The Street focused on the yield curve and net interest margin in the second quarter, and some regional banks gave investors exactly what they wanted.
Several regional banks — ones that reported relatively stable NIM or detailed hedging strategies that protect against margin compression — have seen their stocks appreciate by 7% or more since the money-center banks kicked off earnings season July 16. That compares to a 3.7% gain for the SNL U.S. Bank and Thrifts index and a 0.0% total return for the S&P 500.
The superregional banking group, defined as publicly traded banks with $50 billion to $500 billion in assets that reported by July 26, generally reported weaker margins as noninterest-bearing deposits continued to run off. Just two of the 21 banks in the group reported a linked-quarter increase in margin, and the median decline was 7 basis points.
While most banks reported softer margins, stock prices were up across the sector. David George, an analyst for Baird Equity Research, attributed the sector's appreciation during earnings season to continued strength in credit quality and signs that consumer credit remains robust.
"The potentially ominous macro signal from the inverted yield curve was not consistent with loan growth or credit commentary from banks," George wrote in a July 30 note.
While strong credit quality and loan growth drove the group's stock gains, banks that also reported minimal margin compression saw even more appreciation. Among the 21 superregional banks, just three reported year-over-year declines in normalized EPS with a median increase of 7.9% across the group. Credit quality also remained pristine with aggregate net charge-offs down from the linked quarter and the median net charge-off ratio equal to 0.25% of average loans.
U.S. Bancorp fit that bill, with a linked-quarter decrease of just 1 basis point in its NIM and a stock price gain of 7.6% since July 16. During the bank's July 17 earnings call, management attributed the outperformance to loan growth and some accretion from its investment portfolio. The bank reported a 4.7% year-over-year increase in its commercial loan portfolio.
"I think part of that resiliency [in NIM] is just loan growth," said CFO Terrance Dolan. "I think that was one of the major drivers."
Looking forward, management said they expect NIM to decline by high single digits in the third quarter. About half of that drop will be due to the declining rate environment with the other half coming from a regulatory change that will force the bank to purchase more high-quality liquid assets.
Fifth Third Bancorp was also an outlier in margin and stock performance during second-quarter earnings, with a sequential increase of 13 basis points in its net interest margin. The company's stock is up 7.4% since reporting earnings July 23.
Some of the bank's NIM growth came from its acquisition of MB Financial Inc., which management said was progressing as expected. Even excluding the deal, the bank's core NIM expanded by 4 basis points, said James Leonard, treasurer for the bank, on the earnings call. The bank had prepared for a lower-rate environment through an active hedging strategy, but management said the current pricing of derivatives might make it difficult to continue expanding its hedges.
"I would love to do more but not at these entry points," said Chairman, President and CEO Greg Carmichael, adding that the bank has also repositioned its investment portfolio in recent months due to the high pricing of derivatives. "We've done a lot behind the scenes to help protect [against lower] rates, and that's starting to shine through in the results."
At the other end of the spectrum, First Republic Bank reported more NIM compression than expected, as the key metric declined 11 basis points from the previous quarter. Investors sold off the stock, causing a 4.5% decline the day of the company's earnings. Since then, the bank's stock has recovered alongside the sector's rally and is up 1.8% since the earnings report. Management said they expect NIM pressure to persist through the second half. Casey Haire, an analyst for Jefferies Group LLC, lowered the research group's earnings estimate for the bank for 2019 and 2020 due to the margin compression.
"Intense loan pricing pressure will likely keep asset yields under pressure and drive NIM lower, barring a steepening of the curve," Haire wrote in a July 17 note.
While the market expects the Federal Reserve to cut its key benchmark rate as many as four times by 2020, Baird's George wrote that he was skeptical of such aggressive cuts, considering credit quality remains strong. He forecasts NIM compression of 5 basis points in the third and fourth quarter and coming in flat to only slightly lower in 2020 and 2021 for the 21 money-center and regional banks under coverage.
"We reason that if the Fed is aggressively cutting rates it will reflect notably weaker economic trends and corporate earnings/stocks should be much lower," George wrote. "For that reason, we view the more aggressive Fed action warily."
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