Kevin T. Timmons
Strong results
The first quarter of 2002 has passed, leaving community and regional bankers mainly unscathed – yet again – by the recession and insulated from the big hits taken by national banks. But according to one executive, community institutions are not entirely free of worries, especially since non-performing loans often take up to three quarters before they emerge to trouble a bank’s portfolio.
Over the past year the recession dragged on, earnings reports tumbled and scandal rocked accounting firm Arthur Andersen. But while national banks worried about non-performing loans, charge-offs and investigations, community and regional bankers, while watchful, fared well.
Pennsylvania-based Sovereign Bancorp, which has a strong New England presence, posted a huge leap in net income, moving from $4.6 million in the first quarter last year to $66.9 million this year. Of course, that was due in large part to the completion last year of payments to FleetBoston Financial for branches it purchased in 1999, said Tye Barnhart, senior vice president of Sovereign Bank.
Another factor that helped regional and community bankers was the steep yield curve, according to Robert B. Segal, a portfolio manager with J. William Mantz Investment Advisors in Gloucester.
“The yield curve has been steep for a while so a lot of banks, especially now, are seeing the benefit on the deposit side,” said Segal, who added that deposits are costing banks less and CD rates have had time to cycle through to lower rates. Sovereign’s cost of deposits as a percentage of total deposits was 1.91 percent this quarter compared with 3.74 percent a year ago.
The bank also beat consensus estimates for operating earnings per share by one cent, with an operating EPS of 30 cents in the first quarter, up 11 percent from the same quarter last year. “We’d rather be right on or a penny above than a penny short, obviously, but it is helpful to hit the number as close to possible without missing it,” said Barnhart.
The stock market in general has wreaked such havoc on investors that any time companies hit estimates there is a collective sigh of relief, said Segal. But hitting estimates is something smaller community and larger regional banks have been able to do pretty much through the recession, said Segal.
“I don’t think they [community bank investors] were expecting any bad news at all. The industry isn’t expecting any major credit problems. The consumer’s been in great shape through this recession and that’s really the bread and butter of community banks,” he said.
But while there haven’t been a plethora of non-performing loans, delinquencies or charge-offs, the industry remains watchful, said Barnhart.
“We clearly stated on our earnings call that we are very much focused on asset quality and monitoring NPAs [non-performing assets] very closely, as our competitors are doing,” said Bernhart. “The reason for that is that non-performers and charge-offs and negative credit items tend to lag the economic cycle anywhere from two to three quarters,” he said.
So, while economic indicators are beginning to point to a mild recovery, the banking sector is still a couple of quarters away from seeing improvement in those numbers, he said.
‘Credit
Culture’
The recent decade-long strong economy was another factor that helped community and regional banks during the recession. The inherent credit culture that preceded the recession is really fundamental to how well a bank does during a recession, said Barnhart. Fortunately, the region has had a very strong credit culture for many years.
“So our loss severity, which is essentially the percentage of a new loan that you ultimately write off, is pretty low relative to our peers. [A] strong credit culture is No. 1 [among factors keeping earnings strong] and very much keeping an eye on expenses and just trying to be as productive as possible,” he said.
Net interest margin is the area to watch going forward, said Segal. “A real key for earnings is going to be the ability for banks to maintain that net interest margin,” he said. If the economy recovers, that may impact net interest margins.
The shape of the yield curve can drag down the net interest margin, Segal explained. “The yield curve is probably going to flatten because, at some point, the Fed’s going to have to tighten,” he said. While the Federal Reserve controls short-term interest rates, the market’s anticipation of the Fed’s raising rates may cause long-term rates to increase.
As far as projections for the rest of the year, Sovereign expects to earn between $1.25 and $1.30 per share fully diluted on an operating basis. “The steepness of the yield curve implies higher rates beginning in the second half of 2002,” James D. Hogan, chief financial officer, said in the bank’s quarterly report. “While we are hopeful that economic expansion will occur and lead to higher short-term interest rates, we are not relying on higher rates to realize our earnings targets. If short-term rates remain at current levels, our net interest margin may contract slightly, as the company is mildly asset-sensitive.”
But for now, results were good across the board, said Kevin T. Timmons, senior analyst at CL King & Assoc. in New York. While no single bank in the New England region really stood out as far as earnings, Banknorth Group continued to have solid numbers. The full impact of their spate of acquisitions has not been fully factored in yet but “they’re very good at it,” said Timmons, and shouldn’t have problems with their continuing acquisition plans.
“As we emerge from the recession of last year, it is difficult to predict how fast business activity and employment levels will recover, so we are pleased to achieve record earnings in what is historically our slowest quarter of the year,” said William J. Ryan, president and chief executive officer of the Portland, Maine-based Banknorth, which operates in the Bay State as Banknorth Massachusetts. “Our acquisitions meant higher expense growth than normal but they also contributed to stronger loan and deposit growth,” he said in an earnings release.
Quarterly earnings for Banknorth were $67.3 million, up 22 percent from last year’s earnings of $55.1 million.
The element driving earnings has been net interest income, said Ryan during an earnings conference call. In the first quarter, Banknorth’s net interest income was up 26 percent over the same quarter last year. That figure would have reflected an 11 percent increase without factoring in Banknorth’s recent acquisition of Andover Bancorp and MetroWest Bank. “[It was] a really strong quarter for us. It’s being driven by good deposit pricing, good pricing on our loans, a good yield curve,” Ryan said.
But public companies like Banknorth weren’t the only ones doing well. Privately held Eastern Bank improved 13.8 percent over last year’s net income, as well, earning $10 million in the first quarter this year vs. $8.8 million last year. Bryan Texeira, chief financial officer of Eastern, said that’s due to balance sheet management.
“We have not taken a lot of interest rate risk, so we have fared the decline of the interest rates fairly well. We have a very strong credit review process and we clearly do our best to minimize our risk to our lending practice as well,” Texeira said, adding that monitoring expenses and carefully choosing which large projects to undertake also has had a positive effect on earnings.
Although Eastern doesn’t have to worry about shareholders and meeting analyst expectations, the employees are bankers by nature, said Texeira, and therefore are compelled to get the best returns in order to continue to serve their niche market well into the future.
