The pace of banks' converting to S corporations slowed considerably in the first quarter, because most of the eligible institutions had already made the switch.
According to Federal Deposit Insurance Corp. statistics released last week, the number of S corporations jumped 20%, to 1,253, from the end of 1998 to March 31. That compares with a 72% surge during the same period a year earlier.
Industry watchers say that with the number of eligible institutions dwindling, the pace will slow even more over the next year.
"We're coming to the tail end," said Richard A. Suokup, a partner at Grant Thornton LLC in Chicago. "I expect a 10% increase for 1999."
S corporation banks pay no federal taxes and must have 75 shareholders or fewer. However, proposed federal legislation could expand the number of eligible banks by increasing that to 150 stockholders.
Still, the large number of S corporation conversions has helped offset declining profitability at small banks.
During the first quarter, without S corporation banks, the return on assets at banks with less than $100 million of assets would have been 33, not 23, basis points lower than at larger banks, according to the FDIC.
Overall, ROA at banks with less than $100 million of assets dropped to 1.1% from 1.2%, while return on equity slipped to 9.94% from 11%, the FDIC reported.
Returns at banks with $100 million to $1 billion of assets also slipped, though not as dramatically. In the quarter ended March 31, the average return on assets for those banks dropped to 1.3% from 1.37%, while return on equity fell to 13.6% from 14.24%, compared with the same period in 1998.
And the evidence shows smaller banks are making less than large ones. Of those with less than $100 million of assets, 54% did not earn as much as they did in the same quarter a year earlier. Only 27% of banks with more than $10 billion of assets made less.
Moreover, Veribanc Inc., a Wakefield, Mass.-based bank research firm, said in a report issued this week that 5.79% of banks - or 536 institutions - lost money in the first quarter, the highest percentage in any first quarter since 1992.
Most of those that lost money had less than $100 million of assets, said research director Warren G. Heller. More than half the money-losers were start-ups, and 17% were farm banks.
"I think we're beginning to see a splitting of the industry," said Jeffrey Warlick, senior vice president at Hovde Financial Inc. in Washington.
Though feeling the pinch, small banks have benefited from an unprecedented seven-year run. Each year, beginning with 1992, banks with less than $1 billion of assets have posted an average full-year ROA above 1%, FDIC researcher Ross Waldrop reported.
The challenge, Mr. Waldrop said, is keeping that pace when economic expansion is creating competition for small banks and putting pressure on loan pricing and funding costs.
"Maintaining the historical highs is starting to prove difficult," he said.