The banking industry turned in a stellar performance in the third quarter, and initial signs suggest that the fourth quarter could be just as good.
The third-quarter results deserve high marks by almost every measure. Data from 128 banks tracked by Keefe, Bruyette & Woods Inc. show that:
* For the first time since the 1988, return on assets surpassed 1%, the industry's traditional benchmark for good performance.
* Banks were able to sustain historically high profit margins.
* Problem assets dropped to the lowest level in almost two years.
* Stronger earnings and large stock issues provided banks with the strongest balance sheets in years.
What's more, all of that was accomplished amid a weak economic recovery that has left other industries staggering.
"Third-quarter earnings were superb," says Dennis Shea, an analyst at Morgan Stanley & Co. "What it showed was a continued momentum in the recovery from the serious problems of the recent recession."
And - unless there's a sudden increase in interest rates - analysts see no reason why the strong performance won't continue.
Loss Reserves Boosted
In fact, some banks could have posted even bigger profits in the quarter but chose instead to build up loan-loss reserves, even while nonperforming assets were dipping.
"The industry is trying to repair balance sheets as a top priority," says Thomas Brown, an analyst with Donaldson, Lufkin & Jenrette Securities Corp. "Earnings come second."
Banks that used this strategy, Mr. Brown says, could be paving the way for a big earnings jump this quarter or early next year, when much less would have to be set aside for loan losses and when a long-awaited increase in loan demand might offset any squeezing of net interest margins.
Some banks that may be in for a big bounce: Norwest Corp., First Interstate Bancorp, and Bank of Boston Corp.
Norwest, for example, took $ 55 million in writedowns on intangibles and the value of branches. Richard Kovacevich, the company's president, defended the move as prudent, but some analysts think the writedowns were unnecessary. Without them, Norwest's earnings would have - been nearly 10% higher - a benefit that would show up down the road if the analysts are right.
When the Federal Deposit Insurance Corp. finishes adding up the numbers, the industry's earnings will probably break last quarter's record $7.9 billion. Profits at about 60% of the top 140 banks exceeded the consensus projections.
The fatter profits didn't come from banks adding more high-yield loans to their books. The lack of new loans, in fact, was the only negative in the third quarter, analysts say.
Help from Wide Margins
What fueled the gain was high net interest margins, which on average remained unchanged from the 4.67% reported last quarter, according to Keefe.
Fewer profits came from the sale of bonds in investment portfolios than a year ago, but such revenues stir contributed sizably to earnings.
"Are the good profitability trends of last quarter based on securities gains?" asks David S. Berry, an analyst with Keefe. "Yes, but not as much as a year ago."
Mr. Berry expects banks to continue to rely less on securities gains to prop up profits in the future.
One of the industry's most encouraging trends was the fall in nonperforming assets. Three of four big banks reported lower levels than in the previous quarter.
Shawmut National Corp. in Hartford, Conn., led the way by reducing nonperforming assets a whopping 17%, the biggest drop among major banks.
Overall, Keefe says nonperforming assets account for 2.73% of assets, down from 3.06% last quarter and the high water mark of 3.14% in the first quarter.
Even so, banks took the opportunity to increase provisions, boosting their coverage of loans.
Equity-to-assets levels continued their dramatic climb because of retained earnings and a round of stock issuance. The average ratio stood at 7.36% on Sept. 30 at the 128 banks followed by Keefe, up from 7.13% on June 30 and 6.64% two years earlier.
ROA Edges Above 1%
The Keefe study found that the median return on assets reached 1.05%, up from 0.98% in the third quarter. Return on equity rose five basis points, to 14.01%.
Analysts believe banks can sustain the high level of ROA. But ROE is problematic. Banks have continued to boost their equity without making loans. But lacking the big spreads that loans can provide, banks risk reducing their return and possible hurting their share price. Analysts believe some banks are overcapitalized
That's one reason nine major banks either boosted or restored common-stock dividends recently.
Bankers, however, caution that the industry has not fully recovered from the body blows inflicted by bad loans. Many banks, they say, have to raise more equity.
"If you add up the risk profile of the industry and look at the challenges it still has from an asset-quality standpoint, I think the industry needs even more capital," says Mr. Kovacevich of Norwest.ProfitabilityBy CategoryThird-quarter return on assets Money-center banks 0.77% Eastern regionals 0.85% Western regionals 1.02% Southern regionals 1.11% Midwestern regionals 1.17%The regional banks measured all haveassets exceeding $2 billion.Source: Keefe, Bruyette & Woods Inc.