Many regional banks in the US emerged stronger after the 2008 financial meltdown. However, as the unwinding of Quantitative Easing (QE) unfolds, these banks might be faced with increased volatility in interest rates coupled with higher interest rates. While higher interest rates mean higher returns on loans, they also tend to hinder loan growth. The first quarter was marked with higher interest rates. Let’s see how U.S. Bancorp (NYSE:USB), PNC Financial Services (NYSE:PNC) and SunTrust Banks, Inc. (NYSE:STI) performed and what should be expected from them in the second quarter.
Stronger balance sheets and capital, post 2008 crisis
US regional banks were among the most hit companies by the sub-prime mortgage and the resultant financial crisis of 2008. However, since then, these banks have emerged stronger in terms of their capital positions and balance sheets.
U.S. Bancorp (NYSE:USB) reported a Basel 1 Tier 1 capital ratio of 11% at the end of the most recent quarter. In contrast, the bank reported an 8.3 % Basel 1 Tier 1 capital ratio at the end of the full year 2007. The bank managed assets worth $219 billion in 2007, which have swelled to 351 billion at the end of the first quarter of the current year, while loans and deposits surged 54% and 96%, respectively over the same time period.
Similarly, PNC Financial Services (NYSE:PNC) reported a Basel 1 Tier 1 common ratio of 9.8% at the end of the most recent quarter. In contrast, its Basel 1 Tier 1 common ratio at the end of the full year 2007 was 6.8%. The bank saw a significant growth in its assets since the start of the year 2007. Assets saw around 2 folds increase, while deposits surged 220% and loans climbed 270% over the same time period.
SunTrust Banks, Inc. (NYSE:STI) reported a Basel 1 Tier 1 common ratio of 10.13% at the end of the first quarter of the current year, compared with 7.72% at the end of year 2007. Total assets were $182 billion at the end of the first quarter of the current year, which surged 6%, while loans edged up 1% since the end of the full year 2006.
Performance during climbing interest rates
The first quarter of the current year was a glimpse of what investors should expect if the Fed unwinds QE. The quarter was marked with interest rates that climbed. While higher interest rates tend to expand the net interest rate margins of these banks, it also has the effect of discouraging borrowing. Let’s see what the net impact of the conditions were in the first quarter.
SunTrust reported its total managed loans declined 1.35% over the fourth quarter of the prior year. At the same time, its net interest margin dropped 5 bps. The net effect was a 4% decline in the bank’s net interest income. Net interest income is the income coming from the bank’s interest based investments. Therefore, it’s clear SunTrust did not perform better during rising interest rates.
PNC Financial Services (NYSE:PNC) reported 2.75% sequential growth in its first quarter’s total loans, while the bank’s net interest margin plunged 1 bps. The net effect of the rise in interest rates was 41 bps decline in net interest income of the bank during the first quarter of the current year.
U.S. Bancorp (NYSE:USB) reported total loans of $222.4 billion at the end of the first quarter of the current year, up 3.3% from the linked quarter. However, net interest margin fell 7 bps, causing net interest income to decline 2.7% over the fourth quarter of the prior year.
It appears that PNC Financial Services (NYSE:PNC) and U.S. Bancorp (NYSE:USB) have been able to grow their loan portfolios, despite higher rates during the first quarter. However, the net effect of rising rates was a decline in the net interest income of all three banks.
A challenging future ahead
The future for these banks will be even more challenging as commercial and industrial loan growth has deteriorated over the current quarter. The growth figures have gone down from as high as around 14% in the mid of year 2012 to around 9%. At the same time, total lending activity has also seen some downturn. Total loans growth has gone down from 4% at the beginning of the current year to around 2% now.
Among the three banks considered, SunTrust remains my least preferred. Since interest income accounts for around 60% of the bank’s total revenues, SunTrust needs to do the most in order to survive the volatile interest rate environment. SunTrust is heavily exposed to commercial and industrial (C&I) loans, as around 49% of its total loans are C&I. Looking at this, and the lack of positive stock price drivers, UBS AG (USA) (NYSE:UBS) downgraded SunTrust to neutral.
For PNC Financial Services (NYSE:PNC), the near term stock price driver is its $9.5 billion decision on BlackRock, Inc. (NYSE:BLK). The bank has a 21% stake in BlackRock, Inc. (NYSE:BLK), which is a profitable entity. If PNC Financial decides to get rid of its stake in BlackRock, it will lose 13% of its profits. However, a sale of the stake could make significant amounts to cash available to PNC Financial for other more profitable investments. However, the bank is also heavily exposed to C&I lending. Therefore, the sluggish growth in C&I during the current quarter will hurt the bank.
U.S. Bancorp (NYSE:USB) is expected to perform better during the current quarter’s higher interest rate environment. The bank’s CFO has been reported by the Wall Street Journal as saying that management expects the bank to report higher revenues despite rising interest rates. It is already the third largest home lender in the US, and it expects its mortgage originations to grow further.
While these banks emerged stronger after the crisis, the prevailing volatility in interest rates, which is discouraging C&I loans, will cause SunTrust to report lower earnings at the end of the current quarter. PNC Financial is also heavily exposed to C&I. However, I believe US Bancorp is best positioned to further expand its mortgage banking activity and increase its top line.
The article Are These Banks Well Suited for Rising Interest Rates? originally appeared on Fool.com and is written by Adnan Khan.
Adnan is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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