Bank Capital, Profitability and Interest Rate Spreads MUJTABA ZIA * * Assistant Professor of Finance, Rankin College of Business, Southern Arkansas University, 100 E University St, Slot 27, Magnolia AR 71753, USA. Tel: +1 (870) 235 4307, E-mail address: mujtabazia@saumag.edu This draft version: March 01, 2017 Abstract Over the past few decades, interest rates in the United States fluctuated considerably. The fluctuations in interest rates affected US banking industry. Over the same period, many important bank regulatory acts passed. In this paper, we examine how interest rate fluctuations from low single digit levels in 1960 s to double digit highs in the 1980 s and then back to the current low levels of 1-2 percent affected bank capital, profitability and risk. In this paper, we examine bank capital, profitability, and stock price performance in response to interest rate changes since in four main periods since 1962: non-crises periods, all financial crises periods, during the Great Recession of 2007, and in the post-great Recession period. JEL Classification: G18, G21, G28 Keywords: Banks, Financial Crisis, Banking Regulation 1
1. Introduction Since the publication of the seminal work of Milton Friedman and Anna Schwartz in 1963 about the monetary history of the United States 1, the Federal Reserve System (the Fed) gradually leaned towards a more active monetary policy. Interest rates, especially the Fed Funds rate 2 became one of the major policy targets of the Fed when conducting monetary policy. The Fed Fund s rate fluctuated from approximately 4% in 1960 s to 19% in late 1970 s and fell to the low 0.25% during the recent financial crisis of 2007 and 2008. These substantial changes were mainly due to the Fed s policy response to economic conditions. Dramatic interest rate changes in financial markets in the last few decades introduced important challenges for the banking industry on which the interest rates play a special role. One implication of interest rate changes is that a sudden change in interest rates affects the earnings and profitability of banks. The traditional banking model suggests that banks are financial institutions that receive deposits which are subject to withdrawals at any time and make loans that are not subject to calls by banks. This structure poses maturity risk for banks. On the other hand, a majority of loans tend to be of fix-rate nature creating interest rate risk for banks if interest rates change significantly. Another implication of interest rates is on the solvency of banks. Loans typically have longer maturities than bank certificates of deposits. If interest rates increase in financial markets, investors may withdraw funds from banks if they don t pay comparable interest rates. On the other side, banks cannot recall loans before their maturities or raise interest charges on them if rates are fixed by contract. Such solvency problem has to be managed by maintaining adequate bank capital. 1 Friedman and Schwartz (1963) 2 The Fed Fund s rate is the rate which banks charge each other on overnight loans from the excess reserves maintained at the Federal Reserve System. 2
The last, but not least implication of interest rates on banks is due to the nature of the banking industry being more closely regulated. Major regulation changes in the last few decades, especially during financial crises, also impacted the banking industry. While some of the banking regulation acts introduced limitations on banking practices and brought challenges to the banking industry, others relaxed some of the limitations and helped banks provide more innovative products and services that may have bolstered bank capital and earnings. While determinants of bank profitability and related issue to bank capital have been well studies, a comprehensive analysis of how bank performed in terms of their capital level and profitability in response to interest rate that covers all major financial crises as well as normal times has not been done. This gap in banking research literature exists. Motivated by the above implications of interest rates and the banking literature gap, we examine bank capital, profitability and risk levels in response to interest rate changes since 1962 and conduct further analysis in sub-periods that include financial crises.we investigate how US banks adapted to major interest rate fluctuations and regulatory policy changes since 1962 and intends to shed light on how bank capital, profitability and risk changed in response to these changes. The rest of this paper is organized as following. In section 2, we review previous studies. In section 3, we discuss data and methodology. In section 4, we present results, and in section 5, we conclude with brief remarks. 2. Literature Review Bank interest rate margins 3 have perhaps the greatest impact on bank profitability and losses. Fluctuations in the levels of interest rates therefore have significant implications for bank interest rate margins. Ho and Saunders (1981) are among the first researchers who model and 3 Interest rate margin is defined as the difference of interest rates banks charge on loans and interest rates banks pay to finance the loans. 3
analyze bank interest rate margins and their determinants. They extend the hedging hypothesis 4 and expected utility maximization hypothesis 5 of banking firms to analyze determinants of bank margins. They find four main determinants for bank interest margins: the degree of bank management risk aversion; the market structure in which banks operate; the size of banks; and the variance of interest rates. Hanson and Rocha (1986) study the determinants of interest rate margins using data for 29 countries over the period 1975-1983 and determine bank profitability and losses to be highly dependent on inflation, scale of economies and market structures. Demirguc-Kunt and Huizinga (1999) study the determinants of bank interest rate margins across 80 countries and find that interest rate margins vary across countries and reflect a variety of determinants such as macroeconomic conditions, deposit insurance regulation and taxation. Saunders and Schumacher (2000) study a panel of banks from 7 OECD countries between 1988 and 1995 and find that bank interest rate margins vary widely across countries and more importantly, the size of the margins change over time. Entrop et al (2015) study the impact of maturity transformation on interest rate margins of German banks between 2000 and 2009 and find that banks interest rate margin is mainly priced based on the asset side of bank balance sheet. Other related studies on interest rate margins, bank capital, profitability and losses are conducted by Athanasoglou, Brissimis and Delis (2008), Albertazzi and Gambacorta (2009), Bolt et al (2012), Gambacorta and Mistrulli (2014), Saghi-Zedek and Tarazi (2015) and DeAngeli and Stulz (2015). The consensus is that bank profitability depends on many factors including regulatory environment, tax codes, and economic conditions such as financial crisis. 4 The hedging hypothesis of banking models view banks as firms tying to match the maturity of assets and liabilities to hedge against refinancing risks. 5 The expected utility maximizing hypothesis is based on microeconomic structure of firms that views bank as firms trying to maximize expected wealth or utility of wealth. 4
While these valuable studies fill gaps in banking research literature and address important questions, a more comprehensive study of US banking practices and adaption to interest rate fluctuations and regulatory changes to cover the recent few decades has not been adequately investigated. We intend to fill this literature gap in banking research and hope to contribute to the understanding of banking dynamics since 1960 s. 3. Data and Methodology Data on bank capital and financial ratios comes from the Reports of Condition and Income (Call reports) and is available from the Federal Financial Institutions Examination Council (FFIEC) and Federal Deposit Insurance Corporation (FDIC.) Data on interest rates comes from the Federal Reserve System. The period of study in this paper is from the last quarter of 1962 to the last quarter of 2015. Data on bank fundamentals are quarterly data and our dataset consists of 79820 total quarterly observations. Interest rates are available daily and we take the quarterly average to make them compatible with bank quarterly data. We use two measures for bank capital, Tier-1 capital and cash ratio. Tier-1 capital is based on Basel Accords 6 and reflects banks ability to absorb losses, while cash ratio reflects the ultimate liquid capital level of a bank. To measure bank profitability, we use return on equity, but also include net income alone in our analysis. 7 Although interest rates are very dependent on each other and only one interest rate benchmark will reveal sufficient information, we use different measures of interest rates in this study. The main interest rates we use are the Fed Fund s rate, the prime rate, the 30-year 6 The Basel Accords refer to Basel I, Basel II and Basel II accords, which are set of recommendation prescribed by the Bank for International Settlements in an attempt to standardize bank regulations across countries. 7 Another measure of bank profitability could be return on assets. However, because banks typically have better access to short-term and long-term funds including funds from the Federal Reserve System and operate with higher levels of liability than non-bank firms, return on asset does not reflect bank profitability as well as return on equity does. 5
mortgage rate. For technical efficiency reasons, we analyze interest rate changes in terms of spreads among them. We use two major interest rate spreads, the spread between the 30-year mortgage rate and the prime rate and the spread between the prime rate and Fed fund s rate. Using interest rate spreads, rather than interest rates alone may reveal additional information regarding bank capital and profitability trends as they can be considered interest rate margins. A higher spread may allow banks to absorb some interest rate fluctuations. To investigate the level of risk in the banking industry throughout the study period, we use debt ratio. A more detailed measure of risk is the Altman s Z-score. However, debt ratio plays a central role in all risk measures including the Z-score, especially in the banking industry. On the other hand, we are interested in how bank level of debt versus equity has changed over time. Therefore, we use debt-ratio as the main proxy for bank risk We analyze bank capital, profitability and risk in four periods since 1962. We consider bank practices during all financial crises, during the non-crises period, during the Great Recession of 2007 and 2008 and during the post-great Recession period. There were six financial crises identified by the Federal Reserve System. 8 These crises are the crisis of early 70 s from the fourth quarter of 1973 to the first quarter of 1975; the crisis of 1980 from the first quarter of 1980 to the second quarter of 1980; the crisis of 1981 from the third quarter of 1981 to the fourth quarter of 1982; the crisis of 1990 from the third quarter of 1990 to the first quarter of 1991; the crisis of 2001 from the second quarter of 2001 to the last quarter of that year; and the Great Recession from the last quarter of 2007 to the first quarter of 2009. The post-great recession period of our study is from the second quarter of 2009 to the last quarter of 2015. We also conduct analysis over all the whole period since 1962. For further analysis, we classify 8 The stock market crash of 1987 (the Black Monday) is not separately studied as a stand-alone period, but we do report relevant findings during the crash. 6
banks into two main groups, large banks and small banks. We define banks with $500 billion or more assets as large banks and the rest as small banks. 4. Results 4.1. General trends in bank capital, profitability and risk Interest rates have fluctuated considerably in the last few decades. Concurrently, bank capital, profitability and risk have also changed over the same period. Chart 1 depicts the changes in interest rates and bank capital and profitability. Since the Tier-1 capital was first reported in early 1990 s until 2000, bank profitability was positively related to Tier-1 capital ratio. After 2000, banks with higher capital ratios experienced weaker profitability. This is consistent with the boom market of pre-great Recession years during which banks holding more capital could not invest funds in financial markets and therefore, experienced weaker profitability. The relationship of bank capital and profitability becomes blurred in the post-great Recession period. Although in general banks held more capital 7
between 2009 and 2012 and had improved solvency, they experienced volatile return on equity. For the whole study period period since Tier-1 ratios have been reported, the average level has been 11.77%. The ratio fell to 11.04% during the Great Recession and rose to 12.84% in the post-great Recession period. Bank profitability was relatively stable and hovering around 2.5% from 1962 to the beginning of 1980. During the financial crisis of 1980 and 1981, bank profits became dramatically volatile and fell to as low as -22% and rose again to as high as 15%. During the market crash of 1987 (The Black Monday), banks experienced -20% return on equity. From early 2000 until the Great Recession, bank profitability was relatively stable, but was declining. During the Great Recession, banks profitability became volatile and maneuvered in both negative and positive territories but never fell below -7%. The average return on equity during the period was -0.82%. In the aftermath of the Great Recession, the profitability level increased to 1.83% on average. For the whole study period, the average return on equity has been 2.33%. Bank risk level measured as long-term debt to asset ratio has steadily declined over time. While the average ratio for the whole study period is 183.62%, it declined to 11.47% during the Great Recession and reached a low average level of 7.43% in the post-great Recession period. The average debt ratio from 1962 to 2000 is 387%, while the same ratio is only 21% between 2000 and 2015. 9 The results suggest that bank s operate with less long-term debt compared to what they did prior to 2000. 9 A debt ratio of greater than 100% indicates insolvent condition. For a bank that is about to go bankrupt, the value of its assets may become considerably smaller than its total debt. This causes debt ratio to become extremely high resulting in higher average debt-ratios for the sample of banks. Further investigation is required to clarify the situation regarding bank bankruptcies in the last few decades. Examining debt ratios of failing banks just before their bankruptcies in comparison to their situation well before the bankruptcies may clear the ambiguity whether banks truly operate with less long-term debt these days compared to 1970 s and 1980 s or is it because of more bankruptcies in 1970 s and 1980 s. 8
4.2. Regression analysis of bank stock price performance and profitability To understand whether bank profitability depends on interest rate levels or how interest rate fluctuations affect bank profitability, we conduct regression analysis of bank profitability on interest rate levels. The interest rate benchmarks we use are the Fed funds rate, the prime rate, and the 30-year mortgage rate. For technical efficiency, we use the spreads between these rates rather than the rates themselves. The first spread is the difference between 30-year mortgage rate and the prime rate and the second spread is the difference between the prime rate and the Fed fund s rate. When conducting the analysis, we control for other bank parameters such as bank size and cash ratio in addition to Tier-1 capital and debt ratio. We further analyze bank stock price performance and profitability in different sub-periods. We also conduct the analysis on the subgroups of large banks and small banks. Table 1 summarizes descriptive statistics of our sample set for different periods. [Insert Table 1 about here] Further investigation of big banks, banks with $500 billion assets or more, during the Great Recession of 2007 and in the aftermath of the Great Recession provides valuable insight as the argument of too-big-to-fail banks became one of the discussion subject in bank research literature, especially during the Great Recession. Therefore, we conduct separate analysis on banks that has $500 billion or more in assets. Table 2 summarizes descriptive statistics for big banks during the Great Recession and in the aftermath of the Great Recession. [Insert Table 2 about here] 9
Do well capitalized banks perform better in stock markets, especially during financial crises? While, it is intuitive to believe so as well capitalized banks have better chances of staying solvent and weathering financial crises, we find that for the whole study period of 1962 to 2015, stocks of better capitalized banks do not perform higher. The results don t change for large banks versus small banks. Further analysis of Tier-1 capital as an explanatory variable for bank stock performance in sub-study periods of financial crises, non-financial crises, Great Recession and post-great Recession indicates that Tier-1 ratio is a significant explanatory variable only in the non-crises period for small banks, but not significant for large banks. For all other periods, the ratio yields insignificant results for both groups of banks, large and small. To understand whether well capitalized banks yield higher profits, we examine Tier-1 ratio as a determinant of bank profitability measured by returns on equity for small banks and large banks in different sub-periods. We find that for the entire study period, Tier-1 ratio yields significant negative results in explaining return on equity for small banks, but not for large banks. The coefficients are negative and significant at 1% level for small banks. The coefficients are statistically insignificant for the crises periods and non-crises periods including the Great Recession of 2007, but are negative and significant at 5% level in the post-great Recession period for all small and large banks. This indicates that maintaining higher capital ratios cost bank equity holders in the aftermath of 2007-2008 financial crises and is an insignificant cost in other periods. To further understand whether capital levels affect net income of banking firms in general, we analyze Tier-1 ratio as an explanatory variable for net income. Our results suggest that Tier-1 ratio is a significant explanatory variable only in the post-great Recession period for both larger and small banks. However, the coefficients are negative for large banks and positive 10
for small banks. The coefficients are both significant at 1% level. This interesting result implies that maintaining higher levels of capital is more costly for larger banks compared to small banks in the post-great Recession period. Does bank profitability depend on interest rate spreads? To address this question, we examine the interest rate spreads between the prime rate and the Fed fund s rate and the spread between the 30-year mortgage and prime rate as explanatory variables for return on equity as well as for net income. Results suggest that the spread between the prime rate and the Fed fund s rate significantly affect bank profitability for large banks in the whole study period of 1962-2015 but not during financial crises periods. The spread negatively affects small banks during financial crises periods including the Great Recession. During the Great Recession, the spread effect for small banks was smaller, but still significant at 5% level. Contrary to our expectations, bank profitability and stock market prices are not affected by fluctuations in the spread between mortgage rates and prime rates during the Great Recession. In fact the spread is not a significant explanatory variable for bank profitability in any of the periods. Detailed results are reported in Table 3 through Table 7. [Insert Table 3 through Table 7 about here] 5. Summary While bank capital and determinants of bank profitability have been studied in different periods, how bank capital and profitability have changed in response to interest rate fluctuations in the US have not been sufficiently investigated. We attempted to fill this literature gap by examining Tier-1 capital ratio of banks as a measure of bank capital, return on equity as a 11
measure of profitability and debt ratio as a measure of risk for bank holding companies since 1962. We analyzed banks in five main periods, the whole period covering 1962-2015, financial crises periods since 1962, non-financial crises periods, the Great Recession period of 2007 and 2008, and the post-great Recession period of 2009-2015. We also divided banks into two groups, large banks and small banks. We defined banks with $500 billion or more in assets as large banks. Our results indicate that bank capital has consistently remained stable throughout all periods at around 11-13% on average, although it fell to 8.52% for large banks in the Great Recession period of 2007 and 2008. Bank profitability experienced extreme fluctuations during the financial crisis of 1980 and 1981 and relatively less dramatic fluctuations during the Great Recession compared to the financial crisis of 1980, 1981 and the stock market crash of 1987. Bank capital level fails to significantly explain these profitability fluctuations in the banking industry both during financial crises and non-crises periods. However bank capital significantly affects bank profitability in the post-great Recession period. It negatively affects large banks but positively affects small banks. Interest rate fluctuations affect large banks more than small banks for the entire study period, but not during financial crises. Interest rate fluctuations measured by spread of prime rate and Fed fund s rate negatively affect small banks during financial crises, but not large banks. Large banks seem to be more immune to interest rate fluctuations during financial crises. This is consistent as large banks have better access to funds, especially government sponsored funds. 10 In general, during normal times when financial markets are not in turmoil, interest rates do not explain bank capital levels or profitability. 10 In the context of too-big-to-fail argument, it makes sense to believe that big banks get more government support during financial crises and therefore are not as affected as small banks during financial crisis. 12
References: Albertazzi, U., & Gambacorta, L. (2009). Bank profitability and the business cycle. Journal of Financial Stability, 5(4), 393-409. Athanasoglou, P. P., Brissimis, S. N., & Delis, M. D. (2008). Bank-specific, industry-specific and macroeconomic determinants of bank profitability.journal of international financial Markets, Institutions and Money, 18(2), 121-136. Bolt, W., De Haan, L., Hoeberichts, M., Van Oordt, M. R., & Swank, J. (2012). Bank profitability during recessions. Journal of Banking & Finance, 36(9), 2552-2564. DeAngelo, H., & Stulz, R. M. (2015). Liquid-claim production, risk management, and bank capital structure: Why high leverage is optimal for banks. Journal of Financial Economics, 116(2), 219-236. Demirgüç-Kunt, A., & Huizinga, H. (1999). Determinants of commercial bank interest margins and profitability: some international evidence. The World Bank Economic Review, 13(2), 379-408. Entrop, O., Memmel, C., Ruprecht, B., & Wilkens, M. (2015). Determinants of bank interest margins: Impact of maturity transformation. Journal of Banking & Finance, 54, 1-19. Friedman, M., & Schwartz, A. J. (1963). A Monetary History of the United States. Princeton University Press. Gambacorta, L., & Mistrulli, P. E. (2014). Bank heterogeneity and interest rate setting: what lessons have we learned since Lehman Brothers?. Journal of Money, Credit and Banking, 46(4), 753-778. Hanson, J. A., & de Rezende Rocha, R. (1986). High interest rates, spreads, and the costs of intermediation: Two studies (Vol. 18). World Bank. Ho, T. S., & Saunders, A. (1981). The determinants of bank interest margins: theory and empirical evidence. Journal of Financial and Quantitative analysis, 16(04), 581-600. Saghi-Zedek, N., & Tarazi, A. (2015). Excess control rights, financial crisis and bank profitability and risk. Journal of Banking & Finance, 55, 361-379. Saunders, A., & Schumacher, L. (2000). The determinants of bank interest rate margins: an international study. Journal of international money and finance,19(6), 813-832. 13
Table 1. Summary Statistics. The table summarizes the quarterly data for all banks in our sample study from the last quarter of 1962 to the last quarter of 2015. The sample consists of North American bank holding companies (BHC) that filed Consolidated Report of Condition and Income (Call report) with the Federal Deposit Insurance Corporation (FDIC). Panel A: Summary Statistics for all BHC Variable Obs Mean Std.Dev Min Max Total Assets 63022 23850.67 164560.40 0.00 3879172.00 Total Equity 61587 1604.05 10534.33-2488.94 257683.00 Return on Equity 61082 2.33 70.37-3151.76 11797.07 Tier 1 Ratio 40751 11.77 4.71-19.65 238.89 Cash Ratio 60488 8.32 7.72-0.13 100.00 Net Income 63688 36.28 370.70-33196.34 11672.69 Net Interest Margin 27550 157.44 862.70-634.76 18428.09 DEBT RATIO 58865 183.62 23872.05-3.80 3937000.00 30YMortgage Rate 77141 7.35 2.54 3.36 17.74 Fed Funds Rate 79394 3.96 3.16 0.07 17.78 Prime Rate 79416 6.64 2.83 2.00 20.32 48M Consumer Loan Rates 76580 8.35 2.56 4.00 17.36 Panel B: Summary Statistics for all BHC during all Financial Crises Variable Obs Mean Std.Dev Min Max Total Assets 7304 29656.79 201829.90 0.27 3879172.00 Total Equity 7161 1704.19 10286.68-179.66 239549.00 Return on Equity 7150 1.17 62.77-1275.81 3373.72 Tier 1 Ratio 4432 11.04 4.18-0.10 139.37 Cash Ratio 7040 9.52 9.65 0.12 99.99 Net Income 7377 16.12 622.99-33196.34 11453.96 Net Interest Margin 2860 191.39 1088.06-150.00 18428.09 DEBT RATIO 6971 13.59 374.16 0.00 31239.23 30YMortgage Rate 8361 8.41 3.86 5.01 17.74 Fed Funds Rate 8361 4.40 4.39 0.18 14.51 Prime Rate 8361 7.28 4.16 3.25 17.01 48M Consumer Loan Rates 8361 9.69 3.74 6.79 17.36 14
Table 1. Summary Statistics. Continued Panel C: Summary Statistics for all BHC during the Great Recession of 2007 Variable Obs Mean Std.Dev Min Max Total Assets 4228 43800.34 261633.80 0.27 3879172.00 Total Equity 4216 2479.87 13150.21-18.86 239549.00 Return on Equity 4209-0.82 61.49-1275.81 3373.72 Tier 1 Ratio 3678 11.04 4.22-0.10 139.37 Cash Ratio 4162 4.94 6.77 0.12 99.99 Net Income 4275 15.20 808.58-33196.34 11453.96 Net Interest Margin 2341 210.18 1177.33-150.00 18428.09 DEBT RATIO 4177 11.47 9.32 0.00 76.28 30YMortgage Rate 4412 5.70 0.49 5.01 6.32 Fed Funds Rate 4412 1.36 1.13 0.18 3.18 Prime Rate 4412 4.49 1.07 3.25 6.21 48M Consumer Loan Rates 4412 6.97 0.16 6.79 7.27 Panel D: Summary Statistics for all BHC in the Post-Crisis Period of 2009Q2-2015Q4 Variable Obs Mean Std.Dev Min Max Total Assets 14053 55597.32 290459.10 0.77 3209629.00 Total Equity 13963 3926.59 19422.71-2488.94 257683.00 Return on Equity 13951 1.83 135.91-3003.31 11797.07 Tier 1 Ratio 12275 12.84 5.19-19.65 238.89 Cash Ratio 13699 6.72 6.05 0.17 99.99 Net Income 14364 63.74 516.79-14234.11 11672.69 Net Interest Margin 7950 229.71 1235.63-460.67 17368.98 DEBT RATIO 13755 7.43 7.41 0.00 191.55 30YMortgage Rate 14877 4.31 0.46 3.36 5.16 Fed Funds Rate 14877 0.14 0.06 0.07 0.36 Prime Rate 14877 3.26 0.05 3.25 3.50 48M Consumer Loan Rates 14877 5.15 0.96 4.00 6.61 Notes: We included the following financial crises that happened during the last few decades for which data is available. The crisis of 1973: 1973-quarter 4 to 1975 quarter 1; the crisis of 1980: 1980-quarter 1-1980-quarter2; the crisis of 1981: 1981 quarter 3 to 1982-quarter 4; the crisis of 1990: 1990-quarter 3 to 1991-quarter 1; the crisis of 2001: 2001-quarter 2 to 2001-quarter 4; and the Great Recession of 2007: 2007-quarter 4 to 2009-quarter 1. We exclude stock market crashes that lasted less than one quarter and were not classified as financial crisis by the Federal Reserve System, such as the stock market crash of 1987 (the Black Monday) and the market disruption of 1998 (the Long-Term Capital Management case.) 15
Table 2. Summary Statistics for Big Banks. The table summarizes the quarterly data for big banks, banks with total assets of $500 billion or more, during the Great Recession and post-great Recession periods. Panel A: Summary Statistics for Big Banks during the Great Recession of 2007 Variable Obs Mean Std.Dev Min Max Total Assets 90 1590911 860954 519134 3879172 Total Equity 90 75799 47477 14179 239549 Return on Equity 90 0.73 7.67-44.73 25.54 Tier 1 Ratio 90 8.52 1.52 6.38 15.81 Cash Ratio 90 7.11 4.35 0.52 18.81 Net Income 90 264 4150-33196 11454 Net Interest Margin 90 7100 4874 2 18428 DEBT RATIO 90 15.86 7.38 5.14 33.83 30YMortgage Rate 90 5.67 0.52 5.01 6.32 Fed Funds Rate 90 1.22 1.07 0.18 3.18 Prime Rate 90 4.35 1.02 3.25 6.21 48M Consumer Loan Rates 90 6.938597 0.1 6.8 7.3 Panel B: Summary Statistics for Big Banks in the Post-Crisis Period of 2009Q2-2015Q4 Variable Obs Mean Std.Dev Min Max Total Assets 360 1690400 681940 500965 3209629 Total Equity 360 104394 59031 16939 257683 Return on Equity 360 1.66 2.90-14.50 20.26 Tier 1 Ratio 360 12.26 2.01 7.70 19.10 Cash Ratio 360 10.57 5.96 1.87 29.05 Net Income 360 832 2018-14234 11673 Net Interest Margin 360 4814 5157 1 17369 DEBT RATIO 360 13.98 7.29 0.00 36.24 30YMortgage Rate 360 4.32 0.43 3.36 5.16 Fed Funds Rate 360 0.13 0.05 0.07 0.36 Prime Rate 360 3.26 0.04 3.25 3.50 48M Consumer Loan Rates 360 5.14 0.96 4.00 6.61 16
Table 3. Bank Profitability and Stock Price Performance. The table summarizes regression results for the study period. Panel A: Stok price performance BHC for the period 1962Q4-2015Q4 Stock Price Coefficients P-Values Coefficients P-Values Coefficients P-Values Net Income 0.0028*** 0.0010 0.0015*** 0.0000 0.0142*** 0.0000 Net Interest Margin -0.0031*** 0.0000 0.0000 0.9650-0.0039* 0.0220 Size 6.0893*** 0.0000-15.8098*** 0.0010 5.8870*** 0.0000 Tier 1 Capital Ratio 0.0793 0.3150-0.6674 0.3840 0.0850 0.2840 Cash Ratio 0.0276 0.6640 0.9197** 0.0020 0.0110 0.8640 Debt Ratio -0.3813*** 0.0000 0.6466 0.1010-0.3870*** 0.0000 30YMortgage Prime Spread -2.8642*** 0.0000 1.0588 0.5370-2.8167*** 0.0000 Prime FF Spread -25.3605*** 0.0000-4.3452 0.7990-24.8173*** 0.0000 Intercept 59.905*** 0.0000 254.217** 0.0010 59.6441*** 0.0000 N 23409 186 23223 Prob>F 0.0000 0.0000 0.0000 Adjusted R-squared 0.0472 0.2231 0.048 Panel B: Return on equity performance BHC for the period 1962Q4-2015Q4 Return on Equity Coefficients P- P- Coefficients Values Values Coefficients P-Values Net Income 0.0015 0.3630 0.0013*** 0.0000 0.0079 0.2130 Net Interest Margin -0.0004 0.6610-1.1186*** 0.0000-0.0021 0.5210 Size -0.3954 0.3670-2.4069*** 0.0000-0.4244 0.3950 Tier 1 Capital Ratio -0.4530** 0.0060 0.0498 0.6180-0.4562** 0.0060 Cash Ratio 0.3279* 0.0130-0.1704*** 0.0000 0.3257* 0.0150 Debt Ratio 0.0493 0.5740 0.0153 0.7120 0.0489 0.5790 30YMortgage Prime Spread 0.2993 0.6220 0.3789 0.0750 0.3230 0.5980 Prime FF Spread -4.2031 0.5580-7.0112** 0.0050-3.9331 0.5870 Intercept 21.4002 0.3190 59.1230*** 0.0000 20.8325 0.3360 N 24138 283 23855 Prob>F 0.0632 0.0000 0.0503 Adjusted R-squared 0.0003 0.7395 0.0003 Panel B: Net income performance BHC for the period 1962Q4-2015Q4 Net Income Coefficients P- P- Coefficients Values Values Coefficients P-Values Net Interest Margin 0.2441*** 0.0000 982.9730*** 0.0000 0.3272*** 0.0000 Size 4.7556** 0.0040 34.3789 0.9490-1.0517* 0.0380 Tier 1 Capital Ratio -0.0212 0.9730 117.7961 0.3340 0.3227 0.0560 Cash Ratio 2.5341*** 0.0000 93.9051* 0.0230 1.0867*** 0.0000 Debt Ratio -0.2421 0.4690-45.2359 0.3710-0.0058 0.9480 30YMortgage Prime Spread -7.2085** 0.0020-555.4331* 0.0320-4.2065*** 0.0000 Prime FF Spread -107.2944*** 0.0000-7333.6010* 0.0140-30.9058*** 0.0000 Intercept 283.7368*** 0.0010 20388.5700 0.0600 89.6483*** 0.0000 N 24138 283 23855 Prob>F 0.0000 0.0000 0.0000 Adjusted R-squared 0.2288 0.0933 0.4945 Legend: * 5% significance, ** 1% significance, and *** 0.1% significance. 17
Table 4. Bank Stock Price and Profitability Performance for the Non-Crises Periods Panel A: Stock price performance BHC for non-crisis period Stock Price Coefficients P-Values Coefficients P-Values Coefficients P-Values Net Income -0.0012 0.6860 0.0029*** 0.0000 0.0020 0.7830 Net Interest Margin 0.0000 0.9850 4.0932 0.0560 0.0000 0.9860 Size 6.5377*** 0.0000-6.8707* 0.0420 6.9195*** 0.0000 Tier 1 Capital Ratio 0.6696** 0.0020-0.2950 0.6690 0.6847** 0.0020 Cash Ratio -0.2002 0.2770 0.6355** 0.0070-0.1786 0.3380 Debt Ratio -0.5291*** 0.0000-0.3401 0.1480-0.5187*** 0.0000 30YMortgage Prime Spread -2.2958** 0.0050-0.2177 0.8860-2.2868** 0.0060 Prime FF Spread -6.6060 0.6050-35.1800 0.1540-5.5301 0.6670 Intercept -2.4558 0.9490 224.4697** 0.0020-8.7517 0.8200 N 36475 245 36230 Prob>F 0.0000 0.0000 0.0000 Adjusted R-squared 0.0044 0.2423 0.0046 Panel B: Return on equity performance BHC for non-crisis periods Return on Equity Coefficients P-Values Coefficients P-Values Coefficients P-Values Net Income 0.0022 0.1030 0.0014*** 0.0000 0.0091** 0.0060 Net Interest Margin 0.0000 0.9840-1.1517*** 0.0000 0.0000 0.9840 Size -0.1305 0.6210-2.3524*** 0.0000-0.2994 0.3010 Tier 1 Capital Ratio -0.1848 0.0590-0.1076 0.3180-0.1844 0.0600 Cash Ratio 0.1327 0.1150-0.1695*** 0.0000 0.1263 0.1380 Debt Ratio 0.0364 0.4750-0.0310 0.3990 0.0361 0.4810 30YMortgage Prime Spread 0.0019 0.9960 0.1835 0.4300 0.0310 0.9360 Prime FF Spread -4.5164 0.4400 0.3330 0.9310-3.8592 0.5130 Intercept 18.2528 0.2960 37.8075*** 0.0010 17.3670 0.3240 N 37722 259 37463 Prob>F 0.2308 0.0000 0.0499 Adjusted R-squared 0.0001 0.6195 0.0002 Panel C: Net income performance BHC for the non-crises periods Net Income Coefficients P-Values Coefficients P-Values Coefficients P-Values Net Interest Margin 0.0000 0.9210 1076.8240*** 0.0000 0.0000 0.9140 Size 64.2982*** 0.0000 1000.8560* 0.0230 35.4284*** 0.0000 Tier 1 Capital Ratio -0.2406 0.5240-300.9585*** 0.0010 0.0290 0.8500 Cash Ratio 4.2365*** 0.0000 54.4235 0.0760 2.1300*** 0.0000 Debt Ratio 0.4710* 0.0170-38.1131 0.2140 0.2711*** 0.0010 30YMortgage Prime Spread -3.6840* 0.0120-248.6219 0.2010-4.1442*** 0.0000 Prime FF Spread -116.773*** 0.0000 3265.5190 0.3080-96.2434*** 0.0000 Intercept -98.7681 0.1440-21395.5100* 0.0230 46.5667 0.0910 N 37722 259 37463 Prob>F 0.0000 0.0000 0.0000 Adjusted R-squared 0.1137 0.1518 0.1734 Legend: * 5% significance, ** 1% significance, and *** 0.1% significance. 18
Table 5. Bank Stock Price and Profitability Performance for the Crises Periods Panel A: Stock price performance BHC for all crisis period Stock Price Coefficients P-Values Coefficients P-Values Coefficients P-Values Net Income 0.0015 0.0940 0.0002 0.6940 0.0116** 0.0030 Net Interest Margin 3.6481*** 0.0000-2.3618 0.5340 3.6931*** 0.0000 Size 4.2582*** 0.0000-10.6762 0.0980 4.3875*** 0.0000 Tier 1 Capital Ratio 0.1162 0.5110 2.6133 0.2510 0.1209 0.4950 Cash Ratio 0.3785* 0.0190 1.1412 0.1060 0.3375* 0.0390 Debt Ratio -0.2239** 0.0040-2.9619*** 0.0000-0.2200** 0.0050 30YMortgage Prime Spread -0.8872 0.3100-7.9618 0.0820-0.8440 0.3380 Prime FF Spread -1.3957 0.7190 9.6288 0.6700-1.3628 0.7270 Intercept -20.59972 0.107 185.9486 0.086-21.72287 0.092 N 4545 46 4499 Prob>F 0.0000 0.0021 0.0000 Adjusted R-squared 0.0327 0.3394 0.0328 Panel B: Return on equity performance BHC for all crisis periods Return on Equity Coefficients P-Values Coefficients P-Values Coefficients P-Values Net Income 0.0015 0.2030 0.0012*** 0.0000 0.0068 0.1730 Net Interest Margin -1.1552 0.2090-0.4312 0.5240-1.2081 0.1940 Size 0.4184 0.4330-2.5466* 0.0400 0.4499 0.4420 Tier 1 Capital Ratio 0.0819 0.7200 0.7052 0.1080 0.0828 0.7180 Cash Ratio 0.1437 0.4890-0.1953 0.1460 0.1331 0.5280 Debt Ratio -0.0892 0.3810-0.1043 0.4260-0.0936 0.3620 30YMortgage Prime Spread 0.2489 0.8250-0.6170 0.4710 0.2694 0.8120 Prime FF Spread -14.5825** 0.0040-4.5201 0.2950-14.6576** 0.0040 Intercept 44.9728** 0.0070 48.9997* 0.0200 45.2322** 0.0070 N 4648 47 4601 Prob>F 0.0715 0.0000 0.0679 Adjusted R-squared 0.0014 0.8155 0.0014 Panel C: Net income performance BHC for the crisis years Net Income Coefficients P-Values Coefficients P-Values Coefficients P-Values Net Interest Margin 10.2734 0.3630 1242.5640 0.2300 4.1737 0.1320 Size 10.4052 0.1120-2737.4200 0.1370 9.6853*** 0.0000 Tier 1 Capital Ratio -0.6728 0.8100 733.7841 0.2680 0.0654 0.9240 Cash Ratio 5.2452* 0.0400 216.5538 0.2870 3.3590*** 0.0000 Debt Ratio 0.0842 0.9460-327.0736 0.0990 0.5083 0.0970 30YMortgage Prime Spread -31.7182* 0.0210-3149.3650* 0.0130-4.3770 0.1960 Prime FF Spread -60.6211 0.3270-4336.3590 0.5120-7.6990 0.6110 Intercept 106.988 0.5980 49296.5000 0.1100-73.2508 0.1420 N 4648 47 4601 Prob>F 0.0291 0.1124 0.0000 Adjusted R-squared 0.0018 0.1100 0.0137 Legend: * 5% significance, ** 1% significance, and *** 0.1% significance. 19
Table 6. Bank Stock Price and Profitability Performance for the Great Recession Period Panel A: Stock price performance BHC for the 2007-2008 crisis period Stock Price Coefficients P-Values Coefficients P-Values Coefficients P-Values Net Income 0.0014* 0.0220 0.0004 0.4110 0.0119*** 0.0000 Net Interest Margin 3.0389*** 0.0000-2.7282 0.4540 3.1031*** 0.0000 Size 3.9251*** 0.0000-6.5653 0.3940 4.1343*** 0.0000 Tier 1 Capital Ratio 0.1893 0.1470 2.2091 0.4230 0.1909 0.1440 Cash Ratio 0.4055*** 0.0010 0.0502 0.9400 0.3731*** 0.0040 Debt Ratio -0.2342*** 0.0000-2.9033** 0.0020-0.2292*** 0.0000 30YMortgage Prime Spread -3.2925*** 0.0000-8.4859 0.0700-3.1282*** 0.0000 Prime FF Spread 5.5887* 0.0500 19.2312 0.3290 5.2901 0.0640 Intercept -36.7470*** 0.0000 108.6287 0.4240-37.6172*** 0.0000 N 37772 38 3734 Prob>F 0.0000 0.0016 0.0000 Adjusted R-squared 0.0639 0.4170 0.0659 Panel B: Return on equity performance BHC for the 2007-2008 crisis Return on Equity Coefficients P-Values Coefficients P-Values Coefficients P-Values Net Income 0.0015 0.2730 0.0012*** 0.0000 0.0064 0.2610 Net Interest Margin -1.6663 0.1460-0.9751 0.2930-1.7179 0.1390 Size 0.4148 0.5290-3.3341 0.0940 0.4731 0.5130 Tier 1 Capital Ratio 0.0532 0.8470 1.2476 0.0810 0.0553 0.8420 Cash Ratio 0.1718 0.5200-0.1811 0.2870 0.1595 0.5560 Debt Ratio -0.1123 0.3630-0.0368 0.8630-0.1165 0.3490 30YMortgage Prime Spread -0.4514 0.7600-0.3881 0.7370-0.4241 0.7760 Prime FF Spread -12.5194* 0.0370-5.2906 0.2900-12.6250* 0.0370 Intercept 41.3425* 0.0340 58.2500 0.0970 41.4908* 0.0360 N 3838 38 3800 Prob>F 0.1698 0.0000 0.1709 Adjusted R-squared 0.0009 0.8179 0.0009 Panel C: Net income performance BHC for the crisis year of 2007-2008 Net Income Coefficients P-Values Coefficients P-Values Coefficients P-Values Net Interest Margin 7.2118 0.6060 1518.9990 0.3000 4.0138 0.2290 Size 1.0536 0.8960-2539.0330 0.4140 5.0908* 0.0140 Tier 1 Capital Ratio -0.8687 0.7960 1027.5310 0.3550-0.0912 0.9090 Cash Ratio 6.5174* 0.0450 317.7580 0.2360 3.7396*** 0.0000 Debt Ratio 0.1075 0.9430-254.7905 0.4550 0.4717 0.1870 30YMortgage Prime Spread -51.3235** 0.0040-3571.2350* 0.0460-11.4167** 0.0080 Prime FF Spread -3.5545 0.9610-3748.8090 0.6370 12.9320 0.4580 Intercept 20.0973 0.9330 40004.7300 0.4660-97.5688 0.0870 N 3838 38 3800 Prob>F 0.0479 0.2167 0.0000 Adjusted R-squared 0.0019 0.0811 0.0088 Legend: * 5% significance, ** 1% significance, and *** 0.1% significance. 20
Table 7. Bank Stock Price and Profitability Performance for the Post-Great Recession Period Panel A: Stock price performance BHC for the post 2007 crisis Stock Price Coefficients P-Values Coefficients P-Values Coefficients P-Values Net Income -0.0016 0.7940 0.0025*** 0.0000-0.0038 0.8200 Net Interest Margin -0.6671 0.8180-5.9060 0.0690-1.0217 0.7270 Size 7.0833*** 0.0000-7.6608 0.1320 8.1783*** 0.0000 Tier 1 Capital Ratio 1.5157* 0.0180-2.3788 0.0870 1.5402* 0.0170 Cash Ratio -0.3919 0.4410 0.7526* 0.0370-0.3405 0.5100 Debt Ratio -1.4154** 0.0010-0.8988* 0.0420-1.3953*** 0.0010 30YMortgage Prime Spread -9.1171 0.1250 7.2350 0.1720-9.2678 0.1240 Prime FF Spread 16.2082 0.8300-37.0721 0.4990 17.9578 0.8150 Intercept -72.7262 0.7610 290.9030 0.1380-85.3162 0.7250 N 12037 144 11893 Prob>F 0.0000 0.0000 0.0000 Adjusted R-squared 0.0029 0.2175 0.0030 Panel B: Return on equity performance BHC for post 2007 crisis Return on Equity Coefficients P-Values Coefficients P-Values Coefficients P-Values Net Income 0.0024 0.4090 0.0009*** 0.0000 0.0136 0.0890 Net Interest Margin 0.6479 0.6230-1.3175*** 0.0000 0.6032 0.6510 Size -0.9478 0.2290-3.0281*** 0.0000-1.2120 0.1620 Tier 1 Capital Ratio -0.6374* 0.0240-0.2273* 0.0120-0.6508* 0.0220 Cash Ratio 0.4441 0.0630-0.0612** 0.0090 0.4349 0.0730 Debt Ratio 0.2359 0.2330 0.0055 0.8450 0.2345 0.2410 30YMortgage Prime Spread -0.7899 0.7790 0.3690 0.2810-0.6613 0.8170 Prime FF Spread 5.2821 0.8830-4.6800 0.1880 4.3949 0.9040 Intercept -5.4052 0.9620 64.0746*** 0.0000-0.5662 0.9960 N 12423 144 12279 Prob>F 0.2257 0.0000 0.1205 Adjusted R-squared 0.0002 0.8668 0.0004 Panel C: Net income performance BHC for post 2007 crisis Net Income Coefficients P-Values Coefficients P-Values Coefficients P-Values Net Interest Margin -0.1537 0.9700 1288.9270** 0.0040 4.6829** 0.0020 Size 75.2314*** 0.0000-815.0629 0.2500 29.0535*** 0.0000 Tier 1 Capital Ratio -0.0406 0.9630-523.8947** 0.0060 0.9296** 0.0040 Cash Ratio 7.5289*** 0.0000 175.9671*** 0.0000 2.3275*** 0.0000 Debt Ratio 1.6999** 0.0050-110.7003 0.0710 0.4171 0.0650 30YMortgage Prime Spread -12.7531 0.1430-626.8504 0.3970-12.6866*** 0.0000 Prime FF Spread 93.6352 0.3980-3195.5960 0.6770 87.2977* 0.0340 Intercept -866.2218 0.0130 27026.1100 0.3230-505.741*** 0.0000 N 12423 144 12279 Prob>F 0.0000 0.0000 0.0000 Adjusted R-squared 0.0912 0.2120 0.0820 Legend: * 5% significance, ** 1% significance, and *** 0.1% significance. 21