February 18, 2015

Bank revenue under pressure

Banks could run into challenges generating revenue growth as their ability to tap into loan-loss reserves deteriorates.

Loan-loss provisions disappear
During the final quarter of last year, the average provision - and the ratio of provisions to average loans - was largely unchanged at small and midsize banks when compared to the prior three months, according to preliminary analysis provided by investment banking firm Keefe, Bruyette & Woods and reported on by American Banker. After several years of drawing down these resources, excess loan-loss provisions seem to have finally disappeared.

Thusly, reserve releases - which banks have also used to improve their financial results - have come to a halt, according to American Banker. The aggregate loan-loss reserves of commercial banks dropped below $115 billion at the end of September, after hitting an all-time high of $245 billion in early 2010, according to data provided by the Federal Reserve Board. Frederick Cannon, research director for Keefe, Bruyette & Woods, emphasized the new situation.

"The ability to profit by reducing reserve levels is ending," he told American Banker. "The combination of loan growth and reserve releases has gotten to the point where [reserves] can't be reduced any further."

Cost management challenges
At the same time banks are coping with these challenges, many of them reported higher-than-expected expenses during the fourth quarter, according to American Banker. Banks indicated their noninterest expenses climbed almost 3 percent from the same time in 2013, according to an analysis American Banker conducted on 275 institutions that reported results.

A research note released last month by Sterne, Agee & Leach stated that during the quarter, more than 85 percent of banks reported expenses that surpassed consensus estimates, American Banker reported. Analysts referred to the sharp increase as "one of the biggest stories coming out of this earnings season."

"Banks have focused on cutting costs for the past several years, and generally they have been successful," Terry McEvoy, an analyst at Sterne Agee, told American Banker. However, he emphasized that producing cost reduction "has been getting harder each year."

Amid these challenges, banks will encounter substantial pressure to push their revenue higher over the next few quarters, according to American Banker. To generate the improvements they need, financial institutions must focus on lending. One way banks can enhance the income they generate from such activities is buying loan portfolios.

To increase the odds of purchasing the right bundle of loans, financial institutions might benefit from working with Garnet Capital Advisors, a loan sale advisory firm that has significant experience spanning many different kinds of debt.