A host of U.S. regional banks published their earnings reports this month. Loan-related problems and the pressure of the high-percentage interest rates put a damper on the results. Nevertheless, diversity allowed them to compensate for these problems, and major banks still look like solid investments.
San Francisco-based Wells Fargo (NYSE: WFC) exceeded analyst expectations. It saw a first-quarter profit of $2.24 billion, or 66 cents per share, while last year's profit was $2.02 billion, or 60 cents per share. Wells Fargo's revenue has reached $9.44 billion, exceeding that of last year by more than 10%, and also exceeding analyst predictions of $9.33 billion.
Credit losses are the weak spot in Wells Fargo's performance. Credit losses have grown by 65%. Most of these losses are related to subprime mortgages. Increasing interest rates, caused by the high Fed Funds Rate, mean that some borrowers are simply unable to pay on their loans. However, 11% growth in commercial lending has helped compensate the losses suffered from subprime mortgages.
Different Banks -- Same Problem
A similar situation can be observed with two other major banks: US Bancorp ( NYSE: USB) and SunTrust Banks (NYSE: STI).
In this quarter, Minneapolis-based US Bancorp has a profit of $1.13 billion, or 63 cents per share, roughly the same level as last year and about two cents under analyst expectations. As is the case with Wells Fargo, the weakest part of U.S. Bancorp is its meager mortgage profit. This has caused the bank's net-interest-margin -- one of the key indicators in bank activity -- to fall to 3.51% compared with 3.8% a year ago.
Atlanta-based SunTrust saw a decrease in profit to $513.9 million, or $1.44 per share, from $531.5 million, or $1.46 per share a year ago. And again, the reason for the slump is the bank's unsuccessful mortgage activity whose profitability has plummeted 90%.
Diversification the Key
Bad loans have hurt the big banks; however, this has not provoked a serious crisis in the banking sector or the economy as a whole.
It comes down to the rule: Don't put all your eggs in one basket. By upholding this principle, the banks have been able to partially compensate their losses on mortgage loans using other profit sources. The larger the bank is, the more opportunities for diversification it has. Also, banks need to improve the quality of their loan portfolios by only granting loans to reliable customers -- as Howard Atkins, chief financial officer of Wells Fargo, said, "We try to make sure we bring people into loans only if they can afford them."
The major banks coped with their mortgage-loan problems quite confidently. By diversifying activity and improving their loan portfolios banks will improve performance and secure themselves against any potential problems. Once again this proves that despite a high Fed Funds Rate, bank shares still have considerable growth potential.
Shares of WFC, STI and UBS have continued to rise the last five years, even against the background of an ever-increasing Fed rate. Obviously, a recession could hurt future growth, but at the moment concerns of the kind are not topical, and I recommend that you keep buying shares from the major banks.
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