U.S. banks are starting to look a lot better as the risk of yet another economic slump has gradually abated and the ability to endure pressures from the operating environment has improved. Adding to these are the tailwinds from sustained GDP growth and reduction in unemployment.
Further, although the prevailing low interest rate environment curbs net interest margin – banks' key source of earnings – it will continue to act as a key performance driver for some time. Asset quality, one of the most important performance indicators, will in particular keep building up on the back of low interest rates, which are expected to prevail at least till mid 2015.
Looking at fundamentals, cost containment and balance sheet recovery hold the key to the banks' success. While cost containment can be perceived as a defensive measure, balance sheet recovery should help banks prosper.
Balance Sheet Recovery Underway
Lack of low-risk investment opportunities has been continuing to aid deposit growth. Also, demand for loans has been increasing with recovering economic conditions and banks' efforts to ease lending standards. Moreover, improvement in GDP, employment and other economic indicators have been helping banks strengthen their balance sheets, but reversal of interest rate environment will result in unrealized losses on underlying securities.
However, banks are trying to reorganize risk management practices to address potential solvency issues from rising interest rates. Asset-quality troubles are also being addressed by divesting nonperforming assets. Yet, we don't expect balance-sheet strength to return to the pre-recession peak any time soon.
“Problem Banks List” Shortens, but Not Reasonable Yet
The FDIC's “Problem List” contained 329 names as of Sep 30, 2014, down from 354 as of Jun 30, 2014. This is the lowest level since 305 in the first quarter of 2009 and represents a 63% decline from the post-crisis high of 888 as of Mar 31, 2011. This reflects improvement no doubt, but the number looks extremely high considering the occurrence of the financial crisis six years back. There were only 76 banks on the Problem List at the end of 2007, just before the crisis.
