Federal regulators this spring plan to adjust the way community bank profitability is calculated, to compensate for the lift S corporation banks give to the ratios.

The move is intended to more accurately portray the return on assets of banks with less than $1 billion of assets and to make peer group comparisons more compatible.

John Smuolen, a project manager at the Federal Financial Institutions Examination Council, said the change "should make the numbers look more realistic on a tax-adjusted basis."

Don Inscoe, associate director of research at the Federal Deposit Insurance Corp., said the agency is considering breaking out S corporation banks as their own statistical group. "It is clearly an issue to examine," he said. "It has become quite interesting analytically for people who track individual banks."

Industry observers have said that S corporation banks-tax-exempt companies with fewer than 75 shareholders-are artificially skewing the average return on assets for smaller community banks, possibly leading industry watchers to draw incorrect conclusions.

Many S corporations have inflated ROAs because they do not pay federal income taxes, an exemption that adds from 30% to 40% to the bottom line. ROA is calculated by dividing after-tax income by total average assets.

"The statistics are not telling the facts," said Jeff Warlick, senior vice president at Hovde Financial Inc., a Washington investment banking firm. "S corporations have hidden a diminishing ROA for smaller community banks."

For instance, 16 of the top 20 small community banks that made the 1997 American Banker list of most profitable companies were S corporations.

To help paint a more accurate picture, Mr. Smuolen said, ROA data for S corporation banks in the exam council's upcoming performance reports will include the assumed tax rates incurred by non-S corporation banks. Those reports are distributed to banks nationwide.

An interagency task force-including officials from the FDIC, Office of the Comptroller of the Currency, Federal Reserve Board, Office of Thrift Supervision, and National Credit Union Administration-was formed last year to examine the problem and decided last month to make the adjustment, Mr. Smuolen said.

Keith Leggett, an economist at the American Bankers Association, said he supports the move but doubts whether it will eliminate confusion. "The comparisons still won't be accurate," he said. "Tax structures change the way a company manages itself."

Richard A. Soukup, a partner at Grant Thornton LLP, acknowledged that S corporation and non-S corporation banks cannot be compared. But he said he does not think the rise of S corporations has seriously affected the industry average ROA for community banks. "It doesn't excite me too much," Mr. Soukup said.

Adoption of the S corporation structure has surged in popularity since 1997-the first year the option was made available. As of Sept. 30, 1,054 banks had become S corporations, up from 590 a year earlier, according to the FDIC.

And more could be on the way. Legislation is pending that would double to 150 the number of shareholders S corporations could have.

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