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TESTIMONY OF

L. WILLIAM SEIDMAN
CHAIRMAN
FEDERAL DEPOSIT INSURANCE CORPORATION
WASHINGTON, D.C.

ON

Y

CONDITION OF THE BANK INSURANCE FUND

BEFORE THE

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS SUPERVISION,
REGULATION AND INSURANCE
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
UNITED STATES HOUSE OF REPRESENTATIVES




10:00 A.M.
September 19, 1989
Room 2128, Rayburn House Office Building

Good morning, Mr. Chairman and members of the Subcommittee.

We

are pleased to report on the integrity of the Bank Insurance
Fund and the status of supervision as the Federal Deposit
Insurance Corporation begins to implement the Financial
Institutions Reform, Recovery and Enforcement Act of 1989
(FIRREA).

The Bank Insurance Fund is solvent and can meet the

obligations as we foresee them today.

The FDIC's supervisory

staff will meet its obligations under the new legislation but
only with extraordinary efforts and with some start up strains.

Status of the Bank Insurance Fund

Despite reporting the first operating loss in our fifty-five
year history at year-end 1988, the overall financial condition
of the FDIC remains strong, and the outlook for the Bank
Insurance Fund is positive.

For the first six months of 1989,

net income for the Fund was $171 million.

Comparing this to the

same period in 1988, Insurance Fund revenues increased by eight
percent, while expenses fell 40 percent.

We expect the fund to

break even or show a slight reduction for the full year and to
show an increase in 1990.

Last year a record 200 banks failed and 21 institutions required
financial assistance.

These included the failure of First

Republicbank in Dallas and the assistance of the Houston-based
First City Bancorporation.

Overall, the FDIC set aside reserves

for losses on approximately $80 billion of failed or failing




2

bank assets in 1988, more than the combined total of assets
handled during the Corporation's first fifty-five years.

Included in the 1988 operating loss was the commitment of funds
to handle the resolution of three large problem banks in Texas
—

MCorp of Dallas, Texas American Bancshares of Fort Worth, and

National Bancshares Corporation of San Antonio —
were resolved earlier this year.

all of which

In total, provisions for

insurance-related losses in 1988 were $6.3 billion, more than
twice the provision in 1987.

As a result, the Insurance Fund

declined 23 percent from $18.3 billion, to a net worth of $14.1
billion at year-end 1988.

For the first six months of 1989,

provisions for insurance losses were $1.3 billion, significantly
below the $2.4 billion reserved after the same period one year
ago.

The composition of the Fund is an important barometer of its
condition.

At year-end 1988, nearly 74 percent of total assets,

or $16.5 billion, was in the form of cash or U.S. Treasury
securities.

Despite record insurance-related outlays, new

approaches to dealing with bank failures and aggressive
management of assets under liquidation enabled the Corporation
to maintain the investment portfolio of U.S. Treasury securities
at a level essentially unchanged from 1987.

The flexibility

these liquid assets provide is another reason we are confident
that the Bank Insurance Fund will remain adequate to handle any
foreseeable problems in the industry.




3

I Assessments from insured institutions and the interest earned on
the portfolio of U.S. Treasury securities are the primary
sources of FDIC income.

In 1988, the FDIC assessed insured

banks at the rate of 8.3 basis points of assessable deposits —
the static rate required by law prior to enactment of FIRREA.
Income from assessments totaled $1.8 billion, an increase of
$77 million from 1987 assessments.

During the first six months

of 1989 assessment revenues increased by $58 million over the
comparable period of a year ago.

This increase is in line with

our 1989 projection of $1.9 billion in assessment income by
year-end.

Interest on our portfolio of U.S. Treasury

obligations for 1988 amounted to $1.4 billion, a slight decline
from 1987.

For the first six months of 1989, interest earned on

Treasury obligations was $711 million, a $16 million increase
over the same time period in 1988.

In addition, the sale of NCNB, First City and Continental
Illinois National Bank stock will contribute significantly to
income in 1989.

However, this will be balanced by the necessary

repayment of approximately $3 billion in loans and advances from
the Federal Reserve Banks of Chicago and Dallas which resulted
from the Continental Illinois and NCNB Texas Bridge Bank
agreements.

This will only affect the composition of the fund,

not total net worth.

Several provisions in FIRREA provide the FDIC with additional
flexibility to help ensure that the Bank Insurance Fund can



4

effectively address future problems in the industry.

The

statutory assessment rates have been increased as a result of
FIRREA.

In 1990, insurance premiums will increase to 12 basis

points of assessable deposits, and in 1991 to 15 basis points.
We estimate that, ‘with a modest four percent annual growth rate
in assessable deposits, assessment income would be about $3
billion and $3.9 billion in 1990 and 1991, respectively.

In

addition, the FDIC has the flexibility to increase these rates
based upon the experience of the Fund.

The increased statutory

rates and the flexibility to change those rates will allow the
Fund to attain and then maintain the 1.25 percent target ratio
of the Insurance Fund to insured deposits.

This ratio also may

be increased if the FDIC determines that there is a significant
risk of substantial loss to the Fund.

The law also provides for

entrance fees on institutions entering or converting to the Bank
Insurance Fund in order to preserve the designated reserve
ratio.

Notwithstanding the record level of failures and assistance
transactions, in 1988 the FDIC acquired only 106,000 assets from
failed and assisted institutions with a book value of $9.3
billion.

This was a significant decline from the past three

years when the FDIC had 178,000 assets with a book value of
$11.3 billion having been acquired by year-end 1987; 192,000
assets with book value of $10.9 billion by year-end 1986 and
180,000 assets with book value of $9.6 billion by year-end
1985.




This reduction can be attributed to improved marketing
strategies and new approaches to selling failed-bank assets.
Retaining fewer assets from bank failures means that the FDIC
has more cash available for dealing with problem banks, and
there is less federal intervention in the marketplace.

Our success in reducing the size of the existing asset portfolio
was facilitated greatly by the success of our '’whole-bank"
purchase-and-assumption program.

In a "whole-bank"

purchase-and-assumption transaction, the acquirer agrees to
assume most of the assets of the failed bank, including the
nonperforming loans.

Thus, by pursuing "whole-bank" deals, more

failed-bank assets remain in the private sector.

We began using "whole-bank" transactions in 1987, and completed
19 of the 133 purchase-and-assumption transactions that year by
passing almost all of the failed banks' assets.

Of the 164

purchase-and-assumption transactions completed in 1988,
sixty-nine, or 42 percent, were "whole-bank" transactions.

With respect to the assets retained by the FDIC, strong
marketing and asset management has resulted in significant asset
sales at or near current appraised values.

Our policy is that

every asset is for sale at the appraised market price.

Getting

these assets back into the private sector at market prices is
the first step in helping troubled regional economies recover.




6

XftQ_Economy and the Condition of the Banking Industry

The financial well-being of the industry determines the
financial condition of the Bank Insurance Fund.

Bank failures

and open-bank assistance transactions were at record levels
during 1988 in size, number, and total cost to the Insurance
Fund.

This year, as of early September, 155 banks failed with

aggregate assets in excess of $26.6 billion.

However, we

believe that the worst of the problems in the banking industry
are behind us.

We expect this year's failure rate to be similar

to or slightly better than last year and we project the pace of
bank failures to slow next year.

As more fully described later,

the number of problem banks has decreased from 1,624 in mid-1987
to 1,193 as of September 15, 1989.

This is the first time since

the beginning of 1986 that the number of problem banks has been
fewer than 1,200.

The condition of the banking industry is closely tied to the
state of the national and regional economies.

We attach our

most recent Quarterly Banking Profile— released last week— which
provides statistics on current banking results.

Banks have had

record profits for the first six months of this year.
Furthermore, the outlook for inflation and interest rates is
positive at present.

Regional economies have been improving, particularly in the
Midwest, where the agricultural recovery has led to a strong




7

performance by banks in that region.

Although the economy in

the Southwest has shown signs of improvement, the lingering
effects of the oil and gas industry deterioration and the
collapse of the real estate market continue to limit the
recovery of Southwestern banks.

Most failed banks in 1988 were

located in Texas, Oklahoma and Louisiana.
for 113 failures —

Texas alone accounted

more than half of all failures last year.

So far this year, Texas has accounted for about two-thirds of
all failures.

The number of problem banks is decreasing in all

areas of the country except the Southwest.

Though the number

appears to have leveled off, the slow recovery in the Southwest
has precluded any improvement there.

The level of nonperforming assets historically has been an early
indicator of a problem.

Industrywide, nonperforming loans have

been rising slowly in 1989, and now comprise 2.25 percent of
total loans.

Although they are not at the 2.6 percent level

reached in early 1987, the regional breakdown of nonperforming
loans is something we are monitoring closely.

In the Northeast, a softening real estate market has boosted the
level of noncurrent real estate loans in bank portfolios.
Second quarter results for the Northeast region show noncurrent
real estate loans to be 2.76 percent of all real estate loans,
an increase of more than one percentage point over the second
quarter of 1988.

The Northeast also is where most of the

FDIc-insured savings banks are located.




The condition of these

8

institutions has weakened over the past few years, as net
interest margins have narrowed and nagging asset quality
problems have become more pronounced.

However, the relatively

strong capital position of these institutions will help to
reduce potential losses to the Insurance Fund.

Overall, banks have performed well and profit levels are
impressive.

During the first half of 1989, banks earned a

record $14.3 billion, compared to $10.4 billion in the first
half of 1988, while return on assets (ROA) for the first six
months was 0.91 percent as compared to 0.69 percent for the same
period one year ago.

Bank Supervision

The FDIC directs its supervisory efforts toward maintaining the
safety and soundness of the banking system and protecting the
deposit insurance funds.

We are the primary federal supervisor

for over 8,000 state nonmember commercial and savings banks with
over $900 billion in assets.

In addition, we monitor the

condition of approximately 6,000 national and state member banks
and cooperate with the other federal and state regulatory
authorities in their efforts to ensure the safe and sound
operation of these insured banks.

A major goal of the FDIC's bank supervisory program is to
control risk.




This is accomplished through a combination of

on-site examinations; off-site monitoring; the exchange of
information with other regulators (state and federal); the
development of supervisory guidelines, policy statements, rules
and regulations; the use of informal and formal enforcement
actions and, if needed, the termination of insurance.

In July of last year, we revised our statement of goals
regarding examination priorities to increase the level and
frequency of on-site supervision.

Our goal is to have an

on-site examination every 24 months for well-rated institutions
(those rated 1 or 2) and one every 12 months for problem and
near-problem institutions (those rated 3, 4, or 5).

Some of

these intervals can be extended if an acceptable state
examination is conducted.

In 1988, we conducted 4,019 on-site

s a f

ety-and-soundness

examinations compared to 3,653 in 1987 and 3,194 in 1986.

We

expect to complete more than 4,100 examinations during 1989.

We

had expected to do considerably more than 4,100 this year, but
had to revise that goal due to our involvement as conservator
for insolvent thrifts.

Even with that additional role, however,

we will still exceed last year's examination tally.

As of March 31, 1989, ninety-one percent of the 4- and 5-rated
state nonmember banks had undergone an FDIC examination,
visitation, or state examination within the preceding
twelve-month period.




The other nine percent are monitored

10

closely, and in most cases were examined within the last two
years.

This nine percent of the 4- and 5-rated banks generally

already had supervisory corrective actions in place, and
management was being responsive to these supervisory
recommendations.

Also, as of March 31, 1989, only eight percent of all 1- and 2rated state nonmember banks have not had an FDIC or acceptable
state examination or visit within the last three years.

It is

important to note that even when the FDIC has not conducted an
on-site examination within the goal period, the bank's condition
has been analyzed through quarterly off-site monitoring, short
on-site visitations or targeted examinations and the review of
state and other federal agency examination reports, and other
pertinent information.

It is only after these reviews that the

examination cycle is extended.

We continuously look at all

problem and special situations and review work completed by the
other federal and state regulators.

Since many of our banks are

members of multibank holding companies, we also review holding
company reports from the Federal Reserve and examination reports
of other banks in the holding company to remain as informed as
possible.

Today's banking environment demands that we identify emerging
trends with potential areas of risk and pinpoint individual
banks with symptoms of higher than normal risk.

The traditional

methods of conducting on-site examinations based on fixed




11

examination cycles are giving way to more continuous methods of
supervision.

We believe our current program of using on-site

examinations or visitations complemented with off-site
activities is the most efficient use of supervision resources at
this time.

Improvement in examination frequency is accomplished by
increasing the number of field examiners.

We have been

increasing staff since 1984, when our examiner force numbered
only 1,389.

At year end 1988, the FDIC employed 1,983 bank

examiners and we expect this number to increase to about 2,400
by the end of 1989.

We are hiring talent as rapidly as they can

be absorbed and expect to establish a new, higher staffing
target when we complete an analysis of resource requirements for
our thrift responsibilities under FIRREA.

In order to continue to attract and retain the best possible
candidates, we have recently increased salaries and are building
a new training center.

Further, we are able to hire very good

talent due to an expedited hiring procedure available with
respect to college students who have a 3.5 grade point average
or who are in the top ten percent of their class.

We are

committed to maintaining our own well-trained examiner work
force and to providing training support to examiners from state
banking departments.

Our examiner turnover ratio of approximately 12 percent during
1988, while somewhat high, is mostly reflective of the increase



12

in new hires over the last few years.

Traditionally, turnover

is above average for newly hired examiners.

This rate is

nevertheless higher than we desire and we are currently studying
ways to retain as many of our highly trained and qualified
examiners as possible.

Our cooperative Federal/State examination program, which was
implemented in July 1988, is providing valuable support and
flexibility to our bank examination work.

It has built on our

long-standing tradition of federal and state cooperation by
explicitly stating the FDIC's policy to communicate and
coordinate regularly with the states and to make maximum use of
state examination resources.

The support this program provides

was recently demonstrated when a significant part of our
examination force was required to assist in assuming control of
over 200 S&Ls.

With the help of the state supervisors, we saw

that all banks in need of close supervision continued to receive
it.

We expect that our responsibilities for savings

associations will take full advantage of acceptable work by the
Office of Thrift Supervision and the various states.

Thrift Supervision

FIRREA has assigned the FDIC substantial responsibilities for
the supervision of some 2,900 savings associations.
to deposit insurance and general backup enforcement




In addition

responsibilities, the FDIC also has responsibility for
overseeing several important thrift activities —

such as the

exercise of nontraditional powers, the holding of junk bonds and
the acquisition of brokered funds.

In order to assure that these responsibilities are fully and
properly addressed, we expect to have an FDIC on-site presence,
either a full scale examination and/or a targeted visit(s), in
every insured savings association by the end of 1990.

Our

approach will emphasize coordination and close working
relationships with the Office of Thrift Supervision and state
regulators with the goal being timely and effective supervision
of savings and loans and the avoidance of duplication of effort
on the part of the various regulatory agencies.

We will fulfill our new thrift industry responsibilities, but
only with extraordinary efforts and some start up strains.

We

also intend to meet those responsibilities without material
impact on our supervisory role on the commercial bank side.

Bank Capital

In March of this year, the FDIC joined the Comptroller of the
Currency and the Federal Reserve Board in adopting risk-based
capital guidelines.

These guidelines establish ratios of total

capital to risk-weighted assets of 7.25 percent by year-end 1990
and eight percent by year—end 1992.

Currently, these guidelines

are in addition to the six percent leverage ratio which is



14

uniformly in place at all three federal banking agencies.

The Comptroller of the Currency has suggested a new capital
standard which has been issued for public comment.
important parts of the Comptroller's initiative.

We support
First, we

agree the various capital components need to be commonly defined
in applying both the leverage and the risk-based tests.
Moreover, we can agree on the proposed three percent core equity
requirement as well as the exclusion of reserves for loan and
lease losses as a component of core capital.

However, the Comptroller's proposal envisions no additional
leverage requirement beyond the three percent core and we think
that is unwise as it would lower capital requirements during a
period of problems in both the thrift and banking industries.
Our analysis indicates that the Comptroller's current proposal
would reduce the required minimum amount of capital in the
banking system by at least $8 billion.

As the insurer of the

industry, we would regard that as being an undesirable effect.
Thus, we believe the three percent core leverage test must be
supplemented with a total capital requirement which could
include secondary forms of capital such as those allowed under
the current leverage framework.

Common capital standards among the three Federal banking
agencies have been beneficial to the industry as well as the
insurance fund.




We are confident that acceptable common

15

standards will be developed before the risk-based standards
first begin to apply at year-end 1990.

Capital standards are only a first step in the supervisory
process for evaluating capital adequacy.

Many other factors

must be weighed before determining whether a bank's capital is
adequate for its particular circumstances.

Additional capital

above regulatory minimums will be necessary in institutions
contemplating significant expansion plans or those with higher
than normal risk profiles.

Factors such as interest rate risk,

asset quality, earnings performance, and the level of debt
outstanding in areas such as lesser developed countries and
leveraged buyouts, are fully considered by examiners when
evaluating a bank's capital adequacy.

However, minimum

standards are a safeguard which becomes more significant as the
supervisory force meets the challenge of enlarged
responsibilities.

Problem Banks and Enforcement Actions

After reaching an historical high of 1,624 in mid-1987, the list
of FDIC-insured problem banks has been declining.

This is due

primarily to increased supervisory attention, improvements in
the economy of the Midwest and the record number of failures.
As of September 15, 1989, the Bank Insurance Fund's problem bank
list contained only 1,193 institutions.

Although failures

contributed to the decline, many more problem banks have been




16

rehabilitated, usually with close supervisory guidance.

In

1988, 680 banks were removed from the problem list, with only
221 removed as a result of failure or FDIC financial assistance.

Historically, inept or abusive management has been a primary
cause of problem banks and this remains true today.

Weak

regional economic conditions reveal the vulnerability of weak
managements and the combination is the key reason for the recent
increases in bank failures.

During 1984 through 1988, of the 2,072 state nonmember banks
that at some point were considered problem banks, 899 or 43
percent were the subject of some form of FDIC formal action.
Additionally, informal actions such as memorandums of
understanding and corrective resolutions by a bank's board of
directors were used in less severe cases and where bank
management was considered responsive and committed to correcting
problems.

In these instances, the FDIC seeks to work in

cooperation with the bank's management in a joint effort to
restore the institution to financial stability.

Our Capital Forbearance program is an example of the approach we
believe is both useful and beneficial to the FDIC and
participating banks.

The program is available to any bank with

difficulties primarily attributable to economic problems beyond
the control of management.

Under the Capital Forbearance

program, a bank may operate temporarily with capital below




17

normal supervisory standards if it is viable and has a
reasonable plan for restoring capital.

Of the 193 banks

admitted to the program through July 31, 1989, 113 banks remain
in the program while 33 have been successfully terminated by
restoring capital and 47 banks were terminated unsuccessfully.
The period for banks to apply for this program expires on
December 31, 1989.

The FDIC believes that an independent external auditing program
combined with a strong internal audit function substantially
lessens the risk that a bank will not detect potentially serious
problems.

It also complements the FDIC's supervisory process by

further identifying or clarifying issues of potential concern or
exposure, especially in banks where problems have been
identified.

As a result, we adopted a statement of policy in

late 1988 which explicitly encourages banks to have an annual
external auditing program performed by an independent auditor.
We recognize that certain banks may decide not to engage a CPA
to perform an opinion examination and in those cases, the FDIC
recommends that each bank, at a minimum, have certain specific
auditing procedures performed annually by a qualified
independent external party.

We have issued for comment a policy

statement that contains specific recommended auditing procedures
for five high-risk areas: securities, loans, allowance for loan
losses, insider transactions and internal controls.




18

Fraud and Insider Abuse

The FDIC is taking a leading role in the fight against fraud and
criminal conduct in the banking industry.

Fraud and insider

abuse contribute to about one third of bank failures and
outright criminal conduct was present in about ten to twelve
percent of bank failures in recent years.

According to the

Federal Bureau of Investigation, the financial services industry
lost more than $2 billion due to criminal fraud cases closed in
1988, more than double any previous year's loss.

Since 1984, the FDIC has greatly strengthened its supervisory
response to bank fraud and insider abuse.

We published a list

of time tested "Red Flags” and other warning signs of fraud and
abuse to be used by examiners and auditors.

These have proven

very effective in ferreting out such practices.

Training for

all examiners has been improved, and about 70 senior examiners
have been chosen as fraud specialists.

They have been given

extensive training in fraud detection and investigative
techniques.

This "fraud squad" can be called upon to conduct

full-scale fraud investigations leading to a referral of
apparent criminal activity to the Department of Justice.

They

can assist federal investigators and prosecutors to understand
complex transactions and serve as expert witnesses at trial.
They also are available as a resource for other FDIC examiners
and act as on-the-job trainers for less experienced examiners.




19

We believe that fraud losses should be restored to the federal
deposit insurance funds wherever possible.

The FDIC is working

with the Department of Justice to convince judges to order
restitution to the insurance funds when losses are attributed to
dishonest insiders or customers.

We think restitution orders

should be sought and granted as a matter of course to minimize
the cost of criminal acts to the insurance funds and to prevent
offenders from enjoying their ill-gotten gains.

Less Developed Countries (LDC) Debt Situation

The regulatory agencies are implementing the International
Lending Supervision Act in a manner consistent with the language
and legislative history of the statute.

Through the Interagency

Country Exposure Review Committee (ICERC), the regulatory
agencies have required that specific reserves be established
against appropriate loans.

The agencies have required increased

capital in those banks involved in international lending.

Risks

to the banking system have been reduced significantly.

We continue to believe that decisions on reserving for losses
should be determined by individual borrower's debt service
capacity.

We find nothing to support banks reducing their LDC

reserves at this time.

For those banks with intentions to

dispose of LDC loans, higher reserves could be appropriately
determined by secondary market values.

Future actions in this

area will depend upon the results of current negotiations now
underway with debtor countries.



20

Leveraged Buyout (LBQ) Debt

We are taking special supervisory action to monitor banks'
participation in high-yield, high-risk "junk" bonds and highly
leveraged loans used to finance corporate restructurings.

Banks

have currently invested about $150 billion in leveraged buyout
loans.

Rising interest rates or an economic downturn could

result in highly leveraged businesses defaulting on these
loans.

Although banks usually reduce their exposure to losses

by selling the bulk of these loans, defaults on the amounts they
do retain could result in losses to the institutions.
Concentrations in this area must be avoided.

At this time we

see no immediate threat to the insurance fund.

However, should there be an economic downturn, defaults on such
debt could increase the risk of failures and thereby increase
costs to the FDIC.

Thus, as insurer, we will continue to

closely monitor LBO transactions to assure that risks are
controlled.

That concludes my prepared remarks.
to any questions at this time.




I would be happy to respond

ti* FDIC

uarterh
anking JLrofile
J

U Quarter 1989

L. William Seidman, Chairman

COMMERCIAL BANKING PERFORMANCE -S E C O N D QUARTER 1989

• Bank Earnings Remain Strong — First-Half Earnings Highest Ever
• Banks Boost Net Worth Ratio to Pre-1987 Level
• Asset Quality Problems Move East
• Southwest Banks Register Loss, But Turnaround May Be Imminent
• Number of Problem Banks Reaches Lowest Level in Three Years
Commercial banks earned $7 billion in the second
quarter, down from the $7.3 billion earned in the first
quarter, but 30.7 percent above the $5.4 billion earn­
ed in the second quarter of 1988. For the first six
months of 1989, industry net income totalled $14.3
billion, the most ever earned in a six-month period.
Equity capital increased by $9.8 billion during that
period, with $4.6 billion added during the second
quarter. Asset quality showed some overall improve­
ment, as nonperforming assets ended the first half
below the level of a year ago, but regional trends
were mixed. In a reversal of recent experience,
nonperforming asset levels fell in the three regions
west of the Mississippi River, and rose in the three
eastern regions.
Continuing improvement in net interest income,
strong gains in noninterest income, and reduced
loan-loss expenses were key factors in the record

t Billion*

Chart A — Quarterly Net Income of
FDIC-lnsured Banks, 1985—1989

Ç
r *1°* Rmarch

pllstics

* Wiidrap
*98-3951

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2
1985
1986
1987
1988 1989




Chart B — Quarterly Net Interest Margins
1983—1989

Net Interest Margin (%)

earnings results. Earning assets were only 4.8 per­
cent higher than a year earlier. Growth was led by
real-estate loans, up 12.8 percent from a year ago,
and consumer loans, up 6.0 percent. Funding
shifted slightly from deposits, up 4.1 percent yearto-year, to nondeposit liabilities, up 7.1 percent. With
interest rates mostly stable during the second
quarter, smaller banks were able to increase their
net interest margins over first-quarter levels. Larger
banks’ margins remained essentially unchanged.
Banks’ aggregate loan-loss reserves have declined
in each quarter after peaking in the first quarter of
1988. Large banks in particular have steadily in­
creased their equity capital as a percentage of total
assets, aided by strong earnings and prompted by
new risk-based capital requirements. Because of
this, the growth in the industry’s equity capital has
more than offset a decline in loss reserves, so that
the cushion of equity and reserves has increased
relative to nonperforming assets.

The increase in nonperforming assets in the eastern
regions has come from troubled loans to develop­
ing countries and real estate. The 20 percent write­
down of loans to Argentina that was mandated in
the second quarter was the main reason that banks
in the Northeast and Central regions had a higher
quarterly charge-off rate than in the second quarter
of 1988. Banks in the other four regions had lower
charge-off rates than a year earlier. The decline in
asset quality has been greatest in the Northeast
region, with banks in the Central and Southeast
regions reporting only slight increases in the
percentage of nonperforming assets. The Northeast
was the only region to show a year-to-year increase
in the proportion of banks losing money.
Chart C — Distribution of Banks by Problem Asset
Coverage Levels and Asset Size
June 1987 & June 1989

Percent of Banks with Capital Plus Reserves:

£3

Less Than Nonoerfomiing Assets
5 -10 Times Non performing Assets

I

j 1 • 5 Times Nonpertorming Assets
Over 10 Times Non performing Assets

Recent trends in Southwest bank performance sug­
gest that the prolonged deterioration of that region’s
banking sector may have finally ended. The improve­
ment in asset-quality indicators in the Southwest
region is especially encouraging, even though much
of the improvement is attributable to FDIC interven­
tion in failure and assistance transactions in recent
years. Second-quarter net charge-offs were almost
two-thirds lower than a year earlier, and nonperfor­
ming assets declined by 27.6 percent. The percen­
tage of banks with earnings losses has been
declining in recent quarters. Southwest banks still
have the highest percentage of nonperforming
assets, more than twice the national average, as
well as the highest percentage of banks on the
FDIC’s “Problem List.”

Chart D — Numbers of FDIC-Insured Commercial
Banks & Branches, 1969—1989
T>».od.

13.473

BANKS

14,230

14.364

ThoM.nd.

14,496

12,944

20 ,34 «

BRANCHES

26,629

36.466

41,907

number as in the first half of 1988. For the second
half of 1989, the failure rate is expected to moderate,
with the average asset size of failed institutions well
below the average for failed banks in 1988. This ex­
pectation is based on the continuing decline in the
number of “problem” banks since midyear 1987.
The 1,256 commercial banks on the “Problem List”
is the fewest since June 1986.
The outlook for bank performance in the remainder
of 1989 is clouded by uncertainties as to the earn­
ings impact of the recently completed Mexican debt
restructuring. The outlook for other developingcountry loans remains problematic. The continuing
rapid expansion of domestic real-estate loan port­
folios, in the face of rising nonperforming rates in
some areas, may portend more losses ahead. The
recent economic climate, characterized by positive
economic growth and low interest-rate levels, has
been largely favorable for asset quality. Any adverse
changes in these conditions could exacefàate cur­
rent asset problems and trigger losses, especially
in commercial credits extended in highly-leveraged
transactions. At this point it is uncertain whether
full-year earnings will exceed the all-time record of
$25.1 billion earned last year.
Chart E — Percent of Banks on “Problem List”
by Region, June 1987 & June 1989
Parcant

The number of commercial banks fell during the
quarter, as the industry continues the consolidation
process begun in 1985. The 12,944 banks operating
at the end of June was a record low since the crea­
tion of the FDIC in 1934. A continued high rate of
bank failures, a lower rate of new bank charters, and
conversion of multibank holding company sub­
sidiaries into branches have contributed to reduc­
ing the number of commercial banks. Despite this
shrinkage, the total number of banking offices has
continued to grow.
In the first six months of 1989, 101 banks failed or
received assistance to avert failure, the same



47.761

NORTHEAST

SO CTM EA ST

CENTRAL

MIDWEST

SOUTHW EST

WEST

Selected Indicators, FDIC-lnsured Commercial Banks

Nonperfomning assets to a s s e ts ...............
Net charge-offs to lo a n s ...............................
Net operating income growth ....................
Percentage of unprofitable b a n k s .............
Number of problem b a n k s ..........................
Number of failed/assisted b a n k s ...............

........
........
........
........
........
........
........
........
........
........
........

'Through June 30; ratios annualized where appropriate.

0.12%
2.00
6.04
7.70
2.46
0.92
203
-8527
17.66
1,559
201

0.83%
13.37
628
7.85
2.14
0.99
5.68
1666.92
14.44
1,394
221

0.69%
11.35
6.15
7.86
2.39
1.00
4.92

0.91%
14.22
6.44
7.99
225
0.87
4.95
47.98
9.72
1,256
101

HIM
13.46
1,455
101

1986

1985

1984

0.63%
9.94
620
722
1.94
0.98
7.71
-20.65
19.79
1,457
144

0.70%
11.31
620
6.91
1.87
0.84
8.86
6.30
17.09
1,098
118

0.65%
10.73
6.15
6.91
1.97
0.76
7.11
3.40
13.06
800
78

1987

1988

1988"

1989*

N/M—Not meaningful

Table II. Aggregate Condition and Income Data, FDIC-lnsured Commercial Banks
(dollar figures in m illions)

______________________________ _____________________

Preliminary
2nd Qtr
1989
Number of banks reporting.....................
Total employees (full-time equivalent) —

CONDITION DATA
Total assets............................................
Real estate loans.............................
Commercial & industrial loans .......
Loans to individuals.........................
Farm loans.....................................
Other loans and leases.................
Total loans and leases...................
LESS; Reserve for losses .............
Net loans and leases.........................
Temporary investments.....................
Securities over 1 y e a r.......................
All other assets.................................
Total liabilities and capital.....................
Noninterest-Peanng deposits.............
Interest-bearing deposits...................
Other borrowed fun ds.......................
Subordinated d e b t.............................
All other lia b ilitie s.............................
Equity capital....................................
Primary capital......................................
Nonperforming assets...........................
Loan commitments and letters of credit
Domestic office assets.........................
Foreign office assets.............................
Domestic office deposits.......................
Foreign office deposits.........................
Earning assets......................................
Volatile liabilities ..................................

Preliminary
First Half
1989

INCOME DATA
Total interest in c o m e ................................. ..........
Total interest expense ............................... ..........
Net interest in c o m e ............................... ..........
Provision for loan lo s s e s .......................... ..........
Total noninterest in c o m e .......................... ..........
Total noninterest expense ........................ ..........
Applicable income taxes .......................... ..........
Net operating in co m e ............................. ..........
Securities gains, n e t ................................... ..........
Extraordinary gains, n e t ............................. ..........
Net income ..
..........
Net chargeoffs .

..........

Net additions to capital s t o c k .................. ..........
Cash dividends on capital s t o c k ............. ..........




First Half
1988

1st Qtr
1989

2nd Qtr
1988

%Change
88-289-2

12944
1,544,594

13,003
1,526,179

13,411
1,536,763

-3.5
0.5

$3207,318
719,640
612341
379,152
31,048
246,958
1,989,139
45,065
1,944,074
478,735
394,640
389,869
3207,318
455,846
1,997,018
420,674
17,684
109,568
206,527

$3,150,604
695,032
604,348
371,494
28,729
247,327
1,946,929
45,891
1,901,037
484,320
386,505
378,741
3,150,604
440200
1,988,462
399,338
17,350
103,339
201,916

$3,055,956
638,107
599,454
358255
30,617
256,422
1,883,077
49,305
1,833,771
467,712
387,746
366,728
3,055,956
463,096
1,893216
391,125
17206
103,438
187,875

4.9
12.8
2.1
5.8
1.6
-3.7
5.6
-8.6
6.0
2.4
1.8
6.3
4.9
-1.6
5.5
7.6
2.8
5.9
9.9

255227
72052
849,830
2788,717
418,601
2129,554
323.311
2817,449
1,138,678

251,671
69,503
837,726
2736,044
414,560
2103,810
324,852
2771.863
1,116,099

240,967
72,901
813,634
2638,775
417,181
2027,190
329,122
2,689228
1,070.636

5.9
-12
4.4
5.7
0.3
5.0
-1.8
4.8
6.4

Preliminary
2nd Qtr
1989

2nd Qtr
1988

% Change

%Change

$155,511
99,326
56,185
7,983
24,544
52,850
5.965
13,932
212
178
14,322

$129,450
78,095
51,355
9203
22,144
50.090
4,791
9,415
534
436
10,385

20.1
272
9.4
-13.3
10.8
5.5
24.5
48.0
-60.3
-59.1
37.9

$80,177
51,945
28232
4,383
12.829
26,977
2981
6,720
161
148
7,028

$65,751
39,722
26,029
4,589
11,131
25218
2424
4,930
142
306
5,378

8,529
314
6,675

9296
347
6,086

-8.3
-9.4
9.7

5,053
114
3,504

5,305
144
2.906

3

21.9
30.8
8.5
-4.5
15.3
7.0
23.0
36.3
13.0
-51.8
30.7
-4.8
-20.5
20.6

Table III. First Half Bank Data

(D o lla r fig u re s in b illio n s , ra tio s in % )
i

All Banks

Asset Size Distribution
Less
$100 Million
than $100
to
$1-10
Million
$1 Billion Billion

‘---

Geographic Distnbution
Greater
than $10
Billion

EAST
Northeast
Region

Southeast
Region

WEST
Central
Region

Midwest
Region

Soonest
Region

FIRST HALF Preliminary

West
Reg«oÄ
—

(The way it is . . . )
Number of banks re p o rtin g ...........................
12,944
Total assets .................................................... $3,207.32
Total deposits.................................................. 2,452.86
Net income (in m illions ) ......................................................................
14,322
Percentage of banks losing money ............
9.7%
Percentage of banks with earnings gains .
64.9%

10.081
$371.76
329.09
1,668
11.0%
62.6%

2.487
336
$588.54 $1,042.66
503.67
773.54
2,808
4,401
5.3%
5.9%
73.1%
72.3%

40
$1,204.35
846.57
5,445
2.5%
65.0%

1,094
$1,275.86
913.65
5,515
8.8%
71.2%

1,958
$457.76
362.54
2.224
9.5%
67.1%

2.884
$519.79
413.37
2,768
3.4%
68.0%

3.064
2.446
$207.44
$258.05
164.39 . 216.41
1,150
84
4.6%
21.8%
59.5% í
59.0%

1.498
$488.42
382.51
2.580
13.7°/c
72.0%

Performance Ratios (annualized)
Yield on earning a sse ts.................................
Cost of funding earning assets...................
Net Interest margin .......................................
Net noninterest expense to earning assets .
Net operating cash flow to a ss e ts ..............
Net operating income to a s s e ts ...................
Return on a s s e ts ...........................................
Return on equity ...........................................
Net charge-offs to loans and leases............
Loan loss provision to net charge-offs........

11.25%
7.18
4.06
2.05
1.77
0.88
0.91
14.22
0.87
93.59

10.49%
5.90
4.59
2.75
1.68
0.88
0.91
10.07
0.64
123.10

10.79%
6.15
4.64 '
2.63
1.81
0.96
0.97
12.98
0.62
123.09

11.05%
6.74
4.31
2.21
1.86
0.84 ■
0.86
13.66
0.87
119.07

11.91%
8.55
' 3.36
1.36
1.70
0.89
0.92
17.99
1.05
61.03

11.89%
8.28
• 3.61
1.67
1.69
0.87
0.88
14.61
0.90
74.51

10.80%
6.53
4.27
2.37
1.69
0.97
0.99
14.18
0.46
138.57

10.61%
6.61
4:00
2.03
1.76
1.08
1.09
15.89
0.67
92.65

10.92%
6.43
4.49
2.03
2.21
1.10
1.13
14.68
0.93
117.96

10.15%
6.59
3.56
2.31
1.06
0.03
0.07
1.12
1.77
98.29

Condition Ratios
Loss allowance to:
Loans and leases.......................................
Noncurrent loans and leases.....................
Nonperforming assets to asse ts...................
Equity capital ra tio .........................................
Pnmary capital ra tio .......................................
Net loans and leases to de po sits.................

2.27%
74.19
2.25
6.44
7.99
79.26

1.67%
72.27
1.92
9.08
9.96
59.41

1.57%
75.52
1.77
7.55
8.53
71.50

1.73%
85.75
1.58
6.35
7.51
86.77

3.26%
69.56
3.16
5.16
7.53
84.73

2.64%
68.97
2.52
6.06
7.90
84.97

1.32%
96.28
1.12
7.02
7.88
78.76

1.89%
99.15
1.29
6.89
8.16
74.34

1.96%
94.56
1.59
7.82
9.02
73.09

2.56%
44.66
4.75
5.84
7.07
59.63

2.54°, c
83.50
2.57
6.15
8.18
85.15

Growth Rates (year-to-year)
A ssets..........................................................
Equity capital ..................................................

4.9%
9.9

5.8%
5.3

9.5%
9.3

11.1%
12.0

4.1%
14.3

4.6%
11.7

9.5%
9.7

6.8%
8.7

0.8%
4.7

-4.7%
2.8

14.0W

11.39°:
6.15
5.24
2.63
2.25
1.00
1.06
17.85
0 9 e,

106.61

7#

Net interest in co m e .......................................
Net incom e......................................................

9.4
37.9

11.9
22.3

16.9
18.8

15.2
10.4

6.6
1.5

8.1
-3.9

10.3
9.1

10.1
6.8

44
7.0

-1.2
N/M

17.2
49.5

Nonperfonming a s s e ts .............................
Net charge-offs................................................
Loan loss p ro v is io n ........................................

-1.2
-8.3
-13.3

3.3
1.7
2.6

16.4
17.9
17.8

24.6
-7 2
30.5

3.1
16.2
5.9

13.0
45.8
12.6

15.3
-17.6
13.3

13.2
-3.3
16.8

-8.6
-29.5
-2.7

-27.6
-53.6
-63.9

-7.4
-6.4
23.4

-2.08° o
-0.08
0.82

0.77
0.26
0.47

PRIOR FIR ST HALVES

(The way it was . . . )
Return on assets................................. 1988
................................. 1986
..................................1984

0.69%
0.68
0.63

0.72%
0.75
0.97

0.78%
0.85
0.92

0.69%
0.75
0.73

0.64%
0.49
022

0.96%
0.80
0.63

0.99%
1.10
0.99

1.09%
0.93
0.25

1.06%
0.77
0.93

Equity capital r a tio ............................. 1988
................................. 1986
................................. 1984

6.15
6.33
6.07

8.78
8.65
8.66

7.35

723
7.16

620
6.16
5.82

4.58
5.03
4.41

5.67
5.83
5.39

7.01
6.80
6.79

6.76
7.02
6.45

7.53
7.53
7.65

5.41
6.92
7.01

5.80
5.57
5.38

Nonperfonming assets to assets . . . . 1988
............................... .1986
................................. 1984

2.39
2.03
1.70

2.07
2.37
0.66

1.81
1.90
0.84

1.72
1.59
1.46

3.36
2.33
2.86

2.33
1.59
1.70

1.07
1.03
0.66

121
1.52
1.79

1.75
2.44
1.10

6.26
3.57
1.52

2.99
316
2.69

Net charge-offs to loans and leases . 1988
................................. 1986
................................. 1984

1.00
0.84
0.61

0.75
1.16
0.59

0.74
0.78
0.48

1.16
0.80
0.56

1.06
0.81
0.72

0.65
0.57
0.33

0.62
0.50
0.32

0.75
0.60
1.00

1.40
1.81
0.69

3.40
1.53
0.93

1.09
1.12
0.77

REGIONS: Northeast — Connecticut, Delaware, D istrict of Columbia, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania
Puerto Rico, Rhode Island, Vermont
Southeast — Alabama, Florida, Georgia, M ississippi, North Carolina, South Carolina, Tennessee, Virginia, West Virginia
Central — Illinois, Indiana, Kentucky, Michigan, Ohio, W isconsin
Midwest — lowa, Kansas, Minnesota, Missouri, Nebraska, North Dakota, South Dakota
Southwest — Arkansas, Louisiana, New México, Oklahoma, Texas
West — Alaska, Arizona, California, Colorado, Hawaii, Idaho, Montana, Nevada, Oregon, Pacific Islands, Utah, Washington, Wyoming




4

Table IV. Second Quarter Bank Data (Dollar figures in billions, ratios in %)
Asset Size Distribution
Less
$100 Million
than $100
to
$1-10
All Banks
Million
$1 Billion Billion

V

Geographic Distribution
Greater
than $10
Billion

EAST
Northeast
Region

Southeast
Region

WEST
Central
Region

Midwest
Region

Southwest
Region

West
Region

SECOND QUARTER Preliminary

(The way it is . . . )
¡Number of banks rep ortin g........................
le t income...................................................
Percentage of banks losing money ..........
Percentage of banks with earnings gains .

12,944
7,028
10.4%
61.9%

10,081
801
11.8%
59.6%

2,487
1,401
5.6%
69.9%

336
2,036
6.3%
72.3%

40
2,790
5.0%
62.5%

1,094
2,786
9.3%
64.7%

1,958
1,132
10.3%
62.1%

2,884
1,381
3.8%
65.4%

3,064
541
5.5%
57.7%

2,446
-34
22.4%
57.6%

1.496
1,222
14.5%
68.4%

Performance Ratios (annualized)
Shield on earning assets...............................
lost of funding earning assets...................
le t interest m a rg in ..................... ............
Net noninterest expense to earning assets
le t operating cash flow to a ss e ts............
Net operating income to a sse ts................
petum on a sse ts.........................................
etum on equity .......... .. m . . . . . . . . . .
Net charge-offs to loans and leases..........
loan loss provision to net charge-offs

11.49%
7.45
4.05
2.03
1.77
0.85
0.89
13.78
1.03
86.75

10.66%
6.05
4.60
2.74
1.69
0.84
0.87
9.58
0.74
118.68

10.99%
6.34
4.65
2.63
1.82
0.95
0.96
12.78
0.68
116.96

11.29%
6.98
4.31
2.20
1.87
0.77
0.79
12.45
0.94
127.50

12.20%
8.89
3.31
1.33
1.69
0.87
0.93
18.20
1.36
48.95

12.16%
8.59
3.58
1.68
1.66
0.83
0.88
14.58
1.19
59.54

10.95%
6.71
4.23
2.33
1.70
0.97
1.00
14.26
0.51
132.08

10.83%
6.83
4.01
1.95
1.84
1.08
1.08
15.64
0.74
93.65

11.28%
6.72
4.56
2.15
2.16
1.05
1.07
13.60
0.92
118.08

10.45%
6.93
3.51
2.28
1.05
-0.11
-0.05
-0.91
1.92
106.28

11.60%
6.37
5.23
2.57
2.28
0.95
1.02
16.58
1.04
113.69

Growth Rates (year-to-year)
le t interest incom e...... .............................
le t income.............. ............................

8.5
30.7

10.5
20.2

15.0
20.5

14.3
2.8

5.8
2.8

7.0
-5.6

9.5
13.9

9.2
8.8

4.6
-1.8

-2.1
N/M

16.0
49.7

le t chargeoffs................ ............................
¡can loss pro visio n................ ....................

-4.8
-4.5

32
4.6

5.1
9.6

-14.7
31.9

46.8
6.5

102.1
18.3

-2.0
3.0

9.4
32.3

-32.0
-9.8

-64.2
-52.9

-20.4
30.3

0.71%
0.60
0.56

0.67%
0.63
1.00

0.75%
0.80
0.94

0.67%
0.80
0.74

-1.79%
-0.15
0.84

0.73%
-0.04
0.54

1.14
0.97
0.77

0.89
1.45
0.69

0.93
0.94
0.63

1.38
0.86
0.72

4.75
1.93
0.97

1.40
128
0.94

IOR SECOND QUARTERS

(The way it was . . . )
Rj m

on assets..................................1988
....................
1986
.................................. 1984

|Net charge-offs to loans and leases . 1988
.................................. 1986
........................
1984

0.74%
0.32
-0.02
1.10
0.92
0.93

0.97%
0.77
0.61

0.96%
1.09
1.04

0.63
0.64
0.41

0.57
0.56
0.37

1.06%
0.90
-0.25
0.73
0.66
1.48

1.08%
0.77
0.94
1.41
2.06
0.89

flOTES TO USERS
■OMPUTATION METHODOLOGY FOR PERFORMANCE AND CONDITION RATIOS
I 11income figures used in calculating performance ratios represent amounts for that period, annualized (multiplied by the number of penods in a year)
II asset and liability figures used in calculating performance ratios represent average amounts for the period (begmning-of-penod amount plus end-of-penod amount plus any
pods in between,, divided by the total number of penods).
asset and liability figures used in calculating the condition ratios represent amounts as of the end of the quarter
DEFINITIONS
iProNem" Banks—Federal regulators assign to each financial institution a uniform composite rating, based upon an evaluation of financial and operational entena The rating
is cased on a scale of 1 to 5 in ascending order of supervisory concern. "Problem" banks are those institutions with financial, operational or managenal weaknesses that threaten
™eir continued financial viability. Depending upon the degree of nsk and supervisory concern, they are rated either "4'' or “ 5".
¿aming Assets—all loans and other investments that earn interest, dividend or fee income.
field on Earning Assets—total interest, dividend and fee income earned on loans and investments as a percentage of average earning assets
ost of Funding Earning Assets—total interest expense paid on deposits and other borrowed money as a percentage of average earning assets
f et Interest Margin—the difference between the yield on earning assets and the cost of funding them, i.e., the profit margin a bank earns on its loans and investments
Cel~ ° " intefest ExPens«—lota! noninterest expense, excluding the expense of providing for loan losses, less total noninterest income A measure of banks overhead costs
ie
Income—income after taxes and before gains (or losses) from securities transactions and from nonrecumng items The profit earned on banks' regular banking business
(rn!n° Pera,<in9 Cash Flow—pre-tax net operating income before the provision for loan and lease losses; a measurement of banks' cash flow, net of interest and overhead expenses
f
regular operations. Previously referred to as "adjusted net operating income".
petum on Assets—net income (including securities transactions and nonrecumng items) as a percentage of average total assets The basic yardstick of bank profitability
petum on Equity—net income as a percentage of average total equity capital
[9eK>Ms—,otal loans 30(3 'eases charged off (removed from balance sheet because of uncollectibility) dunng the quarter, less amounts recovered on loans and leases
deviously charged off.
onperfoemmg Assets—the sum of loans past-due 90 days or more, loans in nonaccrual status, and noninvestment real estate owned other than bank premises
fjoncunent Loans & Leases—the sum of loans past-due 90 days or more and loans in nonaccrual status
icannw
equ,ty C3p,,al P,us ,he allowance for loan and lease losses plus minority interests in consolidated subsidianes plus qualifying mandatory convertible debt
yjjjLO'exceed 20 percent of total pnmary capital), less intangible assets except purchased mortgage servicing nghts.
■ P ns arKl Leases—total loans and leases less unearned income and the allowance for loan and lease losses
,nv®stmen*s—the sum of interest-beanng balances due from depository institutions, federal funds sold and resold, trading-account assets and investment securities
r n remair"ng maturities of one year or less.
ate Liabilities—the sum of large denomination time deposits, foreign office deposits, federal funds purchased, and other borrowed money

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