U.S. Banks Continue Recovery (Update 1)

Updated with comments from American Bankers Association chief economist James Chessen

NEW YORK ( TheStreet) - U.S. banks continued their recovery during the third quarter, with a combined profit of $37.6 billion, for the industry's best performance in six years, according to a Federal Deposit Insurance Corp. report issued Tuesday.

The third-quarter industry results improved from combined profits of $34.5 billion during the second quarter, and $35.3 in the third quarter of 2011. The FDIC said that "more than half of all institutions (57.5 percent) reported higher earnings than a year ago, and only 10.5 percent reported negative net income for the quarter," which was the lowest proportion of unprofitable banks and thrifts since the second quarter of 2007.

With credit quality continuing to improve, banks continued to see their bottom lines boosted by the release of loan loss reserves, which declined by $9.6 billion as of Sept. 30, as third-quarter net charge-offs (loan losses less recoveries) totaled $22.3 billion. The FDIC said that "this is the tenth consecutive quarter that the industry's reserves have declined," and that "much of the total reduction in reserves was concentrated among larger institutions."

The FDIC said that "the amount of loans and leases that were noncurrent (90 days or more past due or in nonaccrual status) declined by only $100 million (0.03 percent) during the third quarter," which was "the tenth consecutive quarter that noncurrent loan balances have declined, but it is the smallest decline registered during that time."

While most of the largest banks continued releasing reserves, the FDIC said that "a majority of institutions (53.5 percent) added to their reserves during the quarter." Still, with the big banks continuing to wind down reserves, the FDIC said that "the industry's 'coverage ratio' of reserves to noncurrent loans declined from 60.4 percent to 57.2 percent during the quarter."

According to data supplied by Thomson Reuters Bank Insight, 15 of the nation's 19 banks with total assets exceeding $100 billion released loan loss reserves during the third quarter. Among the exceptions, the only bank adding significantly to reserves was HSBC Bank USA NA (a subsidiary of HSBC ( HBC)), which increased its allowance for loan and lease losses by $18.7 million to $637.1 million, as of Sept. 30.
  • JPMorgan Chase's (JPM) main banking subsidiary JPMorgan Chase Bank, NA, saw its allowance for loan losses decline by $959 million during the third quarter. The company's smaller credit card subsidiary Chase Bank USA, NA added $5.2 million to reserves, which is a very small amount, considering that the card subsidiary's allowance for loan losses totaled $4.3 billion, as of Sept. 30. JPMorgan Chase Bank NA's ratio of nonperforming assets (excluding government-guaranteed loan balances and properties) to total assets was 1.29% as of Sept. 30, improving from 1.32% the previous quarter, according to Thomson Reuters Bank Insight, while the bank's loan loss reserves (including allocated transfer reserves) covered 2.96% of total loans. This level of reserve coverage was way "ahead of the pace" of loan losses, as the annualized third-quarter ratio of net charge-offs to average loans was 1.20%, implying that we will be seeing much more in the way of reserve releases from JPMorgan's largest subsidiary.
  • Citibank, NA -- the main banking subsidiary of Citigroup (C) -- saw its loan loss reserves decline by $1.7 billion during the third quarter. The bank's nonperforming assets ratio was 0.99% as of Sept. 30, increasing slightly from 0.93% the previous quarter. Loan loss reserves covered 3.57% of total loans as of Sept. 30, and the bank's ratio of net charge-offs to average loans of 2.48% in the third quarter.
  • Bank of America (BAC) main subsidiary Bank of America, NA released $3.5 billion in reserves during the third quarter. The bank's ratio of nonperforming assets to total assets was 2.44% as of Sept. 30, increasing from 2.20% the previous quarter. Reserves covered 2.53% of total loans, and the third-quarter net charge-off ratio was 1.35%. Bank of America's FIA Card Services, NA subsidiary released $560 million in loan loss reserves during the third quarter, with a third-quarter net charge-off ratio of 4.76%, improving from 5.36% in the second quarter. FIA's reserves covered 5.34% of total loans as of Sept. 30.
  • Wells Fargo Bank, NA -- the main banking subsidiary of Wells Fargo (WFC) -- released $980 million in reserves during the third quarter. The bank's nonperforming assets ratio improved to 2.55% as of Sept. 30, from 2.64% the previous quarter, and reserves covered 1.91% of total loans. The third-quarter ratio of net charge-offs to average loans was 1.06%. On the holding company level, Wells Fargo continues to out-earn the other members of the "big four" U.S banking club, with a third-quarter operating return on average assets of 1.46%, increasing from 1.40% the previous quarter, and 1.27% a year earlier, according to data supplied by Thomson Reuters Bank Insight. JPMorgan Chase was in second place, with a third-quarter ROA of 1.01%, increasing from 0.88% in the second quarter, and 0.76% in the third quarter of 2011.

The FDIC reported that the industry continued to see pressure on net interest margins, which was no surprise, as the Federal Reserve has kept its short-term federal funds rate in a target range of zero to 0.25% since late 2008, while purchasing long-term securities in an effort to keep long-term rates at their historically low levels. Most banks have already seen most of the benefit from a decline in funding costs, while loans continue to reprice at lower rates and new securities investments also carry lower rates.

The industry's aggregate net interest margin -- the average yield on loans and investments, less the average cost for deposits and wholesale borrowings -- narrowed to 3.43% during the third quarter, from 3.46% the previous quarter, and 3.56% a year earlier.

Despite the margin pressure, with nearly 68% of banks and thrifts reporting narrower margins, the banking industry saw its net interest income increase by $746 million year-over-year, which was "made possible by a 4.6 percent increase in interest-earning assets." Total loans and leases grew by 0.9% during the third quarter.

The FDIC also reported that the industry's third-quarter net operating revenue was up by $4.9 billion, or 3% year-over-year, and that "Almost half of all institutions (47.8 percent) reported year-over-year improvement in income from asset sales," reflecting not only profits on the sale of securities, but gains on the quick sale of newly originated residential mortgages, amid a wave of refinancing.

The number of institutions on the FDIC's "problem" list declined to 694 as of Sept. 30 from 732 the previous quarter, with 12 banks and thrifts failing. This was the lowest quarterly number of bank failures since the fourth quarter of 2008.

Once again, not a single banking charter was granted during the third quarter, making it five straight quarters since a new institution has been organized.

American Bankers Association chief Economist James Chessen said that although the third quarter was "another strong one for the banking industry... continuing uncertainty surrounding the fiscal cliff is already slowing economic activity and businesses are hesitant to borrow."

While the FDIC obviously can't do anything to influence the negotiations between President Obama and the Republican leadership in the house of Representatives over the Fiscal Cliff, Chessen said that his organization was "urging Congress to pass a temporary two-year extension of the FDIC's Temporary Account Guarantee program."

Amendments to the Federal Deposit Insurance Act extended unlimited deposit insurance coverage for noninterest-bearing transaction accounts through the end of this year, and no extension is planned by the FDIC. Chessen said that "In today's uncertain environment, security of deposits is trumping yield for businesses. A temporary extension will take at least one piece of uncertainty off the table for businesses at year-end."

-- Written by Philip van Doorn in Jupiter, Fla.

To contact the writer, click here: Philip van Doorn.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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