Every quarter, the FDIC reports aggregated financial data on all of its 6,500-plus member banks. This Quarterly Banking Profile is an excellent tool to track the industry for trends, both positive and negative.
This month, the FDIC released its report for the third quarter of 2014, and with it comes the news that bank profits are growing, driven by something the industry has been missing for quite some time: revenue growth.
With banks, profits aren't just profits
When the financial crisis swept the nation, banks were forced to dramatically increase their loan loss reserves as protection from the onslaught of defaulting loans. Loan loss reserves are a sort of rainy day fund that banks pull out of income every quarter. When loan losses increase, they act as a headwind to profits, and when they decrease, they can be added back to income and help boost short-term profits.
As the crisis subsided, banks returned to profitability in relatively short order. The issue, however, was that those profits were largely being driven by reductions in the aforementioned loan loss reserves. Revenues, on the other hand, were flat or declining.
We can use the FDIC's historical data to show exactly what's happening. First, here's a graph of the banking industry's aggregate profit from 2006 to the third quarter of this year.
In the third quarter of this year, the industry reported a profit of $38.7 billion -- a 7.3% increase year over year, though it's down from the $40.1 billion reported in the second quarter. These results are a continuation of the trend first started around 2011 as the industry began its rebound from the steep losses of 2008 and 2009.
However, these profits have been a result of cost-cutting and reserve reductions -- not by growth in revenue. Here's a look at industry revenue over the same period of time.
Since 2010, industry revenue has essentially been flat, taking into consideration the natural ups and downs of an industry in flux. The third quarter bucked that trend, with revenue jumping a considerable 4.8% year over year -- the largest annual percentage jump since 2009.
At the same time, the credit cycle showed signs of continuing change as banks actually increased their loan loss reserves year over year for the first time in five years.
2015: The year of bank stocks?
The results of the third quarter paint an optimistic picture of bank fundamentals. Profitability has been back for some time, but experts were always wary, given how large a role the loan loss provision has played in those profits. The question has always been: Without revenue growth, are these profits anything other than an accounting anomaly?
This quarter, that question seems to have been answered, and the outlook for 2015 appears to shine even brighter. The Federal Reserve is expected to begin raising interest rates sometime in 2015, which will benefit banks, as they will be able to charge more for loans. Further still, credit quality data continues to improve across the board, freeing banks to extend new credit to businesses, growing revenue even further, instead of concentrating resources on struggling existing loans.
Nothing is ever certain, but 2015 is shaping up to be a year of great opportunity for banks and bank investors alike.