The FDIC released its Quarterly Banking Profile
(QBP) for the second quarter of 2011 earlier this week. Unsurprisingly, there was widespread coverage of the continuing meager loan growth in the industry, the ongoing release of loan loss reserves as asset quality improves, and the trend of declining revenues for the industry. While these are all noteworthy issues, there were some other interesting points in the QBP that are worth noting, as shown in the table below.
Source: CPG Analysis if data from the FDIC. All data as of June 30, 2011.
As one can see above, the balance sheets of banks have become extraordinarily liquid. The loan to deposit ratios declined sharply over the last five years. The ratio stood at 72.76% at June 30, 2011, compared to 82.19% seen in the second quarter of 2009, and the 91.91% seen in the second quarter of 2007. The same liquidity trend holds true when looking at loans as a percentage of assets, with the 52.25% reported for the second quarter of 2011 lower than that seen for the same time periods in 2009 and 2007. An influx of deposits coupled with the recent dip in economic growth, a lack of creditworthy borrowers, and cautiousness on the part of banks toward assuming more credit risk have resulted in these high levels of liquidity. Profitability under this scenario is due to an artificially low interest rate environment which enables banks to pay close to nothing for deposits. This is not sustainable.
Also notable is that noninterest expense as a percent of assets remains elevated compared to levels seen in the second quarter of 2007 (though this ratio has decreased since the second quarter of 2009). This expense metric is likely to stay high as banks continue to deal with loan workouts and increased compliance costs. Additionally, this ratio could increase due to restructuring and severance costs in the coming quarters, as many large banks have announced planned layoffs over the next year.
While the industry is operating in the black, banks remain significantly less profitable relative to levels prior to the recession. Return on equity is 33% below what it was four years ago and return on assets similarly remains 29% below levels in the second quarter of 2007.
In conclusion, without a marked improvement in the economy, quality borrowers will remain elusive and therefore loan growth will remain largely absent, driving excessive liquidity and lower profitability within the industry. Until this key piece of the puzzle is addressed, there is unlikely to be a significant improvement in the prevailing environment of mediocre profitability.
You can find our 1Q2011 Earnings Update here.