Profits and balance sheet developments at U.S. commercial banks in 1996 - includes related articles on consolidation of commercial banks, credit card banks

Federal Reserve Bulletin, June, 1997 by William R. Nelson, Ann L. Owen

U.S. commercial banks had another very good year in 1996. Profits posted strong growth, preserving the high levels of return on equity and return on assets that have prevailed over the past four years (chart 1). Helping to boost profits were continued strong growth of interest-earning assets, a slight widening of the net interest margin, significant gains in noninterest income, and continued containment of noninterest expense (table 1). Return on assets edged up despite a slight increase in provisioning for loan and lease losses relative to assets. Delinquency and charge-off rates stayed low for business loans but climbed throughout the year for consumer loans.(1)

[Chart 1 ILLUSTRATION OMITTED]

1. Selected income and expense item

Percentage of average net consolidated assets

Item                             1991   1992   1993   1994   1995

Net interest income              3.61   3.90   3.90   3.79   3.73
Noninterest income               1.79   1.95   2.13   2.00   2.02
Noninterest expense              3.73   3.87   3.94   3.76   3.65
Loss Provisioning                1.03    .78    .47    .28    .30
Realized gains on investment
    account securities            .09    .11    .09   -.01    .01
  Income before taxes and
    extraordinary items           .73   1.32   1.70   1.74   1.81

Taxes and extraordinary items     .22    .41    .50    .58    .63
 Net income (return on assets)    .51    .91   1.20   1.15   1.18

Dividends                         .45    .41    .62    .73    .75

Retained income                   .07    .50    .59    .42    .43

                                              Annual average
Item                             1996                       Change,
                                        1985-92   1993-96   1985-92
                                                              to
                                                            1993-96

Net interest income              3.76   3.55      3.79        .24
Noninterest income               2.19   1.56      2.08        .52
Noninterest expense              3.73   3.47      3.77        .30
Loss Provisioning                 .38    .90       .36       -.54
Realized gains on investment
  account securities              .03    .06       .03       -.03
  Income before taxes and
    extraordinary items          1.86    .81      1.78        .97

Taxes and extraordinary items     .65    .25       .59        .34
 Net income (return on assets)   1.21    .56      1.19        .63

Dividends                         .91    .40       .75        .35

Retained income                   .29    .16       .43        .27

Capital

The share of their assets that banks funded with capital was about the same in 1996 as it was in 1995. As a result, the leverage ratio remained basically unchanged last year, on net, although risk-based capital ratios (tier 1 and total) declined slightly (chart 9).(7) The risk-based capital measures have fallen a bit over the past two years because of the relatively more rapid growth of loans, which carry higher risk weights than do securities.(8) Despite the decline in industry-average capital ratios, the fraction of bank assets at well-capitalized banks--those with sound capital ratios and positive examiner ratings--increased again last year, crowding still closer to 100 percent.

[Chart 9 ILLUSTRATION OMITTED]

Banks boosted their equity last year even though they significantly increased the share of income they paid out as dividends. This high payout by banks contributed to generous distributions by bank holding companies. The top fifty bank holding companies increased their dividends about 20 percent. Furthermore, net expenditures on stock repurchases by these companies grew more than 50 percent last year and approached four-fifths of the amount disbursed through dividends.

TRENDS IN PROFITABILITY

The net income of U.S. commercial banks grew 8 percent in 1996, the seventh consecutive annual increase. The return on equity remained in the elevated range it has occupied since 1993, and the return on assets posted a new high. The increase in profitability was widespread: The average return on assets rose for all four bank size groups, and net income was positive at 95 percent of all banks, accounting for 99 percent of total bank assets. Profits were boosted a bit by growth of net interest income but more by higher noninterest income. Taken together, the gains in net interest and noninterest income exceeded the increases in non-interest expense and provisioning for loan and lease losses. Propelled in part by growth of profits, stocks of large bank holding companies outperformed the broader market in 1996, as they had in 1995 (chart 10).

[Chart 10 ILLUSTRATION OMITTED]

Last year was the fourth consecutive year in which measures of commercial bank profitability significantly exceeded the long-term norms. For example, the return on assets averaged 63 basis points more over the past four years than over the preceding seven years (table 1). The recent improvement is due in part to a sharp drop in loss provisioning relative to assets, which has allowed some other longer-term trends boosting return on assets to show through. First, the ratio of net interest income to assets has been increasing because banks have been shifting their portfolios toward riskier assets, which carry higher yields, and have been funding a larger share of assets with capital instead of interest-bearing liabilities. Also, ongoing improvements in efficiency have helped banks lower the ratio of noninterest expense to revenue. Finally, noninterest income has accounted for a steadily growing share of revenue, partly because of the increasing importance of off-balance-sheet activity.(9)