WASHINGTON - Higher interest rates and elevated litigation expenses at one large bank last quarter led to the industry's first year-over-year earnings decline in more than four years, the Federal Deposit Insurance Corp. said Tuesday.

Banks and thrifts earned a still-impressive $36 billion in the third quarter, but that was 3.9% below the industry's profit in the third quarter of 2012. It was the first year-over-year drop since the second quarter of 2009.

The FDIC, which released its Quarterly Banking Profile, said although institutions are still benefiting from improvements in credit quality, an increase in medium and long-term interest rates in the previous quarter caused lower values for certain fixed-income assets. The higher rates also reduced demand for mortgage refinancings, the agency said.

Overall, net operating revenue fell 3.6% from a year earlier to $163 billion. Noninterest expenses rose nearly 2% from the third quarter of 2012 to $106.5 billion, driven in significant part by a $4 billion year-over-year increase in litigation expense for one large institution. While the FDIC did not identify the bank, it is likely JPMorgan Chase, which has been entangled in a series of civil cases tied to its mortgage holdings. If not for the bank's litigation expenses, the industry's overall earnings would have been up from a year earlier.

Meanwhile, balances for all major loan categories, except residential mortgages, increased modestly compared to the second quarter of this year. Total loans rose by 0.9% to $7.8 trillion, the eighth increase in 10 quarters. Auto loans increased by 3.2%, credit card balances rose by 1% and loans to states and municipalities rose by 7.3%. But home equity lines of credit decreased by 2.1% and balances for other types of residential real estate loans fell by 0.7%. Major mortgage lenders saw their mortgage originations drop sharply, by 30%, compared with the second quarter.

FDIC Chairman Martin Gruenberg said the industry is still benefiting for an overall improvement in credit quality.

"Most of the positive trends we have been seeing in industry performance continued in the third quarter," he said. "Fewer institutions reported quarterly losses, lending grew at a modest pace, credit quality continued to improve, more banks came off the 'Problem List,'" and fewer banks failed."

Deposits grew by 2.3% - or $247.8 billion - from the previous quarter to $11 trillion. The biggest growth was in accounts with more than $250,000.

The FDIC said banks on the "Problem List" declined by 38 to a total of 515 institutions. The balance of the Deposit Insurance Fund grew by about $3 billion, to $40.7 billion. The ratio of insurance reserves to insured deposits grew by 4 basis points, to 0.68%.

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