WASHINGTON - Thrift earnings in the second quarter fell 9% from the first quarter, to $2.02 billion, the Office of Thrift Supervision said Tuesday.

Despite the drop in earnings, OTS Director Ellen Seidman said the industry's second-quarter performance was "quite strong."

Heavy competition, increasing reliance on nondeposit funds for loans, and more nonperforming commercial loans could affect performance, Ms. Seidman said. "All this adds up to serious challenges for thrift management."

However, stabilizing interest rates should help thrifts, she said. "The specter of rising interest rates has at least begun to moderate."

The industry's average return on assets fell to 0.93%, from 1.04% in the first quarter and 1.01% in the second quarter last year. Troubled assets dropped to $5.1 billion, or 0.58% of total industry assets, from $5.3 billion, or 0.61% in the previous quarter.

Loss provisions rose to 0.24% of assets, from 0.16% in the previous quarter, and net chargeoffs fell to 0.18% of assets, from 0.19% in the first quarter. Ms. Seidman credited this improvement to subprime lenders' heeding her agency's call to put more assets into reserve to better manage their risk.

Deposits held by thrifts climbed 0.61%, to $508.8 billion. However, as a percentage of total assets, deposits dropped to 57.3%, from 58.2% in the previous quarter.

The agency noted the number of thrifts with a Camels rating of 3, on a scale of 1 to 5, increased to 86 with assets of $34.2 billion, from 80 thrifts with assets of $32.5 billion in the first quarter.

The change was caused primarily by increased interest rate risk exposure and credit quality concerns, the agency said.The number of thrifts with a Camels rating of 4 or 5 held steady at 14, though the combined assets of problem thrifts climbed 43.4%, to $7.6 billion.

The assets held by the 1,091 OTS-regulated thrifts in the second quarter rose 9% from the first quarter, to $888 billion. The assets continued to be concentrated in residential mortgages, which accounted for 8.7% of all assets.

Family mortgage originations jumped 33% from the first quarter, to $52.9 billion, which represented a 20% drop from the second quarter last year.

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