WASHINGTON — Despite widespread optimism about the broader economy, a regulatory report out Thursday showed that the banking industry remains deep in crisis.
In the second quarter the industry lost $3.7 billion, credit quality dropped to all-time lows, the troubled-bank list reached a 15-year high and federal reserves backing deposits fell to their lowest level since the savings and loan crisis.
"For now, the difficult and necessary process of recognizing loan losses and cleaning up balance sheets continues to be reflected in the industry's bottom line," Federal Deposit Insurance Corp. Chairman Sheila Bair said Thursday at the release of the agency's Quarterly Banking Profile.
After a first-quarter profit tied in large part to the government's bailout of the banking sector, the industry's net quarterly loss was only its second since 1990.
The FDIC cited a 33% rise in loss provisions from the year-ago quarter — to $67 billion — and huge writedowns on asset-backed commercial paper as main drivers for the decline.
But perhaps more troubling were alarming signs of credit-quality deterioration. The net chargeoff rate last quarter of 2.55% was the highest ever, exceeding the fourth-quarter record of 1.95%.
Bair said credit problems are now hitting a broader class of loans than just mortgages.
"While the early losses were related to residential loans and complex mortgage-related assets — where the crisis really began — we're now seeing problems with more conventional types of retail and commercial loans that have been hit hard by the recession," she said.
In a year that has already seen 81 failures — more than three times the level for all of 2008 — the report made it clear more are on their way. The agency's problem-bank list rose 36%, to 416, while assets held by those banks jumped by roughly a third, to $300 billion.
"We expect the numbers of problem banks and failures will remain elevated, even as the economy begins to recover," Bair said.
The Deposit Insurance Fund also continued to decline — confirming expectations that the FDIC will have to charge another special assessment this year. The agency set aside $11.6 billion for expected future failures — 76% more than the first quarter provision — as reserves in the DIF fell to just $10.4 billion. At the end of the second quarter the DIF held 22 cents for every $100 in insured deposits, a 5-basis-point drop from the first quarter and far below the statutory minimum of 1.15%.
The conventional wisdom is that the FDIC will now have to charge another special assessment this year — and may even charge two. Under a rule finalized in May, the FDIC may charge an assessment of up to 5 basis points of a bank's assets minus its Tier 1 capital in a single quarter. Some observers are speculating the agency will charge a special assessment in both the third and fourth quarters.
During the press conference, Bair reiterated that another special assessment was likely, but said the agency would have to meet to discuss the issue soon.
Agency officials tried to cast the report in a positive light, noting how the general economy has found its legs and suggesting the industry's problems may be near their peak.
"The banking industry, too, can look forward to better times ahead," Bair said.
But as loans continued to go into delinquency — noncurrent loans rose 14% in the quarter, to $332 billion — bad credit made up an unprecedented share of the industry's portfolio. The average noncurrent loan rate of 4.35% — a 60-basis-point jump from the previous quarter — was the highest rate in the 26 years that such data has been reported.
"Rising credit costs continue to adversely impact bank performance," said John Corston, a deputy director in the agency's division of supervision and consumer protection. "Deteriorating asset quality and its ultimate impact on earnings and capital levels remains the most significant supervisory concern."
Despite the industry's aggressive provisioning, noncurrent loans still grew faster than reserves. Reserves-to-total loans rose 26 basis points during the quarter to 2.77%, a new record. But the ratio of reserves to noncurrent loans fell to 63.5% from 66.8%, the lowest point since the third quarter of 1991.
The negative earnings picture was also attributable to huge one-time losses — mostly in asset-backed commercial paper — of $3.6 billion. (These "extraordinary losses" rose 890% from a year earlier.) The agency also cited its own deposit insurance assessments as a drain on the industry's income.
Overall, earnings for nearly two out of every three institutions were lower than a year earlier, and more than a quarter of the industry lost money over the three-month period that ended June 30. The average return on assets was negative 0.11% in the second quarter, compared with 0.14% a year earlier.
The industry's total assets fell 1.8%, to $13.3 trillion. Over half of the decline was a result of a drop-off in total loans, which dipped 1.4%, to $7.6 trillion.
Bair did note some areas of improvement.
Despite the growth of noncurrent loans, which are 90 days or more past due, loans 30 to 89 days past due declined by $16.7 billion, to $141 billion, the largest such drop ever reported. Delinquencies also declined for some loan classes. For example, noncurrent home equity loans fell by 13%, to $11.5 billion — the first decline in three years.
The growth in noncurrent loans was led by delinquencies of mortgages (up 12.7%, to $137 billion), construction and development loans (up 16.6%, to $72 billion), and loans secured by real estate other than homes and farms (up 29%, to $31 billion).
On the plus side for banks, the industry's noninterest income rose 10.6% from a quarter earlier, to $67 billion, while net interest income jumped 3.5%, to $100 billion.
Most institutions also enjoyed higher net interest margins compared with the previous quarter, though the year-over-year improvement was concentrated in larger institutions. The average margin rose 9 basis points during the quarter, to 3.48%.
Bair and other officials emphasized that banking often lags the broader economy, and the cycle may begin to turn for the industry within months. "Are these signs of a turning point in asset quality? This may turn out to be the case," Bair said. "But we're going to need another quarter or two to confirm a trend."
Ross Waldrop, the agency's senior banking analyst, said that, despite the earnings drag through the crisis, the industry's revenues have shown resilience. "This resilience is important because it underlines the industry's ability to generate cash flow even in a severe recession," Waldrop said. As "the loss provisions eventually begin to subside, a larger share of these revenues will make it to the industry's bottom line as profits."
Officials said the industry could see further losses down the road tied to problems stemming from commercial real estate. Even though the sector has already been hit hard by the recession, it may take time before the impact on institutions' balance sheets hits its peak, they said.
"There's distress there that we're going to see in the next couple of quarters," said Richard Brown, the FDIC's chief economist.
The report also said institutions lowered their reliance on nondeposit funding as total deposits increased 0.7%, to $9 trillion. Large-denomination transaction accounts, which can be guaranteed by the FDIC under a voluntary program begun last year, rose 4.9%, to $900 billion.