Home Mutual Funds Why Bigger Increasingly Means Better In US Banking

Why Bigger Increasingly Means Better In US Banking

by admin



KEY TAKEAWAYS

  • U.S. banking giants, led by JPMorgan Chase, fared much better in the first quarter than the rest of the industry.
  • Higher interest rates have boosted interest banks earn on loans, but they also have increased the amount they pay on deposits.
  • Large banks benefited from more diversified revenue streams that helped offset sluggish net interest income—streams most regional banks don’t have.

First-quarter earnings reports highlighted a deepening reality in the world of finance: When it comes to banking, the bigger, the better.

Lenders large and small faced declining growth or outright declines in net interest income, a key driver of profitability. But large U.S. banks managed to offset it with strong revenue growth from other sources—mainly investment banking and capital markets trading.

Most smaller regional, mid-sized and community banks don’t have that luxury, and their earnings reports showed it. They increasingly battled for deposits as the Federal Reserve’s pause in interest rate hikes effectively capped their ability to raise loan fees.

At the same time, the unsteady commercial real estate market that accounts for a sizable portion of regional banks’ loan business has provided additional challenges, especially after the financial turmoil they endured a year ago at this time. Moreover, they rely on real estate loans or real estate as collateral to a greater degree than large banks.

It all adds up to a growing financial chasm between the nation’s largest banks and, essentially, all other lenders. It’s a gulf last year’s turmoil illuminated, and the spotlight hasn’t dimmed.

“In terms of the major trends, the smaller banks are in big trouble,” said Charles Calomiris, a finance professor at Columbia University and former senior official in the Office of the Comptroller of the Currency. “What’s the business model for smaller banks going forward? I don’t know.”

Loan Demand and Deposit Growth Under Pressure

The quarter revealed lackluster loan demand that will pressure net interest income if interest rates remain higher for longer than previously thought, said Suryansh Sharma, a banking analyst with Morningstar. He added that trading revenue, which has doubled in recent quarters for some large banks, offers a cushion smaller banks don’t have.

The nation’s largest bank, JPMorgan Chase (JPM), surpassed consensus first-quarter earnings projections despite lower-than-expected net interest income. Notably, its investment banking and trading profit more than doubled from the fourth quarter and accounted for the majority of the bank’s 44% net income gain.

Likewise, Citigroup (C), Wells Fargo (WFC) and Bank of America (BAC) all exceeded quarterly earnings estimates, mostly on the strength of investment banking, trading and other non-consumer banking activities.

“Regional banks for the most part do not play in that space,” Sharma said. “From a long-term perspective, it’s all about their deposit market share.”

Depositors flocked to larger banks when last year’s balance-sheet woes surfaced at regional banks. However, some regional lenders have capital markets and/or investment banking divisions, albeit much smaller than their money-center rivals. Citizens Financial (CFG), for instance, reported a strong recovery in capital markets fees that helped it boost net income from the fourth quarter.

Still, that wasn’t enough to overcome a drop in average loans and declining net interest income that kept Citizens from meeting the market’s profit expectations. As Wedbush Securities noted in a recent report, that’s a theme running throughout regional banking.

“We believe the lagged impact from the Fed’s rate increases over the past two years may continue to pressure negative credit migration, especially for banks with outsized exposure to commercial real estate and consumer loans,” Wedbush stated. “We believe the pressure on credit metrics for the industry should continue to weaken, especially in a higher for longer rate environment.

The Problem With Commercial Real Estate

A combination of high interest rates and remote work have pressured the commercial real estate (CRE) market. In particular, the values of office buildings and multi-family properties have fallen considerably.

“Smaller banks are confined to things they can do competitively, and that’s almost exclusively real estate,” Calomiris said, noting the local nature of real estate lending can make relationship development easier for nearby banks. “But commercial real estate has been a problem, and it’s about to get a lot worse. It’s been a slow-moving train wreck.”

Last year’s turmoil highlighted the significant CRE exposure many regional banks maintain, and that scrutiny hasn’t abated.

This year, New York Community Bancorp’s (NYCB) woes have cast a shadow over all regional banks. Its shares have plunged 70% this year as the bank required a $1 billion cash injection to stay afloat amid exposure to troubled commercial real estate loans. The bank also identified “material weaknesses” in internal controls that led to the removal of its CEO.

Investors Notice

Even before earnings report season, U.S equity markets revealed the disparity between banking giants and regionals.

Shares of JPMorgan, Citi, Wells and Bank of America each surged 13%-18% in the first quarter. Meanwhile, the KBW Nasdaq Regional Banking Index, a representation of the regional banking sector as a whole, fell 6.6% in the first three months of the year.

Not all regional bank stocks have declined this year. KeyCorp (KEY) and Citizens Financial saw double-digit percentage gains in the first quarter, while U.S. Bancorp (USB) rose 4% and Comerica (CMA) fell marginally

Despite those pockets of gains, regional banks, at least from an investment perspective, have struggled to recover from last year’s balance-sheet scare. The KBW Regional Banking Index has gained just 14% in the past year, compared with 25% for the S&P 500 Index.

Source link

related posts