The latest quarterly report on the United States banking system indicates a profitable and improving industry that seems to contradict the fearful selloff in the marketplace over the last few months.

Net Income
The report was issued by the Federal Deposit Insurance Corporation (FDIC) and covers all commercial banks and savings institutions insured by that organization. The FDIC reports that the 7,513 institutions covered earned $28.8 billion in the second quarter of 2011, up 38% from the same quarter in 2010.

TUTORIAL: Safety and Income

This improvement in earnings was led by lower provisions for loan losses by many banks, which continued to work through the bad loans that piled up over the last few years.

The FDIC also reported that capital levels moved higher with the leverage capital, tier 1 risk-based capital, and total risk-based capital ratios reaching all time highs in the second quarter of 2011. (Find out how economic capital and regulatory capital affects risk management; check out How Do Banks Determine Risk?)

A look at the capital levels of the top five banks in the United States demonstrates this improvement in Tier One capital relative to the peak of the financial crisis and recession:

Company Capital Level
Q1 - 2011 Q4 - 2008
Bank of America (NYSE:BAC) 8.75% 4.70%
JP Morgan (NYSE:JPM) 10.03% 6.53%
Citigroup (NYSE:C) 11.53% 2.43%
Wells Fargo (NYSE:WFC) 9.37% 3.30%
U.S. Bancorp (NYSE:USB) 8.18% 5.41%
Source: FIG Partners

Problem Institutions
The FDIC assigns a rating to each institution under its jurisdiction, as a means of determining which require special attention. Banks given a 4 or 5 rating are those that have "financial, operational, or managerial weaknesses that threaten their continued financial viability" and are labeled as problem institutions.

The number of these problem institutions declined on a sequential basis, to 865 from 888 in the first quarter of 2011. This is the first decline since before the recession and financial crisis began. Some of this decline may be due to the 61 banks that either failed or merged during the second quarter of 2011, but at least the trend is moving in the right direction.

The market has been inundated with talk of a double-dip recession, which has caused many investors to abandon the financial sector as they seek to avoid another bloodbath in their portfolios.

The Financial Select Sector SPDR (NYSE:XLF) peaked at $17 per share in February 2011 and sold off down as low as $11.81 before recovering slightly. This exchange-traded fund is dominated by large banks but also contains some insurance companies.

The SPDR KBW Bank ETF (NYSE:KBE) had a similar and more pronounced selloff over the same time frame, as this exchange-traded fund is exclusively composed of banks.

The Bottom Line
The recent selloff in banks and other financials due to fears of another recession might create opportunities for some investors. The FDIC report, although backward looking, gives confirming evidence of a vastly improved banking system.

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