A lower tax rate offered a considerable lift to bank earnings in the first quarter, but profitability still improved by greater amounts at credit unions, which are not subject to corporate income taxes.
Despite continued increases in both short- and long-term rates in the first quarter, loan yields only moved modestly higher at U.S. banks as the competition for quality credits remained fierce amid weak loan growth.
Funding costs rose even more than loan yields, pushing bank margins lower for the first time in more than a year. There is still some hope for margins to rebound later this year, assuming that loan growth improves from the anemic levels witnessed in the first quarter, but continued competition and increases in deposit costs should limit expansion in the key profitability metrics.
The fight to grow loan portfolios led to pressure on loan yields at credit unions as well, but the group managed to report a 3-basis-point decline in the cost of shares and deposits in the first quarter. That decrease in funding costs allowed the institutions to report additional margin expansion and the highest levels of profitability in nearly a decade.
The banking industry saw its earnings jump in the first quarter as well, surging 27.5% higher from year-ago levels, largely due to the passage of tax reform.
Other fundamental trends were less encouraging across the banking industry. While the first quarter is seasonally slow, loan growth failed to meet the Street's expectations, particularly at small institutions.
In the first quarter, commercial banks' loans and leases rose just 0.5% from the linked quarter and declined 0.1% among the 10 largest banks by total assets. Banks with less than $100 million in the assets experienced even weaker trends, reporting that their portfolios fell 0.5% from the fourth quarter.
Credit unions reported stronger loan growth, with their portfolios increasing 1.5% from the prior quarter and 9.7% from a year earlier.
There are some concerns that loan growth could fail to rebound this year as corporations remain flush with cash due to tax reform, while a potential trade war with China could weigh on business investment. U.S. President Donald Trump on June 15 announced a 25% tariff on $50 billion of goods from China and warned that he would impose additional levies if China retaliated.
Lackluster loan growth has come as most banks have faced increases in their deposit costs. Rising funding pressures encouraged many to maintain their deposit balances, and fees and service charges on consumer accounts continued to slide, falling to the lowest point since banks began disclosing the metric in 2016.
Credit quality trends remained fairly benign across the banking industry in the first quarter and reaffirmed U.S. consumer strength. Net charge-offs-to-average loans held flat with year-ago levels, while new loss formation continued to decline. Delinquent loans dropped to 1.80% of total loans, down 9 basis points from the prior quarter and 20 basis points from a year earlier, largely due to decline in delinquent one- to four-family and consumer loans.
The vast majority of institutions' balance sheets remain on strong footing, with the FDIC designating just 92 "problem" banks at March 31, the lowest total in a decade. Very few banks seem in great need for capital, with 26 banks and thrifts reporting an adjusted Texas ratio above 100% and only 11 institutions reporting capital ratios below minimum requirements.
Asset quality remained even stronger at U.S. community banks, which saw their net charge-offs fall 13.4% from a year ago, but the same was not true for their credit union counterparts. Those institutions reported that net charge-offs increased 13.4% to $1.46 billion, while the ratio of net charge-offs to average loans climbed 2 basis points to 0.60%. The largest dollar-value increase in net charge-offs at credit unions was in "other consumer" loans, which jumped by $78.3 million, or about 20%, from year-ago levels.
Net charge-offs also increased at a majority of the largest credit unions year over year. Thirteen of the country's 20 largest credit unions by loans and leases reported an increase in the ratio of net charge-offs to average loans compared to the first quarter of 2017.
For now, asset quality trends remain encouraging but some deterioration among credit unions, which largely cater to individuals, is worth watching closely. The funding costs of those institutions also merits close attention since they tout their ability to offer members higher rates on their funds.
Thus far in the current rate cycle, credit unions have managed to hold the line on deposit costs better than their banking counterparts but it seems unlikely that the former will continue to report decreases in funding costs in the coming quarters.
Click here for an analysis comparing fundamental trends between U.S. banks and credit unions in the fourth quarter of 2017.
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