Banks have had a notable runup in the second half of the year as interest rates — both on the long and short end — have moved up:
Here's a few of the major questions investors are grappling with:
- Are bank stocks getting ahead of themselves? The Street seems divided on this. Most are still trading below their price-to-book ratio. The good news: banks have lots of cash, better cost control, credit quality is still improving (concerns about big losses in energy are declining), and capital markets show improvement. The bad news: a difficult revenue environment and slowing loan growth. It's hard to make more money with interest rates so low, and with push-back from any attempt to raise fees.
- What's the impact from higher interest rates? The good news: higher short-term rates are a clear benefit for bank loan portfolios. The bad news: yields have risen across the board, so the yield curve is still relatively flat. That means the difference between lending short-term and lending long-term (net interest margin, or NIM) stays relatively flat, mitigating some of the gains from higher short-term rates.
- Is loan growth continuing to improve? The good news: overall loan growth--commercial and consumer loans--is up roughly 7 percent year-over-year, according to Mike Mayo at CLSA. That's healthy growth. The bad news: commercial loan growth appears to be slowing. Commercial loan growth is flat in the third quarter compared to the second quarter, while consumer loans are up 2 percent. Several banks have already lowered their guidance for commercial loan growth. What's the problem? It's not entirely clear, but it's likely due to slower capital expenditures by corporations, which reduces the need for loans.
- How far along are banks in the regulatory cycle? This is the big wildcard. The Wells Fargo debacle is no help, and bank investors have been jittery this week about the (very small) chance that the House could go Democratic, which would greatly increase regulatory scrutiny of banks.
"We are late in the game, but we have to get past Nov. 8. Then we can figure out a way for banks to facilitate growth rather than being the whipping boys for the economy," Mayo told me.
Bottom line? Given the price runup, prudence seems to be the order of the day. Wedbush, in a note to clients this morning, reflected this caution: "The environment remains challenging for the bank group and we believe it will be evident in third quarter earnings, reflecting ongoing margin pressure and moderating loan growth... Given the run in the bank group, we believe upside is limited."