Big Banks Boost Industry Profit - Analyst Blog

Following the dreadful phase of the economic downturn, the banking industry’s profits soared during the first quarter of 2010. However, this was primarily led by the big banks, while small banks remained strained due to deteriorating credit conditions.

According to the quarterly banking industry report released by the Federal Deposit Insurance Corp. (FDIC) on Thursday, the industry made an $18 billion profit, a record since the financial crisis in 2008.

This improvement in the industry data reflects near-zero interest rates and lower reserves for losses. As a result, more than half of the industry participants reported improvements over the prior-year period.

Though the profit for the reported remained historically weak, it jumped from $5.6 billion in the year-ago period.

The biggest banks (with at least $10 billion of assets) have earned nearly 79% of the industry’s total first-quarter profit. These banks together earned $14.2 billion during the reported quarter, almost double compared with the year-ago period. However, profit for small banks (with less than $1 billion in assets) increased only 16%.

The big banks include JPMorgan Chase & Co. (JPM), Wells Fargo (WFC), Goldman Sachs (GS), Morgan Stanley (MS), Bank of America (BAC) and Citigroup (C).

Big banks enjoyed significantly lower funding cost compared to two years ago. According to FDIC, funding cost was at its lowest since 1984.

Now the question to ponder is whether this impressive industry data can be viewed as a significant step up for the industry. Probably, the answer would be ‘No’. The banking industry as a whole is not yet out of the woods as tumbling home prices, soaring loan defaults and a high unemployment rate continue to take their toll on small banks.

In the first quarter, the number of banks on the FDIC’s list of problem institutions grew to 775, from 702 in the prior quarter and 305 in the year-ago quarter. This is the highest since the savings and loan crisis in the early 1990’s.

There have been 72 bank failures already this year, compared to 140 in 2009, 25 in 2008 and 3 in 2007. Increasing loan losses on commercial real estate are expected to cause hundreds more bank failures in the next few years. The FDIC anticipates bank failures to cost about $100 billion over the next three years.

Failure of both residential and commercial real estate loans as a result of the credit crisis has primarily hurt banks. As the industry tolerates bad loans made during the credit explosion, the trouble in the banking system goes even deeper, increasing the possibility of more bank failures.

The FDIC has set aside about $3 billion in additional provisions during the reported quarter for expected bank failures.

The major acquirers of failed institutions since 2008 include JPMorgan Chase, Fifth Third Bancorp (FITB), U.S. Bancorp (USB), Zions Bancorp (ZION), SunTrust Banks (STI), PNC Financial (PNC), BB&T Corporation (BBT) and Regions Financial (RF).

We think the Treasury’s instruction to banking institutions to focus on higher-quality capital will help banks absorb losses. Though this would somewhat limit the profitability of banks, a proper implementation would bring stability to the overall sector and hopefully address bank failures.

The improved profit for the industry was primarily driven by a diminution in reserves that banks hold for anticipated loan losses. However, the majority of the diminution was confined to the largest banks.

In conclusion, further growth in profitability is very much desirable considering the current state of the economy. However, the government should set policies to help all the industry participants contribute to the overall profitability. Otherwise, we will see only a few large banks survive, exposing the industry to oligopolistic conditions, which are not desirable.

Big Banks Boost Industry Profit – Analyst Blog

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