Themes For 2018: Trends For Banks

By Chris Marinac

The FIG Partners Research team has outlined seven critical issues in the banking industry for 2018.

Bank investors should consider the following strategic issues:

Pending Tax Bill Creates Noise On 4Q17 As Losses Get Accelerated, Plus Tax Impairments. While it is still possible for significant changes and even a failure-to-pass on the tax reform bill in Congress, we think banks are already making advance moves. Any securities losses, OREO losses, or even loan charge-offs (one-off issues that may exist) should have happened in December ‘17 and all of 4Q17 before a drop in the Federal statutory rate (i.e., from 35% to 20% or 22%).

Deposit Costs Are Rising, And December’s Fed Hike Could Be A Watershed For Depositors. Banks’ total deposit cost rise in the prior 3Q17 data may seem benign (i.e., median deposit beta was near 20%), but we hear from numerous companies (public and private, large and small) that the incremental cost for new deposits is 50% or higher as its relates to rising Fed Funds rates.

Can NIM Rise For All Banks? Higher Loan Yields Are Key, Each Fed Rate Hike Is A Challenge. If Net Interest Margin (NIM) rises for a bank under the current rising rate environment, it is a function of higher yields on loans and earning assets and slower gains in deposit/funding costs. It is true that many banks have achieved their intended “asset sensitivity” as disclosed in their 10-Ks during the past three quarters.

Executing On Loan Growth & Overcoming The Headwind Of Paydowns. Median loan growth is 6% annualized in 4Q17 but rises above 8% by 4Q-2018 via Bloomberg Street consensus data. This covers over 300 public banks traded on NYSE and NASDAQ and we highlight that large-cap banks’ growth pace is considerably lower at sub-1% in 4Q17 and only +3.2% over the next 5 quarters through 4Q17. Our outlook is less than banks need to grow faster, but they must execute on this expected growth (especially by late 2018).

How Will Companies Utilize Lower Rates? Expect Less Than 100% Reaches Earnings For Many. With the signing of the new tax reform bill, there is a reasonable chance that banks’ tax rates are materially lower in 2018 and in future years. Will all of this benefit be realized in net income and EPS? We feel that lower taxes are initially going to be treated just like any other unusual securities gain, net charge-off recovery, or OREO gain … not all of the benefit reaches the bottom-line.

Banks Continue To Manage Expenses, Regulatory Cost Relief Is Likely Absorbed By Tech Spend. A lower efficiency ratio and positive operating leverage are common goals at most banks. This should only intensify in 2018. The industry may be fortunate to have accelerating regulatory reform in 2018 which reinforces our point that regulatory spending may have peaked (as a percentage of total overhead). However, we expect new spending on deeper cybersecurity measures, mobile products, and platform delivery enhancements. In general, we see pressure on overhead although most banks seek revenue expansion and balance sheet growth.

Credit Quality Should Not Lull-To-Sleep Bankers Or Investors. It is easy to ignore credit quality in the next several quarters since nonperforming assets and classified assets (i.e., rated substandard) remain limited with low net charge-offs at most institutions. Our outlook is for more of the same in 2018, but a caveat exists. We think banks need better coverage of quarterly loan losses in their provision expenses such that reserves expand. Simply put, loan growth must be matched with stronger provision.

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