NEW YORK (TheStreet) -- Yes, it was a difficult third-quarter bank earnings season, and the fourth-quarter is expected to be even worse.However, many banks have grown their earnings considerably over the past few years.
Two of the main challenges to the industry have been widely covered. First is the pressure on the net interest margin, which is the difference between a bank's average yield on loans and investments and its average cost for deposits and borrowings. With the Federal Reserve keeping its target federal funds rate in a range of zero to 0.25% since the end of 2008, most banks have already seen all the benefit on the interest expense side that they are likely to see. Meanwhile, the central bank in September expanded its purchases of long-term mortgage-backed securities by $40 billion a month -- known as QE3 -- in an attempt to push long-term rates lower, or at least keep them at their historically low levels.
Banks are also expected to see a sharp decline in commercial and industrial loan origination during the fourth quarter. Before this year's boom in residential loan refinancing, C&I lending was a bright spot for the industry. FBR analyst Paul Miller said last week that commercial borrowers are entering into new agreements for bank credit lines, but "but they are not borrowing the money," as they keep their expansion powder dry and wait for the election results and for Congress to compromise on the "fiscal cliff."
The fiscal cliff could cause the income tax cuts -- including the 15% maximum tax rate on qualified dividends -- signed into law by President George W. Bush and extended by President Obama in 2010, to expire as part of the 2010 budget compromise. Unless a fiscal cliff deal is worked out, there will be mandatory federal spending cuts, along with the tax increases, which the Congressional Budget Office and many economists think will send the U.S. economy back into recession.Moving past the gloom and doom, many banks grew their earnings sequentially and year-over-year during the third quarter, and not just from credit quality improvement and the release of loan loss reserves. Banks typically add to their loan loss reserves each quarter, which is called the "provision" for reserves. If the provision is negative, or if it is less than the dollar amount of loans charged-off during the quarter, the bank has "released" reserves. In order to keep banks from "managing" their earnings by manipulating their quarterly provisions for reserves when credit quality is strong, regulators frown on banks "over-reserving" during the good times, and may even force banks to over-reserve during an economic downturn. With the general improvement in credit quality as we move through the slow economic recovery, most large banks have been seeing quite an earnings boost from the release of loan loss reserves over the past two years. Using the partial set of third-quarter data that is now available , we have identified five banks that have significantly grown their pre-provision net revenue. Pre-provision net revenue is calculated by adding a bank's net interest income -- tax-adjusted if possible -- to its non-interest income, and subtracting its noninterest expense. Using this approach can lead to some rather extreme results, with one-time items affecting one quarter's earnings, so we have narrowed the sample to include only companies that were profitable, with positive operating returns on average assets (ROA) for the past five quarters, and companies that also saw their pre-provision net revenue grow quarter-over-quarter. Two of the "big four" U.S. banks have seen their pre-provision net revenue grow significantly over the past year:
- Wells Fargo (WFC) saw its pre-provision net revenue -- backing out gains on equity investments and gains on debt securities available for sale -- grow 13% year-over-year, to $9.1 billion in the third quarter, according to Thomson Reuters Bank insight. While third-quarter tax-adjusted net interest income declined to $10.10.820 million from $10.714 million a year earlier, noninterest income rose to $10.384 billion from $8.442 billion, and noninterest expense declined by over $1 billion to $12.112 billion. Mortgage banking revenue was up 53% year-over-year to $2.807 billion in the third quarter, while the company reported net gains from trading activities of $529 million, compared to losses of $442 million, a year earlier. Overall earnings performance remained strong, with a third-quarter ROA of 1.45% and a return on equity of 13.38%.
- For JPMorgan Chase (JPM), pre-provision net income increased 14% year-over-year to $10.317 billion. The company's tax-adjusted net interest income declined to $11.176 billion in the third quarter from $11.950 billion a year earlier, as the company's net yield narrowed by 23 basis points year-over-year, to 2.43%. But the company's third-quarter noninterest income -- backing our securities gains -- increased to $13.712 billion from $11.339 billion in the third quarter of 2011. JPMorgan's Corporate/Private Equity business line saw profit increasing to $221 million in the third quarter, from a loss of $645 million a year earlier. Meanwhile, Retail Financial Services profit grew 21% year-over-year, to $1.408 billion, amid the wave of mortgage loan refinancing.
- Citigroup (C) saw a 22% year-over-year decline in pre-provision net revenue, to $5.887 billion in the third quarter. Third-quarter tax-adjusted net interest income declined to $12.054 billion from $12.252 billion a year earlier, reflecting a decline in earning assets, as part of the company's long-term strategy to right-size its balance sheet. Citi's net interest margin actually expanded, to 2.86% in the third quarter, from 2.83% a year earlier. Noninterest income declined to $6.237 billion in the third quarter from $8.098 million a year earlier. The third-quarter bottom-line results included a pre-tax loss of $4.7 billion from the sale of a 14% interest in the Morgan Stanley Smith Barney joint venture and the write-down on Citi's remaining 35% interest in the joint venture, which will eventually be sold to Morgan Stanley (MS). A major positive for Citigroup an estimated Basel III Tier 1 common equity ratio was strong 8.6% as of Sept. 30, giving investors hope that the company could receive Federal Reserve approval for a significant return of capital during 2013.
- For Bank of America (BAC), one-time items brought the company's third-quarter pre-provision net revenue down by 55% year-over-year, to $4.380 billion in the third quarter. Third-quarter results included pretax litigation expenses totaling $1.6 billion, including the settlement of a 2009 class action lawsuit, related to the company's acquisition of Merrill Lynch. Bank of America's net interest income declined to a tax-adjusted $10.167 billion in the third quarter, from $10.739 billion a year earlier. Noninterest income was down 36% year-over-year, to $10.157 billion in the third quarter, in part because the third-quarter 2011 results included a $3.6 billion gain on sales of shares in China Construction Bank, which was partially offset by a loss of $2.2 billion on private equity and other investments, including the CCB stake.
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