Banks Still Tanking, but Recovery on the Horizon

(MoneyWatch)  For the U.S. banking industry, things are going to have get worse before they get better, according to the FDIC's latest industry report card.

Agency chairman Sheila Bair said deteriorating loans remain the heaviest drag on bank earnings, as institutions set aside more capital to prepare for worsening conditions. Also hurting are bank writedowns of asset-backed commercial paper, along with higher fees for deposit insurance and rising credit card-related losses.

"For now the difficult and necessary process of recognizing loan losses and cleaning up balance sheets continues to be reflected in the industry's bottom line," she said in a press conference to discuss the FDIC's findings (video coverage available here).

FDIC-insured commercial banks and savings institutions lost a total of $3.7 billion in the second quarter, with firms boosting provisions to offset rising levels of nonperforming loans. Lending related to commercial construction and development has been especially hard hit. with net chargeoffs up significantly over the previous quarter. Banks wrote off a total of nearly $49 billion, nearly double what they reported last year.

Nearly two-thirds of institutions reported lower quarterly earnings than a year ago, while roughly 28 percent reported a net loss. By comparison, fewer than one in five banks were unprofitable in the second quarter of 2008, when the industry as a whole racked up profits of $4.7 billion. The average return on assets for the latest quarter was -0.11 percent, versus 0.14 percent in the year-ago period.

As a result, more and more banks are entering the danger zone. The number of troubled institutions has reached a 15-year high, with 416 banks holding total assets of $300 billion on the FDIC's "problem" list. That's a big increase from the last quarter, when the agency identified 305 problem banks with a combined $220 billion in assets.

Banks are faring much worse during this latest financial crisis than they did during the dot-com bust. No surprise there -- after all, the fire started in the financial industry. This downturn is more reminiscent of what occurred during the recession in the early 1990s, which saw 10 consecutive quarters of falling loan balances. By that measure, we have a ways to go, since loan levels to date have declined for only four straight quarters.

Still, a few signs suggest the banking sector is starting to heal. Average net interest margins improved slightly from first quarter levels, as funding costs fell (click on chart to expand). Troubled loans also are increasing at a slower rate. In addition, total mortgage originations in the first half of the year were up over 2008, fueled by rising lending backed by the so-called Government-Sponsored Enterprises, Department of Veterans Affairs and Federal Housing Administration.

Generally, the industry is showing some resilience during the recession. Although many banks are hurting, they continue to generate cash. When loan-related losses finally subside, banks should be able to trim their provisions, which should boost earnings.