Banking Has Far From Recovered

Econintersect:  The latest quarterly report from the FDIC (Federal Deposit Insurance Corporation) is accompanied by an 85-page graphics book containing over 150 graphs, charts and tables that are very revealing regarding the financial health of the U.S. banking system.  While some are proclaiming the great financial crisis (GFC) is far behind us, much data about banks reveals the health of that sector is far less than the (apparent) health before the GFC.  One example is the continued inefficiency of the largest banks in loan underwriting as indicated in the write-off data for 2012.

Click on graph for larger image.

The points of emphasis in the FDIC report were reported previously by GEI News (28 February 2013).  Here is an excerpt:

For the 14th quarter in a row banks have reportedyear-over-year improvement in earnings. And for the full year 2012 the FDIC member banks have reported earnings of $141.3 billion, the second highest year on record. The highest year was 2006 (and we all remember what happened after that record was set). The increase for 2012 over 2011 was more than 19%. Improvement in quarterly net income from a year ago was reported by 60% of all institutions. The share of institutions reporting net losses for the quarter fell to 14.0% from 20.2% a year earlier.

But, digging in the 1590 plus graphics bbok many problem areas for banks are found.  Some of these are presented below.

The number of troubled banks is down 26% from December 2010, but remains elevated at approximately 10 times pre-crisis levels.

Earnings from net interest income actually decreased. Banks are finding it much more lucrative to make money from activities other than lending money.

No surprise here: Small banks do much less non-traditional business than do the larger institutions. The small banks also showed much less volatility in noninterest income during the financial crisis. Small banks do less of the non-traditional activities, and they also do it better (with less volatility risk).

When the small banks are divided into those with subchapter S organization (required to have 50 or fewer shareholders) return on assets is more than double that of all other small banks. An inference is that management interests are better aligned with shareholder interests for subchapter S banks. This is fully consistent with the likelihood that management share of ownership is probably much larger on average than for subchapter C institutions. The likelihood of reduced accounting fraud and other means of management “skimming money off the top” aligns with higher levels of management equity ownership.

The ability to use total noninterest income in net operating revenue is a perverse incentive which leads to reduced efficiency when noninterest expense is allowed to increase for marginal improvement in total noninterest income. There is no proof that is occurring from this data but the fact that total noninterest expense is approximately 50% greater than total income in the noninterest category begs the question.

It is great to see the breakout of sources of noninterest income. But half is “other” which is far from informative.

The difference between yield and cost of funding has remained in the 3% to 3.5% range over the past six years. But the ratio of cost to yield has dramatically improved; it was about 2:1 before the financial crisis and is closer to 6:1 today. This is a powerful advantage for earning from interest bearing activities (lending) and yet the banks are having trouble in growing net income from that source.

The other factor to note in these graphs is the cost of funding for the small banks is 22 basis points higher than for those with assets over $1 billion. This may be reflective in part of the advantage that the TBTF (too big to fail) banks (who are in the larger bank group) have in obtaining capital because there is still an implied government backstop. Without further breakdown of how the large bank data is distributed this conjecture cannot be verified.

The level of first lien delinquencies has remained stubbornly high and junior liens and HELOC (home equity lines of credit) have risen over the past three years. First lien delinquencies have declined by about 10% while the second mortgage categories have each increased by about 50%.

The other situation that deserves further investigation is the much higher first lien delinquency rates compared to the second liens. Why should first mortgage delinquencies be 3-5 times greater than second mortgages? Are many people delinquent on their first mortgage continuing to pay on the second liens?

How long are the delays for a second lien foreclosure filing and repossession compared to first mortgages? It has been reported that many first mortgages remain delinquent for tens of months before mortgagors are evicted. Is the processing of second liens much faster? Are some mortgagors making second lien payments to extend the time they can live nearly “rent free” awaiting eventual repossession?

The return on equity has only returned to approximately 2/3 of the level from before the financial crisis.

Watch the video of the FDIC presentation:

Here is the full summary from the report:

INSURED INSTITUTION PERFORMANCE

• Fourth Quarter 2012 Earnings Total $34.7 Billion

• Full-Year ROA Reaches 1 Percent for First Time in Six Years

• Domestic Deposit Growth Sets Record

• Quarterly Loan Losses Fall to Five-Year Low

Net Income Is More Than a Third Higher Than in Fourth Quarter 2011

Bolstered by higher noninterest income and lower provisions for loan losses, earnings at FDIC-insured institutions in fourth quarter 2012 posted a $9.3 billion (36.9 percent) increase over the total for fourth quarter 2011. The $34.7 billion in fourth-quarter net income was the highest total for a fourth quarter since 2006. Well over half of all institutions-60 percent-reported year-over-year improvement in quarterly earnings, while the share of institutions reporting net losses for the quarter fell to 14 percent, from 20 percent a year earlier. The average return on assets (ROA) rose to 0.97 percent from 0.73 percent in fourth quarter 2011.

Noninterest Income Rebounds From Year-Earlier Weakness

The $10 billion (18.2 percent) year-over-year improvement in noninterest income was driven primarily by higher gains on loan sales (up $2.4 billion, or 132.4 percent, over fourth quarter 2011), increased trading revenue (up $1.9 billion, or 75.3 percent), and reduced losses on sales of foreclosed property (down $1.2 billion, or 72 percent). Additionally, noninterest income at some large banks was adversely affected a year ago by appreciation in the fair values of their liabilities; the absence of similar accounting losses in this quarter’s results also helped to improve noninterest income.1 Overall, almost two out of every three banks (62.3 percent) reported year-over-year increases in noninterest income.

Insured Institutions Continue to Reduce Their Loss Provisions

Banks set aside $15.1 billion in loan-loss provisions in the fourth quarter, a $4.9 billion (24.6 percent) reduction compared with fourth quarter 2011. This is the smallest fourth-quarter loss provision since 2006, and marks the 13th consecutive quarter with a year-over-year decline in loss provisions. More than half of all institutions-53.6 percent-reported lower loss provisions.

Banks See Margins Erode

The increase in noninterest income and reduction in loss provisions helped offset a $2.7 billion (2.5 percent) year-over-year decline in net interest income. Fourth-quarter net interest income totaled $104.4 billion, compared with $107.1 billion a year ago. This is the lowest quarterly total since fourth quarter 2009, when the industry had $1.4 trillion less in interest-bearing assets. The average net interest margin (NIM) fell to 3.32 percent, from 3.57 percent in fourth quarter 2011, as average asset yields declined more rapidly than average funding costs. This is the lowest quarterly NIM for the industry since fourth quarter 2007. More than two-thirds of all banks-67.9 percent-reported year-over-year NIM declines.

Full-Year Earnings Are Second Highest Ever

Full-year net income totaled $141.3 billion, a $22.9 billion (19.3 percent) improvement over 2011. This is the second-highest annual earnings ever reported by the industry, after the $145.2 billion total in 2006, when the industry had $2.7 trillion less in assets. The average ROA rose to 1.00 percent from 0.88 percent in 2011. The largest contribution to the increase in earnings came from reduced provisions for loan losses, which fell by $19.3 billion (24.9 percent). Noninterest income was $18.4 billion (8 percent) higher than in 2011, thanks to an $11.2 billion (174.4 percent) increase in gains on loan sales, a $6.8 billion (93.9 percent) increase in servicing income, and a $2.4 billion (51.8 percent) reduction in losses on foreclosed property sales. The improvement in noninterest income was limited by a $12.4 billion negative swing in results from trading credit exposures. Net interest income was $1.3 billion (0.3 percent) lower than in 2011, as the full-year NIM fell from 3.60 percent to 3.42 percent. Realized gains on securities and other assets added $4.2 billion (75.7 percent) more to pretax earnings than a year earlier.

Loan Losses Improve Across All Loan Categories

Asset quality indicators continued to improve in the fourth quarter. Net charge-offs (NCOs) totaled $18.6 billion, down $7 billion (27.4 percent) from fourth quarter 2011. This is the 10th consecutive quarter that NCOs have declined. It is the lowest quarterly NCO total since fourth quarter 2007. All major loan categories showed year-over-year improvement in quarterly NCO amounts. The largest declines occurred in 1-to-4 family residential mortgages, where quarterly NCOs fell by $1.5 billion (29.3 percent), in real estate construction and development loans, where NCOs declined by $1.3 billion (62.6 percent), in credit cards, where NCOs were $1 billion (14.1 percent) lower, and in loans to commercial and industrial (C&I) borrowers, where NCOs were also $1 billion (39.7 percent) lower.

Noncurrent Rate Declines to Four-Year Low

The amount of loans that were noncurrent (90 days or more past due or in nonaccrual status) declined by $16.1 billion (5.5 percent) during the quarter. At year-end, noncurrent loan balances totaled $276.8 billion, compared with $292.8 billion at the end of the third quarter. The percentage of total loans and leases that were noncurrent fell from 3.86 percent to 3.60 percent, the lowest level since the end of 2008. Noncurrent balances fell in all major loan categories in the fourth quarter. Noncurrent 1-to-4 family residential mortgage balances declined by $6.4 billion (3.5 percent), while noncurrent real estate construction and development loans fell by $3.6 billion (17.3 percent), and noncurrent nonfarm nonresidential real estate loans declined by $3.1 billion (9.2 percent).

Coverage of Noncurrent Loans Improves Despite Reduction in Reserves

Insured institutions reduced their reserves for loan losses by $5 billion (3 percent) in the fourth quarter, as fourth-quarter loss provisions replenished only $15.1 billion of the $18.6 billion taken out of reserves by NCOs. This is the 11th consecutive quarter that the industry’s reserve balances have declined. The trend toward lower reserves continues to be led by larger institutions. More institutions added to their reserves than reduced them (48.8 percent versus 43.5 percent, respectively). Despite the overall reduction in reserves, the larger decline in noncurrent loan balances at insured institutions meant that the industry’s coverage ratio of reserves to noncurrent loans increased from 57.0 percent to 58.5 percent during the quarter.

Decline in Securities Values Contributes to Reduction in Equity Capital

Total equity capital fell by $5.6 billion (0.3 percent) in the fourth quarter. The decline reflected a $7.2 billion decrease in accumulated other comprehensive income, as unrealized gains on securities held for sale fell by $7.6 billion (10.4 percent). For the industry as a whole, retained earnings made no contribution to equity formation in the fourth quarter, as declared dividends of $35.5 billion exceeded the $34.7 billion in quarterly net income. The high level of dividends was the result of a large quarterly dividend declared at one institution. A majority of institutions, 55.2 percent, added to their equity capital during the quarter.

Loan Balances Increase for Sixth Time in Seven Quarters

Total assets increased by $227.8 billion (1.6 percent). Loans accounted for more than half of the increase, as net loan and lease balances rose by $123.2 billion (1.7 percent). Loan growth was led by C&I loans (up $53.4 billion, or 3.7 percent), credit cards (up $28.2 billion, or 4.2 percent), and nonfarm nonresidential real estate loans (up $14.6 billion, or 1.4 percent). Home equity loan balances fell by $12.6 billion (2.2 percent) during the quarter, while balances of real estate construction and development loans declined by $6.6 billion (3.1 percent). Loans to small businesses and farms increased by $1.7 billion (0.3 percent), as small C&I loans (original amounts of $1 million or less) rose by $5.3 billion (1.9 percent), and small farmland loans (original amounts of $500,000 or less) increased by $234 million (0.6 percent). Cash and balances due from depository institutions increased by $87.2 billion (6.4 percent), as banks increased their balances with Federal Reserve banks by $60.2 billion (9.1 percent). Banks’ investment securities portfolios grew by $23.5 billion (0.8 percent) during the quarter.

Large Denomination Deposit Balances Surge

Total deposits increased by $313.1 billion (3 percent), as deposits in domestic offices posted a record $386.8 billion (4.3 percent) increase. Most of the growth consisted of large denomination deposits. Balances in accounts of more than $250,000 increased by $348.5 billion (8.2 percent). Uninsured deposit balances increased by $252.7 billion (12.7 percent), while balances in noninterest-bearing transaction accounts above the basic FDIC coverage level of $250,000 that had temporary full FDIC coverage through the end of 2012 increased by $49.5 billion (3.3 percent). Banks reduced their nondeposit liabilities by $76.9 billion (3.7 percent), and their foreign office deposits by $73.7 billion (5.1 percent).

Quarterly Failures Decline to 4 ½ Year Low In the fourth quarter, the number of insured commercial banks and savings institutions reporting financial results fell from 7,181 to 7,083. During the quarter, 88 institutions were merged into other banks, and eight insured institutions failed. This is the smallest number of failures in a quarter since second quarter 2008. For the sixth quarter in a row, no new reporting institutions were added. The year 2012 is the first in FDIC history that no new reporting institutions were added, and the second year in a row with no start-up de novo charters (the three new reporters in 2011 were all charters created to absorb failed banks). The number of institutions on the FDIC’s “Problem List” declined for a seventh consecutive quarter, from 694 to 651. Total assets of “problem” institutions fell from $262 billion to $233 billion. During the fourth quarter, insured institutions increased the number of their employees by 4,259 (0.2 percent).

1 See FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities in Notes to Users.

Here is the full press release by the FDIC:

February 26, 2013

Commercial banks and savings institutions insured by the Federal Deposit Insurance Corporation (FDIC) reported aggregate net income of $34.7 billion in the fourth quarter of 2012, a $9.3 billion (36.9 percent) improvement from the $25.3 billion in profits the industry reported in the fourth quarter of 2011. This is the 14th quarter in a row that earnings have registered a year-over-year increase. Increased noninterest income and lower provisions for loan losses continued to account for most of the year-over-year improvement in earnings. For the full year, industry earnings totaled $141.3 billion — a 19.3 percent improvement over 2011 and the second-highest ever reported by the industry after the $145.2 billion earned in 2006.

“The improving trend that began more than three years ago gained further ground in the fourth quarter,” said FDIC Chairman Martin J. Gruenberg. “Balances of troubled loans declined, earnings rose from a year ago, and more institutions of all sizes showed improved performance.”

Sixty percent of all institutions reported improvements in their quarterly net income from a year ago. Also, the share of institutions reporting net losses for the quarter fell to 14.0 percent from 20.2 percent a year earlier. The average return on assets (ROA), a basic yardstick of profitability, rose to 0.97 percent from 0.73 percent a year ago.

Fourth quarter net operating revenue (net interest income plus total noninterest income) totaled $169 billion, an increase of $7.3 billion (4.5 percent) from a year earlier, as gains from loan sales rose by $2.4 billion and trading income increased by $1.9 billion. Net interest income was $2.7 billion (2.5 percent) lower than in the fourth quarter of 2011, as the average net interest margin fell to a five-year low.

Asset quality indicators continued to improve as insured banks and thrifts charged off $18.6 billion in uncollectible loans during the quarter, down $7.0 billion (27.4 percent) from a year earlier. The amount of noncurrent loans and leases (those 90 days or more past due or in nonaccrual status) fell for the 11th consecutive quarter, and the percentage of loans and leases that were noncurrent declined to the lowest level in four years.

Financial results for the fourth quarter of 2012 and the full year are contained in the FDIC’s latest Quarterly Banking Profile, which was released today. Also among the findings:

Total loan balances increased. Loan balances posted their sixth quarterly increase in the last seven quarters, rising by $118.2 billion (1.6 percent). Loans to commercial and industrial borrowers increased by $53.4 billion (3.7 percent), while credit card balances posted a seasonal increase of $28.2 billion (4.2 percent) and loans secured by nonfarm nonresidential real estate properties grew by $14.6 billion (1.4 percent). However, home equity lines of credit declined by $12.6 billion (2.2 percent), and real estate construction and development loans fell by $6.6 billion (3.1 percent).

“Growth in lending continues to be led by commercial and industrial loans,” Chairman Gruenberg noted. “Insured institutions of all sizes increased their loan balances during the quarter.”

The flow of money into deposit accounts increased sharply. Total deposits increased by a record $313.1 billion (3 percent) in the fourth quarter, surpassing the previous quarterly high of $308 billion set in the fourth quarter of 2008. Deposits in domestic offices increased by $386.8 billion(4.3 percent), while deposits in foreign offices fell by $73.7 billion (5.1 percent). The amount of domestic deposits in accounts with balances of more than $250,000 rose by $348.5 billion (8.2 percent).

The number of institutions on the FDIC’s “Problem List” declined for a seventh consecutive quarter. The number of “problem” banks fell from 694 to 651 during the quarter. During the recent financial crisis, “problem” banks reached a high of 888 at the end of the first quarter of 2011. Eight FDIC-insured institutions failed in the fourth quarter. This was the smallest quarterly total since the second quarter of 2008, when two insured institutions were closed. For all of 2012, there were 51 failures, compared to 92 in 2011 and 157 in 2010.

Full-year net income improved for a third consecutive year. The increase in annual earnings over 2011 was attributable to lower expenses for loan-loss provisions and higher noninterest income. Banks set aside $58.2 billion in loss provisions in 2012, a reduction of $19.3 billion (24.9 percent) from 2011. Noninterest income was $18.4 billion (8 percent) higher in 2012, as gains from loan sales rose by $11.2 billion (174.4 percent). The average ROA rose to 1.0 percent, from 0.88 percent in 2011. This is the first time since 2006 that the industry’s annual ROA has reached the 1 percent level.

The Deposit Insurance Fund (DIF) balance continued to increase. The audited DIF balance — the net worth of the fund — rose to $33.0 billion at December 31 from $25.2 billion at the end of September. Assessment income and a decrease in estimated losses associated with past bank failures made the biggest contributions to growth in the fund balance. The fund also received an additional $1.8 billion that had been previously set aside for debt guarantees under the FDIC’s Temporary Liquidity Guarantee Program (TLGP). The program began in October 2008 and ended when the last debt guarantee expired on December 31, 2012. At its peak, the program guaranteed $346 billion of outstanding debt. TLGP contributed a total of $9.3 billion to the DIF over the life of the program. Estimated insured deposits grew 2.2 percent in the fourth quarter.

The complete Quarterly Banking Profile is available at http://www2.fdic.gov/qbp on the FDIC Web site.

John Lounsbury

Sources:

• Quarterly Banking Profile (FDIC, 26 February 2013)

• QBO Graph Book (FDIC, 26 February 2013)

• FDIC Report 4Q 2012: “Banks are Stronger” (Mostly) (GEI News, 28 February 2013)