Bank Stocks Jump Despite Disappointing Near-Term Outlook

The major U.S. stock indexes ended the day relatively flat yesterday. But if we check the individual sectors, finance, particularly the bank stocks witnessed a rally. Financial Select Sector SPDR Fund, KBW Nasdaq Bank Index and SPDR S&P Bank ETF KBE rose 1.5%, 3.6% and 3.4%, respectively.

Big banks – JPMorgan JPM, Bank of America BAC, Citigroup C and Well Fargo WFC – jumped more than 2.5%. Shares of almost all the small and mid-sized banks rallied too.

This rally happened on the day major banks like BofA, Citigroup and Well Fargo presented their near-term outlook at an investors’ conference. Other banks, including JPMorgan, Goldman Sachs GS and Morgan Stanley MS are slated to present later this week.  
If you are thinking that banks provided upbeat guidance, then you are wrong. Citigroup’s Chief Financial Officer Mark Mason commented that trading and investment banking revenues are expected to decline in third-quarter 2019.

Further, the bank now expects net interest income (NII) to rise in the range of 3-4% for 2019, lower than the prior projection of 4% amid more Fed rate cut expectationsand flattening of the yield curve. This is despite the fact that Citigroup is less asset sensitive compared with other big banks.

Nevertheless, management expects to achieve a 12% return on tangible common equity ratio target this year.  

BofA, which did not offer NII guidance, projects investment banking revenues in the third quarter to be up the low-single digits range on a year-over-year basis. The company’s M&A business, which had been lagging behind its peers, seems to be benefiting from the bank’s focus on regaining market share.

Additionally, Chief Operating Officer Tom Montag stated that fixed income trading revenues are down “a little bit” while equity trading business has performed well so far this quarter. He further added that September remains the most important month.

Now Wells Fargo, which depends majorly on interest rates to boost revenues, anticipates NII to decline 6% this year. This is the second time that the bank has lowered NII projection. Earlier, the company was expecting a fall of 5%.

The bank, which is facing regulatory scrutiny related to business mishandlings, expects a boost in mortgage originations volumes in the third quarter following a strong second-quarter performance. However, mortgage servicing revenues are likely to be muted as prepayments are expected to rise.

Further, non-interest expenses for 2019 are expected to be at the higher end of the $52-$53 billion range, as regulatory-related spending will remain high.

So, what led to this sudden rally in the bank stocks at the time when the industry is reeling under several concerns that are expected to hamper their profitability?

Well, the yield on the 10-year Treasury note rose to 1.611%. A rise in longer-term yields boosts bank profits, as widening spreads between long and short-term rates lead to an increase in net interest margin and support top-line growth.

While markets had already factored in that growth in banks’ NII this year will be hampered due to the Fed’s rate cuts, this rise in long-term yield cheered investors. However, operating challenges remain for the banking sector.

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