stocks, as a group, have been struggling for many months now. While the broader
S&P 500 made a new high in August and September of this year, bank stocks,
as a group, did not and remained below their January 2018 peak.
banks were the beneficiary of cheap funding and an artificially steep yield
curve. Recently, that has changed.
have been struggling with an increased cost of funding, a flattening yield
curve, shrinking assets, and reduced deposits. It is not all bad news as bank
stocks had an enormous rally from 2016-2018 on less regulation and lower taxes.
America (BAC), for example, saw its
stock price rise roughly 200% from 2016-2018. Bank stocks, in general, had a
one-time repricing due to lower regulation and tax cuts that now have to be
"comped" against in 2019. It is becoming increasingly likely that most
financial companies will not be able to post strong growth rates against
inflated 2018 numbers.
BAC is now
essentially in a bear market with shares falling 19.5% from the March high
nothing specifically wrong with Bank of America's reported financial results
but they do, in fact, suffer from the same negative trends that are plaguing
the financial sector.
reflex of most analysts is to assume that rising interest rates are good for
all bank stocks. This is not true.
steepening yield curve is good for banks but if short-term rates rise and the
cost of funding increases, that could be a negative.
In the nine
months ended September 30th, BAC posted a 15% year over year increase in total
interest income. Rising rates allowed BAC to increase their interest revenue.
other hand, however, BAC posted a 48% increase in their interest expense.
expense rising faster than interest income is not good, on the margin.
nominal dollars, interest income is rising faster than interest expense, this
is not likely to be the case in 2019.
analysts are not forecasting a compression in net interest income although that
is likely to materialize in 2019 as short-term interest rates continue to rise,
deposits shrink from Quantitative Tightening (QT) and long-term interest rates
remain somewhat capped.
BAC only posted a revenue increase of 2% year over year. While net income
increased more than that, BAC is not an exception to the banking sector trends
which shows attempts at cost cutting to profitability. Reducing operating
efficiency is, of course, a positive but cost-cutting to prosperity is not
going to yield the same results in terms of share price gains as previous
a 3% decline in non-interest expense.
lower tax rate (19% compared to 31%) and reduced expenses was the theme across
all bank earnings and BAC was no different.
interest income starts to slow more rapidly in 2019, the decline in bank shares
will be more than justified.
In the Q3 presentation, BAC
claims that the bank is positioned for net interest income to continue to rise
given a parallel shift in the yield curve. BAC sees an increase of almost $3B
or roughly $750M per quarter in net interest income if the yield curve has a
parallel move 100 basis points higher. That assumes the Federal Reserve
increases interest rates four more times and the 30-year yield moves up to 4.3%
in the next 12 months.
past eight quarters, a parallel shift in the yield curve is not exactly what
has happened. Short-term rates have risen rather materially while long-term
rates have only drifted higher.
Below is a
chart of the quarterly average interest rate for the Federal Funds rate, the
3-month Treasury rate, the 2-year Treasury rate, and the 30-year Treasury rate.
rates have been moving higher while long-term rates are barely up in the last
short-term rates move up faster than long-term rates, a flattening yield curve
is a result.
say that the yield curve is not at a "dangerous" level yet but that
is just an opinion. Rates of change matter. The yield curve is either getting
steeper or flatter and a flatter yield curve is less beneficial for banks on
Quantitative Tightening, the Federal Reserve is draining excess reserves from
the banking system. Roughly $1 trillion in excess reserves have been removed
from depository institutions.
may say the nominal level of reserves is still "plentiful" but the
rate of change is one of less liquidity and lower reserves.
be the case that increasing reserves to $2 trillion was a net benefit to the
banks but cutting reserves in half is indifferent.
is getting tight and funding costs are rising. This is, on the margin, hurting
bank earnings and BAC is a great example of that.
top of rising interest costs, a flattening yield curve and tightening
liquidity, the housing market is on shaky ground. Bank CEOs have had to address
the problems in the mortgage market.
Brian Moynihan, admitted to CNBC that the mortgage origination business was
slowing from $13 billion last year to $10.5 billion this year. While no crisis
or immediate danger appears on the radar screen at the moment, a slowing
housing market is adding just another reason why bank stocks, and BAC, are
losing the edge they had over the past few years.
funding is over and banks are finding it more difficult to post accelerating
rates of growth without one-off benefits like tax cuts.
trends show that the results out of BAC are not an outlier. Total bank credit
reported by the Federal Reserve shows the growth in bank loans and securities
is also decelerating.
growth is down from 8% to just above 3% in year over year terms.
estate loan growth has also fallen roughly 60% to 3.2% year over year.
data is aggregated by the Federal Reserve and representative of all commercial
I want to
make it clear that there is nothing systemically wrong with banks today as
there was a decade ago and no crisis is imminent. Banks, however, are facing
massive headwinds moving into 2019 and the results out of BAC and the rest of
the industry show that to be the case.
going to face a higher cost of capital, a flatter yield curve and a continued
drain on excess reserves given the stated path of the Federal Reserve from
actions including rate increases and QT.
that interest expense is rising significantly faster than interest income. The
nominal dollar change is still allowing net interest income growth to be
positive but that may change in 2019 as short-term rates continue to rise and
the cost of funding continues to increase.
There was a
massive run in bank stocks and BAC over the past two years. The headwinds today
may indicate that bank stocks simply ran too far, valuations got too extended
and now new challenges are on the horizon.
now repricing to face these new issues that are challenging the industry as a
and BAC may be due for a rally given how sharp the declines have been but over
the next 12 months, the group is likely to continue to underperform.
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