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FDIC-Insured Banks: Q2 Earnings Grow on Higher Revenues

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Federal Deposit Insurance Corporation (FDIC)-insured commercial banks and savings institutions reported second-quarter 2016 earnings of $43.6 billion, inching up 1.4% from the prior-year quarter. Notably, community banks, constituting roughly 93% of all FDIC-insured institutions, reported net income of $5.5 billion, up 9% year over year.

Banks with assets worth more than $10 billion contributed a major part of the earnings in the said quarter. Though such banks make up for only 1.8% of the total number of U.S. banks, they accounted for over 80% of the industry earnings. Some of the leading names in the space are Wells Fargo & Co. (WFC - Free Report) , JPMorgan Chase & Co. (JPM - Free Report) , Bank of America Corp. (BAC - Free Report) , Citigroup Inc. (C - Free Report) and U.S. Bancorp (USB - Free Report) , among others.

An increase in net interest income driven by loan growth and a slight rise in fee income aided the banks’ earnings. However, a weak energy sector which led to a significant rise in provision for loan losses remained an undermining factor. Further, absence of significant legal costs partly supported the expense base, which recorded a marginal rise.

Banks are consistently striving to reap profits and are consequently boosting productivity. Around 60.1% of all institutions insured by the FDIC recorded quarterly net income improvement. Also, the percentage of institutions reporting net losses for the quarter dropped to 4.5% from 5.8% in the prior-year quarter. Notably, the percentage was the lowest recorded since the first quarter of 1998.

Steady Revenue Growth; Costs Up Slightly

Net operating revenue was $179.3 billion, up 3.3% on a year-over-year basis. Improvement in net interest income driven by higher average interest-bearing assets along with a marginal rise in non-interest income was the driving factor.

Net interest income was recorded at $113.5 billion, up 4.8% from the year-ago quarter. Further, average net interest margin increased 5 basis points (bps) year over year to 3.10%.

Non-interest income inched up nearly 1% year over year to $65.8 billion for the banks. A rise in trading income was partially offset by fall in servicing income.

Total non-interest expenses for the establishments were $104.8 billion in the quarter, up 0.3% on a year-over-year basis. This marginal increase reflected a rise in salary and employee benefit expenses, which was almost offset by a significant decline in non-recurring charges.

Notably, eight of the ten largest banks recorded year-over-year declines in their total non-interest expenses. However, for the industry as a whole, only 30% institutions reported a decline in expenses.

Asset Quality Worsens

Net loan and lease charge-offs rose on a year-over-year basis for the third consecutive quarter. Net charge-offs (NCOs) increased to $10.1 billion, up 13.1% year over year, reflecting the third yearly rise in the past 22 quarters. Majority of the increase in NCOs was in commercial and industrial (C&I) loans (up 100.3%).

In the quarter under review, loan-loss provisions for the institutions came in at $11.8 billion, surging 44.2% year over year. This was the eighth consecutive quarterly rise in loss provisions, with nearly 38.7% banks reporting an increase.

However, non-current loans and leases (90 days or more past due or in nonaccrual status) rate of 1.49% was down 9 bps year over year.

Strong Loan & Deposit Growth

As of Jun 30, 2016, total deposits continued to rise and were recorded at $12.5 trillion, up 5% year over year. Further, total loans and leases came in at $9.1 trillion, up 6.7% from the year-ago quarter. All major loan categories witnessed an increase in balances outstanding during the reported quarter.

As of Jun 30, 2016, the Deposit Insurance Fund (DIF) balance increased to $77.9 billion from $67.6 billion as of Jun 30, 2015. Interest earned on investment securities and assessment income primarily led to the growth in fund balance.

The measure for profitability or average return on assets (ROA) edged down to 1.02% from 1.06% in the prior-year quarter.

Less Bank Failures; Shrinking Problem Institutions

During second-quarter 2016, two insured institutions failed, while 57 were acquired. As of Jun 30, 2016, the number of "problem" banks declined from 165 to 147, reflecting the lowest number in eight years and plunged significantly from 888 recorded in first-quarter 2011. Total assets of the "problem" institutions also fell to $29 billion from $30.9 billion.

Our Take

Though a fall in the number of problem institutions is encouraging, the quarter remained challenging. Though banks were able to improve revenue growth,  low interest rate environment continues to hurt financials. Also, credit risk is on the rise related to energy and agriculture loans.

However, with banks gradually easing their lending standards and trending toward higher fees, the pressure on the top line will reduce. Further, sustained expense control and stable balance sheets should act as tailwinds in the upcoming quarters.

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