The Federal Deposit Insurance Corp. released its quarterly banking profile this week, and the data show that two of the trends affecting the country's largest banks continue to play out, one bullish, the other bearish. Let's start with the good news (for the banks and their shareholders, not for taxpayers):

The big get bigger
Back in December 2009, I made three 10-year predictions for the banking industry, including this one:

At the end of the third quarter, the top four U.S. banks -- Bank of America, JPMorgan Chase (NYSE: JPM), Citigroup (NYSE: C), and Wells Fargo (NYSE: WFC) -- had combined assets of $7.4 trillion, which is equivalent to over half the GDP. In 2020, I expect the top 10 banks' share of total banking assets and total deposits to be equal to or higher than today's levels.

It was partially on the grounds of that dominant market share that I suggested a basket trade consisting of those four banks in November 2010, to which I added US Bancorp (NYSE: USB) in April (to track this basket using My Watchlist, click here). If we compare this group against the entire sector, the trend toward increased concentration appears to be chugging along:


Q1 2011

Q4 2010

Q4 2009

Q1 2006

Top 5 Banks -- Total Assets $8.0 trillion $7.9 trillion $7.6 trillion $4.9 trillion
As a % of All FDIC-Insured Institutions 59.5% 59.0% 58.4% 44.0%
Top 5 Banks -- Total Deposits $3.9 trillion $3.8 trillion $3.7 trillion $2.3 trillion
As a % of All FDIC-Insured Institutions 40.9% 40.7% 40.9% 31.8%

Sources: Capital IQ, a division of Standard & Poor's, and FDIC.

An unsustainable source of profit growth
Increasing market share is a positive headwind for the basket trade, but the FDIC's report highlights a downside risk as well. The industry's profit growth during the first quarter was the product of decreasing reserves rather than loan growth, which can't be repeated indefinitely (i.e., actual loan losses came in lower than reserves so that part of the reserves are "released," which boosts profits). Decreasing reserves and revenue -- both were concentrated within the largest banks.

Waiting for loan growth
This could be a "show me" situation, in which the market will want to see sustained, positive loan growth before it revalues the shares. That growth depends on the strength of the economic recovery -- sure enough, the basket has performed miserably over the past month, just as growth prospects have dimmed. I continue to think this basket will ultimately produce excellent returns -- on a relative and an absolute basis -- but investors will need to be patient to capture them, as it could take 12-24 months for the trade to work out.

These banks may be "too big to fail," but we've got " Too Small To Fail – 2 Small-Caps the Government Won't Let Go Broke ."