Quarterly Banking Profile Press Briefing
Second Quarter 2003 Results for FDIC-Insured Institutions
Thursday, September 4, 2003
Generally favorable economic and financial conditions boosted the earnings of
FDIC-insured institutions to a second consecutive quarterly record in the period
ending June 30.
The industry earned $30.2 billion during the quarter, surpassing the earnings
record of $29.4 billion set in the first quarter.
The increase in second-quarter earnings was attributable to a three main
1) Gains on the sale of securities and other assets, helped by a decline in
long-term interest rates to their lowest levels in more than a generation.
2) Strong loan growth, led by mortgage loan origination volumes which
soared to record levels as long-term interest rates declined. Strong loan
growth boosted net interest income even as net interest margins narrowed.
3) A third consecutive quarterly decline in net loan losses, which helped
to reduce provision expenses.
Although the financial strength of the industry remains evident, the sharp
rise in long-term interest rates since June creates ‘headwinds’ that could make
it harder for the industry to set new earnings records in the quarters ahead.
Low Long-Term Interest Rates Have Boosted Earnings
In recent quarterly press briefings, we have described how the slow-paced
economic recovery since late 2001 has been highly conducive to the record
earnings posted by FDIC-insured institutions in 2002 and the first quarter of
Low and declining long-term interest rates have been a key element of this
A three-and-a-half year rally in long-term Treasuries drove the yield on
10-year U.S. government bonds down to a 45-year low of 3.11 percent as of June
In this environment, FDIC-insured institutions have been able to consistently
realize large gains on the sale of securities and other assets.
In the second quarter, pre-tax gains on the sale of assets amounted to $4.9
billion, compared to $3.7 billion in the first quarter. In fact, the increase in
gains on sale accounted for virtually all of the net increase in industry
earnings during the quarter.
The three-year decline in long-term interest rates also brought about record
volumes of mortgage originations, led by refinancing activity.
The weekly mortgage origination index of the Mortgage Bankers Association of
America peaked at an all-time high in the second week of June. Since then,
weekly mortgage applications have fallen by 60 percent while “refi” applications
have fallen by more than 75 percent.
In terms of today’s results, I would point out that mortgage lending made up
72 percent of loan growth in the second quarter, up from 70 percent in the first
A Changing Economic Environment
During June the economic climate seemed to shift rather suddenly. The most
visible aspect of this shift was a sharp increase in long-term interest rates.
The yield on 10-year Treasury instruments rose by 130 basis points between
June 13 and the end of July.
The monthly increase of 65 basis points in July was the largest monthly
increase since May 1987.
Although many factors are thought to underlie the rise in long-term interest
rates, the trend appears to have roughly coincided with a shift in investor
sentiment as to the future direction of the U.S. economy, the downside risks of
the economic outlook, and how those trends might shape Federal Reserve policy.
Indeed, recent signs appear to confirm what economists have been forecasting
for much of this year—that the pace of economic activity will be markedly faster
in the second half of this year compared to the first half of the year and 2002.
The consensus forecast of the Blue Chip Economic Indicators, for example,
calls for real growth in U.S. gross domestic product to be 3.7 percent in the
third quarter and 3.8 percent in the fourth quarter.
How A Faster Recovery Will Affect FDIC-Insured Institutions
A question we have discussed in previous quarterly briefings is how the
anticipated upturn in the U.S. economy may shape the earnings of FDIC-insured
institutions in future quarters.
Our perspective has been that with the excellent financial performance of the
industry during the slow-growth portion of the recovery, there was little reason
to expect this performance to deteriorate significantly as the pace of economic
activity picked up.
Record earnings in the second quarter appear to confirm this overall
We continue to see the generally strong earnings and balance sheet
fundamentals of the industry remaining in place for the foreseeable future.
However, given the dependence of the industry on securities gains and
mortgage lending in the first half of the year, and the significant rise in
long-term interest rates since June, it may well be that earnings comparisons
with the first half of the year could become more difficult in coming quarters.
I’ll discuss some of these developing “headwinds” to earnings growth in
future quarters as I summarize the components of second quarter earnings.
First, some details from the second quarter results.
Return on assets for the industry remained at 1.38 percent—the same as last
quarter and one basis point ahead of a year ago.
More than half of all institutions (57 percent) reported higher earnings than
a year ago, while almost half (47 percent) had a higher ROA.
Only 533 institutions reported a net loss for the quarter, down from 676 in
the second quarter of 2002. This is the lowest number of unprofitable
institutions in over five years.
Both the number and total assets of problem institutions fell during the
The reserve ratio of the FDIC’s Bank Insurance Fund (BIF) rose by one basis
point to 1.29 percent.
The reserve ratio of the Savings Association Insurance Fund (SAIF) also rose
by one basis point to 1.38 percent.
The 12-month rate of asset growth of the industry rose for the fifth
consecutive quarter to 11 percent.
Almost three quarters of this growth occurred as a result of mortgage
lending. This activity will certainly slow in coming quarters due to higher
But while refi activity has already fallen off, substantial volume remains in
the origination pipeline and housing activity remains very strong.
Existing home sales remained at all-time highs in August, while housing
starts rose to new highs for this cycle.
Commercial loans, on the other hand, declined for the tenth consecutive
As before, the shrinkage is mainly concentrated at a few large banks. But
annual data collected in June also show that the trend has been spreading to
small commercial loans during the past year.
Tighter standards play some role, but slack loan demand has played a larger
We expect that business loan demand should pick up in the second half of the
year along with overall economic activity.
Given their generally strong financial condition, FDIC-insured institutions
will remain reliable providers of credit for both businesses and households.
Falling interest rates during the second quarter continued to put downward
pressure on net interest margins. But the strong growth in mortgage loans, in
particular, allowed banks to grow their net interest income in spite of the
Margins could improve going forward due to the recent rise in long-term
interest rates, but that will depend on what kind of volume we see in mortgage
lending and securities purchases.
Higher rates are unlikely to cause significant increases in funding expenses,
since banks and thrifts tend to fund their assets with short-term liabilities.
The challenges of generating margin growth in this unique interest rate
environment represents one of the “headwinds” for the industry in terms of
generating growth in net interest income going forward.
Asset-quality indicators improved for the third consecutive quarter.
The percentage of total loans that were noncurrent – 90 days or more past due
or in nonaccrual status – fell from 1.31 percent to 1.24 percent during the
The amount of loans charged off was $118 million below the level of the first
quarter and $1 billion less than a year earlier.
The area of greatest improvement in asset quality has been commercial and
After 5 years of rising levels of troubled loans, we have seen significant
improvement in noncurrent commercial and industrial (or C&I) loans and in C&I
loan charge-offs for three consecutive quarters.
This improvement has occurred where most of the previous deterioration took
place – at large commercial banks.
This looks to us like a longer-term trend, albeit one that depends on
continued improvement in the overall economy.
Credit-card loans remain an exception to the improving trend in asset
Net charge-off rates on credit-card portfolios have continued to rise in line
with increases in personal bankruptcy filings, which totaled some 1.6 million in
the 12 months ending in June.
The profitability of credit card lenders has not been adversely affected by
higher loan losses; as a group, credit card lenders earned a return on assets of
over 4 percent during the quarter.
Asset-quality indicators for the other areas of the industry’s loan portfolio
remain fairly stable. This includes commercial real estate portfolios, where
market conditions have deteriorated but loan performance remains strong.
The improving overall trend in asset quality continues to have a positive
effect on core earnings.
Loan-loss provisions have declined from year-earlier levels in each of the
last three quarters.
Lower loss provisions accounted for more than one-third of the year-to-year
improvement in net operating revenue during the second quarter.
A key factor in subsequent quarters will certainly be lower gains on the sale
of securities and loans.
These gains have been one of the fastest-growing components of net income for
more than a year, reaching a record high in the second quarter.
However, now that interest rates have risen, these gains are unlikely to be
as high again.
Operating earnings, which exclude these gains, have not been rising as
rapidly as net income; without these gains, net income improvement will be more
difficult to achieve.
Pressure on operating earnings could come from slower asset growth.
Higher interest rates will slow origination volumes for mortgage loans. While
we anticipate higher demand for commercial loans, it is not clear that that
handoff has taken place as of yet.
On the plus side, lower expenses for loan-loss provisions should continue to
boost operating earnings.
Overall, the near-term outlook is for continued strong earnings, but new
quarterly earnings records may become harder to achieve.