Banks' Performance Lags

The Federal Reserve Bank of San Francisco's Economic Letter recently asked, "Has Bank Performance Peaked?" The genesis of Simon Kwan's question relates to the lag of the S&P Bank Composite Index behind the S&P 500 index. Beginning with the third quarter of 1998, the bank stock index gradually fell while the general market index rose. In addition, the yield spread over treasuries on A-rated bank subordinated debt rose sharply in the first half of 2000. Finally, in the second quarter of 2000 the return on assets (ROA) of all commercial banks fell to 1.0 percent, the lowest level since 1992.

Kwan concludes that the poor performance of banks' common stock "was not a blip in an otherwise upward trend. This may be the beginning of banks' reckoning with the easy loan standards and terms that they extended to commercial borrowers during the mid-1990's. Nevertheless, to the extent that loan losses were expected and properly priced, they simply even out the supra-normal profits recorded during the boom time, and banks will remain healthy."

These general comments are also applicable to the consumer credit portfolios of commercial banks, as shown in the accompanying table. Consumer loans of banks involve significantly higher risk than commercial and real estate loans. It is also noteworthy that the consumer loan portfolios of small banks are significantly less risky than those of large banks, whereas the reverse is true for their credit card portfolios. (Large banks are those with assets greater than $1 billion.)