On the surface the latest FDIC Quarterly Banking Profile reflects a recovering banking industry with robust profit growth. For the fourth quarter of 2013 banks collectively reported net income of $40.3 billion which is a $5.8 billion or 16.9% increase from the previous year’s fourth quarter.
Making the picture look even brighter is the fact that bank earnings have now increased on a year over year basis for the 17th time in the last 18 quarters.
A look at annual bank earnings since 2000 shows that after the disastrous years of 2008 and 2009, total net earnings of $154.7 billion for 2013 actually surpassed peak bank earnings of $145.2 billion recorded during 2006.
Below the surface, however, the robust earnings recovery since 2010 is less impressive after considering the source of increased banking industry profits. According to the FDIC the decline in loan loss provisions since 2011 “was the single largest component of the improvement in industry earnings.” For the latest quarter ending December 31, 2013, improved earnings were primarily attributable to a decline of $8.1 billion in loan-loss provisions.
The improvement in bank earnings from reduced loan-loss provisions can only go so far. In addition, any type of adverse macro economic shock that pushes borrowers into increased default rates would require banks to quickly start increasing loan-loss provisions which would immediately reduce profits. Although the banking industry has stabilized, increasing organic growth has been difficult. For the year ending December 31, 2013, the recent decline in mortgage lending due to rising rates along with reduced trading revenue resulted in a year-over-year decline in net operating revenue (total of net interest income and noninterest income). Many small banks are still unable to recover from the financial crisis and in the fourth quarter of 2013 12.2% of all banks lost money.
According to FDIC Chairman Martin J. Gruenberg, the banking industry has been making a slow and steady recovery but challenges from “narrow margins, modest loan growth, and a decline in mortgage refinancing activity have made it difficult for banks to increase revenue and profitability.”
On the positive side, banks have been able to increase their net interest margin during the 2013 fourth quarter. Due to interest rate suppression by the Federal Reserve depositors are actually receiving negative interest rates on their savings after inflation and accordingly the cost of funding for most banks has declined substantially. A steeply positive yield curve has allowed banks to borrow short at super low rates and lend long at higher rates. During the fourth quarter of 2013 net interest margins increased for all banks except those with total assets of over $100 billion. Large banks are currently holding large balance low yield reserve balances with the Federal Reserve which drags down their overall net interest margin.
The banking industry appears to be on the path to recovery but until loan growth starts to show sustained increases, future profit growth for banks is going to become more and more difficult to achieve.