By Liz Hoffman 

Bank stocks reached their highest point in nearly 10 years on Wednesday, building on postelection gains that reflect hopes firms will soon shake free the shackles of stringent regulation, superlow interest rates and sluggish economic growth.

The KBW Nasdaq Bank index, a measure of 24 of the biggest U.S. bank stocks, rose more than 3% to touch its highest level since late 2007. The gain, which followed President Donald Trump's address to Congress on Tuesday night, brought its rise since Nov. 8 to about 32%. The index has outperformed the S&P 500 by around 20 percentage points during this time.

Among big banks, Bank of America has led the charge higher. It is up 50% since the election; on Wednesday the stock gained 3.6%.

Investors aren't the only ones who believe the outlook for banks has changed drastically -- and for the better. Bank executives themselves are now looking to reinvest in their businesses rather than just hoping to return more capital to shareholders. That is a big change from recent years when executives were mostly in a defensive crouch.

"We have the capacity to increase our balance sheet if the opportunity presents itself," Morgan Stanley finance chief Jonathan Pruzan told analysts earlier this year after the firm's fourth-quarter earnings report. "That's certainly an opportunity that we haven't seen in the past."

Granted, banks' financial results haven't yet shown actual gains. Among the six biggest U.S. banks, for example, only J.P. Morgan Chase & Co. and Wells Fargo & Co. posted returns on equity for 2016 that exceeded the 10% level that investors generally consider to be a bank's cost of capital.

Lighter regulation that allows banks to hold less capital could help to bolster those returns, though. And analysts are already forecasting increased profitability.

Analysts' earnings-per-share expectations for 2018 for the six big banks have increased, on average, by about 11% from the end of October to the end of February.

Reflecting this optimism, J.P. Morgan executives on Tuesday struck a bullish tone at the bank's annual investor day. And while the bank continues to focus on returning capital, Chairman and Chief Executive James Dimon noted growth is a priority. "The most important thing we do, bar none, is investing in our own businesses and the opportunities are everywhere to do better services, better profit-creating processes and more vision," he said.

J.P. Morgan also said its balance sheet, which stood at $2.49 trillion at the end of last year, is likely to increase to about $2.6 trillion by the end of 2017. In recent years, the bank mostly had held assets steady, or in some years reduced them.

At Morgan Stanley, the balance sheet has shrunk to about $800 billion today from more than $1 trillion in 2007. The biggest cuts at the firm have come in its trading and banking divisions, whose share of total assets has fallen more than 18 percentage points over the past decade.

Granted, if Mr. Pruzan wants to start growing the balance sheet, he will have to have capital. But that is one thing Morgan Stanley has plenty of: Keefe, Bruyette & Woods analysts estimate the firm is holding 10% more capital than it needs to pass the Federal Reserve's annual "stress test," the highest proportion of any big bank.

Mr. Pruzan isn't alone. Retained earnings at the six largest U.S. banks have doubled over the past five years and now make up 62% of combined total shareholders' equity, up from 44% in 2010.

"For a few years, the story on capital was 'when can you return it?' but that's because there was no business opportunity to put it to use," UBS Group AG analyst Brennan Hawken said.

Pivoting to growth mode will pose a test for bank executives. While investors would welcome opportunities that bolster returns, firms are still under pressure not to fritter capital away on pipe dreams. And large-scale acquisitions, often a favorite way for CEOs to put capital to work, are still unlikely at firms labeled "systemically important" to the financial system.

But there are other ways to invest. Much as retailers can revamp their supply chain, build new factories or open new stores, banks -- whose business is refining raw financial products such as cash and simple securities into finished, more complicated ones -- can invest in each leg of the process.

That could include dangling incentives to lure new customer deposits, greenlighting riskier trades, making more loans or purchasing "smart" ATMs in branches. The latter, at up to $100,000 apiece, are exactly the kind of expenses banks were once eager to avoid.

One tantalizing opportunity is on trading desks, which have been slowly starved of capital in recent years. The value of financial instruments held by Goldman Sachs Group Inc., for example, has fallen by one-third since 2012, even as asset prices have risen. Smaller portfolios make it harder for traders to meet client demand; day to day, it means they say "no" more often than they once did.

Speaking on his bank's earnings call last month, Goldman's current finance chief, Harvey Schwartz, talked of the choices that will face his successor, R. Martin Chavez, who will take over as chief financial officer in April.

"If he has the chance to deploy capital back to our clients, not to return as much to shareholders, grow risk-weighted assets, those are the environments that we thrive in," Mr. Schwartz said. "Ultimately, that's our preferred way to deploy capital."

At Citigroup Inc., CEO Michael Corbat said in January the bank was looking to invest in its core businesses. He singled out upgrading "tired" branches in Mexico and increasing its deposits and trading from hedge funds, a business that can weigh heavily on a bank's balance sheet.

"It's things that we need to do," he said. "We think we've got the ability not just to maintain but to grow share and to grow profitability."

--Emily Glazer contributed to this article.

Write to Liz Hoffman at liz.hoffman@wsj.com

 

(END) Dow Jones Newswires

March 02, 2017 02:47 ET (07:47 GMT)

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