The Latest Earnings Results for Banks
The latest earnings results for banks include words like “record,” “outstanding,” and “doubles.” So far, 2023 has been a banner year for the sector, at least from an earnings perspective. But bank stock prices have yet to eclipse their previous highs. The KBW NASDAQ Global Bank Index, which tracks global banks, has barely grown since the current rate-hiking cycle began in early 2022 and generally has not exceeded its pre-COVID-19 peaks. Other bank indexes haven’t outperformed either. The S&P Regional banks index is trading at 2016 levels.
Banking is a complex sector with many influences. So, to understand the mid- to long-term outlook, we need to understand the three key drivers at work in the industry today.
- The Transition to a Higher Rate Environment
The US Federal Reserve’s hiking cycle has been the fastest in decades, and the banking sector has profited from it. As rates rise, a bank’s assets tend to reprice faster than its liabilities and thus a bank’s net interest income, which constitutes the bulk of its earnings, increases. That is what has happened in the current rate cycle, which has created a tailwind for the industry’s financials.
But higher interest rates are a double-edged sword. Many banks loaded up on sizable portfolios of long-duration securities during the easy money era, and their prices have plunged as rates have risen. Held-to-maturity — or hide-’til-maturity — accounting has shielded bank financials from the impact, but should these portfolios be unwound, the losses will materialize and the bank’s capital will take a hit. This is a sector-wide concern, as W. Blake Marsh and Brendan Laliberte observe in “The Implications of Unrealized Losses for Banks.”
- Reduced Competition from Neobanks
Neobanks and fintechs are the offspring of low rates and technological disruption. Low rates forced banks to look for alternative sources of income amid historically low spreads on their bread-and-butter products, which meant charging higher fees for credit cards, cash transfers, etc., to generate non-interest income. This combined with old technology stacks and start-ups financed with cheap money created fierce competition for traditional banks.
That is, until the fintech winter settled in. With easy financing rounds a thing of the past, most neobanks will have trouble surviving.
- Market Multiples
So, how are the market variables moving for banks? Not very well. The sector is still underpriced relative to other industries. Price-to-book is banking’s universal multiple, and many banks are still below the magic value of 1.
There are several reasons for this. Even though earnings are improving, clouds are gathering on the horizon. Unilateral government action through direct taxes as in Italy, increased regulation, and additional capital requirements are all possibilities. Bank compliance departments are growing ever larger and constituting an ever greater drag on profitability.
Looking Forward
The banking sector is in better shape now than during the last decade of low or negative rates. The fintech winter will ease competitive pressure and give some banks the opportunity to buy out neobanks and appropriate their technology stack. However, latent losses in banks’ securities portfolios, the political temptation to overtax and overregulate the sector, and the damage higher rates may inflict on the economy could take a toll on an otherwise bullish outlook. So, the next few quarters should present both considerable challenges and opportunities.
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