FDIC-Insured Banks: Q3 Earnings Strong, Revenues Improve

Federal Deposit Insurance Corporation (FDIC)-insured commercial banks and savings institutions reported third-quarter 2016 earnings of $45.6 billion, up 12.9% year over year. Notably, community banks, constituting 93% of all FDIC-insured institutions, reported net income of $5.6 billion, up 11.8% year over year.

Banks’ earnings were driven by higher revenues, partially offset by rise in loan-loss provisions. Moreover, improved trading revenue was another positive. However, expenses increased.

Banks with assets worth more than $10 billion contributed a major part of the earnings in the said quarter. Though such banks constitute only 1.8% of the total number of U.S. banks, these accounted for approximately 80% of the industry’s earnings. Leading names in the space include Wells Fargo & Co. (NYSE:WFC) , Bank of America (NYSE:BAC) Corporation (NYSE:C) , Citigroup Inc. (NYSE:C) and U.S. Bancorp (NYSE:USB) .

Among the abovementioned banks, Wells Fargo, Citigroup and U.S. Bancorp carry a Zacks Rank #3 (Hold), while BofA carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Revenues Escalate, Costs Up Slightly

Banks are persistently striving to reap profits and are consequently boosting productivity. Around 60.8% of all institutions insured by the FDIC reported improvement in their quarterly net income, while the remaining recorded a decline in comparison to the prior-year quarter. Moreover, the percentage of institutions reporting net losses for the quarter dropped to 4.6% from 5.2% in the last-year quarter. Notably, the percentage was the lowest since the third quarter of 1997.

The measure for profitability or average return on assets (ROA) increased to 1.10% from 1.03% in the prior-year quarter.

Net operating revenue was $183.3 billion, up 6.5% on a year-over-year basis. A rise in net interest income and elevated non-interest income were the driving factors.

Net interest income was recorded at $118.8 billion, up 9.2% year over year, driven by a rise in interest-bearing assets net interest margin (NIM). NIM increased to 3.10% from 3.02% in the prior-year quarter.

Non-interest income climbed 1.9% year over year to $64.5 billion for the banks. Notably, an increase in trading revenues and servicing income attributed to the rise.

Total non-interest expenses for the establishments were $106.7 billion in the quarter, up 1% on a year-over-year basis. Efficiency ratio improved to 57.5% in the third quarter, from 60.2% in the year-ago quarter, depicting the lowest level since second-quarter 2010.

Credit Quality Asset Quality Worsens

Overall, credit quality was a mixed bag in the reported quarter. Net charge-offs increased to $10.1 billion, up 16.9% year over year, reflecting the fourth yearly rise. Notably, all major loan groups recorded a year-over-year rise in charge-offs except residential and commercial real estate loans.

In the quarter under review, provisions for loan losses for the institutions came in at $11.4 billion, up 34% year over year. The level of non-current loans and leases decreased 1.8% year over year to $134 billion, reflecting the 25th decline in non-current loan balances in the last 26 quarters. The non-current rate was 1.45%.

Strong Loan & Deposit Growth

The capital position of the banks was strong. Total deposits continued to rise and were recorded at $12.8 trillion, up 6.7% year over year. Further, total loans and leases were $9.2 trillion, up 7% year over year.

As of Sep 30, 2016, the Deposit Insurance Fund (DIF) balance increased to $80.7 billion from $70.1 billion as of Sep 30, 2015. Moreover, interest earned on investment securities and assessment income primarily led to the growth in fund balance.

Less Bank Failures, Shrinking Problem Institutions

During the third quarter of 2016, two insured institutions failed. As of Sep 30, 2016, the number of "problem" banks declined from 147 to 132, reflecting the lowest number in approximately more than 7 years and significantly decreased from 888 recorded in first-quarter 2011. Total assets of the "problem" institutions also fell to $24.9 billion from $51.1 billion.

Our Viewpoint

The decline in the number of problem institutions was encouraging with the quarter witnessing top-line growth with higher NIM. However, asset quality remained challenging. Further, low oil prices on energy companies resulted in escalating losses on commercial and industrial loans for banks.

Banks have been gradually easing their lending standards and trending toward higher fees to counter the pressure on the top line. Then again, continued expense control and stable balance sheets should act as tailwinds in the upcoming quarters.

With lingering uncertainty in the economy, we do not see this issue-ridden sector returning to its pre-recession levels anytime soon. What encourages us though is that the U.S. banks are getting accustomed to increased legal and regulatory pressure and hence resorting to safer alternatives for higher earnings. This indicates their ability to better encounter challenges and grow at a moderate pace.

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