Interest rates have yet to rise, but some analysts, anticipating a rate increase, are already voicing concerns about net interest margins at regional banking companies.
Loan growth is still sluggish, and a flatter yield curve and rising rates could slow revenues from lending significantly, observers say.
When will such a slowdown hit, and how severe will it be?
Edward R. Najarian, a regional bank analyst at Merrill Lynch & Co., said he expects the effects to show up this year. He predicts that the average revenue growth rate for the banks he follows should slow to 7% in the second half of the year and 5.5% next year, versus 12% in the first quarter.
In a research note last week, Mr. Najarian wrote that such a slowdown "is likely to translate into decelerating bottom-line growth rates."
In other words, net profits will also get pinched.
Just about everyone agrees that when rates go up, banks' margins narrow and revenues suffer, but when it comes to details, analysts and economists are quick to cite a number of factors that could alter the outcome for regional banks.
The extent of the rise in interest rates is one factor, analysts and economists said. The timing of the increase by the Federal Reserve Board is another. Then there is the question of asset and liability mixes, which differ widely among banking companies, as does their ability to hedge interest rates risks.
The outcome also depends on an individual company's ability to generate loan growth, particularly in commercial and industrial loans, where growth has been dismal for some time, observers say.
"We are hopeful that commercial loan growth will pick up," Mr. Najarian said in an interview Thursday, though he said he would not bet on it. Loan demand in general "will not be enough to improve revenues."
Not everybody shares such modest assumptions for loan growth. Keith Leggett, an economist with the American Bankers Association in Washington, said he expects commercial loan growth to pick up and consumer loan growth to remain "robust."
While net interest margins have peaked at some banking companies and are likely to fall, other banks' margins will actually widen as long as interest rates remain stable. That is because the interest paid on some products, such as certificates of deposit, bottomed out some time ago, and rising short-term interest rates would widen the spread on these products.
Yet another group of regional banks, those with a large core deposit base, could also benefit, said Sung Won Sohn, the chief economist at Wells Fargo & Co. in San Francisco.
So-called asset-sensitive banking companies, such as Cullen/Frost Banks Inc. of San Antonio and Mercantile Bankshares Corp. of Baltimore, would fall into this category. They have a lot of fixed-rate deposits and little wholesale funding, so when rates go up, they can charge more for loans while keeping deposit rates stable.
Core deposits are most likely to decline when an improving economy draws money back to the stock markets, but many bankers are already working to mitigate that trend. Some already provide customers with more compelling deposit rates and products with rates more compatible with investment products. Banking companies are also increasing their fee income, from sources ranging from cash management to debit cards, Mr. Marinac said.
Mr. Najarian concedes that most regional banks seem to have spotted the problem of being dependent on interest rates "and are working diligently to enhance their internal sale cultures, hoping to offset potential margin erosion with stronger sales volume and growing loan and deposit balances."
But those who benefited most from margin expansion will not be able to sustain their revenue growth, he said.
In his report, Mr. Najarian cited SouthTrust Corp. and Compass Bancshares, both of Birmingham, Ala., as examples of companies with "superior sales cultures." Other companies, including Regions Financial Corp. and AmSouth Bancorp of Birmingham, Colonial BancGroup Inc. of Montgomery, and National Commerce Financial Corp. of Memphis, have improved their sales cultures, he wrote.
Nevertheless, he said he expects revenue growth to slow at each one of these companies.
Sloan Gibson 4th, AmSouth's chief financial officer, begs to differ. In an interview Friday, he said that he does not expect revenues at his company to decelerate, even if interest rate rise.
"Since the third quarter of 2000 we have structured our balance sheet to dramatically limit the negative impact of changing margins," he said. "Our balance sheet is as close to neutral as we can get."
In that time AmSouth has sold $4 billion of fixed-rate securities, securitized $1 billion of fixed-rate consumer loans, and emphasized flexible-rate consumer and small-business loans, Mr. Gibson said.
There may be a silver lining in the symbolic meaning an interest rate hike would carry. Such an increase would be an indication of an economy on the mend, and perhaps the end of credit problems.
Richard J. DeKaser, the chief economist at National City Corp. in Cleveland, said when the pressure on asset quality eases, reserve building will not be as much of an issue, and that fact will improve the bottom line.
