By Mary Ellen Biery, Research Specialist, Sageworks
As U.S. banks begin reporting second-quarter earnings in the next few weeks, several risk-related areas of their results may be worth examining by shareholders. Wells Fargo & Co. (NYSE:WFC) and JPMorgan Chase & Co. (NYSE:JPM) are scheduled to kick off the second-quarter earnings reports from major publicly traded U.S. banks on July 12.
A twice-yearly report out last week on issues that federal regulators see as potential threats to the safety and soundness of national banks and federal savings and loan associations highlighted commercial and industrial lending, loan-loss provisions and commercial real estate trends as being among some of the focus points.
The Office of the Comptroller of the Currency's National Risk Committee said in its "Semiannual Risk Perspective" that supervisory staff will continue to scrutinize commercial credit underwriting practices for signs of slippage in structure and terms of underwriting, and they will examine the appropriateness of institutions' allowance for loan and lease losses (ALLL) and their exposure to commercial real estate, among other things.
Those three areas provide investors with a few things to examine in earnings reports, said Mike Lubansky, a senior analyst with Sageworks, a financial information company that provides risk management solutions to financial institutions.
"We talk with a lot of banks that are still being pressed and will continue to be pressed on monitoring their commercial real estate concentrations and doing stress testing and sensitivity analyses on their CRE concentrations," he said.
Investors may want to monitor commercial real estate levels as banks report their second-quarter results. "Where are they in terms of concentration? Do they have room to grow if there's increased opportunity or do they not?" Lubansky said.
The OCC said that the economic outlook for 2013 is positive, but banks' anxiety over slow growth in revenue and core profits remains high.
"Low interest rates, narrow loan demand, and lower fee income continue to hinder stronger revenue gains, while lower loan-loss provisions have largely supported profits," the report said. As managements seek ways to generate acceptable returns in this environment, strategic risk continues to increase for many banks, according to the OCC.
"The primary driver of improved earnings over the past year was lower provision expense, although noninterest income and realized securities gains also supported profit growth," the report said.
But the pace of improvement in the credit quality of bank portfolios is stabilizing, the OCC said. So while bank earnings have been fueled in recent quarters by rapid reductions in banks' allowance for loans and lease losses (ALLL), those reductions may stabilize or slow as the allowance returns to a more normal share of loans.
"Lower provisions are likely to provide a diminishing benefit to earnings performance in 2013, should loan-loss reserves stabilize as expected," it said.
Lubansky said this will be one area to watch during upcoming earnings reports. Banks continue to face pressure from regulators to keep the ALLL at a sufficient level. In addition, many are concerned about how upcoming changes to the accounting standards will affect that estimate over the next couple of years. A recent survey by SNL Financial found that half of respondents expect the changes will increase reserves between 10 and 50 percent.
Another issue to watch in banks' upcoming earnings reports will be reported trends in commercial and industrial lending. "You want to see if they increased lending but also see if it's tied to decreased underwriting standards," Lubansky said.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: Submitted on behalf of Mary Ellen Biery by the Sageworks Media Relations Team. Sageworks has no business relationship with any company whose stock is mentioned in this article.