How Smaller Banks Are Growing With Rates Low, Big Banks Performing

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Smaller banks are highly exposed to movements in the yield curve and they’re up against aggressive spending from the big banks.

TheStreet spoke with Citizens Bank CEO Bruce Van Saun, who explained why his company is winning over investors in the current environment.

For starters, here’s a review of how the large-cap banks performed in the fourth quarter:

Large-Cap-Bank Performance

Some real bright spots among the majors reflect the advantage of investing in diversified banks that have scale.

JPMorgan Chase reported revenue of $28.3 billion, beating estimates of $27.8 billion. Earnings per share were $2.57, beating the $2.35 consensus estimate. Net interest income — the amount of interest income minus amount of interest paid to lenders — was $4.3 billion, beating estimates of $14 billion. Markets revenue was $5 billion, up 56% from a year earlier. JPM shares are up 1.4% since the earnings report earlier in the week.

Citigroup's revenue beat estimates, coming in at $18.4 billion versus $17.8 billion. EPS was $2.15, beating estimates of $1.81. Importantly, Citi ended the full year with return on tangible equity of 12.1%, against estimates of 11.5%. The bank has a long-term goal of getting toward 13%. The metric is net income as a percentage of book value and signifies how efficiently a bank leverages its assets.

Driving revenue the most was trading revenue. Fixed-income trading revenue grew 49% to $2.9 billion. With net interest margins narrowing, Citi still remains on track to deliver 0.6% net-interest-income growth for 2020, as loan demand has strengthened. The stock is up 2.2% since the earnings report.

Bank of America posted lower net interest income for its quarter and is expected to see a year-over-year drop of less than 1% in the metric for 2020. The stock is about flat, at $34.68 a share, since its earnings report.

Smaller Banks

So how can smaller banks grow when the yield curve is relatively flat and big banks are exercising their scale and might?

For starters, Citizens Bank sees roughly two-thirds of its $6 billion annual revenue stream from interest payments on loans to businesses and consumers. Bank of America and JPMorgan see half and less than half of revenue from lending, respectively, according to FactSet data.

Still, Citizens saw EPS grow 8% to $3.84 in the fourth quarter. Revenue from sources other than interest rose 9%, excluding acquisitions. Net interest income was flat with the year earlier but is expected to rise 0.4% in 2020. The stock rose 3.23% after earnings Friday to $40.87. 

Van Saun also explained that not only is the bank focused on growing its wealth-management business, but it can provide value-added services to midsized corporate borrowers, while also maintaining market share against large banks.

"What’s unique is the approach we take with midsized business — it’s having that really experienced relationship banker who assembles the product specialist to talk about the customer and [looks] at the customer situation,” Van Saun told TheStreet.

“We give value-added ideas — an M&A idea or a capital-structure matter or hedging of risks idea.”

He added, "Increasingly, we can go up against the megabanks.”

He said not all large banks work so closely with the needs of a business. One way to get in the door with businesses: "We enter as a credit provider and then we go to the world of showing all our services for them.”

Larger banks often have technologically superior platforms for corporate customers and Van Saun said his company has run into that headwind.

Large banks also have top-tier cash-management systems for corporate customers. But “we addressed that and this year we moved onto a great platform,” Van Saun said, adding that “we are moving to the same platform that JPMorgan uses for cash management.”

These investments could pressure Citizens’ near-term free cash flow. But the company's Q4 earnings call showed that the bank is putting roughly $28 million of capital expenditures — 0.4% of estimated 2020 revenue — into an improved digital platform for clients’ cash holdings.

And there’s one other key to supporting loan volumes at a time when loan demand, rather than fatter margins, will drive growth in net interest income: marketing and data analytics.

“How many marketing dollars do you want to spend to stimulate demand?” Van Saun asks. Too much marketing spend will compress the operating margin. So the bank turns its attention to data.

“One of the things that is really important is the investments we’ve made in data analytics,” he said. “Because of what we know about households and customers, we can personalize our products to what people really need .”

For context, PNC Financial sees roughly 55% of its $18 billion revenue stream come from lending but is on track to grow net interest income by 0.9% in 2020 without too much spend. Its operating margin is expected to stay steady over 2019, at 40%.

PNC is maintaining its quarterly dividend payment, while Citizens just increased it 8% to 39 cents.