanwhile, 149 new banks were created in 2001, down from 217 in 2000 and the fewest since 1995. The result was a reduction in the number of commercial banks operating in the United States, to 8,129 as of December 31, 2001 (chart 3). (1) Mergers between Chase Manhattan and Morgan Guaranty and between U.S. Bank and Firstar Bank enlarged the share of bank assets held by the 10 largest commercial banks from 38 percent in 2000 to 40 percent in 2001. However, the share of assets held by the 100 largest banks edged up only slightly, to 73 percent.

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The number of mergers between bank holding companies (BHCs) declined from 180 in 2000 to 155 in 2001, and the share of banking and nonbanking assets held by the top 50 BHCs ticked up, to almost 78 percent last year. However, newly created BHCs pushed up the total number of BHCs by 11 over the year, to 5,943. Finally, the number of BHCs that have acquired financial holding company status, which increases the scope of their allowed activities under the Gramm-Leach-Bliley Act, rose to 672 in 2001 from 552 at the end of 2000.

BALANCE SHEET DEVELOPMENTS

Total bank assets grew 5.2 percent in 2001, down from 8.7 percent in 2000 but about equal to the pace in 1999 (table 1). The slowdown was caused entirely by a deceleration in the growth of total loans and leases to 1.8 percent, a level well below the average of 8.7 percent over the past two years. Acquisitions of mortgage-backed securities boosted growth in securities held, even as U.S. Treasury securities on bank balance sheets continued to run off.

The expansion of total loans and leases was not spread evenly across types of loans. Commercial and industrial lending contracted over the course of the year, as banks' lending standards tightened and demand for short-term credit declined. Real estate lending, both commercial and residential, continued to grow smartly with the support of falling interest rates. Some slowing in consumer borrowing and an increase in securitizations held down growth of consumer loans on banks' balance sheets.