Condition and performance of commerical banks

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

Since 1997, large banks have also had better success in reducing noninterest expense, which has declined as a fraction of net operating revenue for large banks, but has risen for small banks. Until 1998, noninterest expense account for about the same fraction of net operating revenues at both small and large banks. Since then the ratio has dropped from 65 percent to 54 percent for large banks, but has risen slightly for small banks. First-quarter results showed a further decline for large banks, although the results were distorted by a change in the accounting rules concerning the treatment of merger-related goodwill. Most conspicuous has been the difference in salary expense. Salaries now account for less than 25 percent of net operating revenue at large banks, compared to about 33 percent at small banks.

Overcapacity continues to be a problem in many sectors-both in the old economy (e.g., iron and steel, electrical machinery), and the new economy (e.g., telecommunications, computers), where capacity expanded rapidly during the investment boom of the 1990s. Even robust economic growth would not quickly soak up this excess capacity. The overhang of excess capacity is likely to hold down profits in many sectors and delay an improvement in credit quality.

Community banks have less direct exposure to the weakest industries, because they are not an important source of loans for large manufacturers. Nonetheless, community banks remain exposed indirectly, as they serve the communities where many troubled firms are located. Community banks located in areas with a heavy tech or telecom presence may face particular problems. Most vulnerable are business-oriented community banks, those specializing in business loans, or loans for business real estate.

The consumer side remained strong through the recession, in contrast to the corporate side. Fueled by tax cuts and decreases in energy prices, consumer spending grew every quarter in 2001 and continues to grow in 2002. Another factor in the strong performance of the consumer sector has been the rapid appreciation in home prices. This has made consumers feel wealthier and more inclined to spend money. In some regions, home prices have risen substantially faster than household income; this is not sustainable in the long run. If a correction comes, it would dampen consumer sentiment in these regions, cutting into consumer spending. Household debt levels (the ratio of consumer plus mortgage debt to disposable income) rose steadily from early 1998 until the third quarter of 2001. Debt levels then eased off briefly as homeowners took advantages of 40-year lows in interest rates to refinance their mortgages (70 percent of mortgage originations in the fourth quarter of 2001 were refinancings). But debt levels have risen again and now stand at a 15-year high. The nonperforming ratio for consumer loans tends to move with the household debt service ratio, although with a one- or two-year lag. This suggests that consumer loan quality could deteriorate over the next year or two.