Banks experience trend of higher earnings, risk

In an apparent reflection of the overall economy, the banking industry is increasingly characterized by higher earnings and increased risk, according to a release from Veribanc Inc., a bank research and analysis firm.

Record-setting profitability, increased volatility and growth, driven both by management choices and such external factors as interest rates, will likely dominate the banking system until the onset of the next general economic downturn, Veribanc stated.

Bank problem areas include business loan defaults, agricultural financing erosion and credit card delinquencies. Details from Veribanc appear below, based on the firm's analysis of the Federal Reserve Board's March 16 release of raw call report data for the nation's 9,122 banks. Earlier data is also factored in.

New highs in profitability

As the banking industry establishes another year of record profitability, institutions continue to polarize into the have and have not categories. Among the haves, 43 banks with stable asset bases* recorded returns that exceeded 5 percent of their assets. Twenty-one of these enjoyed double digit or better returns on assets. The 10 most profitable banks in the country, many of them specialty institutions that take advantage of off-balance sheet transactions to keep their size and capital requirements down, are listed below.

*Quarterly average assets remained within 20 percent of average assets for the year.

Rapid souring of business loans

Seriously delinquent* commercial and industrial loans rose to $12.5 billion during the fourth quarter, up from $10.4 billion at year end 1998 and $8.6 billion at the end of 1997. This growth, somewhat faster than the overall increase in business lending, appears to indicate banks' lowering of loan underwriting standards insofar as few areas of the industrial economy appear to be faltering.

*Ninety days or more past due or nonaccrual

Slower growth in ag loan delinquency

For the past several years, as the farm economy has suffered from unusually low commodity prices, damage to overseas markets, scattered droughts and shifting government support programs, banks' credit risk in the agricultural sector has increased, Veribanc stated. As the table below illustrates, the rise was not as severe in 1999 as in previous years.

A total of 46 agricultural banks have amounts of seriously delinquent loans net of reserves and government guarantees in excess of 25 percent of their equity. They are located in the states of Arkansas, Colorado, Iowa, Illinois, Indiana, Kansas, Missouri, Minnesota, North Dakota, Nebraska, South Dakota, Oklahoma, Texas, Wisconsin and Wyoming.

Rising rates pinch securities portfolios

Banks have a total of $171 billion in securities that they intend to hold until they mature. These assets are carried on their books at values based on their cost. When interest rates rise, such securities typically lose value. At year-end 1999, all banks together had unrecognized losses of $3.7 billion in their held-to-maturity securities portfolios, Veribanc reports.

These embedded losses contrast with unrecognized gains of $2 billion at year-end 1998. On the average, damage to banks' securities portfolios by recent interest rate increases is minimal. However, for 235 institutions, unrecognized securities losses represent double digit percentages of their equity (vs. eight banks that had unrecognized losses in their held-to-maturity securities portfolio in excess of 10 percent of equity as of year-end 1998). This problem will worsen if the Federal Reserve continues to boost rates.

Credit card debt nonpayment remains high

Credit card debt to bank customers exceeded $500 billion in the fourth quarter. Serious delinquencies crossed the $4 billion level. However, both the ongoing delinquency and charge-off rates continue to follow a seasonal pattern that averages to yearly charge-offs of $1 for every $22 of card debt outstanding on banks' balance sheets.

Average amounts that are seriously delinquent continue to hover near 2 percent of bank card debt outstanding. For comparison, seriously delinquent non-card consumer debt is 1.02 percent of all non-card consumer debt.

Current levels of seriously delinquent card debt, although down from 1997 and 1998, are considerably higher than during the mid-1990s.

With few exceptions, card issuers are able to remain profitable in the face of these credit losses by their continued reliance on fee income. The continuing risk associated with this business model is twofold in a sharp economic downturn, nonpayment of card debt will rise significantly while fee income, much of which is discretionary to cardholders, will fall.

Banks with problems

In the final reporting quarter of 1999, a total of 1,011 banks reported negative income. This amount represents approximately 11 percent of all banks, virtually unchanged from the final quarter of 1998. While some of these institutions were beset only by temporary problems, others have more deep-rooted difficulties, including rates of loss sufficient to exhaust equity within one year, equity of less than 5 percent of assets and problem loans net of reserves exceeding equity.