Slideshow Tax hits, deposit wars, paydown blues: A 4Q preview

Published
  • December 07 2017, 10:04pm EST

Tax hits, deposit wars, paydown blues: A 4Q preview

The next bank earnings season (Didn’t we just finish the last one?) will kick off on Jan. 12, when Wells Fargo and JPMorgan Chase are set to report fourth-quarter results.

Fourth-quarter reports can be noisy as companies throw in special items and charges to close the books on the year, and by mid-January, once the calendar has turned over, those reports often seem anticlimactic. However, they sum up the previous 12 months, and, more importantly, often provide chief executives with a platform to share their forecasts for the new year during conference calls with analysts.

At a Goldman Sachs financial services conference this week in New York, top executives of the big banks gave a peek at what’s on their mind and what’s in store for the current quarter and in 2018. If anything, it seems like 2018 will be a lot like 2017 — but on steroids.

Credit cards and other consumer lending will stay hot, competition for deposits on the retail side will be fierce, commercial lending could remain rocky if and until it improves, and the short-term and long-term impacts of tax reform and other policy reforms will be debated for months.

Tax reform could prompt some one-time bites — ouch to the possible $20 billion at Citigroup — and its impact on loan growth in 2018 will be mild or muted, depending on whom you ask. Interest rates rates are expected to rise, but so, too, might deposit costs as consumer lenders fund growth and VIP customers (businesses and wealthy clients) shop more aggressively for optimal rates. Trading revenue and loan paydowns will be wild cards.

Looks like a fun year lies ahead.

Tax reform: The Good, the bad, the ugly

Citigroup, JPMorgan Chase and Capital One Financial warned that tax reform could cost it billions of dollars in one-time charges.

Citi grabbed headlines when it said it would have to take a noncash charge to earnings of about $20 billion if the Senate bill becomes law. Most of the hit would be a writedown of the value of its deferred tax assets, and about $3 billion to $4 billion would come from taxes on repatriated foreign earnings. The $20 billion figure was $5 billion higher than its estimate in July.

JPMorgan predicted a charge of about $2 billion largely tied to taxes on foreign earnings, and Capital One said it would expect to pay $1.8 billion on an adjustment to its deferred tax assets.

Meanwhile, bank chiefs debated how much of an impact the congressional tax legislation would have on loan demand.

Provisions in the tax bill to enhance the deduction for capital expenditures would likely encourage companies to invest and borrow more, PNC Financial Services Group CEO William Demchak said, but it’s “wildly optimistic” to assume that companies are simply standing on the sidelines, waiting for Congress to act before they decide to do so.

“For me to say, yes, that’s true, then I’d also have to say that I think [gross domestic product] is going to be 5% next year, and I don’t think that’s going to be the case,” Demchak said.

Others were more upbeat. “I think it’ll unleash activity, no question,” said Brian Moynihan, CEO of Bank of America.

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Hungry for deposits ...

Capital One needs an infusion of deposits to help fund its torrid consumer loan growth. While deposits at the $407 billion-asset company have grown by a healthy 10% over the last two years, they have been unable to keep pace with a 20% increase in credit card loans and a whopping 30% jump in car loans. The result: Capital One’s net loan-to-core-deposit ratio, which stood at about 100% two years ago, is now above 110%. The industry for average for banks with more than $250 billion of assets is around 81%, according to the Federal Deposit Insurance Corp.

“It’s very clear to us that we need and we want to…grow our deposits significantly,” Chairman and CEO Richard Fairbank said.

It’s an unfamiliar position to be in for McLean, Va.-based Capital One, which was awash in deposits following its 2012 acquisition of ING Direct. The good news is that, unlike many of its big-bank competitors, Capital One has a national direct bank, now known as Capital One 360, that “gives us another avenue for deposit growth other than just trying to bang more deposits into one branch at a time,” Fairbank said.

... But with deposits come costs

Over the past year, net interest margins across the industry steadily climbed higher, boosted by a series of interest rate hikes from the Federal Reserve.

But a big question facing banks when they report fourth-quarter results is whether the costs of paying up for deposits from large businesses and wealthy clients will eat into their margin gains.

At least one big bank — U.S. Bancorp in Minneapolis —
said this week that it expects its margin to dip by about two basis points from the third quarter. As of Sept. 30, its margin was 3.10%. Chief Financial Officer Terry Dolan did not provide an explicit reason for the projected decline.

Still, he said competition for commercial and wealth management deposits is on the upswing — particularly on the East Coast, given the concentration of corporate clients, and on the West Coast, where foreign-owned banks are stepping up competition.

Payoffs continue to dampen loan growth

Executives at BB&T in Winston-Salem, N.C., and KeyCorp in Cleveland said that higher levels of payoffs would hurt fourth-quarter loan growth. That has been a common complaint of bankers in recent quarters, as commercial clients have used excess cash to pay down debt and invest and have sometimes turned to the capital markets for cheaper financing.

At the $220.3 billion-asset BB&T, payoffs in the bank’s commercial portfolio were also compounded by the bank’s intentional reduction of certain portfolios, like residential mortgages and prime auto lending. Chairman and CEO Kelly King (pictured above) said Tuesday that while BB&T previously anticipated fourth-quarter loans to decline slightly on a quarterly basis, it now expects loan growth will be mostly flat from the prior quarter.

“The whole loan area is really about huge, increased payoffs over the last few months, and that subdues total loan growth,” King said.

“What we've seen so far this quarter has been consistent with the third-quarter performance as far as continuing to see high levels of paydowns and capital market type of activities,” KeyCorp Chief Financial Officer Donald Kimble said.

But the executives tried to be as positive as possible.

The paydown trend has helped KeyCorp’s capital market’s business, Kimble said. And King was sounded a note of optimism for the New Year.

“We think as we head into next year, that'll begin to subside some,” King said. “The economy will be better, and so we would be somewhat more optimistic as we head into next year in terms of loan growth.”

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Clouds parting on commercial lending?

Wells Fargo is feeling more optimistic after several quarters of gloomy results in commercial lending.

Beyond the broader industry slowdown, several one-time factors weighed on Wells’ commercial loan book during the third quarter, according to CEO Tim Sloan. He pointed to “idiosyncratic impacts” from the runoff of financing provided alongside the sale of Wells’ guaranteed student loan book, as well as its acquisition of wholesale loans from GE.

As of Sept. 30, U.S. commercial and industrial loans were flat from a year earlier, at $270.1 billion. But things have started to look up during the last three months of the year, according to Sloan.

“My expectation in terms of C&I growth for the fourth quarter is that you’re going to see much better results than what we saw in the third quarter,” Sloan said.

Hot for consumer lending

PNC Financial Services Group made news when it said it would introduce a consumer lending product that it will market through both its mobile wallet and in new branches.

The company intends for the new loan product to be available on a national scale, Chairman and CEO William Demchak said. It plans to open branches “in the markets where we have no presence in retail today,” but where PNC has expanded its commercial-and-industrial lending. Those markets include Minneapolis, Dallas and Kansas City.

Balancing the card portfolio

Since it began a credit card partnership with Costco in 2015, Citigroup has boasted about how successful the business has been. It’s apparently been such a success that it has affected Citi’s M&A strategy.

Citi operates two different types of credit cards through partnerships with retailers. One type is the co-branded card business, like the Costco arrangement, where consumers can use the card anywhere. The other is private-label cards, where the card can only be used at the retailer whose name appears on the card; Citi has such an arrangement with Best Buy, Home Depot and others.

Citi wants to acquire another card portfolio. But the Costco portfolio has outgrown Citi’s projections and now Citi is overweighted in co-branded cards, Chief Financial Officer John Gerspach said. To maintain an adequate balance, Citi would thus prefer to purchase something in the private-label realm, he said.

“Just because of the success of Costco, we're more heavily weighted towards co-brand right now in U.S. branded cards than we had originally intended,” Gerspach said.

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Judicious M&A

SunTrust Chairman and CEO Bill Rogers said the bank has a taste for niche deals that complement its core businesses.

SunTrust probably won't use its capital to acquire banks, as that strategy represents the old mindset of using M&A to focus on “geography and branches and physical deposits,” Rogers said. "They're just things that just aren't as important to us."

What’s more likely to happen are deals like SunTrust’s 2016 acquisition of Pillar Financial, a nonbank lender that specializes in commercial real estate, which augmented the bank’s existing CRE lenders, he said.

“We’re already sort of seeing the benefits in that,” Rogers said.

Trading slump

Trading revenue has dropped 15% so far this quarter compared with a year earlier, warned top executives from JPMorgan Chase and Bank of America.

Part of the problem is it’s hard to beat the fourth quarter of last year, when markets tried to correct mistaken bets made before Donald Trump’s surprising presidential election win.

“There hasn’t been that many catalysts, it hasn’t been that exciting,” JPMorgan Chase CFO Marianne Lake said. “Volatility sill remains pretty low across the spectrum; it’s a very competitive environment.”

The slump perpetuates a trend that has lasted most of the year. Goldman Sachs sounded a similar warning in November.