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FDIC-Insured Banks' Q3 Earnings Disappoint, Costs Escalate

Priti Dhanuka

The Federal Deposit Insurance Corporation (“FDIC”)-insured commercial banks and savings institutions reported third-quarter 2019 earnings of $57.4 billion, down 7.3% year over year. Notably, community banks, constituting 92% of all FDIC-insured institutions, reported net income of $6.9 billion, up 7.2%.

Banks’ earnings were impacted by elevated provisions and high expenses, along with fall in net interest margin. However, higher revenues were a positive. Further, rise in loans and deposits were tailwinds. Moreover, decline in the number of ‘problem banks’ was a tailwind.

Banks, with assets worth more than $10 billion, accounted for a major part of earnings in the third quarter. Though such banks constitute only 1.8% of the total number of domestic banks, these accounted for approximately 80% of the industry’s earnings. Leading names in this space include JPMorgan JPM, Bank of America BAC, Citigroup C and KeyCorp KEY.

All the above-mentioned banks carry a Zacks Rank #3 (Hold), at present. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Net Operating Revenues Improve, Costs Flare Up

Banks have been striving to boost productivity and generate higher profits. Around 62% of all FDIC-insured institutions reported improvement in quarterly net income, while the remaining witnessed a decline from the prior-year quarter level. Additionally, the percentage of institutions reporting net losses in the quarter went up above 4%.

As of Sep 30, 2019, the measure for profitability or average return on assets edged down to 1.25% from the 1.41% recorded as of Sep 30, 2018.

Net operating revenues came in at $208.3 billion, up 2.3% year over year. A rise in net interest as well as non-interest income was the driving factor.

Net interest income was $138.8 billion, up 1.2% year over year. Notably, around 70.9% of banks witnessed rise in net interest income. Net interest margin (NIM) edged down to 3.35% from the 3.45% recorded in the year-earlier quarter. Higher funding costs, partly offset by yield on earnings assets, resulted in this decline.

Non-interest income for banks increased 4.3% year over year to $69.5 billion. This upside resulted from higher other non-interest income and net gains on loan sales.

Total non-interest expenses for the establishments were $120.1 billion in the July-September quarter, up 5.7% on a year-over-year basis due to rise in salary and employee-benefit expenses, goodwill impairment charges and other non-interest expense.

Credit Quality: A Mixed Bag

Overall, credit quality was a mixed bag in the reported quarter. Net charge-offs increased to $13.1 billion, up 17.2% year over year. Notably, higher credit card, together with commercial and industrial charge-offs, aided this upside.

In the September-end quarter, provisions for loan losses for the institutions were $13.9 billion, up 16.9% year over year. The level of non-current loans and leases declined 5.6% to $95.5 billion. The non-current rate was 0.92%.

Strong Loan & Deposit Growth

Capital position of banks remained solid. Total deposits continued to rise and were $14.3 trillion, up 5.2% year over year. Additionally, total loans and leases were $10.4 trillion, jumping 4.6%.

As of Sep 30, 2019, the Deposit Insurance Fund balance increased to $108.9 billion from $100.2 billion as of Sep 30, 2018. Furthermore, interest earned on investment securities primarily supported growth in fund balance, partly muted by lower assessment income.

Low Bank Failures, Shrinking ‘Problem’ Institutions, New Charters Added

During the July-September period, none of the banks failed, four new charters were added, while 46 were merged. As of Sep 30, 2019, the number of ‘problem’ banks declined from 56 to 55. This signifies the lowest number reported since first-quarter 2007. Total assets of the ‘problem’ institutions increased to $48.8 billion from the $48.5 billion reported in the previous quarter.

Our Viewpoint

Fall in the number of ‘problem’ institutions looks encouraging, with the third quarter registering top-line growth on higher net interest as well as non-interest income. Banks have been gradually easing their lending standards and trending toward higher fees to counter pressure on the top line.

Though the recent interest-rate cut and inversion of the yield curve might impact lending scenario, banks need to maintain their underwriting standards, along with cautious risk management, to sail through the existing economic cycle. However, rise in expenses was on the downside which needs to be controlled to keep the profits up.

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