JPMorgan Chase – Bank Equity Recovery Hits Concerns Over Short-Term Rates | Zoom Fintech


US bank stocks have skyrocketed in recent months amid expectations of rising earnings as well as long-term interest rates that track 10-year Treasury yields. But some analysts believe that optimism may be overdone and that bank profitability remains under pressure.

The bullish argument for banks is that rising long-term rates, coupled with low short rates, create a steep yield curve, which means banks’ deposit costs are low and their yields on loans. and securities are high, which implies large profit margins.

But banking products such as commercial loans are more closely tied to short rates than to long rates, and the Federal Reserve has signaled its determination to keep those rates low. The challenge this poses is evident from Wall Street earnings estimates, which show big bank profits in 2022 have remained close to 2019 levels.

Marty Mosby, banking analyst at Vining Sparks, said he recommended clients who profited from the rally in bank stocks reduce their exposure ahead of the release of first quarter results next month.

“Banks typically have two-thirds of their balance sheets in assets that are five years old or less – people get excited when the 10-year (year) bond goes up, but part of the [rate] curve that matters is not going anywhere, ”he said.

The CFO of a major U.S. bank told the Financial Times that 60 to 75 percent of his bank’s net interest income was sensitive to the federal funds rate – the overnight lending rate the Fed targets – and the remainder at long-term rates. .

The pricing of commercial loans remains low, because it is linked to short rates, and credit spreads remain tight. “The price of commercial loans on Libor or the prime rate, and that’s where we haven’t seen a lot of progress,” said Jeff Harte of Piper Sandler.

Normally, higher long rates suggest that short rates will increase over time. But in this cycle, the Fed plans to anchor short rates even if inflation exceeds target. Additionally, deposit costs are already close to zero for many banks, so the cost savings resulting from lower rates during the pandemic have been offset by the losses.

As a result, Chris Whalen of Whalen Global Advisors believes yields on bank assets are expected to fall by 5-10 basis points over the next year, a significant drop given those yields hover around 1%.

Nonetheless, investors treated the rise in 10-year Treasury yields as a signal to bank buy. Since yields hit their lowest last August, the KBW Banking Index has risen by two-thirds, tripling the performance of the S&P 500.

The correlation between 10-year Treasury yields and bank stocks has been above 50% since August, meaning that about half of the rise in bank stocks can be explained by yields. The correlation with the shorter rates was weaker.

Eric Hagemann of Pzena Investment Management said the banks have also rallied because they are trading at a steep discount to the market and are about to release the huge loan loss pools they have set aside. during the Covid crisis. He thinks stocks could gain higher valuations “when people realize how resilient banks have been.”

For many of the biggest banks – Bank of America, Citigroup, Wells Fargo, US Bancorp and M&T – Analysts expect profits in 2022 to be flat or lower than in the pre-Covid year of 2019.

JP Morgan chase away is expected to increase its profits the most strongly, with total growth of just 12% between 2019 and 2022. It also slashed its outlook for interest income in February, citing declining card and mortgage balances. He said loan volumes are expected to “normalize” by the end of the year.

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