The Banking Industry Is Strengthening

 | Aug 06, 2014 | 5:00 PM EDT
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U.S. banks have filed their second-quarter Consolidated Reports of Condition and Income (call reports) with their relevant regulators. I will provide a brief review of the banking industry today. Tomorrow I will focus on the money centers: JPMorgan Chase (JPM), Citigroup (C), Bank of America (BAC) and Wells Fargo (WFC).

The first-quarter review is here.

Consolidation in the banking industry is continuing. The number of certified institutions in the U.S. declined by 72, to 6,657 in the second quarter, from 6,729 in the first quarter. This trend has been in force for many years, and all indications are that it will continue; the number is expected to decline by as much as 50% over the next decade. The majority of this consolidation will be accomplished by way of mergers and acquisitions. Tim Melvin has been writing about this for a long time, and he did so again last week.

This is an excellent investment opportunity, and I would encourage those who are interested to reach out to Tim about it.

The consolidation is also resulting in increased efficiencies, allowing for fewer employees, even as bank assets continue to rise. Although there were only about 1,000 fewer bank employees in the second quarter than in the first quarter, there has been a reduction of about 30,000 in the past year and a reduction of about 50,000 since the peak of 2,110,000 in the fourth quarter of 2012.

Even as the number of banks and bank employees continues to decline, the amount of assets has grown, breaching the $15 trillion dollar mark in the second quarter, about 2% higher than in the first quarter.

The total number of loans outstanding increased to about $8.1 trillion in the second quarter, from $7.9 trillion in the first quarter. with the increase being much broader based across almost all loan categories, both retail consumer and commercial.

The biggest gain was again in commercial and industrial loans (C&I), which increased by about $50 billion to $1.66 trillion in the second quarter, from $1.61 trillion in the first quarter. But there were also increases in mortgages, auto loans and credit card balances on the retail side, and in commercial real estate and construction and development on the commercial side.

The number of nonperforming residential mortgages declined by about $8 billion, to $113 billion in the second quarter, from $121 billion in the first quarter. As a percentage of mortgage loans outstanding, the decline was to about 6.5%, from 7%. Although this is good news, at the trend rate of resolution, the legacy balance-sheet issues from the last housing bubble and crash will take another decade to be completed.

Although there have been media reports recently about an increase in auto loan defaults, it is not evident in the banks. The value of bank-held auto loans increased by about 3% in the second quarter, to $370 billion, from $359 billion in the first quarter, while the default rate remained at about 0.25%, which is about where it has been for the past three years.

The expected increase in auto loan defaults as subprime loans were brought back to the space about three years ago has not materialized. This may help support the case for loosening restrictions on residential mortgage underwriting in the near future.

Further bolstering the case for easing lending restrictions on mortgages is the accelerating rate of growth in construction and development (C&D) loans concurrent, with a substantial reduction in nonperforming loans in the space. 

C&D loans have been increasing each quarter since bottoming in the first quarter of 2013 and jumped by $9 billion in the second quarter to $223 billion, from $214 billion in the first quarter, while the percentage of nonperforming loans in the space declined in both dollar and percentage terms; it is now at about 2.75% of all C&D loans. To put that in perspective, about 15% of all C&D loans were in default three years ago.

Lastly, the recovery rate on nonperforming residential mortgages has surged to the highest level in 10 years and is now at about 55%. That's almost twice what it was in the first quarter alone. Three years ago, it was only 6%, and at the height of the financial crisis in the fourth quarter of 2008, it was 0%. The recovery rate is the net return received by the bank as a percentage of the balance outstanding on a mortgage when it went into default. In general, the balance is charged off and absorbed by loan-loss provisions. The bank then incurs expenses to resolve the issue by way of foreclosure and resale of the collateral or some other resolution.

Net operating income, net income, net interest margin and non-interest income all rebounded strongly, after a reduction in the first quarter from the fourth quarter of 2013.

All told, the second-quarter call reports indicate a banking industry that is strengthening with the legacy issues from the 2008 financial crisis mostly resolved. The remaining issues are largely concentrated in the money centers, which I will discuss tomorrow.



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