The recurrence of the intimidating 2008 meltdown is not expected
for the U.S. banking industry in 2012 as the financial institutions
are actively responding to every legal and regulatory pressure. In
fact, this promptness has positioned the banks well to encounter
impending challenges.
However, the potency of the sector is not expected to return to its
pre-recession peak anytime soon. The economic intricacy may even
result in further disappointments in the upcoming quarters.
As the sector is undergoing a radical structural change, it will
witness headwinds in the near- to mid-term. But entering the new
capital regime will significantly improve the industry’s long-term
stability and security.
Along with increasing earnings, a major recovery in the asset
markets, improving balance sheets and declining credit costs
promise growth for the U.S. banking sector, though at a
slower-than-normal pace. Yet the outlook for the industry remains
in question due to several negatives, including asset-quality
troubles, weak revenue growth, steeper costs, continuation of both
residential and commercial real estate loan defaults, weak loan
demand, and the impact of tighter regulations and policy
changes.
Looking back, after enduring overwhelming recessionary shocks, the
U.S. banking industry has gradually started recovering. Financial
support from the U.S. government ultimately transformed to
stability during the year.
The government undertook several steps, including programs offering
capital injections and debt guarantees, to stabilize the financial
system. Also, the banks are working hard to address problem credit,
primarily in residential and commercial real estate. Commercial
real estate loan performance is expected to show strong improvement
during 2012. However, the industry is still grappling with weak
revenue, ebbing loan demand and low liquidity challenges.
Earnings Growth to Decelerate
Though reduced loss provisioning has helped the industry witness
strong earnings growth over the last couple of years, we don’t
expect a significant pick up in upcoming earnings to come from
provision reductions as the difference between loss provisions and
charge-offs is gradually reducing.
Banks will definitely try to look at other areas -- interest
income, non-interest income and operating costs -- to keep the
earnings growth intact, but we don’t see any significant
opportunity with respect to top line in the upcoming quarters.
Interest income will remain under pressure due to low interest
rates and a sluggish loan growth. Though banks will try to cut
interest expenses and take additional risks to improve net interest
margins, the flattening of the yield curve will mar the efforts.
Ultimately, banks will be forced to face lower margins. In fact, if
the banks shift assets toward longer maturities to keep net
interest margin strong, this could backfire once interest rates
start rising.
On the other hand, attempts to boost revenues through non-interest
sources -- introducing new fees, increasing minimum balances
requirement on deposit accounts and encouraging customers to use
credit cards -- are expected to be hampered by ongoing regulatory
actions, a volatile global economy and soaring overhead. So,
non-interest income will be able to marginally contribute to total
revenue.
Lower industry revenue will finally force these banks to cut costs
in order to stay afloat. As a result, banks will continue cutting
jobs and reducing the size of operations by selling non-core
assets. So, any cost cutting measure will act as a defense.
Balance Sheet Recovery to Take Time
Since last year, banks have been trying to address asset-quality
troubles through the disposition of nonperforming assets. Also,
non-core asset shedding has become an industry trend as banks have
no other alternative to keep capital ratios above regulatory
requirements.
This non-core asset-selling along with elevated charge-offs and
weak demand will likely keep loan growth under pressure in the
near- to mid-term. Moreover, heightened regulatory restrictions and
soaring delinquency rates will hinder loan growth. However, banks
will experience steady deposit growth on the lack of low-risk
investment opportunities due to the global economic turmoil and
volatility in equity markets.
So, we don’t expect a significant strength in balance sheets to
return anytime soon.
Resistance to Regulatory Challenges
Following the latest recession, the regulatory environment has
become tougher and costlier for U.S. banks. During 2011, banks had
to face a number of regulatory requirements under several laws,
including the Dodd-Frank legislation, the Durbin Amendment and the
Volcker Rule. Banks are expected to face many other regulatory
headwinds in the upcoming quarters as regulators are focused on
global alignment. Though the aim is to meaningfully change the
business models of banks to make them self-sufficient over the
longer term, the cost of compliance will drag down profitability in
the near- to mid-term.
While the implementation of the Basel III requirements will boost
minimum capital standards, there will be a short-term negative
impact on the financials of U.S. banks as they will have to adjust
their liquidity management processes. In the long run, though, a
greater capital cushion for the larger banks will add to their
ability to withstand future shocks. However, banks will get the
time to strengthen their capital position as the Basel III
requirements will be gradually introduced during the 2013 to 2019
period.
Macroeconomic Headwinds
There are several macroeconomic factors that may weigh on the
profitability of the U.S. banks. The most crucial among these is
the uncertain outlook for the U.S. economy.
Though economic data points to optimism in 2012, the economy
entered the first quarter of 2012 with a lot less momentum than was
earlier anticipated. Concerns have crept up in the slothful stock
market momentum, exacerbated by the ongoing concerns related to the
European debt crisis.
Though the U.S. commercial banks appear to have significant direct
and indirect exposure to Europe, the potential costs are expected
to be manageable. However, if the crisis extends further, there
will be significant impact on worldwide capital markets and U.S.
will not be left unscratched. Consequently, U.S. banks will face
increased challenges.
On the other hand, the extremely low interest rate environment is
another manifestation of this uncertain macro backdrop. Concerns
about European finances and soft U.S. growth prospects have made
treasury instruments the choice of safe asset class.
As a result, yields on benchmark treasury bonds have been hovering
around record low levels. The Fed’s commitment to keep the Fed
Funds rate at current levels for another two years is adding to
this low interest rate trend.
Bank Failures Continue
While the financials of a few large banks have been stabilizing on
the back of an economic recovery, the industry is still on shaky
ground. Nagging issues like depressed home prices along with
still-high loan defaults and unemployment levels continue to
trouble such institutions.
Lingering economic uncertainly and its effects also continue to
weigh on many banks. The need to absorb bad loans offered during
the credit explosion has made these banks susceptible to severe
problems.
Furthermore, government efforts have not succeeded in restoring
lending activity at the banks. Lower lending will continue to hurt
margins, though the low interest rate environment should be
beneficial to banks with a liability-sensitive balance sheet.
Increasing loan losses on commercial real estate could trigger
hundreds of bank failures in the upcoming years. However, the worst
appears to be over and the pace of bank failures is expected to be
slower. Considering the course of failure last year, the number of
bank failures in 2012 is not expected to exceed the 2011 tally.
Eventually, the strong banks will continue to take advantage of
strategic opportunities, with the big fish eating the little
ones.
Conclusion
Clearly, the banking system is not yet out of the woods, as there
are several nagging issues that need to be addressed by the
government before shifting the strategy to growth. We believe that
the U.S. economy will regain its growth momentum once these are
resolved.
However, before the banking sector regains investors’ confidence,
it is likely to meet several disappointments on the way that would
offset positive developments.
OPPORTUNITIES
The regulatory requirement of focusing on banking institutions
toward higher-quality capital will help banks absorb big losses.
Though this would somewhat limit the profitability of banks, a
proper implementation would bring stability to the overall sector
and hopefully keep bank failures in check.
Specific banks that we like with a Zacks #1 Rank (short-term Strong
Buy rating) include
Metrocorp Bancshares Inc.
(MCBI),
Texas Capital BancShares Inc. (TCBI),
Viewpoint Financial Group (VPFG),
S&T
Bancorp Inc. (STBA),
Sterling Bancorp
(STL),
First Financial Corp. (THFF),
Privatebancorp Inc. (PVTB),
First
Community Corporation (FCCO),
Oriental Financial
Group Inc. (OFG),
StellarOne Corporation
(STEL),
BBCN Bancorp, Inc. (BBCN) and
Heritage Commerce Corp. (HTBK).
There are currently a number of stocks in the U.S. banking universe
with a Zacks #2 Rank (short-term Buy rating). These include
BOK Financial Corporation (BOKF),
Southwest Bancorp Inc. (OKSB),
Center
Bancorp Inc. (CNBC),
Financial Institutions
Inc. (FISI),
Horizon Bancorp. (HBNC),
Chemical Financial Corp. (CHFC),
Park
National Corp. (PRK),
First Horizon National
Corporation (FHN),
IberiaBank Corp.
(IBKC),
First Republic Bank (FRC) and
U.S.
Bancorp (USB).
WEAKNESSES
The financial system is going through massive deleveraging, and
banks in particular have lowered leverage. The implication for
banks is that the profitability metrics (like returns on equity and
return on assets) will be under pressure.
There are currently three stocks with a Zacks #5 Rank (short-term
Strong Sell rating). These are
Old Second Bancorp
Inc. (OSBC),
BofI Holding Inc. (BOFI) and
Hanmi Financial Corporation (HAFCD).
BOK FINL CORP (BOKF): Free Stock Analysis Report
FIRST COMMTY CP (FCCO): Free Stock Analysis Report
HERITAGE COMMRC (HTBK): Free Stock Analysis Report
METROCORP BANCS (MCBI): Free Stock Analysis Report
ORIENTAL FINL (OFG): Free Stock Analysis Report
PRIVATEBANCORP (PVTB): Free Stock Analysis Report
S&T BANCORP INC (STBA): Free Stock Analysis Report
STELLARONE CORP (STEL): Free Stock Analysis Report
STERLING BANCRP (STL): Free Stock Analysis Report
TEXAS CAP BCSHS (TCBI): Free Stock Analysis Report
FIRST FINL-IND (THFF): Free Stock Analysis Report
VIEWPOINT FINL (VPFG): Free Stock Analysis Report
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