IIF RESEARCH NOTE

Recent Trends in the U.S. Banking Sector

Higher profitability and more loan demand support stronger growth in U.S. bank lending
September 2014
CONFIDENTIAL
As Fed exit nears, the U.S. banking sector continues its steady
recovery, with the share of unprofitable banks declining to 6.8%
in 2014Q2 from 8.4% a year earlier. Encouraging Q2 results
reflect the ongoing decline in troubled loans, but also a solid rise
in loan demand, while bank balance sheet trends highlight the
persistent search for yield.

Chart 1

COST-CUTTING HELPS THE BOTTOM LINE

In the aftermath of the 2008-09 financial crisis, U.S. banks have
been constrained in their ability to grow revenues. For a start,
the low interest rate environmentcombined with relatively
sluggish credit growthhas weighed on interest income. Indeed, aggregate net interest margin has dropped from over
3.8% in 2010 to just 3.15% in the second quarter of 2014the
lowest level since 1989. Low interest rates and lack of volatility
are also hurting banks non-interest income, with interest rate
and FX trading revenues remaining subdued (Chart 1 offers a
long-term perspective on these trends).

2.0

Moreover, recent growth in U.S. bank lending has been concentrated in large bankslending by small banks was down
6%oya in Q2. This also helps account for the relative weakness
in consumer lending, where smaller banks have traditionally
been very active. More broadly, the U.S. credit-to-GDP gap
remains wide, with the credit-to-GDP ratio some four percentage
points below its long-term trendsuggesting potential for some
catch-up in consumer credit growth as the U.S. economy continues to strengthen.
On the funding side, the surge in bank deposits has been particularly marked, with the ultra-low rate environment making it
relatively inexpensive for depositors to remain liquid. With the
loan-to-deposit ratio (76%) at its lowest level in 30 years, U.S.
banks have sharply reduced their reliance on wholesale funding
(Chart 4, next page).

1.2
0.8
0.4
0.0

84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14

Source: FDIC, IIF.

Chart 2
U.S. Banks: Return on Equity
percent

Return on equity

1984-2014Q12 avg.

16
14
12
10

quarterly

STRENGTH IN BUSINESS LENDING, DEPOSIT GROWTH

While it has been some time coming, a pickup since early
2013 has brought overall U.S. bank lending (7.7%oya in Q2)
close to its long-run average (1960-2014: 7.4%oya). Business
lending has been particularly robustC&I lending was up
13%oya in Q2. In contrast, despite the improvement in household wealth and easier bank lending standards, growth in consumer credit has been moderate, hovering under 4%oya since
early 2013. While growth in auto and student loans has been
robust (+10%oya), and mortgage loan growth edged back into
positive territory in 2014 (for the first time since 2008), the stillmodest recovery in the U.S. housing market has left real estate
lending as a relatively weak spot. Outstanding mortgage loans,
currently accounting for almost 50% of total bank loans, remain
around 7% below their peak in 2008.

1.6

annual

However, cost-cutting has helped bring down non-interest

expenses in recent years. Combined with the benefit of lower
loan loss provisions (with troubled assets on the decline), this has
supported bank profits. The level of non-performing assets and
net charge-offs has fallen to near pre-crisis levels while release
of previously accumulated allowance for loan losses continues.
All this has helped support U.S. banks return on equitythough
it remains well below pre-crisis levels (Chart 2).

U.S. Banks : Interest and Non-Interest Income

percent of total assets; dotted lines= linear trend
2.8
Interest income
2.4
Noninterest income

8
6
4
2
0

-2

01

03

05

07

09

11

13

14Q2

Source: FDIC, IIF.

Chart 3
U.S. Bank Lending
percent change over a year ago

C&I
Real estate
Consumer loans

30
20

10
0

-10
-20
-30

1960-2014 avg.
C&I: 6.8%
Real estate: 8.3%
Cons. credit: 6.5%

-40
2000

2002

2004

2006

2008

2010

2012

2014

Source: Federal Reserve, IIF.

Copyright 2014. The Institute of International Finance, Inc. All rights reserved. The contents of this report may be neither reproduced nor
distributed in whole or in part outside the membership without the prior written approval of the Institute of International Finance, Inc.

IIF RESEARCH NOTE

Chart 4

EASIER CREDIT STANDARDS REFLECT MORE RISK APPETITE

The past two years have seen a notable increase in U.S. banks
risk appetite. Helped by the improving economic outlook and
increased competitionnotably from non-bank firms as noted
by the OCCbanks have been loosening credit standards
(albeit with small banks lagging). According to the OCCs Survey
of Credit Underwriting Practices, easing in underwriting standards, particularly in credit card lending, indirect consumer lending (mainly auto loans) and leveraged lending, was marked in
2013. Reduced collateral requirements and looser covenants
have been prevalent. In addition, the latest Fed Senior Loan
Officer Opinion Survey on Bank Lending Practices indicates that
banks continue to ease credit standards for almost all types of
loans this year (Chart 5).

U.S. and Euro Area Banks' Wholesale Funding

percent of total liabilities
55
50
45

Euro area

40

U.S.

35
30

25
20
15

In another manifestation of search for yield, growth in U.S.

banks aggregate investment portfolios has been striking in the
aftermath of the 2008-09 financial crisis. Driven by pressure on
margins, relatively weak loan demand, and strong deposit inflows, banks have accumulated more mortgage-backed securities (MBS), and municipal bonds, as well as U.S. Treasuries. Indeed, banks MBS holdings are up over 30% since 2008
potentially a significant duration extension risk in a rising-rate
environment. As a case in point, the surge in Treasury yields in
May 2013 led the Barclays MBS duration index to climb from 2.6
to over 4.5 years within a month.

10

'98

'00

'02

'04

'06

'08

'10

'12

'14

Source: FDIC, ECB, IIF.

Chart 5
U.S. Bank Lending Standards
net percentage (>0 implies easing)

14H1

13H2

13H1

12H2

Large&medium firms

With the Fed expected to end its bond purchase program in

October 2014, and the first rate hike to be seen in mid-2015, it
remains to be seen how banksparticularly those with more
exposure in long-term assets, such as mortgage-backed securities and long-dated U.S. Treasurieswill adjust their balance
sheets. On the positive side, however, a striking feature of the
last few years has been the surge in banks cash holdings from
3% of total assets in 2007 to 20% in August 2014 a front line
defense against potential future stresses.

Small firms
Consumer loans*
Credit cards
Auto loans
Mortgages
0

BIG EXPANSION OF U.S. BANK LENDING OVERSEAS

Despite a modest slowdown last year, the expansion of U.S.
banks overseas since 2008 has been dramatic. As of March 2014,
the share of U.S. banks in international claims of all BIS-reporting
banks topped 12% ($3.4 trillion) from 6% in late 2007 (Chart 6).
U.S. banks are now the third largest credit provider to the rest
of the world after the U.K and Japan, overtaking Germany,
France, Switzerland and Netherlands. The expansion has been
driven mainly by lending to other developed countries (+120%),
with the largest increases in lending to France and Japan. U.S.
banks have also nearly doubled their exposure to emerging markets during this period.

10

20

Source: Federal Reserve, IIF. *excluding auto loans and credit cards

Chart 6
Foreign Consolidated Claims of U.S. Banks
$ trillion, immediate borrower basis, end-March 2014
3.5

A number of factorsincluding the retrenchment of European

banks after the 2008-09 financial crisis and during the Euro Area
sovereign debt crisishave played a role in this expansion.
However, as noted in a recent NY Fed staff report, global liquidity conditions also play a significant role in influencing banks
decisions on credit extension, both to domestic and foreign clients. An environment of rising rates and declining liquidity
could slow the pace of growth in U.S. cross-border lending, perhaps with more of a tilt towards domestic lending.

Offshore centres

3.0

Emerging markets

2.5

Other mature economies

2.0

Euro Area

1.5

Japan

1.0
0.5
0.0

01 02 03 04 05 06 07 08 09 10 11 12 13 14

Source: BIS, IIF.

(Excerpted from IIF Capital Markets Monitor, September 2014, author:

Emre Tiftik, etiftik@iif.com, 1-202-857-3321)