Mounting evidence of deteriorating credit quality has market watchers paying much more attention to revenue growth and they see a problem.
Analysts say many banking companies are not generating enough revenue growth to compensate for steadily rising levels of nonperforming loans. This was not the case for much of the last decade, when loan-loss provisions and chargeoffs were on the decline, the cost of capital fell, and banks aggressively bought back stock.
Rising interest rates are changing that. Credit costs are up as well, and with stronger competition for new customers, revenues are not growing fast enough, said Henry C. Dickson, an analyst at Lehman Brothers. Banks dont have the operating leverage they enjoyed in most of the 1990s, he said.
The outlook for 2001 earnings reflects this sentiment. Consensus estimates for a host of big and mid-tier regional banks including Bank of America Corp., Chase Manhattan Corp., SunTrust Banks Inc., Wachovia Corp., BB&T Corp., and Pacific Century Financial Corp. dropped in the days after they announced their third-quarter earnings. Financial services companies share prices have also tumbled in recent weeks on fears of losses from problem loans and junk bond trading and a slowdown in the capital markets activities that have lifted bank profits for the last few years.
Bankers themselves have raised questions. L.M. Bud Baker, chairman of Wachovia, which reported a 55% spike in nonperforming assets from second-quarter levels, said, This is a new environment, and we still dont know as much about it as we should.
Even if fee revenue were stronger, what has so far been a relatively minor rise in the ratio of nonperforming assets to total loans for the industry would not be cause for panic, analysts said, but some added they were skeptical that that would happen. The current weakness in the equity and high-yield markets creates substantial risk that investment banking, venture capital, trading, principal investing, and asset management revenues are all vulnerable to a decline, said George Bicher, an analyst at Deutsche Banc Alex. Brown.
Is the problem more one of perception than reality?
Two weeks ago, a report on the Shared National Credit Program was made public. It said 3.3% of $1.9 trillion in loan commitments was classified by regulators as substandard, doubtful, or loss. That is viewed as an alarming rise from the 2% found in 1999, but it is nowhere near the 10% level reached in 1991 at the height of the lending crisis.
People are worried about the market, credit quality, the IPO calendar. There has been a broad scare, said Lori Appelbaum, an analyst at Goldman Sachs Group. She added, however, the industry is in decent shape, and that most of the problems have been isolated to a few companies so far.
Indeed, SouthTrust chairman Wallace D. Malone Jr. said this month that he expects an easing of pressure on profits from lending in the coming months. We are comfortable with the current First Call consensus for the fourth quarter, he said.
Diane Glossman, a bank analyst at UBS Warburg, said that while the big problems expected in the third quarter for companies like First Union Corp. and Bank of America Corp. did not materialize, any increase in nonperforming assets is worrisome. Pretty soon, it adds up to real money, she said.
Nonperforming assets at Bank of America rose 13% from the second quarter, to $4.40 billion. James Hance, chief financial officer, said he expects bad loans to increase in the next two quarters as well. The company, he added, is comfortable with these projections.
Marni Pont ODoherty, a bank analyst with Keefe, Bruyette & Woods Inc., says the problem is a real one. We knew this would be on the horizon, but the needle wasnt moving yet, she said. Now, the needle is moving.
