Banks swing back to profit

The economic recovery has been paying off on the bottom line for the country’s banks, but the forecast for the industry remains cloudy.

The sector recorded its strongest quarterly earnings since 2007 as projected loan losses shrank for the first time in more than four years, the Federal Deposit Insurance Corp. reported Tuesday.

But banks in California and the West lagged behind the national recovery as they continued to work through losses on construction loans and troublesome commercial mortgages, according to a Federal Reserve report.

The U.S. industry’s convalescence helped improve the health of the FDIC’s deposit insurance fund for the second quarter in a row, but it wasn’t enough to take the fund out of the red.

Commercial banks and savings institutions nationwide earned $21.6 billion in the second quarter, the FDIC said, compared with a $4.4-billion loss a year earlier.

Nearly 2 in 3 banks reported a year-over-year improvement in earnings.

“As long as economic conditions remain supportive, most institutions should maintain profitability and increase their capacity to lend,� FDIC Chairwoman Sheila Bair said.

But she added: “Without question, the industry still faces challenges.�

The latest earnings total was the highest since summer 2007 but well below the $30-billion-plus level that the industry topped for 17 straight quarters before it was brought to its knees by the mortgage meltdown and the ensuing recession.

Banks’ loan portfolios are still shrinking, reflecting retrenchment by the industry as well as a lack of demand for loans, said Christopher Whalen, a principal at market research firm Institutional Risk Analytics in New York.

“The good news is that the immediate crisis is past,� Whalen said, “but the prospect is for a couple more years of consolidation and cleanup.�

The stock market, meanwhile, is focused on the possibility of a “double dip� recession, which could put many banks back into crisis mode. An index of 24 major bank stocks slumped 11% in August on double-dip fears, leaving it up only slightly this year. The index gained 1.1% on Tuesday while the overall market was flat.

In California and the West overall, bank results have strengthened this year but not as sharply as elsewhere in the country.

In the first half of 2010, banks and thrifts based in California earned $1.3 billion, reversing a loss of $987 million in the first six months of 2009.

The average return on assets at California banks -- a standard measure of profitability -- was less than a third of the national figure, said Ross Waldrop, a senior FDIC banking analyst.

Of the 10 states with the worst second-quarter banking results from banks, seven are in the Federal Reserve’s 12th District, including badly battered Arizona and Nevada, according to researchers at the Federal Reserve Bank of San Francisco.

The nine-state region includes areas with some of the biggest home price declines in the country. Making matters worse, many of the banks based in the West specialized in construction lending and commercial mortgages, sectors in which losses have run high.

Commercial real estate “was what drove the economy over the past 15 years� in California, said banking consultant Gary Findley of Anaheim. “So when the economy takes it on the head, of course there are problems at the banks.�

Nationwide, a ratcheting back of bad-loan fears showed up on bank balance sheets.

The U.S. industry’s ratio of loss reserves to total loans outstanding fell to 3.4% in the second quarter, down from 3.5%, but was still at its second-highest level in the 63 years for which the FDIC has data.

A similar reduction in the projected costs of expected bank failures helped bolster the FDIC’s deposit insurance fund, which moved closer to a positive net worth.

--

[email protected]