Commercial banks will post higher earnings for the third quarter, but that rise will be tempered by increased margin pressure, combined with what should be a seasonal slowdown in lending, analysts say.
Wall Street widely expects a more competitive environment for deposits, and a continued flattening yield curve, to force some of the top 10 banking companies to report narrower margins next month when they begin reporting quarterly results.
Keefe, Bruyette & Woods Inc. said in its quarterly preview this week that it expects large banks to report that earnings rose roughly 8% from a year earlier.
"We are expecting a very respectable earnings performance from the banking industry in the third quarter, but we hasten to add that the operating environment has deteriorated incrementally," analysts from the New York investment banking boutique said.
Other analysts agreed that it is becoming difficult for banks to meet their projections. Last month the Federal Reserve Board raised the federal funds rate to 3.75%, the highest level in more than four years. The increase was the 11th since June of last year.
Andrew Collins, an analyst at Piper Jaffray & Co., said in a Wednesday phone interview that there "isn't much room for upside" when it comes to margins. He predicted that large banks will report contractions of anywhere from 3 basis points to 10 basis points from the second quarter.
Several banking companies, including Fifth Third Bancorp of Cincinnati and SunTrust Banks Inc. in Atlanta, have already told investors that they expect continued margin pressure in the third quarter.
And Richard Kovacevich, the chairman and chief executive officer of Wells Fargo & Co. of San Francisco, summed up the situation during an investor presentation last week, when he said tightening spreads are creating "the toughest environment" right now for banks and forcing everyone to "work a little harder."
During an investor conference Sept. 13 sponsored by Lehman Brothers, U.S. Bancorp chief financial officer David Moffett said spreads are under pressure more from the competitive landscape than from rates.
"Ultimately, over the next six to nine months, competition is really going to make the difference," he said. John Pandtle, an analyst at Raymond James & Associates, said in an interview Thursday that because of their reliance on securities portfolios, large banks could face even more pressure from rising rates than some regionals.
"All in all, the margin picture is much poorer," he said.
Not all of the blame can be directed toward the rising rate environment, though, and some executives have spent the quarter discussing how a slowdown in deposits is affecting their business. Some analysts said they expect deposits, once an area of robust growth, to be flat or up only slightly from the second quarter, and that some banks would have been forced to turn more to higher-cost wholesale funding.
At least commercial loan portfolios are growing, though even there analysts sound a note of caution. After picking up in the second quarter, some analysts say, loan growth could have been tempered by a seasonal slump and by the effects of Hurricanes Katrina and Rita on gas and oil prices.
Ruchi Madan, a Citigroup Inc. analyst, has said she expects the industry to post an annual loan growth rate of 7% to 8% for the quarter, down from 11% in the second quarter. In a Sept. 9 note, she wrote that higher growth in commercial real estate and residential mortgages should be offset by a slowdown in commercial and industrial loan growth and further slowing in home equity lending.
At the same time, analysts said credit quality, which has remained stellar and even improved for most in recent quarters in spite of conventional wisdom, is unlikely to get any better.
Analysts are not expecting much hurricane-related news from the largest banking companies. JPMorgan Chase & Co., for instance, is the only one of the top 10 commercial banks to have branches in Louisiana. Mr. Collins said the New York company could report a special third-quarter charge as it braces for losses tied to Katrina, but he said he "wouldn't expect it to be material."
Large banks have several levers they can pull to make their numbers, but some analysts say many have fewer options than they did in past quarters.
The research team at Sandler O'Neill & Partners LP said in a Sept. 26 quarterly preview that they "see limited opportunities" for cost containment. Competition for qualified lenders remains intense and "could continue to drive personnel costs higher," the team wrote.
Analysts also expect an increase trading returns from the second quarter. (They project, however, that trading activity will not match the torrid pace of the first quarter).
Mr. Collins projected in a pair of research notes issued Wednesday that Citi would post a 20% increase in trading revenue from the second quarter, to more than $3 billion, and that JPMorgan Chase would report that such revenue nearly doubled, to $1.2 billion.
Some analysts are less optimistic about investment banking returns. Ms. Madan predicted a modest decline from the second quarter, largely because of weaker debt underwriting and syndicated loan volume. B of A could post a 7% decrease and JPMorgan Chase could post a 12% drop, she said.
