JPMorgan Torpedoes Bank Industry Earnings

NEW YORK (TheStreet) -- U.S. banks finally stopped their long streak of year-over-year earnings growth, with combined third-quarter earnings coming in at $36.0 billion, according to the Federal Deposit Insurance Corp.

Industry earnings were down from $42.2 billion in the second quarter and $37.5 billion during the third quarter of 2013.

This was the first year-over-year aggregate earnings decline for FDIC-insured U.S. banks and thrifts in 17 quarters.

Without naming names, the FDIC placed the blame squarely on JPMorgan Chase Bank NA, the main subsidiary of JPMorgan Chase (JPM): "The earnings decline was mainly attributable to a $4 billion increase in litigation expenses at one institution," the regulator said.

JPMorgan Chase Bank, NA earned $401 million during the third quarter, declining from $4.9 billion in the second quarter and $4.0 billion during the third quarter of 2013.

On the holding company level, JPMorgan reported a third-quarter net loss of $380 million, springing from $9.15 billion in provisions for litigation expenses, before taxes. Those provisions brought the company's litigation reserves to $23 billion as of Sept. 30. The company's total fourth-quarter residential mortgage-backed securities (RMBS) litigation tab has come to $17.5 billion so far, including JPMorgan's landmark $13 billion settlement with the Department of Justice and other government authorities, and a $4.5 billion RMBS settlement with institutional investors.

A Hostile Rate Environment

Getting back to the industry results, U.S. banks saw their net interest income for the third quarter decline 1.3% year-over-year to $104.3 billion, as the combined net interest margin narrowed to 3.26% in the third quarter from 3.43% a year earlier. There was some benefit from a widening of interest rates spreads as long-term rates rose during the third quarter, with the margin remaining unchanged in the second quarter.

But what most banks need in order to significantly improve their margins is a parallel rise in interest rates. Investors can expect long-term rates to rise when the Federal Reserve begins tapering its "QE3" purchases of long-term bonds, which have been running at a net rate of $85 billion a month since September 2009. But short-term rates won't budge as long as the central bank keeps the federal funds rate in a target range of zero to 0.25%, as it has done since late 2008.

The Fed has indicated that it is unlikely to consider raising the federal funds target rate until the U.S. unemployment rate drops below 6.5%. The October unemployment rate was 7.3%, increasing from 7.2% in September. Federal Reserve Chairman Ben Bernanke has indicated that the central bank may keep the federal funds rate in its current range for some time after the unemployment rate falls below 6.5%.

Another negative factor for bank earnings was the decline in mortgage loan volume brought about by rising long-term interest rates. The U.S. banking industry's combined noninterest income declined by $4.7 billion or 7.4% year-over-year to $59.0 billion, "as income from sale, securitization, and servicing of 1-to-4 family mortgage loans at major mortgage lenders fell by $4 billion," or 45%, according to the FDIC.

Loan Losses Keep Declining

The industry continued to see benefits from improving credit quality, with combined loan losses coming in at $11.7 billion in the third quarter, down 47% from a year earlier.

Many banks over the past several years have seen a boost to earnings from the release of loan loss reserves. This follows a typical pattern, with banks over-reserving during bad times. U.S. banks released a combined $6.5 billion in reserves during the third quarter. Reserves covered 1.83% of total loans and 64.5% of noncurrent loans as of Sept.30. While reserves to total loans have been declining for 14 straight quarters, coverage of problem loans increased from 62.3% at the end of the second quarter.

U.S. banks' assets grew by 1.3% during the third quarter, with all loan classes showing sequential growth, except for residential mortgage loans.

During the third quarter, six U.S. banks failed, while 43 institutions were "absorbed through mergers," according to the FDIC. The regulator's "Problem List" of troubled banks declined to 515 from 553 the previous quarter.

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-- 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.