As 4Q Credit Quality Improves, Revenue, Fee Income Stall

WASHINGTON — How you assess the banking industry's health from the Federal Deposit Insurance Corp.'s latest earnings report may depend on which page you turn to.

On the one hand, banks are making all the right moves: cleaning up loan portfolios, lending in sectors enjoying an economic rebound and seeing income steadily rise.

But on the other, the FDIC's fourth-quarter report shows an industry stuck in neutral. Declining loan balances, sluggish revenue growth and lower fee income cast doubt on banks' long-term earning potential.

FDIC Chairman Sheila Bair noted banks continue to feed earnings by draining loss reserves, a trend that began in mid-2010.

If banks "want to have long-term sustainable earnings, you can only rely on reduced loan-loss provisions for so long," she said at the release of the Quarterly Banking Profile.

Banks and thrifts posted earnings of $21.7 billion last quarter, a huge improvement from the $1.8 billion quarterly loss a year earlier. For all of 2010, earnings totaled $87.5 billion, the highest since 2007 and a reversal from a $10.6 billion loss in 2009.

Nearly two out of three institutions had higher quarterly income than a year earlier. For the full year, just 21% of institutions were unprofitable, compared with 30.6% in 2009. It was the first time in six years the percentage of unprofitable institutions fell.

The FDIC credited the smallest quarterly loss provision ($31.6 billion) in over three years for most of the earnings success. The amount set aside for losses was just a little more than half the provision a year earlier.

The FDIC noted that one large institution — thought to be Bank of America Corp.'s credit card subsidiary — restated earnings to reflect a higher writedown for goodwill expenses in 2009 than previously reported, and a lower writedown for 2010.

The restatement meant a negative adjustment for industry earnings in 2009 by about $20 billion and $10 billion of additional income in last year's third quarter.

Higher asset values also fed earnings. Gains on the sale of loans and other assets in the quarter increased more than threefold from a year earlier, to $4 billion. Nonperforming assets were lower for the third straight quarter while deposits grew 1.6%, to $9.4 trillion. The 24 new institutions on the agency's "Problem List" — bringing the total to 884 — was a smaller number than in the previous quarter, the fourth straight time that has happened. Assets held by problem banks jumped $11 billion, to $390 billion.

"Overall, 2010 was a turnaround year, with four straight quarters of positive earnings," Bair said. "While earnings in 2010 remain well below precrisis levels, the past year marked a significant milestone on the road to recovery."

But the positive factors were still not accompanied by net loan growth. Total loans decreased $13.6 billion, to $7.37 trillion, which was greater than the decrease in the third quarter. While some areas showed improvements — one-to-four-family mortgages rose 0.9%, to $1.9 trillion, and commercial and industrial loans rose 1%, to $1.19 trillion — real estate construction and development loans were largely responsible for the overall loan decline, falling more than 9% to $321 billion.

Bair said that, though the drops in loan balances continue to be slight, the numbers are still disappointing. "The rate of decrease is slowing. … So that is positive. And C&I loans are up. Residential mortgages were up," she said. "But it's not going at as fast a pace as I would like to see. Banks need to be focused on this."

Other FDIC officials who briefed reporters said that more robert asset growth could be just around the corner.

"The overall effect of the growing categories versus the declining categories is that we are seeing progressively smaller decreases in the overall loan portfolios in the industry, and we're very close to a point where we expect to see some growth in the overall," said Ross Waldrop, the agency's senior banking analyst.

Richard Brown, the FDIC's chief economist, said banks do not appear as ready to jump back into the real estate market as into other markets.

The deleveraging "in commercial loan portfolios and consumer credit appears to be abating and starting to turn around. Real estate is another matter," he said.

Declining loan balances are not the only indicator that the industry still faces obstacles.

Net operating revenue of $163.6 billion was just 1.7% higher than a year earlier, and 1.3% less than third-quarter revenue. The year-over-year revenue increase was the second smallest in the past two years.

Meanwhile, service charge income for deposit accounts — totaling $8.2 billion in the quarter — was 20.7% lower than a year earlier.

Bert Ely, an independent consultant based in Alexandria, Va., said banks' difficulty in expanding their balance sheets mirrors the broader economy's slump.

"What we have is an industry on the mend but in a sluggish recovery," he said. "The basic trends are good. … What is different is the slowing revenue growth and fee income declines. If you have a sluggish economy, you're going to have a sluggish recovery in banking."

Ely added that the heightened regulatory environment is also having an effect, as banks implement new restrictions — such as a recent FDIC regulation on overdraft fees — and brace for others imposed by the Dodd-Frank Act. Some institutions are already incorporating measures from the new law and are focused more on minimizing their costs than expanding into new products, he said. "You're already seeing banks starting to restructure their account fees and their product offerings," Ely said. "We're going to see some expense cutting, such as branch closures, as banks try to get the cost of running their retail business in line with the revenue being generated."

The industry continued to whittle its bad loans in the fourth quarter. Net chargeoffs in the quarter fell 23.7% from a year earlier, to $41.9 billion. Noncurrent loans, meanwhile, declined 4.7% from the third quarter, to $359 billion.

The FDIC said the ratio of insurance reserves to insured deposits rose 3 basis points, to negative-0.12%.