Meet the Author

James B. Thomson |


James B. Thomson

James Thomson is a former vice president and financial economist in the Research Department of the Federal Reserve Bank of Cleveland. He retired in February 2013.


Economic Trends

A Close Look at Fourth District Bank Holding Companies*

by James B. Thomson and Cara Stepanczuk

A bank holding company (BHC) is a parent company that owns one or more commercial banks. It may also own other types of depository institutions as well as nonbank subsidiaries. While BHCs come in all sizes, here we focus on BHCs with consolidated assets of more than $1 billion. There are 21 BHCs headquartered in the Fourth District that meet this definition, including seven of the top fifty BHCs in the United States, as of December 31, 2006.

The ongoing consolidation of the banking system nationwide is also evident within the Fourth District. Between 1999 and 2006, the number of BHCs in the Fourth District fell one-eighth (from 24 at the beginning of 1999 to 21 at the end of 2006), but the total assets of the remaining BHCs increased every year except 2000. The decline that year reflects the acquision of Charter One Financial by Citizens Financial Group, a BHC headquartered in another district.

The largest seven BHCs in the Fourth District rank in the top 50 largest banking organizations in the nation. In all, Fourth District BHCs with more than $1 billion in assets account for around 4.7 percent of BHC-held assets nationwide and the majority of assets held by BHCs in the Fourth District.

The income stream of Fourth District BHCs has improved slightly in recent years. The return on assets has risen unevenly from 1.9 percent in 1998 to 2.3 percent in 2006. (Return on assets is measured by income before taxes and extraordinary items, because a bank’s extraordinary items can distort the true earnings picture.) This increase occurred despite weakening net interest margins (interest income minus interest expenses, divided by earning assets). Currently at 3.06 percent, the net interest margin is at its lowest level in eight years.

Another indication of the strength of earnings is the continued low level of income earned but not received. If a loan allows the borrower to pay an amount that does not cover the interest accrued on the loan, the uncollected interest is booked as income even though there is no cash inflow. The assumption is that the unpaid interest will eventually be paid before the loan matures. However, if an economic slowdown forces an unusually large number of borrowers to default on their loans, the bank’s capital may be impaired unexpectedly. Despite a slight rise over the past two years, income earned but not received at the end of 2006 (0.58 percent) was still well below the recent high of 0.82 percent at the end of 2000.

Fourth District BHCs are heavily engaged in real-estate-related lending. As of the fourth quarter of 2006, about 38 percent of their assets were in loans secured by real estate. Including mortgage-backed securities, the share of real-estate-related assets on the balance sheet is 50 percent.

Deposits continue to be the most important source of funds for Fourth District BHCs. Saving and small time deposits (time deposits in accounts less than $100,000) made up 52 percent of liabilities at the end of 2006. Core deposits (the sum of transaction, saving, and small time deposits) made up 60.8 percent of Fourth District BHC liabilities as of the end of 2006, the highest level since 1998. Finally, total deposits made up nearly 70 percent at the end of last year. Despite the requirement that large banking organizations must have a rated debt issue outstanding at all times, subordinated debt represents only around 3 percent of funding.

Problem loans are loans that have been past due for more than 90 days but are still receiving interest payments, as well as loans that are no longer accruing interest. Problem commercial loans rose sharply starting in 1999, peaked in 2002, and settled below 0.75 percent of assets in 2004, thanks in part to the strong economy. Currently, 0.68 percent of all commercial loans are problem loans. Problem real estate loans are only 0.47 percent of all outstanding real-estate-related loans, though this percentage edged upward in 2006. Problem consumer loans (credit cards, installment loans, etc.) remained relatively flat, declining slightly in 2006. Currently, 0.39 percent of all outstanding consumer loans are problem loans.

Net charge-offs are loans removed from the balance sheet because they are deemed unrecoverable, minus the loans that were deemed unrecoverable in the past but which have been recovered in the current year. As with problem loans, there was a sharp increase in net charge-offs of commercial and consumer loans in 2001. Fortunately, the charge-off levels returned to their pre-recession levels in recent years. The net charge-offs in the fourth quarter of 2006 were limited to 0.42 percent of outstanding commercial loans, 0.73 percent of outstanding consumer loans, and 0.14 percent of outstanding real estate loans.

Capital is a bank’s cushion against unexpected losses. The recent upward trend in the capital ratios indicates that Fourth District BHCs are sufficiently protected. The leverage ratio (balance sheet capital over total assets) stands at 9.9 percent, and the risk-based capital ratio (a ratio determined by assigning a larger capital charge on riskier assets) is at 11.9 percent, both signs of strength for Fourth District BHCs.

An alternative measure of balance sheet strength is the coverage ratio. The coverage ratio measures the size of a bank’s capital and loan loss reserves relative to its problem assets. As of the fourth quarter of 2006, Fourth District BHCs have $17.72 in capital and reserves for each dollar of problem assets. While the coverage ratio is below its recent high at the end of 2004, it remains well above the levels at the end of the 1990s.

[UPDATE: The number of BHCs and their assets relative to BHCs nationwide have been updated since this article was originally posted.][top]