Tech spending sprees, construction comeback: Takeaways from 3Q earnings

Third-quarter bank earnings season is all about grappling with the unknown: When will the next economic slowdown come, and how should top executives be preparing for it? How much tech spending is enough — or too much? And are construction and consumer lending strong alternatives to commercial lending, or are they poised to go sour?

These were the questions, or the subtext of questions, big-bank executives have had to answer for the past week in conference calls with analysts.

The bankers’ answers — in which they defended their investments in new digital and other technologies, discussed the high-wire acts that are loan underwriting and deposit pricing these days, and complained about the competitive tactics of nonbanks and smaller lenders in the fight for C&I market share — evoked passionate responses and signs of frustration. They also provided a glimpse of the tension between banks and their investors that could intensify in the coming months.

The following is an outline of five hot-button issues that will be major preoccupations of bankers over the next several quarters.

AB-EXPENSES-101818

Full speed ahead on tech spending

Big banks defended their aggressive spending on technology, even as investors — fearful that revenue growth could be leveling off — are urging them to tap the brakes.

Bank of New York Mellon Chairman and CEO Charles Scharf offered a particularly impassioned defense of his company’s digital investments during a conference call with analysts on Thursday, after the custody bank said that noninterest expenses climbed 3% in the quarter when compared with a year earlier.

“No. 1 is, in the short term, we are going to spend more money on technology,” Scharf told analysts who asked about opportunities to improve efficiency. “That is the livelihood of who we are. We need to do it. We need to improve our basic operating infrastructure, and we need to build products and capabilities for the future.”

BNY Mellon bank booked its technology costs in several line items, including software and equipment, which rose 12%, and professional services, which climbed 9%.

Scharf said that BNY Mellon would partly fund investments in tech by cutting costs elsewhere in the company. “As you walk around the place, it becomes more obvious what those things are,” he said.

Terry Dolan, the chief financial officer at U.S. Bancorp, echoed those remarks in an interview with American Banker Wednesday. Technology and related expenses at the Minneapolis company jumped 9%, while overall noninterest costs climbed 2%.

“If it’s a lower revenue environment, we will continue to make the investments in terms of those digital initiatives and capabilities, and we’ll figure out other discretionary types of spending that we can be managing,” Dolan said.

Bill Demchak, the CEO of PNC Financial Services Group, said that skimping on tech investments is simply not an option.

“In the near term that would make our expense look great, and in the long term it would kill us,“ he told analysts late last week.
construction lending over past decade

A comeback for construction lending?

Construction lending was like kryptonite for many banks after the financial crisis. But now it appears that the category is coming back into favor.

After construction loans went oh-so wrong in the lead-up to the housing crash, many banks either cut their exposure or exited the category entirely.

But some are getting comfortable with it again. First Horizon National in Memphis, Tenn., is originating more construction loans because it is underweight in the category, Chief Financial Officer BJ Losch said in an interview after the company issued third-quarter results.

“There are a lot of other regional lenders that are very overweight, and that allows us to be thoughtful and continue to do business,” Losch said.

Umpqua Holdings in Portland, Ore., in June hired an executive to lead its homebuilding-finance unit. That partly explains why construction loans rose 24% to $646.7 million in the third quarter compared with a year earlier.

M&T Bank in Buffalo, N.Y., has seen a recent uptick in construction loan commitments, “which gives us a little bit of optimism for the next six to 12 months,” CFO Darren King said during an Oct. 17 conference call.

And at the $2.2 billion-asset United Community Financial in Youngstown, Ohio, “new construction lending continues to be very strong for us,” CEO Gary Small said during an Oct. 17 call.

Some banks are being more cautious. Texas Capital Bancshares in Dallas has cut its construction exposure, “and we’re just reducing our risk overall,” CEO Keith Cargill said Thursday during a conference call.

“For an asset class, it’s still really great in our portfolio, but we know it’s more cyclical in a downturn than other asset classes,” Cargill said.
oil field, the oil workers are working; used in item about C&I lending
oil field, the oil workers are working
zhengzaishanchu - stock.adobe.com

The shifting C&I landscape

Intentionally or not, large and regional banks appear to be ceding some market share in business lending to smaller competitors.

Traditional commercial lenders such as Comerica, JPMorgan Chase and U.S. Bancorp all reported lackluster year-over-year growth in commercial and industrial lending, while smaller regionals such as Pinnacle Financial Partners in Nashville and Umpqua Holdings in Portland, Ore, reported double-digit gains.

Overall commercial loans at the nation's 25-biggest banks rose by just 2.3% over the 12-month period that ended Oct. 3, based on Federal Reserve data. In comparison, commercial portfolios at all other banks increased by 9.4% over the same period.

On earnings calls, executives at large banks were peppered with questions about why they have seemingly become complacent about competing for commercial credits. The responses were varied

Annual stress testing, which encourages conservative underwriting, is a factor, Marianne Lake, JPMorgan Chase’s chief financial officer, said when asked about the company’s 1% linked-quarter decrease in C&I loans.

Large banks are “increasingly bound by standard risk-weighted assets” and face pressure to keep the quality of their loan portfolios pristine, Lake said. “On some level, we have to generate a positive return and shareholder value … and on these very high-credit-quality loans that we’re producing. It’s expensive.”

Competition from community banks and nonbanks is another factor.

“The nonbanks are still very, very aggressive and they are clearly penetrating further down into the commercial portfolio than they ever have,” Kelly King, BB&T’s chairman and CEO, said during his company’s quarterly conference call.

Nonbanks are lowering interest rates and compromising other terms, making it “substantially tougher for commercial banks to be able to compete,” King said. C&I loans at BB&T increased by just 2% from a year earlier.

“My own view is they're taking enormous risk, and when we do have a cycle you're going to see a lot of them washed out,” King said. “That will be a very good thing. But today they are a competitive factor.”

Community banks are also beginning to compromise more to land commercial loans, King said.

“I think some of the smaller institutions are clearly taking more risk than what you see the large regionals or big banks taking,” he said.

Not all regional banks are struggling to add commercial loans. KeyCorp and PNC Financial Services Group are two that reported strong growth relative to their peers.

Meanwhile, some large banks are taking steps of their own to win back some of the market share they are losing to other institutions.

U.S. Bancorp, for example, said this week that it is adding commercial lenders in New York to pursue middle-market business in the nation’s largest metropolitan market. It has also launched a digital small-business lending platform.
scherr-stephen-bl041712-365.jpg

Caution in consumer lending

In unsecured consumer credit, bankers are taking steps to prepare for the next economic downturn.

The U.S. unemployment rate is at a nearly 50-year low, but once it starts to rise, losses in the credit card business typically follow suit.

During the third quarter, both Bank of America and JPMorgan Chase built their reserves in the card business.

At BofA, U.S. credit cards accounted for 36.3% of the total loss allowance, an increase of 5.8 percentage points from the same period a year earlier. At JPMorgan, card loans made up 55.2% of the loss allowance, up 5.2 percentage points from the third quarter of 2017.

“Cards is the one product where reserves are still building,” analysts at Autonomous Research wrote in a recent note to clients.

Meanwhile, Goldman Sachs warned that loan growth in its fledgling unsecured personal loan business may be curtailed in 2019, depending on what happens in the credit cycle.

“There’s no material evidence to suggest that it’s turning,” Stephen Scherr, CEO of Goldman Sachs Bank, said on a conference call with investors. “But equally, we take stock of just how long the cycle has gone.”

Just how much banks are trimming their sails in unsecured consumer lending will become clearer over the next week. American Express, Synchrony Financial, Capital One Financial and Discover Financial Services are all scheduled to report their third quarter earnings within the next seven days.
mobile-check-deposit-ts.jpg
Deposit Check with Cell Phone
OrlowskiDesigns/Getty Images/iStockphoto

Battle for deposits heats up

Deposit competition intensified in the third quarter, and the big challenge for banks of all sizes is trying to expand — or at least maintain — market share while keeping deposit costs in check.

Some banks, such as First Republic in San Francisco and Webster Financial in Waterbury, Conn., reported strong growth in deposits, thanks in large part to the niche markets they serve. First Republic largely caters to business owners and high-net-worth households and Webster is among the nation's largest administrators of health savings accounts.

Others, like Bank of New York Mellon and BB&T in Winston-Salem, N.C., saw deposits fall or stagnate, as consumers and businesses sought higher yields elsewhere. Digital banks have been especially aggressive in raising rates on deposits and are undoubtedly siphoning business away from other banks.

In the face of stiff competition, many banks, especially those that lack a large national presence, are having to pay up to attract depositors.

At the $27.3 billion-asset Webster, for example, deposit costs rose 45% from last year, in tandem with a 5.5% increase in overall deposits to nearly $22 billion. Deposits in Webster’s HSA Bank grew 14.5% to $5.6 billion.

The $96 billion-asset First Republic saw an even sharper rise in deposit costs, apparently the price of doing business with a wealthy clientele. Total deposits grew 14% on a yearly basis to $74.8 billion. But interest expenses for deposits more than doubled on a yearly basis, totaling $81.4 million in the third quarter.

First Republic President Hafize Gaye Erkan defended the bank’s deposit gathering strategy on a conference call. First Republic has seen particular success in growing deposits by offering attractive rates on certificates of deposit, which she described as “an effective way to attract new client relationships and deepen existing ones.”

Roughly three-quarters of those CD deposits are new money, and more than half of those clients have other deposit relationships with First Republic, she said.

Even some of banks that saw little to no deposit growth still got hammered on interest expenses. At BNY Mellon, average deposits fell 3% to $193 billion, but the bank still grappled with rising deposit costs. Interest bearing deposits increased 4% to $149 billion while noninterest bearing deposits fell 14% to $60.7 billion.

During a Thursday morning conference call, analysts expressed concern about BNY Mellon’s interest expenses and suggested that the bank was neglecting its deposit management.

Chairman and CEO Charlie Scharf didn't entirely disagree.

“We feel like we could do a better job at gathering deposits,” he said. "I think we all believe we that we can be far more proactive...about attracting the kind of deposits that we would like to attract."
MORE FROM AMERICAN BANKER