This week BankRegData.com reviews 2013 Q1 U.S. Banking Net Income and a few driving components. As reported by many news outlets aggregate bank income was a "record" $40.3 billion in the first quarter.
With 52.09% of the quarter's net income coming from the Top 4 banks (up from 29% in 2003) these types of reviews are increasingly a representation of our ever more concentrated banking industry.
A less lazy author would break out (at least) 3 tiers of $1+ Trillion, $5-999 Billion and <$5 Billion to show that there are very different and distinct trends for the 3 groups. That said, I'll stick with the "industry" for the following commentary. The quarter over quarter Net Income numbers:
In terms of absolute dollars the $40.3B is indeed a record. Reviewing the past 10 years Return on Assets, however, we see that while Q1 was the best in 23 quarters the industry is trailing the consistent 1.35% levels from 2003-04 and the 1.25% of 2005-06.
The following table details those items which had positive contributions to the incremental $5.555 Billion Quarter on Quarter increase in net income.
Net Income Contributors
From the table above it's clear that the majority (if not all and then some) of the net income increase comes from a drop in quarterly Provision, extraordinary gains from Trading and a 13.80% drop in Net Charge Offs.
We'll discuss some of the above in more detail shortly, but let's first take a quick look at those items that were a drag on Net Income.
Net Income Drains
While historically low interest rates continue to affect Net Interest with a quarterly drop of $1.809 Billion, it is interesting to see that higher Salary & Benefits expenses (including Q1 bonuses) were the larger drag.
Next up we'll review a handful of the items in detail to determine if the income gains were sustainable or transitory.
Does the Provision figure make sense?
The $11.01B provision for Q1 was the lowest in 24 quarters since the $9.2B from 2007 Q1 which, on the surface, should give us some pause. The issue is whether aggregate allocated Provision is "enough" and that lead us to review the Provision to Net Charge Off ratio for the past 10 years.
The 0.69 ratio ($11.01B provision / $15.98b net charge offs) is the 5th lowest ratio in the past 10 years - the other 4 lowest were in 11Q1, 12Q1, 12Q3 and 11Q2. For every $1 in net charge offs $0.69 of provision was allocated to replenish reserves. The next chart tracks Reserves to Adjusted NPLs (coverage ratio).
While 0.92 ($0.92 of reserves for every $1 in adjusted NPLs) is higher than most of recent history it is substantially lower than 1.50+ figures from 2004-06 which were deemed acceptable just prior to the crisis.
Combined, these 2 charts leave me with the feeling that provision and reserves are better than recent history, however, they are no where near where they were in 2005-06. If delinquencies begin to increase banks are in a worse position today regarding reserves than they were prior to the financial meltdown.
Are Trading Gains sustainable?
While the 7.50B gain is impressive, it was only the fifth highest gain in the past 4.5 years.
Given this, I suspect it's entirely possible we'll see another "perfect quarter" from the big banks and have another blockbuster Trading gain. These guys must be really smart - perhaps they should move some of their traders into the credit underwriting group.
Are lower Net Charge Offs realistic?
In the pre-2007 world the answer would have been "no, banks just can't keep delaying charge offs over the long run". Today, however, it appears that large bank executives, regulators and auditors are more than happy to continue to ignore charge off policies - especially on GNMA Guaranteed 1-4 Family NPLs.
My favorite method to determine whether charge offs are legitimate is to review a bank's NPLs to Charge Offs across time. The higher the ratio the more a bank is delaying charge offs and keeping NPLs higher than they would normally be. The following chart is the NPL to CO ratio for the entire US banking system:
For every $1 of charge offs U.S. Banks held $8.43 of Adjusted NPLs (the adjusted figures back out guarantees) - this is a significant jump over the 2012 Q4 figure of $7.58.
The historical ratio is $5.50 which means that over the course of the past 3 years banks are increasingly delaying charge offs. While most loan types experienced jumps in the ratio, some of the largest were in 1-4 Family 1st Liens, 1-4 Family Jr. and Home Equity.
1-4 Family 1st Liens NPL to CO ratio:
In the 4th Quarter of 2012 the ratio jumped from the mid-40s to 55.10 and then to 62.07 in 2013 Q1. The simplest way to engineer a "housing rebound" is to begin shutting off supply (especially the homes dragging prices down) and from the chart we can see that banks started to reduce 1-4 Family charge offs in late 2011-early 2012.
Three banks (BAC, WFC & JPM) control 67.87% of 1-4 Family 1st Liens NPLs sitting on banks' books - yes 3, I know, it's stunning. Let's review what has happened to the NPL to CO ratio for these three banks in the past 5 quarters:
1-4 Family 1st Liens NPL to CO ratios for BAC, WFC & JPM:
Bank of America was at an already inflated $72.36 in 2012 Q4 and then skyrocketed to $124.46 in 2013 Q1. JPMorgan Chase clearly showed the way in 2012 Q4 jumping from $59.77 to $196.84. Frankly, I'm a little surprised they even bother charging any off - my guess is they must have been non-GNMA guaranteed loans.
The ratio clearly shows that Charge Offs in 1-4 Family Liens are being brought to a trickle for the 3 largest NPL banks. The 3 banks control 67.87% of 1-4 NPLs yet only had 32.62% of the charge offs in the quarter.
The result is "record" bank profits, a "housing turnaround" and gains on legacy REO liquidations - it's a win-win-win for everyone. Well, everyone except for those who plan to buy a home and anyone who pays property taxes. Oh, wait, another win - state & local governments! And realtors, let's not forget them.
Government policy that encourages (desires) higher housing prices is terribly misguided in my opinion. For better or worse (worse in my book) we are a consumer based economy. Every additional dollar the consumer is required to put towards housing (or student debt) is a dollar not being spent on other goods or services.
Worse yet, it's a 'dead' dollar in that it goes to pay debt (held by a few) rather than a shirt, stereo or dinner benefiting a local retailer or service provider that then gets recycled when they spend. It bleeds money from discretionary to non-discretionary items.
Bonus Chart: Some Perspective on 1-4 Family NPLs
Is the housing crisis over? The chart below details the dollar amount of 1-4 Family NPLs (left axis, yellow area) and the NPL % (right axis, maroon line).
The peak was $185.56 Billion in 2010 Q1 and we have dropped $22.99B to $162.57B today.
In a normal environment 1-4 Family NPLs should be around 1% - which indicates that we should be around $17.82B. The difference between where we're at ($162.57B) and where we would normally be ($17.82B) is $144.75 Billion (86.29%) of unresolved (un-charged off) NPLs.
Yes, home prices have rebounded and yes, banks are making tons of money. The reality, however, is that we have only worked through a fraction of the outstanding problem. If the world is smooth sailing for the next 5-7 years then we'll look back and be impressed with how well the issue was managed.
If, however, for any reason, the economy tanks and 1-4 Family NPLs begin to increase they will be increasing from an already (extremely) elevated level. Adding to the issue is that Provisions & Reserves are not catching up to levels found before the last crisis. In my (increasingly addled) mind, it sacrifices systemic safety for the veneer of "normalcy" and possibly transient higher profits and stock valuations.
Data Source: All data is derived from FDIC Call Reports