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By Jeremy Glaser | 10-18-2011 02:55 PM

Bank Results Lose Their Spark

Banks are losing some recovery-related tailwinds and are still struggling to replace lost revenue, but some stocks--especially regionals--look attractive today, says Morningstar's Jim Sinegal.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.

Many of the big banks have reported their third-quarter earnings, and I'm here today with Jim Sinegal. He is the associate director of banking here at Morningstar. We are going to take a look at what these earnings mean and what investors should look forward to for the rest of the year.

Jim, thanks for talking with me.

Jim Sinegal: Thanks for having me back.

Glaser: So, as I said, a lot of the big banks have given us earnings. Are we seeing any big trends that kind of link all of them together?

Sinegal: I think the big trend is that there is nothing in the results to be excited about. For a while we had improving credit trends. That was nice after all the losses in 2007, 2008, 2009. Now, credit has kind of tapered off, but the banks are having a hard time replacing some of their lost revenue. Loan demand is very weak, loan growth is weak, and net interest income is down due to the low interest rate environment.

Glaser: What about write-offs? Have we seen anything this quarter of banks coming out again and saying that these portfolios are not worth what they thought, or do you think that most of those provisions have already been taken?

Sinegal: Most of the credit provisions, I think, have been taken, and we have seen a slowing pace of improvement. That's something that's surprised people as banks have been releasing reserves into earnings for a while. They had gotten really conservative in the downturn and were able to release some of those provisions coming out. Now, things have stabilized a little bit. So, that's kind of an earnings tailwind that's starting to taper off.

Glaser: Now, a lot of people are worried about Europe, particularly the European banks. Did you hear any discussion from management teams about how U.S. banks might be exposed to problems in Europe?

Sinegal: Management teams gave a little more detail about their European exposure this quarter, but really the U.S. banks don't have a great deal of direct exposure to Europe. I think it's the case that there could be second-order consequences if Europe were really to fall apart, but you know the banks just don't have enough direct loans to Europe or European banks for it to be a major issue.

Glaser: You mentioned that revenue, or replacing revenue, as something that's been difficult, and fees are one way to do it. We have heard a lot about fees. Recently Bank of America's $5 debt card fee has been gaining a lot of press, a lot of talk from politicians. What's your outlook for fee income for banks? Do you think they are going to be able to really successfully implement these fees and pass along higher cost to customers?

Sinegal: I think some of the fees will be difficult to replace. Things like interchange fees that were basically a very high margin source of profit for the banks. In terms of other fees, though, banks are experimenting now. We haven't seen a lot of that in the results, but I think it's very hard for regulators to limit fees. If they limit fees on interchange, as you can see, the banks are now charging people just to use debit accounts. So, there are a lot of levers the banks have to pull, and I think that consumers should not look forward to declining fees.

Glaser: So even if the government gets kind of excited about this and tries to limit some fees, you think they'll just pop up some place else.

Sinegal: Yes, I think banks will find ways to make money one way or another.

Glaser: And then looking forward, what are you [expecting] in for full year results? And into 2012, what do you think are going to be the big drivers of bank results?

Sinegal: I think the fourth quarter unfortunately looks like it might be very much the same as the third. I think until the European crisis is resolved, you are probably not going to see a lot of deal activity, maybe volatile trading. So the investment banks and the investment banking portion of the large banks probably are not going to have a good fourth quarter. And I don't think we are really going to see an uptick in loan growth either. We have seen some commercial loan growth. Consumer loan demand is still very weak. With unemployment still very high, I wouldn't be too optimistic on that front either.

Glaser: Then thinking about stock picks, are there any banks right now that you think look attractively priced?

Sinegal: We think most of the banks look cheap to one extent or another. We'd focus more on regional banks than the large banks. As I mentioned, commercial loan growth looks like a much better prospect than consumer loan growth. A lot of the regional banks are commercially focused, whereas the big four banks are really consumer focused. Also, the regional don't have the regulatory headwind that some of the bigger banks have. So we look at smaller regional banks like City National in California. [There are] a lot of troubled peers in California. They still might be able to acquire failed banks or at least troubled banks and grow that way going forward.

Glaser: Well, Jim, thanks so much for your thoughts today.

Sinegal: Thanks for having me.

Glaser: For Morningstar, I'm Jeremy Glaser.

 

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