U.S. banks are showing signs of strength despite being compelled
to meet strict regulatory standards. Though it's too early to be
confident about the sector's growth prospects, the progress seen in
the first half of 2013 indicates a brighter future for those
depending less on risky activities and resorting to other
Nonstop expense control, sound balance sheets and lesser credit
loss provisions are the key drivers of this advancement. Moreover,
a favorable equity and asset market backdrop, falling unemployment,
a progressive housing sector and flexible monetary policy have been
making the road to growth smoother.
Yet top-line growth remains uncertain due to continued sluggishness
in loan growth, pressure on net interest margins from the sustained
low rate environment and less flexible business models owing to
stringent risk-weighted capital requirements (Basel III standards).
However, banks have been gradually easing their lending standards
and trending toward higher fees to dodge the pressure on the top
Now that the interest rate environment is reversing, net interest
margins are likely to improve and support the top line
significantly. But revenues from mortgage fees will lessen as the
boom in mortgage refinancing fizzles out. But whether the loss of
fee revenue will be compensated by gains from interest rate spreads
can be said only in the course of time.
However, it's good to see that U.S. banks are taking legal and
regulatory pressure in their stride, indicating their ability to
encounter impending challenges. But with the economy in disarray,
we don't see the sector returning to its pre-recession peak anytime
Overall, structural changes in the sector will continue to impair
business expansion and investor confidence. Several dampening
factors -- asset-quality troubles, mortgage liabilities and tighter
regulations -- will decide the fate of the U.S. banks in the
quarters ahead. But entering the new capital regime will ensure
long-term stability and security for the industry.
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-Major Regional and Banks-Midwest
is #26, Banks-West is #36, Banks-Northeast and Banks-Southeast is
#40 and Banks-Southwest is #61. Considering the Zacks Industry Rank
of the six banking industries, one could safely say that the
near-term outlook for the group is 'Positive.'
Earnings Trend of the Sector
The broader Finance sector, of which U.S. banks are part, remains
in excellent shape with respect to earnings. So far, 83.3% of the
sector participants have reported second-quarter results, which
have been very strong in terms of both beat ratios (percentage of
companies coming out with positive surprises) and growth.
Both earnings and revenue beat ratios were pretty robust at 73.8%
and 61.5%, respectively. Also, total earnings for the companies
that have reported so far have shown an impressive 29.8% year over
year increase on 8.6% growth in revenues. This compares with a
substantially lower earnings improvement of 7.4% on 5.1% growth in
revenues in the first quarter of 2013.
The consensus earnings expectations for the rest of the year also
depict a fairly strong trend. Though earnings growth is expected to
slowdown to 8.0% in the third quarter, a stupendous improvement of
27.9% is expected in the fourth quarter. Overall, the sector is
expected to register full-year growth of 16.1%.
For a detailed look at the earnings outlook for this sector and
others, please read our weekly
Banks Show Potency
While 16.7% of the companies in the Finance sector are yet to come
out second-quarter 2013 results, all major banks have already
reported. Surging profits of the mammoths such as
JPMorgan Chase & Co.
Wells Fargo & Company
) were primarily backed by loan loss reserve releases. Similar to
the last few quarters, banks set aside less money for bad loans
this quarter. So, the core earnings power of the sector is still
Overall results of the mega banks show that top line still needs to
improve for assured strength in performance. However, the positive
developments of the sector and better macroeconomic elements helped
most of the business segments of banks report improved results. A
boom in investment banking in recovering financial markets led to
The Federal Deposit Insurance Corporation (FDIC) has yet to release
the second-quarter results for FDIC-insured commercial banks and
savings institutions. But the progress seen in the first quarter is
a clear growth indicator.
FDIC-insured institutions earned $40.3 billion in the first
quarter, up 15.8% from the year-ago quarter. This marked the 15th
straight quarter of year-over-year earnings increase.
Besides contraction in provisions for credit losses and cost
containment, marked recovery in the bond and equity markets and
consequent growth in noninterest income helped most of the banks
report higher-than-expected earnings. Given the solid results by
the mega-banks in the second quarter, the improvement is likely to
have further gained ground.
Bank Failures and Problem Institutions
During the second quarter of 2013, the failure of FDIC-insured
banks increased to 12 from only 4 in the first quarter. However, 16
bank failures in the first half of the year compare favorably with
31 in the year-ago period.
The reduced pace of bank failures indicate continued improvement in
the sector. Though fewer banks are expected to fail in 2013
compared to 2012 (51 bank failures), the industry is still to see
an average failure of just four or five banks annually, which would
indicate maximum strength in the industry.
Moreover, as of Mar 31, 2013, the number of banks on the FDIC's
"problem list" declined from 651 to 612. The continued decline in
problem banks indicates a nonstop recovery of the industry. The
latest positive trends in the industry are expected to further
shorten the FDIC's "problem list" for the second quarter of 2013.
Bottom Line Growth: Still a Challenge
We don't expect reduction in provisions for credit losses to
significantly help earnings growth in the upcoming quarters, as the
difference between loss provisions and charge-offs is gradually
Banks will definitely try to look at other areas -- interest
income, non-interest income and operating costs -- to maintain
earnings growth, but there will be limited opportunities given
regulatory restrictions and sluggish 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.
Though rising interest rates will help improve net interest margins
-- the key source of bank's profitability -- revenues from mortgage
fees will reduce significantly. The prolonged low-rate environment
encouraged many people to refinance their mortgages, which resulted
in hefty fees for banks. Now the rising interest rates will lessen
mortgage refinancing and consequently fee revenues.
Conversely, increasing revenues through non-interest sources --
prepaid cards, new fees, higher minimum balance requirement on
deposit accounts and pushing credit cards -- could be hampered by
regulatory actions, economic volatility 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. So, non-interest income can support
total revenue to some extent.
Eventually, banks will have to take resort to cost containment
through job cuts and reduced size of operations to stay afloat. So,
any cost-cutting measure will act as a defense. The industry
witnessed more than half a million layoffs over the last five
years, and the story continues.
Balance Sheet: Recovery Underway
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 through the remainder of the year. 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
rising interest rates will act as dampeners.
However, banks are trying to reorganize risk management practices
to address potential solvency issues due to rising interest rates.
Efforts are also being given to address asset-quality troubles by
divesting nonperforming assets. However, we don't expect
balance-sheet strength to return anytime soon.
Basel III: A Major Concern
The implementation of Basel III requirements from this year will
boost minimum capital standards. But adjusting liquidity management
processes will cause a short-term negative impact on the financials
of U.S. banks.
This will ultimately make credit costlier and reduce employment.
But a greater capital cushion will help larger banks withstand
internal and external shocks over the long run.
Macro Backdrop Still Uncertain
Improved economic data such as higher consumer spending and GDP,
improving housing market and declining unemployment rate point
towards optimism, but the current low-rate environment and an
expected increase show a bumpy road map toward growth.
The European debt crisis, which is still not over, could make the
situation worse. Though U.S. commercial banks appear to have
significant direct and indirect exposure to Europe, potential costs
are expected to be manageable. There are some signs of hope, but if
the crisis deepens further, global capital markets will face a big
blow, and the U.S. will not go unscathed.
Though improved performances by banks seem already priced in and
significant concerns remain, the sector is unlikely to disappoint
investors in the upcoming quarters.
Specific banks that we like with a Zacks Rank #1 (Strong Buy)
Enterprise Financial Services Corp.
First Interstate Bancsystem Inc.
East West Bancorp, Inc.
Glacier Bancorp Inc.
Metro Bancorp, Inc.
Webster Financial Corp.
Farmers Capital Bank Corporation
Virginia Commerce Bancorp Inc.
Prosperity Bancshares Inc.
Stocks in the U.S. banking universe with a Zacks Rank #2 (Buy)
currently include JPMorgan Chase & Co., Wells Fargo &
Company, Citigroup, Inc.,
State Street Corporation
BofI Holding, Inc.
Center Bancorp Inc.
Community Bank System Inc.
Synovus Financial Corporation
City Holding Co.
First Financial Bankshares Inc.
Difficulty in liquidity management due to regulatory restrictions
will restrict top-line growth of banks in the quarters ahead.
Specific banks that we don't like with a Zacks Rank #5 (Strong
Eagle Bancorp Montana, Inc.
CNB Financial Corp.
Financial Institutions Inc.
Malvern Bancorp, Inc.
First Community Bancshares, Inc.
Peoples Financial Corporation
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