Page 7 - Banking Outlook 2014 - An Industry at a Pivot Point

Banking Outlook 2014: An Industry at a Pivot Point | 5

What’s at stake
It isn’t only bankers who are dependent on the long-term health of the banking industry. So too are businesses,
consumers, and politicians. A strong U.S. banking system creates jobs, links business organizations,
nurtures and promotes technology transfer, builds human capital, and underpins the creation of our country’s
infrastructure. It is a critical catalyst for generating government tax revenues. Without sound and active banks,
the creation of products and services that benefit consumers and businesses would be nearly impossible. In
short, any hope of a sustained recovery by the U.S. economy depends in no small part on banks getting their
houses in order. Do all that, and the industry will earn its just rewards. The industry will find a more vibrant
market for its products and services, boosting its revenues. An industry in order also will buttress the argument
for a less volatile and convoluted regulatory environment than the one it faces now. At the moment, the
environment of uncertainty has hamstrung the industry’s long-term planning capabilities.

Contribution of ALL Reversal to Net Income

45.0 100%
40.0 90%
36.0
35.0 80%
70%
30.0
60%
25.0
20.9 50%
20.0
45% 40%
15.0
30%
10.0 20%
16%
5.0 10%
0.0 0%
Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 Feb-13 Apr-13 Jun-13 Aug-13
Total Net Income (billions) Excess ALL charge-off ass a % of NI The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. NDPPS 227982
Source: SNL Financial; KPMG Research © 2014 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Printed in the U.S.A.
To expand on the credit point we raised earlier, our analysis suggests that reversing loan loss reserves, or allowances
for loan losses (ALL), contributed to approximately 40 percent of net income in 2010 and 2011 and more recently, as ALL
balances have declined, to roughly 20 percent of net income. In estimating these amounts, we viewed charge-offs in
excess of loan loss provisions as effectively reversing the ALL provision. We believe charge-offs in excess of provisions
(with no tax effecting) represents a simple and reasonable way to estimate the contribution to banks’ net income of ALL
reversals.
In the second quarter of 2010, for instance, excess charge-offs totaled $9.3 billion, or roughly 45 percent of total net
income. A comparable level of contribution continued through the second quarter of 2011. Over those five consecutive
quarters, ALL releases averaged 41 percent of net income.
As nonperforming loans and ALL balances declined, however, the magnitude of the ALL releases declined as well. From
the third quarter of 2011 to second quarter 2012, ALL releases dropped to $6.8 billion, or approximately 21 percent of net
income. This tapering trend has continued to date, as ALL reversals from third quarter 2012 to third quarter 2013 averaged
$5.5 billion, contributing approximately 15 percent of net income.
The impact of ALL releases will continue to wane as a contributor to net income as ALL balances decline and banks’ loan
portfolios either stop contracting or begin to grow. Total ALL balances measured $263 billion in the first quarter 2010 and
totaled $143 billion at the end of the third quarter 2013, a decline of 46 percent. Also, as lending ticks gradually upward,
banks’ exposure to credit risks will increase likely causing provisions in excess of charge-offs.
The impact of this reduced ALL releases as a contributor to net can be seen in results: FDIC-insured institutions saw
their year-over-year earnings fall by $1.5 billion or 3.9 percent in the third quarter of 2013, the first quarterly downturn
since the second quarter of 2009. Increasingly, banking industry earnings will now be determined not by cyclically
4
low loan loss provisions, but the ability to grow revenues.

4 FDIC: “Quarterly Banking Profile, Third Quarter 2013.”