Tuesday, August 31, 2010

2Q Results: Banking Industry Regaining Strength

The FDIC released its Q2 bank earnings report today, which shows that, even with significant economic headwinds, the banking industry continues to regain its strength. Capital increased, earnings were up and margins improved. Moreover, troubled loans were down, provisions fell and charge-offs declined.

Banks reported their highest earnings since the third quarter of 2007, with a second quarter profit of $21.6 billion.

Banks have increased their capital levels and set aside strong reserves to cover problem loans that typically result from high levels of unemployment and business failures. Problem loans are down, allowing banks to put losses behind them and look for new lending opportunities as the economy improves.

It was no surprise to learn that all major loan categories reduced balances during the quarter, given the still weak economy and the regulatory uncertainty that has been hovering over the industry for nearly two years. This will, unfortunately and incorrectly, be reported as banks not lending. As I’ve mentioned in several blog posts, banks have to first replace loan losses and repaid (and amortizing) loans just to stay even each quarter with loan volumes. Clearly,not an easy task – or a reasonable one – given the poor economic conditions facing many communities and the emphasis by regulators on higher levels of capital.

There was other good news surrounding problem loans: net charge-offs totaled $49 billion in the second quarter, a $214 million decline from a year earlier and the first year-over-year decline since the fourth quarter of 2006. Further, noncurrent loans declined by $19.6 billion during the second quarter, the first quarterly decline since the first quarter of 2006.

Banks overall are in a strong financial position. 95.6% of banks – holding over 98.8% of the industry’s assets – are classified as "well capitalized," which is the highest regulatory designation possible. These numbers reflect an increase in banks in the well-capitalized category from the first quarter. Banks added another $27 billion in equity capital in the second quarter and total industry capital is now just short of $1.5 trillion. When added to the more than $250 billion in reserves banks have set aside to cover losses, this makes for a total buffer of $1.74 trillion against losses.

The increase in the number of banks on the list of troubled institutions (from 775 to 829) is not surprising given some parts of the country are still mired in the recession. However, the total assets of troubled institutions declined to $403 billion (from $431 billion), signaling a decline in asset size of banks that are currently on the list (from $520 million to $486 million on average). The Deposit Insurance Fund reduced its deficit for the second consecutive quarter, resulting from the largest quarterly gain in FDIC’s history -- $5.47 billion. This was attributable to both higher assessments ($3.2 billion) and, importantly, $2.5 billion of recaptured loss provisions resulting from a downward revision in expected losses for this year. The FDIC did report the highest quarterly operating expenses of $382 million for the quarter.

The banking industry is committed to maintaining the strength of the deposit insurance fund. All costs of the FDIC are borne by the industry, not taxpayers. Each depositor is fully insured up to $250,000, and in the 75-year history of the FDIC no depositor has ever lost a penny of insured deposits.

Navigating the ups and downs of the economy is nothing new to banking. The vast majority of banks have been in business for more than 50 years, and one of every three banks has served its local community for more than a century. Through good times and bad, it is this philosophy of building long-term relationships with customers that has made banks successful.

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