Strong Q3 Earnings for FDIC-Insured Banks, Revenues Up - Analyst Blog

Federal Deposit Insurance Corporation (FDIC)-insured commercial banks and savings institutions reported third-quarter 2014 earnings of $38.7 billion, surpassing the year-ago earnings of $36.1 billion by 7.3%. Notably, community banks constituting 93% of all FDIC-insured institutions, reported net income of $4.9 billion, up 7.8% year over year.

Overall, during the third quarter, the banking industry witnessed a gradual improvement. The number of troubled assets and institutions significantly dipped, which is encouraging.

Further, organic growth aided by higher revenues, improved loan and deposit balances was recorded. However, a rise in non-interest expenses and pressure on margins was experienced.

Banks with assets worth more than $10 billion contributed a major part of the earnings in the said quarter. Though such banks constitute merely 1.6% of the total number of U.S. banks, these accounted for approximately 80% of industry earnings.

Such major banks include Wells Fargo & Co. (WFC), Citigroup Inc. (C), JPMorgan Chase & Co. (JPM) and U.S. Bancorp (USB).

Performance in Detail

Banks are striving to reap profits and are consequently bolstering their productivity. Around 63% of all institutions insured by the FDIC reported improvement in their quarterly net income, while the remaining recorded a decline in comparison to the prior-year quarter. Moreover, the percentage of institutions reporting net losses for the quarter slumped to 6.4% from 8.7% in the last-year quarter.

The measure for profitability or average return on assets (ROA) rose to 1.02% from 1.00% in the prior-year quarter. The average return on equity (ROE) increased to 9.04% from 8.94%.

Net operating revenue was $171.3 billion, up 4.8% year over year. The increase was due to a rise in both non-interest as well as net interest income. This is the highest year-over-year growth in revenue since the fourth quarter of 2009.

Net interest income was recorded at $106.9 billion, up 2.3% year over year. The average net interest margin declined to 3.14%, from 3.26% in the prior-year quarter, depicting the lowest quarterly margin for the industry since the third quarter of 1989. Notably, around 51% of banks recorded increased margins as compared with the prior-year quarter.

Non-interest income jumped 9.2% year over year to $64.3 billion for the banks. Notably, gains from loan sales surged 45.6%. Further, trading revenue increased 25.3% year over year.

Total non-interest expenses for the institutions were $108.5 billion in the quarter, up 1.9% on a year-over-year basis. Higher expenses for goodwill impairment and elevated salaries and employee benefits led to the rise. However, litigation expenses reduced.

Credit Quality

Overall, credit quality was a mixed bag in the reported quarter. Net charge-offs fell to $9.2 billion from $11.7 billion in the third quarter of 2013. Notably, all major loan groups recorded a year-over-year decline in charge-offs, except auto loans.

In the quarter, provisions for loan losses for the institutions came in at $7.2 billion, up 23.9% year over year. The reported figure represents year-over-year increase in provisions for the first time in the last five years.

The level of non-current loans and leases (those 90 days or more past due or in non-accrual status) declined 22.3% year over year to $171.9 billion. Moreover, the percentage of non-current loans and leases fell to 2.11%, which was the lowest since the second quarter of 2008 (2.09%).

Balance Sheet

The capital position of the banks was strong. Total deposits continued to rise and were recorded at $11.6 trillion, up 5.2% year over year. Further, total loans and leases came in at $8.2 trillion, up 4.6% year over year.

As of Sep 30, 2014, the Deposit Insurance Fund (DIF) balance increased to $54.3 billion from $40.8 billion as of Sep 30, 2013. Moreover, assessment revenues and recoveries from litigation settlements primarily drove the growth in fund balance.

Bank Failures and Problem Institutions

During the third quarter of 2014, two insured institutions failed compared with six failures in the prior-year quarter. As of Sep 30, 2014, the number of "problem" banks declined from 354 to 329, reflecting the 14th consecutive quarter of decrease. Total assets of the "problem" institutions also fell to $102.3 billion from $110.2 billion.

Our Viewpoint

Though decline in the number of problem institutions is encouraging, the quarter remained challenging with soft trading volumes, sluggish mortgage banking activities and legal costs. Moreover, consistent top-line growth remains uncertain as pressure on net interest margins from a nagging low rate environment prevails.

However, banks have been gradually easing their lending standards and trending toward higher fees to dodge the pressure on the top line. Then again, continued expense control and stable balance sheets should act as tailwinds in the upcoming quarters. Further, a favorable equity and asset market backdrop, and favorable macroeconomic factors – such as falling unemployment, a progressive housing sector and flexible monetary policy – should pave the way for stability.

With lingering uncertainty in the economy, we do not see this issue-ridden sector returning to its pre-recession peak anytime soon. What encourages us though is that the U.S. banks are getting accustomed to increased legal and regulatory pressure and resorting to safer alternatives for higher earnings. This indicates their ability to better encounter challenges and grow at a moderate pace.

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