Banking Industry In Q2 2024

Yesterday, the FDIC released their Quarterly Banking Profile for the Second Quarter of 2024.

FDIC Chairman Martin Gruenberg highlighted the banking industry’s net income of $71.5 billion for the second quarter, a $7.3 billion increase from the prior quarter, or an 11.4% gain.

One-Time Transactions

He also mentioned that this was mainly due to one-time items, including gains on equity security transactions and the sale of an insurance division.

Looking more closely, the equity security transactions reflect the gains resulting in the conversion of Visa Inc. (V) shares by several banks.

In 2008, Visa went public, and it allotted restricted Class B shares to financial institutions that had been issuing Visa branded credit cards under a previous cooperation agreement. Due to pending litigation, most institutions carried the Class B shares at zero until the lawsuits were resolved.

In January 2024, Visa shareholders approved a plan allowing Class B shareholders to convert their restricted shares into marketable Class A ones. In May, Visa accepted more than 98% of all Class B shares that were tendered.

Several financial institutions, led by JPMorgan (JPM), chose to sell their new Visa shares, recognizing large gains.

JPMorgan booked a gain of $7.9 billion in 2Q24, while Northern Trust, PNC, Citi and Commerce Bancshares recorded gains of $878 million, $754 million, $400 million and $176 million, respectively. Cumulatively, these banks recognized a gain of more than $10 billion for the quarter.

JPMorgan’s gain alone was greater than the $7.3 billion income increase for the entire banking industry in the quarter. Adjusting the industry’s income for the whole Visa windfall, net income dropped to $61.4 billion, switching the industry’s quarterly income from a gain of 11.4% Q/Q to a decline of 4.4% Q/Q.

In addition, Truist Financial (TFC) divested of its insurance business, resulting in a one-time gain of $4.8 billion. Reflecting this sale in the industry’s net income again drops income from operations to $56.6 billion, an 11.8% decline Q/Q.

The net impact of these one-time items for 6 banks causes the net income for the full industry of 4,539 institutions to shift from an 11.4% quarterly gain to an 11.8% decline, a $14.8 billion swing.

Net Interest Margin

The banking industry’s weakness in its operations is reflected in the drop in their net interest margin. Among the Money Center Banks, which represent more than 85% of the entire banking industry, net interest margin declined in the quarter to 2.87% from 2.91%. This represents the fifth decline in the past six quarters. Net interest margin is down a total of 19 basis points from the high of 3.06% in 4Q22. It is also below its pre-pandemic level for the second consecutive quarter.

Deterioration in Asset Quality

Part of the reason for the weakness in net interest margin is due to the deterioration in asset quality. Two of the weakest areas are in credit cards and commercial real estate.

Credit card delinquencies increased to 10.93%, the highest level in twelve years.

Among the Money Center Banks, the weakest real estate segment is in the commercial real estate market. Non-performing commercial real estate loans increased for the seventh consecutive quarter to 4.85%, the highest level since 3Q11.

The banking industry’s Quarterly Credit Loss Provision was $23.3 billion, a $2.7 billion gain from 1Q24. This was the provisions’ eleventh increase in thirteen quarters. According to the FDIC:

“the increase in provision expense was driven by the largest institutions and reflects quarterly loan growth, deterioration in office markets, and high credit card charge-offs.”

Declining Deposits

The banking industry has also been impacted by its shrinking deposit base. Deposits for the quarter declined by $190 billion, the seventh decline in the past nine quarters. Since the Fed began tightening in 2Q22, the banking industry’s deposits have fallen by $1.1 trillion, a 5.6% decline. Much of this has been a shift away from banks to higher yielding money market funds.

Unrealized Gains (Losses) on Investment Securities

One of the looming problems in the banking industry is the large Unrealized Losses in their Investment Securities. This was the issue that caused the banking crisis in March 2023, and it has not gone away.

Total unrealized losses were -$512.9 billion in 2Q24, a slight improvement of $3.6 billion from the prior quarter. However, as the FDIC stated:

“this is the tenth straight quarter of unusually high unrealized losses for the industry since the Federal Reserve began to raise interest rates in 1Q22.”

Conclusion

Bank Stocks, as reflected in the KBW Bank Stock Index, and the KBW Regional Bank Stock Index, have recovered from their weakness following the Banking Crisis of 2023, which resulted in three of the four largest bank failures in American history.

Upon closer scrutiny, however, the banking industry still has many issues.

Net Income was bolstered by large one-time gains, and has weakened on an operating basis.

Deterioration in asset quality, particularly in credit cards and commercial real estate, has led to increases in delinquencies and larger loan loss provisions, which have negatively impacted net interest margins.

Deposit growth continues to suffer as banks aren’t competitive with money market funds.

Additionally, the industry is still positioned with large unrealized losses in their securities portfolio.

As the Fed prepares to cut rates in response to a weakening economy, banks aren’t showing they are well positioned for the new environment.