Summary
According to the FDIC, troubled assets continued to mount at insured commercial banks and savings institutions in the third quarter of 2008, placing a growing burden on industry earnings. Expenses for credit losses topped $50 billion for a second consecutive quarter, absorbing one-third of the industry’s net operating revenue (net interest income plus total noninterest income). Third quarter net income totaled $1.7 billion, a decline of $27.0 billion (94.0%) from the third quarter of 2007. The industry’s quarterly return on assets (“ROA”) fell to 0.05%, compared to 0.92% a year earlier. This is the second-lowest quarterly ROA reported by the industry in the past 18 years. Evidence of a deteriorating operating environment was widespread. A majority of institutions (58.4%) reported year-over-year declines in quarterly net income, and an even larger proportion (64.0%) had lower quarterly ROAs. The erosion in profitability has thus far been greater for larger institutions. The median ROA at institutions with assets greater than $1 billion has fallen from 1.03% to 0.56% since the third quarter of 2007, while at community banks (institutions with assets less than $1 billion) the median ROA has declined from 0.97% to 0.72%. Almost one in every four institutions (24.1%) reported a net loss for the quarter, the highest percentage in any quarter since the fourth quarter of 1990, and the highest percentage in a third quarter in the 24 years that all insured institutions have reported quarterly earnings.
Yield Environment
One of the few relatively bright spots in third quarter results was net interest income, which was $4.4 billion (4.9%) higher than a year ago. The average net interest margin (“NIM”) in the third quarter was 3.37%, unchanged from the second quarter but up from 3.35% in the third quarter of 2007. Two out of every three institutions reported margin improvement over second-quarter levels, but more than half of all insured institutions (54%) reported lower NIMs than in the third quarter of 2007. The year-over-year improvement in the industry’s NIM was concentrated among larger institutions. Higher margins helped offset sluggish growth in interest-earning assets. Earning assets increased by only $52.3 billion (0.5%) during the quarter, after shrinking by $33.6 billion (0.3%) in the second quarter. Over the 12 months ended September 30, the industry’s interest-earning assets were up by only 4.2%, the lowest 12-month growth rate in more than six years.
Asset Quality
The industry reported year-over-year growth in net charge-offs for the seventh consecutive quarter. Net charge-offs totaled $27.9 billion in the quarter, an increase of $17.0 billion (156.4%) from a year earlier. Two-thirds of the increase in charge-offs consisted of loans secured by real estate. Charge-offs of closed-end first and second lien mortgage loans were $4.6 billion (423%) higher than in the third quarter of 2007, while charged-off real estate construction and development (C&D) loans were up by $3.9 billion (744%). Charge-offs of home equity lines of credit were $2.1 billion (306%) higher. Charge-offs of loans to commercial and industrial (C&I) borrowers increased by $2.3 billion (139%), credit card loan charge-offs rose by $1.5 billion (37.4%), and charge-offs of other loans to individuals were $1.7 billion (76.4%) higher. The quarterly net charge-off rate in the third quarter was 1.42%, up from 1.32% in the second quarter and 0.57% in the third quarter of 2007. This is the highest quarterly net charge-off rate for the industry since 1991. The failure of Washington Mutual on September 25 meant that a significant amount of charge-off activity was not reflected in the reported industry totals for the quarter.
TThe amount of loans and leases that were noncurrent (90 days or more past due or in nonaccrual status) increased to $184.3 billion at the end of September. This is $21.4 billion (13.1%) more than insured institutions reported as of June 30 and is up by $101.2 billion (122%) over the past 12 months. The percentage of total loans and leases that were noncurrent rose from 2.04% to 2.31% during the quarter and is now at the highest level since the third quarter of 1993. The growth in noncurrent loans during the quarter was led by closed-end first and second lien mortgage loans, where non-currents rose by $9.6 billion (14.3%). Non-current real estate C&D loans increased by $6.9 billion (18.1%), while noncurrent loans secured by nonfarm nonresidential properties rose by $2.2 billion (18.1%). Non-current C&I loans were up by $1.8 billion (13.7%) during the quarter.
Loan-loss reserves increased by $11.7 billion (8.1%) during the quarter, the smallest quarterly growth in reserves since the third quarter of 2007. The industry’s ratio of reserves to total loans and leases increased from 1.81% to 1.95%, its highest level since the first quarter of 1995. However, reserve growth did not keep pace with the growth in noncurrent loans, and the “coverage ratio” of reserves to noncurrent loans fell from 89 cents in reserves for every $1.00 of noncurrent loans to 85 cents. This is the tenth consecutive quarter that the industry’s coverage ratio has fallen; it is now at its lowest level since the first quarter of 1993.
Growth
Total assets of insured institutions increased by $273.2 billion (2.1%) in the third quarter, led by growth in balances at Federal Reserve banks (up $146.8 billion, or 505%) and a $74.6-billion increase in asset-backed commercial paper holdings. A number of large banks experienced sizable deposit inflows during the quarter and elected to place a large share of these funds with Federal Reserve banks. The increase in holdings of commercial paper was attributable to the creation of a special lending facility—the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (“AMLF”)—by the Federal Reserve aimed at providing liquidity to money market mutual funds (“MMFs”) by funding bank purchases of asset-backed commercial paper from the MMFs. Loans in categories experiencing the greatest credit-quality problems shrank in the third quarter. Residential mortgage loans declined by $52.1 billion (2.4%), while real estate C&D loans fell by $10.2 billion (1.6%). One of the few loan categories showing significant growth was real estate loans secured by nonfarm nonresidential properties, which increased by $24.4 billion (2.4%). Unused loan commitments declined by $298.1 billion (3.7%) during the quarter. The decline was led by a reduction in unused credit card lines, which fell by $122.8 billion (2.6%).
Non-deposit liabilities increased by $162.5 billion (4.8%) in the third quarter, as insured institutions increased their borrowings from the Federal Reserve’s Discount Window (which was used to fund the AMLF), as well as their advances from Federal Home Loan Banks. Securities sold under repurchase agreements registered strong growth, rising by $64.2 billion (11.2%). Total deposits increased by $154.8 billion (1.8%), as noninterest-bearing deposits in domestic offices rose by $175.7 billion (14.4%). The growth in deposits was concentrated in a few large banks. Deposits in foreign offices declined by $38 billion (2.5%).
The number of insured commercial banks and savings institutions fell to 8,384 in the third quarter, down from 8,451 at midyear. During the quarter, 73 institutions were absorbed in mergers, and 9 institutions failed. This is the largest number of failures in a quarter since the third quarter of 1993, when 16 insured institutions failed. Among the failures was Washington Mutual Bank, an insured savings institution with $307 billion in assets and the largest insured institution to fail in the FDIC’s 75-year history. There were 21 new institutions chartered in the third quarter, the smallest number of new charters in a quarter since 17 new charters were added in the first quarter of 2002. Four insured savings institutions, with combined assets of $1.0 billion, converted from mutual ownership to stock ownership in the third quarter. The number of insured institutions on the FDIC’s “Problem List” increased from 117 to 171, and the assets of “problem” institutions rose from $78.3 billion to $115.6 billion during the quarter. This is the first time since the middle of 1994 that assets of “problem” institutions have exceeded $100 billion.