Trader Talk

Regional banks have a problem, but the Street doesn't want to hear it

Pisani's market open mixed, financials leading

PNC is demonstrating the problem all the banks—particularly regionals—are having.

PNC metrics (quarter over quarter):

  • Net interest margin: down
  • Net interest income: down
  • Loan growth: flat

Net interest income (down 1 percent, in line with forecasts) and net interest margin (down 9 basis points to 2.73 percent, in line with expectations) are not expanding because yields remain low.

US Bancorp, also out this quarter, had similar metrics: net interest margin declined 5 basis point to 3.03 percent (in line with expectations) with loan yields down slightly.

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This is an issue because regionals were investor favorites in the second quarter on a modest increase in rates. The SPDR Regional Banking ETF, a basket of regional banks, was up about 10 percent in the second quarter on higher volume.

So investors piled in, but the payoff—in the form of better net interest income—has yet to materialize because loan growth has been flat to modestly positive and rates have not risen all that much.

How long will investors wait? Some have already begun exiting, initially because banks usually sell off a bit going into earnings. I suspect that more will exit soon.

PNC did say it expects modest growth in loans, but anticipates net interest income to remain unchanged in the third quarter. The other major revenue source for regionals—fee income—will also remain flat.

In other words, core earning power is not going to change much.

Despite these disappointments, most of the Street remains bullish on banks.

Why? Because the one thing most traders believe is that rates will be higher at the end of the year than they are now.

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If you're trying to put together a story on higher rates, it's natural to make banks a core part of a second half rally.

A second part of the argument is that banks are still relatively cheap. Citigroup, for example, is at 10 times forward earnings. PNC and USB are at 13 times forward earnings.

None of these could be considered particularly expensive.