Recent developments in the profitability and lending practices of commercial banks.

Recent Developments in the Profitability and Lending Practices of Commercial Banks Martin H. Wolfson and Mary M. McLaughlin, of the Board's Division of Monetary Affairs, prepared this article. Douglas Carpenter and Vernon McKinley provided research assistance. The profitability of U.S.-chartered insured commercial banks recovered in 1988, after a year of record low earnings. Large banks registered the sharpest turnaround; their rates of profitability were the highest in many years after huge losses in 1987. At all commercial banks, the lowest level of loss provisions in five years, in conjunction with higher net interest income, contributed to a return on assets of 0.84 percent, the highest in two decades. The return on equity increased sharply to 13.52 percent. This strong performance allowed banks to pay dividends to shareholders that were generous by historical standards, while still increasing their equity capital ratios somewhat. Banks chose to provision at a lower level last year, even though charge-offs increased, particularly on foreign loans. Net charge-offs in fact exceeded provisions, and consequently, banks ended 1988 with loss reserves down from a year earlier.

Short-term interest rates rose steadily throughout most of last year as the Federal Reserve took steps to restrain inflation. With the demand for bank credit generally strong and its cost rising, the rate of return on banks' loan portfolios rose significantly. In contrast, rates paid on many retail deposits at commercial banks adjusted only partially to the increases in market rates. As a result, the spread between interest income and interest expense (net interest margin) widened.

Despite strong domestic demand for loans, overall asset growth of U.S. banks remained moderate last year. Acquisitions of securities slowed, in part to accommodate higher domestic loan growth in the context of tighter monetary policy and in part as a result of the continued runoff of tax-exempt securities following the 1986 tax law change. Foreign loans declined as large banks reduced their exposure to developing countries by recognizing losses and slowing new loan growth. Partly to improve capital ratios, money center banks reduced their assets by stepping up loan sales and striving to pare back holdings of narrow-margin assets.

In their funding strategy last year, banks relied heavily on both large and small time deposits. In contrast to other retail deposits, interest rates paid on small time deposits generally kept pace with rising market rates, and the rate of growth of these deposits picked up sharply. In the category of managed liabilities, a strong advance in large time deposits reflected in part a shift of funding sources from foreign office deposits, which declined.

A record 198 commercial banks insured by the Federal Deposit Insurance Corporation failed last year. As in 1987, the majority of the nation's failed banks were located in the Southwest, where real estate losses remained high. On the other hand, the farm economy continued to improve last year, despite the drought, and the profitability of agricultural banks exceeded that of the banking system as a whole.

BALANCE SHEET DEVELOPMENTS

Interest-Bearing Assets Expansion of bank credit increased slightly last year, as a marked slowdown in the acquisition of securities offset an acceleration in the growth of loans. All size groups of banks registered strong loan growth except for money center banks, at which loan volume contracted. The fastest-growing component of bank credit was real estate loans. Domestic business loans registered a sharp increase in their growth rate, while foreign business loans contracted. Growth of U.S. government securities slowed while municipal securities ran off. At large banks, holdings of total securities shrank. Several very large banks that act as primary dealers of government securities registered declines in their security holdings because their parent holding companies spun off their dealer departments into nonbank subsidiaries. These subsidiaries were formed to engage in newly authorized activities, including underwriting securities such as commercial paper, bonds secured by one- to four-family mortgages, and municipal bonds.

Awareness of the new risk-based capital guidelines, due to go into effect in a transitional stage in 1990 and to take full effect in 1992, probably was an important influence on banks' portfolio decisions in 1988. The new guidelines rank asset categories by credit risk and require that banks have capital equal to 7.25 percent of risk-weighted assets by the end of 1990 and 8 percent by year-end 1992. In addition, half of the capital requirement must be met with "core" capital, defined as common equity, retained earnings, and perpetual preferred stock.

Commercial and Industrial (C&I) Loans. C&I loans made by U.S. commercial banks to domestic borrowers expanded nearly 7 percent in 1988, up strongly from the weak pace in 1987. The pickup in domestic business loan demand was associated with an increase in the gap between capital expenditures and internal funds of nonfinancial corporations, a typical development as a business cycle progresses, and with continued strong credit demands associated with acquisitions, mergers, and other corporate restructurings. Business loan demand also accelerated because nonfinancial corporations focused their credit demands last year on short-term markets, despite the considerable increase in the level of short-term interest rates. Other short-term nonfinancial corporate debt instruments expanded even more strongly last year. Commercial paper growth accelerated to 18 percent and C&I loans to U.S. residents made by U.S. branches and agencies of foreign banks advanced almost 17 percent. Firms apparently chose to postpone longer-term issues in the expectation that lower credit costs were on the horizon. Also, investors began to shun corporate investment-grade bonds after the announcement late last year of the RJR Nabisco leveraged buyout. Fears developed that the value of such debt could decline if the issuing firms became takeover targets--so-called event risk.

The faster growth of domestic C&I loans resulted mainly from expansion at banks with assets of more than $5 billion other than money center banks, although C&I loan growth increased at smaller banks as well. At money center banks, the volume of business loans contracted in 1988, as it typically has in recent years. Partly as a result of loan sales, C&I loans at these banks have fallen from 32 percent of average assets in 1984 to 23 percent last year. This trend also reflects the continuing ability of money center banks' most creditworthy business borrowers to go directly to the money and capital markets for funds. Many of these borrowers have better credit ratings than most of the money center banks. Capital pressures, which have caused money center banks to deemphasize narrow-margin loans, also have contributed to their runoff of C&I loans. Data from the Federal Reserve's Survey of Terms of Bank Lending illustrate this development. Over the period from 1985 through 1988, the percentage of gross business loan extensions made by large banks at rates below prime has declined. Loans made at rates below prime typically are priced at rather narrow spreads over funding costs.

Overnight loans provide a good example of this type of lending. These loans tend to be made in very large denominations, on the order of $5 million to $20 million. Among other purposes, they are used by firms to facilitate a delay in issuing commercial paper or bonds in the expectation of improving market conditions. Banks have raised the cost of these loans relative to the federal funds rate in the past couple of years, and the amount of overnight loans on banks' balance sheets has declined.

These developments notwithstanding, money center banks continue to be heavily involved in the C&I loan business. By selling loans without recourse, these banks have been able to exploit their well-developed capabilities of originating loans and to generate fee income without increasing required capital. According to the general pattern revealed by the Senior Loan Officer Opinion Survey of Bank Lending Practices (LPS),(1) the leading sellers of C&I loans are the money center banks, although other large banks are becoming increasingly important participants in this market. About 80 percent of C&I loans sold by LPS respondents are purchased by other banks--presumably those with lower costs of capital or cheaper deposits, as well as banks wishing to diversify their portfolios or banks whose total production costs for these loans exceed the purchase price. Particularly important purchasers have been domestic branches and agencies of foreign banks. Nonbank purchasers include nonfinancial corporations, life insurance companies, and thrift institutions.

About 43 percent of loan sales at LPS respondents in 1988 involved merger-related loans. Although large banks have been active in selling merger credits, these institutions also hold considerable amounts of merger-related loans in their own portfolios. As of December 31, 1988, merger-related loans--defined to include loans made to finance leveraged buyouts (LBOs), other mergers and acquisitions, and defensive or other financial restructurings--accounted for about 11 1/2 percent of LPS respondents' C&I loan portfolios, down from 15 3/4 percent a year earlier. About 80 percent of these loans were made to finance LBOs. Such loans frequently have quite attractive yields (prime plus 1 1/2 percentage points or LIBOR plus 2 1/2 percentage points represent typical terms). To date, the losses on these loans have been low, and thus they apparently have worked to boost banks' net interest income and profitability. Moreover, large upfront and commitment fees, particularly for lead banks, have contributed to noninterest income.

The loan sales market has grown rapidly in recent years, with the outstanding dollar volume of loans sold by LPS respondents rising almost 40 percent in the 15 months ending with June 1988, to $53 billion. When this market began several years ago, it consisted predominantly of loans made to investment-grade borrowers; as it has grown and matured, however, an increasing share of loans sold have been those made to non-investment-grade borrowers.

In addition to loan sales, banks have expanded their involvement in several other types of off-balance-sheet activities such as loan commitments, interest rate swaps, and foreign-exchange trading. Reflecting growth of these activities, noninterest income of commercial banks rose to 1.47 percent of average consolidated assets last year, up from 1.41 percent the year before. Since 1984, noninterest income at all banks relative to assets has risen 38 basis points. Of course, these activities add to costs, but noninterest expense (other than loss provisions) has risen less in recent years, up 29 basis points over the same period, measured as a percentage of assets.

Loan commitments constitute one of the most important types of off-balance-sheet activity. The predominant form of loan commitment for C&I loans is the revolving line of credit. According to the LPS survey, business borrowers prefer formal revolving loan commitments to other lending arrangements for several reasons. These include convenience, minimization of loan arrangement costs, and access to credit at a predetermined spread over reference rates. This assured access can be advantageous in case of a general credit tightening or a deterioration in the borrower's creditworthiness. Banks often protect themselves against this latter event, however, by including in loan commitments "material adverse change" clauses that allow them to void a commitment if a borrower's credit condition deteriorates beyond limits specified in the commitment contract.

Real Estate Loans. Although growth of real estate loans decelerated a bit in 1988, these loans increased faster than any other major component of bank credit, as they have for the past five years. As a result of this rapid growth, real estate loans in 1988 climbed to more than 20 percent of commercial bank assets, edging out C&I loans as banks' largest single loan category. Although real estate loans are relatively more important at smaller banks, all size groups of banks have shared in this growth. Indeed, even at money center banks, real estate loans accounted for nearly 14 percent of assets last year, up from less than 10 percent in 1984.

For banks of all sizes, the largest category of real estate loans outstanding is that secured by one- to four-family residences. Expansion of this component last year included an increase of 37 percent in revolving home equity loans. This debt instrument has become much more popular in response to a provision of the Tax Reform Act of 1986 that phased out the tax deductibility of household interest payments for nonmortgage debt. Even at very large banks, where business-oriented mortgages (such as those for construction and land development and those secured by nonfarm nonresidential properties) rival home mortgages in importance, growth of home equity loans was strong last year.

High vacancy rates and other difficulties experienced recently in the commercial real estate market have slowed the growth of the nonfarm nonresidential component of real estate loans, especially in areas of the Southwest where the energy industry is important. For banks in Texas, Oklahoma, and Louisiana, real estate loans dropped 4 percent overall in 1988, with major declines in the commercial area. Net charge-offs of real estate loans accounted for a considerable part of this decline. Problems with real estate loans, including the necessity for larger loss provisions and interest lost from nonperforming assets, contributed to the poor profit performance of these banks. In the northeastern United States, where the volume of real estate construction has been well above average for several years, concerns have developed about overbuilding.

The growth of real estate loans secured by farmland slowed last year, likely owing to improvements in the agricultural economy. In periods of stress, such as the mid-1980s, farm production loans often are collateralized by farm real estate, causing loans secured by farmland to expand while damping the growth of unsecured loans for agricultural production and other loans to farmers.

Consumer Loans. Growth of loans to individuals picked up in 1988, but remained moderate. Demand for consumer loans has slowed in recent years because of burgeoning home equity loans, the proceeds of which frequently are used to pay down more expensive credit card and consumer installment loans. Consumer loan growth also was held down last year by the securitization of consumer receivables by several very large banks. This development boosted noninterest income and contributed to the contraction of consumer loans at money center banks last year.

Loans to Foreign Addressees. Both loans to foreign governments and business loans to non-U.S. addressees contracted substantially last year.(2) These two categories, especially loans to foreign governments, contain many of the loans made to developing countries. Such loans are made almost exclusively by large banks. These banks, particularly regional banks, made a concerted effort last year to reduce their exposure to heavily indebted developing countries. The primary methods used were secondary market sales, debt exchanges (such as Mexico's exchange of some of its debt for new bonds backed by U.S. Treasury zero-coupon bonds), and prepayments (with reductions) of debt by private-sector borrowers. All of these methods have required that banks recognize a loss on their loans outstanding.

At large regional banks, loans to foreign governments fell 26 percent and C&I loans to foreign addressees declined almost 19 percent last year. At money center banks, loans to foreign governments were about unchanged, while foreign C&I loans declined 12.8 percent. For the most part, loans to developing countries represent a smaller share of regional banks' total assets than is the case for the money center banks. Thus, regional banks have been able to write off or otherwise reduce their holdings of these loans with less capital erosion.

Regional banks charged off $1.9 billion of loans to foreign governments and also allowed their loans outstanding to drop an additional $1.4 billion. In contrast, $1.3 billion in charge-offs at money center banks was offset by $1.4 billion in new lending. At both groups of banks a relatively small share of the decline in foreign business loans was due to charge-offs.

Security Loans. The volume outstanding of these loans, extended mainly to brokers and dealers, was little changed last year after two years of considerable declines. The market for security loans is dominated by money center banks. These banks apparently have chosen to deemphasize this type of credit, perhaps because of its relatively low rate of return. As with C&I loans, large banks are in the practice of selling some of the security loans they have originated.

Agricultural Loans. With some improvement in the farm economy, the three-year decline in the volume of farm borrowing from banks halted in 1988. Total loans to farmers (unsecured production loans plus loans secured by farmland) rose slightly, both on average and for all sizes of banks. This development had particular implications for the smallest banks, where agricultural credit represents a substantial 10 percent of their portfolio and where more than 70 percent of all loans to farmers are booked. In 1988, agricultural banks charged off loans at only three-fourths the national rate, an improvement over the preceding few years, and their nonperforming assets represented a smaller portion of their total loans than that for the industry as a whole.

Farm debt at all lenders has declined almost 25 percent since the early 1980s. Difficulty in servicing debt incurred earlier to expand real estate holdings and changes in federal farm subsidy programs resulted in a lower level of agricultural loan extensions. Charge-offs by several farm lenders, especially around mid-decade, further reduced the stock of such loans. Because banks' portfolios were affected by these developments less than those of other agricultural lenders, banks' share of all agricultural credit has risen to 30 percent, more than any other lender.

Securities. Commercial banks' security holdings were up slightly last year. Securities issued by states and political subdivisions in the United States ran off, as they have since passage of the Tax Reform Act of 1986. A provision of that act disallowed the deduction from taxable income of 80 percent of the interest costs of funding most tax-exempt obligations acquired after August 7, 1986. In anticipation of that date, many banks, particularly larger ones, had acquired a considerable volume of long-term grandfathered instruments, which are likely to be running off well into the next decade.

Growth of U.S. government securities slowed to 5 percent last year, well under the pace of the past two years, as large regional banks ran off these liquid instruments and their growth at money center banks fell by half. Banks' holdings of U.S. government-issued or guaranteed certificates of participation in pools of residential mortgages increased 22 percent in 1988, about half the rate of the preceding two years.(3) Growth of this instrument was strong at all size groups of banks. These large increases in holdings of mortgage-backed securities, along with continued strong real estate lending, underscore the expanded role for commercial banks in real estate markets.

Trading account assets grew 8 2/3 percent last year. Three-fourths of these assets are held by the money center banks. These very large banks realized larger trading gains and fees, relative to total assets, than other banks did on average. They also earned sharply higher interest income on these assets than other banks did.

Asset Quality The overall charge-off rate resumed its upward climb last year, after falling somewhat in 1987. Partly as a result of this development, nonperforming assets reported by banks declined as a percentage of the loan portfolio.

In the aggregate, banks charged off 0.97 percent of their loan portfolio last year, up from 0.92 percent the year earlier. Banks with assets of more than $5 billion were responsible for the increase. In particular, large banks other than money center banks reported a ratio of net charge-offs to loans of 1.25 percent, up sharply from 1.00 percent in 1987. As noted earlier, charge-offs of loans to developing countries were an important factor contributing to the increase.

Detailed data on charge-offs net of recoveries by type of loan are available for banks with assets of more than $300 million. Small improvements in 1988 were reported in several areas: domestic business loans, loans to consumers, and real estate loans. (The overall figure for real estate charge-offs, however, is an aggregate of relatively high losses on commercial real estate and relatively low losses on one- to four-family residential properties.) Significant increases were reported in charge-offs of foreign loans: foreign business loans, loans to foreign banks, and especially, loans to foreign governments.

With some of their most troubled loans charged off, the reported quality of commercial banks' nonperforming assets improved in 1988. For all banks, the proportion of loans either past due or not accruing interest fell somewhat, to 4.65 percent. The total of nonaccrual loans plus other real estate owned (OREO)--mostly foreclosed real estate--also registered improvement over 1987. Real estate loans on nonaccrual status were about unchanged; at large banks other than money center banks, however, they increased sharply.

Banks are not required to report data on nonperforming loans to foreign governments; they do, however, report such information for three other categories of foreign loans. Of these, the largest by far is foreign business loans. A significant proportion of these loans did not accrue interest last year. At money center banks, foreign business loans on nonaccrual status increased in 1988, in contrast to all other banks reporting these data, where the proportion of such loans on nonaccrual status declined sharply.

Liabilities Growth of commercial bank deposits advanced last year despite declines at foreign offices. At domestic offices, deposits accelerated strongly. This pickup stemmed partly from a small expansion in demand deposits after a major contraction in 1987. Growth of small time deposits nearly doubled last year. Their yields responded relatively promptly to increases in market rates, likely drawing in funds from more liquid deposit categories for which deposit rates tend to be more sluggish. Nevertheless, retail liquid deposits grew a bit over the moderate pace of 1987. Retail deposits at commercial banks may have been augmented last year by funds that were withdrawn or diverted from thrift institutions. Thrift institutions historically have offered higher deposit rates than banks. Last year, however, this premium narrowed, in part due to pressure by regulators. Depositor reaction to the relative decline in the overall attractiveness of thrift deposits, perhaps along with increased concern late in the year about the financial condition of these institutions, probably reduced their deposit growth and led to higher growth at banks.

TRENDS IN PROFITABILITY Commercial banks of all sizes enjoyed improved profitability last year, although large banks did best and sectoral differences remained.(4) At the money center banks, a return on assets of 1.06 percent was about double their performance in any recent profitable year and well above the previous peak, reached in the early 1970s. Other large banks registered a return on assets that was about even with that for the industry as a whole. At money center banks, loss provisions relative to assets were at their lowest level since 1983; at other large banks, this ratio was lower last year than at any time since 1984.

At money center banks, about 60 percent of loss provisions in 1988 were attributable to international business, well below the record 1987 share but a little above the average of previous years. A quarter of loss provisions made by other large banks was ascribed to international business, in line with the average of the mid-1980s. For all banks with foreign offices, profits from business abroad last year rose to the pre-1987 share of about one-fifth of total net income; for money center banks the contribution was about one-third.

The increased level of profitability of banks with assets of less than $5 billion resulted almost entirely from declines in provisions for losses, as other factors affecting the earnings of these banks were not much changed on balance. Losses at banks in Texas, Oklahoma, and Louisiana deepened for the third consecutive year, and in 1988 were equivalent to almost 1 percent of assets. Late last year, the subsidiary banks of the largest bank holding company in Texas, First Republic Corporation, were taken over by NCNB Corporation in an FDIC-assisted merger. Apparently recovered from their problems earlier in the decade, agricultural banks outperformed the industry average. Their return on assets, 0.90 percent, has doubled over the past two years.

Net Interest Margin Higher interest rates lifted both interest income and interest expense last year. Increased returns on commercial bank loan portfolios accounted for most of the increase in gross interest income in 1988. Rates paid on deposits, however, rose less steeply, and the taxable equivalent net interest margin widened 17 basis points over the year, to 3.78 percent.

The net interest margin at money center banks improved considerably more than it did at other banks, despite a relatively large increase of three-quarters of a point in interest expense. Interest income accounted for more than a percentage point more of their assets in 1988 than in the previous year. This component was boosted substantially by the signing by Brazil of a refinancing plan late last year that brought current the interest on its loans with U.S. banks.(5) The wider interest rate margin at the money center banks also is consistent with their efforts to reduce holdings of narrow-margin assets, discussed previously. Nevertheless, at 3.07 percent, the margin at these banks remained well below the industry average. Other large banks also benefited from the higher interest income from Brazilian loans, which helped to increase their margin 18 basis points.

Medium-sized banks, with assets between $300 million and $5 billion, registered slightly smaller changes in both interest income and expenses than large banks other than money center banks. They finished the year with interest income somewhat below and with interest expenses significantly below the industry's levels as a proportion of assets. Thus, their margin continued to exceed the average.

The smallest banks registered growth in interest income and expense that was less than half that for all banks. Over time, this group has tended to have higher interest income and lower interest expense than larger institutions. Small banks' net interest margin, at 4.33 percent of assets, continued to be well above the average spread for all banks. While rates paid on interest-bearing deposits nationally rose 38 basis points from 1987 to 1988, at this group of banks the increase was only 20 basis points. This difference likely reflects both a lower degree of interest rate pass-through to depositors at smaller banks and a higher proportion of retail deposits.

Noninterest Income and Expense and Security Gains The increase in noninterest income in 1988 was twice that of noninterest expense (excluding loss provisions). As a result, the negative spread between these two components continued to contract.

An important part of the improvement in income was attributable to increased fees from merger-related financing activities at banks with assets of $5 billion or more, as well as fee income and gains on assets held in trading accounts. However, these large banks earned less from foreign exchange transactions last year than they did in 1987. Large banks also spent slightly more in 1988 for all types of noninterest expenses. In particular, money center banks' wages and benefits as a percentage of assets rose 2 percent last year (compared with no change at all banks) and remained above those for all banks for a second year, likely indicative of the costs of managing growing off-balance-sheet activities.

Both noninterest income and expense were little changed at banks with assets of less than $5 billion. Noninterest income, 1.11 percent of assets, remained 3/4 of a percentage point lower at these banks than at larger banks. This development was likely attributable to less involvement in off-balance-sheet and trading account activities. Deposit service charges and trust income accounted for half of their noninterest income but showed no growth over 1987. Expenses for salaries and premises declined relative to assets at these banks for the second consecutive year.

Capital gains on the sale of securities held in investment accounts fell for a second straight year across all sizes of banks. The money center banks hold about one-third as much of their assets in securities as banks on average do; yet their gains on sales from investment accounts, expressed as a share of assets, were triple the average for all banks last year.

Dividends and Retained Earnings Commercial banks paid dividends equal to 0.44 percent of their assets in 1988, a higher rate than in any of the past 20 years. While most smaller institutions paid out about 64 percent of profits in dividends, the share for money center banks was only about 36 percent. As a group, these latter banks had to dip into capital in 1987 to pay dividends, and they retained a larger proportion of their net income this past year to replenish those funds. Nevertheless, even at money center banks dividends were paid out at a rate well above the average of recent years.

The stock price index of regional banks rose relative to the Standard and Poor's 500 index until the third quarter of last year and fell off somewhat after that. Nonetheless, it outperfomed the general market overall in 1988, likely reflecting the boost to dividends. The growth of the index of stock prices for money center banks was little different from that of the S&P 500 during the first four months of 1988. But it trended upward thereafter and since late 1988 has even gained on the index for regional banks.

Capital Retained earnings funded three-fifths of the additions to equity capital in 1988. The industry's ratio of regulatory primary capital to assets increased 13 basis points to 7.93 percent in 1988. While on average banks showed only a small change in capitalization, money center banks, which as a group have relatively low capital ratios, improved their capital positions substantially. A full 90 percent of the increase in their equity capital came from retained earnings.

Regardless of size, there was a general connection between banks' equity positions at the beginning of the year and subsequent expansion of interest-earning assets and equity capital last year. Banks that began the year with relatively low equity capital made greater efforts to boost its level; those that started 1988 with less need for additional capital showed slower equity growth. At the same time, banks' growth of interest-earning assets was inversely correlated with expansion of holdings of equity. For example, large banks in the lowest quartile shrank their interest-earning assets 2.7 percent and increased their equity one-third. Conversely, the best-capitalized large banks expanded interest-earning assets 11 1/2 percent and added less than 4 percent to their equity. Smaller banks, which are in general better capitalized, exhibited less sensitivity than larger banks in terms of the relation of the growth of equity and assets to initial capitalization.

Smaller banks also had a wider dispersion of capital ratios than large banks did. For banks with assets of less than $5 billion, the average ratio of equity capital to assets for those in the top quartile was more than 7 percentage points higher than it was for those in the lowest quartile. For larger banks, this range was about half as wide.

DEVELOPMENTS IN EARLY 1989 The profitability of commercial banks continued to increase during the first quarter of 1989. The improvement resulted from higher net interest margins, continued low provisions for loan losses, and slow growth of expenses. Banks of all sizes registered gains. Some of the largest banks, however, suffered declines in net income, in part due to lower profits from trading in bonds and foreign exchange.

The spring of this year witnessed the failure of MCorp, the last large Texas banking company to have remained independent of banking interests outside the state. In what is likely to be the third largest failure in U.S. banking history (exceeded only by Continental Illinois and First Republic), the FDIC took control of 20 of MCorp's 25 subsidiary banks. In total, 86 banks had failed in the United States as of June 3 (compared with 74 for a similar period of time last year).

Another development early in the year was the announcement by Secretary of the Treasury Nicholas F. Brady of a new plan to address the economic situation of heavily indebted countries. A key element of the Secretary's initiative involves encouraging commercial banks to reduce debt payments for those countries that implement acceptable economic adjustment programs. Financial guarantees for banks that reduce their debt loads would be provided by the World Bank and the International Monetary Fund.

APPENDIX: DATA SOURCES The basic source of data for this article is the Report of Condition and Income (the Call Report) filed by every insured commercial bank with its regulatory agency. This report provides a complete balance sheet and income statement for each bank. Unless otherwise noted, the data reflect the foreign and domestic operations of banks on a fully consolidated basis. Supplementary sources of data used in this article are the Survey of Terms of Bank Lending (STBL) and the Senior Loan Officer Opinion Survey of Bank Lending Practices (LPS). Details on these two surveys may be found in an appendix to the article by Thomas F. Brady, "Changes in Loan Pricing and Business Lending at Commercial Banks," FEDERAL RESERVE BULLETIN, vol. 71 (January 1985), page 13. Results of the LPS may be obtained by writing to the Banking and Money Market Statistics Section, stop 81, Division of Monetary Affairs, Board of Governors of the Federal Reserve System, Washington, D.C. 20551. (1)The LPS provides the Board with information on evolving lending practices of 60 large domestically chartered banks, including the money center banks. The appendix describes this survey in more detail. (2)Loans to foreign banks also declined. (3)Holdings of mortgage pools issued or guaranteed by the U.S. government exceed private mortgage pools in banks' portfolios by more than 20 to 1. (4)The profitability picture is less improved when examined from the perspective of the National Income and Product Accounts. This accounting system reduces net income by the amount of net charge-offs rather than by the amount of loss provisions. (5)Despite the receipt of past-due interest income, most money center banks did not remove Brazilian loans from nonperforming status.