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FDIC-Insured Banks Q2 Earnings Encouraging, Margins Improve

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Federal Deposit Insurance Corporation (FDIC)-insured commercial banks and savings institutions reported second-quarter 2017 earnings of $48.3 billion, up 10.7% year over year. Notably, community banks, constituting 92% of all FDIC-insured institutions, reported net income of $5.7 billion, up 8.5% year over year.

Banks’ earnings were stemmed by higher revenues and loan growth. On the other hand, expenses flared up and loan loss provisions rose.

Banks, with assets worth more than $10 billion, contributed a major part of the earnings in the reported quarter. Though such banks constitute only 1.8% of the total number of the U.S. banks, these accounted for approximately 80% of the industry’s earnings. Leading names in this space include Wells Fargo & Co. (WFC - Free Report) , Bank of America Corp. (BAC - Free Report) , Citigroup Inc. (C - Free Report) and U.S. Bancorp (USB - Free Report) .

All the above mentioned banks carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Revenues Escalate, Costs Flare Up

Banks have been consistently striving to reap profits and are consequently boosting productivity. Around 63.4% of all institutions, insured by the FDIC, reported improvement in quarterly net income, while the remaining recorded a decline in comparison to the prior-year quarter. Additionally, the percentage of institutions reporting net losses for the quarter edged down to 4.1% from 4.6% in the year-ago quarter.

The measure for profitability or average return on assets (ROA) inched up to 1.14% from 1.08% recorded in the year-earlier quarter.

Net operating revenue was $190.5 billion, up 6.1% year over year.  A rise in net interest income, as well as non-interest income, was the driving factor.

Net interest income was recorded at $123.7 billion, up 9.1% year over year, driven by rise in interest-bearing assets and net interest margin (NIM). NIM advanced to 3.22% from 3.08% recorded in the year-earlier quarter. It depicts highest average margin for the industry since fourth-quarter 2013.

Non-interest income for the banks climbed 1% year over year to $66.8 billion. Increase in servicing income stemmed this rise, mostly offset by lower trading income and reduced gains on asset sales.

Total non-interest expenses for the establishments were $108.6 billion in the quarter, up 3.3% on a year-over-year basis. Increase in salary, and employee benefit costs and other non-interest expense led to this rise.

Credit Quality a Concern?

Overall, credit quality was a mixed bag in the reported quarter. Net charge-offs increased to $11.3 billion, up 11.2% year over year, reflecting the seventh quarterly rise. Notably, higher credit card charge-offs led to this rise.

In the reported quarter, provisions for loan losses for the institutions came in at $12.0 billion, up 2.3% year over year. The level of non-current loans and leases decreased 14.5% year over year to $116.6 billion, indicating the 28th decline in non-current loan balances in the last 29 quarters. The non-current rate was 1.23%, reflecting the lowest rate since third-quarter 2007.

Strong Loan & Deposit Growth

The capital position of the banks remained solid. Total deposits continued to rise and were recorded at $13.1 trillion, up 4.6% year over year. Further, total loans and leases were $9.5 trillion, up 3.7% year over year.

As of Jun 30, 2017, the Deposit Insurance Fund (DIF) balance increased to $87.6 billion from $77.9 billion as of Jun 30, 2016. Furthermore, interest earned on investment securities and assessment income primarily led to the growth in fund balance.

Less Bank Failures, Shrinking Problem Institutions

During second-quarter 2017, three banks failed, while 62 were merged. As of Jun 30, 2017, the number of ‘problem’ banks declined from 112 to 105, underlining the lowest number in more than seven years and significantly decreased from 888 recorded in first-quarter 2011. Total assets of the ‘problem’ institutions decreased to $17.2 billion from $23.7 billion.

Our Viewpoint

The decline in the number of problem institutions looks encouraging with the quarter witnessing top-line growth on higher NIM. Banks have been gradually easing lending standards and trending toward higher fees to counter pressure on the top line. In addition, more interest rate hikes will dodge the pressure on interest income. Then, again, consistent expense control and stable balance sheets will likely act as tailwinds in the upcoming quarters.

With lingering uncertainty in the economy, we do not see this issue-ridden sector returning to its pre-recession levels anytime soon. What encourages us though is that a lot depends on to what extent Trump lives up to his promises. Bank stocks may be hit hard if he does not deliver on certain policy goals.

The Fed’s actions on expediting rate hike – which is again a function of economic growth based on Trump’s policy alterations – will also play a key role in keeping the optimism on bank stocks alive.

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