A major recovery in the asset markets, improving balance sheets and
declining credit costs promise growth for the U.S. banking sector.
Yet, the outlook for the industry remains in question due to
several negatives, including asset-quality troubles, the
continuation of both residential and commercial real estate loan
defaults, weak loan demand, and the impact of tighter regulations
and policy changes.
After enduring overwhelming recessionary shocks, the U.S. banking
industry is now slowly recovering. 2010 can be certainly
characterized as a year of reform. Financial support from the U.S.
government ultimately transformed to comparative stability during
the year.
The government had taken 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. However, the
industry is still grappling with weak revenue, ebbing loan demand
and low liquidity challenges.
After more than two and half years of initiating the Troubled Asset
Relief Program (TARP), a lot has improved with respect to the
economic crisis. Also, looking back at the calculation released by
the Treasury in March, TARP will finally earn about $23.6 billion
by 2013. Considering the effectiveness in easing credit and capital
market pressure, restoring confidence in the financial system, and
recovering the injected money at a lower-than-expected cost, it can
be concluded that the government’s highly criticized bailout
program has finally turned out to be a winner.
Out of the total $700 billion bailout money, about $245 billion was
handed out to banks in 2008. With repayments by
SunTrust
Banks, Inc. (STI),
KeyCorp (KEY) and
Financial Institutions Inc. (FISI) in March,
taxpayers have recovered a total of $251 billion from bailed out
banks, realizing profit of about $6 billion. This recovery includes
dividends and interest income from banks.
However, more than $20 billion is still due from over 550
institutions. Once these institutions reimburse, profits from the
bank bailout will increase even more.
With more banks releasing reserves, we expect provision for loan
losses to continue declining at least till the end of 2011. Also,
the problems with small banks might end up under the wing of bigger
institutions.
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.
Macroeconomic Headwinds
There are several macroeconomic factors that may cave in the
profitability of the U.S. banks.
Among others, the quantitative easing policy (QE2) of the Federal
Reserve is expected to significantly reduce long-term rates, which
will keep net interest margins under pressure.
Though the financial reform law signed by President Obama in 2010
empowers the government to tighten regulations for companies that
could jeopardize the economy, these may pose threats to
profitability for the country's biggest banks in the near- to
mid-term. Many restrictions under the law related to proprietary
trading and interchange fees are the most notable among such
risks.
Then again, while the implementation of Basel III 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 process.
Bank Failures Continue
While the financials of bigger banks have been stabilizing on the
back of an economic recovery, many smaller banks are still
struggling to survive. Rock-bottom home prices along with
still-high loan defaults and unemployment levels continue to
trouble such institutions relentlessly.
Many banks continue to shoulder the lingering effects of the
financial crisis. It becomes a prerequisite for such banks to
absorb bad loans offered during the credit explosion, making them
susceptible to some severe problems. As a result, we continue to
see bank failures.
Furthermore, government efforts have not succeeded in restoring
lending activity at the banks. Lower lending will continue to hurt
margins and the overall economy, though the low interest rate
environment should be beneficial to banks with a
liability-sensitive balance sheet.
Eventually, the strong banks will continue to take advantage of
strategic opportunities, with the big fish eating the little
ones.
Adding to the banking woes are the lingering economic concerns.
While the economy is in a recovery phase, a lot remains to be done.
The Treasury continues to hold huge direct investments in
institutions like
Fannie Mae (FNMA) and
Freddie Mac (FMCC).
However, according to an article published by Standard & Poor's
on December 1, 2010, U.S. banks are expected to slowly improve
their profitability with the fall of credit costs in 2011.
Additionally, Fitch Ratings retained its stable outlook on the
banking industry for 2011. The rating agency expects the financials
of banks to improve modestly as macro conditions will take some
time to stabilize.
Though it will be a while before we can write the end for this
crisis story, banks are expected to perk up in 2011.
OPPORTUNITIES
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
Webster Financial Corp. (WBS),
State Bancorp Inc. (STBC),
Independent
Bank Corp. (INDB),
Chemical Financial
Corp. (CHFC) and
TriCo Bancshares
(TCBK).
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 Corp. (BOKF), Access National Corp.
(ANCX),
Ameris Bancorp (ABCB),
Arrow
Financial Corporation (AROW),
Bancorp Rhode Island
Inc. (BARI),
Tower Financial Corporation
(TOFC),
Enterprise Financial Services Corp. (EFSC)
and
Bridge Capital Holdings (BBNK).
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 lower than in recent years.
Furthermore, the financial crisis has resulted in industry
consolidation, which might expedite in the upcoming quarters.
Among the Zacks covered U.S. banks,
Bank of America
Corporation (BAC) currently retains a Zacks #5 Rank, which
translates into a short-term Strong Sell rating. Also, based on the
company’s disappointing first quarter results and the Federal
Reserve’s objection to its proposed capital deployment in the
second half of 2011, we maintain our long-term Underperform
recommendation on the stock.
Also, there are currently three more stocks with a Zacks #5 Rank
(short-term Strong Sell rating), which are
MBT Financial
Corp. (MBTF),
Princeton National Bancorp
Inc. (PNBC) and
Washington Banking Co.
(WBCO).
AMERIS BANCORP (ABCB): Free Stock Analysis Report
ACCESS NATL CP (ANCX): Free Stock Analysis Report
BOK FINL CORP (BOKF): Free Stock Analysis Report
CHEMICAL FINL (CHFC): Free Stock Analysis Report
FINANCIAL INST (FISI): Free Stock Analysis Report
FREDDIE MAC (FMCC): Free Stock Analysis Report
FANNIE MAE (FNMA): Free Stock Analysis Report
INDEP BK MASS (INDB): Free Stock Analysis Report
KEYCORP NEW (KEY): Free Stock Analysis Report
STATE BANCRP NY (STBC): Free Stock Analysis Report
SUNTRUST BKS (STI): Free Stock Analysis Report
TRICO BANCSHRS (TCBK): Free Stock Analysis Report
WEBSTER FINL CP (WBS): Free Stock Analysis Report
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