WASHINGTON — Eroding asset quality proved a serious challenge to earnings in the first quarter, as problem loans kept climbing and institutions struggled to build volume, the Federal Deposit Insurance Corp. said Thursday.
Industry earnings fell nearly $1 billion, to $36 billion, from the first quarter of last year, as loan-loss provisions shot up 55%, to $9.2 billion and chargeoffs jumped 48%, to $8.1 billion, the agency said in its Quarterly Banking Profile.
FDIC officials blamed the decline on the residential real estate market, unfavorable interest rate conditions, and slower growth in the economy.
"There is little question the credit environment is somewhat more challenging than it has been in recent years," said FDIC Chairman Sheila Bair.
Loans 90 days or more past due grew 7% from the fourth quarter, to $60.5 billion, and made up 0.83% of all loans — the highest level in two and a half years. Noncurrent residential mortgage loans increased by 7.3% in the quarter, to $24.4 billion, while noncurrent construction and development loans increased 36.1%, to $5.5 billion. The FDIC said the rising trend in noncurrent loans was "fairly widespread" and noted that 45% of institutions reported an increase for the first quarter.
Chargeoffs, meanwhile, surged almost 50% compared with a year earlier, including a 93% rise in chargeoffs for mortgages, to $555 million. Chargeoffs rose in nearly every loan category, including 29% for credit cards, to $3.76 billion, and 79% for commercial and industrial borrowers, to $1.07 billion.
More than half of institutions reported a drop in income from the previous quarter, while nearly 70% of institutions reported lower net interest margins than a year earlier.
At smaller banks, net interest margins fell to a 16-year low of 3.91%. The industry's overall net interest margin was 3.32% in the first quarter, a 12-basis-point rise from the previous quarter but down from the 3.46% margin achieved a year earlier.
Though loan-loss provisions were just below the $9.8 billion the industry set aside in the previous quarter, the increase from a year earlier was the largest since the first quarter of 2002. The FDIC said much of that increase was at larger institutions. While only 36% of all institutions reported higher loan-loss provisions, 73% of those with assets of more than $10 billion reported an increase.
The spike in chargeoffs and noncurrent loans occurred as loan growth slowed. Loans increased 0.6%, to $7.27 trillion — the smallest quarterly rise in five years. The agency said loan growth was dragged down by declines from the previous quarter in mortgages, which fell 0.3%, as well as in home equity lines of credit (down 0.5%) and multifamily real estate loans (0.6%).
"One of the factors that contributed to record earnings for the industry again last year was expansion of the balance sheets," but "that slowed … in the first quarter of this year," said Richard Brown, the FDIC's chief economist. "The ongoing housing slowdown obviously is one factor. And regulatory surveys are also indicating somewhat more stringent underwriting standards for subprime and nontraditional mortgage loans."
While nonresidential loans — which in past quarters had picked up the slack left by paltry home loan growth — were still strong in the quarter, FDIC officials noted an easing of performance there as well. Commercial and industrial loans grew 2.9% in the quarter, to $1.25 trillion, "although there were some signs of slowing demand," Mr. Brown said. "We saw slower business investment spending and inventory reductions in the first quarter."
The $16.8 billion growth in construction and development loans — or about 3% — was the smallest quarterly increase since the second quarter of 2004, the agency said.
Ms. Bair said pressure on profits in the first quarter validated moves by regulators to finalize policy meant to help banks protect against future troubles.
First on her list of policy priorities was the need for the federal agencies to reach consensus on proposed new capital standards, the Basel II plan for large banks and the Basel IA proposal for smaller institutions. The FDIC has taken a strong position — in contrast to other agencies — that regulators should not abandon capital floors and other safeguards that make the U.S. version of Basel II different from the European one. Ms. Bair said Thursday's results demonstrated the need for strong capital.
"We have capital for the bad times, not for the good times," she said. "We're seeing an uptick in noncurrent loans and chargeoffs. It reminds us why we have these strong capital cushions. It's my job as FDIC chairman to protect those capital cushions because that is our first line of defense against bank insolvencies."
She also repeated her forecast of a June or July release of the agencies' final guidelines on subprime lending, despite last-minute issues raised by other regulators. "I think we've very close to agreeing on all the points," she said.
Ms. Bair said industry participants are moving forward in helping troubled borrowers to keep their homes. She said the American Securitization Forum, an affiliate of the Securities Industry and Financial Markets Association that brings together all participants in the loan securitization process, would be releasing a set of best practices as early as next week.
For the first time, the agency reported the proportion of total residential mortgages that have negative-amortization features, largely exotic loans such as interest-only and payment-option adjustable-rate mortgages.
The agency required banks to break those loans out separately as regulators last fall required stricter underwriting standards for the exotic products. Overall, negative amortization loans made up 9.5% — or $207 billion — of the $2.17 trillion of mortgages that institutions had on their books in the first quarter.
The agency also reported that the assets of its problem-bank list nearly tripled, from $8 billion in the fourth quarter to $21 billion in the first, even though it added only three institutions to the list.
Bert Ely, an independent analyst in Alexandria, Va., said he suspected that the large institution added to the list might be the $8.8 billion-asset Doral Bank subsidiary of Doral Financial Corp. in San Juan, Puerto Rico. The subsidiary has already been strapped with an FDIC enforcement order as its parent undergoes a massive debt refinancing.
"Doral is an excellent candidate," Mr. Ely said. "I can't imagine any other institution that could account for it. … Doral certainly should be on the problem-bank list. They should have been there a long time ago."
On May 17, Doral's holding company unveiled a recapitalization plan backed by a group of private-equity and hedge fund investors. The $11.9 billion-asset company said it would issue $610 million of new common stock to a new holding company, Doral Holdings, which would own 90% of Doral Financial. A group led by Bear Stearns Cos.' private-equity arm is putting up $415 million of that total, but that investment is contingent on Doral's raising another $215 million.
Doral has been wrestling with accounting problems for more than two years and must refinance $625 million of debt by July 20. It has said that if the recapitalization fails it would probably file for bankruptcy.
Asked whether Doral accounted for the surge in problem assets, a bank spokesman did not answer directly. "Doral Bank Puerto Rico is well capitalized and moving forward strong with its growth strategy and business plan," she said in an e-mail reply.
