Data showed last week that the net income of US banks was higher in the first quarter than at any time since the financial crisis. However, a rough patch may be round the corner, according to analysts.
A potential double risk of a renewed downturn in the real estate markets and a debt default by at least one euro-zone nation may restrain net income in future quarters and perhaps constrain the supply of credit, Capital Economics analysts Paul Ashworth and Paul Dales wrote in a note on Monday.
U.S. banks shook off the dark days of the credit crisis and the recession by registering a growth in net income in successive quarters mainly owing to their ability to reduce their loan loss provisions. According to the analysts, the rise in net income would not have been possible if banks were unable to cut provisions for bad loans.
"In the first quarter, banks' earned income fell by $3bn, from $191bn to $188bn, and their expenses declined by $4bn, from $129bn to $125bn. The increase in net income would therefore have been much smaller if banks had not cut their loan loss provisions by $12bn, from $32bn to $20bn."
"Net income only improved because banks expect fewer loans to go bad."
The analysts point out that U.S banks are better capitalized now than at any time in at least 20 years and that neither a rise in real estate loan losses nor a debt default by any of the four euro-zone nations would severely trouble the US banking sector.
"Nonetheless, any such losses may prevent banks from further reducing their loan loss provisions and boosting net income," they caution.
The most recent drop in overall bank loans has more to do with a decline in the demand for borrowing than a contraction in the supply, according to the analysts. "This will only remain the case if banks are able to continue to generate net income by reducing their loan loss provisions," they say.
However, they caution that there are at least two risks that may prevent that from happening. At some point banks may have to absorb losses generated by the escalating fiscal crisis in the euro-zone, they say. And then, there is a chance that banks' exposure to real estate losses may yet increase.
"... there remains a lot of uncertainty over what a sovereign debt default by a euro-zone nation would mean for global financial markets and European banks. It is not too hard to envisage a scenario in which global liquidity becomes scarce and US banks struggle to recoup funds from eurozone government or European banks," Ashworth and Dales wrote in the note.
"In the first quarter, 40%, or $4200bn, of banks' assets were linked to the residential and commercial real estate markets. And banks are currently writing-off 1.5% of those loans, resulting in losses of $60bn per year.
"Admittedly, that net charge-off rate has fallen from 2.7% at the end of 2009, which explains why banks have been able to reduce their loan loss provisions and boost net income. But it is possible that at some point the net charge-off rate will rise again," they cautioned.