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Industry Outlook -- Finance: BANKING

BANKING

If the economy holds up, it'll be smooth enough sailing. But don't expect the earnings growth of '96-profits won't be so easy to come by

Judging by their 1996 performance, U.S. banks have never been healthier. Flush with capital, they are busily buying back their own shares. Loan problems seem manageable. More efficient operations have cut the cost of providing services. Low interest rates are spurring healthy loan demand, while lucrative new sources of fee income are boosting the bottom line.

All this bodes well for earnings in 1997, especially if, as expected, the U.S. economy keeps growing moderately and interest rates stay low. "Bank profits have been consistently rising. I do not see anything standing in the way of that," says Harry V. Keefe Jr., chief executive of Keefe Managers, an investor in financial institutions.

Just don't be surprised if profit growth slows down. The main reason: revenue growth of 6% to 7% in 1997, vs. 1996's heady 14% to 15%, says PaineWebber Inc. analyst Lawrence W. Cohn. In 1997, he sees loan growth of 5% to 6%, down from 1996's robust 8% to 9% level. Moreover, banks' fierce fight to make loans is squeezing margins. And battling for fees from such areas as mergers-and-acquisitions advice and credit cards will be more cutthroat.

DOING DEALS. With profit growth slowing, banks will woo investors through share buybacks. Rising profits since 1991 have spawned excess capital. In 1996, banks spent some $20 billion on share repurchases, and that should rise to nearly $30 billion in 1997, says UBS Securities Inc. Managing Director Gerard L. Smith.

Some of the money for buybacks could come from securities underwriting and insurance, two areas in which banks are making inroads. Regulators--and perhaps even Congress--are likely to speed this process by easing restrictive rules, such as the Glass-Steagall Act, the 1933 law separating investment and commercial banking. Already, fee income is important at some banks. For instance, advising on deals should be hot again in 1997. "All the factors are in place to have continued strong levels of mergers-and-acquisition activity," says Thomas B. Ketchum, head of investment banking in the Americas for J.P. Morgan & Co.

Many banks will also spend more on technology to develop the ATM, phone, and computer-banking expertise they'll need to provide low-cost banking services in the future. The entire industry will keep a tight rein on expenses.

Banks will have to keep a firm grip on credit quality, too. Record personal bankruptcies in 1996 caused losses for credit-card lenders, but these are expected to stabilize in 1997, as many issuers have cut back solicitations and tightened standards. Commercial loan quality remains sound. "Credit quality is not really going to present a problem for the industry," says Richard A. Zona, chief financial officer at First Bank System Inc. Reserves are high, and larger loan-loss provisions in 1997 should lift them higher.

Of course, the economy could falter--killing loan demand and ravaging credit quality. But barring that, careful and industrious bankers can look forward to another good year.By Alison Rea in New YorkReturn to top

TABLE

Prognosis 1997

POSITIVES

-- The pace of banking mergers should pick up, helping banks that execute well to reduce their costs

-- Regulators will allow commercial banks to be more active in investment banking and insurance

NEGATIVES

-- Revenue growth will be tough to come by for many banks, especially with the rate of loan growth slowing

-- Rising loan-loss provisions will eat into profits

-- Technology costs keep risingReturn to top


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