Notes to Users

Industry Net Income Falls to $5 Billion Quarterly Loss Provisions Surpass $50 Billion Asset Quality Indicators Continue to Deteriorate Industry Assets Post First Decline in Six Years

Second-Quarter Earnings Are 87 Percent Below Year-Earlier Level

The continued downturn in the credit cycle, combined with lingering weakness in financial markets and falling asset values, had a pronounced negative effect on banking industry performance in the second quarter. Insured commercial banks and savings institutions reported net income of $5.0 billion for the second quarter of 2008. This is the second-lowest quarterly total since 1991 and is $31.8 billion (86.5 percent) less than the industry earned in the second quarter of 2007. Higher loan-loss provisions were the most significant factor in the earnings decline. Loss provisions totaled $50.2 billion, more than four times the $11.4 billion quarterly total of a year ago. Second-quarter provisions absorbed almost one-third (31.9 percent) of the industry's net operating revenue (net interest income plus total noninterest income), the highest proportion since the third quarter of 1989. A year ago, provisions absorbed only 7.3 percent of industry revenue. The average return on assets (ROA) in the second quarter was 0.15 percent, compared to 1.21 percent a year earlier. Large institutions as a group had more substantial earnings erosion than smaller institutions, but downward earnings pressure was widely evident across the industry. At institutions with assets greater than $1 billion, the average ROA in the second quarter was 0.10 percent, down from 1.23 percent a year ago. At institutions with less than $1 billion in assets, the average second-quarter ROA was 0.57 percent, compared to 1.10 percent in the second quarter of 2007. More than half of all insured institutions (56.4 percent) reported year-over-year declines in quarterly net income, and almost two out of every three institutions (62.1 percent) reported lower ROAs. Almost 18 percent of all insured institutions were unprofitable in the second quarter, compared to only 9.8 percent in the second quarter of 2007.

Market-Sensitive Revenues Remain Weak

Net operating revenue was only $772 million (0.5 percent) above the level of a year earlier, even though revaluations of certain assets and liabilities under fair value accounting provided a $7.9-billion boost to pretax earnings in the second quarter. Noninterest income of $60.8 billion was $7.4 billion (10.9 percent) lower than in the second quarter of 2007. The decline in noninterest income was attributable to lower trading income (down $5.5 billion, or 88.6 percent); smaller gains from sales of loans, foreclosed properties, and other assets (down $1.7 billion, or 41.2 percent); and lower income from securitization activities (down $1.5 billion, or 28.3 percent). In addition to the decline in noninterest income, securities sales yielded $2.3 billion in net losses in the second quarter, compared to $573 million in net gains a year earlier. Expenses for goodwill and other intangibles totaled $4.5 billion, more than double the $2.1 billion incurred by the industry in the second quarter of 2007. Net interest income was one of the few bright spots in industry revenues, rising by $8.2 billion (9.3 percent) over year-earlier levels. Servicing fee income increased by $1.9 billion (35.9 percent). Service charges on deposit accounts increased by $853 million (8.6 percent) at insured commercial banks and state-chartered savings banks.

Margins Show Little Change as Average Yields and Funding Costs Fall

The average net interest margin (NIM) improved slightly compared to the first quarter, from 3.33 percent to 3.37 percent. Improvements and declines were fairly evenly divided among insured institutions, with 46.9 percent reporting lower margins than in the first quarter, and 51.5 percent reporting improved NIMs. The relatively small change in quarterly NIM contrasted with declines of more than 50 basis points in both average asset yields and average funding costs between the two quarters. The average yield on interest-bearing assets fell from 6.27 percent in the first quarter to 5.76 percent in the second quarter, while the average interest expense to fund interest-bearing assets fell from 2.95 percent to 2.38 percent. The industry average NIM has remained within a 5 basis-point range during the last six quarters, as community bank margins have fallen by 21 basis points and margins for larger institutions have risen by 10 basis points.

Net Charge-Off Rate Rises to Highest Level Since 1991

Loan losses registered a sizable jump in the second quarter, as loss rates on real estate loans increased sharply at many large lenders. Net charge-offs of loans and leases totaled $26.4 billion in the second quarter, almost triple the $8.9 billion that was charged off in the second quarter of 2007. The annualized net charge-off rate in the second quarter was 1.32 percent, compared to 0.49 percent a year earlier. This is the highest quarterly charge-off rate for the industry since the fourth quarter of 1991. At institutions with more than $1 billion in assets, the average charge-off rate in the second quarter was 1.46 percent, more than three times the 0.44 percent average for institutions with less than $1 billion in assets. Net charge-offs increased year-over-year for all major loan categories in the second quarter. Charge-offs of 1-4 family residential mortgage loans increased by $5.8 billion (821.9 percent), while charge-offs of real estate construction and land development loans rose by $3.2 billion (1,226.6 percent). Net charge-offs of home equity loans were $2.8 billion (632.7 percent) higher than a year earlier, charge-offs of loans to commercial and industrial (C&I) borrowers were up by $1.8 billion (127.5 percent), credit card charge-offs increased by $1.7 billion (47.4 percent), and charge-offs of other loans to individuals grew by $1.4 billion (70.3 percent).

Noncurrent Loan Rate Rises Above 2 Percent for the First Time Since 1993

The amount of loans and leases that were noncurrent (90 days or more past due or in nonaccrual status) rose for a ninth consecutive quarter, increasing by $26.7 billion (19.6 percent). This is the second-largest quarterly increase in noncurrent loans during the nine-quarter streak, after the $27.0-billion increase in the fourth quarter of 2007 when quarterly net charge-offs were $10 billion lower. All major loan categories registered increased levels of noncurrent loans in the second quarter. The amount of 1-4 family residential real estate loans that were noncurrent increased by $11.7 billion (21.2 percent) during the quarter, while noncurrent real estate construction and land development loans rose by $8.2 billion (27.2 percent). Large increases were also reported in loans secured by nonfarm nonresidential real estate properties (up $2.0 billion, or 19.6 percent), C&I loans (up $1.8 billion, or 15.0 percent), and home equity loans (up $1.7 billion, or 25.5 percent). At the end of June, the percentage of the industry's total loans and leases that were noncurrent stood at 2.04 percent, the highest level since the third quarter of 1993.

Large Boost in Reserves Does Not Quite Keep Pace with Noncurrent Loans

For the third consecutive quarter, insured institutions added almost twice as much in loan-loss provisions to their reserves for losses as they charged-off for bad loans. Provisions exceeded charge-offs by $23.8 billion in the second quarter, and industry reserves rose by $23.1 billion (19.1 percent). The industry's ratio of reserves to total loans and leases increased from 1.52 percent to 1.80 percent, its highest level since the middle of 1996. However, for the ninth consecutive quarter, increases in noncurrent loans surpassed growth in reserves, and the industry's "coverage ratio" fell very slightly, from 88.9 cents in reserves for every $1.00 in noncurrent loans, to 88.5 cents, a 15-year low for the ratio.

Capital Growth Slows Despite Cutbacks in Dividends

The industry added $10.6 billion to its total regulatory capital in the second quarter, the smallest quarterly increase since the fourth quarter of 2003. A majority of institutions (60.0 percent) reported declines in their total risk-based capital ratios during the quarter. More than half (50.9 percent) of the 4,056 institutions that paid dividends in the second quarter of 2007 reported smaller dividend payments in the second quarter of 2008, including 673 institutions that paid no quarterly dividend. Dividend payments in the second quarter totaled $17.7 billion, less than half the $40.9 billion insured institutions paid a year earlier. Even with reduced dividend payments, fewer than half of all institutions (45.5 percent) reported higher levels of retained earnings compared to a year ago. Less than one-fourth of the $23.1-billion increase in industry loan-loss reserves in the second quarter was included in regulatory capital because the amount of reserves in regulatory capital cannot exceed 1.25 percent of an institution's total risk-weighted assets, and a number of institutions now have reserves that exceed that limit. Despite the slowdown in capital growth and the erosion in capital ratios at many institutions, 98.4 percent of all institutions (accounting for 99.4 percent of total industry assets) met or exceeded the highest regulatory capital requirements at the end of June.

Reductions in Trading Accounts Cause Total Industry Assets to Decline

Total assets of insured institutions declined by $68.6 billion during the quarter, the first time since the first quarter of 2002 that industry assets have decreased, and the largest quarterly decline since the first quarter of 1991. The reduction in assets was driven by a few large institutions, although almost 40 percent of all insured institutions reported lower assets at the end of June, compared to the end of March. Assets in trading accounts, which increased by $135.2 billion in the first quarter, declined by $118.9 billion (11.8 percent) in the second quarter. The industry's 1-4 family residential mortgage loans, which declined by $25.9 billion in the first quarter, fell by an additional $61.4 billion (2.8 percent) in the second quarter. Real estate construction and development loans registered their first quarterly decline since the first quarter of 1997, falling by $5.4 billion (0.9 percent). Total unused loan commitments declined by $145.9 billion (1.8 percent), while letters of credit increased by $28.9 billion (5.9 percent). Other real estate owned-properties acquired through foreclosure-increased by $3.5 billion (29.1 percent) during the quarter, to $15.6 billion at midyear.

Growth in Small Business Loans Slowed in the Last 12 Months

The annual data on loans to small businesses and farms that are reported as of each June 30 showed that total small business and farm loans increased by $25.3 billion (3.4 percent) during the 12 months ended June 30. In contrast, larger loans to businesses and farms increased by $249.4 billion (18.4 percent) during that period. In the June 2006 to June 2007 period, small business and farm loans increased by $55.2 billion (7.9 percent). These loans currently account for almost one-third (32.7 percent) of all business and farm loans to domestic borrowers.

Deposits Decline in Domestic Offices

Total deposits at insured institutions increased by only $6.9 billion (0.1 percent) in the second quarter, as the decline in industry assets reduced overall funding needs. Deposits in foreign offices increased by $46.8 billion (3.1 percent), while deposits in domestic offices fell by $39.8 billion (0.6 percent). In domestic offices, interest-sensitive deposits fell during the quarter, while interest-insensitive deposits grew. Domestic office time deposits declined by $50.6 billion (1.9 percent), while other domestic interest-bearing deposits fell by $19.6 billion (0.1 percent). Noninterest-bearing deposits in domestic offices rose by $30.4 billion 2.5 percent). Nondeposit liabilities declined by $66.1 billion (1.9 percent) during the quarter, due in large part to a $48.5-billion (11.9-percent) drop in liabilities in trading accounts.

Two More Banks Fail in the Second Quarter

The number of institutions filing quarterly financial reports fell to 8,451 at the end of the second quarter, down from 8,494 at the end of the first quarter. Twenty-four new charters were added during the second quarter, while 64 existing charters were merged into other institutions. Two insured institutions failed during the quarter, bringing the total for the first six months of 2008 to four failures. Three mutually owned savings banks, with combined assets of $1.1 billion, converted to stock ownership in the second quarter. The number of institutions on the FDIC's "Problem List" increased from 90 to 117 during the quarter. Assets of "problem" institutions increased from $26.3 billion to $78.3 billion.