FDIC-Insured Banks' Q4 Earnings Slump on High Legal Costs - Analyst Blog

Federal Deposit Insurance Corporation (FDIC)-insured commercial banks and savings institutions reported fourth-quarter 2014 earnings of $36.9 billion, lagging the year-ago earnings of $39.8 billion by 7.3%. Notably, community banks constituting 93% of all FDIC-insured institutions, reported net income of $4.8 billion, up 27.7% year over year.

The decline in overall earnings resulted from a $4.4 billion rise in litigation expenses at a few mega banks including Citigroup Inc. (C), JPMorgan Chase & Co. (JPM) and Bank of America Corp. (BAC). Moreover, persistent decline in mortgage-related income was a downside.

Overall, during the fourth quarter, the banking industry witnessed a gradual improvement. The number of troubled assets and institutions dipped significantly, which is encouraging.

Further, organic growth aided by higher revenues, improved loan and deposit balances was recorded. However, a rise in non-interest expenses and pressure on margins was experienced.

Banks with assets worth more than $10 billion contributed a major part of the earnings in the said quarter. Though such banks constitute merely 1.6% of the total number of U.S. banks, these accounted for approximately 80% of industry earnings. Such major banks include Wells Fargo & Co. (WFC) and U.S. Bancorp (USB).

For 2014, earnings were $152.7 billion, down 1.1% year over year.

Performance in Detail

Banks are persistently striving to reap profits and are consequently bolstering their productivity. Around 61.2% of all institutions insured by the FDIC reported improvement in their quarterly net income, while the remaining recorded a decline in comparison to the prior-year quarter. Moreover, the percentage of institutions reporting net losses for the quarter slumped to 9.4% from 12.7% in the last-year quarter.

The measure for profitability or average return on assets (ROA) fell to 0.96% from 1.09% in the prior-year quarter. The average return on equity (ROE) decreased to 8.56% from 9.76% a year ago.

Net operating revenue was $167.2 billion, up about 0.6% year over year, due to a rise in net interest income, partially offset by lower non-interest income.

Net interest income was recorded at $107.5 billion, up 1% year over year. The average net interest margin declined to 3.12%, from 3.27% in the prior-year quarter, depicting the lowest quarterly margin for the industry since the third quarter of 1989.

Non-interest income inched down 0.3% year over year to $59.7 billion for the banks. Notably, revenue from the sale, securitization and servicing of residential mortgage loans dropped. Yet, around 54.4% of all banks reported rise in non-interest income as compared with the prior-year quarter.

Total non-interest expenses for the establishments were $107.6 billion in the quarter, up 4.8% on a year-over-year basis. Higher litigation expenses mainly aided the rise.

Credit Quality

Overall, credit quality was a mixed bag in the reported quarter. Net charge-offs fell to $9.9 billion from $12.1 billion in the fourth quarter of 2013. Notably, all major loan groups recorded a year-over-year decline in charge-offs.

In the quarter, provisions for loan losses for the institutions came in at $8.2 billion, up 12% year over year. The reported figure represents year-over-year increase in provisions for the consecutive quarter in the last five years.

The level of non-current loans and leases (those 90 days or more past due or in non-accrual status) declined 21.5% year over year to $162.7 billion. Moreover, the percentage of non-current loans and leases fell to 1.96%, which was below 2% for the first time, since the first quarter of 2008.

Balance Sheet

The capital position of the banks was strong. Total deposits continued to rise and were recorded at $11.8 trillion, up 5.4% year over year. Further, total loans and leases came in at $8.3 trillion, up 5.1% year over year.

As of Dec 31, 2014, the Deposit Insurance Fund (DIF) balance increased to $62.8 billion from $47.2 billion as of Dec 31, 2013. Moreover, interest earned on investment securities primarily led to the growth in fund balance.

Bank Failures and Problem Institutions

During the fourth quarter of 2014, two insured institutions failed. In 2014, eighteen insured institutions failed as compared with twenty-four in 2013. As of Dec 31, 2014, the number of "problem" banks declined from 329 to 291, reflecting the 15th consecutive quarter of decrease. Total assets of the "problem" institutions also fell to $87 billion from $102 billion.

Our Viewpoint

Though decline in the number of problem institutions is encouraging, the quarter remained challenging with soft trading volumes, sluggish mortgage banking activities and legal costs. Moreover, uncertainty regarding top-line growth persists as pressure on net interest margins from a nagging low rate environment prevails.

However, banks have been gradually easing their lending standards and trending toward higher fees to dodge the pressure on the top line. Then again, continued expense control and stable balance sheets should act as tailwinds in the upcoming quarters. Further, an encouraging equity and asset market backdrop, along with favorable macroeconomic factors – such as falling unemployment rate, a progressive housing sector and flexible monetary policy – should pave the way for stability.

With lingering uncertainty in the economy, we do not see this issue-ridden sector returning to its pre-recession peak anytime soon. What encourages us though is that the U.S. banks are getting accustomed to increased legal and regulatory pressure and hence resorting to safer alternatives for higher earnings. This indicates their ability to better encounter challenges and grow at a moderate pace.

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