An Update on Emerging Issues in Banking 

Favorable Interest-Rate Environment Drives Record 

First-Quarter Bank Earnings 

June 3, 2002 

Summary

Commercial banks earned a record $21.7 billion in the first quarter of 2002, 

besting the previous quarterly earnings record set in the first quarter of 

2001 by 9.6 percent (see Chart 1). The average return on assets was 1.33 

percent, the third-highest ever for the industry. 

D

The greatest contribution to the improvement in earnings in the first quarter 

came from a highly-favorable interest rate environment that boosted net 

interest income. The increase in net interest income reflected wider net 

interest margins at large banks, whose average funding costs fell more rapidly 

than their average asset yields during the quarter. Earnings also were helped 

by slow growth in operating expenses, which were only two percent higher 

than a year ago. These positive developments outweighed the negative effects 

of rising expenses for loan-loss provisions, lower market-sensitive noninterest 

revenues, and lower gains on securities sales. Almost two-thirds (64 percent) 

of all commercial banks reported higher earnings than in the first quarter of 

2001. Earnings gains were lower at small banks. 

The effects of last year's economic weakness were evident in rising levels of 

loan losses and noncurrent loans. Most of the deterioration in asset quality 

occurred at larger banks, in commercial and industrial (C&I) loans and in 

credit-card loans. Foreign borrowers accounted for a rising share of troubled 
C&I loans in the first quarter. A sharp increase in charge-offs of credit-card 

loans was caused by a few large charges related to loan sales and 

restructurings. 

In line with higher credit losses, the industry has also seen more failures and 

more problem banks. Six insured commercial banks failed during the first 

quarter, the largest number of bank failures in a quarter since the third quarter 

of 1994. The number of commercial banks on the FDIC's "Problem List" 

increased from 95 to 102 in the quarter, and assets of "problem" banks rose 

from $36 billion to $37 billion. 

Total loans at commercial banks fell during the quarter, the first time in five 

years that they have contracted. Commercial and industrial loans declined for 

the fifth consecutive quarter, even though a majority of banks reported 

increases in their C&I loans. Residential mortgage loans also declined. Growth 

remained strong in commercial real estate loans and home equity loans, as 

well as in credit cards and other consumer lending. Total deposits at 

commercial banks declined along with industry assets. The percent of assets 

funded by deposits remained unchanged during the quarter, at 66.9 percent. 

The composition of deposits continued to shift toward a larger proportion of 

domestic savings deposits, while deposits in foreign offices, domestic demand 

deposits, and domestic time deposits all declined. 

Last Updated 06/03/2002 

Chart 1

Bank Net Income Sets a New Record in First Quarter

FDIC-Insured Commercial Banks, Dollars in Billions

Year Quarter Net Operating 

Income 

Securities and Other 

Gains/Losses, Net 

1998 1 14.9 1.1

1998 2 15.7 0.4

1998 3 14.7 0.4

1998 4 14.0 0.7

1999 1 17.6 0.3

1999 2 16.9 0.1

1999 3 19.5 -0.2

1999 4 17.7 0.0

2000 1 20.0 -0.5

2000 2 15.5 -0.9
2000 3 20.0 -0.7

2000 4 17.2 0.5

2001 1 19.3 0.5

2001 2 18.6 0.6

2001 3 16.6 0.7

2001 4 17.8 0.9

2002 1 21.4 0.4

Source: FDIC Preliminary Bank Earnings Report, First Quarter 2002