Bank loans drop, even as profits jump

May 8, 2013, 3:00 PM UTC

FORTUNE — The credit crunch may be over, but we are crawling our way out.

After rising for all of last year, bank lending dropped in the first three months of the year, according to FDIC data compiled by bank research firm The drop comes as low interest rates are squeezing how much money banks can make from their traditional loan business.

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That wasn’t enough to halt the recent rise in bank bottom lines, though. Banks earned more in the first quarter than in any three-month period since the downturn. Collectively, U.S. banks earned $40.3 billion. That was up $5.5 billion from a year ago.

Profits rose, even as banks appeared to be lending less. U.S. banks had $44 billion less in loans at the end of the first quarter than they did three months before. There is some seasonality to the numbers. The biggest drop was in credit card borrowing, which normally falls in the first three months of the year. But home loans were off, too. That’s probably a result of higher interest rates in the first month or so of the year. Rates have fallen since, so mortgage lending could be rising again.

Other categories of lending, though, were up. Business lending rose $24.2 billion. Consumers took out an additional $5.6 billion in auto loans in the first three months of the year.

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A portion of the profit jump came from banks selling their loans to investors rather than holding them on their books. Wall Street’s securitization machine, which turns loans into bonds, has sprung back to life this year after freezing up in the financial crisis. Sales of bonds based on subprime auto loans and mortgages not backed by the government are up. That suggests the drop in borrowing was not as bad as it looked.

“It’s entirely possible that lending was up, but banks sold more of the loans they made than in the past,” says Bill Moreland, who runs

What’s more, nearly half of the profit jump at banks came from fewer loan charge-offs. That makes some sense. As the economy recovers, fewer borrowers are going delinquent on their loans.

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The problem is loan charge-offs are dropping faster than delinquencies. That may be producing unsustainable gains, and setting the banks up for more losses down the road.

“They are delaying charge-offs,” says Moreland. “And they are doing it more and more.”

Had banks charged off loans at the same rate they did a year ago, which was already below average, profits would have been $2.4 billion lower in the quarter.

The banks are not quite fixed.

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