U.S. Banks Set Another Earnings Record: FDIC

NEW YORK ( TheStreet) -- U.S. banks continued their upward path during the second quarter, setting another industry record with earnings of $42.2 billion, the Federal Deposit Insurance Corp. reported Thursday.

Industry earnings increased from $40.3 billion in the first quarter and $34.4 billion during the second quarter of 2012. The second quarter was the 16th straight quarter of year-over-year earnings growth for the banking industry.

"The trends we have seen in recent quarters continued in the second quarter," said FDIC chairman Martin Gruenberg in the regulator's press release. "Asset quality continues to recover, loan balances are trending up, fewer institutions are unprofitable, the number of problem banks is down, and the number of failures is significantly below levels of a year ago."

But Gruenberg added that "industry revenue growth remains weak, reflecting narrow margins and modest loan growth. And the current interest rate environment creates an incentive for institutions to reach for yield, which is a matter of ongoing supervisory attention."

The regulator reported that year-over-year earnings improved for nearly 54% of reporting institutions and that the proportion of unprofitable banks and thrifts declined to 8.2%, from 8.4% the previous quarter and 11.3% a year earlier.

The combined U.S. banking industry's second-quarter return on average assets (ROA) was 1.17%, increasing from 1.08% in the first quarter and 0.99% during the second quarter of 2012.

Reserve Releases Keep Feeding Earnings

With asset quality continuing to improve, the industry's combined second-quarter provision for loan losses dropped to $8.6 billion, from $11 billion the previous quarter and $14.2 billion a year earlier. The FDIC said that provisions for reserves were at their lowest point since the third quarter of 2006.

The industry's combined loan loss reserves declined by $6.4 billion during the second quarter. While most banks continue to set aside reserves each quarter, if the provision for reserves is outweighed by net loan charge-offs, a bank "releases" loan loss reserves, which provides a boost to pretax earnings. The industry's annualized ratio of net charge-offs to average loans for the second quarter was a low 0.78%, while reserves covered 1.93% of total loans, setting the stage for a continued release of loan loss reserves, although many analysts have recently said that for large banks, the reserve releases must soon be curtailed.

According to data supplied by Thomson Reuters Bank Insight, all but five of the nation's 20 banks with total assets exceeding $100 billion released loan loss reserves during the second quarter. Among the exceptions was U.S. Bank, NA (held by U.S. Bancorp ( USB)), which added $118 million to loan loss reserves.

The following figures for several of the nation's largest banks underscore the likelihood of continued large reserve releases for some, since reserve coverage of nonperforming loans remains quite strong:
  • Citibank, NA-- the main banking subsidiary of Citigroup (C) -- saw its loan loss reserves decline by $1.6 billion during the second quarter. The bank's ratio of nonperforming assets to total assets was 1.33% as of June 30. Citibank's loan loss reserves covered 3.00% of gross loans as of June 30, while the bank's second-quarter net charge-off ratio was just 1.91%.
  • JPMorgan Chase's (JPM) main banking subsidiary JPMorgan Chase Bank, NA, saw its allowance for loan losses decline by $775 million during the second quarter. The bank's NPA ratio as of June 30 was 1.14%. Reserves covered 2.52% of total loans, while the second-quarter net charge-off ratio was a very low 0.46%.
  • Bank of America's (BAC) main banking subsidiary Bank of America NA released $723 million in loan loss reserves during the second quarter. The bank's NPA ratio was 2.17%, while its second-quarter net charge-off ratio was 0.56%. Reserves covered 1.91% of total loans as of June 30.

The FDIC said that the combined industry's noncurrent loans (90 days or more past due or in nonaccrual status) declined by $21.7 billion during the second quarter and made up 3.09% of total loans as of June 30, which was the lowest percentage since the end of 2008.

More Margin Pressure

The FDIC reported the U.S. banking industry's aggregate second-quarter net interest margin was 3.26%, declining only slightly from 3.27% the previous quarter.

The Federal Reserve has kept the short-term federal funds rate in a range of zero to 0.25% since late 2008. The central bank has also been making monthly purchases of $85 billion in long-term securities since last September, in an effort to hold long-term rates down. The market has anticipated a tapering of the Fed's bond purchases as early as next month, and has sent the yield on 10-year U.S. treasury bonds up by over 100 basis points since the end of April.

A steepening of the yield curve will help most banks to improve their net interest margins, but it will take some time for a major effect on earnings, since some assets are continuing to reprice at lower yields. The sharp rise in mortgage loan rates will also have a negative effect on banks' fee income.

Another negative effect of higher interest rates is the decline in market values for available-for-sale securities. These values rose considerably as long-term rates declined, but during the second quarter, unrealized gains on AFS securities were down by $51.1 billion, or 89% from the previous quarter, according to the FDIC. " Unrealized gains and losses on available-for-sale securities do not affect current earnings, but they do have implications for future earnings if the securities are sold," the agency said.

Getting back to the second-quarter results, the FDIC said that banks' combined noninterest income grew to $66.9 billion in the second quarter from $66.5 billion the previous quarter and $60.2 billion a year earlier.

With banks continuing to do everything they can to cut expenses, the industry's combined efficiency ratio improved to 58.76% during the second quarter, from 58.92% during the first quarter and 61.29% during the second quarter of 2012. The efficiency ratio is, essentially, the number of pennies of expenses incurred for each dollar of revenue.

There were no new banking charters granted in the United States during the second quarter, making eight straight quarters that no new banks have been added. Aside from charters granted for the purchase of failed banks, there have been no new banks formed since the fourth quarter of 2010. Continuing the decades-long consolidation trend, there were 62 bank mergers during the second quarter, which combined with 12 bank failures lowered the number of U.S. banks and thrifts to 6,040 as of June 30.

The FDIC also said that the number of banks on its "problem list" declined to 553 as of June 30 from 612 the previous quarter.

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

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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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