Notes to Users

Quarterly Net Income of $36.7 Billion Is Fourth-Highest Ever Net Interest Margins Register Modest Gains Over First Quarter Loss Provisions Continue to Rise at Large Institutions Increase in Noncurrent Loans Is Largest Since 1990 Foreign Office Deposits Increase Sharply

Higher Expenses Hold Down Earnings

Industry earnings remained strong in the second quarter of 2007, despite an operating environment that was decidedly less favorable than in earlier quarters. A flat yield curve, rising levels of troubled loans, and a weak housing market all made the task of improving earnings more difficult. Insured commercial banks and savings institutions reported $36.7 billion in net income for the quarter, a decline of $1.3 billion (3.4 percent) from the second quarter of 2006, but $772 million (2.1 percent) more than they earned in the first quarter of 2007. The decline in earnings compared to a year ago was caused by higher provisions for loan losses, particularly at larger institutions, and by increased noninterest expenses. The impact of these higher costs was partly offset by increased noninterest income and net interest income. For the second consecutive quarter, fewer than half of all insured institutions reported higher quarterly earnings than a year earlier. The average return on assets (ROA) for the second quarter was 1.21 percent, down from 1.34 percent in the second quarter of 2006. More than half of all institutions -- 59 percent -- reported lower ROAs than a year earlier. There were 824 institutions reporting net losses for the quarter, compared to 600 unprofitable institutions a year earlier. This is the largest year-over-year increase in unprofitable institutions since the third quarter of 1996. The increase in unprofitable institutions was greatest among institutions with less than $1 billion in assets, and among institutions with high levels of residential real estate and commercial loan exposures. The proportion of unprofitable institutions -- 9.6 percent of all insured institutions -- was the highest level for a second quarter since 1991. More than half of the unprofitable institutions (52.2 percent) were less than five years old.

Loss Provisions Rise Significantly

Insured institutions added $11.4 billion in provisions for loan losses to their reserves during the second quarter, the largest quarterly loss provision for the industry since the fourth quarter of 2002. This was $4.9 billion (75.3 percent) more than they set aside in the second quarter of 2006. At institutions with assets greater than $1 billion, loss provisions absorbed 7.7 percent of net operating revenue (net interest income plus total noninterest income); a year earlier, provisions siphoned off only 4.5 percent of revenue. Noninterest expenses were $5.6 billion (6.6 percent) higher than a year earlier. Spending for salaries and other employee benefits was up by $3.5 billion (9.1 percent). The greatest positive contribution to earnings came from noninterest income, which grew by $5.6 billion (9.0 percent). The improvement in noninterest income was led by higher trading revenue (up $1.4 billion, or 28.5 percent), increased servicing income (up $1.1 billion, or 25.1 percent), and increased fiduciary income (up $1.0 billion, or 15.8 percent, at institutions filing Call Reports).

Earning Asset Growth Lifts Net Interest Income

Net interest income also made a positive contribution to earnings; at $88.6 billion, it was $2.8 billion (3.3 percent) higher than a year earlier, because interest-earning assets were 6.6 percent greater. The growth in earning assets overcame a 12 basis-point decline in the industry's average net interest margin between the second quarter of 2006 and the second quarter of 2007 to produce the year-over-year improvement in net interest income. More than two out of every three institutions (67.1 percent) reported margins below their year-ago levels. The average net interest margin in the second quarter was 3.34 percent, compared to 3.46 percent a year earlier, but it was above the 3.32 percent average in the first quarter of 2006.

Charge-offs Continue to Rise

Net charge-offs totaled $9.2 billion in the second quarter, the highest quarterly total since the fourth quarter of 2005, and $3.1 billion (51.2 percent) more than in the second quarter of 2006. This was the second consecutive quarter that net charge-offs have had a year-over-year increase. The loan categories with the largest increases in net charge-offs included consumer loans other than credit cards (up $757 million, or 60.9 percent), commercial and industrial (C&I) loans (up $577 million, or 71.4 percent), residential mortgage loans (up $422 million, or 144.3 percent), and credit card loans (up $393 million, or 12.1 percent). All of the major loan categories posted both increased net charge-offs and higher net charge-off rates.

Real Estate Leads the Growth in Noncurrent Loans

The amount of loans and leases that were noncurrent (loans 90 days or more past due or in nonaccrual status) grew by $6.4 billion (10.6 percent) during the quarter. This is the largest quarterly increase in noncurrent loans since the fourth quarter of 1990, and marks the fifth consecutive quarter that the industry's inventory of noncurrent loans has grown. Almost half of the increase (48.1 percent) consisted of residential mortgage loans. Noncurrent mortgages increased by $3.1 billion (12.6 percent) during the quarter. Real estate construction and development loans accounted for more than a third (34.2 percent) of the increase in noncurrent loans. Noncurrent construction loans increased by $2.2 billion (39.5 percent) during the quarter. The amount of home equity lines of credit that were noncurrent increased by $407 million (16.6 percent) during the quarter. The industry's noncurrent loan rate, which was at an all-time low of 0.70 percent at the end of the second quarter of 2006, rose from 0.83 percent to 0.90 percent during the second quarter. This is the highest noncurrent rate for the industry in three years.

Pace of Reserve Growth Picks Up

Banks and thrifts grew their loss reserves by $2.6 billion (3.2 percent) during the quarter, as loss provisions of $11.4 billion surpassed net charge-offs of $9.2 billion. The $2.6-billion rise in loss reserves was the largest quarterly increase since the first quarter of 2002, but it barely kept pace with growth in the industry's loans and leases. The ratio of reserves to total loans increased from 1.08 percent to 1.09 percent during the quarter, but remains near the 32-year low of 1.07 percent reached at the end of 2006. For the fifth quarter in a row, reserves failed to keep pace with the increase in noncurrent loans. As a result, the industry's "coverage ratio" of reserves to noncurrent loans fell from $1.30 in reserves for every $1.00 of noncurrent loans to $1.21 during the quarter. This is the lowest level for the coverage ratio since the third quarter of 2002. Reserves increased at 60 percent of institutions during the quarter.

Securities Depreciation Limits Growth in Equity

Equity capital increased by only $11.4 billion (0.9 percent), the smallest quarterly increase in seven quarters. Declining market values for securities held for sale limited the growth in equity during the quarter. Net unrealized losses on securities at insured banks that file Call Reports grew from $6.1 billion to $20.6 billion during the quarter. Under Generally Accepted Accounting Principles (GAAP), these unrealized losses are subtracted from equity. The industry's ratio of equity to total assets fell from 10.58 percent to 10.43 percent during the quarter.

Commercial Lending Remains Strong

Total assets grew by $279.9 billion (2.3 percent) in the quarter, led by a $188.4-billion (2.6-percent) increase in loans and leases. C&I loans increased by a quarterly record $51.3 billion (4.1 percent), home equity lines of credit grew by $19.9 billion (3.6 percent), credit card loans increased by $18.7 billion (5.3 percent), residential mortgage loans rose by $18.8 billion (0.9 percent), and real estate construction loans increased by $17.9 billion (3.1 percent). In addition to the growth in loans, assets in trading accounts grew by $43.9 billion (6.4 percent) in the quarter. Interest-bearing balances due from depository institutions increased by $36.6 billion (20.1 percent), with most of the growth occurring at a few large banks. Mortgage-backed securities increased by $21.6 billion (1.8 percent). Total mortgage assets increased by $60.3 billion (1.5 percent) in the second quarter, accounting for just over one-fifth of all asset growth.

Small Business Lending Grew More Rapidly in the Past Year

Data on lending to small businesses and farms, collected annually as of midyear, show that lending to small business accelerated during the last 12 months. Loans of less than $1 million to C&I borrowers grew by $28.5 billion (9.6 percent) between June 30, 2006 and June 30, 2007. This is the largest increase for these loans in the 12 years for which growth data are available. The 9.6-percent growth rate is substantially greater than the 3.5-percent growth registered in the 2005 - 2006 period. The growth rates for loans to small businesses and farms remained below the growth rates of lending to larger borrowers, as has been the case throughout much of the period that small business loan data have been reported.

Record Growth in Foreign Office Deposits

Deposits in foreign offices increased by a record $143.3 billion (11.9 percent) during the quarter, as a few large banks shifted their funding away from deposits in domestic offices. Nondeposit liabilities increased by $128.3 billion (4.6 percent) during the quarter. Deposits in domestic offices declined by $3.2 billion (0.05 percent), the first time since the third quarter of 2003 that domestic deposits have fallen. Short-term (less than 1 year) nondeposit borrowings grew by $66.8 billion (14.9 percent) during the quarter at banks filing Call Reports.

"Problem List" Registers Modest Increase

The number of insured institutions reporting financial results fell from 8,649 in the first quarter to 8,615 in the second quarter, a net decline of 34 institutions. There were 48 new charters added during the second quarter, and 81 insured institutions were absorbed by mergers. No insured institution failed in the second quarter. During the quarter, two mutually-owned savings institutions, with $2.9 billion in combined assets, converted to stock ownership. The number of institutions on the FDIC's "Problem List" increased from 53 to 61 during the quarter, and total assets of "problem" institutions grew from $21.5 billion to $23.1 billion. At the end of the third quarter of 2006, there were 47 "problem" institutions, the fewest in at least 36 years. Since then, the number and assets of "problem" institutions have risen in each successive quarter, although they remain low by historical standards.