Bank Earnings Rise, but Not Real Estate Lending

TheStreet.com

NEW YORK (TheStreet) -- The Federal Deposit Insurance Corporation reported that the banking system earned $42.2 billion in the second quarter of 2013, up 22.6% from the second quarter of 2012. The drivers of this improved profitability continue to be noninterest income and reduced loan loss provisions, not increased lending.

This morning I read a post on Seeking Alpha that indicated that the larger regional banks including Bank of America , JP Morgan and Wells Fargo have been experiencing reduced demand for mortgages due to rising interest rates. Bank of America announced plans to cut about 2,000 jobs from its mortgage origination business. JP Morgan expects to lose money on its mortgage operations in the second half of 2013. Wells Fargo expects its mortgage originations to decline by nearly 30% in the second half of the year. This slippage was already noticeable in the FDIC QBP for the second quarter of 2013.

Source: Courtesy of FDIC

For the third quarter in a row net interest income posted a year-over-year decline. The decline for the second quarter was $1.8 billion as interest income from loans and other investments. This implies that the banking system remains reluctant to lend as long as troubled assets remain on the books of many banks.

A Review of the Sequential Mix of Real Estate Assets first quarter 2003 vs. second quarter 2013:

Total Assets On Monday I wrote, JP Morgan Upgraded As Banking System Heals and indicated that JP Morgan reduced assets by $47.5 billion in the second quarter, which pulled total assets in the banking system down $14.8 billion sequentially.

Residential Mortgages declined by $22.1 billion in the second quarter which is a sign that mortgage credit guidelines remain too tight, and that demand for mortgages have declined as rates rise.

Nonfarm Nonresidential Real Estate Loans rose by $11.1 billion in the in the second quarter which is a sign that banks feel saver lending to builders of office buildings, strip malls, condos and apartments, rather than single-family homes.

Construction & Development Loans rose by $897 million in the in the second quarter which is a sign that banks are beginning to be less stingy to community developers and homebuilders. However C&D loans are still likely to include the majority of noncurrent loans.

Home Equity Loans declined by $9.8 billion in the second quarter despite the continued rise in home values. In my judgment this asset category continues to house noncurrent loans.

Total Real Estate Loans declined by $19.95 billion in the second quarter as write-offs exceed new lending.

Insured Deposits declined by $61 billion in the second quarter as bank CD rates did not rise along with Treasury yields. Many of the 24 banks in the KBW Banking Index are posting five-year CDs at rates at 0.30% to 1.00% despite the fact that the yield on the 5-Year Treasury note rose from 0.625% on May 3 to 1.865% on Sept. 6.

Higher Treasury yields led to a mark-to-market decline in the value of securities portfolios among our nation's banks. These unrealized losses totaled $51.1 billion in the second quarter in holdings categorized as 'available-for-sale' securities. This mark-to-market does not affect current earnings, but they will impact future earnings if securities are sold at a loss.

Notional Amount of Derivatives rose by $3.85 trillion in the second quarter, which is a concern. With total derivatives at $236.5 trillion banks are increasing leverage when they should be decreasing these exposures.

Reserves for Losses declined by $6.4 billion in the second quarter and down 15.6% year over year.

Noncurrent Loans declined by $21.7 billion in the second quarter and down 18.3% year over year.

Other Real Estate Owned declined by $3.28 billion in the second quarter and down 21.9%% year over year.

While this continues to show a more healthy banking system, it's a question of whether the glass is half full or half empty. Let's look at the Q2 2013 statistics vs. the statistics in Q4 2007.

Number of Banks The number of FDIC-insured financial institutions declined by 1594 since the end of 2007 to 6,940 at the end of Q2 2013. That's a decline of 18.7%.

Total Assets Despite the Great Credit Crunch total assets in the banking system increased by $1.37 trillion since the end of 2007, up 10.5% to $14.41 trillion.

Residential Mortgages declined by $390.1 billion since the end of 2007, a slide of 17.4%.

Nonfarm Nonresidential Real Estate Loans increased by $114.9 billion since the end of 2007 a gain of 11.9%. This segment of CRE loans have been deemed less risky.

Construction & Development Loans declined by $426.4 billion since the end of 2007, a whopping 67.8%. This is the real estate segment that took the deepest hits.

Home Equity Loans declined by $78.7 billion since the end of 2007. It has been difficult for banks to collect on bad loans in this category if the bank that granted this loan does not control the first lien mortgage.

Total Real Estate Loans declined by $780.4 billion since the end of 2007, down 17.5%.

Other Real Estate Owned while declining significantly in recent quarters this category is up $20.5 billion since the end of 2007, up 168.6%. This is a hidden inventory of homes and other real estate properties.

Notional Amount of Derivatives many of the problems that surfaced during the Great Credit Crunch occurred in derivatives, yet the banking regulators have allowed this category to rise by $70.4 trillion since the end of 2007, or by 42.4%.

Deposit Insurance Fund The DIF first quarter balance rose to $37.9 billion sequentially from $35.7 billion. Member banks are the major source of these funds via assessments. When you compare current DIF to that of 2007, the fund is down $14.5 billion, or 27.7%. The DIF balance rose from 0.59% as of March 31 to 0.63% as of June 30. By law, the DIF must achieve a minimum reserve ratio of 1.35% by 2020. This could become a future source of stress over the next seven years.

Insured Deposits increased by $1.674 trillion or 39.0% since the end of 2007, and if this growth continues the DIF pressures intensify.

Reserves for Losses while declining nicely in recent quarters; reserves are still up $47.3 billion since the end of 2007, up 46.5%.

Noncurrent Loans have declined significantly in recent quarters, but are still up $129.4 billion since the end of 2007, a gain of 117.7%.

Reading the Table

OV/UN Valued: Among the regional banks only one is undervalued, First Niagara is undervalued by 7.0%.

VE Rating: Only two of the stocks in the regional banking index have "4-Engine" buy ratings, First Niagara and JP Morgan Chase . The remainder have "3-Engine" hold ratings.

Last 12-Month Return (%): All 24 components of the regional banking index had gains over the last 12 months; between 3.6% for BB&T Bank and 68.8% for Bank of America.

Forecast 1-Year Return: After significant gains over the last 12 months these stocks are projected to move sideways over the next 12 months between a loss of 0.6% for Huntington Banc and a gain of 4.8% for JP Morgan.

All 24 components of the regional banking index are above their 200-day simple moving averages, which reflects the risk of a reversion to the mean.

Value Level: Price at which to enter a GTC limit order to buy on weakness. The letters mean; W-weekly, M-monthly, Q-quarterly, S-semiannual and A-annual.

Pivot: A level between a value level and risky level that should be a magnet during the time frame noted.

Risky Level: Price at which to enter a GTC limit order to sell on strength.

At the time of publication the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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