Low rates will weigh on 4Q2016 U.S. Bank earnings

U.S. bank earnings will not expand in the near term given political uncertainties, prolonged low interest rates and modest economic growth.

U.S. banks earningsU.S. bank earnings are experiencing a modest expansion in the third quarter of 2016 (3Q16) relative to 2Q16; however, earnings will not materially expand in the near term given political uncertainties, prolonged low interest rates, modest economic growth and softness in key economies globally, according to the 3Q16 U.S Banking Quarterly Comment from Fitch Ratings, which reviews the largest 17 U.S. banks.

Political uncertainty has resulted in softer demand for commercial credit from businesses, particularly in the middle-market, which resulted in sluggish loan growth for most U.S. banks and could extend into 4Q16,” said Bain Rumohr, Director, Fitch Ratings.

After a strong start to the year, loan growth was muted, particularly for commercial loans. Fitch also believes a regulatory commercial real estate (CRE) regulatory guidance from December 2015 has impacted CRE loan growth. However, banks are increasing their consumer lending efforts with many growing credit card balances and mortgage portfolios while pulling back from indirect auto lending which has shown recent signs of weakness. Large mortgage originators all reported growth in originations and applications in 3Q16. Despite sluggish loan growth, deposit growth continues to be strong as consumers and businesses remain relatively less levered.

Overall most banks with large loan portfolios reported sequential improvement in loan losses, but Fitch expects losses to deteriorate from currently unsustainably low levels. Median credit losses for the group have been 50-60 bps lower than the FDIC long-term average over the last five quarters.

Citing a slowdown in growth and broad credit improvement some banks released loan loss reserves this quarter; however, JP Morgan Chase and Citi both built reserves tied to credit quality expectations and growth in consumer portfolios going forward.

Following a good 2Q16, capital markets results for the large global trading and universal banks were once again strong in 3Q16, relatively flat to 2Q but increasing 20% from the year-ago quarter. Higher revenues from FICC trading, drove the growth while equities trading remained relatively muted.

“As we expected, most banks reported flat or compressed net interest margins for the quarter and Fitch reiterates that a sustained and consistently steep yield curve will be critical to improving NIMs for a meaningful period and the shape of the curve to be more important than the level of short-term interest rates,” added Rumohr.

Given this persistently low rate environment banks of all sizes have been especially focused on controlling and/or cutting expenses. During the 3Q16 earnings season, many large U.S. banks pointed to new or expanded cost cutting measures to be carried out going forward.

In general, Fitch believes that many of the easier cost cuts have already been executed on and that incremental savings will be more difficult to produce going forward.