Regional banks' commercial lending slowed in the third quarter, and there appears to be no shortage of reasons why.
In earnings calls with analysts Tuesday, bank executives cited everything from weakening borrower demand to regulators' crackdown on commercial real estate concentrations to the uncertainty of who will be the next president as explanations for why commercial and industrial lending — which looked so promising at the start of the year — has tailed off in recent months.
In the meantime, regional banks are ramping up their consumer and specialty lending to help drive profits. They are also relying heavily on cost-cutting while holding out hope that the Federal Reserve will finally raise interest rates later this quarter and give net interest margins a much-needed boost. Here are the key takeaways from Tuesday's earnings calls.
The cloudy election picture could be suppressing loan demand.
Bankers say that most of their small and midsize business customers have the capacity to borrow, but that some may be holding off until they know who will be the next president and which parties will control the House and the Senate.
Though he acknowledges that his observations are purely anecdotal, Synovus Financial Chairman and Chief Executive Kessel Stelling said customers are "sitting there unsettled" by the political uncertainty.
Comerica Chairman and CEO Ralph Babb echoed those comments, adding that the sluggish economic growth is also tamping down demand.
"Businesses are doing well, they are generating cash and holding more cash than they have in the past," Babb said in an interview following the bank's earnings call. But, he added, "they are being very careful because of the uncertainty. And we just haven't seen a significant pick-up in the [gross domestic product] for a sustained period of time" to give borrowers the confidence to try to meaningfully grow their businesses.
"They are just doing what they need to do in order to meet demand," Babb said.
The CRE crackdown has created more competition in C&I lending.
As regulators have stepped up scrutiny of commercial real estate loans, more small banks that have traditionally focused on CRE are pursuing commercial and industrial credits, increasing competition in a sector that is already fiercely competitive.
Synovus said it has become more cautious in C&I lending as others have entered the market; the $29.7 billion-asset company increased its C&I loans by less than 2% over the last two quarters.
C&I is "by far the most competitive space to lend in," Chief Credit Officer Kevin Howard said on Tuesday's conference call. To overcome this, Synovus is leaning more on specialty lending lines like senior housing, Howard added.
Babb agreed that competition has picked up in recent quarters, though he stopped short of attributing it to competition from small banks worried about increased scrutiny of CRE concentrations.
The competition is "across the board," he said.
The $72 billion-asset Comerica said that average loans in the quarter fell 5.3% from just three months earlier to $49.2 billion. Much of the decline could be attributed to its decision to scale back its lending to energy firms, though the Dallas company also reported weakening demand in the dealer services and technology and life sciences sectors. On the plus side, it saw improved demand for CRE loans and an uptick in lending to mortgage finance companies.
Regions Financial in Birmingham, Ala., said that commercial and industrial loans and leases fell 2% from the prior quarter to $35.4 billion, and that CRE loan balances declined 2.4% to $7.4 billion.
Loans in both the C&I and CRE categories have shrunk in part because Regions has pulled back in the area as specific projects have exhibited potential signs of trouble; Regions placed three multifamily projects on criticized status during the quarter, two in Houston and one in Oklahoma. Additionally, Regions is also being cautious on lending for medical office buildings.
"We continue to experience muted customer demand and heavy competition … particularly in the middle-market, commercial and small-business sectors," Regions Chairman and CEO Grayson Hall said during a conference call.
On top of those concerns, some large corporate customers have paid down their balances early by raising funds through stock or debt sales on the public markets, Hall said.
"[We] had an abnormally high level of payoffs and paydowns and in particular around reductions in outstandings on commercial lines of credit," Hall said.
As a result, Regions cut its forecast to an expectation of no loan growth this year; its previous forecast had been for growth between 3% and 5%. The lack of loan growth could be offset by fee income, which Regions expects to rise 6% this year, up from its previous estimate of between 4% and 6%.
Specialty lending is picking up some of the slack.
Many banks, including Synovus and First Horizon National, are increasingly turning to specialty lending as one way to diversify their loan portfolios and find better yield.
"Every bank is looking for a way to diversify their loan book and are looking for ways to add additional yield to the portfolio," said Brad Milsaps, an analyst at Sandler O'Neill. "It's tough to find."
Synovus has partnered with Social Finance, which primarily refinances student loan debt, and GreenSky, which helps customers to apply for credit at places like home improvement stores. Management is expecting those partnerships to contribute up to 3% of its loan portfolio possibly as early as middle of next year.
So far Synovus has been "very pleased" with those partnerships in terms of asset quality and the overall yield that they bring, Stelling said.
The $125 billion-asset Regions also has a partnership with GreenSky and recently launched a partnership with Avant, an online consumer lender.
Memphis, Tenn.-based First Horizon is seeing "good growth opportunities" in its specialized business lines, such as franchise finance and healthcare finance businesses, CEO Bryan Jordan said Friday during a call with analysts discussing the company's third-quarter results.
Overall, specialty lending is a growth area for the $28.4 billion-asset company. In September, First Horizon acquired a restaurant franchise finance business from GE Capital and on Tuesday, it announced that it had hired bankers in the areas of franchise and healthcare finance, music industry banking and structured equipment finance.
Energy fears have subsided — for now.
A major bright spot at Regions has been improvement in the energy portfolio as stabilizing oil and gas prices have improved the balance sheets of its energy clients. The bank cut its allowance for loan and lease losses to 7.9% of direct energy loans from 9.4% three months earlier.
Like many energy lenders, Regions is also making fewer loans to companies directly involved in energy and in areas that have a high concentration of energy firms, such as Houston and Baton Rouge, La.
"We are deliberately limiting [loan] production in certain areas," Hall said.
Comerica has its reduced its energy exposure by roughly $800 million over the past year, though criticized energy loans remain elevated at roughly 60% of its oil and gas portfolio. Pete Guilfoile, its chief credit officer, said that credit quality should continue to improve as long as oil prices stay within a range of $40 to around $55.
"There are a lot of things happening in energy right now," he said. "Prices have been stable, capital markets are improving, asset sales remain very robust, and we're getting a lot of paydowns on our criticized credits."
Still, Guilfoile added, there are a number of exploration and production companies in bankruptcy, "and we want to see what happens there. Drilling activity has been coming back, but it is not as robust as we would like to see it."
Cost-cutting is still a priority.
Both Comerica and Regions are in the midst of major cost-cutting programs, though Comerica appears to be further along.
Comerica has given layoff notices to about 700 employees — including hundreds of managers — over the last few months and has announced plans to close nearly 40 branches. Those efforts, combined with plans to outsource certain technology functions and reduce tech applications, have put it on pace to reduce overhead by $150 million in 2017 and $200 million in 2018.
Analysts like what they are seeing. On Tuesday, Sandler O'Neill sharply increased its earnings-per-share targets at Comerica for 2016, 2017 and 2018, in part due to the improved expense outlook.
By contrast, some analysts seemed impatient with Regions' timeline for completing its cuts by 2018. Steve Moss of FBR Capital Markets asked if the cuts could be implemented next year.
"[We] are looking to pull forward as much as is prudent without harming the long-term franchise," Chief Financial Officer David Turner responded. "I think getting all of that in 2017 will be very difficult."
Regions expanded the size of its cost-cutting program as a result of the likelihood of continued low interest rates, Turner said during the call. The company now plans to cut $400 million of expenses, up from the $300 million it announced this time last year.
Although Regions did not provide specifics on where the expense cuts will come from, they are likely to come from job cuts and branch closings. Regions has eliminated 1,200 jobs this year it has reduced its retail branch network by 2% to 1,597 locations from a year ago.
Chris Marinac, managing principal and director of research at FIG Partners in Atlanta, said that Regions made good progress on expense reductions in last year's fourth quarter and this year's first quarter, but has failed to meet investors' expectations in the last two quarters.
"They have set themselves up for a must-see fourth quarter," Marinac said. "Investors want to see them execute on expenses. They have to do it."