Federal Deposit Insurance Corporation (:FDIC)-insured commercial banks and savings institutions reported second-quarter 2014 earnings of $40.2 billion, above the year-ago earnings of $38.2 billion by 5.3%. Notably, community banks constituting 93% of all FDIC-insured institutions, reported net income of $4.9 billion, up 3.5% year over year.

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

Further, lower loan loss provisions and improved loan growth was recorded. Moreover, banks’ revenues benefited from lower non-interest expenses and higher net interest income. However, a decline in non-interest income was experienced as trading income subdued and reduced mortgage-related activity was recorded.

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 82% of industry earnings.

Such major banks include Wells Fargo & Co. (WFC), Citigroup Inc. (C), JPMorgan Chase & Co. (JPM) and Bank of America Corp. (BAC).

Performance in Detail

Banks are striving to reap profits and are consequently bolstering their productivity. Around 57.5% 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 6.8% from 8.4% in the last-year quarter.

The measure for profitability or average return on assets (:ROA) rose to 1.07% from 1.06% in the prior-year quarter. The average return on equity (:ROE) increased to 9.54% from 9.46%.

Net operating revenue was $169 billion, down 0.9% year over year. The decrease was due to a fall in non-interest income, mostly offset by an increase in net interest income.

Net interest income was recorded at $105.5 billion, up 1.9% year over year. The average net interest margin declined to 3.15%, from 3.25% in the prior-year quarter, depicting the lowest quarterly margin for the industry since the third quarter of 1989. Notably, 9 of the 10 largest banks recorded reduced margins as compared with the prior-year quarter.

Non-interest income declined 5.3% year over year to $63.5 billion for the banks. Notably, income from sale, securitization and servicing of 1-to-4-family home mortgages suffered a fall. Further, trading revenue decreased 10.1% year over year and represented the fourth consecutive quarter of decline.

Total non-interest expenses for the institutions were $104.9 billion in the quarter, down 1.4% on a year-over-year basis. Reduced expenses for goodwill impairment and lower salaries and employee benefits led to the decline. However, litigation expenses were on the downside.

Credit Quality

Overall, credit quality considerably improved in the reported quarter. Net charge-offs fell to $9.9 billion from $14.1 billion in the second quarter of 2013. Notably, all major loan groups recorded a year-over-year decline in charge-offs, except auto loans.

In the quarter, provisions for loan losses for the institutions came in at $6.6 billion, down 22.4% year over year. The reported figure represents the lowest quarterly loan loss provisions since the second quarter of 2006.

The level of non-current loans and leases (those 90 days or more past due or in non-accrual status) declined 24% year over year to $181.8 billion. Moreover, the percentage of non-current loans and leases fell to 2.24%, which was the lowest since the second quarter of 2008 (2.09%).

Balance Sheet

The capital position of the banks was strong. Total deposits continued to rise and were recorded at $11.9 trillion, up 10.2% year over year. Further, total loans and leases came in at $8.1 trillion, up 4.9% year over year.

As of Jun 30, 2014, the Deposit Insurance Fund (:DIF) balance increased to $51.1 billion from $48.9 billion as of Mar 31, 2014. Moreover, assessment revenues primarily drove the growth in fund balance.

Bank Failures and Problem Institutions

During the second quarter of 2014, seven insured institutions failed compared with 12 failures in the prior-year quarter. As of Jun 30, 2014, the number of "problem" banks declined from 411 to 354, reflecting the 13th consecutive quarter of decrease. Total assets of the "problem" institutions also fell to $110.2 billion from $126.1 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 high legal costs. Moreover, top-line growth remains uncertain 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, a favorable equity and asset market backdrop, and favorable macroeconomic factors – such as falling unemployment, 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 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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