Lending Is Up, But Still Not Key Driver in Industry's Earnings

WASHINGTON — Banks were once again able to notch higher loan balances in the third quarter but — as in many past quarters — they largely made their money doing other things.

The Federal Deposit Insurance Corp.'s health report on the industry showed a jump in noninterest income combined with a further drop in loan-loss provisions, which helped to drive another strong earnings performance. But banks' successes — including significantly higher gains from asset sales — highlighted just how far removed a lending recovery still is from the industry's growth.

"We've now seen … an extended period of increasing loan balances. But that's still relatively modest. What we really would like to see is more revenue being generated by expanded lending," FDIC Chairman Martin Gruenberg said at the release of the Quarterly Banking Profile.

To be sure, revenue did increase noticeably. In addition to another round of cuts to loss provisions, the industry's quarterly net income of $37.6 billion — its highest in six years — was also spurred by the biggest year-over-year increase in net operating revenue in almost three years. Overall, more than 57% of all institutions had higher earnings in the quarter than a year earlier, while just over 10% reported a net loss. The percentage of unprofitable institutions was the lowest in over five years. Loan-loss provisions declined for the 12th straight quarter, falling by 20.6% from a year earlier to $14.8 billion.

"There continue to be signs that the recovery is encompassing more financial institutions," Gruenberg said. "It is particularly encouraging to see smaller banks improving their earnings. The impact of the financial crisis and recession affected their performance later than that of larger banks, and their recovery began later as well."

The $169.6 billion in revenue was 3% higher than a year earlier, driven by a 7% rise in noninterest income to $63.7 billion. Net gains on assets sales totaled $5.6 billion, compared to just $639 million a year earlier.

"In previous quarters, we have noted that revenue growth has been sluggish, and most of the improvement in earnings could be traced to lower provisions for loan losses. This pattern actually changed in the third quarter, as net operating revenue … was 3% higher than a year ago," Gruenberg said.

But he added that the revenue strength in the noninterest-related part of the balance sheet was not replicated by interest-related revenue.

"The largest contribution to the increase in revenue came from gains on assets sales, particularly loan sales," he said. "This underscores the continuing weakness in other revenue sources."

Loans continue to steadily rise. The industry's total assets rose by 1.4% from the second quarter to $14.2 trillion, as institutions' loan balances grew for the fifth time in the last six quarters. Loans rose by 0.9% to $7.58 trillion. Commercial and industrial loans grew by 2.2% to $1.45 trillion. Increased volume of interest-earning assets helped institutions overcome a decline in net interest margins. Net interest income rose by 0.7% from a year earlier, while the average net interest margin fell 13 basis points to 3.43%.

"Loan balances increased by $65 billion in the quarter, and more than 55% of all banks reported loan growth," Gruenberg said. "We are also seeing improvement in growth trends across most major loan categories."

In addition to C&I loans, residential mortgages rose by 0.8% during the quarter to $1.89 trillion. Loans to individuals increased 1% to $1.29 trillion, led by a 2.4% uptick in automobile loans to $296 billion. Yet balances for other categories continued downward. That includes construction and development loans, which declined — by 3.2% to $210 billion — for the 18th straight quarter.

With reduced expenses for bad loans still playing a large role in boosting net income, Gruenberg echoed concerns first raised by Comptroller of the Currency Thomas Curry that an overreliance on lowering provisions to improve the bottom line could threaten the strength of banks' loss reserves. Overall, banks lowered their reserves by 5.4% during the quarter, as net charge-offs totaling $22.3 billion — though 16% less than charge-offs a year earlier — still far outpaced loss provisions. It was the 10th straight quarter of lower reserves.

"We've seen a continuing trend in improving asset quality, in reductions in charge-offs and delinquent loans. That improvement in credit quality has allowed the institutions to reduce loan-loss reserves," he said. "But it gets to a point, though, where the reductions in reserves are not going to be able to continue to drive income. It also gets to the point at which we have concerns about the adequacy of reserves. … We share [Curry's] concern and it's a matter of ongoing attention for us."

Meanwhile, deposits continue to grow. Noninterest-bearing checking deposits fully insured by the Transaction Account Guarantee program remained popular in the third quarter, despite the scheduled yearend expiration of the temporary program. Over three-quarters of the $146 billion increase in domestic deposits during the quarter — to $9.06 trillion — was attributable to deposits receiving the extra coverage.

Gruenberg reiterated the FDIC's neutral stance in the legislative debate over whether to extend TAG. Yet he and other FDIC officials said banks have bolstered their balance sheets sufficiently since the program was created in 2008 to be able to withstand any deposit reductions that may result from the program's expiration.

"As a general matter, if Congress allows it to expire at the end of the year, we think institutions are in a position to manage that in an orderly way," Gruenberg said.

The FDIC reported continued progress in rebuilding the Deposit Insurance Fund. The fund's ratio of reserves to insured deposits increased by 3 basis points to 0.35%. Institutions on the agency's "Problem List" declined by 38 to a total of 694, and assets of problem institutions fell by 7% to $262.2 billion.