2014 US Banking-Sector Analysis

Abstract

US economy has been showing some early signs of revival after the major slump of 2008-09. But, Q1 2014 real GDP growth unexpectedly dropped to -2.9% giving a big jolt to sluggish economic revival (economy grew by on average 2.5% in past 4 quarters). The contraction in the last quarter was mainly caused by bad weather and economy is expected to grow by 4% in next quarter.De-leveraging exercise is almost complete. Now, banks are well capitalized. Share of equity capital in banks’ total assets has now increased (around 11%).Banking revenue got impacted by narrow NIM, modest loan growth, and a decline in noninterest income as higher interest rates have reduced mortgage-related activity and a lower trading income.Asset quality continues to improve, loan balances are trending up, fewer institutions are unprofitable, and the number of problem banks continues to decline.On Return of Assets (RoA) and Return on Equity (RoE) front, Net operating revenue was down by 4.0% in the quarter, as the increase in net interest income was outweighed by the drop in non-interest income. As a result, the average return on assets (RoA) fell to 1.01% in the first quarter from 1.12% a year earlier, and the average return on equity (RoE) fell to 8.99% from 9.96%.Overall, the net interest margin is on downward trajectory (hovering at the 2007-08 crisis level of 3.1) primarily because of low interest rate environment since 2008.Most of the banks are ready to meet the tough guidelines of capital adequacy under BASEL III. Regulatory and litigation expenses are taking a toll on bottom lines. These regulations are even forcing many banks to change their operating model. Many banks are now getting rid of non-strategic business lines.Because of commencement of FED tapering, the interest rate has started increasing (though benchmark rate is still at near zero level). Moreover, citing improvement in economy and job markets, Janet Yellen (the Federal Reserve chairperson) has indicated that she may start increasing the interest rate by mid 2015. This would lead to increase in interest rate even further.Three largest banking groups – JP Morgan Chase, Bank of America and Citigroup – all of which reported a Q-o-Q increase in interest margins in Q4 2013, the first such increase in at least three years. However, the other two largest U.S. commercial banks – Wells Fargo and U.S. Bancorp – are still struggling with their interest margins mainly because of having a different business models (different loan portfolio and source of funds).