Banks Boost Lending, But Find Profits Elsewhere

WASHINGTON — Banks notched another quarter of significant profits, and showed further signs of life in the lending sector, but a government report on second quarter earnings once again raised the question of how long the good times will continue to roll.

Although the Federal Deposit Insurance Corp.'s banking update released Tuesday showed institutions of all types moderately growing their loan balances, their earnings were mostly due to reduced loss provisions. Indeed, the continuing level of low interest rates raised concerns over just how much banks can thrive on lending growth in the future.

"The industry's improvement in net income has been driven thus far by reductions in [loss] reserves," Acting FDIC Chairman Martin Gruenberg said at the release of the Quarterly Banking Profile. "There's only so far that can take you."

After a $63 billion decline in loans in the first quarter, institutions increased their loan balances by $102 billion over the next three months, the second-highest real growth since late 2007. Gruenberg noted that loan growth was more "widely shared" than in other past quarters, with over half of all institutions reporting more loans.

But deriving income from loans was another story. With rates still historically low, and large institutions using lower-yield assets, the average margin of 3.46% was the lowest in three years. Net interest income declined 0.3% from the year-earlier quarter to $105.6 billion. With trading income hit by the multibillion-dollar loss in JPMorgan's London investment office, net operating revenue in the second quarter was only $1.3 billion more than in mid-2011. (Trading income declined 70% from a year earlier to just under $2 billion.)

"Margins in the second quarter were lower than a year ago at banks of all sizes," Gruenberg said. "In the current environment of extremely low interest rates, older, higher-yielding assets are maturing, and are being replaced by lower-yielding investments."

Institutions overall earned $34.5 billion during the quarter, an increase of more than 20% from a year earlier but a 1% drop from the first quarter. Nearly two out of three banks had higher profits than in mid-2011. The average return on assets of 0.99% was 14 basis points higher than a year earlier and the third-highest return since mid-2007. It was the 12th straight quarter of year-over-year earnings improvement.

To overcome the lower net interest income, banks benefited once again from continued asset quality improvement. The $14.2 billion in loan-loss provisions was the lowest in five years and 26% lower than a year earlier. Noncurrent loans fell 4.2% from the first quarter to $292 billion, the ninth straight such decline, and were lower in all major loan categories. Noncurrent construction and development loans declined 17.8% to $23 billion.

Meanwhile, lending growth appeared somewhat more broad-based than in other past quarters. Over 60% of institutions reported loan growth compared to the prior quarter. And although nearly half of the total dollar-amount growth came from commercial and industrial loans, which increased 3.6% from the previous quarter to $1.42 trillion, residential mortgages also jumped by 0.9% to $1.87 trillion. Credit card balances grew as well by 2.3% to $664 billion. However, institutions also reported the 17th straight quarterly decline in balances for C&D loans, and the 13th straight decline for home equity lines of credit.

Gruenberg highlighted a chart in the report showing upward trends in the 12-month growth rates for four major loan categories. The data included a 0.38% 12-month growth rate for loans related to residential real estate, which was the first positive such rate in 16 quarters. (The category includes other types of loans in addition to mortgages, such as home equity lines.)

After the FDIC's press conference, James Chessen, the chief economist for the American Bankers Association, said banks and borrowers alike are still acting cautiously with continued uncertainty about the pace of the economic recovery.

"One of the consequences of really low interest rates is borrowers know there's no urgency to borrow. They can wait for the next two years and see what happens with the debt levels in the U.S., what happens to their foot traffic," Chessen told reporters. "They're not anxious to borrow and it has consequences, not only for the banking industry but for the rest of the economy."

As in past quarters, much of the industry's deposit growth came from non-interest-bearing transaction accounts that are fully insured until yearend under a provision in the Dodd-Frank Act. Those fully insured deposits that are above the FDIC's standard $250,000 insurance limit increased from the previous quarter by about $66 billion, or 5%, to $1.38 trillion. The total increase in domestic deposits was not much more, totaling $71.7 billion.

With community banks urging Congress to extend the full coverage for transaction accounts, Gruenberg, when asked his position, said it was for lawmakers to decide. But he said the decision should be based on what is best for the stability of the financial system. The predecessor to the Dodd-Frank coverage was an FDIC-created program meant to prevent deposit outflows during the near-panic of 2008.

"We've said all along that it was financial-stability considerations that brought the program into being in 2008, and was really the basis for the extension in 2010," Gruenberg said. "I think that really should be the basis for the judgment going forward."

The banking industry's total equity increased by 1.3% during the quarter to nearly $1.59 trillion, driven by an infusion of $14.9 billion in retained earnings. The FDIC said it was the second-highest total for retained earnings since the third quarter of 2006.

The industry finished its fourth consecutive quarter without adding a new charter. Institutions on the "problem" list fell by 40 to 732, and assets for those on the list declined by 3% to $282 billion.

The Deposit Insurance Fund's ratio of reserves to insured deposits increased 10 basis points to 0.32%, and the fund's balance increased by $7.4 billion to $22.7 billion. The FDIC collected about $2.9 billion in deposit insurance assessments.