Banks Have Best Year Since '06 but Problems Still Loom

By Halah Touryalai, Forbes Staff

NEW YORK ( Forbes) - The nation's banks took in nearly $120 billion in net income last year, the most since 2006, but that doesn't mean they are back in their glory days.

The Federal Deposit Insurance Corporation (FDIC) is out with its quarterly report on bank earnings and says banks and savings institutions reported an aggregate profit of $26.3 billion in the fourth quarter of 2011, a $4.9 billion jump from the $21.4 billion in net income the industry reported in the fourth quarter of 2010.

FDIC Acting Chairman Martin J. Gruenberg said that "2011 represented the second full year of improving performance by the banking system. Banks reported higher positive aggregate earnings, the numbers of 'problem' banks and failures declined, and loan balances increased in the final three quarters of the year."

More from Forbes
The World's Richest Countries
The World's Tiniest Hotel Rooms
The Worst Career Blunder You Can Make

That's all great but there's a problem facing banks: revenue. Banks can't seem to increase their top line numbers which also means the profits they are generating are coming in other ways.

For many banks last year the profits came from either cutting expenses (layoffs) or by releasing their rainy day funds, also known as loss provisions. Bank set aside these provisions for loans on their books that can go bad. For example, if a bank expects many of their customers to default or if a loan's terms are renegotiated and is worth less the provision is there to help offset those losses. A bank's loan loss provisions are higher when they expect greater losses on loans.

So consider the following from the FDIC:
"Fourth-quarter loss provisions totaled $19.5 billion, about 40 percent less than the $32.7 billion that insured institutions set aside for losses in the fourth quarter of 2010."

That's great because banks are likely expecting fewer customers to default, for instance. What's not great is the following:
"Net operating revenue (net interest income plus total noninterest income) was $3.8 billion (2.3 percent) lower than a year earlier, due to a $4.4 billion (7.4 percent) decline in noninterest income."

That's the third time in the last four quarters net operating revenue has dropped. Further full-year net operating revenue declined for only the second time since 1938-the only other decline occurred in 2008. That means banks are having a tough time making money off the loans they make, the most basic of bank activities.

So those huge profits are not telling the whole story. There's a bigger issue here and that's the banking industry's revenue problem as interest rates remain at low levels.

That's one reason you might see banks looking for new ways to make money via fees on basic services like checking. (Remember the debit card fee issue?)

The good news, if there is any here, is that because interest rates are so low it appears more people are getting loans. The FDIC says growth in loan portfolios continued with banks' loan balances posting a quarterly increase for the third quarter in a row. Total loans and leases increased by $130.1 billion (1.8 percent), as loans to commercial and industrial borrowers increased by $62.8 billion, residential mortgage loan balances rose by $26.0 billion, and credit card balances grew by $21.3 billion.

Says Gruenberg, "The industry is now in a much better position to support the economy through expanded lending. However, levels of troubled assets and 'problem' banks are still high. And while the economy is showing signs of improvement, downside risks remain a concern."

--Written by Halah Touryalai at Forbes.
Since 1917, Forbes has stood, unwavering, for one overriding principle: the unshakable belief in the power of free enterprise. Our mission has also been clear and unchanging: to provide insights and information that ensure the success of those who tap into Forbes.