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Solid 2Q Earnings for FDIC-Insured Banks

JPM WFC C BAC

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Federal Deposit Insurance Corporation (FDIC)-insured commercial banks and savings institutions reported second-quarter 2013 earnings of $42.2 billion, outpacing the year-ago earnings of $34.4 billion by 22.6%. This marks the 16th consecutive quarter in which earnings soared on a year-over-year basis.

Overall, the banking industry is exhibiting signs of gradual improvement as evident from the second-quarter results. The number of troubled assets and institutions marked a decline and are striving to improve.

Further, reduced loan loss provisions and higher non-interest income were the primary drivers for the record earnings posted by the banks. Lower non-interest expenses reflect prudent expense management by the banks. However, these positives were partially offset by reduced net interest income, reflecting lower margins and meek loan growth.

Banks with assets worth more than $10 billion contributed to the overall earnings growth during the second quarter. Though these constitute only 1.5% of the total U.S. banks, the banks account for approximately 82% of the industry earnings.

Such major banks include Wells Fargo & Company (WFC - Analyst Report), Citigroup Inc. (C - Analyst Report), JPMorgan Chase & Co. (JPM - Analyst Report) and Bank of America Corporation (BAC - Analyst Report).

Performance in Detail

Banks are striving hard to be profitable and are bolstering their productivity.
Around 53.8% of all institutions insured by the FDIC reported improvement in their quarterly net income compared to the prior-year quarter. Moreover, shares of institutions reporting net losses for the quarter slumped to 8.2% from 11.3% in the last-year quarter.

The profitability measure – average return on assets (ROA) surged to 1.17% from 0.99% in the prior-year quarter. Notably, the current quarterly ROA for the industry is the highest since 1.22% recorded in the second quarter of 2007.

Net operating revenue stood at $170.6 billion, up 3% year over year. The increase was due to a rise in non-interest income, partially offset by lower net interest income.

Net interest income was recorded at $103.7 billion, down 1.7% year over year, reflecting the third consecutive quarter of decline. The fall in net interest income was due to interest income from loans and other investments declining faster than interest expense on deposits and other liabilities.

The average net interest margin declined to 3.26%, from 3.45% in the prior-year quarter, as average asset yields were less than the average funding costs.

Non-interest income rose 11.1% year over year to $66.9 billion for the banks. Moreover, trading income more than tripled from the year-ago quarter, in which net loss on credit derivatives was reported. Further, net gains on sales of loans and other assets jumped 63.7% year over year.

Total non-interest expenses for the institutions were $102 billion in the quarter, down 1.4% on a year-over-year basis. The decline was aided by lower other non-interest expenses and reduced premises and equipment expenses, partially offset by higher salaries and employee benefits expenses.

Credit Quality

Overall, credit quality marked an improvement in the second quarter of 2013. Net charge-offs plummeted to $14.2 billion from $20.5 billion in the second quarter of 2012. The decline was primarily due to lower charge-offs in residential real estate loans.

Provisions for loan losses for the institutions in the reported quarter were recorded at $8.6 billion, down 39.6% year over year, reflecting the lowest quarterly loss provision since the third quarter of 2006.

The level of non-current loans and leases (those 90 days or more past due or in non-accrual status) declined 8.3% year over year. Moreover, the percentage of non-current loans and leases declined to 3.09%, the lowest level since 2008.

Balance Sheet

The banks exhibited a strong capital position. Total deposits continued to rise and were recorded at $10.8 trillion, up 4.9% year over year. Further, total loans and leases came in at $7.7 trillion, up 2.7% year over year.

As of Jun 30, 2013, the net worth of Deposit Insurance Fund (DIF) increased to $37.9 billion, up from $35.7 billion as of Mar 31, 2013. Moreover, assessment revenues primarily impelled growth in the fund balance.

Bank Failures and Problem Institutions

During the second quarter of 2013, 12 insured institutions failed, up from 4 failures in the prior quarter. Moreover, as of Jun 30, 2013, 20 failures were recorded, as compared with 40 failures in the comparable prior-year period.

As of Jun 30, 2013, the number of "problem" banks declined from 612 to 553, reflecting the ninth consecutive quarter of decrease. Total assets of the "problem" institutions also plummeted to $192.5 billion from $213.3 billion.

Our Viewpoint

Besides the encouraging decline in the list of problem institutions, the 16th straight quarter of consolidated profit from FDIC-insured banks is quite impressive. U.S. banks are showing signs of strength despite being compelled to meet strict regulatory standards. Though it is too early to be confident about the sector’s growth prospects, the progress seen in the first half of 2013 indicates a brighter future for the banks that are less dependent on risky activities and resort to other profit-making ways.

Continuous expense control, sound balance sheets and lesser credit loss provisions are considered to be the key growth drivers. Moreover, a favorable equity and asset market backdrop, falling unemployment, a progressive housing sector and flexible monetary policy have contributed significantly to the improvement.

Yet, top-line growth remains uncertain due to continued sluggishness in loan growth, pressure on net interest margins from the sustained low rate environment and less flexible business models owing to stringent risk-weighted capital requirements (Basel III standards). Now that the interest rate environment is turning around, net interest margins are likely to improve and support the top line significantly. However, revenues from mortgage fees are expected to lessen as the boom in mortgage refinancing fizzles out.

However, it is impressive to observe that U.S. banks are taking legal and regulatory pressure in their stride, indicating their ability to encounter impending challenges. But with the economy in disarray, we do not envision the sector returning to its pre-recession peak anytime soon.

Overall, structural changes in the sector will continue to impair business expansion and investor confidence. Several dampening factors -- asset-quality troubles, mortgage liabilities and tighter regulations -- will decide the fate of the U.S. banks in the quarters ahead. However, entering the new capital regime is expected to ensure long-term stability and security for the industry.

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