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Rapid rate change bodes well for liability-sensitive regional banks' Q4 results

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Rapid rate change bodes well for liability-sensitive regional banks' Q4 results

Regional bank earnings should highlight how a drastic change in the rate environment in 2019 has reversed net interest margin trends, but some analysts think investors will be more interested in forward-looking guidance than results.

Banks will be reporting 2019 fourth-quarter earnings over the next couple weeks, and analysts are expecting liability-sensitive lenders — defined as those that see liabilities reprice faster than assets — to post margin expansion. However, from a market reaction perspective, year-end results might not be as important as forward-looking guidance, some analysts said.

"I think the fourth-quarter numbers themselves will almost be an afterthought and most folks will be focused on the guidance," said David Chiaverini, an analyst with Wedbush Securities.

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For most of the industry, margins will be under pressure due to declining rates and loan growth expectations will be muted due to weak reports from the Federal Reserve's H.8 data, which shows industry-wide loan growth and suggests a slowdown in the 2019 fourth-quarter. Since the regulator releases H.8 data on a roughly two-week lag — year-end data was posted on Jan. 10 — investors are already aware of the 2019 fourth-quarter slowdown and will instead focus on 2020 expectations, analysts said.

Further, fourth-quarter earnings seasons tend to feature a lot of guidance from banks to provide investors expectations for the year ahead. Stephen Scouten, an analyst with Piper Sandler & Co., said he expects even more guidance this quarter due to several banks declining to offer guidance during recent investor conferences.

In actual results, analysts expect the asset-sensitive banks positioned to benefit from a rising-rate environment to report margin compression. When the Federal Reserve raised its key benchmark rate in 2017 and 2018, liability-sensitive banks faced intense margin pressure. But a rapid deterioration in the economic outlook forced the Fed to reverse course and start cutting rates in 2019, to the chagrin of asset-sensitive banks and to the benefit of liability-sensitive lenders.

As a result, a pair of liability-sensitive banks — Investors Bancorp Inc. and New York Community Bancorp Inc. are the only names among the 30 institutions with $25 billion to $100 billion in assets that analysts expect to report a sequential NIM increase in 2019 fourth-quarter earnings. By contrast, both regional banks posted margin compression when rates were rising from 2017 through 2018, a time period in which the industry generally experienced margin expansion. Analysts at Janney Montgomery Scott named Investors Bancorp a top pick in a recent note looking at the year ahead.

When key benchmark rates like Libor move lower, bank assets immediately reprice, lowering banks' interest income. But deposit repricing tends to take more time, limiting banks' ability to offset the lost income.

Scouten said he expects net interest margins to "hopefully" bottom in the first quarter and that lower deposit pricing would flow through to banks over the next three to four quarters. The speed of the recent rate move combined with banks' reluctance to raise deposit rates in the first place complicates efforts to lower deposit costs, he said.

"It's hard to go to your clients and say, 'I know we just moved it up to 2% after waiting as long as we could, but now we want to go back to 1.25%,'" Scouten said in an interview.

Beyond margin and guidance, Scouten and Chiaverini said investors would remain attentive to any blips in credit quality. Idiosyncratic credit issues plagued regional banks in the first half of 2019 before waning in the third quarter. Both analysts said they expect few credit issues in earnings reports based on what bankers have said so far.

"We were getting to a point where the one-offs were hard to call one-offs because there were so many of them, but that does seem to have abated," Scouten said. "Everything that we're hearing from our covered banks is that credit is as good as it has ever been and the lower rate environment should, in theory, elongate the credit cycle even further."

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