Commercial banks and savings institutions insured by the Federal Deposit Insurance Corporation (FDIC) reported an aggregate profit of $29 billion in the first quarter of 2011, an $11.6 billion improvement (66.5 percent) from the $17.4 billion in net income the industry reported in the first quarter of 2010. This is the seventh consecutive quarter that earnings registered a year-over-year increase. For the sixth consecutive quarter, reduced provisions for loan losses drove the improvement in earnings.
You should notice that the title of this post is “make accounting gain of” instead of “earned” because it is not clear at all that US banks earned $29 billion. After all, the FDIC has indicated that these accounting gains are driven by lower provisions for loan losses.
What’s happening is that banks are saying the economy is now relatively calm. They can therefore lower the provisions they take to account for future losses on their existing loan books. But, this is an accounting estimate of the future losses for present loans that banks must undertake to comply with accrual accounting standards. Q1 2011 loss provisions came in at $20.7 billion; that’s less than half the $51.6 billion set aside in Q1 2010. If the banks did set aside in Q1 2011 as much as they did last year, the banks would have shown a loss for the quarter. If these estimates prove wrong, the actual earnings will be different.
In any event, $29 billion is a large number, 65% bigger than the gain a year ago. And it shows us that under present accounting guidelines, US banks are recapitalizing. The key is loan loss provisions. I think banks are certainly better capitalized than a few years ago but I also believe we are seeing under-provisioning. Time will tell if I am right.