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Banking & Finance AN EIGHTH DISTRICT PERSPECTIVE WINTER 1988 Margin Analysis at District Banks In the com petitive world of com m ercial banking, the financial success o f a bank is contingent on the institution’s ability to m axim ize the difference between revenue and cost. Ensuring success entails actions by bank m anagement to generate revenue and control costs. M ore c o n c re te ly , m a n a g e rs m ake n u m e ro u s d e c is io n s concerning asset and liability m anagem ent, the pricing of services and operating expenses. Two indicators of the results of these decisions are interest and noninterest m argins. This issue of Banking and Finance examines these indicators for com m ercial banks in the Eighth Federal Reserve District and throughout the United States for the years 1986 and 1987. Table 1 Net Interest Margin 19871 District U.S. Aggregate < $25 million in assets $25-50 million $50-100 million $100-300 million $300-1 billion $1-10 billion > $10 billion 4.08% 3.71% 4.23 4.29 4.18 4.34 4.22 4.38 4.22 4.36 4.41 4.35 3.71 4.07 N.A. 2.84 1986 District U.S. 4.05% 4.30 4.20 4.24 4.12 4.12 3.74 N.A. 3.76% 4.29 4.34 4.39 4.33 4.26 3.92 3.12 ’Annualized based on data through September 1987 Net Interest Margin An important measure of the results of asset and liability management is the net interest margin, the difference between interest income and interest expense as a percent of average assets. This ratio indicates how well interestearning assets are being employed relative to interest-bearing liabilities. On the asset side, this includes interest income and fees related to interest-earning assets. Examples are interest on loans, points on loans, income on tax equivalent municipal loans and bonds and income on U.S. government securities. On the liability side, interest expense includes the amount paid on all categories of interest-bearing deposits, short-term deposit-like instruments and capital notes. In simplest terms, net interest margin is the difference between what a bank earned on loans and investments and what it paid its depositors relative to average assets. A bank is concerned not only with the level of the net interest margin, but also with the variability of the net interest margin over time. With volatile interest rates, the stability of the net interest margin indicates that the interest sensitivity of assets and liabilities is matched. Source: FDIC, “Consolidated Reports of Condition and Income for Insured Commercial Banks,” 1986-1987. Table 1 shows the average net interest margin for com m ercial banks on a national and regional level. For 1986 and 1987, the average aggregate net interest margin of D istrict banks exceeds that of the nation. The average results, however, conceal differences between asset-size classes. U pon clo se r in spection of the asset-size categories, banks across the nation tended to outperform banks in the Eighth District. For five of the six categories encom passing banks with assets less than $10 billion, averages for the D istrict banks are below the national average. The overall national average is reduced because of the net interest m argins of the banks (none of w hich are in the Eighth District) with assets greater than $10 billion. This category of banks experienced a decline in net interest m argin due, in part, to lost income from nonperforming foreign loans. In 1987, many large banks placed millions of Latin A m erican loans on nonaccrual status, m eaning that even if the bank FEDERAL RESERVE BANK OF ST. LOUIS WINTER 1988 receives an interest payment it will not be counted as interest-earning income. Noninterest Margin The noninterest m argin is an indicator of the efficiency of a bank’s operations and the result of its pricing and marketing decisions. The noninterest m argin is the difference betw een other (noninterest) incom e and noninterest expense as a percentage of average assets. Since noninterest expense generally exceeds other income, the calculation yields a negative num ber; however, it is common practice for the noninterest margin to be reported as a positive number. Thus, sm aller noninterest m argins indicate better bank performance, holding all other things constant. As a supplement to income generated from earning assets, banks have been concentrating their efforts on fee income. Noninterest income derived from bank services and sources other than interest-bearing assets has increased as banks seek to price more of their products explicitly. Sources of noninterest income include fees for checking accounts, discount brokerage services, credit cards, fiduciary activities, mortgage loan servicing and safe deposit box rentals. Noninterest expense includes all the expense items involved in overall bank operations. Noninterest expense (overhead) includes employee salaries and benefits as well as expenses of premises and fixed assets. Noninterest expense also covers such items as director’s fees, insurance premiums, legal fees, advertising costs and litigation charges. Table 2 shows the noninterest margin for banks in the Eighth District and in the nation grouped by various asset sizes. As presented in the table, D istrict banks outperform ed the national average across all asset sizes for both 1986 and 1987. In the aggregate, however, the nation outperform ed the District prim arily because of the pricing strategies and operating efficiencies of banks with assets greater than $10 billion. These banks continue to expand their noninterest sources of incom e while c o n tro llin g th e ir n o n in te re st expenses. S m aller institutions, on the other hand, have had m uch slower growth o f noninterest income. Therefore, noninterest income relative to average assets has rem ained essentially unchanged at small banks while increasing at banks with assets greater than $300 m illion. Noninterest expenses have been moving upward for the past several years in both the D istrict and the nation. As a result, banks are closely m onitoring personnel and occupancy costs in an effort to improve profits. Some banks have elected to reduce staff in an effort to streamline operations. In addition, mergers and consolidations have allowed banks the opportunity to centralize operations, improving efficiency due to improved economies of scale. —Lynn M . Barry Table 2 Noninterest Margin 19871 District U.S. Aggregate < $25 million in assets $25-50 million $50-100 million $100-300 million $300-1 billion $1-10 billion > $10 billion 2.00% 2.43 2.08 2.04 2.02 2.16 1.78 N.A. 1.92% 2.81 2.55 2.40 2.36 2.30 1.98 1.44 1986 District U.S. 1.97% 1.92% 2.51 2.90 2.13 2.58 2.07 2.47 2.01 2.36 2.34 2.20 1.61 1.95 N.A. 1.42 1Annualized based on data through September 1987 Source: FDIC, “Consolidated Reports of Condition and Income for Insured Commercial Banks,” 1986-1987. Banking & Finance—An Eighth District Perspective is a quarterly summary of banking & finance conditions in the area served by the Federal Reserve Bank of St. Louis. Single subscriptions are available free of charge by writing: Research and Public Information Department, Federal Reserve Bank of St. Louis, P.O. Box 442, St. Louis, Missouri 63166. Views expressed are not necessarily official positions of the Federal Reserve System. WINTER 1988 FEDERAL RESERVE BANK OF ST. LOUIS EIGHTH DISTRICT BANKING DATA LARGE WEEKLY REPORTING BANKS*1 Rates of Change Level IV/1987 ($ millions) Current Quarter 111/1987IV/1987 Current Year IV/1986IV/1987 Same Periods Previous Year IV/1985111/1986IV/1986 IV/1986 Selected Assets & Liabilities $20,054 6,619 4,767 5,535 816 2,315 Total Loans & Leases Commercial Loans Consumer Loans Real Estate Loans Loans to Financial Institutions All Other Loans Total Securities U.S. Treasury & Agency Securities Other Securities Total Deposits Non-Transaction Balances MMDAs $100,000 CDs Demand Deposits Other Transaction Balances2 13.4o/o 14.9 25.4 23.6 9.6 -1 9 .8 10.8% 8.0 17.7 13.6 22.3 - 2 .4 12.3 22.8 - 6 .2 21.0 48.9 -1 4 .1 7.3 13.8 - 2 .4 5.7 10.4 - 6 .0 28.9 - 5 .4 10.7 18.0 4.0 21.5 - 0 .6 41.0 50.9 7.9 3.1 22.1 - 3 .7 14.0 26.7 8.7% 12.4 - 3 .7 26.2 -2 5 .6 3.4 8.5% 8.0 8.4 25.4 -2 8 .6 - 3 .2 4,830 3,366 1,465 15.4 22.4 1.1 23,194 14,492 2,627 4,856 6,214 2,488 11.1 12.9 -1 5 .3 36.5 11.3 1.0 EIGHTH DISTRICT INTEREST RATES3 Dec 1987 NOWs MMDAs Time CDS 92 — 182 days 1 — 2 V2 years 2 1/2 years and over Nov 1987 Oct 1987 Dec 1986 5 .050/0 5.42 5.05% 5.39 5 .030/0 5.42 5.07% 5.27 6.45 7.05 7.57 6.32 6.97 7.58 6.42 7.09 7.59 5.63 6.26 6.73 All data are not seasonally adjusted. 1 2 3 A sample of commercial banks with total assets greater than $750 million. Historical data have been revised to incorporate adjustm ent factors that offset the cumulative effects of mergers and other changes involving weekly reporting banks during 1986. These adjustment factors, which are computed each year, are used to construct a consistent time series for which year-to-year growth rates can be calculated. Adjustment factors are available upon request from the Statistics Section of the Research and Public Information Department. Rates of change are compounded annual rates. Includes NOW, ATS and accounts permitting telephone or pre-authorized transfers. Average interest rates paid on new deposits by a sample of Eighth District commercial banks. 3 BANK PERFORMANCE RATIOS1 Eighth District 111/87 111/86 United States 111/85 111/87 111/86 m /85 Return on A verage Assets (annualized) <$100 million $100 — $300 million $300 million — $1 billion >$1 billion .99% 1.01 .96 .59 1.06% .99 .83 1.01 1.07% 1.09 .48 .84 .65% .81 .57 - .3 3 .66% .85 .68 .65 .87°/ .93 .84 .68 Return on A verage Equity (annualized) <$100 million $100 — $300 million $300 million — $1 billion >$1 billion 11.02 12.31 12.11 8.90 11.88 12.29 10.68 14.93 12.09 13.58 6.36 12.98 7.35 10.35 8.15 -6 .1 8 7.56 11.26 9.80 11.25 9.82 12.12 11.81 12.21 56.71 65.94 69.64 85.95 55.37 62.22 67.69 81.98 56.64 64.54 67.06 79.13 59.20 65.70 75.63 87.23 58.51 64.06 72.52 86.78 60.41 65.35 71.22 86.36 2.31 2.09 1.87 2.42 2.84 2.24 2.58 2.12 3.08 2.31 2.85 2.45 2.94 2.47 2.56 4.10 3.41 2.68 2.74 2.97 3.33 2.72 2.47 3.24 1.50 1.41 1.39 1.92 1.42 1.33 1.37 1.43 1.26 1.16 1.30 1.39 1.63 1.53 1.71 3.08 1.53 1.41 1.59 1.66 1.30 1.27 1.31 1.42 .47 .42 .52 .46 .61 .57 .59 .39 .66 .36 .52 .45 .73 .53 .66 .55 .92 .64 .65 .61 .74 .50 .45 .49 Loans as Percent of Deposits < $ 10 0 million $100 — $300 million $300 million — $1 billion >$1 billion N onperfo rm ing Loans as Percent of Total Loans 2 < $ 10 0 million $100 — $300 million $300 million — $1 billion >$1 billion Loan Lo ss R ese rve s as Percent of Total Loans < $ 1 0 0 million $100 — $300 million $300 million — $1 billion >$1 billion Net Loan Losses as Percent of To ta l Loans < $ 1 0 0 million $100 — $300 million $300 million — $1 billion >$1 billion 1 Size range based on bank assets. 2 Includes past due greater than 89 days and nonaccrual.