Fourth District Bank Holding Companies
A bank holding company (BHC) is an organizational form that consists of a parent company that owns one or more commercial banks, other depository institutions and nonbank subsidiaries. While BHCs come in all sizes, we focus here on BHCs with consolidated assets of more than $1 billion. There are 21 BHCs headquartered in the Fourth District that meet this definition, including five of the top fifty BHCs in the United States, as of the fourth quarter of 2007.
The ongoing consolidation of the banking system nationwide is evident in the Fourth District. Despite the decline in Fourth District BHCs with assets over $1 billion (from 24 to 21 since the beginning of 1999 through the end of 2007), their total assets increased every year except 2000. In that year, assets held by Fourth District BHCs declined, reflecting the acquisition of Charter One Financial by Citizens Financial Group (which is headquartered in the First Federal Reserve District).
The largest five BHCs in the Fourth District rank in the top 50 of the largest banking organizations in the nation. Fourth District BHCs of all asset sizes account for roughly 4.6 percent of BHC assets nationwide, and BHCs with over $1 billion in assets make up the majority of the assets held by Fourth District BHCs.
The income stream of Fourth District BHCs deteriorated somewhat in 2007. The return on assets - measured by income before taxes and extraordinary items because a bank's extraordinary items can distort the true earnings picture - declined sharply to 0.98 percent, its lowest level in almost 10 years. This decrease has coincided with a weakening of net interest margins (interest income minus interest expense divided by earning assets). Currently at 2.89 percent, the net interest margin is at its lowest level in over 9 years.
Another indicator used to measure the strength of earnings is the level of income earned but not received. The level has been low for some time for Fourth District BHCs. 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 3 years, income earned but not received in the fourth quarter of 2007 (0.60 percent) is well below the recent high of 0.82 percent, which was recorded at the end of 2000.
Fourth District BHCs are heavily engaged in real estate related lending. As of the fourth quarter of 2007, about 40 percent of their assets are 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. Savings and small time deposits (time deposits in accounts less than $100,000) made up 53 percent of liabilities in the fourth quarter of 2007. Core deposits, the sum of transaction, savings, and small time deposits, made up 60 percent of Fourth District BHC liabilities as of the fourth quarter 2007, the highest level since 1998. Finally, total deposits made up about 70 percent of funds in 2007. Despite the requirement that large banking organizations have a rated debt issue outstanding at all times, subordinated debt represents only 2.8 percent of funding. As with large holding companies outside the Fourth District, BHCs in the Fourth District rely heavily on large negotiable certificates of deposit and nondeposit liabilities for funding.
Problem loans are loans that are more than 90 days past due 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. In the fourth quarter of 2007, 0.78 percent of all commercial loans were problem loans. Problem real estate loans, which have been creeping upward since 2005, jumped to their highest level (1.4 percent) at the end of 2007. Problem consumer loans (credit cards, installment loans, etc.) edged up slightly to 0.55 percent in the fourth quarter of 2007.
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 have been recovered in the current year. Net charge-offs for consumer loans and real estate loans increased slightly in the fourth quarter of 2007, and for commercial loans they remained flat. Net charge-offs in the fourth quarter of 2007 were limited to 0.42 percent of outstanding commercial loans, 0.91 percent of outstanding consumer loans, and 0.23 percent of outstanding real estate loans.
Capital is a bank's cushion against unexpected losses. The risk-based capital ratio (a ratio determined by assigning a larger capital charge on riskier assets) for Fourth District BHCs fell sharply from its peak in 2006 to 10.5 percent in 2007. The lower the capital ratio, the less protected is the bank. The leverage ratio (balance sheet capital over total assets) edged down to 9.2 percent from its recent peak of 9.9 percent in 2006.
An alternative measure of balance sheet strength is the coverage ratio. The coverage ratio measures the size of the bank's capital and loan loss reserves relative to its problem assets. As of the fourth quarter of 2007, Fourth District BHCs have $8.14 in capital and reserves for each dollar of problem assets, the lowest level in almost 10 years.