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Why Did Higher Loan Loss Provision Hurt Banks’ Earnings?

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Net operating revenue growth

During the first quarter, net operating revenues of FDIC-insured institutions were higher by 2.7% YoY (year-over-year) at $173 billion. Net operating revenue is calculated as the sum of net interest income and total non-interest income. Net interest income grew 6.7%—aided by the Fed rate hike in December. Non-interest income fell 3.4%. The trading income at large banks was considerably lower. Net interest income inched higher as net interest margins improved due to a sharp rise in asset yields and an increase in interest earning assets. Large banks such as Goldman Sachs (GS), Bank of America (BAC), Wells Fargo (WFC), and J.P. Morgan’s (JPM) asset portfolios were better positioned to gain from the rate hike. They had improved margins.

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Higher loan loss provisions impacted 1Q16 earnings

During the first quarter, banks created loan loss provisions of $12.5 billion. This was ~50% higher YoY. A large portion of the increase comes from large banks that have large exposure to loans in the oil and gas sector.

US banks had a rough start to the year as oil prices fell sharply. Major banks have large oil and gas loan portfolios. With the drop in oil prices, the collateral on these loans becomes less valuable. Companies in the oil and gas sector failed to honor payments on their outstanding loans after they incurred heavy losses when oil prices fell. Large banks increased provisions for losses on these loans. Banks with direct exposure to the energy sector are more vulnerable to the fall in oil prices.

In the next part, we’ll take a look at the net interest margins of US banks (XLF) in the first quarter.

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