November 3, 2015

Banks Cutting Costs to Boost Earnings as Interest Rates Remain Low

Big banks in the US are experiencing declines in profits as interest rates continue to lag.

With the sustained low interest environment and weak fixed-income trading activity, banks are taking serious measures to keep revenues up. And one of the major ways they are doing this is by cutting costs.

Sustained Low Interest Rates Eating Banks' Incomes

The extended low-interest rate environment that banks have found themselves dealing with for far too long now is linked to a decrease in profitability, especially for smaller financial institutions. The banking sector's profitability decreases with drops in interest rates charged without a corresponding lowering of deposit rates, which cannot occur as deposit rates are near zero.

Decreases in Federal funds rates directly decrease the yield on this money, which in turn directly affects banks' earnings.

The crux of banks' profitability lies in its lending activity. The spread between the yield generated with money invested in short-term notes and interest paid out to customers increases with higher rates, and plummets with lower rates. Banks are waiting for an interest rate hike so they can start enjoying direct earnings as a result of a wider spread.

The nation's biggest banks have reported a decline in revenue and income from interest on loans - with the exception of Wells Fargo & Co. Bank of America and JPMorgan Chase reported a drop on this front, as historically low interest rates continue to shorten the spread between any interest earned on loans and the cost of funds.

NYC-based JPMorgan reported a 6.4 percent plummet in revenue, while Charlotte-based Bank of America reported that only one of its four main businesses realized an increase in revenue.

Investors continue to be hesitant about making any trades amidst ambivalence about when the Fed will finally hike interest rates amid extraordinarily unsettled market activity throughout 3Q. Many believed that September would finally be the time when the Federal reserve would increase rates, but that month has come and gone with no sight of a hike just yet. The longer the postponement of an interest rate increase, the more downward squeeze is placed on revenue for banks.

Cost Cutting as a Means of Lifting Earnings

Some of the biggest banks in the nation are resorting to cost-cutting as a means to protect earnings. Bank of America has seen the positive effects of taking such measures. The bank reported third-quarter revenue of $21.7 billion, compared to $20.43 billion from the same time last year.

Investors and bankers are still waiting by the sidelines for the Fed to make a move on interest rates.

In addition to favorable credit conditions, increase in equity income, and lower expenses, Bank of America's 3Q earnings were also largely a result of shaving 31 percent of its non-interest expenses off its books. BofA recently proposed to lay off over 2,000 employees in its lagging mortgage division.

Bank of New York Mellon Corp. also reported an increase in profits, thanks in part to slashing costs and selling assets, including its headquarters. The NYC-based bank boosted 3Q profits by 16 percent as assets and fees increased, and expenses dropped. Net income increased to $766 million from $661 million from the same time last year.

Citigroup's profits also spiked over 51 percent thanks to lower costs. The bank's legal costs plummeted compared to the same time last year, and its operating expenses dropped 18 percent as it works through plans to exit businesses where certain prospects are not proving profitable.

Salt Lake City-based Zions Bancorp. posted stronger 3Q earnings as a result of cost cuts and higher fee income. Its earnings spiked 6 percent from the same time last year to $84.2 million, or 41 cents a share.

How Can Banks Continue to Profit During a Lagging Loan Market?

Clearly, cutting costs is an important and effective way in which banks are padding earnings. In addition to such critical tactics, it's also imperative for financial institutions to come up with strategies to leverage balance sheets to put healthy, profitable loans on the books. Done correctly, this can help banks benefit from an increase in revenue and income from interests on loans, despite the continued lull in the interest rate environment.

In order to ensure such steps are taken carefully and skillfully, it's critical for banks to partner up with a team of experts who are well versed in the realm of optimizing loan portfolios even amid compromised loan markets. Garnet Capital is your source for such expertise, and we're dedicated to protecting - and building - your bank's bottom line.

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