Banks return to an industry Americans can bank on

Vilified as a chief cause of the global financial crisis three years ago, America’s banks appear to be quietly on the mend.

The Federal Deposit Insurance Corp.’s “Problem List” of troubled banks has shrunk to fewer than 700 for the first time in three years, and the industry is poised to see about half the number of bank failures of 2011 and one-third the number that collapsed in 2010 in the wake of the Great Recession.

The financial markets are picking up on these positive signs from the banking community. Across the industry, profits are at six-year highs among banks that are insured by the FDIC, although bankers say the rebound isn’t fully appreciated in Washington.

“I bristle when I hear these polarizing extremes: ’The banks are all bad, let’s hang them from the highest rafters,’” said David Stevens, president and CEO of the Mortgage Bankers Association, contending that the lenders who caused the most damage have been forced out of the market.

Dick Bove, a bank analyst with Rafferty Capital Markets, said the banks that have survived the tough times have emerged stronger as the economy starts to recover.

“Everyone has done nothing but beat on the banks for the havoc they caused,” he said. “It’s not very well understood that banks in the United States are extraordinarily profitable right now and have been growing for the last few years.”

In the third quarter of 2012, U.S. banks made $37.6 billion in profits, according to the FDIC, a 6.6 percent increase from the same period the previous year. Mr. Bove said he expects record profits in 2013.

More important, fewer banks are closing. In 2012, 51 banks have failed, down from 93 last year, and a fraction of the 297 banks that were shut down in 2010 and 2011. The 2012 failure total is on pace to be the lowest since 2008.

The number of banks on the Problem List fell for the sixth consecutive quarter to 694 institutions, the FDIC announced this month.

“The declining number of failures is reflective of an improving trend in the banking system over the last few years,” said Chris Newbury, associate director of the insurance and research division at the FDIC. “We have a generally profitable industry. They improved significantly in the period immediately after the financial crisis.”

Mr. Stevens noted that the financial services industry made mistakes, which resulted in weeding out shaky banks.

“Everybody acknowledges that, and many of those institutions are out of business today,” Mr. Stevens said. “They’ve been absorbed by other companies. Wells Fargo has Wachovia on its balance sheet. Bank of America has Countrywide on its balance sheet. JPMorgan has Washington Mutual on its balance sheet.”

The market notices

Wall Street has responded positively. The Standard & Poor’s 500 financials index, which tracks banks and other financial institutions, has posted a nearly 35 percent spike since last December – compared with a 20 percent increase for the entire S&P 500 over the same period. The Dow Jones U.S. financials index has jumped nearly 32 percent during that time, while the overall Dow Jones industrial average is up about 13 percent.

Some banks have performed particularly well. Bank of America Corp. stock has more than doubled, while JPMorgan Chase & Co., Citigroup Inc., Wells Fargo & Co. and Capital One Financial Corp. are up an average of about 40 percent.

Banks are growing stronger for several reasons, analysts say. After the financial crisis, they tightened lending standards and beefed up the capital they hold to protect against failure.

“If you talk to any bank in America today, the message they’re getting from their CEOs is, ’I don’t want to be in the headlines ever again. Don’t do any bad loans that could cause a regulatory impact and does significant damage to my balance sheet,’” Mr. Stevens said.

A few years later, the bad loans are being cleaned out of the system. According to the FDIC, loss provisions in the third quarter dropped 20 percent from the same period in the previous year to $14.8 billion.

“When the economy rolled over in 2008, credit became nearly impossible for borrowers with poor credit, so the bad loans have been flushed out and the new loans that are made to replace them are of much better quality,” Mr. McBride said.

This has allowed banks to chip away at some of the excess capital they stockpiled in the wake of the financial crisis and invest it. “What they have set aside in years past is actually now being deemed as more than was needed,” Mr. McBride said.

Mr. Bove agreed, saying banks “overreserved” to cushion against losses at the beginning of the sharp U.S. downturn.

“So at the beginning of the crisis, they drove profits below normal, and now they’re getting those profits back,” he said.

They’re using that extra money to make more loans and increase profits – although not at a pace many credit-starved lenders might like.

Not all bullish

Despite the good numbers, U.S. banks face a number of clouds on the horizon. A McKinsey & Co. survey of the global banking industry, released in October, concludes that American banks are in better shape than many of their European and Asian rivals, but they still face major questions in getting back to pre-recession levels.

In addition to boosting capital, “American banks became more stable as they successfully cleaned up balance sheets through significant write downs and the creation of ’good bank/bad bank’ structures to sequester and remove troubled assets,” the McKinsey report says.

“However, the sector still faces significant challenges,” including sluggish revenue growth, “volatile” lending margins and increased costs.

Banks around the world have bounced back from the depths of the Great Recession, the report says, but haven’t settled on a “sustainable model” to guarantee adequate profitability in the years ahead.

Still, the size of American banks’ loan portfolios increased for the fifth time in the past six quarters by $64.8 billion, or nearly 1 percent, and loan sales rose by $3.9 billion, according to the FDIC.

“It’s still modest growth, but after many quarters of contraction in loans, it’s a positive sign,” Mr. Newbury said.

Another factor in the banking comeback is an improving economy. “Even though the economy is a little bit sluggish, we do have positive growth and have for a few years now,” Mr. Newbury said. “That’s better than no growth.”

Bankrate.com analyst Greg McBride said the rising economy has played a role in turning around the banking industry.

“It all revolves around the economy,” Mr. McBride said. “When the economy’s bad, people don’t borrow money and they don’t pay back what they’ve already borrowed. When the economy’s better, borrowing increases and people are more likely to pay back the money they owe.”