WASHINGTON - Commercial banks earned $19.2 billion in the second quarter, but lurking behind their fifth-highest quarterly profit ever was a dramatic increase in past-due loans and other danger signs, the Federal Deposit Insurance Corp. reported Wednesday.
Speaking at his first news conference, FDIC Chairman Donald E. Powell also broadly endorsed the agency's deposit insurance reform proposals, including a recommendation that the federal guarantee of $100,000 per account be indexed to inflation. He said he would elaborate in testimony at a House hearing next week.
Though Mr. Powell said the earnings report raised several red flags, he emphasized the industry's overall health.
"These are notable soft spots in the industry's performance," he said. "Nevertheless, I want to stress that we're not seeing a general downturn in banking. Life wasn't quite as easy as it has been - but that doesn't mean it has been difficult."
The FDIC said overall earnings were higher than a year earlier because rapidly falling interest rates boosted gains on securities sales, and because companies had fewer restructuring and credit-related charges. Still, slightly less than half of all commercial banks reported higher profits in the second quarter, and a majority reported a lower return on assets compared to a year earlier.
The agency noted an increase both in chargeoffs and in loans more than 90 days past due. Banks wrote off $7.9 billion of bad loans in the second quarter, an increase of $1 billion from the previous quarter; total noncurrent loans rose by nearly 6% to $48.8 billion.
Much of that was caused by deterioration of credit quality for commercial and industrial loans. These loans accounted for two-thirds of the hike in noncurrent loans, and constituted almost 40% of all chargeoffs in the second quarter. The FDIC said that commercial and industrial loans generated more than half of the increase in all noncurrent loans in every quarter since the beginning of 1998. More than 2% of commercial and industrial loans were noncurrent at the end of the second quarter, the highest rate for such loans since 1993.
"Although commercial and industrial loans represent only a little more than a quarter of commercial bank loans, they are driving the overall trend for both chargeoffs and noncurrent loans," Mr. Powell said. "Other types of loans, however, are also showing deterioration in credit quality."
Also to blame were $2.8 billion in chargeoffs for credit card loans during the second quarter, a 26.5% increase from a year before.
The FDIC said noncurrent rates increased for other types of lending as well, including agricultural real estate and production, leases, and commercial real estate properties.
As a result, the industry's "coverage ratio" fell for the sixth consecutive quarter, to $1.35 of reserves for every $1 of noncurrent loans - the lowest level since the first quarter of 1994.
The FDIC also continued to sound warnings over shrinking margin rates for the smallest banks. Institutions with less than $100 million of assets were the only group to report a decline during the quarter as interest rate margins fell by 3 basis points to 4.26% - 36 basis points lower than a year before. Nearly 12% of these banks said they were unprofitable during the second quarter.
Mr. Powell said he thought the shrinking margins were the result of community banks' funding woes.
"I dealt with this 60 days ago," said Mr. Powell, the former chairman, president and chief executive officer of the First National Bank of Amarillo, Tex. "Smaller banks as a component of the banking industry on the liability side do not react as fast as the larger banks, thus the margin shrinks. Plus community banks are always worried about funding, so they are hesitant to drop CD rates therefore they have a squeeze on the margins."
But he brushed aside concerns about the viability of smaller banks in a weakening economy.
"I think small banks are prepared not only from a capital standpoint but also from the level of their loan-loss reserves and can stand if in fact there is some downturn in the economy," he said. "Small banks are not going anywhere. There will always be an independent bank in America."
Mr. Powell acknowledged that community banks feel that some of their funding problems could be solved by an increase in the deposit insurance coverage level per account, and said that he agreed with the agency's position that it should be indexed for inflation. But he left the door open for when the indexing should start - which would make a significant difference in the amount of coverage.
"Depositor coverage is something that should be spoken to," he said. "Our position is that it should be in fact indexed. But I'm not sure what year or how it should be indexed."
Mr. Powell added that he expected to testify on all of the agency's recommendations at a House hearing next week, and indicated that he broadly agreed with most of the proposals. Mr. Powell is expected to testify on Sept. 12 in front of the House Financial Services financial institutions subcommittee.
"With some refining... here and there, I will endorse them," he said. "They did some extraordinary work on that. The staff has been very good. That proposal is well thought out and I think it's a model."
A day before Mr. Powell's testimony on reform, John Reich, a board member of the FDIC and former acting chairman, will testify in the Senate on the fall of $2.3 billion-asset Superior Bank FSB. Senate Banking Committee Chairman Paul Sarbanes announced the hearing, which will primarily hear from Office of Thrift Supervision Director Ellen Seidman, on Wednesday. Also expected to testify are Bert Ely, an independent analyst in Alexandria, Va.; George Kaufman, an economics professor at Loyola University in Chicago; and Karen Shaw Petrou, a managing partner at Federal Financial Analytics. 
