We’re back on Fed Watch! With the Federal Reserve’s Open Market Committee expected to announce another rate decision at 2:00 PM on 30 October 2019, markets have baked in more than a 90% likelihood of a 25 basis point cut. We have kept a close eye on regional and diversified banks as earnings season progresses to gauge how lower rates are impacting management commentary and their business and economic implications. We share our analysis below as context ahead of the Fed’s announcement and press conference.
Despite ebbs and flows in investor sentiment, about three-fourths of the S&P 500 has beaten analyst expectations this quarter. Whether that is a signal of zealous analyst pessimism or corporate outperformance is in the eye of the beholder. Either way, we took the opportunity to capitalize on the backlog of earnings calls held this quarter to date to check up on a few names in the banking sector to take their temperature on margins and the rate environment.
We used Amenity’s NLP models to construct a tool that specifically tracks margin-related content within transcripts of earnings calls. We piloted that set of analytic tools by focusing them directly on financial firms and analyzed S&P 500 regional and diversified banks that have reported this quarter in order to quantify management’s commentary and outlook on margins. We know from our previous work that lower interest rate environments put a squeeze on net interest margins and that the uncertainty created is discernible, so we have intentionally kept tabs on regional and diversified banks.
Figure 1 above presents a visualization of S&P 500 regional and diversified banks that have held earnings calls this quarter in which Amenity’s NLP models detect extractions related to margins. (Banks in blue are regional banks whereas banks in green are diversified banks. A reference list of companies and tickers is provided at the end of this note.) We observe a bifurcation in which regional and diversified banks differ dramatically in their net polarity when discussing margins. The notion of a bifurcation is of little surprise but we find the magnitude of that split to be noteworthy with respect to the level of net negativity in regional bank margin-related commentary. As we have discussed elsewhere, regional banks exposed to lower rate environments exhibit measurably more negative margin commentary than their diversified bank peers. With that in mind, there is a conspicuous outlier in U.S. Bancorp (USB), which exhibited highly negative margin commentary compared to its peer group. We offer examples of margin-related commentary from that call below:
"...net interest margin declined by 11 basis points versus the second quarter, in line with our expectations"
"...we would expect fourth quarter to become more challenging as we go into the quarter end and into 2020."
"...when we think about the fourth quarter, we would expect our net interest margin to decline, but kind of in the range of that core level, which is 7 to 8 basis points."
In a more targeted inquiry, we analyzed forecast language related to margins within the same set of regional and diversified banks. In doing so, we sought to identify specifically how management teams talk about margins in a forward looking manner to set expectations for future margin performance. Figure 2 below visualizes our findings by depicting margin forecast commentary by S&P 500 bank management teams in their most recent earnings calls.
We found that only 47% of S&P 500 banks offered margin forecasts on their most recent earnings call. We view this as an indication that the remaining 53% may be avoiding setting a baseline for future expectations or not providing forward looking comments due to underlying uncertainty in an evaporative interest rate environment. We consider both explanations plausible while reflecting on the fact that US Bancorp (USB) was the only diversified bank to offer any margin forecast commentary while Regions Financial Corporation (RF) was the only regional bank to offer positive commentary in their margin forecast language. We offer examples of margin forecast commentary from the latter call and select others below:
"We think our margin could increase into the low to mid 3.40 range."
"However, we expect the first quarter margin to expand into the low 3.40s as the benefits of our hedging strategy begin."
"Adjusted for the liquidity build, we expect net interest margin to decrease 3 to 5 basis points."
"This will negatively impact net interest margins by approximately 3 to 5 basis points in the fourth quarter."
"These actions will provide negative pressure to BB&T’s net interest margin…"
"...overall, margin will still decline given the aforementioned net exposure to short-term interest rates."
"On a stand-alone basis, I would expect our net interest margin to decline by 2 to 5 basis points in the fourth quarter given the impact of the September rate cut."
When compared to our earnings preview offered at the beginning of the quarter, we notice that many of the same financial firms we identified as having a positive or negative baseline net polarity in terms of margin commentary have found themselves in the same buckets once more. We have studied the S&P 500 holistically and continue to believe that regional and diversified banks are an interesting space to focus our tools in an age of unconventional monetary policy and interest rates that are heading towards the zero bound. Whatever the outlook of today’s Fed decision is, we will be checking back in on financials that report after the FOMC’s decision to gauge management outlook and keep you apprised of new developments.
As always, thank you for your readership and please feel free to reach out with questions or comments at any time.
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Amenity Analytics is the industry leader in providing insights from unstructured text by using Natural Language Processing (NLP) assisted by Artificial Intelligence (AI) and Machine Learning (ML). Amenity’s NLP system is a sector-agnostic, language-dependent tool for quantitative text analysis that is deployed across the financial services industry and beyond.
This communication does not represent investment advice. Transcript text provided by S&P Global Market Intelligence.
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