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In 2008, market disturbances and unexpected price volatility besieged the US financial system. Since then weak balance sheets have heightened risk, thus resulting in an unprecedented rise in non-performing loans and credit-related write-offs in mortgage lending related sectors. This paper examines the determinants of US Savings and Loan (S&L) profitability in the time period 1978 and 2009. We use the recently developed unit root econometrics for time-series data analysis. Using ADF as a statistical test by estimation of least squares trend fitting, the study highlights that high leverage and large non-performing loan to total loan ratio leads to a lower rate of return on capital. In addition, the loan ratio has a significant negative coefficient on return on asset and equity capital. While macroeconomic factors such as low interest rates have a negative effect on bank earnings, the effects of interest rates can vary depending on the profit indicator used. By and large, there is evidence that the quality of loan portfolio rather than size (economies of scale) affects profitability negatively. Our results are confirmed by earlier studies that over-leveraging and under-performing loans have the potential to render S&Ls vulnerable to financial shocks, thus contributing to financial instability. |
