Headline Bank Profit Outlook 2016: Earnings Could Rise 50 Percent

Source: Forbes

Bank earnings increased in the second quarter, and I expect much better performance in 2016. Bank executives can maximize their gains by focusing on loan growth, monitoring deposit levels, and working on employee retention.

Quarterly earnings were up thanks to most parts of the income statement. Interest income rose 1.6 percent (all comparisons from four quarters previous), thanks to growth of both loans and securities. Interest expense was down in a flat interest rate environment, probably a combination of older CDs maturing and banks being more aggressive in keeping deposit rates down. Non-interest income rose by just under two percent, less than one would expect given overall economic growth (both in volume and price). However, non-interest expense was reduced despite paying more in salaries and benefits.

The big gainers in the past four quarters have been the large regionals. Banks with assets between one and ten billion dollars saw their ROA and ROE grow significantly. The big guys were roughly unchanged from a year ago. The smallest banks, those with less than $100 million in assets, also increased their returns.

The Fed’s interest rate increase will mostly go to net interest margin. In time, deposit rates will increase, but that won’t happen right away. Banks don’t need to compete for deposits, so they’ll pocket higher loan rates without boosting their payouts to depositors. That could boost the net interest margin from about three percent up to four percent, generating a very big pop in earnings.

In 2016 economic growth should continue to help earning assets to rise. The current loan-deposit ratio remains below the long-term average, so it’s all about demand rather than availability of credit. If the economy continues at its recent growth rate, look for about five percent growth of loans. The new loans will be funded by drawing down banks’ accounts at the Federal Reserve, which currently yield a measly quarter of one percent. That will provide a boost to earnings.

Between these two effects, bank earnings could rise by 50 percent.

Loan quality is likely to be fine, at least until the next recession. When will that be? My current economic forecast suggests that we’re good for the next 18 months at least. The greatest near-term risk is from overseas troubles, in China and Europe. We could probably survive foreign recessions with just a decline in growth, not experiencing a true recession ourselves. The risk of a real recession comes from Federal Reserve mistakes, but that takes over a year to brew. Thus, 2016 and even 2017 look good for bank earnings.

What should be on the minds of bank executives? First is loan growth. Most effort has been put into cutting rates and terms. I’d like to see more banks pursuing niche markets as a long-term growth strategy. Another opportunity is small and medium businesses that need some financial counseling.

Deposits should be the second concern. Right away not much should be done, but volume should be monitored carefully to know when interest rates need to be increased. I would be more inclined to ease fees before raising deposit rates, but that depends on the particular market served.

Staffing would be my third concern for 2016. Labor markets will tighten with economic growth, making retention and recruitment harder. I’m persuaded that quality of employees is more important than quantity. With some extra attention by hiring managers, the best employees can be hired and kept on board.

The year 2016 should be a good one for banks in the United States, with the best managed institutions doing especially well.

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