Condition and performance of commerical banks

US Office of the Comptroller of the Currency: Quarterly Journal, Jun 2002

Summary

The same factors that drove bank performance at the end of 2001 continued in play in the first quarter of 2002. Most important, low short-term rates and wide spreads between short- and long-term rates boosted aggregate net interest margins and earnings. Assets also continued to grow, despite the sluggish economy. The result was record aggregate net income, in dollar terms, with return on equity approaching the record levels of the late 1990s. For national banks, return on equity rose both quarter-- over-quarter and year-over-year. This performance stands in sharp contrast to the record decline in U.S. corporate profits in 2001.

Not all banks have benefited from these favorable trends. Most of the advantages of the low-interest-rate environment have gone to large banks; they are large net borrowers in the wholesale funds market, and have therefore been the major beneficiaries of the drop in the cost of funds. In the first quarter of 2002, net interest margins (NIMs) continued to rise for large banks as a group but fell for small banks, continuing a two-year trend. Asset growth was also predominantly in the large banks.

Asset quality continued to deteriorate for both small and large banks, especially in the commercial and industrial (C&I) sector. Noncurrent loans showed further deterioration in all major categories at both large and small banks.

Key Trends

Net interest income showed strong year-over-year growth in the first quarter, the result of widening net interest margins and growth in total assets. Growth in net interest income more than offset higher provisioning costs, resulting in a 19 percent increase in net income for the quarter, compared to the first quarter of 2001. In contrast, during the recession of 1990-91, asset growth was hardly discernible, and net income declined.

Net interest margins rose for the banking system as a whole, largely the result of low short-term interest rates. But while first-quarter NIM rose for large banks (over $1 billion in assets), it fell for small banks (under $1 billion in assets). Since the first quarter of 2000, large-bank NIM has risen by 34 basis points, and now stands close to the highest level since the data series began in 1984. Over the same two years, small-bank NIM has fallen by 10 basis points, and now stands at its lowest level since the recession year of 1991. During that earlier recession, NIM rose for both large and small banks, but a shrinking asset base led to only a modest rise in net interest income.

In contrast, bank assets continued to grow during the recent recession. Total assets rose over the last several quarters as new deposits flowed into banks. Some of this increase funded new loans. A modest increase in loan volume combined with a substantial boost in NIM contributed to significant gains in net interest income. An even larger share of new assets-and of the increase in net interest income-came from increased holding of securities, primarily at large banks.

In their securities portfolios, both small and large banks have moved toward longer maturities to take advantage of the steep yield curve. Since 1997, both small and large banks have roughly doubled their portfolio shares of securities with maturities over 15 years. Over the same period, both small and large banks have decreased their portfolio shares of securities with maturities of 12 months or less. This movement toward longer maturities raises interest income but also increases interest-rate risk. This lengthening of asset maturities, however, is accompanied by a significant increase in the use of interest-rate derivatives. This reduces interest-rate risk for the national banking system.

Asset quality continued to deteriorate during the first quarter across all classes of loans, for both small and large banks. Banks reported higher noncurrent ratios for commercial real estate and construction loans, and modestly higher noncurrent ratios for home mortgage loans. But as in recent quarters, the biggest problems are in the commercial and industrial (C&I) sector. Corporate profits fell dramatically in 2001 across the economy and have yet to show definitive signs of recovery. Profits of U.S. nonfinancial corporations fell 25 percent from 2000 to 2001, with some sectors chalking up double- and even triple-digit declines. This compares with no change in profits during the recession years of 1990 and 1991. In 2001, Fortune 500 companies set a record for a one-year decline in aggregate profits. Eight companies accounted for three-fourths of the losses for the Fortune 500,

although 100 of these 500 companies lost money. The result was more pressure on credit quality, particularly for large banks, which have most of the exposure to the large, troubled companies.

Since the beginning of the recession in early 2001, credit quality has held up better at small banks than at their larger counterparts. But this aggregate result conceals important differences among the smaller banks. For example, from the first quarter of 2001 to the first quarter of 2002, 8 percent of small banks, but only 2 percent of large banks, had noncurrent ratios above 3 percent (the long-term national average is about 1 percent). This probably contributed to the higher percentage of small banks with weak returns: in the first quarter, only 2 percent of large banks, but 8 percent of small banks, showed a return on assets of less than 0.5 percent (the long-term national average is also about 1 percent).