Raferty Capital Markets’ Richard X. Bove weighs in on retail banking, noting that right now, the outlook is uneven across the sector.
The outlook for the banking industry is not uniform at the moment. There are serious impediments to profit growth in retail banking. Conversely the outlook for commercial banking is quite good. Beyond the traditional banking industry the outlook for non-bank financial companies may be the best of all. This means that in 2014, picking bank stocks will be different.
- It will no longer be a game of riding the worst performers as they return to profitability nor
- Will it simply be buying bank stocks because the perception of the industry has changed.
This year banks stocks must be selected based on the nature of their business models. It will be a stock picking year.
There are major impediments holding back profits in retail banking.
o Guidelines on overdraft payments restrict profits in this important segment.
o Guidelines on late payments and setting interest rates restrict credit card income.
o Price fixing on debit card interchange fees has turned a very profitable business into a break even or money losing effort.
- Product lines
o Most important, the profits on mortgage lending have been severely curtailed or in many cases eliminated due to new regulation.
o Student lending is being phased out at many institutions.
o The growth in automobile lending is slowing as price competition increases.
o Lending to low income households is being constrained or in some instances specifically disallowed by the government.
o The need to continue to forgive monies owed the banks due to government pressure has not abated. The government maintains its view that if a customer does not repay a loan it is the bank’s fault for forcing that customer to take the money in the first place.
- The banks are dealing with these pressures in three fashions:
- Raising prices on any product that is not price fixed.
- Reducing labor intensive services such as tellers in branches.
- Making significant capital expenditures to change distribution channels, build new products, and lower the cost of existing products.
The government is also pressuring commercial banking:
- Capital requirements on commitment lines.
- Demands to avoid leveraged lending.
However, there appears to be a powerful factor driving lending in this sector. For the past few years, corporations have been easing up on capital spending and making acquisitions. They have preferred to put incremental funds into stock buybacks and dividend increases. The net result of these policies has been a weakening trend in productivity and minimal or no revenue growth.
Business Lines Favor Commercial Lending
Ultimately, companies must spend more on growing their businesses and less on their stocks. I believe that 2014 will be the year that this happens for a few compelling reasons:
- The economy is likely to grow at 3% plus this year.
- Failure to spend on new technologies will result in American businesses losing their ability to compete.
- Ultimately stock prices will adjust to revenue and not EPS growth – companies need to get more customers.
Assuming this view is correct, commercial and industrial lending to fund capital and acquisition projects will grow. This will provide the commercially oriented banks with real earnings growth. More capital and acquisition projects will also fuel investment banking and trading activity at the big capital markets companies.
The over regulation of banking and the actions taken by the regulators to cripple the ability of the traditional banks to compete has resulted in significant opportunity to gain business at non-bank financial companies. Look to:
- Business Development Corporations
- Master Limited Partnerships
- Mortgage REITs and mortgage brokers
- Payday lenders and pawn shop organizations
Conclusion for retail banking sector
The financial system in the United States is being overhauled in a fashion that harms retail banking and aids non-bank financial companies. Commercially oriented lenders may avoid some of the pressure. The list on the next page indicates which banks tend to be big commercial lenders as a percent of their assets. The list was generated using the SNL database and only includes banks with assets of $10 billion or greater.