Average loan growth for banks was sluggish in the second quarter of 2013, but there was a strong rebound in end-of-period loan balances to 5.6 percent annualized growth from a 0.9 percent contraction in the first quarter, pointing to strong momentum in the third quarter of 2013.
This optimism is supported by the Fed's August Senior Loan officer Survey, which showed loan demand improving at a faster pace, stronger manufacturer readings, and an improvement in business confidence.
However, the Fed's weekly H.8 loan survey is tracking at just 0.6 percent annualized quarter to date (QTD), compared with 1.2 percent growth in the second quarter. The third quarter to-date pace of 0.6 percent is lower than the 2.7 percent in the same period last year.
Loans are one of the key sources of revenue for a bank, which gets interest income via lending. A reliable leading indicator for loan growth is the outflow of deposits. A borrower typically first uses its deposits to meet business needs and then draws down on its line of credit.
However, according to H.8 Fed data, deposit growth continues to outpace loan growth, up 6.2 percent annualized in the third quarter to date as borrowers remain cautious.
"If these trends persist, our loan growth estimates for the current quarter could prove too optimistic,' BMO Capital Markets analyst Peter Winter wrote in a note to clients.
For the third and fourth quarters of 2013, BMO analysts expect loan growth for the regional bank group to pick up to 4.6 percent annualized and 5.7 percent, respectively, from 3.7 percent in the second quarter.
There has been a continued slowdown in commercial and industrial (C&I) loan growth to just 2.9 percent annualized in the third quarter to date from 9.0 percent in the second quarter and 15.4 percent in the first quarter.
Meanwhile, residential mortgages are on-pace to decline for a fourth straight quarter (down five of the past six quarters). According to the Mortgage Bankers Association, mortgage applications saw a decrease in 11 of the past 12 weeks as mortgage rates have increased.
"With the rise in mortgage rates, more consumers might switch to adjustable rate mortgages, which banks would be more willing to retain on the balance sheet," Winter said.
On the positive side, commercial real estate is on-pace to expand for a fourth straight quarter, with growth accelerating to 3.4 percent quarter-to-date annualized from 2.4 percent in the second quarter.
There is considerable disparity in H.8 loan trends between the largest banks and smaller banks. Loans at the largest 25 banks are tracking at a 0.6 percent annualized contraction compared with a 1.0 percent contraction in the second quarter. Meanwhile, loan growth for the smaller banks increased to a 5.9 percent annualized pace in the third quarter to date from 5.2 percent in the second quarter.
"The major difference is residential real estate is growing at the smaller banks versus declining at the largest banks. In addition, consumer loans are growing at a much faster pace at the smaller banks (9.2% annualized QTD) versus larger banks (2.4%)," Winter noted.
Most management teams expect low- to-mid-single-digit loan growth in 2013, which would imply a pickup in loan growth in the second half.
Unfortunately, deposit growth continues to outpace loan growth, and this could lead to higher excess liquidity, which acts as a drag on net interest margins. Deposit growth accelerated in the third quarter to date to 6.2 percent versus 2.2 percent in the second quarter.
Other earning assets, which are mostly excess liquidity, are held at the Federal Reserve earning less than 25 basis points, make up a median of 3.6 percent of assets at the regionals and 2.3 percent of assets at the small-cap banks.
"The continued uptrend in medium- and long-term yields could lead to more banks shifting excess liquidity into securities to pick up some incremental benefit to earning asset yield," Winter said.
Comerica (NYSE:CMA), New York Community Bancorp (NYSE:NYCB) and Wells Fargo (NYSE:WFC) have been more active purchasing investment securities given the more attractive yields. On the other end of the spectrum, Zinons Bancorp (NASDAQ:ZION), which also has a unusually high share of its earnings assets in excess liquidity, is not investing in the MBS market given the extension risk in a rising rate environment. It is waiting to reinvest the excess liquidity into loans.
Meanwhile, net interest margin guidance provided by bank managements calls for moderate pressure in the second half of 2013. The benefit of better securities yields with the increase in medium- to long-term rates should lessen the burden.
"We expect the average core net interest margin to fall 3 bp to 3.20% in 3Q13, followed by a 1bp decline in 4Q13. Our full-year 2013 forecast is 3.22% compared with 3.38% in 2012. For 2014, we are forecasting an average margin of 3.17%, roughly stable from our 4Q13 estimate," Winter added.
There is a risk of more margin pressure than forecast reflecting the potential for higher excess liquidity as deposit growth is outstripping loan growth, according to the H.8 data. Above all, the banks need to see stronger revenue trends via loan growth to witness higher stock prices.
