What Changed in 3Q to Make Bank Profits Soar

WASHINGTON — For years since the crisis the sharp drop in loan-loss provisions had been a profit center. But banks found other ways to make money last quarter.

With loss provisions rising for the first time in five years, a sudden return of revenue picked up the slack, the Federal Deposit Insurance Corp. said in its third-quarter update on industry health. Net operating revenue — helped significantly by higher loan sale gains — rose 4.8% from a year earlier, the first such increase in nearly five years.

"Most importantly, third quarter income growth was based on revenue growth instead of lower loan-loss provisions. This can be a more sustainable foundation for continued earnings growth going forward," FDIC Chairman Martin Gruenberg said at the release of the Quarterly Banking Profile.

The total net operating revenue of $171.3 billion helped boost total net income to $38.7 billion, a 7.3% increase from the third quarter of last year, but down slightly from the $40.1 billion earned in the second quarter. Overall, nearly 63% of institutions reported year-over-year income improvement. Noninterest income rose 9.2% to $64 billion, compared to a 2.3% increase in net interest income to $107 billion.

The report confirmed recent warnings that banks would eventually need to find earnings boosters other than a drop in provisions. Since 2009, the industry could repeatedly rely on the fact that smaller amounts set aside each quarter to cover losses had a positive effect on income. But experts predicted that would only last so long.

Indeed, provisions in the third quarter finally increased from a year earlier — by nearly 24% to $7.2 billion — the first such increase since 2009, holding down earnings. But gains on loan sales jumped 45%, trading income rose by 25% and 71% of institutions reported higher net interest income.

"Not relying on reductions in loan-loss provisions is a positive indicator," Gruenberg said.

James Chessen, the American Bankers Association's chief economist, agreed that the shift in income drivers was a welcome sign.

"It is terrific that revenue is finally driving the growth," he told reporters after the FDIC presented the report. "We have run out of recapturing the loan-loss provisions to boost revenue, so it is a sign that the economy is picking up."

Total industry assets grew by 1.2%, compared with the second quarter, to $15.3 trillion. The increase was largely due to a 1.7% increase in investment securities.

Loans grew by 0.6% to $8.16 trillion. While that was off the pace of the previous quarter's loan growth of 2.3%, the FDIC said loans still grew in most major categories. Commercial and industrial loans rose by 0.6% to $1.67 trillion, auto loans rose by 2.4% to $379 billion, and real estate construction and development loans rose by 3.3% to $231 billion. However, mortgage balances declined by 0.4% to $1.84 trillion as mortgages sold exceeded new originations.

Community bank loan growth was particularly impressive in the third quarter and is outpacing the industry as a whole. Over the past twelve months, community bank loan balances have increased 8% compared to 4.6% in loan growth for the entire industry.

Community banks "know their customers well and are well positioned to respond to growing loan demand, and in some sense in a more effective way than large institutions," Gruenberg said.

Still, loan demand remains modest compared with historical norms and loan spreads are still tight. The industry's average net interest margin of 3.14% was 12 basis points below the margin a year earlier and mostly unchanged from the second quarter margin of 3.15%.

"The current operating environment remains challenging for banks," Gruenberg said, adding that "low interest rates have put downward pressure on net interest margins, especially for large banks."

Chessen said institutions are still exploring new income drivers as lending activity remains limited.

"There is tremendous focus on new forms of earnings for the banks because you have to look at ways to replace some of the income you just haven't seen in the loan volume," Chessen said.

Noninterest expenses increased 1.9% from a year earlier to $108 billion, driven in part by a 4.3% increase in salaries and employee benefits. However, the industry had 1.5% fewer employees than it did in the third quarter of 2013.

Banks continue to look for safe assets. The FDIC noted that banks increased their investment in Treasury securities by 26.3%, or $72 billion, in the quarter.

"We have seen a real strong consistent growth in low risk, high liquidity assets, so I suppose in a sense it is consistent with that," Ross Waldrop, the agency's senior banking analyst, said at a staff briefing.

Net charge-offs totaled $9.2 billion, which was 21% lower than a year earlier. It was the 17^th straight quarter of a year-over-year decline in charge-offs.

Total deposits increased by 0.9% during the quarter to $11.6 trillion; domestic deposits rose by 1.1% to $10.17 trillion. The FDIC said large-denomination deposits above the agency's $250,000 insurance limit, which increased by 2.5%, were responsible for much of the deposit growth for the second straight quarter.

The FDIC said the number of institutions on the "Problem List" fell by 25 to a total of 329 and that the agency's ratio of deposit insurance reserves to insured deposits rose by 5 basis points to 0.89%.