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U.S. Bank, PNC Lack Options for Countering Low Rates

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The latest quarterly results from U.S. Bancorp and PNC Financial Services Group illustrate the same hard truths: earnings are going to be lackluster until rates go up, and regional banks and their investors will have to keep toughing it out.

Why? Margins are continuing to erode, offsetting low yields with volume is proving tougher than expected, fee businesses are not enough of a supplement, and most cost-cutting efforts have been exhausted.

"All this means that there will likely be continued pressure on earnings — banks can maybe find other ways to manage through such as purchasing assets or look for further cost cuts, but really that's about it," said Scott Siefers, an analyst at Sandler O'Neill. "Whatever relief we had hoped for with rates is further out than we expected ... and banks are left balancing the near-term pain with making sure they have the ability to benefit from hopefully a brighter day ahead."

PNC in Pittsburgh is no different from other institutions in how it is being affected by low interest rates— they are killing its spread income. Net interest income fell 6%, to $2.1 billion, in the first quarter from a year earlier. The net interest margin fell 44 basis points to 2.82%.

Chairman and Chief Executive Bill Demchak forecasted that rates will not rise as soon, or at a fast enough clip, as he would prefer.

"It's also clear given the most recent jobs data and some data out this morning on manufacturing that we are likely to see interest rates rise later and slower than previously anticipated," Demchak said Wednesday. "If correct, it will have an impact on our net interest income for the remainder of the year and out years. We can't ignore the realities of the current environment."

If the Federal Reserve postpones raising rates until the fall, it will keep a lid on revenue growth, Rob Reilly, PNC's chief financial officer, said during the conference call.

Richard Davis, chairman and CEO of U.S. Bancorp, also acknowledged the burning question as to when and how rates will rise: will there be four hikes starting in June, or two hikes starting in September? However, Davis returned to his often-cited theory that a rate increase is going to cause a "tsunami" of activity as borrowers scurry to lock in rates before they tick up higher.

"What's most important is it starts at all," Davis said. "I've got to tell you, that is way more important than the number of times that it occurs."

U.S. Bancorp's net interest income totaled $2.75 billion in the first quarter, up 1.7% from a year earlier and down by the same amount from the fourth quarter. Its net interest margin was 3.08%, down six basis points from the end of the year. Siefers said he was surprised by the further margin erosion, as the company had signaled in the fourth quarter that most of the erosion had ended.

Disappointing loan growth exacerbated the company's linked-quarter decline in net interest income. The company had projected loan growth of 1% to 1.5% for the quarter, but it was 0.6% -- or 0.8% when adjusted for one-time events in the fourth quarter. In an interview, Kathleen Rogers, the company's chief financial officer, attributed the lower-than-expected loan growth to its retail business. The company is expecting the loan growth to be back in the 1% to 1.5% range this quarter and perhaps move as high as 2% later in the year.

PNC and U.S. Bancorp both have robust fee businesses to provide a cushion to the blows in traditional banking. U.S. Bancorp owns merchant processing and payments businesses, and PNC has asset management business. Such operations helped PNC more than U.S. Bancorp last quarter, but neither got a huge pop from them.

The $351 billion-asset PNC posted a year-over-year increase in noninterest income with positive contributions from multiple categories. Fee income rose 5% to $1.7 billion. Asset management, the largest category, rose 3% to $376 million. PNC includes figures from both its own asset-management unit and from BlackRock in the category. PNC owns a 22% stake in BlackRock, the world's largest asset manager.

Corporate services rose 14% to $344 million on higher revenue from treasury-management services. Consumer services, which includes fees for brokerage services and credit cards, rose 7% to $311 million.

U.S. Bancorp reported noninterest income of $2.15 billion, up 2.2% from a year earlier, but down 9.1% from the prior quarter. First quarter revenue for U.S. Bancorp is typically lower because of the weather and spending trends at the beginning of the year. Siefers says it was still lighter than normal.

"Relative to our estimates, most line items were simply a few million dollars weaker than we had anticipated," Siefers said in a research note on Wednesday.

In an interview, Andrew Cecere, U.S. Bancorp's chief operating officer, said that the company prefers fee businesses that carry low volatility, as compared to the highly volatile capital markets business.

Cost cuts have been an answer for many banks in recent years, but the heads of PNC and U.S. Bancorp seemed reticent to cut much more.

They are actually adding staff in the area of compliance.

PNC said its personnel costs rose 7% to $1.2 billion because of the hiring of personnel to comply with new regulations. Meanwhile, U.S. Bancorp said compliance staff is the only place it has added staff since February 2014.

PNC executives added that they will resist the urge to pull back on making investments in technology and other infrastructure needs, such as building new data centers, Demchak said. It would provide a temporary boost in the short-term to cut expenses in these areas, but the investments help give the bank a strategic advantage and will reduce costs over the long run, Demchak said.

PNC has achieved about 30% of its continuous improvement plan, which is slated to reduce costs by $400 million this year, Reilly said.

Expenses at U.S. Bancorp were up nearly 5% to $2.66 billion. Still, Davis was fairly defiant in saying he would not cut costs to juice earnings today.

"If you remember in high school the bar hang …[it] was 90 seconds on the bar. And if you remember it at all, the last 10 seconds were torture," Davis said. He later added: "I am holding on for dear life not to do a reduction in force so that we can have a great future while watching every penny. … It's tough."

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