After a period in which 14 of the 15 largest banking companies in the country reported third-quarter earnings, one lukewarm conclusion emerged: It could have been worse.
In that way the third quarter was remarkably similar to the second: Bankers, regulators, and investors spent much of the quarter lamenting operating conditions, but their concerns did not show up strongly on banks' bottom lines, despite signs of sequential weakening.
Median earnings per share for 15 large banks that had disclosed earnings by last week were up 10% from last year's third quarter but did not rise at all from the second quarter. The factors behind this stagnating growth were no surprise: Funding costs have risen as consumers plow deposits into high-yield accounts, margins are squeezed by the yield curve and competition, and volume has eased in some businesses.
"We faced several challenges this quarter, specifically a flat to inverted yield curve that persisted throughout the quarter, a continued shift in deposit mix, and seasonal slowdowns in key fee-generating areas such as investment banking, trading, and retail investment services," said L. Phillip Humann, the chairman and chief executive of Atlanta's SunTrust Banks Inc., in remarks Tuesday that were echoed throughout the industry. "Although these trends did in fact play out for the quarter and had the effect of slowing our revenue growth," he said, "a number of positive trends continued throughout the period."
The generally positive aspects of bank performance were across-the-board stabilization of the factors that have held back earnings - and persistence of the factors that have supported them. In conference call after conference call, executives said margin woes were abating as they adjusted balance sheets for a flat, and occasionally inverted, yield curve. They said the industry's run of good credit is likely to remain intact, at least for the fourth quarter. And they said funding costs seemed unlikely to get much worse than in the third quarter.
Funding costs - specifically, deposit pricing - garnered more attention than any other topic. Every one of the 13 largest banks that hosted conference calls faced nagging questions from analysts about the migration of dollars from low-yielding transaction accounts to the attractive yields of high-rate checking accounts, money markets, and certificates of deposit. The two banks that did not hold conference calls but offered investors prerecorded telephone calls - Wells Fargo & Co. in San Francisco and Minneapolis' U.S. Bancorp. - also discussed the trend.
And with good reason. Of the banks that disclosed interest expense on deposits, the median showed a 60% increase from the year earlier - though the median bank showed just a 6% increase in deposits during that time. The problem was hardly better in sequential-quarter comparisons, where deposit expense grew 12% as deposits fell marginally.
The Federal Reserve Board's steady push on the short end of the yield curve for the past couple of years took its toll on absolute expenses, but executives were emphatic that the problem was as much about competition as the yield curve's structure.
Nowhere was the issue given a fuller airing than in SunTrust's call. Mr. Humann mentioned rising deposit costs in his introductory remarks and before long turned the floor over to Greg Ketron, the banking company's director of investor relations.
"The continued shift in deposit mix had negative ramifications on net interest income and the margin in the third quarter," Mr. Ketron said.
This was his way of introducing another 1,100 words on the topic. Later, chief financial officer Mark Chancy weighed in on the same problem, followed shortly thereafter by Gene Kirby, who manages the company's retail bank.
"There's no question that the competition for the deposits heated up during the third quarter and that there was some aggressive pricing in certain markets," Mr. Kirby said.
Though it did not say so explicitly, SunTrust was one of those aggressively pricing deposits, at least in some of its markets. The company "targeted some of the regions where we had lower market share," Mr. Kirby said, "and some of the opportunities we felt like we would have less cannibalization risk."
Of the many banks that admitted they had raised deposit rates, none confessed to being a first mover. As usual, all indicated they were reacting to the behavior of their competitors. However, most of the executives seemed to think relief was in sight.
Peter Raskind, who heads the consumer bank at Cleveland-based National City Corp., said during a conference call Tuesday: "Assuming that the Fed is done with increasing rates … there might be modest increases from here in [deposit] rates, but we think the situation is largely stabilized."
Bank executives sang their now-familiar song about credit quality: It can't get much better - despite the fact that almost all showed some weakening. Only three - Regions Financial Corp. in Birmingham, Ala.; Comerica Inc. in Detroit; and Marshall & Ilsley Corp. in Milwaukee - reported lower loss provisions in the third quarter than in the second. In aggregate, the 15 banks set aside $5.7 billion for loan losses, up 23% from the second quarter's $4.6 billion - and not quite enough to cover the $5.8 billion of net chargeoffs they reported.
Year-over-year comparisons were not very instructive. These same banks had provided $7.1 billion for loan losses in last year's third quarter, but outsized provisions in the wake of Hurricane Katrina and in anticipation of a then-new bankruptcy law accounted for almost all the difference between this quarter and the year earlier.
Banking executives again found themselves in the position of carefully praising current credit conditions. Their hard-won experience has pushed them to anticipate an inevitable worsening, but the evidence so far is at most anecdotal, and their ubiquitous warnings about a coming downturn must largely be taken on faith for now.
Bryan Jordan, the CFO of Regions, said: "As we said last quarter and the quarter before, it's going to get worse at some point. I don't think it's in the very near term. I'm not sure if that's in 2007 or beyond." He spoke during a conference call Oct. 13, adding, "We're very optimistic as we go into the fourth quarter about credit levels."
Mr. Jordan's ambivalence about credit quality was repeated by almost every executive commenting on credit quality.
Chris Marshall, the CFO at Fifth Third Bancorp, put it this way: "We think the overall credit environment is going to be relatively good, but it seems reasonable to assume that things will not be as favorable as they've been for the past few years. But I emphasize we do not foresee any sharp turndown on the horizon."
Stability was also the watchword, at long last, for net interest margins. Though few bankers are counting on a steepening yield curve any time soon - "I'm projecting personally that the flat yield curve is going to last for a while," Charles Prince, the chairman and chief executive of New York's Citigroup Inc., said on Thursday - they are learning to manage their way around the problem.
Bank of America Corp.'s CFO, Al de Molina said, "There's a silver lining to a flat-yield, low-volatility environment, and that is that you can position yourself exactly as you want at a relatively low cost."
"We've eliminated virtually all of the first-year risk to higher rates and a flattening curve. We've also maintained almost all of the benefit to the declining rate environment and a steeper curve."
Jerry Grundhofer, the CEO of U.S. Bancorp, said the quarter would probably prove a "very important inflection point" for his bank's margin.
With stability the watchword on margins, credit quality, and competitive pressure, the fourth quarter seems likely to repeat the familiar pattern of the second and third: tough talk, tolerable results.
