By Telis Demos and David Reilly
Interest rates whipsawed bank stocks in the third quarter and
are likely to be the dominant force for shares through the end of
the year, despite investor optimism around a tax-code overhaul.
The S&P financials closed the quarter at a
post-financial-crisis high, bringing their year-to-date rise to
about 11%. But that fell short of the S&P 500's gain of
12.5%.
The performance reflected that banks stocks, after surging in
the wake of last November's election, have struggled at times this
year to maintain their momentum.
In late August and early September, for example, bank stocks
tumbled. That mirrored a drop in the yield of the 10-year Treasury,
which fell to 2.04% from 2.39% in July, amid mounting hurricane
concerns and rising geopolitical tensions.
As hurricane damage proved to be less than the most-dire
projections, the yield reversed course and climbed to 2.33% by the
end of the month. Bank stocks rose along with it.
After dropping about 5% between early August and early
September, J.P. Morgan Chase & Co. bounced back by nearly 8%.
The bank, the biggest in the U.S. by assets and market value, ended
the quarter at a record close of $95.51 a share.
The Trump administration's unveiling of a tax-overhaul plan near
the end of September gave bank stocks an added fillip.
The tax "proposal is a tailwind for the sector," said Jason
Benowitz, senior portfolio manager at Roosevelt Investment Group, a
New York-based asset manager with $3 billion under advisement. "The
banking sector depends on economic growth, and to the extent we get
tax reform that flows through to better growth, that supports the
stocks."
Clarity on tax policy could also spur merger activity. "So we
could see a pickup in activity that would support the advisory
business of the banks," Mr. Benowitz added.
Still, bank stocks remain tethered to interest rates; lending
and trading conditions might also prove short-term drags on their
performance.
Some analysts have ratcheted back their expectations for banks'
growth over the rest of the year. Nomura Instinet said last week
that it lowered its third-quarter forecasts for big banks.
Executives at the biggest firms have already signaled that
trading revenues for the third quarter are likely to decline from
15% to 20% versus a year earlier.
And Federal Reserve loan data also points toward softening loan
growth, particularly in U.S. banks' commercial and industrial
lending, which was down 0.1% from the beginning of the quarter
through Sept. 20, according to analysts at Jefferies. Several
analysts also noted possible dips due to Hurricanes Harvey and
Irma.
Analysts also aren't yet giving any credit for the tax proposal,
even if it holds the promise of quickly boosting banks' bottom
lines.
"Some difficult special interest battles are ahead, suggesting
Congress's true timeline for passage is longer than their currently
stated goal of passage by year-end," wrote analysts at Morgan
Stanley in a note last week.
The result is that banks may be even more dependent on what is
happening with interest rates. On that front, bankers expect
further, gradual rises, rather than any abrupt upward lurch that
could disrupt markets.
"Any sort of planning starts with the environment and...the key
word is measured," said Citigroup Inc. Chief Financial Officer John
Gerspach, speaking to analysts in September. "It's not that we're
talking about crazy increases in interest rates."
Yet plans by the Federal Reserve to begin whittling down its
balance sheet have cast uncertainty over how long-term yields will
behave. More immediately, short-term yields have risen at a faster
pace than long-term ones as the Fed has increased its benchmark
rate.
That has led to a flattening of the yield curve, which can weigh
on bank profits. Banks typically generate higher profits when there
is a bigger difference between short-term rates, which more closely
track how much it costs for banks to gather deposits, and long-term
rates, which tracks how much banks earn when they lend out money to
home buyers or corporations.
The difference, or spread, between yields on the two-year and
10-year Treasurys is one proxy for this. Wells Fargo & Co.
Chief Executive Tim Sloan told analysts in September that the rate
of the bank's growth in the second half of the year will depend in
part on "the level and slope of the yield curve."
Unfortunately for banks, the spread remains low; it was under 1
percentage point throughout the third quarter, although it did tick
up a bit toward the end of September. The spread has averaged
around 1.5 percentage points over the past five years and last was
above 1 percentage point in mid-May.
The upshot is that banks' net interest margins, a key measure of
profit, are likely to remain under pressure, especially with banks'
holdings of longer-dated debt on the rise. "We believe that
exposure to long-dated loans will keep net-interest margin
compressed until bond yields rise," analysts at Keefe, Bruyette
& Woods wrote in a recent note.
Write to Telis Demos at telis.demos@wsj.com and David Reilly at
david.reilly@wsj.com
(END) Dow Jones Newswires
October 01, 2017 07:14 ET (11:14 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.
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