NEWS / Foreign Exchange

Subprime Market Update

• Financial Institutions reported year-over-year earnings decline in first quarter 2007.
• The net interest margin increased slightly from 2006 figure but it was 30 basic points below last five years average.
• Total mortgage assets declined for second quarter in a row, contributing negatively to growth.

Financial institutions reported a total net income of $36.0 billion in the first quarter of 2007, the fourth highest quarterly amount ever, but it was 2.5% below than the earnings posted in the first quarter of 2006. The average return on equity for the quarter was 11.44%, down from 12.95% average of the first quarter of 2006. It was the lowest ROE for the financial institutions since 2001. Higher credit expenses and narrower net interest margins were the causes of such decline.

Rising loan loss provisions reduced profits at financial institutions. In that sense, total provisions increased 54.6% in the last year, to reach $9.2 billion in the first quarter of 2007, reflecting assets quality erosion. At the same time, non interest expenses were 3.6% higher and lower revenues were obtained from securitization and servicing activities, which limited the year over year improvement in non interest income.

A combination of stable interest rates and a flat yield curve had different effects on margins at small and large institutions in the first quarter of 2007. While small institutions had lower average asset yields and higher average costs, which leaded to a reduction in interest margins, larger institution had higher average assets yields and lower funding costs, lifting net interest margins. As a whole, the industry??™s net interest margin was 3.32% in the first quarter of 2007, above the fourth quarter of 2006 figure, which was 3.20%, but below the 3.46% average observed in the first quarter of 2006, according to data from FDIC.

During the twelve months ended March 2007, total assets of insured institutions grew by 6.9%, the lowest rate in four and a half years. Slower loan growth, especially in the real estate segment, was the main factor behind this trend. For the second quarter in a row, total mortgage assets (not only loans but also mortgage-backed securities) of insured financial institutions declined.

From the liabilities side, total deposits grew by $70 billion from previous quarter, which represented the smallest increased (0.9%) since the third quarter of 2003. Time deposits increased by 0.7% while other interest bearing deposits increased by 3.1% from previous quarter. Non deposits liabilities grew 1.1% during the quarter with most of the growth occurring in short term borrowings. But borrowings from the Federal Home Loan Banks declined by 2.3%, after falling 1.8% in the fourth quarter of 2006.