While there is plenty of gloom when it comes to banking, expect a few rays of sunshine when banks start reporting second-quarter results next week.

The good news is that net interest margins are on the rise at most banks, thanks to the Federal Reserve's rate hikes and banks’ discipline in keeping deposit costs low.

Another bright spot for the industry was the Fed’s approval of higher dividend payouts and share buybacks after this year’s stress tests, in which all 34 banks passed.

But there are still areas of concern. Commercial lenders have been struggling as businesses have lost confidence that the new presidential administration will deliver on regulatory relief or tax reform anytime soon. Auto and credit card lending also emerged as a source of problems in the first quarter, as a rise in consumer indebtedness has led to worsening credit quality.

Here is a closer look at the questions bank executives will face later this month. The first banks issue results on July 13, with a group of the largest banks, including JPMorgan Chase, Citigroup and Wells Fargo, reporting the next day.

Margins grind higher

The long-awaited period of rising net interest margins is here to stay — for a while, anyway.

Big banks are expected to report slightly higher margins now that the Fed has approved four 25-basis-point rate hikes since December 2015, when it raised short-term rates for the first time in a decade.

Margins were a mixed bag for big banks last quarter. JPMorgan Chase and PNC Financial Services Group reported slightly higher NIMs. Others, including Citigroup and Wells Fargo, saw their margins decline, dragged down by excess cash deposits. Across the industry, margins climbed on average by 9 basis points from a year earlier, to 3.19%, according to the FDIC.

When banks start reporting results this month, expect NIMs to increase for most big banks, though it is unlikely that the latest rate hike, on June 14, will prove to have been much of a contributing factor.

“I would say that [big banks] are on the precipice” of reporting higher NIMs across the board, said Gerard Cassidy, an analyst with RBC Capital Markets.

A steady increase in the benchmark London interbank offered rate, commonly called Libor, has also lifted margins, said Peter Winter, an analyst with Wedbush Securities.

Margins are expected to continue increasing gradually over the next six to 12 months as banks reap the benefit of paying historically low deposit costs.

Thus far, only short-term rates have improved. But the Fed’s plan to shrink its $4.5 trillion balance sheet by selling off securities should also boost long-term rates, Joe Gladue, an analyst at Merion Capital Group, wrote in a June 29 report. That could lead to a rise in the 10-year Treasury note and other long-term benchmarks.

“Those banks with lots of adjustable-rate loans and significant core deposit funding will see the most benefit,” Gladue said.

But it won’t last forever. Margins will start to come under pressure when big banks boost deposit rates for consumers. Once that happens, the future pace of deposit-rate increases may occur faster than in previous cycles, Cassidy said.

That is because competition for deposits is expected to be fierce as consumers chase higher-yielding accounts. Compared with when the Fed raised interest rates in 2006, consumers can more easily open and transfer funds thanks to advances in digital banking technology.

Additionally, once the Fed starts moving to unwind its balance sheet — which it unveiled plans for in June — all banks could see declining deposit levels, analysts said. That would intensify competition as institutional clients park excess cash in Treasury securities instead of bank accounts.

Commercial loans continue to drag

Commercial lending has been nothing to write home about for months. Don’t expect that to change — at least not much — when banks report second-quarter results.

After decelerating for several months, business lending has remained lackluster, though it is showing some signs of improvement.

Commercial and industrial loan growth declined by about 1% during the first quarter compared with a year earlier, according to data from the Fed. By comparison, it jumped by 6% during the month of April, but nearly flattened to about 1% in May.

“It’s not like the growth is robust by any means,” Winter said, though he noted that bankers have reported a surge in loan pipelines.

Until experiencing a precipitous drop during the third quarter of last year, commercial lending growth consistently hovered between 8% and 12% for banks across the industry.

Experts have attributed the sharp decline in loan growth to uncertainty about the prospect for business-friendly reforms in Washington. The Republican sweep in the November elections, for instance, raised the prospect for tax reform. Additionally, a bill to overhaul the health care system has hit some roadblocks on its way through Congress.

How either of those legislative efforts will play out is unclear.

Legislative uncertainty is not entirely to blame for the slowdown. There has also been a lull in the financing of M&A activity, Cassidy said.

“One of the reasons why it has slowed down is that financial engineering loans have slowed down,” he said.

However, executives at large and midsize businesses still have an appetite to invest in their business, Cassidy said.

All eyes on consumer credit

Credit cards emerged last quarter as a potential new source of trouble, and auto-lending worries have persisted for months. So, many bank watchers will be focused on consumer lending trends in the second quarter.

The six largest card issuers each reported higher chargeoffs in their credit card portfolios in the first quarter, on a yearly basis. Capital One Financial in McLean, Va., which has a large subprime card business, had the biggest increase; its net chargeoff rate rose almost 100 basis points to 5.14% from the same period a year earlier.

But Capital One executives had expected there could be some worsening in credit quality because the bank had grown its subprime card portfolio rapidly.

“We’ve been signaling for a while … that we feel very good about the growth we put on, we think it’s going to pay a massive amount of [value] over time,” Chief Financial Officer Scott Blackley said at the Morgan Stanley Financial Services Conference on June 14.

“But we wanted to make sure that investors appreciated that the losses were going to be accelerating and that was exclusively driven by this growth,” he said.

As for auto lending, many banks are tapping the brakes. Fifth Third Bancorp in Cincinnati has reduced its yearly auto-loan originations to about $3 billion, compared with about $5 billion two years ago, CFO Tayfun Tuzun said at the Morgan Stanley conference.

However, Tuzun stressed that Fifth Third’s decision to reduce auto-loan originations was not because of credit quality concerns. Instead, Fifth Third had been playing in the prime section of the auto-loan market, which has lower returns than subprime lending.

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Kristin Broughton

Kristin Broughton

Kristin Broughton is a reporter for American Banker, where she writes about the business of national and regional banking.
Andy Peters

Andy Peters

Andy Peters writes about regional banks, consumer finance and debt collections for American Banker.