Industry: U.S. Banks
Continued narrowing of the gap between loss provisions and charge-offs will not allow contracted provision to significantly drive earnings in the upcoming quarters. So banks are trying to look at other areas – primarily non-interest income and operating costs. While cost reduction through reorganizing operations and job cuts will support bottom line, opportunities for generating non-interest revenues – from sources like charges on deposits, prepaid cards, new fees and higher minimum balance requirement on deposit accounts – would be curbed by regulatory restrictions and still shaky economic recovery.
Efforts to cut interest expenses and take additional risks to improve net interest margins could be marred by a still-flat yield curve. Further, shifting assets to longer maturities for strengthening net interest margin could backfire if the Fed decides to increase interest rates in the near to midterm.
The persistent low-interest-rate environment has a mixed impact on banks. While it reduced their borrowing costs, limitation to charge high interest on loans marred revenues. When interest rates finally start rising, benefits of banks will depend on their ability to charge more for loans than what is paid on deposits.
However, increasing propensity to invest in the market on the back of an improved employment scenario may create more non-interest revenue sources. Grabbing these opportunities will require higher overhead, so cost management needs to be more efficient to realize some benefit.
As a key strategy, banks will have to resort to cost containment, but it would act only as defense and not a concrete way to lessen top-line pressure. The industry witnessed more than half a million layoffs over the last five years just to stay afloat, and the story will continue.
Steady deposit growth from lack of low-risk investment opportunities is quite possible. Also, demand for loans has been increasing with the recovering economic condition and relatively easy lending standards. But banks have still been witnessing high charge-offs and delinquency rates that could limit loan growth.
Moreover, though growth in gross domestic product (GDP) and reducing unemployment will help banks strengthen their balance sheets, reversal of interest rate environment will result in unrealized losses on underlying securities.
However, banks are trying to reorganize risk management practices to address potential solvency issues from rising interest rates. Efforts are also being given to address asset-quality troubles by divesting nonperforming assets. Yet, we don’t expect balance-sheet strength to return to pre-recession peak any time soon.
The expected near-term sluggishness in the industry and downbeat guidance from a number of industry participants seem to have started pricing in. So one may consider buying some bank stocks that promise better performance based on their strong fundamentals.
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SOURCE Zacks Investment Research, Inc.