Bank profit high not just from rewriting bad debt

Number of banks of FDIC’s ‘problem bank’ list drops to 694

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Dec. 4, 2012, 12:28 p.m. EST 

 

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By Ronald D. Orol, MarketWatch

WASHINGTON (MarketWatch) — Bank profits reached a six-year high in the third quarter — and the increase in the bottom line wasn’t just coming from declining provisions for loan losses.

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Banks earned $37.6 billion in the third quarter, a six-year-high, up from $34.5 billion in the second quarter and up from $35.2 billion in the same period last year, the Federal Deposit Insurance Corp. said in a quarterly report.

Since 2009, quarterly improvements in bank earnings could be largely attributed to lower provisions for bad loan losses, said FDIC Chairman Martin Gruenberg.

However, Gruenberg pointed out that in the third quarter the improvement in quarterly revenue, from asset sales and lending, contributed more to the increase in earnings than reduced loan-loss provisioning for bad loans.

Nevertheless, he noted also that the largest contributor to the hike in revenue came from gains on asset sales, particularly loan sales. Banks recorded revenue of $5.6 billion in the third quarter from the sale of loans, up from $4.2 billion in the second quarter and up from $1.7 billion in the same period in 2011.

Overall, the FDIC said that net operating revenue was 3% higher than the same period a year ago, noting that it was the largest improvement in quarterly revenue in almost three years. Net operating revenue increased by about $5 billion, from $165 billion in the second quarter to $170 billion in the third quarter.

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That the largest contribution to the increase in revenue came from gains on asset sales underscoring “continued weakness in other revenue sources,” Gruenberg said.

Gruenberg told reporters that he would like to see increases in all the major lending categories including residential.

“We’d like to see more revenue growth being generated by standard lending,” he said.

American Bankers Association Chief Economist James Chessen said the shift from loan-loss reserves reduction to revenues generated by lending is a positive development.

“What we’ve seen is loan-losses dramatically decline, and we’ve seen banks improve and as that happens banks are in a much better position to making new loans out into the market,” he told reporters. “As the cost of dealing with loan losses goes down, you start to see that replaced with revenue from aggressive business lending.”

Residential mortgage lending rose by $14.5 billion in the third quarter, from the previous quarter, while loans to commercial and industrial borrowers increased by $31.8 billion. However, home-equity loans declined by $12.9 billion while real estate construction and development loans fell by $6.9 billion.

Reserves for bad loans fell for the 12th consecutive quarter, however they were still high at $14.8 billion in the third quarter.

Gruenberg cautioned that even though improvement in credit quality has allowed banks to reduce loan-loss reserves, it cannot last forever.

“There gets to a point where reductions in reserve cannot drive income, and we are concerned about adequacy of reserves,” Gruenberg said.

Loan balances increased by $65 billion in the third quarter, and more than 55% of banks reported loan growth, the FDIC said. However, the increase was not as sharp as the $102 billion hike in loan growth reported in the second quarter. The FDIC reported growth across most major loan categories, but Gruenberg noted that the increase remains “modest” by historic standards.

The number of banks in financial distress continued to decline. The number of banks on the FDIC’s “problem list” fell to 694 from 732 during the second quarter of 2012 and the assets of problem institutions declined to $262 billion from $282 billion. There were 12 bank failures in the third quarter, the smallest number of failures since the fourth quarter of 2008.

Ronald D. Orol is a MarketWatch reporter based in Washington. Follow him on Twitter @rorol.