A Sore Spot for Regional Lenders -- WSJ

Slowing demand for commercial loans takes a toll on results at smaller banks

By Rachel Louise Ensign and Austen Hufford 

A trading rebound drove growth at big banks in the third quarter. Traditional lenders, lacking that prop, were left to continue battling superlow interest rates.

Firms such as U.S. Bancorp., which reported earnings Wednesday, faced slowing demand for commercial loans, a flattening yield curve and declining net-interest margins. Net profit rose just 1% versus a year earlier.

Morgan Stanley, meanwhile, reported a 57% gain in net income, thanks in part to outsized gains in its bond-trading business.

That is a turn in fortunes. Regional banks such as Minneapolis-based U.S. Bancorp typically fetch higher valuations than firms with more volatile trading operations. And, since the start of this year, U.S. Bancorp has had a larger market value than either Morgan Stanley or Goldman Sachs Group Inc.

That, though, is also due to the fact that U.S. Bancorp has posted higher returns on equity than bigger banks. Its return was 13.5% in the third quarter. While down from 14.1% a year earlier, it was still miles ahead of returns of 11.6% and 11.2% at Wells Fargo & Co. and Goldman Sachs Group Inc., respectively. Those two had the highest returns of the biggest U.S. banks in the quarter.

Still, the regional banks' lack of diversity worked against them in the third quarter, especially as a second rate increase from the Federal Reserve failed to materialize. U.S. Bancorp's net-interest margin, a measure of the difference between what it pays out on deposits and receives on loans and investments, fell to 2.98% in the third quarter from 3.02% the prior one. That is the lowest the margin has ever been at the bank, said finance chief Terry Dolan.

The bank said it expects the margin figure to fall further in the fourth quarter due to the shape of the yield curve. In recent months, long-term rates have declined without a corresponding drop in short-term interest rates, a phenomenon known as a flattening of the yield curve. That squeezes bank profits.

To compensate, banks need loan growth. But business lending, which has been one of the strongest areas of loan growth in recent years, fell slightly in the quarter across the banking industry. That was the first time this has happened in six years.

U.S. Bank Chief Executive Richard Davis said that likely reflected the U.K.'s Brexit vote and the coming U.S. election. He expects growth to pick up again in the fourth quarter.

Similar concerns surfaced at BB&T Corp. and M&T Bank Corp., which also reported results Wednesday. Both showed commercial-loan growth rates that flagged from the prior quarter.

"Loan growth in today's market, to be honest, is just very, very challenging," said Chief Executive Kelly King. Average total loans at BB&T grew 0.3% on an annualized basis from the prior quarter and fell in a number of commercial-loan segments.

Still, the regional banks managed to grind out profits in the face of these headwinds. Winston-Salem, N.C.-based BB&T reported earnings of $642 million, up from $533 million a year earlier. Its total revenue, which is a combination of net interest income and fee-based income, grew 13% to $2.77 billion, above analyst expectations.

At M&T Bank, overall loans rose 1% from the prior quarter and commercial loans were essentially flat. Results came in ahead of Wall Street expectations, though. M&T reported earnings of $350 million, up from $280.4 million a year earlier.

Write to Rachel Louise Ensign at [e-mail] and Austen Hufford at [e-mail]

(END) Dow Jones Newswires

October 20, 2016 02:47 ET (06:47 GMT)

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