Have bank profits peaked?

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Higher interest rates helped boost the bottom line for banks last year, but many investors are skeptical about whether the growth streak can continue.

“It’s the million-dollar question,” said Sandler O’Neill analyst Alexander Twerdahl.

Ultimately the answer will vary, depending on which bank you’re asking. But recent earnings trends at banks that trade on three major exchanges — Nasdaq, the New York Stock Exchange and NYSE MKT — offered hopeful signs for the industry overall.

Against a backdrop of rate hikes, many banks continued to contain deposit costs while benefiting from higher yields on both loans and investment securities.

On a year-over-year basis, fourth-quarter earnings per share rose a median of 25.7% for the 346 publicly traded banks that had reported earnings through Feb. 1, according to Sandler O’Neill.

But a linked-quarter comparison may be a better measure, as the federal corporate income tax cut in December 2017 skews the year-over-year comparisons. For the same group of banks, earnings per share rose a median of 0.7% in the fourth quarter, compared with the previous quarter. Twerdahl had projected earnings per share to fall by the same percentage rate.

Many investors and bankers have said this profit growth could be nearing its end. They argue that banks have held back as long as possible on raising deposit prices.

Retail customers are starting to realize that they can shop around for higher rates on savings accounts, Tom Broughton, CEO of the $8 billion-asset ServisFirst Bancshares in Birmingham, Ala., said in a Jan. 22 conference call.

“They’ve been asleep and now they’re starting to wake up, just like the corporate borrowers have,” Broughton said.

The cost of deposits rose a median of 33 basis points in the fourth quarter, on a year-over-year basis, for the group of 346 banks. The cost of funds, which includes liquidity sources like Federal Home Loan Bank advances, increased a median of 37 basis points. (Sandler O’Neill annualized these figures in its analysis.)

Whether this upward trend signals the end of the industry's profit growth remains to be seen. But for smaller banks, that might be the case, Twerdahl said. They have to pay deposit rates above market averages as a way to overcome the advantage big banks have with their massive retail networks, he said.

The big banks may still have some runway for profits to go higher, because “they’ve got more pricing power and more variable-rate loans,” he said.

Indeed, net interest margin improvement has lagged at smaller banks. For the 92 banks over $10 billion of assets that had reported earnings through Feb. 1, the median year-over-year growth in net interest margin was 11 basis points, according to Sandler O’Neill. For the 254 banks smaller than $10 billion in assets, the median net interest margin improvement was only 1 basis point.

Some argue that loan growth will be the key metric to watch. In the fourth quarter, net loans rose a median of 8.2% from a year earlier, on an annualized basis, for the group of 346 banks.

Twerdahl said median loan growth has been positive for banks of all sizes across all geographies.

The flip side is that led to higher loan-to-deposit ratios. At the banks with more than $10 billion of assets, that ratio rose a median of 71 basis points in the fourth quarter, compared with a year earlier, to 91.38%. For the smaller banks, the increase was a median of 54 basis points, to 94.77%.

But some bankers are optimistic about the profit potential even if loan growth does not continue.

“We’ve got a shot at moving margins up,” Johnny Allison, chairman of the $15.3 billion-asset Home BancShares in Conway, Ark., said during a Jan. 17 conference call.

Allison said that’s mainly because he expects loan rates to continue trending higher.

“Hopefully we can get better on the cost of funds side,” he said. “If we can do that, I think we can increase the spreads and, with or without loan growth, I think we’re going to make more money.”

Chris Marinac, an analyst at FIG Partners, offered a similar optimistic outlook in a Jan. 28 research note, where he compared earnings trends at banks in four separate asset size groupings.

All four groups — $500 million to $1 billion in assets; $1 billion to $10 billion; $10 billion to $50 billion; and those above $50 billion — reported revenue growth. “This is a sign of strength for the banking industry,” Marinac wrote.

Moreover, in his analysis, 60% of the banks that had reported earnings at that point were beating their pretax, pre-provision returns on assets from a year earlier and about half were improved from the third quarter. Marinac used pretax, pre-provision returns on assets as a measurement because it eliminates the impact of taxes.

Those are all signs that augur well for the future, Marinac said.

“Who says profit has peaked at banks?” he asked.

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