Midtier banks desperate for earnings growth will have to wait until interest rates rise, a report from Fitch Ratings says.
Core earnings for 19 regional banks will continue to be pressured by tight margins, declining fee income and lower reserve releases, Fitch said in its annual review of midtier banks, released Thursday. The agency expects flat or declining earnings, and issued an overall stable rating for the sector.
On the positive side, the agency expects good liquidity and capital levels, low credit costs and continued improvement in asset-quality. But these positives could be tempered by core earnings weakness, rising home equity risk and worsening underwriting standards, particularly for commercial loans, Fitch says.
"Fitch believes earnings are near their cyclical trough and will improve once short-term interest rates rise," the report reads. "Absent a rise in short-term rates, a sharp improvement in earnings is unlikely for the midtier group."
Fitch looked at regional banks with assets between $10 billion and $37 billion, giving all but three a "stable" rating. Synovus Financial (SNV) was given a "positive" rating and TCF Financial (TCF) and Peoples United Financial (PBCT) were both rated "negative." Average return on assets for the group was 0.86% in the first quarter, below the 10-year average of 0.94%.
The report comes amid suggestions that the Federal Reserve may raise rates sooner than expected. St. Louis Fed President James Bullard said Wednesday that a rate rise could come late this year; he had previously targeted early 2015 for an increase.
Most midtier banks have positioned their balance sheets to prepare for rising rates, but could be caught unprepared if rates rise in an unexpected way sharply rather than gradually, for instance. Rapidly rising rates could hurt refinance activity and cause a loss of corporate deposits. Overall, the effect of rising rates on bank balance sheets could be "dramatically different" than what most models predict, says Fitch.
Loan growth for the midtier regionals has been solid at 7.5% year-over-year, better than the 3.5% average for large regionals, Fitch said. But the agency warned that underwriting standards have been declining over the past several years, particularly for commercial and industrial loans. The Office of the Comptroller of the Currency sounded a similar note of caution in a report released Wednesday, saying there has been a "gradual loosening of credit policies in response to competitive pressures" among community and midsize banks.
The Volcker Rule's ban on bank holdings of collateral loan obligations will have minimal effect on midtier regionals, Fitch says. Only five banks in the sector hold CLOs: First Niagara Financial Group (FNFG), First Republic (FRC), Webster Financial (WBS), FirstMerit (FMER) and East West Bancorp (EWBC).
Bank stocks were down sharply early Thursday but quickly recovered. The KBW Bank Index was down less than 1% by midafternoon.