Notes to Users

Industry Posts $32.1 Billion Quarterly Loss Loan-Loss Expenses, Goodwill Writedowns, and Trading Losses Outstrip Revenues Asset Quality Indicators Show Further Deterioration Domestic Deposits Register Strong Growth Full-Year Net Income of $10.2 Billion Is Lowest Since 1989

Industry Reports First Quarterly Loss Since 1990

Expenses associated with rising loan losses and declining asset values overwhelmed revenues in the fourth quarter of 2008, producing a net loss of $32.1 billion at insured commercial banks and savings institutions. This is the first time since the fourth quarter of 1990 that the industry has posted an aggregate net loss for a quarter. The -0.94 percent quarterly return on assets (ROA) is the worst since the -1.10 percent in the second quarter of 1987. A year ago, the industry reported $575 million in profits and an ROA of 0.02 percent. High expenses for loan-loss provisions, large writedowns of goodwill and other assets, and sizable losses in trading accounts all contributed to the industry’s net loss. A few very large losses were reported during the quarter—four institutions accounted for half of the total industry loss—but earnings problems were widespread. One out of every three institutions reported a net loss in the fourth quarter. Only 36 percent of institutions reported year-over-year increases in quarterly earnings, and only 33 percent reported higher quarterly ROAs.

Provisions for Loan Losses Are More than Double Year-Earlier Total

Insured banks and thrifts set aside $69.4 billion in provisions for loan and lease losses during the fourth quarter, more than twice the $32.1 billion that they set aside in the fourth quarter of 2007. Loss provisions represented 50.4 percent of the industry’s net operating revenue (net interest income plus total noninterest income), the highest proportion since the second quarter of 1987 when provisions absorbed 53.2 percent of net operating revenue. As in the fourth quarter of 2007, a few institutions reported unusually large trading losses, while others took substantial charges for impairment of goodwill. Goodwill impairment charges and other intangible asset expenses rose to $21.9 billion, from $11.5 billion in the fourth quarter of 2007. Trading activities produced a $9.2 billion net loss in the quarter, compared to a loss of $11.2 billion a year earlier. These are the only two quarters in the past 25 years in which trading revenues have been negative. Other negative earnings factors included a $6.1 billion (13 percent) year-over-year decline in noninterest income, and $8.1 billion in realized losses on securities and other assets in the quarter, more than twice the $3.7 billion in losses realized a year earlier. The reduction in noninterest income was driven by declines in servicing income (down $3.1 billion from a year earlier) and securitization income (down $2.6 billion, or 52.3 percent).

Average Net Interest Margin at Community Banks Falls to 20-Year Low

Net interest income totaled $97.0 billion in the fourth quarter, an increase of $4.5 billion (4.9 percent) from the fourth quarter of 2007. The average net interest margin (NIM) was 3.34 percent in the quarter, up slightly from 3.32 percent a year earlier but lower than the 3.37 percent average in the third quarter. The year-over-year margin improvement was confined mostly to larger institutions. More than half of all institutions (56 percent) reported lower NIMs. At institutions with less than $1 billion in assets, the average margin was 3.66 percent, compared to 3.85 percent a year earlier and 3.78 percent in the third quarter. This is the lowest quarterly NIM for this size group of institutions since the second quarter of 1988. At larger institutions, the average NIM improved from 3.24 percent a year earlier to 3.30 percent, slightly below the 3.32 percent average of the third quarter. When short-term interest rates are low and declining, it is more difficult for banks to reduce the rates they pay for deposits without causing deposit outflows. The cost of short-term nondeposit liabilities, in contrast, tends to follow movements in short-term interest rates more closely. Community banks fund more than two-thirds of their assets with domestic interest-bearing deposits, whereas larger institutions fund less than half of their assets with these deposits. As rates fell in the fourth quarter, average funding costs declined at larger institutions but remained unchanged at community banks.

Full-Year Earnings Fall to Lowest Level in 19 Years

Net income for all of 2008 was $10.2 billion, a decline of $89.8 billion (89.8 percent) from the $100 billion the industry earned in 2007. This is the lowest annual earnings total since 1989, when the industry earned $10.0 billion. The ROA for the year was 0.08 percent, the lowest since 1987, when the industry reported a net loss. Almost one in four institutions (23.6 percent) was unprofitable in 2008, and almost two out of every three institutions (62.8 percent) reported lower full-year earnings than in 2007. Loss provisions totaled $174.4 billion in 2008, an increase of $105.2 billion (152 percent) compared to 2007. Total noninterest income was $25.6 billion (11 percent) lower as a result of the industry’s first-ever full-year trading loss ($1.8 billion), a $5.8-billion (27.4-percent) decline in securitization income, and a $6.6-billion negative swing in proceeds from sales of loans, foreclosed properties, and other assets. As low as the full-year reported earnings total was, it could easily have been worse. If the effect of failures and purchase accounting for mergers that occurred during the year is excluded from reported results, the industry would have posted a net loss in 2008¹. The magnitude of many year-over-year income and expense comparisons is muted by the impact of these structural changes and their accounting treatments.

Quarterly Net Charge-Off Rate Matches Previous High

Net loan and lease charge-offs totaled $38.0 billion in the fourth quarter, an increase of $21.7 billion (132.7 percent) from the fourth quarter of 2007. The annualized quarterly net charge-off rate was 1.92 percent, the highest level in the 25 years that institutions have reported quarterly net charge-offs. The year-over-year increase in quarterly net charge-offs was led by real estate construction and development loans (up $6.1 billion, or 450.9 percent), closed-end 1–4 family residential mortgage loans (up $4.6 billion, or 206.7 percent), commercial and industrial (C&I) loans (up $3.1 billion, or 98.2 percent), and credit cards (up $2.5 billion, or 60.1 percent). Charge-offs in all major loan categories increased from a year ago. Real estate loans accounted for almost two-thirds of the total increase in charge-offs (64.7 percent).

Noncurrent Loans Register Sizable Increase in the Fourth Quarter

The amount of loans and leases that were noncurrent rose sharply in the fourth quarter, increasing by $44.2 billion (23.7 percent). Noncurrent loans totaled $230.8 billion at year-end, up from $186.6 billion at the end of the third quarter. More than two-thirds of the increase during the quarter (69.4 percent) came from loans secured by real estate. Noncurrent closed-end 1–4 family residential mortgages increased by $18.4 billion (24.1 percent) during the quarter, while noncurrent C&I loans rose by $7.6 billion (42.8 percent). Noncurrent home equity loans increased by $3.0 billion (39.0 percent), and noncurrent loans secured by nonfarm nonresidential real estate increased by $3.0 billion (20.9 percent). In the 12 months ended December 31, total noncurrent loans at insured institutions increased by $120.1 billion (108.5 percent). At the end of the year, the percentage of loans and leases that were noncurrent stood at 2.93 percent, the highest level since the end of 1992. Real estate construction loans had the highest noncurrent rate of any major loan category at year-end, at 8.55 percent, up from 7.30 percent at the end of the third quarter.

Reserve Coverage Ratio Slips to 16-Year Low

Total reserves increased by $16.6 billion (10.6 percent) in the fourth quarter. Insured institutions added $31.4 billion more in loss provisions to reserves than they took out in charge-offs, but the impact of purchase accounting from a few large mergers in the quarter limited the overall growth in industry reserves². The growth in reserves, coupled with a decline in industry loan balances, caused the industry’s ratio of reserves to total loans to increase during the quarter from 1.96 percent to 2.20 percent, a 14-year high. However, the increase in reserves did not keep pace with the sharp rise in noncurrent loans, and the industry’s ratio of reserves to noncurrent loans fell from 83.9 percent to 75.0 percent. This is the lowest level for the “coverage ratio” since the third quarter of 1992.

Goodwill Writedowns Produce Drop in Equity Capital

Total equity capital declined for a third consecutive quarter, falling by $10.1 billion (0.8 percent) in the fourth quarter. A $45.5-billion (12.8-percent) decline in goodwill and a $16.5-billion reduction in other comprehensive income were the main reasons for the decline. In contrast, regulatory capital, which does not include goodwill and is not affected by unrealized losses on securities (which are included in other comprehensive income), increased during the quarter. Tier 1 leverage capital increased by $22.8 billion (2.3 percent), to $1 trillion at year-end. Total regulatory capital increased by $28.0 billion (2.2 percent) during the quarter, to $1.28 trillion. For the full year, equity capital fell by $51.2 billion. Other comprehensive income, which includes unrealized gains and losses on securities held for sale, declined by $61.2 billion, and goodwill fell by $41.1 billion. Even though the industry’s dividends fell by more than half in 2008 compared to 2007, the $51.0 billion paid out in 2008 exceeded the year’s net income by almost $41 billion. Of the 5,631 insured institutions that paid dividends in 2007, more than half (55 percent) reduced their dividends in 2008, including 502 institutions (9 percent) that eliminated their dividends. At the end of 2008, 97.5 percent of all insured institutions, representing 98.7 percent of industry assets, met or exceeded the highest regulatory capital standards.

Balances at Federal Reserve Banks Increased by $342 Billion in the Quarter

Total assets of insured institutions increased by $274.2 billion (2.0 percent) in the fourth quarter. The growth was driven by a $341.7-billion (194.3-percent) increase in balances with Federal Reserve banks. While 1,069 banks reported increases in reserve balances during the quarter, five banks accounted for more than half of the entire industry increase. Net loans and leases fell by $131.4 billion (1.7 percent), as several large institutions restructured their loan portfolios. Three large banks accounted for all of the decline in the industry’s loans during the fourth quarter; most institutions grew their loan balances in the quarter. Almost two-thirds of all institutions (64.7 percent) reported increases in their loans and leases, while only about half as many institutions (2,865 institutions, or 34.5 percent of all reporters) had declines in their loan portfolios.

Deposit Share of Asset Funding Rises

Total deposits increased by $307.9 billion (3.5 percent) in the fourth quarter, the largest percentage increase in a quarter in ten years. Deposits in domestic offices grew by $274.1 billion (3.8 percent), with interest-bearing domestic deposits rising by $242.8 billion (4.2 percent). Brokered deposits increased by $101.8 billion (15.3 percent). Deposits in foreign offices increased by $33.8 billion (2.2 percent) during the quarter. Deposit growth outpaced growth in total assets, and at the end of 2008, deposits funded 65.3 percent of industry assets, the highest proportion since mid-year 2007. Nondeposit liabilities fell by $23.6 billion (0.7 percent), as Federal Home Loan Bank (FHLB) advances declined by $124.0 billion (13.6 percent), and Federal funds purchased and securities sold under repurchase agreements declined by $54.7 billion (5.8 percent).

Trust Activities Receded in 2008

In a difficult year for financial markets, it was not surprising that trust activities at insured institutions diminished. Total managed fiduciary assets declined in 2008 by $1.1 trillion (25.1 percent), while non-managed assets fell by $3.4 trillion (19.6 percent), and assets in custodial and safekeeping accounts fell by $7.7 trillion (13.2 percent). Net fiduciary income was $1.1 billion (8.3 percent) less in 2008 than in 2007.

Failures and Assistance Transactions Rose to 15-Year High in 2008

The number of FDIC-insured commercial banks and savings institutions reporting financial results fell to 8,305 at the end of 2008, down from 8,384 at the end of the third quarter. The net decline of 79 institutions was the largest since the first quarter of 2002. Fifteen new institutions were chartered in the fourth quarter, the smallest number in any quarter since the third quarter of 1994. Seventy-eight insured institutions were absorbed into other institutions through mergers, and 12 institutions failed during the quarter (five other institutions received FDIC assistance in the quarter). For all of 2008, there were 98 new charters, 292 mergers, 25 failures and 5 assistance transactions. This is the largest number of failed and assisted institutions in a year since 1993, when there were 50. At year-end, 252 insured institutions with combined assets of $159 billion were on the FDIC’s “Problem List.” These totals are up from 171 institutions with $116 billion in assets at the end of the third quarter, and 76 institutions with $22 billion in assets at the end of 2007.

Footnotes

¹ Under purchase accounting rules that apply to bank mergers, income and expenses that have been booked by an acquired institution are reset to zero as of the date when a change in ownership occurs. Income and expenses that have been accrued prior to that date are reflected in adjustments to the assets, equity capital, and reserves of the acquired institution and are not reflected in subsequent reporting of year-to-date income and expense.

² See footnote 1.