U.S. Banks Stock Outlook - Apr 2014
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U.S. banks are on the verge of releasing their first-quarter 2014
results, which are likely to reflect the tough backdrop endured
since the beginning of the year. The quarter remained challenging
with dreary consumer and corporate activities, soft trading
volumes, sluggish mortgage banking activities, and high legal
costs. Further, reserve release is not expected to be strong
enough to support bottom-line growth similar to the past year.
Overall, U.S. banks are apparently losing their luster with too
many mandatory defensive measures thwarting growth. Moreover,
top-line growth remains uncertain as a dearth of significant loan
growth (primarily the home equity lines of credit) and pressure
on net interest margins from a nagging low rate environment,
However, banks have been gradually easing their lending standards
and trending toward higher fees to dodge the pressure on the top
line. Then again, continued expense control and stable balance
sheets should act as tailwinds in the upcoming quarters. Further,
a favorable equity and asset market backdrop, and favorable
macroeconomic factors - such as falling unemployment, a
progressive housing sector and flexible monetary policy - should
pave way for stability. Of course, financial institutions that
depend less on risky activities and resort to other profit-making
ways seem to have a brighter future.
Now that the interest rate environment has reached a reversal
point with the Fed's tapering of fiscal stimulus, net interest
margins are likely to improve and support top line to an extent.
But revenues from mortgage fees will lessen as the boom in
mortgage refinancing fizzles out. Whether the loss of fee
revenues will be compensated by gains from interest rate spreads
can however be said only in the course of time.
We don't see this issue-ridden sector returning to its
pre-recession peak anytime soon. What encourages us though is
that the U.S. banks are getting accustomed to increased legal and
regulatory pressure and resorting to safer alternatives for
higher earnings. This indicates their ability to encounter
challenges and grow at a moderate pace. But structural changes in
the sector will continue to impair business expansion and
investor confidence for some time.
Zacks Industry Rank
Within the Zacks Industry classification, U.S. banks are broadly
grouped in the Finance sector (one of 16 Zacks sectors) and are
further sub-divided into six industries at the expanded level:
Banks-Major Regional, Banks-Midwest, Banks-West, Banks-Northeast,
Banks-Southeast and Banks-Southwest. The level of sensitivity and
exposure to different stages of the economic cycle vary for each
We rank all the 260-plus industries in the 16 Zacks sectors based
on the earnings outlook and fundamental strength of the
constituent companies in each industry. (To learn more visit:
About Zacks Industry Rank
As a guideline, the outlook for industries with Zacks Industry
Rank of #88 and lower is 'Positive,' between #89 and #176 is
'Neutral' and #177 and higher is 'Negative.'
The Zacks Industry Rank for Banks-Southwest is #14, Banks-West is
#34, Banks-Midwest is #38, Banks-Southeast is #58,
Banks-Northeast is #86, and Banks-Major Regional is #94.
Considering the Zacks Industry Rank of the six banking
industries, one could safely say that the outlook for the group
is leaning toward 'Positive.'
Earnings Preview of the Broad Sector
The broader Finance sector, of which U.S. banks are part, is
expected to witness year-over-year earnings decline in
The sector's earnings are expected to decline 3.9% compared with
22.8% growth in the preceding quarter. On the revenue front, a
7.3% decline is expected, compared to a 12.4% plunge in the prior
Though the numbers for the 7 medium-level (or M-level) industries
in the sector will most likely be positive, the growth rates are
mostly expected to decline. Particularly, Major Banks and Banks
& Thrifts are expected to witness 6.8% and 15.2% decline,
Among major Industry players,
JPMorgan Chase & Co.
The Goldman Sachs Group, Inc.
) are expected to experience year-over-year earnings decline.
The consensus earnings expectations for full-year 2014 and 2015,
however, look decent with 5.5% and 11.2% growth rates,
For a detailed look at the earnings outlook for this sector and
others, please read our
Earnings Outlook report
Mega banks have been continuously benefiting from lower funding
and operating costs since the financial crisis. This is because
of the impression that Federal Reserve will always protect these
banks from failing in case of any major financial trouble.
A recent study by Federal Reserve economists suggests that the
biggest banks still enjoy low borrowing costs and take bigger
risks than smaller players because of the U.S. government's
'too-big-to-fail' impression about them. The study estimated that
the five largest banks have enjoyed 0.31% funding advantage over
their smaller peers since 2009. This is statistically significant
according to the researchers.
This malformed notion will continue to keep these banks at an
advantageous position unless anything unfavorable happens.
Does 'Problem Bank List' Indicate Any Good?
The unofficial number of banks on the FDIC's 'Problem List'
increased to 533 as of Apr 4, 2014 from official number of 467 as
of Dec 31, 2013. There were 515 problem banks as of Sep 30, 2013.
The numbers look extremely high considering that the financial
crisis happened five years back. There were only 76 banks on the
"Problem List" at the end of 2007, just before the crisis.
Considering the recovery witnessed by the economy and stock
markets so far, the number of problem banks should have been much
less. This indicates that the industry is still fraught with
During first-quarter 2014, just 5 banks have failed. Though the
number compares unfavorably with 4 failures in the first quarter
of 2013, it still looks decent.
Though fewer bank failures are expected in 2014 compared to 2013,
the industry is still to see an average failure of just four or
five banks annually, which would indicate maximum strength in the
Growth Will Not Be Easy
As the gap between loss provisions and charge-offs is gradually
narrowing, reduction in provisions is not likely to remain a
significant earnings driver in the upcoming quarters. So banks
are trying to look at other areas -- primarily non-interest
income and operating costs. But opportunities will be curbed by
regulatory restrictions and a 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 with the
expected increase in interest rates in the near to mid term.
The low-interest-rate environment following the financial crisis
has a mixed impact on banks. While it reduced their borrowing
costs, limitation to charging 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.
On the other hand, increasing revenues through non-interest
sources -- charges on deposits, prepaid cards, new fees and
higher minimum balance requirement on deposit accounts -- could
be hampered by regulatory actions and soaring overhead. However,
with a rebound in capital market activity, the propensity to
invest in the market has increased, which may lead to more
non-interest revenue sources.
Eventually, banks will have to resort to cost containment through
job cuts and reduced operational size. But any cost-cutting
measure will act as a defense. The industry witnessed more than
half a million layoffs over the last five years just to stay
afloat, and the story will continue.
Is Balance Sheet Recovery On Track?
Steady deposit growth from lack of low-risk investment
opportunities is quite possible, but high charge-offs and
delinquency rates plus weak demand could keep loan growth under
pressure in the near to mid term. Though banks are easing lending
standards to accelerate loan growth, credit quality concerns are
likely to mar the effort.
Moreover, though growth in gross domestic product (GDP) and
reducing unemployment will help banks strengthen their balance
sheets, expected unrealized losses on underlying securities due
to a likely rise in interest rates will act as dampeners.
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 anytime
The expected near-term sluggishness in the industry seems to have
started pricing in. So it is perhaps the right time to add some
banking stocks with strong fundamentals to your portfolio.
Specific banks that we like with a Zacks Rank #1 (Strong Buy)
Farmers and Merchants Bancorp Inc.
Capital City Bank Group Inc.
Farmers Capital Bank Corporation
First Financial Corp.
Peoples Bancorp Inc.
Central Pacific Financial Corp.
SVB Financial Group
Stocks in the U.S. banking universe with a Zacks Rank #2 (Buy)
Wells Fargo & Company
Tompkins Financial Corporation
Synovus Financial Corporation
Commerce Bancshares, Inc.
Difficulty in liquidity management due to regulatory restrictions
will continue to restrict top-line growth of banks in the
Specific banks that we don't like with a Zacks Rank #5 (Strong
Republic Bancorp Inc.
North Valley Bancorp
). We also don't recommend a few Zacks Rank #4 (Sell) banks
Bank of America Corporation
Chicopee Bancorp, Inc.
Regions Financial Corporation
Park National Corp.
Bank of Hawaii Corporation
Texas Capital BancShares Inc.